corporations outline (holt) (prof. thomas)

8/3/2019 Corporations Outline (Holt) (Prof. Thomas)

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CORPORATIONS OUTLINE Ryan Holt

1. GENERAL CORPORATIONS INTRO(1) General Rules of Ownership, Control, and Liability

Profit is the residual interest in a business who gets whats left after everyone else getspaid? The person who gets the residual is what we think of as the owner of the business.o Ex: Simple ownership w/ employee .

Thomas owns a bunch of rental property. He hires X to manage the properties. Xhas certain control rights that have been delegated to X by Thomas, but Thomas(the owner) has the residual interest after paying Xs salary.

X has delegated authority subject to right of control and ultimate residual interest.o Ex: A creditor gets involved .

Thomas has to take out a loan to buy the properties. The lender, a bank, requires amortgage on the property (it is a condition for lending the money). Thomas has topay the mortgage payments, now, as well as the manager.

The creditor gets paid before Thomas gets paid, o/w creditor forecloses on themortgage.

A typical mortgage includes control rights for the creditorusually, negativecontrol rights, which prevent the owner from doing certain things.

The owner has positive control rights, the rights to initiate actions (but subject toveto of lender). The manager, also, has certain positive control rights subject tothe owners ultimate right of control.

General rule: the law attaches liability to control , because the controlling person isresponsible for the actions of the controlled entity if the actions result in liability of thecontrolled party.o Conversely, if one does not have control, then one does not have liability for what

another does (thus, if a manager is an independent contractor, then maybe the ownercan get around liability by showing managers actions were not controlled by owner).

o Three interests:

Owner has right of positive control and residual interest;

Manager has rights of limited control; and

Creditor has negative control rights.

(2) Five Types of Organizations Covered in Course

(1) PARTNERSHIPS.o Partners are the owners . (1) Partners have the residual intereststhey get paid after

everyone else gets paid. (2) Partners also have the right of control.o Associates are employees of the firm. They get paid a salary and benefits, but they do not

have residual interest in the firm. However, associates do have certain control rights(partners have delegated some control w/in particular sphere).

o The liability created by the associates is borne by the partners, because the partners are

the ones with ultimate control. This incentivizes the partners to create a good system.o Non-equity partners are senior members of the organization who get paid income but do

not have a residual interest. They are not owners, however, because they lack residual

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interest. They are just another form of employee.o Executive committees are delegated more control rights by the partners.

o Managing partner takes care of daily operations of business.

o Creditors may have certain negative control rights.

(2) LIMITED PARTNERSHIPS.o General Partners have control of the firms, and also receive a residual interest. They

therefore have unlimited liability.o Limited Partners contribute something (generally cash) to the business in exchange for a

percentage of the profits (residual interest). However, these are passive investors; theyhave no control rights.

B/c they have no right of control, limited partners are not liable for the otheragents of the firm.

Because we want to encourage capital formation and we are afraid that if weattach liability to everyone who invests in the business no matter what degree ofcontrol they have, we do not attach liability w/o control.

This rule creates the risk, though, that no one will be held responsible if all themoney is w/ the limited partners.

o Creditors

(3) CORPORATIONS.o Shareholders (SHs):

Contribute cash/property to the business, for which they get a piece of papercalled stock, which entitles them to percentage of profits ifdirectors say so.

Get a right to vote on the directors, who run the organization.

Have the residual interest.o

Directors : Have the control rights for the organization.

Liable for the actions of the managers as a general rule.o Managers :

Have most of the authority, which has been delegated to them by the directors.The CEO is usually the manager with the most authority.

o Creditors :

Include banks (who hold mortgages/secured credit), and bond holders (who mayhave secured credit or may not).

Once creditors go from having negative control rights to positive control rights,then the law holds them liable.

(4) LIMITED LIABILITY COMPANIES (LLCs)o Members :

Are the owners who contribute cash and get rights to residual payments.

Statutes limit the liability of the members for the managers. Hence, they can havethe residual interest and control rights but no liability.

o Managers can be either member managed or professionally managed. Basically, the

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LLC can select either the partnership rules for liability or the corporate rules for liability.

(5) LIMITED LIABILITY PARTNERSHIP (LLP)o Just like a partnership, but by statute the law allows the partners to limit their liability for

the actions of others. This also decouples control from liability.

o The states decided to disconnect control and liability in order to encourage capitalformation.

o For smaller businesses, LLCs and LLPs are enormously popular because of the limited

liability.

