business organizations outline.docx final

Introduction to Business Organizations and Agency Law

I. Agency a. Restatement s. 1 – Agency is a fiduciary relation which results from:

i. Manifestation of CONSENT by one person (the principal) to another (the agent) that the other shall act

1. On the Principal’s half AND2. Subject to the Principal’s CONTROL

ii. CONSENT by the Agent so to act.

II. No formal contract is needed in order to create agency. Agencies can be created in non-business settings.

a. Gorton v. Doty, 69 P.2d 136 ( Idaho 1937) i. Facts: D allowed Russell Garst, coach of the football team, to borrow her car to drive

students to a football game. There was an accident and P sued D to recover expenses incurred from P son’s injuries. D didn’t receive compensation.

ii. Issue: Was the coach an agent of D? iii. H&R: Yes, D and Garst had a principal and agent relationship. Agency is the relationship

from the manifestation of consent by 1 person to another that the other shall act on his behalf/subject to his control, and consent by the other so to act. The relationship of principal and agent arises where one undertakes to transact some business or manage some affair for another by authority and on account of the later.

iv. Dissent: Agency is more than mere passive permission; it involves request, instruction or command.

III. There must be agreement, but not necessarily a contract, and can result in the creation of an agency, even if the parties didn’t mean to (that can be proved by circumstantial evidence). Agency is the fiduciary relationship that results from the manifestation of consent by one person to another that the other shall act on hi behalf/subject to his control and consent by the other so to act.

a. Gay Jenson Farms v. Cargill, Inc. 309 N.W. 2d 285 (Minn. 1981) i. Facts: Ps brought action against Cargill/D to recover losses sustained when Warren/D

defaulted on the contracts made with the Ps. Warren had entered into an agreement w/Cargill for financing. Over the course of years Cargill oversaw many of its business moves. At trial the jury found for Ps. D appeals. Ps alleged that Cargill was jointly liable for Warren’s indebtedness as it had acted as principal for the grain elevator.

ii. Issue: Whether Cargill, by its course of dealing with Warren became liable as a principal on contracts made by Warren with Plaintiffs?

iii. H&R: Cargill, by its control/influence over Warren became a principal with liability for the transactions entered into by its agent Warren. It controlled Warren’s day to day operations, wrote checks to pay farmers, and reserved the right of 1st refusal. The court doesn’t buy Cargill’s arguments that it only made recommendations that it was just a financing arrangement and just a buyer/supplier relationship.

IV. The Legal Consequences of Agency: If an agency relationship exists, under what circumstances is the Principal bound to/liable to 3rd parties based on the actions of the Agent?

a. Remember, the LEGAL CONSQUENCES of the agent’s action DO NOT depend on the type of authority!

i. The Actual vs. Apparent Authority distinction relates to how a plaintiff PROVES that the agent had authority to do an act and that therefore the Principal is legally bound by Agent’s act.

b. Contractual (Consent Based) Liability of Principal to 3rd parties in Contracti. Actual Authority – focuses on the Agent’s belief, a reasonable interpretation of the

Principal’s conduct

Business Organizations Outline - Spring 2011 1

1. Express Actual Authority (EAA)a. Focus on what did the agent believe based on what the principal said to

him/her. b. Principal tells Agent to do X, Agent has EAA to do X, and when Agent

does X, the Principal will become bound.

2. Implied Actual Authority (Incidental – IAA) a. Is actual authority circumstantially proven which the principal actually

intended the agent to possess and includes powers as are practically necessary to carry out the duties actually delegated.

b. May arise from past custody by principal toward Agent through industry practice, custom, etc.,

c. Ex: Principal tells A to do X. In order to accomplish X, Agent has to do Y, the Agent can infer that he/she has authority (IAA) to do Y, and if Agent does do Y, the principal is bound.

d. Mill Street Church of Christ v. Hogani. Facts: Church hired Bill Hogan to help paint the church, he had

been hired before and was previously allowed hiring his brother Sam to help. The church decided that they could hire Gary Petty but during a discussion with a church member Bill was told Gary was hard to contact. Bill hired Sam who fell and became injured. Sam filed for workers comp but was denied by the church that he was ever hired.

ii. Issue: Did Bill have the authority to hire Sam?iii. H&R: Yes, Bill had implied authority to hire Sam. The church

allowed Bill to do so in the past, the church didn’t tell Bill he couldn’t hire Sam, Bill had even collected payment for Sam’s work prior to the injury.

ii. Apparent Authority (AA) – focuses on the 3rd party’s beliefs, whether Agent’s authority, based on reasonable interpretation of Principals conduct.

1. Focus on how the third-party understands the agent’s authority.2. Ex: Principal tells Agent to do X, Agent has EAA to do X, when Agent does X, the

Principal is bound. 3. Is not actual, it’s held out by the principal as possessing. Agency can’t be proven

by a mere statement, but it can be established by circumstantial evidence including the acts and conduct of the parties such as the contentious course of conduct of the parties covering a number of successive transactions.

4. An agent has apparent authority sufficient to bind the principal when the principal acts in such a manner as would leave a reasonably prudent person to suppose that the agent had the authority he purports to exercise. Absent knowledge on the part of 3rd parties to the contrary an agent has the apparent authority to do those things which are usual and proper.

5. 370 Leasing Corp. v. Ampex Corp, 528 F.2d 993 (5th Cir 1976) a. Facts: P contracted with D to buy computer core memory. D claimed

that Kay’s, an employee of D’s, never had the authority to finalize any contracts or sales. District Court found that there was an enforceable contract between 370 and Ampex.

b. Issue: Was there a valid contract and acceptance by D?c. H&R: Yes, Kay’s had apparent authority to act for D. Where document

submitted to buyer by seller's salesman had a signature block for seller which was unsigned at the time it was submitted, the document, when signed by buyer, at most constituted an offer by him to purchase, but as


salesman had apparent authority to bind seller, salesman's letter to buyer confirming delivery date could reasonably be interpreted as an acceptance

iii. Inherent Agency Power (IAP – aka inherent authority) 1. Restatement s.8A Inherent Agency Power - The power of the agent is derived

solely from the agency relation, it’s not power derived from authority, apparent authority or estoppel, but solely from the agency relation and exists for the protection of persons harmed by or dealing with a servant or other agent.

2. Undisclosed principals are liable for acts of an agent done on his account, if usual or necessary, even if forbidden by the principal. It is based on how the principal holds out its agent; and whether others believe the agent has authority.

a. Restatement s.4 (3) if the other party has no notice that the agent is acting for a principal, the one for whom he acts is an undisclosed principal.

3. Potential Breadth of IAP: Principle is liable on a contract made by the agent, because it is a kind of contract usually made by such an agent, even though:

a. The agent was forbidden to enter into it (so no EAA or IAA) and,b. There was no manifestation of authority by the Principal to the Third

Party, so no AA existed.

4. Basic Theory of IAP:a. Exists for the protection of persons harmed by or dealing with an

agent

5. Watteau v. Fenwick, 1893 1 Queen’s Bench 346 (1892)a. Facts: Humble was the manager for the D (he originally owned the

business but transferred the business to D), his name was over the door, and the licenses were in his name. Humble and D agreed that Humble wouldn’t have authority to buy any good except ale and mineral waters. P sold cigars on credit to Humble thinking he was an agent of D.

b. Issue: Is D liable? Was there agency in fact? c. H&R: Yes. Ds were undisclosed principals and allowed Humble to carry

their business as an agent. The goods supplied were within the reasonable scope of the agent’s authority. The Court held that the principal is liable if the behavior is something an agent in that position might usually normally do.

c. Ratification i. Restatement s. 82

1. Affirmance by a person of a prior act, which didn’t bind him before but which was done or professedly done on his account, and due to the affirmance binds him.

a. Example, at the time that the event occurred, the agent had no authority but once the principle found out and later said it was okay, the principal is ratifying, they are affirming the event was okay.

ii. Restatement s. 831. Affirmance is the principal is electing to show that he/she accepts them as an

agent with authority.


a. (a) a manifestation of an election by on whose account an unauthorized act has been done to treat the act as authorized, or

b. (b) Conduct by him justifiable only if there were such an election.

2. Implieda. Knowing material factsb. Implied affirmance by silencec. Suing on the contract

3. Express

d. Estoppeli. Principal is liable to a third party if: The third party changed his position (spent

money, suffered a loss or subjected to legal liability) because the third party believed the transaction was entered into by/for the principal

1. Restatement s.8B Estoppel a. (1) A person who is not otherwise liable as a party to a transaction

purported to be done on his account, is nevertheless subject to liability to persons who have changed their positions because of their belief that the transaction was entered into by or for him, if the principal,

i. (a) Intentionally or carelessly caused the third party’s belief ORii. (b) Knew of the situation but did not take reasonable steps to

notify the third party of the facts.

ii. Hoddeson v. Koos Bros, 47 NJ Super 224 (App. Div. 1957)1. Facts: P went to D’s furniture store to buy furniture. They were greeted by a

man who sold her furniture. When the P’s furniture never arrived, she called, the individual turned out to be an imposter.

2. Issue: Does Estoppel bar D from denying liability of the apparent authority of the imposter?

3. H&R: The duty requires the exercise of reasonable care and vigilance to protect the customer from loss occasioned by the deceptions of an apparent salesman. When you act in a certain way, you may be estopped from denying liability.

4. Why isn’t there actual or apparent authority?a. The principal must have done something to lead the imposter think he

had authority or to lead Mrs. Hoddeson to believe that the imposter was authorized. The principal hadn’t done anything. But the court felt that this leaving the plaintiff with no remedy, so the court goes the route of estoppel.

e. Tort Liability of Principal to 3rd parties: i. Servant v. Independent Contractor

1. A master-servant relationship exists where the servant has agreed to work on behalf of the master and be subject to the master’s control or right to control the physical conduct of the servant (manner of how the job is done). Look out for the extent of control by one of the parties, the more control there is, the more likely there is a M/S relationship.

a. Restatement s. 2 i. (1) A master is 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 service.

ii. (2) A servant is an agent employed by a master to perform service in his affairs whose physical conduct in the performance of the service is controlled or is subject to the right to control by the master.


iii. (3) An independent contractor is a person who contracts with another to do something for him but who is not controlled by the other no r subject top the other’s right to control with respect to his physical conduct in the performance of the undertaking. He may or may not be an agent.

b. Restatement s. 219 – Respondeat Superior i. The master is liable for servants’ torts if committed “while

acting within the scope of their employment (SOE).” ii. Master is no liable for torts of servants “Acting OUTSIDE the

scope of their employment, UNLESS one of the exceptions applies:

1. The master intended conduct or consequences.

2. Agent-Independent Contractor agrees to act on behalf of another (principal) but not subject to principal’s control.

3. Non-Agent Independent Contractor – operates independently and simply enters into arm’s length transactions with others.

ii. Scope of Employment 1. Restatement 228(1) Conduct is within the scope of employment ONLY IF:

a. (a) It is the KIND that the Servant is employed to perform b. (b) Substantially within the authorized TIME AND SPACE limitsc. (c) Actuated, at least in part, by PURPOSE to serve the Master

i. Goes to the motivation. In the Miller case, did defendant throw the ball because he’s angry on his own or was he serving his master?

d. (d) If intentional FORCE, was not un-expectable by the Masteri. Foreseeable, as a boss, for example that your bouncer would

use forced in throwing someone out. (a)(b) and (c) MUST ALL OCCUR

e. Example 1: Delivery Man Case i. “If intentional FORCE, was not un-expectable by the Master” –

furniture deliveryman case – customer won’t give check until the deliveryman brings up the mattress for inspection; but the deliveryman wants payment 1st in case (as instructed by the employer), a violent assault occurs.

1. Was the force foreseeable (not “unexpectable”)? Court said D’s instruction of “cash only,” and “payment first,” to employees put D/employer on notice that some violence might occur.

2. Was the purpose to serve the master? The Court states employees’ violence was a purpose to serve the master and the fight ensued from that.

3. What did the court say? D wasn’t entitled summary judgment.

f. Example 2: Road Rage Casei. Truck driver stabs motorist who used obscene hand gesture –

purpose to serve master? 1. No, because the truck driver was angry and acted out

of proportion to necessities of master’s business so outside of the scope of employment.


ii. Truck driver causes accident that injures the plaintiff, whose case passed him – are altercations between drivers foreseeable?

1. Yes.2. Versus opposite view – force not foreseeable unless

the employment is of such a nature that use of force may be contemplated to protect the master’s interests.

2. Restatement 228(2) - Conduct is NOT within the scope of employment ONLY IF:

a. DIFFERENT IN KIND from authorized conduct,b. FAR BEYOND authorized time or space limits, or c. TOO LITTLE ACTUATED by purpose to serve master

3. Restatement 229 – Kind of Conduct within Scope a. (1) of the same general nature as authorized conduct, or incidental to itb. (2) Helpful facts to determine if conduct is so similar/incidental to the

within the scope of employment.

4. Restatement 230 a. Can be w/in the scope of employment even if forbidden or done in a

forbidden manner.

5. Restatement 231 a. Can be within the scope of employment even though consciously

criminal or tortius.

iii. Franchising – Agency or not?1. Murphy v. Holiday Inns., Inc 216 Vs. 490 (1975)

a. Facts: P slip and fell while staying at a holiday inn. She sued the parent corporation alleging that D owned and operated the Holiday Inn. D denied that it does and that the particular Inn was a franchisee. At trial, the court found that the D didn’t own the premises and there was a no principal, agent, master-servant relationship. P argued that there was a master/servant relationship.

b. Issue: Was there a master/servant relationship?c. H&R: No, actual agency is consensual. A fiduciary relation which results

from the manifestation of consent by one person to another that the other shall act on his behalf/subject to is control/consent by the other. Court states that a franchisee-franchisor relationship does not always protect the franchisor from becoming a M/S relationship.

f. Tort Liability & Apparent Agency i. Miller v. McDonald’s Corp., 945 P.2d 1107 (Ore. App 1997).

1. Facts: P was injured after eating at a local McDonalds. She didn’t sue the franchisee owner, she sued the corporation. At trial, the judge gave D summary judgment.

2. Issue: Was the franchisee owner an agent of the D?3. H&R: Yes, through a national campaign the principal/D held out the franchisee

owner as an agent and P relief on that when choosing to eat at McDonalds. D had maintained a right to control the franchisee, and the right to control (right to control the method by which the franchisee performed its obligations under the agreements) actual agency relationship that would make the D vicariously liable for its agent negligence.


a. If the practical effect of the franchise agreement goes beyond setting standards and allocates to the franchisor the right to exercise control over the daily operations of the franchise, than an agency relationship exists. (This is the difference between the Holiday Inn case and this one)

b. Even though there was a sign in the business that indicated that D was not the owner of that local McDonald, it wasn’t enough since D still had overall control.

4. P.58 Note – Reliance: holding out by the principal and reliance by the plaintiff that the franchisee was an agent of theirs.

ii. Manning v. Grimsley, 643 F.2d 20 1. Facts: P was injured by a ball thrown by D during a baseball game. D is a

professional baseball player who was warming up on the side of the stands for the game and was being heckled and boo’ed by the fans in the stands. Trial judge directed a verdict for D’s on battery and the jury entered a verdict for D’s on the negligence count. P appealed the battery account.

2. Issue: was D liable for battery? 3. H&R: A jury could have concluded that the D committed battery against the P. P

would need to show that the employee’s assault was in response to the Ps conduct, which was presently interfering with the employee’s ability to perform his duties successfully. A jury could have reasonably found so, since D’s assault was a response to the heckling, which would interrupt interfere with his ability to play.

V. Agents’ Fiduciary Obligations a. Section 1: Agency is a 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.

b. Section 379(1): Agent must act with standard care and with standard skill + exercise any special skill.

c. Section 387: There is a general duty of loyalty, to act solely for the benefit of the principal d. Other duties include:

i. Section 380: Agent must act in good conduct and protect the reputation of the principal. ii. Section 381: Agent must give Principal relevant information, agent is subject to a duty to

use reasonable efforts to give his principal info which is relevant to affairs entrusted to him and which, as the agent has notice,

iii. Section 382: Keep and render accounts of money, etc., iv. Section 383: Agent must act only as authorized v. Section 385: Obey directions of the principal.

vi. Section 388: Account for profitsvii. Section 389-392: No self dealing

viii. Section 393: No competing with the principal ix. Section 394: No conflict of interestx. Section 395: Can’t use or share confidential information

xi. Section 398: Can’t commingle property, agent receiving or holding things on behalf of the principal is subject to a duty to the principal not to receive or deal with them so that they appear to be his own, and not to mingle them with his own things as to destroy their identity.

e. Remedies: i. Section 399: Principal has an “appropriate remedy,” such as restitution.

ii. Section 401: An agent is subject to liability for loss caused to the principal by any breach of duty.


iii. Section 403: Liability for things received in violation of duty of loyalty – if an agent receives anything as a result of his violation of a duty of loyalty to the principal, he is subject to a liability to deliver it, its value, or its proceeds, to the principal.

f. General Auto Manufacturing Co. v. Singer, 19 Wis. 528 (1963)i. Facts: D was the general manager at P’s business but was also running a side business

that earned him secret profits from the P (he was a respected mechanic and business would go to him asking for to purchase supplies, the P’s business didn’t make the parts so D made other arrangements and made the profits from the sales).

ii. Issue: Was D’s side business a violation of his fiduciary duty to the P?iii. H&R: Yes, D had board powers of management and conducted the business activities of

P. In this role he was P’s agent and owed a fiduciary duty to them. D was bound to act in the utmost faith/loyalty so that he didn’t act adversely to P. D is liable for the profits he earned, minus 3%.

VI. Duties During & After Termination of Agencya. Town & Country House and Home Services, Inc. v. Newbery, 3 NY 2d 554 (1958)

i. Facts: P sued for injunction/damages on unfair competition. D’s worked for P and then left and formed a similar business and solicited customers who transferred business.


PARTNERSHIPSWhat is a partnership? Who are the partners?

I. What is a Partnership? Who are the Partners? Partners Compared with Employees a. What is Partnership Law

i. Common Lawii. UPA/RUPA – 1914 v. 1997

iii. Partnership Agreement – why have one?

b. Uniform Partnership Act (1914) i. S.6 Partnership Defined

1. (1) A partnership is an association of 2 or more persons to carry on as co-owners a business for profit.

a. Co-owner = 2 elements, which typically reflect owners’ usual expectations. Such as equal share of profits (profit sharing is a key element as prima facie evidence that a partnership was created), share of responsibilities, management control, etc.,

ii. S. 7 Rules for Determining the Existence of a Partnership 1. In determining whether a partnership exists, these rules shall apply:

a. (1) Except as provided by § 16 persons who are not partners as to each other are not partners as to third persons

b. (2) Joint tenancy, tenancy in common, tenancy by the entireties, joint property, common property, or part ownership 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.

c. (3) The sharing of gross returns does not of itself establish a partnership, whether or not the persons sharing them have a joint or common right or interest in any property from which the returns are derived.

d. (4) The receipt by a person of a share of the profits of a business is prima facie evidence that he is a partner in the business, but no such inference shall be drawn if such profits were received in payment:

i. (a) As a debt by installments or otherwise.ii. (b) As wages of an employee or rent to a landlord,

iii. (c) As an annuity to a widow or representative of a deceased partner,

iv. (d) As interest on a loan, though the amount of payment vary with the profits of the business.

v. (e) As the consideration for the sale of a good-will of a business or other property by installments or otherwise.

iii. S.18 Role of Consent – No one can become a member of a partnership unless everyone agrees.

c. Forming the Partnership i. Deliberately – Intended/Sought out

ii. Inadvertently – they attempted to not form a partnership, but by their actions are like partners

d. Aspects of a Partnershipi. Intention of the parties to form a partnership

ii. Right to share in profits (not every partnership has to agree in this though)iii. Obligation to share in lossesiv. Ownership and control of the partnership property and business.


v. Community of power in administration and the reservation in the agreement of the exclusive control of the management of the business

vi. Language in the agreement, i.e., parties can call themselves partners and the business a partnership but the language doesn’t indicate it.

vii. Conduct of the parties toward 3rd persons, whether or not they acted like partners to others.

e. Partners Compared with Employees i. Fenwick v. Unemployment Compensation Commission, 133 N.J.L. 295 (1945)

1. Facts: Fenwick was the owner of the beauty salon and employed Chesire. One of the questions was whether Chesire was a partner or an employee. Chesire was employed for a while, and then asked for a raise. Fenwick wanted to pay her more, but was not sure if the store had the business to do it. They came up with an agreement. In the agreement it stated that they were going into a partnership, that Chesire didn’t invest capital, didn’t control or manage the business, would maintain her same job, have no liability and that she would get an extra 20% of net profits, if the business warrants it.

2. Issue: Was there a partnership formed?3. H&R: No, there were several aspects to partnership that was not formed. They

didn’t hold themselves out as partners; she had no liability or control.

f. Partners Compared with Lenders i. Rule of partnership law makes each partner potentially liable for all of the debts of the

partnership. ii. Martin v. Peyton, 246 N.Y. 213 (1927)

1. Facts: P/Creditor claim that the D made investments in the firm and were partners. D claims that they were only creditors. The P is not claiming estoppels, just that an actual partnership was formed. D argues that they only had an interest in making sure their money was returned and that their interest in the profit sharing was merely a way of getting their money back.

2. Issue: Are or did the Ds associate themselves as partners? 3. H&R: No, D’s took normal precautions to protect their assets, no partnership

was created. The Ds were not allowed to initiate transactions like a partner or bind the firm by any actions of their own

iii. The risk of liability could have been avoided in the case if the creditors had been organized as a corporation, under which they would have enjoyed limited liability as equity investors (kind of like partners). The same would be true if they formed a “limited liability company,” or a “limited liability partnership.”

g. Partners By Estoppeli. § 16. Partner by Estoppel.

1. (1) When a person, by words spoken or written or by conduct, represents himself, or consents to another representing him to any one, as a partner in an existing partnership or with one or more persons not actual partners, he is liable to any such person to whom such representation has been made, who has, on the faith of such representation, given credit to the actual or apparent partnership, and if he has made such representation or consented to its being made in a public manner he is liable to such person, whether the representation has or has not been made or communicated to such person so giving credit by or with the knowledge of the apparent partner making the representation or consenting to its being made:

a. (a) When a partnership liability results, he is liable as though he were an actual member of the partnership.


b. (b) When no partnership liability results, he is liable jointly with the other persons, if any, so consenting to the contract or representation as to incur liability, otherwise separately.

2. (2) When a person has been thus represented to be a partner in an existing partnership, or with one or more persons not actual partners, he is an agent of the persons consenting to such representation to bind them to the same extent and in the same manner as though he were a partner in fact, with respect to persons who rely upon the representation. Where all the members of the existing partnership consent to the representation, a partnership act or obligation results; but in all other cases it is the joint act or obligation of the person acting and the persons consenting to the representation.

ii. Young v. Jones, 816 F.Supp.1070 (D.S.C. 1992) 1. Facts: P argues that PW–Bahamas issued a letter that made them believe that

SAFIG was a good company to invest in, so they invested $5million into a bank which just disappeared. P argues that they were induced to invest to their detriment. That letter later turned out to be fraudulent. P argues that PW-US and PW-Bahamas are partners by estoppels, stating that they appeared to the outside world as partners.

2. Issue: Was a partnership by estoppel created?3. H&R: No, P failed to show that PW-Bahamas and PW-US were partners or that

there was any extension of credit to either PW-Bahamas or PW-US by Ps (don’t need to show extension of credit, must show detrimental reliance).

iii. General Rule: as a rule, persons who are not partners as to each other are not partners to 3rd persons. However, a person who represents himself or permits another to represent him, to anyone as a partners in an existing partnership or with others not actual partners, is liable to any such person to whom such a representation is made who has, on the faith of the representation, given credit to the actual or apparent partnership.

iv. Partnership By Estoppel1. Holding Out2. Plaintiff has knowledge of such holding out3. Detrimental Reliance by Plaintiff


PARTNERSHIPSThe Fiduciary Obligations of Partners

I. Introduction: Partners are agents to each other and are subject to agency law. a. UPA (1914)

i. § 20. Duty of Partners to Render Information - Partners shall render on demand true and full information of all things affecting the partnership to any partner or the legal representative of any deceased partner or partner under legal disability.

ii. § 21. Partner Accountable as a Fiduciary1. (1) Every partner must account to the partnership for any benefit, and hold as

trustee for it any profits derived by him without the consent of the other partners from any transaction connected with the formation, conduct, or liquidation of the partnership or from any use by him of its property.

2. (2) This section applies also to the representatives of a deceased partner engaged in the liquidation of the affairs of the partnership as the personal representatives of the last surviving partner.

iii. § 22. Right to an Account - Any partner shall have the right to a formal account as to partnership affairs:

3. (a) If he is wrongfully excluded from the partnership business or possession of its property by his co-partners.

4. (b) If the right exists under the terms of any agreement,5. (c) As provided by § 21,6. (d) Whenever other circumstances render it just and reasonable.

b. Meinhard v. Salmon , 249 N.Y. 458 (1928) i. Facts: D leased an old hotel and renovated it, borrowing money from P. The writing

stated that all losses would be shared equally, that D would be the sole manager and that D would give P a portion of profits to pay back the money borrowed. The two were coadventrurers and were subject to fiduciary duties similar to partners. D was given a chance to enter a new lucrative deal, and did so without informing P. There was nothing express about how long the partnership would last (usually, 1. At will, however long; 2. For a term; 3. For an undertaking-a specific project).

ii. Issue: Did D have a duty to inform P about the new deal? iii. H&R: Yes, D acted in secrecy and excluded his fellow co-adventurer. D was in charge of

managing the property and had a duty to disclose, and undivided loyalty to P, to have honorable and selfless dealings and to act in good faith.

iv. Dissent: Saw that the relationship was limited and that there should have been no expectation of duty.

c. Joint Adventurers - Like co-partners and owe to each other the duty of the finest loyalty. d. Trustees – held to a stricter standard than honesty alone.

II. Grabbing & Leaving a. Meehan v. Shaughnessy, 404 Mass 419 (1989)

i. Facts: P’s were unhappy with their firm and decided to leave and form a new law firm, they thought of which associates they might take and which clients they should inform. After they left, Ps commenced action for money they earned as former partners. Ds sued for breach of duty. At trial the judge found Ps entitled to recover amounts owed under their former partnership agreement, and that Ds were allowed to recover expenses on the cases P removed to their firm.

ii. Issue: Did Ps properly remove clients from Ds office to Ps new office? iii. H&R: No, they delayed giving the client list, lied about leaving, used former partners

letterhead to say they were leaving and provided a one-sided view that they did give clients the option to stay.


1. Fiduciaries may plan to compete with the entity to which they owe allegiance, if in the course of such arrangements they do not otherwise violate their fiduciary duties.

2. A partner is obligated to render on demand true and full info of all things affecting the partnership to any partner.

b. Planning – What should the Partnership Agreement Say? i. Say whatever the deal is. Should discuss all the different components before you become

partners. III. Expulsion

a. When a partner is involuntarily expelled from a business, the expulsion must have been “bona fide” or in “good faith” for a dissolution to occur without violation of the partnership agreement.

b. Lawlis v. Knightliner & Gray, 562 N.E.2d 435 (1990) i. Facts: P had an alcohol abuse problem and the firm gave him several chances to redeem

himself. Eventually he made a recovery, but the firm had already decided to vote him out. During the time that he was there he was given a share of the profits even though he didn’t really work anymore. The UPA doesn’t have an expulsion statute, this is usually dealt with in the partnership agreement, and the P had one with D. P claims that there was wrongful expulsion and that it was done in bad faith.

ii. Issue: Was the P expelled wrongfully and did it violate D’s fiduciary duties to P?iii. H&R: Court said he was not wrongfully expelled, and that he was expelled in accordance

with the partnership agreement. The fiduciary relationship between partners was in good faith, they didn’t just cut him loose, they provided him with benefits until he could find a new position.


PARTNERSHIPSPartnership Property

I. Each partner has 3 Property Rights: 1) Right in Specific Partnership Property; 2) Interest in the partnership and 3) Right to Participate in Management

a. Right in Specific Partnership Property i. S. 25 - Right in Specific Partnership Property

1. (1) A partner is co-owner with his partners of specific partnership property holding as a tenant in partnership.

2. (2) The incidents of this tenancy are such that:a. (a) A partner, subject to the provisions of this Act and to any agreement

between the partners, has an equal right with his partners to possess specific partnership property for partnership purposes; but he has no right to possess such property for any other purpose without the consent of his partners.

b. (b) A partner's right in specific partnership property is not assignable except in connection with the assignment of rights of all the partners in the same property.

c. (c) A partner's right in specific partnership property is not subject to attachment or execution, except on a claim against the partnership. When partnership property is attached for a partnership debt the partners, or any of them, or the representatives of a deceased partner, cannot claim any right under the homestead or exemption laws.

d. (d) On the death of a partner his right in specific partnership property vests in the surviving partner or partners, except where the deceased was the last surviving partner, when his right in such property vests in his legal representative. Such surviving partner or partners, or the legal representative of the last surviving partner, has no right to possess the partnership property for any but a partnership purpose.

e. (e) A partner's right in specific partnership property is not subject to dower, curtesy, or allowances to widows, heirs, or next of kin.

ii. Compare UPA § 25 with UPA § 502 Transferable Interest in Partnership1. The only transferrable interest of a partner in the partnership is the partner’s

share of the profits and losses of the partnership and the partner’s right to receive distributions. The interest is personal property.

b. Interest in the partnershipi. § 26. Nature of Partner's Interest in the Partnership. A partner's interest in the

partnership is his share of the profits and surplus, and the same is personal property.

ii. Assignment of Partner's Interest - section 271. Only a partner’s economic rights are freely assignable (“transferrable”). A

partner may not assign or transfer to someone else the right to participate in management or the right to use partnership p[property for partnership purposes, unless an agreement among the partners allows the assignment.

2. § 27 (1) A conveyance by a partner of his interest in the partnership does not of itself dissolve the partnership, nor, as against the other partners in the absence of agreement, entitle the assignee, during the continuance of the partnership to interfere in the management or administration of the partnership business or affairs, or to require any information or account of partnership transactions, or to inspect the partnership books; but it merely entitles the assignee to receive in accordance with his contract the profits to which the assigning partner would otherwise be entitled.


3. § 27(2) In case of a dissolution of the partnership, the assignee is entitled to receive his assignor's interest and may require an account from the date only of the last account agreed to by all the partners.

4. Compare UPA § 27 with UPA § 503 Transfer of Partner’s Transferable Interest

a. (a) A transfer, in whole or in part, of a partner's transferable interest in the partnership:

i. (1) is permissible;ii. (2) does not by itself cause the partner's dissociation or a

dissolution and winding up of the partnership business; andiii. (3) does not, as against the other partners or the partnership,

entitle the transferee, during the continuance of the partnership, to participate in the management or conduct of the partnership business, to require access to information concerning partnership transactions, or to inspect or copy the partnership books or records.

b. (b) A transferee of a partner's transferable interest in the partnership has a right:

i. (1) to receive, in accordance with the transfer, distributions to which the transferor would otherwise be entitled;

ii. (2) to receive upon the dissolution and winding up of the partnership business, in accordance with the transfer, the net amount otherwise distributable to the transferor; and

iii. (3) to seek under (6) a judicial determination that it is equitable to wind up the partnership business.

c. (c) In a dissolution and winding up, a transferee is entitled to an account of partnership transactions only from the date of the latest account agreed to by all of the partners.

i. (d) Upon transfer, the transferor retains the rights and duties of a partner other than the interest in distributions transferred.

ii. (e) A partnership need not give effect to a transferee's rights under this section until it has notice of the transfer.

iii. (f) A transfer of a partner's transferable interest in the partnership in violation of a restriction on transfer contained in the partnership agreement is ineffective as to a person having notice of the restriction at the time of transfer.

iii. Putnam v. Shoaf, 620 S.W.2d 510 (1981) 1. Facts: Putnam and Charltons owned a portion of Frog Jump Jin. When Putnam

died his wife/P took over his share and business began to decline. The Shoafs agreed to take over Mrs. Putnam’s shares/liability. It was later discovered that the previous bookkeeper was stealing money. P hearing of this claimed that she should have a share of the money. In a quit claim deed the P conveyed all of her interest to the Shaofs/D.