2. AGENTS AND EMPLOYEES(1) Creation of the RelationshipAgency Relationships.

PRINCIPAL-AGENT RELATIONSHIPo Agency is the fiduciary relation that results from the manifestation of consent by one

person (principal) to another (agent) that the other shall act on his behalf and subject tohis control, and consent by the other so to act. RSA 1(1).

The law creates CONTRACTUAL LIABILITY for principal for actions of agent.

Requirements :

The principal must tell the agent to work for him,

The agent must agree to do so, and

The principal must retain the right of control.

MASTER-SERVANT RELATIONSHIPo The 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. RSA 2(1). This is a subset of the principal-agent relationship; it requires the right to control

the physical conductof the agent.

The most common such relationship is the employee-employer relationship.o The law creates BOTH TORT AND CONTRACT LIABILITYfor the master for the

actions of the servant. The addition of tort liability is due to the increased control of theprincipal/master.

A. Gay Jenson Farms. Co. v. Cargill, Inc.; Minn 1981; pg 7.

Cargill entered into an agreement to provide credit to Warren, a local grain elevator, thatcould be used for working capital. Cargill also sought to buy grain from Warren. That K

gave Cargill access to Warrens books and gave Cargill the right of first refusal. Later,Warren acted as an agent for Cargill to buy new grain and sunflower seeds. Cargillextended the credit line after taking more control of operations, but Warren eventuallycollapsed financially.

The farmers who were owed by Warren sued Warren and also named Cargill as a jointlyliable party under a theory that Cargill was Warrens principal. Ps won at trial by jury;affirmed here, as court held that Cargill was a principal.

A CREDITOR MAY BE LIABLE for debts of another when it becomes a principal by:

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o (1) Consenting to such a relationship,

o (2) Having the agent act on its behalf, and

o (3) Exercising control over the agent.

Because Cargill assumed de facto control over its debtors businessby makingmany recommendations, by having right of first refusal, by preventing Warren

from encumbering its assets, by having right of entry, and by financing itsoperating expensesit became a principal for that debtor.

Some sort of agreement is necessary in order to create an agency, but it need notbe a contract and that need not be the intent of the parties.

The relationship here is different from that of a supplier and a buyer because thesupplier cannot be said to have had an independent businessWarren sold almostall of its grain to Cargill, and all portions of its operations were financed byCargill.

The policy argument that such a decision will discourage loans to grain elevatorsis unfounded, b/c most banks are not so actively involved in their debtors grainbusinesses; here, Cargill was first and foremost looking for grain.

The issue in this case is negative vs. positive control rights, in order to determine whether aprincipal-agent relationship was established. The reason for this is because Cargill woremultiple hatsit was a creditor, but it was also a buyer of grain, and it was arguably aprincipal.

PLANNING.o How could a creditor in such a situation refrain from becoming a principal? By not

stepping in and running the operation, by not designating their own person to makedecisions, and by not assuring the creditors of payment.

o How could Cargill avoid a situation like this in the future? If there were multiple

creditors, and the problem w/ the grain elevator was financial distress (in other words, abusiness problem as opposed to corruption/fraud, as happened in Warrens case), thenCargill could go to other creditors and try to negotiate a decrease on the debt load fromall of them in order to keep Warren solvent.

(2) Liability of Principal to Third Parties in Contract

When does the agent have authority to bind the principal when agent interacts w/ 3d parties?

P = principal; A = agent; T = 3rd party.

(A) ACTUAL EXPRESS AUTHORITYo P tells A to go forward and enter into a K with T.

o P is liable for the K with T.

o What is interesting here is the limit of As authority (i.e. could A reject or finalize a deal).

(B) ACTUAL IMPLIED AUTHORITY

o Like above, but A had to travel to negotiate the K with T. P did not expressly tell A to

incur travel expenses, but it was necessary to incur those expenses to negotiate the K.o A thus has implied authority to incur those expenses.

o This is a filling in of the things behind the actual authority so that A can complete the

task in a way agents ordinarily/customarily do that.

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o To determine the scope of actual implied authority, we have to know what the actual

express authority was.

Mill Street Church of Christ v. Hogan; Ky. 1990; pg 14.o Church hires Bill Hogan to paint its building. When Bill gets to a tough to reach spot, he

has discussions with Dr. Waggoner, an Elder, about hiring a helper. He then hires hisbrother Sam. He had hired Sam to help in the past, but the Elders did not know of it thistime until after Sam fell and was injured.

o Sam Hogan sought WC from the church for his injuries. The New Board found Hogan

was an employee and awarded WC; affirmed here.o An agent has implied authority when the principal actually intended the agent to

possess authority such as necessary to carry out the duties of the job.