2. Issue: What interest did the P convey? 3. H&R: This didn’t create a partnership between the Charltons and the Shoafs (in

order for a partnership to develop they would have to create one), the quit claim deed only conveyed P’s interest.


iv. Rights of a Partner’s Judgment Creditors – the Charging Order 1. Judgment creditors seeking to collect on a claim on an individual partner can’t

attach or levy the partnership’s property (belongs to more than one person), and they have no right to the partner’s non-economic rights. A charging order is given by court which functions as a type of garnishment, and a judgment lien.

2. § 28. Partner's Interest Subject to Charging Order.a. (1) On due application to a competent court by any judgment creditor

of a partner, the court which entered the judgment, order, or decree, or any other court, may charge the interest of the debtor partner with payment of the unsatisfied amount of such judgment debt with interest thereon; and may then or later appoint a receiver of his share of the profits, and of any other money due or to fall due to him in respect of the partnership, and make all other orders, directions, accounts and inquiries which the debtor partner might have made, or which the circumstances of the case may require.

b. (2) The interest charged may be redeemed at any time before foreclosure, or in case of a sale being directed by the court may be purchased without thereby causing a dissolution:

i. (a) With separate property, by any one or more of the partners, or

ii. (b) With partnership property, by any one or more of the partners with the consent of all the partners whose interests are not so charged or sold.

c. (3) Nothing in this Act shall be held to deprive a partner of his right, if any, under the exemption laws, as regards his interest in the partnership.

v. Compare UPA § 28 with UPA § 504 Transferable Interest 1. § 504. Partner's Transferable Interest Subject to Charging Order.

a. (a) On application by a judgment creditor of a partner or of a partner's transferee, a court having jurisdiction may charge the transferable interest of the judgment debtor to satisfy the judgment. The court may appoint a receiver of the share of the distributions due or to become due to the judgment debtor in respect of the partnership and make all other orders, directions, accounts, and inquiries the judgment debtor might have made or which the circumstances of the case may require.

b. (b) A charging order constitutes a lien on the judgment debtor's transferable interest in the partnership. The court may order a foreclosure of the interest subject to the charging order at any time. The purchaser at the foreclosure sale has the rights of a transferee.

c. (c) At any time before foreclosure, an interest charged may be redeemed:

i. (1) by the judgment debtor;ii. (2) with property other than partnership property, by one or

more of the other partners; oriii. (3) with partnership property, by one or more of the other

partners with the consent of all of the partners whose interests are not so charged.


d. (d) This [Act] does not deprive a partner of a right under exemption laws with respect to the partner's interest in the partnership.

e. (e) This section provides the exclusive remedy by which a judgment creditor of a partner or partner's transferee may satisfy a judgment out of the judgment debtor's transferable interest in the partnership.

c. Right to Participate in Management

i. § 18. Rules Determining Rights and Duties of Partners. The rights and duties of the partners in relation to the partnership shall be determined, subject to any agreement between them, by the following rules:

1. (a) Each partner shall be repaid his contributions, whether by way of capital or advances to the partnership property and share equally in the profits and surplus remaining after all liabilities, including those to partners, are satisfied; and must contribute towards the losses, whether of capital or otherwise, sustained by the partnership according to his share in the profits.

2. (b) The partnership must indemnify every partner in respect of payments made and personal liabilities reasonably incurred by him in the ordinary and proper conduct of its business, or for the preservation of its business or property.

3. (c) A partner, who in aid of the partnership makes any payment or advance beyond the amount of capital which he agreed to contribute, shall be paid interest from the date of the payment or advance.

4. (d) A partner shall receive interest on the capital contributed by him only from the date when repayment should be made.

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

6. (f) No partner is entitled to remuneration for acting in the partnership business, except that a surviving partner is entitled to reasonable compensation for his services in winding up the partnership affairs.

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

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

ii. § 9. Partner Agent of Partnership as to Partnership Business.1. (9)(1) Each partner = agent of the partnership UNLESS the partner so acting

has in fact a. no authority to act for the partnership in the particular matter, and b. the person with whom he is dealing has knowledge of the fact that he

has no such authority.

2. 9(2): Acts that are NOT apparently for carrying on the partnership business in the usual way do NOT bind it UNLESS authorized by the other partners.


3. 9(3): Unless authorized by the other partners or unless they have abandoned the business, one or more but less than all the partners have no authority to:

a. (a) Assign the partnership property in trust for creditors or on the assignee's promise to pay the debts of the partnership,

b. (b) Dispose of the good-will of the business,c. (c) Do any other act which would make it impossible to carry on the

ordinary business of a partnership,d. (d) Confess a judgment,e. (e) Submit a partnership claim or liability in arbitration or reference.

4. (9)(4) No act of a partner in contravention of a restriction on authority shall bind the partnership to persons having knowledge of the restriction.

iii. National Biscuit Company v. Stroud, 249 N.C. 467 (1959) 1. Facts: Stroud and Freeman entered into a general partnership to sell groceries

under the name of Stroud's Food Center. Thereafter plaintiff sold bread regularly to the partnership. Then defendant Stroud advised an agent of plaintiff that he personally would not be responsible for any additional bread sold by plaintiff to Stroud's Food Center. Even so, P at the request of the Freeman, sold and delivered bread in the amount of $171.04 to Stroud's Food Center. Stroud and Freeman shortly after dissolved the partnership. Proceeding by seller of bread against former partners who had operated food store for value of goods sold and delivered. Superior Court rendered judgment for seller, and partner appealed.

2. Issue: Is Stroud liable for the bread purchase? 3. H&R: Yes! Purchase of bread by food store operated as going concern by two

partners was an ordinary matter connected with partnership business within statute to effect that any difference arising as to ordinary matter connected with partnership business may be decided by majority of partners, and although partner told bread seller he would not be personally responsible for additional bread sold to store, partner and partnership were liable for such purchase by copartner.

a. One partner can not restrict the power/authority for each other. If they wanted to they could have put a clause in their partnership agreement, or have additional partners and/or separate the duties of individuals.

b. UPA 18(e) and (h) were also important in this case.

iv. Partnership Management -- Majority Rule Hypo 1. Partnership profit sharing deal: A: 60%, B: 20%, C: 20%2. Partners disagree on a decision about a business deal & vote on it; B & C

approve of it but A does not. 3. Result? Majority vote wins. Key UPA section: UPA18(h)4. Role of PA? Partners can always change the roles and draft in more or less

bargaining power.

v. Day v. Sidley & Austin, 394 F.Supp. 986 1. Facts: Action was brought by former partner because he was unhappy that the

old partnership merged with another company. P initially approved of the merger idea. P alleges that there was fraud and misrepresentation based on the idea that no Sidley Partner would be worse off as a result of the merger.

2. Issue: Was there fraud that deprived P of any legal right as a result of his reliance on the idea that no Sidley partner would be worse off?

3. H&R: P failed to show any cause of action for fraud as a result of merger pursuant to agreement to which he subscribed, there was no showing of any


breach of contract or of fiduciary duty by partners negotiating merger. The partnership agreement (PA) he signed made no specific mention of his status as a partner, he read and signed the authorization of the PA.

a. Partners have a duty to make a full and fair disclosure to other partners of all information which may be of value to the partnership. The basic duties are:

i. A partner must account for any profit acquired in a manner injurious to the interests of the partnership, such as commissions or purchases on the sale of partnership property

ii. Partner cannot without consent of the other partners, acquire for himself a partnership assets, nor may he divert to his own use a partnership opportunity

iii. He must not compete with the partnership within the scope of the business.


PARTNERSHIPS Partnership & Partner Liability

I. Partnership/Partner Liabilitya. Partnership liability:

i. Sec. 13 – Partnership Bound by Partner's Wrongful Act. Partner’s wrongful act/omission in ordinary course of business makes the partnership is liable to the same extent as the partner so acting or omitting to act

3. ex. tortsii. Sec. 14 – Partnership Bound by Partner's Breach of Trust. Partner’s misapplication

of $/property of a TP which was received by a partner or the partnership 4. ex. Embezzlement

b. Partner liability: § 15. Nature of Partner's Liability.i. 15(a) Jointly and severally for everything chargeable to the partnership under § 13 and

14.ii. 15(b) Jointly for all other debts and obligations of the partnership; but any partner may

enter into a separate obligation to perform a partnership contract.

c. Can a partner recover from the partnership for paying its obligations?i. 18(b) – partners’ right to contribution: (b) The partnership must indemnify every

partner in respect of payments made and personal liabilities reasonably incurred by him in the ordinary and proper conduct of its business, or for the preservation of its business or property.

d. Compare UPA (1997) re: partner liability:i. Sec. 306: liability sharing rule: all partners are liable jointly and severally for all

obligations of the partnership unless otherwise agreed by the claimant or provided by law.

II. How do partners make $$? – This is all subject to the Partnership Agreement a. Salary – Not Guaranteed

i. UPA 18(f) No partner is entitled to remuneration for acting in the partnership business, except that a surviving partner is entitled to reasonable compensation for his services in winding up the partnership affairs.

b. Share of profits – Equal Sharing i. 18 (a) Each partner shall be repaid his contributions, whether by way of capital or

advances to the partnership property and share equally in the profits and surplus remaining after all liabilities, including those to partners, are satisfied; and must contribute towards the losses, whether of capital or otherwise, sustained by the partnership according to his share in the profits.

c. Transfer of interest in partnership i. UPA 27(1) vs. 18(g)

1. 18(g) No person can become a member of a partnership without the consent of all the partners.

2. § 27. Assignment of Partner's Interest.a. (1) A conveyance by a partner of his interest in the partnership does

not of itself dissolve the partnership, nor, as against the other partners in the absence of agreement, entitle the assignee, during the continuance of the partnership to interfere in the management or administration of the partnership business or affairs, or to require any


information or account of partnership transactions, or to inspect the partnership books; but it merely entitles the assignee to receive in accordance with his contract the profits to which the assigning partner would otherwise be entitled.

d. Role of partnership agreement?i. provide for salary

ii. share of profits/losses can be alterediii. can alter consequences/restrict transfer of interest in partnership


PARTNERSHIPS Partnership Dissolution

I. Partnership Dissolution

a. What is Dissolution & How Does it Occur?i. Voluntary vs. Involuntary

ii. Role of partnership agreement (above)iii. What is meant by “dissolution”?

1. Sec. 29 - Someone is no longer associated with the others to operate the business

iv. What happens after a dissolution event occurs? 2. Section 30 –Doesn’t mean partnership is gone, there’s a wind up period then

termination.

v. Sec. 31 – Which causes violate the partnership agreement? Which causes do not? 1. Legal vs. Business Consequences:

a. Legal – No longer a partnershipb. Business - might still be running

2. Relevance of duration of the partnership? How long was the partnership designed for, at will, for term or for an undertaking?

vi. Distinguish power vs. right to dissolve

vii. Role of courts: Courts have the power to dissolve a partnership; they have the discretion and are not required to.

1. Sec. 32 Dissolution by Decree of Court.a. (1) On application by or for a partner the court shall decree a

dissolution whenever:i. (a) A partner has been declared a lunatic in any judicial

proceeding or is shown to be of unsound mind,ii. (b) A partner becomes in any other way incapable of

performing his part of the partnership contract,iii. (c) A partner has been guilty of such conduct as tends to affect

prejudicially the carrying on of the business,iv. (d) A partner willfully or persistently commits a breach of the

partnership agreement, or otherwise so conducts himself in matters relating to the partnership business that it is not


reasonably practicable to carry on the business in partnership with him.

v. (e) The business of the partnership can only be carried on at a loss,

vi. (f) Other circumstances render dissolution equitable.

b. (2) On the application of the purchaser of a partner's interest under § 27 or 28:

i. (a) After the termination of the specified term or particular undertaking

ii. (b) At any time if the partnership was a partnership at will when the interest was assigned or when the charging order was issued.

b. Power vs. right to dissolve/Breach of Partnership Agreement vs. not i. Owen v. Cohen, 19 Cal.2d (1941)

1. Facts: They agreed to open a bowling alley together, plaintiff lent money to the partnership, D refused to do a lot of the required work. P sued for dissolution. The trial judge dissolved the partnership.

2. Issue: Whether or not the evidence warrants a decree of dissolution of the partnership?

3. H&R: a. Yes, there was no express agreement in the partnership agreement for

how long the partnership would last, they disagreed on practically all matters regarding the operation of the partnership, the business was financially stable and at a profit, not a huge factor for the Court, although other courts typically look at profits.

b. Why did the P seek a court dissolution rather than just giving notice of dissolution himself to begin winding up?

i. Section 31(b) he could have dissolved on his own, but perhaps it was too difficult for him to buy out the D.

ii. P wanted his loan money back.iii. One could argue that there was an implicit agreement that the

partnership was long term.

c. Consequences of Dissolutioni. Prentiss v. Sheffeel, 20 Ariz.App. 411 (1973)

1. Facts: Ps sought dissolution of the partnership they formed with D (the purchase of the shopping center). P contends that D was negligent of his duties. Trial court concluded that it was a partnership at will and that there was a freeze out of the D from management and affairs of the partnership.

2. Issue: Was D “frozen out?” Should Ps have been able to buy back the shopping center at the mall?

3. H&R: D was excluded from the management of the partnership, but there was no indication that such exclusion was done wrongfully. The partnership agreement stated that the partnership was at will and no one was set to be the manager. Ps argue that they shouldn’t have been able to buy the assets at the auction, but Court says that they should be able to.

ii. Dissolution: Sec. 38’s Two Paths 1. Dissolution w/o Partnership Agreement Violation : unless o/w agreed, each

P can force liquidation; pay partnership liabilities; pay surplus (if any) to Ps2. Dissolution in contravention of Partnership Agreement. : innocent Ps can

choose:a. (a) liquidate; wrongful P pays damages OR


b. (b) continue bus. using partnership propertyiv. Must pay wrongful P value of his interest in partnership

MINUS damages; ignore value of good-will of business

iii. Death of a Partner 1. FMV = Fair Market Value

iv. Options available to partners

v. Sharing of losses/division of remaining assets1. § 40. Rules for Distribution. In settling accounts between the partners after

dissolution, the following rules shall be observed, subject to any agreement to the contrary:

a. (b) The liabilities of the partnership shall rank in order of payment, as follows:

i. (I) Those owing to creditors other than partners,ii. (II) Those owing to partners other than for capital and profits,

iii. (III) Those owing to partners in respect of capital,iv. (IV) Those owing to partners in respect of profits.

b. (d) The partners shall contribute, as provided by § 18 (a) the amount necessary to satisfy the liabilities; but if any, but not all, of the partners are insolvent, or, not being subject to process, refuse to contribute, the other partners shall contribute their share of the liabilities, and, in the relative proportions in which they share the profits, the additional amount necessary to pay the liabilities.

c. (f) Any partner or his legal representative shall have the right to enforce the contributions specified in clause (d) of this paragraph, to the extent of the amount which he has paid in excess of his share of the liability.

2. Kovacik v. Reed, 49 Cal.2d 166 (1957)a. Facts: P asked D to become a job superintendent and estimator on jobs

that P found. P invested money into the business. He did not ask D to invest any money into the venture. The venture began to lose began to lose money and P asked D to share for the losses. D claimed that he never agreed to be liable for losses and refused to pay.

b. Issue: Are the partners equally liable for losses when they did not both invest capital?

c. H&R: Profits and losses are generally split equally when both parties have contributed capital. When however, one partner contributes the


money capital as against other’s skill and labor than neither party is liable to the other for contribution for any loss sustained. Upon the loss of the money, the party who contributed is not entitled to recover any part of it from the party who contributed only services.

3. Note - UPA (1997) response to Kovacik: UPA is on the side of Kovacik. Nothing in the UPA helps Reed out. 18(a) states that if Reeds wanted a salary, then he should have bargained for it. In UPA 1997, the writers wanted to make it clear that Kovacik was wrongly decided and that Reed should have been held liable for losses.

d. Buyout agreements - A buy out or buy-sell, agreement is an agreement that allows a partner to end his/her relationship with the other partners and receive a cash payments, or some assets of the firm, in return for her/his interest in the firm.

i. What kinds of events trigger a buyout event? 1. Death2. Disability 3. Will of any partner

ii. Option v. Obligation?1. Firm2. Other investors3. Consequences of refusal to buy

a. Obligationb. No Obligation

4. Do the other partners have to buy it out, or can they liquidate?

iii. Price? How is the price determined? Have a set formula. This is something negotiated in the beginning.

1. Book valve2. Appraisal3. Formula 4. Set price each year5. Relation to duration

iv. Payment Terms? When and how does it have to be paid? Payment in installments. 1. Cash2. Installments

v. G&S Investments v. Belman, 145 Ariz. 258 (1984)1. Facts: Nordale was partners with the plaintiffs. The Ps sought a dissolution and

wanted to buy out Nordale because there were continuing disputes between the two parties. Nordale’s estate argues that the dissolution event occurs when the Ps filed the petition (because that would give the estate higher portion of the partnership property).

2. Issue: Whether the surviving general partner, Plaintiffs, is entitled to continue the partnership after the death of Nordale, and how the value of Nordale’s interest in the partnership property is to be computed.

3. H&R: Nordale’s conduct was in contravention of the partnership agreement and affected the daily business. Court looks to UPA s.32 which allows for dissolution by decree of the court. Partnership buy out agreements are valid and binding although the purchase price agreed upon is less or more than the actual value of the interest at the time of death.


vi. Lawlis & Dissolution by Expulsion1. Strategy: Why did Lawlis argue that notice re: upcoming meeting to expel him

and removal of files as expulsion?2. UPA – does it give a right to expel?3. UPA – any limitations on expulsion?

a. Only for cause?b. Bona fide? Must be in good faith. What would be bad faith? Withholding

money that was legally the individual who they are expelling.

vii. UPA (1997) Dissociation 1. s. 601 – dissociation, versus the 1914 terminology of dissolution 2. s. 602 – power to dissociate at any time, but may be wrongful and be basis for

damages; 2 paths…3. Article 7 – Dissociation when business is continuing, purchase dissociated

partner’s interest at buyout price (default calculation method + pay interest from date of dissociation.

4. Article 8 – Dissociation when business is being dissolved and wound up; dissolution (liquidation) events listed (s.801)


PARTNERSHIPS Limited Partnerships

I. Limited Partnerships

a. Limited Partnership – Key Pointsi. Nature and Definition of LP:

1. General Partners’ role and liability – management roles & liabilities like partners

2. Limited partners’ – have limited role and liability, similar to corporate shareholders

a. If a limited partner oversteps their roles they may become viewed as a general partner

b. Method of Formationi. Must take steps towards forming a limited partnership, it doesn’t matter if you call

yourselves limited partners if you fail to file the proper paper works it doesn’t matter, the business may not be deemed limited partnership.

c. Hybrid Between General Partners and Corporation; compare—i. Formation - formed by filing, like corporation

ii. Personal Liability of owners - some owners have personal liability (like General Partners) and others do not (like corporate shareholders)

iii. Management role of owners - some owners manage the business (like GP) but others play a passive role (like SHs)

d. Limited partners risk of losing limited liabilityi. Holzman v. De Escamilla, 86 Cal. App.2d 858 (1948) – Limited Partners liable as

General Partners for taking part in control of the business (ULPA)1. Facts: There were two limited partners who were part of farming venture. The

farm went out of business and the main partner wanted them to share in the loss. In practice, all three partners had a say in the daily operations of the farm.

2. H&R: Even though the partners agreed to be limited partners, they didn’t act that way and acted like partners.

3. Why form a limit partnership? Some people will be active in running the business; others will invest money but will not participate in the business and just expect profits. Investors have different degrees of involvement.

ii. RULPA 303 lessens risk loss of limited liability1. Limit persons to whom may be liable

a. if take part in control, only liable to persons who transact business w/ the LP & and reasonably believe LP is a GP

2. Safe Harbor – actions limited partners can take without being deemed to participate in control:

a. act as officer/director/SH of a corp. that is a GPb. consult with and advise a GPc. propose and/or vote on certain matters, such as dissolution, removal of

an LP or GP, etc.

e. Current status/outlook - now largely eclipsed by newer hybrid forms, esp. LLCs


CORPORATIONS Formation

I. Corporations – Participants a. Shareholders

i. Don’t manage the day to day business

b. Board of Directors i. Elected and manage the business

c. Officers i. Are chosen by the Board and run the daily business

d. Corporationi. Viewed as a separate entity from the people that

own it.

e. Corporate Veil i. Shields the shareholders from liability of the

corporation

II. Nature of Corporation a. Promoters and the Corporate Entity

i. Fiduciary duty of the promoters (below) ii. Pre-incorporation contracts: promoter liability vs. corporate liability

b. Formation of the Corporation (below)

c. The Corporate Entity and limited liabilityi. Piercing – “Piercing the Corporate Veil”

ii. Contract v. Tortiii. Individual shareholder v. parent/subsidiary

d. Role and Purposes of the Corporation

III. Corporation Formation Timeline a. Pre-Incorporation Period - There’s an idea – making plans on how the business will succeed, how

it will run. Many times contracts are signed before the company incorporates.

b. Incorporation – only at this point are owner protected with limited liability.


IV. Corporations: Formation a. How to Form a Corporation – take the steps that the State outlines

b. Where to form a corporation? One state or multiple

c. Basic Incorporation Documents (“Charter”)i. Articles of/Certificate of Incorporation

ii. Bylaws iii. Minutes of Organizational Meeting (or unanimous written consent)

d. Model Business Corporation Act (MBCA) – the Model Act vs. Uniform Act i. § 2.02. Articles of Incorporation.

1. (a)The articles of incorporation must set forth:a. (1) a corporate name for the corporation that satisfies the

requirements of section 4.01b. (2) the number of shares the corporation is authorized to issue;c. (3) the street address of the corporation's initial registered office and

the name of its initial registered agent at that office; andd. (4) the name and address of each incorporator.

2. (b) The articles of incorporation may set forth:a. (1) the names and addresses of the individuals who are to serve as the

initial directors;b. (2) provisions not inconsistent with law regarding:

i. (i) the purpose or purposes for which the corporation is organized;

ii. (ii) managing the business and regulating the affairs of the corporation;

iii. (iii) defining, limiting, and regulating the powers of the corporation, its board of directors, and shareholders;

iv. (iv) a par value for authorized shares or classes of shares;v. (v) the imposition of personal liability on shareholders for the

debts of the corporation to a specified extent and upon specified conditions;

c. (3) any provision that under this Act is required or permitted to be set forth in the bylaws;

d. (4) a provision eliminating or limiting the liability of a director to the corporation or its shareholders for money damages for any action taken, or any failure to take any action, as a director, except liability for (A) the amount of a financial benefit received by a director to which he is not entitled; (B) an intentional infliction of harm on the corporation or the shareholders; (C) a violation of section 8.33; or (D) an intentional violation of criminal law; and

e. (5) a provision permitting or making obligatory indemnification of a director for liability (as defined in section 8.50(5)) to any person for any action taken, or any failure to take any action, as a director, except liability for (A) receipt of a financial benefit to which he is not entitled, (B) an intentional infliction of harm on the corporation or its shareholders, (C) a violation of section 8.33 or (D) an intentional violation of criminal law.

3. (c) The articles of incorporation need not set forth any of the corporate powers enumerated in this Act.


4. (d) Provisions of the articles of incorporation may be made dependent upon facts objectively ascertainable outside the articles of incorporation in accordance with section 1.20(k).

ii. § 4.01. Corporate Name.1. (a) A corporate name:

a. (1) must contain the word corporation, incorporated, company, or limited, or the abbreviation and

b. (2) may not contain language stating or implying that the corporation is organized for a purpose other than that permitted by section 3.01 and its articles of incorporation.

2. (b) Except as authorized by subsections (c) and (d), a corporate name must be distinguishable upon the records of the secretary of state from:

a. (1) the corporate name of a corporation incorporated or authorized to transact business in this state;

b. (2) a corporate name reserved or registered under section 4.02 or 4.03;c. (3) the fictitious name adopted by a foreign corporation authorized to

transact business in this state because its real name is unavailable; andd. (4) the corporate name of a not-for-profit corporation incorporated or

authorized to transact business in this state.

3. (c) A corporation may apply to the secretary of state for authorization to use a name that is not distinguishable upon his records from one or more of the names described in subsection (b). The secretary of state shall authorize use of the name applied for if:

a. (1) the other corporation consents to the use in writing and submits an undertaking in form satisfactory to the secretary of state to change its name to a name that is distinguishable upon the records of the secretary of state from the name of the applying corporation; or

b. (2) the applicant delivers to the secretary of state a certified copy of the final judgment of a court of competent jurisdiction establishing the applicant's right to use the name applied for in this state.

4. (d) A corporation may use the name (including the fictitious name) of another domestic or foreign corporation that is used in this state if the other corporation is incorporated or authorized to transact business in this state and the proposed user corporation:

a. (1) has merged with the other corporation;b. (2) has been formed by reorganization of the other corporation; orc. (3) has acquired all or substantially all of the assets, including the

corporate name, of the other corporation.

5. (e) This Act does not control the use of fictitious names.


CORPORATIONSPromoters

I. Promoters & Estoppel a. Southern-Gulf Marine v. Camcraft, 410 So.2d 1181 (1982)

i. Facts: P, a corporation chartered under the laws of Cayman, British West Indies, field suit alleging breach of contract to furnish a ship. D countered that there was no cause of action based on P’s lack of corporate existence at the time of entering into the contract and subsequent incorporation in another sovereign different from the original state. While P initially said they would incorporate in Texas, they subsequently sent a letter to D that they were choosing to incorporate in the Cayman Islands and D signed off on this agreeing to it.

ii. Issue: Whether D should be estopped from asserting the P’s lack of corporate capacity at the time of the contract was executed after dealing with the P as a corporation?

iii. H&R: Having promise to construct the vessel, D will not be permitted to escape performance by raising an issue as to the character of the organization to which it is obligated, unless substantial rights might thereby be affected.

1. As a general rule, one who contracts with what he acknowledges to be and treats as a corporation, incurring obligations in its favor, is estopped from denying its corporate existence, particularly when the obligations are sought to be enforced.

b. Practice tipsi. No one should sign before incorporation.

ii. Require evidence of:1. incorporation2. authority to sign

iii. If do so, insist that person signing be personally liable (tho’ that person might refuse), at least until corp. is formed and adopts the contract.

iv. Also might insist on right to suspend manufacture if not incorporated by certain date.

II. Promoters – Duties and Liabilities a. Issues:

i. What is a promoter? Promoters identify a business opportunity and puts together a deal, forming a corporation as the vehicle for investment by other people.

ii. Issues arise as to:1. Dealings between promoter and third parties2. Dealings between promoter and corporation

b. Promoter Fiduciary Obligationsi. A promoter owes a fiduciary obligation to the corporation. This obligation is like that

of an agent to a principal, even though no principal exists yet. 1. Duty of good faith and honesty toward corporation coming into existence

a. Fully disclose facts, including personal interestb. Refrain from misrepresentations

2. Duty of loyaltya. Refrain from taking secret profitb. Refrain from using corp. funds for personal purposes

ii. Example: Duties re: sale of land to new corp. – cannot take a secret profit from pre-incorporation dealings:

1. Promoter buys land, suitable for development; P knows an investor who wants to develop the land; P causes a corporation to be formed, with the investor owning all of the stock; P sells the land to the corp. at a profit, without revealing the fact that he is making a profit


a. Is this a breach of duty? Yes, he’s not being honest b. Remedy? When an agent does this, he is disgorged from the profits-this

is similar here. c. What about if P is just good at bargaining? He needs to pass on the

benefits from driving that bargain.

III. More on Pre-incorporation Contracts: These are default rules unless there is intention otherwisea. Once a corporation exists, is it automatically bound? NO!

i. If not, how can it become bound? 1. There should be action by the corporation to adopt as its own, even if it’s not

express. b. Is the promoter who signed liable?

i. If so, does the promoter liability end automatically once incorporation occurs? 1. No, promoter is liable if the promoter signs before the company is incorporated

then he/she is liable. 2. But the corporation could indemnify the promoter.

ii. If not, how can promoter liability end? 1. The promoter needs to get the corporation to agree to let them off the hook.

c. NOTE: These principles apply UNLESS OTHERWISE INTENDED, i.e., unless the promoter and other side intended otherwise when the contract was signed.


CORPORATIONSCorporate Liability

I. Mechanics of Incorporation a. Select a Corporate Name (MBCA 4.01)

b. File Articles/Certificate of Incorporation (2.01-03) i. Mandatory vs. permissible contents

ii. MA “articles of Organization”1. Article I: Name of organization2. Article II: Name & purpose of the corporation, along with how many shares

there will be 3. Article III: What kinds and how many stocks will the corporation will sell4. Article IV: What rights will be given for what kind of stock—such as do you have

the right to vote, right to certain dividends. 5. Article V: Are there any restrictions on the right to transfer?

a. One of the benefits is that stocks are typically fully transferable.6. Article VI: Describe the type of business, where the principal office is and

address where the records are kept. 7. Article VIII: who are the directors

c. Hold Organizational Meeting (MBCA 2.05) i. Elect directors (if not named in Article), appoint officers

1. 2. If articles don’t name directors, incorporator holds meeting. Then either:a. Incorporator chooses directors and completes organizationb. Incorporator chooses directors and THEY complete organization

ii. Approve bylaws (2.06)iii. Authorize bank account; approve minute book, form of stock certificate, etc.,

d. Issue of share of stock to initial shareholders

II. Corporate Entity & Limited Liability a. Limited Liability - Courts will disregard the corporate form, or in other words, “pierce the

corporate veil,” whenever necessary to prevent fraud or to achieve equity.i. Walkovsky v. Carlton,18 N.Y2d 414 (1966) – when limited liability is enough to

protect the shareholders 1. Facts: P was severely injured when a taxi ran into him. He attempted to sue the

corporation but couldn’t get much money because the cab only had 10K in insurance liability. Then he sued D stating that all the corporations should be liable for P’s injuries. D is a shareholder of a bunch of corporations. The claim against D, is that as a shareholder he should be held liable. Enterprise liability-there are a bunch of cabs, owned by several different corporations, but it acts like it’s owned by one, they are repaired by the same place, and garaged at the same place.

2. Issue: Did D use the agency for his personal gain?3. H&R:

a. No, he didn’t. There were no allegations that D conducted business in personal capacity for personal ends, using corporation as dummy so that as a shareholder D would have been liable under respondeat superior. If D was operating the business fraudulently that would justify piercing the corporate veil.

b. Also, no allegations that did business in individual capacity, shuttling personal $ in and out w/o regard to formality and to suit own convenience; not enough to say corp. was undercapitalized and assets were intermingled


c. Relevance of Lack Assets: not having enough assets is not enough to pierce the veil.

d. Relevance of Inadequacy of Insurance? It’s not fraudulent for the owner to take out only the minimum liability. It’s not for the court decide, if people are unhappy, they need to complain to the legislature.

ii. Sea-Land Services, Inc. v. Pepper Source, 941 F.2d 519 (7th Cir. 1991) When limited liability will not protect the shareholder, and the court WILL pierce the corporate veil

1. Facts: D orders a shipment for a large amount of goods. The bill was very large, and D never paid for it. P sues, district court entered a default judgment in favor of P, but Pepper Source couldn’t be found, it was dissolved. P then brought an action against Marchese and 5 business entities that he owns. P wanted to pierce the corporate veil and render Marchese liable, and “reverse pierce” the other corporations that Marchese owns. (Some jurisdictions will consider “reverse piercing, but not all).

2. H&R: A corporate entity will be disregarded and the veil of limited liability pierced when 2 requirements are met:

a. 1) first there must be unity of interest and ownership that the separate personalities of the corporation and the individual (or other corporation) no longer exist

i. Inadequate records and formalities1. In this case, Marchese never held minutes.

ii. Commingling of funds and assets1. Used corporate funds for personal purposes, such as

paying child support and alimony.2. Undercapitalization3. Treated corporate assets as own

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

i. The party was harmed because he was not paid; if the court didn’t do something there would be unjust enrichment. There was also a deliberate attempt to use the corporation to escape creditors.

1. Higher Court states that there needs to be more than just nonpayment, such as unjust enrichment, that a shareholder used a corporation to avoid its responsibilities to creditors.

3. Advice?a. Respect corp. formalitiesb. Provide reasonable capitalizationc. Follow financial practice norms

i. separate bank acctsii. don’t drain out $ regularly, use for personal expenses

d. NOTE – Piercing Corporate Veil liability is like lightning striking – rare but potentially devastating

iii. In Re Silicone Implants Product Liability Litigation 1. Look at the totality of the circumstances to see if the party is liable. The parents

and the subsidiary have similar directors. 2 of MCE directors were Bristol directors. MCE used Bristol and Myers health care group and legal group.