Here, Hogan had implied authority to hire his brother, b/c he had been able to hirehelp in the past, the church knew the other potential helper would be difficult toreach, and the job could not be completed by one person.

Furthermore, it would be unfair for Sam Hogan not to be considered an employee,

b/c he believed that his brother Bill had the authority to hire him and he relied onthat representation (seems like apparent authority).

(C) APPARENT AUTHORITY

o We are focused on the relationship b/w P and T.

o P tells T that A acts on his behalf and has authority to act on his behalf. T reasonably and

actually believes that A has authority. T executes the K that A provides. P is bound.o Requires:

(1) MANIFESTATION FROM P to T that A has authority to deal;

(2) T HAS OBJECTIVE, REASONABLE BELIEF that A has authority to

deal; AND

(3) T SUBJECTIVELY BELIEVED that A had authority to deal.

o Ex: P sends T a fax telling T that A has authority. P tells A that he cannot finalize the

deal. A does not have actual authority to finalize the deal. However, A does has apparentauthority, because T has no notice of the limitation on As authority.

Lind v. Schenley Industries; 3d Cir. 1960 (en banc); pg. 16.

Lind was employed by Parks & Tilford, and he was offered a job as assistant to Kaufman,sales manager for NY. The VP told Lind that Kaufman had the authority to set his salary.Lind was informed by Kaufman that he would be paid 1% commission of gross sales of menunder him. The raise never occurred, though, and Lind sued for expectation damages.

The jury made several specific findings, and also found generally for Lind. The trial judge,though, entered a JNWV and an order for a new trial in event of reversal. The majority herereversed both holdings in favor of the jury verdict for Lind. The dissent, though, thought anew trial was appropriate.

Agency can be created by :o Apparent authority , by which a principal acts in such a manner as to convey the

impression to a 3d party that an agent has certain powers; or

Apparent authority was created because: (1) the VP told Lind that he would need

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to go to Kaufman to get his salary (this is the manifestation of consent by P to 3dparty); (2) Lind had an objective, reasonable belief that Kaufman had authorityb/c other managers also had the 1% commission as part of their deals; (3) Lindapparently had a subjective belief that Kaufman had authority.

o Inherent authority , which arises from an agent being designated by the principal as the

kind of agent who normally possesses certain powers. See post. Here, Kaufman had the inherent authority to offer Lind this particular comp

package, because he was his direct supervisor and the person who would naturallytransfer communications from the upper executives to the lower ones.

Whether the alleged agent actually had salary-setting power is irrelevant in theanalysis of apparent authority. So long as it appear so, liability is created.

Three-Seventy Leasing Corp. v. Ampex Corp.; 5th Cir. 1976; pg 22.

Joyce (370) was working to close a deal with Ampex, through Kays, and his superiorMueller. He was then to lease that equipment to EDS. Ampex sent a document to Joycewithout its own signature, which Joyce executed. He then heard back from Kays that the

computer parts would be delivered. Ampex never delivered to EDS, and 370 sued Ampex fordamages.

The district court found there was an enforceable K. Here, the court affirms on theory thatKays, the agent, accepted a contract.

Here, it was reasonable for a third party to presume that Kays, a salesperson, had authority toaccept the deal on a sale. Also, there was nothing in the document suggesting o/w.o Moreover, Joyce explained that he wanted all communications to go through Kays, and

Mueller agreed (he also told all his staff the same). Joyce could therefore expect thatKays was speaking for the company.

(D) INHERENT AUTHORITY

- An undisclosed P who trusts A with management of business is liable to Ts withwhom the agent enters into transactions usual in such businesses and on theprincipals account, although contrary to the directions of the principal. RSA 195.

A similar rule applies for general agents, who are As who do work for the P on an ongoingbasis: undisclosed P is liable to T when T conducted transactions with A on a continuingbasis. RSA 194.

Watteau v. Fenwick; QB 1892; pg 25. An undisclosed principal inherent authority case.

P sold cigars, bovril, and other articles to a bar which was operated by Humble, but whichhe had transferred to Ds (Watteau, brewers). P had never heard of Ds. Humble failed on his

credit to P, so P sued Ds for the value of the cigars. Trial court found for Ps (that Humble was an agent); affirmed here.