2. Plaintiffs wants to pierce the corporate veil since the parent company controlled so much of the subsidiary. Bristol & Meyers were very involved,


stating that the implants were safe and even stamping the implants with their name; it would only be equitable if they were held liable.

3. Plaintiff’s first theory was that Bristol Meyers controlled the subsidiary and therefore the corporate veil should be pierced. The 2nd theory is Bristol Meyers should be held liable for direct liability. They presented themselves as backing up the product in public.


CORPORATIONSRole and Purpose of Corporations

I. MBCA § 3.02(13) to make donations for the public welfare or for charitable, scientific, or educational purposes

a. A.P. Smith Mfg Co. v. Barlow, 13 N.J. 145 (1953)i. Facts: Company frequently donated money and wanted to donate money to Princeton

University, in the sum of $1500. Certain stockholders objected. The stockholders instituted a declaratory judgment action to stop the donation. Company president thought it was a sound investment, as it obtained good will within the community, and that they were furthering the corporation’s self-interest in assuring the free flow of properly trained personnel. The stockholders argue that the plaintiff’s cert of incorporation doesn’t expressly authorize the contribution and the corp doesn’t have implied/incidental powers to make the contributions. The stockholders 2nd argument is that the NJ statute was enacted after the incorporation of the business, and thus doesn’t apply.

ii. Issue: Is the donation valid?iii. H&R: there is no suggestion that it was made indiscriminately or to a pet charity of the

corporate directors. The corp was donating to an institution of higher learning, was a modest amount and within the limitations of the statutory agreement.

1. NJ Statute = allowed corporations to cooperate with other corps’ and people in the creation and maintenance of community funds and charitable instrumentalities conducive to public welfare and could spend corporate funds by the directors “deem expedient and as in their judgment will contribute to the protection of the corporate interests.”

2. Compare other statutory approaches:a. Delaware – one of the corps’ general powers but must serve basic corp

purpose – making moneyb. California – Power to make regardless of specific benefit c. New York – Power to make irrespective of benefit

b. Dodge v. Ford Motor Co.i. Facts: Investors got yearly dividends of 1.2mil + higher 'special' dividends. Ford decided

to later stop supplying investors with 'special' dividends and to reinvest that money in Ford motor co,. Ford wanted open an iron ore smelting plant to allow for price reduction. Dodge brothers, 10% owner, tried to sell shares back to Ford, Ford denied offer. Dodge sued to enjoin from stopping special dividends

ii. Issue: Should Ford be accountable for the dividends? iii. H&R: Yes, while Ford argues he has implied powers to do what he felt needs to be done

for the company the Court disagrees and held that he needed to pay the special dividends. Courts will not interfere unless they see evidence of fraud or misappropriation of corporate funds , where plenty of $ is had, and refusal to distributer amounts to fraud/bad faith.

iv. Basic rule re: dividends, etc.1. MBCA 6.40(a): basic principal that directors have the discretion to declare

dividends2. 8.01(b): power of the directors to manage the business3. 3.02(13): basic idea of having the power to engage in charitable actions. To

make contributions and other philanthropic types of decisions

c. Shlensky v. Wrigleyi. Facts: Case brought by the shareholders of the Cubs, they wanted the D/owner to install

lights so that they could have night games at Wrigley, they argued that other major leagues had lights and because of that attendance went up meaning greater the


profitability. D refused arguing that the lights would devalue and disrupt the neighborhood by bringing in large, unwanted crowds.

ii. Issue: Is D unwillingness to install lights a bad faith act?iii. H&R: No, courts will not step in and interfere with honest business judgments unless

there is a showing of fraud, illegality, or conflicts of interest. Judgment of directors enjoys the benefit of presumption that it was done in good faith and done to benefit and in the best interest of the corporation. Only if a party comes up with evidence that the other side acted in fraud or with illegality, will the courts further investigate the directors.

II. Corporation Social Responsibility (“CSR”) a. Some examples of corps.’ different areas of focus: b. Why choose particular areas? Determinative factors?c. How do corps. generally describe CSR endeavors? “Good corporate citizen” claim?d. Some examples of corps.’ descriptions of specific projects/ goals/motivations: Any other

goals/motivations?

i. Starbucks tried to do fair trade coffee1. Gives $ to groups to help subsidize fair trade2. Commitment; idea of a shared planet; 3. Importance of fair trade and ethics - just a part of who they are as a corporation4. Present themselves as having environmental and humanitarian responsibilities5. Good business sense to do so too. 6. They say that when they deliver in various areas of their mission, they pass the

success along to their share holders.7. AP Smith - today, people look to corps to do these good deeds. Starbucks feels as

though they're looked at to "set the new standard, yet again..."

ii. RJ Reynolds1. To advocate for children to NOT smoke, seemingly contradictory to the interest

of the shareholders2. Better to have kids wait until they're older because they'll have more money to

spend, and they'll lessen damage to their health during development years which will keep them smoking as an adult longer

3. SOME of their charity work is court ordered4. Make RJ a good place to work5. Making policies for smoking in the workplace6. Done as expectation ( legal expectation requirements) 7. Doing these sorts of things match up to the expectations of their shareholders.

iii. GAP1. Watch out for who's making their products2. Make sure the factories in which their clothing is produced don't involve child

labor.3. Occasionally happens, then have to conduct damage control - subcontracted

without consent. K has since been cancelled. Guidelines to subcontractors explicitly say no child labor, etc…

4. "Not just a good feeling, its good business…"5. Want to point out how decisions are good for business too.

iv. Ben & Jerry's1. Known for promoting themselves as people with a social mission? Deep respect

for human beings?2. Talk about their social, product and economic mission3. Interrelated - linked prosperity


4. They do right by delivering a good product that's good for society, and good for them in an economic level.

5. B&J eventually want to get 100% cage-free, but to do that now would be too much at the detriment of shareholders.

e. Implementation challenges that corporations may encounter? i. Ex. Swinegate, Ben & Jerry’s ice cream debacle. Tried to be eco-friendly by “recycling” ice

cream water waste by giving it to local pig farmers. B&J’s didn’t do research as to whether pigs could drink that much ice cream water. While the pigs gained weight, they also died quickly and their meat was too fatty to sell.

f. What are other pitfalls of CSR endeavors? g. How do/should SHs view these endeavors?h. How does/should the public view these endeavors?i. What is the significance for corporation managers of SH’s and the public


CORPORATIONSThe Roles of Officers, Directors and Other Insiders & The Duty of Care

I. Directors Role in the Corporation a. s. 8.03: 1 or more directors (see articles/bylaws determines how many directors there)

b. Election s. 8.03 – when and by whom?i. Elected annually at shareholders meeting

ii. Unless otherwise provided, shareholders have 1 vote per share; quorum – majority of shares; directors elected by plurality of votes cast (7.25 and 7.28)

c. Term of Office: s. 8.05 – 1 year

d. Role 8.01 – corp powers exercised by/under their authority and business/affairs managed by/under their direction and subject to their oversight

i. Declaring dividends: 6.40(a)

e. Mode of Taking Action: Meeting (8.20)i. Quorum requirement* (8.24) majority

ii. Required vote* (8.24b) majority present – must have 33% of the shareholders presentf. Alternative to action under 8.20*: 8.21

i. Unanimous written consent

g. Default rules or absolute requirements?i. *Unless articles/bylaws provide otherwise

II. Officers’ Role in the Corporation a. What officers does a corporation have?

i. 8.40(a) – set out in bylaws or designated by boardii. 8.40(c) – need one assigned to prepare board and shareholder meetings minutes and

maintain records

b. How are they selected?i. 8.40(b) by board or by other officers

ii. 8.40(d) 1 person may hold 2 offices

c. What authority and functions do they have?i. 8.41 – set out in bylaws or given by board or by other officers

ii. Act as agents of the corporation, not the shareholders

d. Officers’ role vs. directors’ role (8.01) – officers act under the board’s authority and direction

e. Removal (8.43) at any time, with or without cause, by board, appointing officer or other authorized officer

f. See also sample bylaws, section 4i. Designated officers, terms of office

ii. 3 sources of duties and powers


III. Directors’ Duties - Duty of Care and the Business Judgment Rule a. There is no protection for directors who have made “an unintelligent or unadvised

judgment” under the business judgment rule.

b. Kamin v. American Express Company, 89 Misc.2d 809 (1976)i. Facts: Ps demanded that the directors rescind the previously declared dividend in shares

and to take steps to preserve the capital loss which would result from selling the shares. The board rejected. The Ps claim that the Board was wasting corporate assets. The court examined the case and did not see a claim of fraud or self-dealing, or any bad faith or oppressive conduct.

ii. Issue: Whether or not dividend is to be declared or a distribution of some kind should be made is exclusively a matter of business judgment for the Board?

iii. H&R: 1. Courts will not interfere unless the powers have been illegally or

unconscientiously executed or unless it be made to appear that the acts were fraudulent or collusive and destructive of the rights of the stockholders.

a. For there to be actionable wrongdoing there must be a claim of fraud or bad faith.

b. More than imprudence or mistaken judgment must be shown.2. Business Judgment Rule not applicable here.

c. Key Duty of Care Concept: The Business Judgment Rule (“BJR”)i. BJR: defendant directors are entitled to a presumption … (Shlensky p. 277) – Courts will

presume that the directors acted in good faith, and in the best interest of the corporation. ii. How does the BJR operate as to requests for judicial review of a board decision?

1. It insulates the Board from Review. iii. Task of plaintiff alleging breach of Duty Of Care:

1. Must overcome presumption that Board met its duty of care. 2. Must show bad faith, conflict of interest or arbitrary decisions.

iv. How does the BJR operate as to directors’ potential personal liability?1. Helps shield them from their decisions and from personal liability.

d. Plaintiffs’ Task in Duty Of Care Litigation: Rebutting Business Judgment Rule Presumptioni. A.P. Smith (charitable donation): show no reasonable belief it was in best interests, was

excessive in amount or was made for personal reasons. 1. Court stated it would not get involved in such a small amount of money in

comparison to the company profits, and in a donation that was not made for personal gains.

ii. Dodge (dividends): show fraud, misappropriation of assets, bad faith, or arbitrariness (i.e., no rational business purpose for decision)

iii. Shlensky (decision re: lights): show fraud, illegality, or conflict of interestiv. Kamin : Court held the same thing, must show fraud, conflict of interest and bad faith. v. Van Gorkom : Board must act on an informed basis, in good faith, and the action must be

in the best interest vi. IN SUM, plaintiff must show defendants breached one of their duties – care, loyalty,

or good faith

e. Smith v. Van Gorkom, 488 A.2d 858 i. Facts: There was a spilt on the board, there were inside directors (more deeply involved

in the corporation, only sat for this corporation; this was their full time position) and outside directors (who were less involved, and were involved in other businesses). Ps brought a lawsuit against D from coming up with a plan as a merger and selling stock at only $55/share (which they regarded as too low). The board decided to sell based on a 2 hour meeting and one person’s presentation.


ii. Issue: Did the board breach their fiduciary duty by not reaching an informed business judgment and making a fast decision, based on only one individual’s presentation when agreeing to sell the Company?

iii. H&R: Yes! 1. The Court doesn’t buy the Board’s arguments: The Board did not

adequately inform themselves as to Van Gorkom’s roles in forcing the sale of the company and in stabling the per share purchase price, they made an uninformed as to the intrinsic value of the company. Given these circumstances were grossly negligent in approving the sale of the company upon 2 hours consideration, without prior notice and without the exigency of a crisis or emergency.

a. Size of the premium – not enough, doesn’t show it was adequateb. Market test of offer price – someone could have paid more, but no

one came forwardc. Board experience – “other ppl might have needed to be more

informed but this board knew Transunion and didn’t need additional information.”

d. Relied on the Advice of a lawyer – Doesn’t matter, part of the job of the Board is the possibility of being sued.

2. Was the Board at least more informed after the 9/20 meeting? Court says they were EVEN less informed!

3. Remanded – the lower court must determine the fair value of the shares, based on the intrinsic value of Transunion.

4. Dissent: A lesser experienced Board would have needed more time, but they didn’t because they were experts in their own company.

5. Standard: Gross negligence is the proper standard for determining whether a business judgment reached by a board of directors was an informed one.

6. Rule: The Board has a duty to act on an a. Informed basis – requires the Board to make a reasonable effort to

be diligent in informing themselves of all material information reasonably available to them (this depends on the facts and circumstances of the case).

b. In good faithc. And the action must be in the best interest

f. Aftermath of Van Gorkomi. Some of the directors became personally liable, this is very different from the

Dodge/Dividend case (where the Court made the CORPORATION pay, but none of the directors).

ii. After the case many Boards felt very uncomfortable making merger decisions without the aid of outside lawyers and investment bankers to give advice.

g. Justifying the BJR: Why Should Courts Defer to Directors’ Judgment?i. Judges’ lack of competence of business matters

ii. Courts didn’t want to undermine the advantages of corporate structure, passive business partners tend to step down and the best tend to step up.

iii. The Board is willing to serve on board but if we didn’t have the BJR and people always feared being sued how likely would they participate.

iv. The Courts want the Boards to continue to be willing to take business risks, because some risks are good risks.


IV. Duty of Care: a. Duty of Care (“DOC”) – Section 8.30: [8.42—officers] -- focus on diligence, attentiveness, &

prudencei. Act

1. Must be in good faith2. Must be in a manner “reasonably believes to be in the best interests of the

corporation” a. focus on substance of decision-making – decision must be related to

FURTHERING THE BEST INTERESTS of corp. (must have a REAS. BELIEF that furthers best interests)

i. “Reasonable belief” - focus on substance of decision-making – decision must be related to FURTHERING THE BEST INTERESTS of corp. (must have a REAS. BELIEF that furthers best interests)

ii. “Reasonable care” - focus on process of decision-making and oversight – become INFORMED in performing their DECISION-MAKING & OVERSIGHT functions with the CARE that a reasonable person in like position would reasonably believe appropriate “in a like position” – establishes objective standard “under similar circumstances” – take account of complexity/urgency

ii. When becoming informed, discharge duties “with the care that that a person in a like position would reasonably believe appropriate under similar circumstances”

1. “in a like position” – establishes objective standard2. “under similar circumstances” – take account of complexity/urgency

iii. Duty to Act in Good Faith – either separate duty or included in DOC (as in 8.30)1. Be honest, truthful and don’t misrepresent 2. Cannot have/be swayed by a conflict of interest3. Cannot approve or acquiesce in illegal activity

b. Francis v. United Jersey Banki. Facts: Insurance company, they would take on risks and allot some of the risks to a 3rd

company. This was Mrs. Britchard’s husband’s company and she didn’t want anything to do with the business. Her son’s also ran the business but they would take out “loans” against the company and essentially not pay. Eventually the business went under.

ii. Issue: Was there a breach of duty by Mrs. Britchard? iii. H&R: Yes, she didn’t do anything in her time as a director, a simple glance at the financial

statements would have clearly shown that the sons were stealing money from the business.

1. Basic Obligations Knowledge & Monitoring a. Understanding the businessb. Keeping informedc. Monitoring corporation affairs and reviewing financial

information. 2. Any statutory excuses? Not liable if she had in good faith relied on

a. Opinion of counselb. Reports prepared by company accountantc. President/officers of the board of reports

3. How can directors avoid liability if they are aware of misconduct?a. If a director sees that other directors do something they don’t like

they can avoid liability by stating in a writing that he/she disagrees. And even though she resigned eventually, she did so too late (she resigned right before the company went under). Instead of resigning


she should have tried to stop the corruption. Her neglect to act contributed to the free roam of the sons and their corruption.

4. Why isn’t the BJR mentioned? BJR not mentioned b/c it shields directors from liability for decisions they made; decisions not to act are also protected; here, though, she did not exercise any business judgment at all


CORPORATIONSDuty of Loyalty - Self-Dealing & Corporate Opportunity Doctrine

I. Duty of Loyalty a. Duty of Loyalty (“DOL”)

i. fairness & ii. subordinating self-interest to corp.’s interest; avoid self-dealing & don’t take corp.

assets/opportunities

b. Overview of Approaches to Self-dealing Transactionsi. Traditional common law approach:

1. Per se voidable, regardless of fairness/ratificationii. Modern common law/statutory approach:

iii. substantive test and/or procedural test:1. not voidable if intrinsically fair (substantive test) and/or approved by

disinterested, informed directors/SHs (procedural test)iv. Burden of proof?