Inherent authority. P IS LIABLE for all the acts of A that are WITHIN THE

AUTHORITY USUALLY CONFIDED to A of that character , notwithstanding

limitations put on that authority b/w the principal and agent alone.

o The principal need not hold out that the agent has the authority to do particular things in

order for such inherent agency to exist.

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o Here, there is no apparent authority b/c the 3d party had never heard of the principal, so

there could be no manifestation of authority from P to 3d party.o If P authorizes A to do business, and A does business in its ordinary course, then P

should be held liable for As actions.o One cost of such a rule is that it discourages passive investing, b/c Ps are liable to 3d

parties for things that were outside of the control that they wished to exert. (Hence therise of limited liability companies/partnerships.)

Kidd v. Thomas A. Edison, Inc.; SDNY 1917; pg 28. A disclosed P inherent authoritycase.

Edison (D) hired Fuller to negotiated deals with singers to participate in tone test recitalsto promote a sound recording invention. Fuller entered into deals with singer Kidd (P)which were in excess of the actual, unusual limitations on Fullers authority (unlike priorcustom, Edison would not guarantee a singing tour).

P sued D in contract. The jury found for P, and the court here denied a motion to set aside

that verdict b/c Fuller had apparent authority to deal for D. If P does not want A to be able to act in a customary fashion , then P should make sure

that T knows of limited authority.o A general agent [one who engages in repeat transactions for P] for a disclosed or partially

disclosed P subjects P to liability for acts done on his account which usually accompanyor are incidental to transactions which the agent is authorized to conduct if, although theyare forbidden by the principal, the other party reasonably believes that the agent isauthorized to do them and has no notice that he is not authorized. RSA 161,

o The key to understanding this case is custom . This is the part of inherent authority that

applies in the disclosed principal setting. This is analogous to the reasoning in 370Leasing, where the court explained that a salesman would customarily be able to make

sales.o Rationale for inherent authority . The case explains that estoppel is not the best rationale

for holding a principal liable for the dealings of an agent who exceeds his actualauthority, b/c estoppel is not appropriate in that P has never communicated with T.Instead, the court explains that P has vouched for As reliability, and T must be able tobelieve P will be bound to As minor deviations in order to deal effectively.

o Because P was disclosed here (Kidd knew that she was going to work for Edison), 194

and 195 do not apply. There was also no actual authority. There was also nomanifestation from P to 3d party that A had authority, so apparent authority is flawed, aswell.

(E) RATIFICATIONo A shows up at Ts door and says that P wants to enter into a K with T. However, P had

never heard of A. T agrees to contract with P, then A takes the deal to P, who likes whathe sees and ratifies it.

o Here, P is now bound, b/c even though A did not have authority at the time, the deal was

ratified by P later.o Callback Offer Hypo :

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You are at a callback, and the managing partner gives you an offer. Does he haveauthority?

Who is the principal? It is the partnership combined. The managing partner is theagent, and you are the 3d party.

To determine if the MP had actual authority, one must examine the

communication b/w the partnership as a whole and the MP. Suppose you leave the firm, go home, and wait by the mailbox for an offer. A

letter arrives on firm letterhead signed by the MP stating that you have an offer. Isthere apparent authority? Has there been a manifestation by the principle to 3dparty? It may be created by a combination of the letterhead and the title of theMP.

Next, you ask for 6 months off to travel before you start. The MP says it is okay.It is unlikely the MP has the actual express authority. He may, though, have actualimplied authority.

Change of facts: at the interview, an associate tells you that theyd like to haveyou join the firm. Doubtful there is actual authority, unlikely apparent authority.

However, the firm can ratify the unauthorized offer and is then bound.

(3) Liability of Principal to Third Parties in Tort(A) Servant versus Independent Contractor

FRANCHISING Generally

Popularity of franchises .o Perspective of franchisee :

Most franchisees are not typically very experienced businessmen. Such personcan learn the system and yet be independent.

There is also reduced risk of failure.

Advertising is a major benefit, too.o Perspective of company :

The alternative is to do it themselves. However, one limitation is money, andhaving franchisees put up their own money allows franchisors to open up newmarkets lets them ride on backs of franchisees.

It diffuses the risk of failure.

Additionally, they get highly motivated/incentivized people running theirbusinesses (they get paid only if they sell products).

Because franchisors have much more significant bargaining positions, they are able to drawup contracts such that they will not be liable for the workings of the franchisees, therebycausing externalized costs to third parties (when the franchisee is undercapitalized).

It is important to distinguish master-servant from independent contractor (franchisee).o Agent-type independent contractors agree to act on behalf of P, but not subject to Ps

control on how the result is accomplished.o Non-agent independent contractors operate independently and enter into arms length

transactions with others.