1. Defendant has burden of proof; show transaction was fair (no BJR presumption) and/or proper approval was given

v. Defendant entitled to BJR presumption? Yes

c. Directors & Managers i. Business Judgment Rule

1. To encourage freedom of action on the part of directors, and to discourage interference with the exercise of their free and independent judgment, the Business Judgment Rule will defer to the directors.

2. Questions of policy of management, expediency of contracts/action, adequacy of consideration, lawful appropriation of corporate funds o advance corporate interest are usually left to the directors, unless a showing of fraud, improper motive or personal interest can be shown for the court to intervene.

3. The BJR yields to the rule of undivided loyalty.4. If there is any evidence of improvidence or oppression, any indication of

unfairness or undue advantage, the transactions will be voided….their dealings with he corporate engagements with the corporation are


challenged the burden is on the director(s) not only to prove good faith, but also to show inherent fairness.

ii. Bayer v. Beran, 49 N.Y.S.2d 2 (Sup. Ct. 1944)1. Facts: D is a director and spent a lot of money on radio ads, and of hiring a

station where is wife happened to be working for as a singer. He is charged with waste and negligence by the shareholders. Generally BJR would dismiss this case, but because the wife was singing on the show the court decided to look further into the case. The shareholders argued that the director was using the radio for a personal interest and secondly that the agreement to spend the radio money was illegal since there was no formal board meeting.

2. Issue: Whether the action of the directors was intended or calculated to subserve some outside purpose, regardless of the consequences to the company and in a manner inconsistent with the company interest? Was the decision illegal because a board meeting wasn’t held?

3. H&R: a. There was no breach of fiduciary duty: The board researched

how much, and where to place their radio ads. There was care, diligence and prudence exercised by the directors before they committed the company to the ads.

b. General rule is that directors acting separately and not collectively as a board can’t bind the corporation (the reason for this is because the collective procedure is necessary so that there can be a discussion of ideas first and secondly, directors are agents of the stockholders and are not given power by the law to act except as a board).

i. The court doesn’t buy that this because this particular board were fulltime and met frequently.

c. Role of BJR here?i. Meant to “encourage freedom of action on the part of

directors” & “discourage interference with the exercise of their free and independent judgment,” “yields to the rule of undivided loyalty.”

ii. “The burden is on the director … to show the deal’s inherent fairness”

iii. Benihana of Tokyo, Inc. v. Benihana, Inc. 906 A.2d 114 (Del. 2006) 1. Facts: Conflict within the family over who would take control or have

control of the business. They also wanted to gain additional capital in order to remodel the Benihana restaurants. In order to do this they decided to create new stock. They came up Class A stock and common stock. Abdo was involved in the trying to sell and buy the stock. , he negotiated with some board members behind doors and others not. The trial court found that the board was not informed that Abdo had negotiated the deal on behalf of BFC, but they did know he was a principal of BFC.

2. Issue: Did Abdo breach his duty of loyalty? 3. H&R: No.

a. Abdo did not set the terms of the dealb. Did not deceive the board c. Did not dominate or control the other directors’ approval of the

transaction. d. The board chose the best financial option.


iv. MBCA Re: Conflicting Interest Transactions (essentially self-dealing)1. What is a “director’s CIT?” 8.60

a. (1) Conflicting Interest Transaction – a transaction that involves a conflict, which include a director, a related person of a director or officer is interested in the deal.

b. (4) Material Financial Interest – A financially interest that can reasonably impair someone’s objectivity.

c. (5) Related Person – Family members, and any other business entities that a director might have an interest in.

2. What must a director do to insulate a director CIT from a damages/equitable relief claim?

a. 8.61(b) A director's conflicting interest transaction may not be enjoined, set aside, or give rise to an award of damages or other sanctions, in a proceeding by a shareholder or by or in the right of the corporation, because the director, or any person with whom or which he has a personal, economic, or other association, has an interest in the transaction, if:

i. (1) directors' action respecting the transaction was at any time taken in compliance with section 8.62;

ii. (2) shareholders' action respecting the transaction was at any time taken in compliance with section 8.63; or

iii. (3) the transaction, judged according to the circumstances at the time of commitment, is established to have been fair to the corporation.

3. Key definitions: a. Fair to the Corporation 8.60(6)

i. The transaction as a whole was beneficial to the corporation, taking into appropriate account whether it was

1. (i) fair in terms of the director’s dealings with the corporation, and

2. (ii) comparable to what might have been obtainable in an arm’s length transaction.

b. Required Disclosure 8.60(7) i. Disclosure of

1. (i) The existence and nature of the director’s conflicting interest, and

2. (ii) all facts known to the director respecting the subject matter of the transaction that a director free of such conflicting interest would reasonably believe to be material in deciding whether to proceed with the transaction.

c. Qualified Director 1.43(3) is not a directori. (i) as to whom the transaction is a director's conflicting

interest transaction, orii. (ii) who has a material relationship with another director

as to whom the transaction is a director's conflicting interest transaction

4. Director not liable for damages if:


a. Sec. 8.62 – the transaction has been authorized by the affirmative vote of a majority (but no fewer than 2) of the qualified directors who voted on the transaction, after required disclosure by the conflicted director of information not already known by such qualified directors or after modified disclosure in compliance OR

b. Sec. 8.63 if a majority of the votes cast by the holders of all qualified shares are in favor of thetransaction after 1) notice to shareholders describing the action to be taken respecting the transaction, 2) provision to the corp etc… OR

c. Transaction proven fair

d. MBCA Re: Corporate/Business Opportunitiesi. 8.70(a) -- What can a director do to insulate taking advantage of a business

opportunity from a damages/equitable relief claim? 2 possibilities:1. Get approval from qualified directors, those who are disinterested in

the transaction.a. Disclaiming disinterest in corporate opportunity b. Compliance with 8.62 – self-dealing transaction; directors have to

be informed of potential conflict and the terms of the deal in question.

2. Shareholder Approval a. 8.63 – have shareholders with knowledge of the terms of the deal,

with knowledge of the opportunity of the terms, have them disclaim the opportunity.

ii. 8.70(b) – Is this the only way to avoid potential liability, or just an optional “safe harbor”?

1. One approach to immunize opportunity from further attack.

iii. Corporate Opportunity: In re eBay, Inc. Shareholders Litigation1. Facts: Shareholders of eBay filed derivative actions against certain eBay

directors for usurping corporate opportunities. Ps allege that eBay’s investment banking adviser engaged in “spinning,” a practice that involves allocating shares of lucrative initial public offerings of stock to favored clients. Ds argue that it was not a corporate opportunity within the corporation’s line of business or an opportunity in which the corporation had an interest or expectancy—court does not buy it.

2. Issue: Did the Ds take part in corporate opportunities? 3. H&R:

a. The defendant directors were not free to accept this consideration from their investment banking advisors. In the present case eBay was financially able to exploit the opportunities, was in the business of investing in securities, investing is an integral part of eBay’s cash management strategies and eBay was never given an opportunity to turn down the IPO allocations as too risky.

b. 4 Guth Factors - If all present, Director/Officer can’t take the opportunity w/o board of directors approval:

i. Corp. has financial capacity to undertake the opportunityii. Opportunity is in corp.’s line of business

iii. Corp. has interest or reasonable expectancy in opportunityiv. Conflict of interest if O/D takes opp.

4. Notes:a. Litigation Settlement Agreement (2005):

i. individual defendants to pay total of $3 millionii. Goldman to pay $395,000


iii. $ to go into settlement fund; proceeds (minus attys.’ fees, etc., not to exceed $850,000) to go to eBay; give 50% to charity

iv. eBay revised conflict of interest policy – employees & directors can’t purchase IPO allocation shares “if to do so would appear to influence the employee’s business judgment”

v. No admission of liability – maintain opps. were given to def. solely as brokerage customers

iv. Ratification by Shareholders (SHs): Fliegler v. Lawrence, 361 A.2d 218 (1976) 1. Facts: Shareholder derivative action brought on behalf of Agau Mines, a

Delaware corporation against its officers and directors and USAC, a Montana corporation. Lawrence/D, president of Agau acquired certain properties under a lease-option and offered to transfer to Agau, but after meeting with some other Agau directors, he and they agreed that the corporations legal/financial position wouldn’t permit acquisition/development of the properties, so the properties were instead transferred to USAC (which is a closely held corporation, formed just for this purpose, and a majority of stock owned by Ds). But an option was held open for Agau to take over stock of USAC. The trial court entered judgment in favor of defendants and plaintiff appealed.

2. Issue: Whether the defendants, in their capacity as directors and officers of both corporations, wrongfully usurped a corporate opportunity belonging to Agau and whether all defendants wrongfully profited by causing Agau to exercise an option to purchase that opportunity?

3. H&R: a. Where defendant officers, directors, and shareholders of the first

corporation had held a significant interest in the second corporation which was acquired by the first corporation, burden was on those defendants to show the intrinsic fairness of the transaction, and that defendants met that burden.

b. In view of evidence that corporation was not in a position, either financially or legally, to accept corporate opportunity at the time that it was offered to it by the president of the corporation, president and other persons associated with the corporation were entitled to acquire the opportunity for themselves after it was rejected by the corporation.

c. Shareholders approved to exercise this option; Even though it's a conflict of interest, there's no problem because there was disclosure to the shareholders, and the shareholders still approved of exercising the option


CORPORATIONSClosely Held Corporations & Abuse of Control

I. Basic Roles & Rights of Shareholders a. Liability for corporate acts/debts 6.22(b)

i. Shareholders expect to not be liable for Corp debts/actsii. Once they pay for their share, not personally liable for acts of corporations simply

by being shareholdersb. Have “preemptive rights” IF in articles 6.30

i. What are they?1. A right that a SH might have to buy new shares as they're being sold for the

first time by the corporationa. If your stock has preemptive rights, you get first dibs on newly

issued shares before going to publicb. Allows you to maintain your percentage ownership of the

corporation2. Don't have preemptive rights unless the corp's articles of incorporations

say you do3. Generally seen with smaller corporations

a. Where people are concerned with having a particular ownership percentage of their corp; want to prevent dilution by entrance of new shareholders

b. Large corps not overly concerned; individuals generally have small %

i. .002% of IBM doesn't give you much "pull"c. Receive Dividends IF declared 6.40

i. Power of Board of Director's (BoD) to authorize dividends to SH's1. Right to receive distributions if declared by BoD's2. Big "IF"- at discretion of BoD

d. Annual Meeting 7.01i. Annual meeting of SH's; vote on matters before them;

1. Typical matter is voting for directors

e. Votes per share 7.21i. Usual is 1 vote per share, except as otherwise provided by the articles of

incorporation (Benihana - 1 share=1/10 vote)

f. Proxy Voting OK 7.22 i. Have someone else cast your vote on your behalf

1. If not able to go to the meeting, can still cast your vote through TP

g. Elect directors by plurality (7.28)i. No director needs majority; just plurality

ii. Compare 7.25:

h. May bring derivative suit (7.40-7.46)i. Shareholders can bring derivative suits

1. COA on behalf of the corps- reedy for damages against the corpa. Any damages recovered belong to the corp rather than the

shareholders2. Assume much more active role than usual;

a. Dir's and officers are often the D's in these casesb. Need to inform BoD's of lawsuit to bring action


i. Vote on conflicting interest transactions (8.63), business opportunities (8.70); amend articles (10.03); some mergers (11.04)

i. is it okii. Vote on taking of bus opportunity

iii. Other extraordinary/rare actions1. Decision of BoD to amend articles req shareholder approval

iv. Mergers1. Shareholders must approve merger deal in order to go through

j. PLUS any extra rights for “preferred stock” (6.01)i. Dividend and/or liquidation preference

ii. Preferred stock gives additional rights1. Special rates, etc would be set out in articles of incorporation2. First crack at dividends3. Liquidation preference

a. If corp is dissolved, whatever is leftover is left to shareholders, but preferred shareholders might get a set amount per share BEFORE regular shareholders

II. Bylaw Provisions – Shareholders a. 2.5 Action at Meeting [of Shareholders]

i. [A] majority of the votes entitled to be cast . . . shall constitute a quorum . . . . [I]f a quorum . . . exists, (1) favorable action on a matter, other than the election of directors, is taken . . . if the votes cast . . . favoring the action exceed the votes cast opposing the action, & (2) directors shall be elected by a plurality of the votes cast.

b. 2.6 Voting and Proxiesi. [E]ach share shall have one vote on any matter to be considered at the meeting.

Shareholders may vote either in person or by proxy . . . . c. 2.7 Action by Consent

i. Any action required or permitted to be taken at a shareholders' meeting may be taken without a meeting if the action is taken . . . by all shareholders entitled to vote . . . . [as] evidenced by . . . written consents . . . .

III. Galler v. Galler, 32 Ill.2d (1964) a. Facts: 2 brothers owned a drug company. Owned it together 1919-24. In 1924 it was

incorporated business- 50-50. Sold 12 total shares to employee, sold back to only one brother. In 1955 there was an argument that when 1 died spouse would receive salary to support family. 1 brother died, other brother denies intent to honor agreement. Son took control of co. Wife filed suit.

b. Issue: whether public policy requires invalidation of shareholders' agreement?c. H&R:

i. Dealings Between Shareholders or Members of Same Corporation: Unless agreement is part of corrupt scheme, agreements between stockholders dealing on equal terms should be invalidated on grounds of public policy only where corrupt or dangerous tendency clearly and unequivocally appears on face of agreement or is necessary inference from matters expressed.

ii. For purpose of determining whether public policy requires invalidation of shareholders' agreement, a “close corporation” is one in which stock is held in a few hands, or in few families, and wherein it is not at all, or only rarely, dealt in by buying or selling.

1. Where corporation was close corporation, clause of stockholders' agreement providing for election of certain persons to specified offices for period of years did not require invalidation.

iii. Where the agreement was not a voting trust but a straight contractual voting control agreement which did not divorce voting rights from ownership of stock in a close corporation, the duration of the agreement, which was interpreted as continuing so


long as one of the two majority stockholders lived, did not offend public policy and did not render the agreement unenforceable.

IV. Share Agreement Provisions a. Directors

i. Husbands or wives would serve as Directors (people are the SH's, and maybe other members of the family. They will run/be directors of the corp). Court leaves this stuff usually alone. Usual role shareholders play- electing directors. If they want to agree to this ahead of time, courts feel confident to allow them to have the agreement and enforce that provision

b. Officersi. Upheld provisions in the past where persons are specified as officers for a certain

amount of time. 1. In these agreements, careful deliberation by those who created them. 2. Less of a reason to invalidate them by the court

a. Historically, courts were reluctant to enforce this ( job of directors)ii. In close corp, where shareholders are in agreement as to who Dirt's are to be,

wouldn’t they agree on who the officers would be too?1. Cts recognize this and took more modern approach- as long as no minority

shareholders are objecting, where's the problem? .why should it not be enforced? ( rhetorical)

c. Annual dividendsi. Up to Director's to decide

1. Min. annual div of 50k, limited so long as annual surplus is 500k. Below that affects dividend

a. Ct approves, min surplus protects corp, no reason to have a problem with the annual dividend

b. Protects corp and creditorsi. With protection in place, no problem. No harm caused by

requirementd. Salary continuation

i. Surviving spouse receives 2x annual amount paid to husband for 5 yrs. following death

1. Court sees these agreements as a common feature of corp exec employment2. Limit protection for tax-deductible basis for corp

a. Built-in protection for corp agreed to by both parties3. Historically, waste of $. Both sides agreed already; A-ok!

ii. Right of first refusal if want to sell shares1. If one bros wanted to sell shares, before selling to outsider, had to offer to

other shareholdersa. After current shareholders accept/pass, goes off to publicb. Concerned for outsiders to come in and take over corpc. Commonly doned. Shareholder only matter; courts have no problem with this either

e. Courts Conclusioni. All this seems ok; no problem

ii. Closely held corp1. These things are common ebay case shareholders are in this situation with

potential to be taken advantage of by shareholders. Protects their interests ahead of time

f. Other factors to support enforceabilityi. No apparent public injury

1. No way public could be injured by enforcement of this agreementii. Absence of complaining minority interest

1. No min shareholders


iii. No apparent prejudice top creditors1. No injury to creditors either2. Financial limitations in agreement protects creditors

iv. No clearly prohibitory statutory language is violated1. Haven't agreed to something they're not lawfully allowed to do

V. “Freeze Out”a. Meaning – when the majority frustrates the minority’s reasonable expectations of benefit

from their ownership of shares b. Techniques

i. May refuse declare dividends ii. May drain off the corporation’s earnings in the form of exorbitant salaries and

bonuses to the majority share-holder offers and perhaps to their relatives, or iii. Deprive minority shareholders of corporate offices and of employment by the

companyiv. May cause the minority shareholders to sell out its shares at an inadequate price.

VI. Donahue – duties of shareholders in close corporations:a. Standard: strict good faith and loyalty standard. b. Rationale/Concern:

i. Stockholders in the corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another.

ii. Stockholders in close corporations must discharge their management and stockholder responsibilities in conformity with this strict good faith standard. They may not act out of expediency, or self interest, in derogation of their duty of loyalty to the other stock stockholders and the corporation.

VII. Abuse of Control: a. Wilkes v. Springside Nursing Home, Inc. 370 Mass 842 (1976)

i. Facts: Wilkes acquired an option to purchase a building and lot and organized a corporation and used the lot as a nursing home. At the time of incorporation it was understood by all the parties that each would be a director of the nursing home and each would be active in the management and decision making involved in operating the corporation. Eventually bad blood formed between the directors and Wilkes attempted to sell his shares. At an annual meeting Wilkes was not reelected as a director, or reelected as an officer, and left off a list of those who were paid. Despite the strained relationship, Wilkes continued to consistently carry out his responsibilities in a satisfactory manner.

ii. Issue: Was there a legitimate business purpose, if any, against the practicability of a less harmful alternative

iii. H&R: There was a freeze out with no legitimate business purpose. At a minimum, the duty of utmost good faith and loyalty would demand that the majority consider that their action was in disregard of a long-standing policy of the stockholders.

1. Rule: Must balance right to “selfish ownership,” against duty to the minority shareholders.

2. Two-Prong Test:a. Prong 1: Controlling group must show legitimate business purpose, b. Prong 2: If it does, then minority must show same goal could have

been accomplished by alternative course of action less harmful to minority’s interest

c. Court’s role: weigh legitimate business purpose against practicability of less harmful alternative

iv. Aftermath of Wilkes1. Some states have adopted the 2-prong test. 2. Some states have only followed by taking the first prong of the test.


3. Possible solutions in Galler/Wilkes scenarios a. Buyout by the majority shareholders b. Dissolution of the corporate assets by the shareholders c. Dissolution by a court

b. Brodie v. Jordan, 447 Mass. 866 (2006) i. Facts: Malden is a MA corporation that operates a machine shop. The plaintiff’s

deceased husband, Walter, was one of the founding members. Jordan was also a director. Walter and Jordan each held 1/3 share. Walter made requests for the company to buy his shares but they were rejected. Plaintiff asked D to perform a valuation of the stock, but it was never made.

ii. Issue: Whether Plaintiff was entitled to the remedy of a forced buyout of shares by the majority?

iii. H&R: No, a buyout would have put her in a better situation than she is entitled to and she would have enjoyed a position significantly better than she would have absent wrongdoing and would have exceeded her reasonable expectations.

1. Rule: Stockholders in a close corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another.

2. The proper remedy for a freeze out is “to restore the minority shareholder as nearly as possible to the position she would have been in had there been no wrongdoing.”

VIII. Summary: Devices/Strategies for Control in Closely Held Corporations a. Shareholder agreements - these are very important (some consider malpractice if as an

attorney you don’t suggest this). They typically consist of:i. Electing directors, choosing officers, buy-out opportunity, etc.,

ii. See MBCA Sec. 7.32 – Very open ended, gives you room to agree to almost whatever you want.

b. Special statutory provisions (where available) i. A set of provisions that allows you to choose close corporation status allows for

management by shareholders, etc. c. “Bail out” via court-ordered dissolution/buyout

i. Brodie case was reluctant to order a buyout. d. Organize instead as limited liability company (LLC) under LLC statute

i. Can choose to be managed by “members” (like partnership) or “managers” (like corporation)


Introduction to Federal Securities Law:Securities Act of 1933Disclosure & Fairness

I. Trading in corporate securities, such as stocks or bonds, takes place on 2 basic types of markets:a. Primary Market – the issuer of the securities i.e. company that created the securities-sells

them to investorsb. Secondary Market – investors trade securities among themselves without any significant

participation by the original issuer. i. Securities Exchange Act of 1934 – principally concerned with secondary market

transactions, such as insider trading, corporate insiders, and regulation of shareholder voting.

II. Securities Act of 1933 – primarily concerned with the primary market. In drafting it Congress was concerned with 2 goals: mandating disclosure of material information to investors & the prevention of fraud.

a. Anti-Fraud Rule i. Plaintiffs have an easier time when they bring a suit under securities laws than they

would if they had to bring a suit under state common law fraud rules.

b. Securities i. Stock (aka equity securities) – represents ownership interest in corporation

common, preferred, etc., ii. Bonds etc. (aka “debt securities”) – represent debt owed by the corporation to the

bondholder; example: notes, bonds, and debentures. 1. Debt Securities is when the corporation borrows money from the public.

c. Basic Rule – Must register with Securities & Exchange Commission (SEC) before you can sell any securities to the public, UNLESS you have an exemption.

i. Congress was trying to stop fraud so that the stocks wouldn’t crash again. Congress was very concerned about fraud as well; they focused on disclosure requirements so that people would have all the information before they invested.

d. Section 5 – Registration i. Cannot offer to sell stock, etc. before filing a “registration statement” AND

ii. Cannot sell stock, etc. UNTIL:1. Stock is REGISTERED* with the SEC &

a. Even though a stock is registered it doesn’t mean the SEC is saying it’s a good investment, they are simply saying that in comparison to other stocks that stock has fulfilled the disclosure requirements.

2. Buyer of stock received copy of the PROSPECTUS – Can’t take people’s money until you give them a prospectus.

a. What is the prospectus? Kind of info included? Prospectus includes key disclosure/sales document; = core of the registration statement

i. General information about the businessii. Information about the stock, what kind of rights an

individual will get by purchasing it. iii. NOTE: Prospectus has conflicting purposes/goals

1. It’s a disclosure document, but it’s also a sales document, leads to tricky issue to those who draft it, people who won’t disclosure and those who sell.

iv. *“Registered” = SEC signed off on registration statement’s compliance w/ disclosure requirements in SEC registrations., NOT on merits/value of the stock, etc.…UNLESS an EXEMPTION is available


e. 1933 Act – Liability i. Common law fraud – liability for misrepresentation of a material fact vs. 1933 Act.

In common law fraud cases there was no liability for omissions. ii. 1933 Act – liability for misrepresentation OR omission; creates:

1. Private right of action & 2. Basis for criminal prosecution

iii. Other foundations for 1933 Act liability:1. Not registering when should have2. Failing to deliver prospectus

III. When is a Sale Exempt from the Registration Requirement?a. Exempted securities

i. Ex. issued by US or a state ii. Ex. issued by a bank

b. Exempted transactions i. Ex. not involving a “public offering”

ii. Ex. small offering of securities; $ limit; limited amount of people with limited about of money.

iii. Ex. offering (within $ limit) of securities to “accredited investors” ( = institutions & wealthy/ sophisticated individuals)

c. NOTE: If exempt from registration requirement, the corporation still cannot commit FRAUD.

d. Private Offering Exemption: i. Doran v. Petroleum Management Corporation

1. Facts: Doran bought unregistered LP interest (= a security); sued for Securities Act violation (alleging that the company had failed to register. PMC’s defense was that it was exempt from having to register because they had a private offering. Sec. 4(2) language: “transactions by an issuer not involving any public offering” – this does NOT define what a private or public offering is. The court determined that it was a small amount of offerings, but the key focus is whether there was disclosure?

2. Issue: Was there disclosure? Did Doran have a realistic opportunity to learn about the facts essential to making a good investment?

3. H&R: The court is not concerned with the small amount of units offered, the relatively modest financial stakes or the offering being characterized by personal contacts. The problematic factor is the number of offerees, there were only 5 and Doran found out about the stock through a broker who knew PMC, Doran did not know PMC personally himself.

a. Requirements to qualify for 4(2) -- 4 factors:i. Number of offerees & relationship to each other & issuer

ii. Number of units offerediii. Size of the offeringiv. Manner of the offering

b. Doesn’t matter how sophisticated an investor is, they must have all the information a registration document would give them. Sophistication is not a substitute for access to the information that registration would disclose.


IV. Pros and Cons of Registration a. Cons

i. Cost of Process - Very expensive to register, lots of filling fees ii. Time commitment to the process - Might require the company to go back and fix

forms if SEC don’t approve itiii. Disclosure concern (initial, ongoing)

b. Compare to the Pros: Benefits of registrationi. Distribution to wider market- Registered stocks can be sold publicly, meaning

more people and potential for high sales. ii. Ease of sale (b/c of ease of re-sale) - Because the stocks are registered anyone can

buy it and re-sell it. If someone buys stock that was exempt from registration they will have a very difficult time re-selling it, the exception would be that if an individual bought stock they could re-sell if they are also exempted, safe harbor rule 144.

iii. Psychological appeal of Initial Public Offerings (IPO) - Have the feeling that you made it. That you are selling stock in your company.

c. Other Exemptions i. Regulation D

1. Provides a series of safe-harbors that issuers can use to come within the private-placement exemption and avoid or reduce their required disclosure.

ii. Safe Harbor Rule: Rule 144 1. Subject to various qualifications, the rule allows buyers to resell stock they

acquire in a Regulation D offering if they first hold it for 1 year and then resell it in limited volumes.

V. Disclosure & Exchange Acta. Covered corporations must register with the SEC by filing an initial Form 10. b. The corporation thereafter must annually file a form 10-K, which contains audited financial

statements and management’s report of the previous year’s activities and usually also incorporates the annual report sent to shareholders.

c. 10-Q must be filed for each of the 1st three quarters of the year. It must contain unaudited financial statements and management’s report on material recent developments

d. Form 8-K must be filed within 15 days after certain important events affecting the company’s operations or financial condition.

VI. Attorneys’ Rolesa. Where are the attorneys? Issuer, UW, SECb. Prepare reg. statement/prospectus (issuer/UW)

i. Under Writers’ attorneys.’ role – “due diligence” review1. Review corp. minute books, articles & bylaws, annual & other reports, etc.2. Interview corp. officers, etc.3. Goal – conduct reasonable investigation re: accuracy & adequacy of

disclosure in reg. statement. c. Prepare other deal documentsd. Prepare closing documents


SECURITIES FRAUD & INSIDER TRADING

I. Securities Exchange Act of 1934 – Congress is focused on securities transactions/matters after initial issuance by corporation; covers:

a. Securities fraud, including insider tradingb. Periodic public disclosure requirements

i. Must be a continuing obligation to disclose information. c. Annual, quarterly, certain events, insiders’ trades

i. Must file annual reports with SEC.d. Takeover regulation

i. The process of how one corporation takes over another corporation. e. Proxy regulation

i. Giving someone else authority to hold their shares at the meeting.

II. 1934 Act – Rule 10b-5’s Breadth a. Applies to all persons.b. Covers . . .any public or private.

i. Untrue statements of a material fact/omissions of material facts 1. Failure to tell the truth and lying. 2. To engage in any act, practice, or course of business which operates or

would operate as a fraud or deceit upon any person. 3. . . . in connection with the purchase or sale of any security

ii. Deals with any securities. 1. i.e., securities fraud in general2. Insider trading3. Other kinds of fraud, deceit, etc.

c. Provides a FEDERAL remedy for securities fraud.

III. Rule 10b-5: SEC v. TX Gulf Sulphur Co., 401 F.2d 833 (1969) a. Facts: They did an exploratory dig and found valuable mineral, but they didn’t want to drive

the price of the land up so they put a gag order on all its workers. Rumors spread that the company was going to strike a large amount of minerals. In order to calm the growing rumors it released a statement stating that their drills were in the ordinary course of business and it was nothing to speculate about. The court below found that two of the defendants had violated Section 10(b), and Rule 10b-5, but otherwise the Commission's complaint was ordered dismissed. Appeals were taken. Court of Appeals held that not only are directors or management officers of corporation ‘insiders' within meaning of rule of Securities and Exchange Commission, so as to be precluded from dealing in stock of corporation, but rule is also applicable to one possessing information, though he may not be strictly termed an ‘insider’ within meaning of Securities Exchange Act, and thus anyone in possession of material inside information is an ‘insider’ and must either disclose it to investing public, or, if he is disabled from disclosing it in order to protect corporate confidence, or he chooses not to do so, must abstain from trading in or recommending securities concerned while such inside information remains undisclosed.

i. 2 claimed Rule 10b-5 violations1. 10b-5(1): Trading “on the basis of” material nonpublic information in

insider trading cases. 2. 10b-5(2): Duties of trust or confidence in misappropriation insider trading

cases. b. H&R:

i. All transactions in TGS stock or calls by individuals apprised of the drilling results of K-55-1 were made in violation of Rule 10b-5.


ii. It was the intent of Congress that all members of the investing public should be subject to identical market risks.

iii. No inside trading! - Purpose of provision of Securities Exchange Act that it shall be unlawful for any person, directly or indirectly, by use of any means or instrumentality of interstate commerce, or of mails, or of any facility of any national securities exchange, to use in connection with purchase or sale of any security any manipulative or deceptive device in contravention of rules of Securities and Exchange Commission was to prevent inequitable and unfair practices and to insure fairness in securities transactions generally, whether conducted face-to-face, over the counter or on exchanges. Securities Exchange Act of 1934, § 10(b)

c. Insider trading claim i. Duty of “anyone” with material inside info:

ii. Test of materiality:1. Balancing aspect of test:

iii. Application to K-55-1 discovery & related IT:1. Material? Any thing that could affect the stock price. Anything the average

and reasonable investor would want to know about when they are buying/selling the stock.

2. Trades violated the law? Yes.

IV. Insider Trading: Dirks v. SEC a. What did Secrest & Dirks do, and why?

i. Secrest asked Dirks to investigate alleged fraud at Secrest’s corp., EFA, which Dirks did; Dirks told others about his suspicions; did it to expose fraud & never traded or benefited himself

b. What was Dirks charged with & what duty did the SEC argue he had as a “tippee”?i. Charged with aiding & abetting Rule 10b-5 violation by repeating fraud allegations

to others who traded their EFA stock ii. SEC said that he knew that the info was confidential and came from an insider so he

had a duty, inherited from the insider, to disclose or abstain (p. 484); he breached his duty by tipping potential traders (p. 485); b/c the SEC thought his action brought a fraud to light, however, he was just censured (p. 484)

c. What did Chiarella say about the basis for 10b-5 liability & the disclosure duty?i. To show a Rule 10b-5 violation, must show:

1. Relationship giving access to info only for corp. purposes and2. Unfairness of allowing insider to use info for trading w/o disclosure (p.

484) 3. The duty, it does not exist where the person who traded was not the

corporate agent, was not a fiduciary, & was not someone in whom the sellers of securities had placed their trust & confidence (p. 485)

ii. Chiarella – there must be a fiduciary duty that has been breached for a 10b-5 violation.

1. C was charged with insider trading. 2. First time SEC went after someone on criminal prosecutions. 3. At the Supreme Court, the question is whether Dirks was properly indicted?

The Court says no, that he didn’t violate Rule 10b-5

d. BUT it was UNCLEAR how all of this applied to TIPPEES, who, unlike insiders, usually have NO relationships/duties re: corp. and its SHs, SO it was unclear how a tippee inherits an abstain or disclose duty (p. 485)


e. When does a tippee have a duty to disclose or abstain?i. NOT just b/c the tippee has knowingly received nonpublic material info from an

insiderii. only inherit duty if info was made available to them IMPPOPERLY, i.e., in breach of

insider’s duty (p. 487)iii. WHEN IS THE INFO MADE AVAILABLE IMPROPERLY? (p. 488)

1. When the insider will benefit, directly or indirectly, from the disclosure2. SO if insider received no personal gain, then giving the tip did not breach a

duty to SHs, so there’s no derivative breach

f. Application to Dirks? Result?i. Dirks was a stranger to EFA (so no personal duty to SHs, etc. – p. 488) & did not

illegally obtain the info, so he had no duty unless Secrist breached a duty in tipping him, which he did not – no personal benefit or purpose of giving gift, etc.

ii. Dirks therefore had no duty to SHs that was breached

V. U.S. v. O’Hagan a. Even if you were not breaching a duty as an insider, if you can be seen as misappropriating

information that can be the basis of a 10b-5 violation. b. O’Hagan was a partner in a firm, the firm was retained to tender an offer to take over

another company. Early on O’Hagan he bought a lot of stock and options to stock, he owned more than any other individual investor, over the company that was buying over. He ended up making a large sum of profit by taking advantage of the advance notice of the take over.

c. Basic question – Does federal insider trading law reach beyond the “classical” form of insider trading?

i. Distinguish: 1. corporate insiders (including temporary) - Classic kind if someone is a

corporate insider and they trade in their own stock, which breaches their fiduciary duty. Temporary insiders also have an obligation not to inside trade.

vs.2. outsiders

d. Def.’s actions re: “material” inside info:i. He’s misappropriating information from his client. Him and his client received

information from a client that was buying over another company, but then he took that information, deceptively, and for his own purposes and profit and bought stocks. The Court finds that he misappropriated the information.

e. Traditional/Classical Insider Theoryi. Content of Duty? – to refrain or disclose information

ii. Source of Duty? – source is that you have a relationship of trust and confidence with that corporation, which gives rise to a duty to abstain from disclosing.

iii. Duty owed to whom? It’s owed to the corporation, and shareholders of the corporation.

f. Misappropriation Theory i. Content of Duty? Making use of the information for your own purposes. If you want

to do something with that information then you need to ask/inform that you would use that information to trade/by stock.

ii. Source of Duty? It’s the relationship you have with the source, the relationship of loyalty and confidentiality.

iii. Duty Owed to Whom?


g. Court’s view of misappropriation theory: Look at 1934 Act, Sec. 10(b)i. “Deceptive device”? – fraudulent conduct

ii. “In connection w/ purchase/sale of a security”? - Yes, he ultimately went

h. Rule 14e-3(a); if they can’t get the person under a 10b-5 violation, the SEC can try under Rule 14e-3(a). Anyone who has information that is not public and takes substantial step(s) to commerce, commenced or tenders an offer will have committed a fraudulent, deceptive or manipulative act or practice.

VI. Summary: Insider Trading – Scope of Rule 10b-5 a. Corporate insiders: violate 10b-5 by if trade in corp.’s stock on basis of confidential info

b/c owe fiduciary duty to corp. & its SHsi. “Permanent” insiders: directors/officers

ii. “Temporary” insiders/fiduciaries: attys., etc.

b. Corporate outsiders: violate 10b-5 if make use of tip improperly given by insider (Dirks) OR misappropriate and trade on confidential info in breach of duty of trust or confidence owed to the source of the info (O’Hagan)

i. Rule 10b-5 DOES NOT REACH other “outsiders” w/ no inherited duty, duty of trust & confidence, etc.

1. ex. Barry Switzer case; eavesdropper – q. 2 489, Switzera. Not liableb. Dirks: “there is no general duty to disclose before trading on

material nonpublic information”; duty to disclose arises from “the existence of a fiduciary relationship” (p. 484)

ii. Compare general “outsiders”:1. Chiarella (1980)

a. Defendant (corp. “outsider”) relied on non-public info to trade BUT defendant was not a corporate “insider” – NOT LIABLE under Rule 10b-5 because there was no “duty of trust and confidence” between Chiarella and the SHs of the corps. whose shares he traded

VII. Policy & Penalties a. Why prohibit insider trading? Why not just treat IT profits as a “perk” for corporate

insiders?i. Property rights

1. If someone is inside trading, they are using trading on someone else’s property rights. This is a violation of that person’s property rights.

ii. Fairness1. People who have access to the info and trade on it have an affect on the

stock market. It’s an unfair advantage. iii. Market confidence

1. If others in the market feel that there are people involved in insider trading they won’t want to risk putting their money and investments in the market.

iv. Perverse incentives1. If people know they can take advantage of the market they might withhold

information so that they can have an upper hand. They will recognize that corporate officers are in a position that they can make money if they take part in insider trading.

b. Available penalties: criminal prosecution (willful violations), civil penalties (including treble damages), liability to contemporaneous traders, disgorgement of profits, etc.; informant bounties


VIII. Insider Trading & Attorneysa. Can be corp. “insiders” as to corp. whose material non-public info they have access to:

i. “Permanent” (ex. Directors/officer of a corp.) orii. “Temporary” insiders/fiduciaries (such as attorneys doing some legal work for

corp.)iii. Corporate insiders violate 10b-5 by trading in corp.’s stock on basis of confidential

info b/c owe fiduciary duty to corp. & its SHs

b. Can be corp. “outsiders” but STILL may be prohibited from trading on inside info -- ex. O’Hagan (misappropriation theory)

i. Corporate outsiders: violate 10b-5 by trading when inherited duty from tipper or by misappropriating confidential info for trading purposes in breach of duty of trust or confidence owed to the source of the info

1. ex. attorney uses info received from law firm client to trade in the stock of another corporation

c. Example of yielding to temptation: what NOT to do during your first month at a Wall Street firm – the Craig Spradling story . . .


THE LIMITED LIABILITY COMPANY (LLC)

I. Limited Liability Company (“LLC”) Basics a. What is it?

i. It’s an alternative form of business organization that combines certain features of the corporate form with others more closely resembling general partnerships.

ii. LLC investors are called members.iii. Like a traditional corporation, the LLC provides a liability shield for its members,

while allowing for more flexibility than the corporation in developing rules for management and control.

b. Advantageous Tax Treatmenti. The LLC offers advantageous tax treatment, in comparison to a corporation.

ii. Investors in an LLC are taxed, like partners, only once on its profit1. Can elect pass-through tax treatment (like partnership or “S corp.”): =

owners alone pay tax on entity’s income iii. Versus a corporation, which is like a double tax because shareholders pays tax on its

profits earned and then pay a second tax when those profits are distributed to them.1. Double taxation (= usual “C corp.” taxation) – entity pays tax on its income

& owners also pay tax when they get some of it (ex. dividends)

c. Compare with a Limited Liability Partnership (LLP): i. Most LLP statutes provide limited liability only for partnership debts arising from

negligence and similar misconduct (other than misconduct of which a partner is directly responsible for), but not for contractual obligations. This is a narrow shield.

ii. A few provide protections for both contract and tort claims/liabilities – this is a broad shield.

II. Formationa. Formation of an LLC, like formation of a corporation, requires some paperwork and filings

with a state agency. b. Distinct entity

i. S. 201 of Uniform Limited Liability Company Act (ULLCA)1. A LLC is a legal entity distinct from its members.

ii. like corp. (and partnership under 1997 UPA)

c. Participants = member(s) (and managers)i. The default is for an LLC to be managed by members. If you want otherwise, it has to

be stated.

d. Organization s. 202 i. One or more members may organize an LLC.

e. Content of Articles (203):i. An LLC must have articles of organizations similar to that of a corporation. It

must set forth 1. Name of the company2. Address 3. Name & address of initial agent for service of process4. Name & address of each organization5. Whether company is to be term company6. Whether company is to be manager-managed (default for LLC is that it’s

member managed).


ii. Comply with LLC name requirements, i.e., must contain “limited liability company,” “limited company,” “LLC,” “LC” (s. 105)

f. Members MAY decide to enter an operating agreement (103) i. An operating agreement is a mix of corporate by-laws and a partnership agreement.

ii. It provides the maximum flexibility in creating a business structure tailored to the members’ particular needs and desires.

III. Relation of Managers & Members (& Therefore the LLC) to Third Parties

a. The LLC may be managed by all its members (as in a partnership) or by managers, who may or may not be members (as in a corporation).

b. Agency/authority – Who are the agents?i. Participants -- either members or managers

ii. In member-managed LLC (301(a)) -- like partnershipiii. In manager-managed LLC (301(b)) -- like corp.

c. S. 302 LLC liability for third party losses for wrongful acts or omissions, etc. like UPAi. An LLC is liable for loss/injury caused to a person as result of a wrongful act or

omission of a member or manager acting in the ordinary course of business of the company or with authority of the company.

d. S. 303 Limited liability– like corp.i. Note no “piercing” for failure to observe formalities, etc.

ii. A manager or member is not liable for a debt, obligation or liability of the company solely by reason of being or acting as a member or manager.

IV. Water, Waste & Land (“Westec”) v. Lanham, 955 P.2d 997 (199) a. Facts: Third party brought suit against agents for limited liability company (LLC), and LLC

for amount due on contract for engineering services. Lanham & Clark were both members/ managers of Preferred Income Investors, L.L.C (PII LLC). Clark contacted Westec about having some work done. Clark gave the Westec rep a business card that read, “P.I.I.” (w/o “LLC”) and had Lanham’s address, the card had no indication of LLC or what PII stood for. Westec proceeded to do the work on Clark’s instruction and later billed Lanham. County court entered judgment in favor of Westec, finding that Clark was an agent of Lanham and the company, there was a valid/binding K, Westec didn’t know of a business entity. District Court reversed relying in part on the notice provision of the LLC Act, which provides that the filing of the articles of organization serve as constructive notice of a company’s status as a LLC.

b. Issue: Is Lanham liable under agency law, or not b/c of LLC stat. notice provision?c. Court:

i. Applicable legal principles:1. Common law of agency an agent is liable on a contract entered on behalf

of a principal if the principal is not fully disclosed. An agent who negotiates a contract with a 3rd party can be sued for any breach of the contract unless the agent discloses both the fact that he or she is acting on behalf of a principal and the identity of the principal.

2. Altered by statute? Statutory notice provision applies only where a 3rd party seeks to impose liability on an LLC’s members or managers simply due to their status as members or managers of the LLC. The LLC Act’s notice provision was not intended to alter the partially disclosed principal doctrine.


ii. Outcome: Ct--notice provision does not trump common law agency rule-partially disclosed principal (agent is party to a contract and liable where existence of principal is known but not his identity).

iii. Rules:1. Agent who negotiates contract with third party can be sued for any breach

of contract unless agent discloses both fact that he or she is acting on behalf of principal and identity of principal.

2. Duty to disclose identity as well as existence of principal lies with agent.a. The legislature did not intend the notice language to relieve the

agent of a LLC of the duty to disclosure its identity in order to avoid personal liability.

3. Agent is liable on contracts negotiated on behalf of “partially disclosed” principal; that is, principal whose existence-but not identity-is known to other party.

4.d. SO what must members do to avoid liability?

V. Management Rights - Management (404) & Distributions (405)a. In member-managed LLC 404(a):

i. Each member has equal right to manage and conduct the company’s businessii. Except for 404(c) most matters may be decided by a majority vote

b. In manager-managed LLC 404(b): i. Each member has equal right to manage and conduct the company’s business

ii. Any matter relating to the business of the company may be exclusively decided by the manager or if there is more than one manager then a majority.

iii. Selected by membersc. Matters requiring unanimous member vote 404(c):

i. Amendment of the operating agreement ii. Authorization of acts or transactions that would violate the duty of loyalty.

iii. An amendment to the articles of organization iv. Compromise of an obligation to make a contribution under s.402(b)v. Admission of new member

vi. Consent to dissolve company vii. Consent to merge companies

viii. And more… d. Distributions – equal shares 405(a)

i. Any distributions made by a LLC before its dissolution and winding up must be in equal shares.

VI. Piercing the LLC Veil (?) a. Limited liability s. 303

i. (a): Basic rule 1. A manager or member is not liable for a debt, obligation or liability of the

company solely by reason of being or acting as a member or manager. ii. (b): “Piercing” for failure to observe formalities

1. The failure to observe usual company formalities or requirements relating to the exercise of its company powers or management of its business is not a ground for imposing personal liability on the members or managers for liabilities of the company.

iii. (c): exception allowing for member liability1. Members can be liable for specified debts, obligations if

a. (1) a provision to that effect is contained in the articlesb. (2) the member has consented in writing to the adoption of the

provision or to be bound by it.


b. Kaycee L. and L. v. Flahivei. Facts: Flahive is a LLC with no assets. Kaycee entered into a contract with Flahive

allowing Flahive to use the surface of its real property. P alleges damages to the land and seeks damages, seeking to pierce the LLC veil and hold D personally liable. This was sent as a certified question of law to the MN Supreme Court. The Ds argue that the legislature did not intend for LLCs members to be personally held liable. Court doesn’t buy it.

ii. Issue: Could piercing doctrine apply to all LLC’s?iii. H&R:

1. Every state that has enacted LLC piercing legislation has chosen to follow corporate law standards and not develop a separate LLC standard.

2. There is no reason to treat LLCs differently than corporations. If the members and officers of an LLC fail to treat it as a separate entity as contemplated by statute, they should not enjoy immunity from individual liability for the LLC’s acts that cause damage to 3rd parties.

3. Keep in mind that LLCs are designed to be more flexible than corporations s. 303(b)

VII. General Standards of Member’s and Manager’s Conducta. 409(b) Duty of Loyalty

i. To account and to hold as trustee for it any property, profit or benefit derived by the member

ii. Refrain from interests adverse to the companyiii. Refrain from competing with the company

b. 409 (c) Duty of Carei. Refraining from engaging in grossly negligent or reckless conduct, intentional

misconduct or a knowing violation of law.

c. 409 (d) Good faith & fair dealingi. Shall discharge duties and exercise any rights with good faith and fair dealing.

d. Manager-managed 409(h)i. Members who are not managers owe NO DUTIES to the company or to other

members. ii. Managers: are held to the same standard of conduct as for above

VIII. Fiduciary Obligationa. McConnell v. Hunt

i. Facts: Member of LLC formed for purpose of investing in and operating professional hockey franchise, who had created separate corporation which competed with company and obtained expansion franchise, brought declaratory judgment action along with second member against company and its other members. The Court of Common Pleas granted declaratory judgment that plaintiffs had not violated any fiduciary duties or committed any other tortious conduct, dissolved limited liability company, and awarded attorney fees to plaintiffs. Appeal was taken, and the Court of Appeals, held that:

1. (1) operating agreement expressly allowed plaintiffs to compete with company in seeking franchise;

2. (2) plaintiffs were properly granted leave to amend complaint; 3. (3) plaintiffs could properly seek declaratory judgment that they had not

violated any fiduciary duties; 4. (4) no fiduciary duties were breached during competition for franchise; 5. (5) company was properly dissolved after plaintiffs obtained expansion

franchise and company's reason for existence was eliminated; and


6. (6) award of attorney fees to plaintiffs was an abuse of discretion.ii. H&R:

1. Affirmed.2. Operating agreement of limited liability company formed for purpose of

investing in and operating professional hockey franchise, which expressly provided that members of company were not prohibited from or restricted in engaging or owning an interest in “any other business venture of any nature,” including any venture which might be competitive with business of company, allowed members of company to compete against company in seeking award of expansion hockey franchise; word “other” simply meant a business venture other than company, and did not limit type of business venture in which members could engage.

3. Member of limited liability company formed for purposes of investing in and operating professional hockey franchise did not breach company's operating agreement, which allowed members of company to compete against company in seeking award of expansion hockey franchise, when he formed separate corporation for sole purpose of competing directly with company's application for expansion franchise without first obtaining vote of all members of company; because member's acts were not taken on behalf of company, operating agreement's approval requirements were not implicated.

b. Key factor: terms of Operating Agreement

IX. Distributional Interests, Dissociationa. Member’s Distribution Interest (501 etc.)

i. (a) a member not co-owner of LLC property and has no transferable interest in, property of LLC

ii. (b) a distributional interest in a LLC is personal property and subject to sections 502 and 503, may be transferred in whole or in part.

iii. (c) an operating agreement may provide that a distributional interest may be evidenced by a certificate of the interest issued by the LLC and subject of 503, may also provide for the transfer of any interest represented by the certificate.

b. Member’s Dissociation (601 etc.)i. A member is dissociated from a LLC upon these trigger events

1. Member wishes to withdraw2. Event agreed in the operating agreement causes dissociation 3. Transfer for distributional interest

c. Member’s Power to Dissociate; Wrongful Dissociation s. 602 i. A member has the power to dissociate from a LLC at any time, rightfully or

wrongfully. ii. Wrongful if…

1. Breach of an express provision of the agreement2. Before expiration of the term of the company3. Member withdraws by express will 4. Member is expelled5. Member is dissociated by becoming a debtor in bankruptcy.

d. Effect of Member’s Dissociation s. 603i. Depends on whether at will or term LLC (and if term, whether LLC will wind up &

dissolve or not – 603)