Two major TYPES OF FRANCHISES :

(1) PRODUCT AND TRADE NAME franchise .

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o The franchisor licenses a wholesaler/retailer to sell its product.

o Franchisor exercises some control over the franchisee (ex: making sure franchisee cleans

the bathrooms).o General examples : automobile dealership; gasoline service stations.

(2) BUSINESS FORMAT franchise .

o The franchisor provides the franchisee with an entire business concept, includingmarketing/advertising strategy, operational manuals, and ongoing assistance in makingsure the standards are met.

o The relationship b/w the franchisor and franchisee is a contract. That K embodies the

entire relationship b/w the franchisor and franchisee.o Typically, the former provides the latter w/ training, advertising, assistance, supplies, and

the right to use the franchisors trademark.o The franchisee agrees to pay an initial fee and a royalty payment, and to follow the

requirements of the franchisors system.o The K also includes termination clauses.

o The franchisee cares much about territorial exclusivity (they want other franchises to be

further away).

Humble Oil v. Martin; Tex. 1949; pg 48. Servant case.

Mrs. Love left her car at a filling station operated by Schneider. It rolled into the street,injuring 3 Martins. The station was owned by Humble Oil, who financed all the operations,set Schneiders hours, and had other control.

Martins sued Humble for Ss negligence; Ps were successful. Affirmed here (S was a servantof Humble).

An operator of a gas station is a servant of the oil company when the oil company has

control rights in the contract, finances much of the operation, and controls the day-to-

day operations of the gas station (i.e. the hours of operation).

o There was little difference b/w Ss situation and that of a store clerk who worked for

commission; his only authority was to hire and fire his workers.o Schneiders only real power was to hire and fire workers, and there was language in the

K that S had to do everything that Humble told him.

The complication here is that the harm was caused not by the gas-selling aspect of the fillingstation, which Humble cared about, but rather by the car repair division which Humble hadno interest in. However, the court here viewed these two aspects of the business as integrated,perhaps b/c that was the custom at the time (gas stations and mechanics went hand-in-hand).

Due to respondeat superior, a master is liable for his servant in tort.

Hoover v. Sun Oil Co.; Del. 1965; pg 50. Independent Contractor case. Ps were injured as result of a fire at filling station operated by Barone. Sun Oil owned the

station and all of its equipment and leased it to Barone. Sun had some control of theoperations (Barone was required to maintain certain equipment and use it only for Sunproducts) but not all control (Barone made no written reports to Sun, assumed all financialrisk, and set his own hours).

Ps sued Sun for the negligence of Barone in the fire. Sun won at SJ (Barone was anindependent contractor, not a servant); affirmed here.

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For an operator of a filling station to be a servant of the oil company, the oil company

must retain the right to control the details of the daily operation of the station; control

or influence over results alone is not enough.

o While Sun did have some areas of negative control and it maintained close contact with

Barone through a sales rep who came by weekly, this is merely because they shared an

interest in the stations financial success. How to explain the different results in Sun OilandHumble Oil?

o Better drafting .

The K in Sun Oildid not give the franchisor control.

However, in that case, the franchisor came and made a wide variety ofsuggestions (thus, while the indicia of control was removed, its substance may nothave been).

o Who bears the risk and gets the returns ?

Whoever has the risk and return (i.e. who pays the utilities, how rent is calculated,etc) is really the owner, and that entity is the party that has the incentives and

ability to control. The question, then, is who has the residual interest (who will take any profits),

and who will suffer any liability. InHumble Oil, the oil company would suffer allthe loss. In Sun Oil, Barone bears the risk of loss and has the residual interest.

Going back to Cargill, the creditor had the residual interest in the business b/c thedebtor was approaching the vicinity of insolvency, so any future profits would gotowards paying back the debt.

Looking at risk/return is helpful when things like contractual language can be somanipulable.

Murphy v. Holiday Inns, Inc.; Va. 1975; pg 53.

Holiday Inns gives a complete system of marketing and operating their franchise inexchange for a fee from the franchisor (this is a business format franchise). Betsy-Len is thefranchisee.

P slipped and fell, and then sued Holiday Inns, and the trial court entered SJ for D. Affirmedhere (there was no master-servant relationship).

Because the franchisor did not retain POSITIVE CONTROL RIGHTS over the sort of

day-to-day operations that would affect the maintenance of the facility and whether

people would slip and fall, there is no master-servant relationship.

o While the contractual provisions may have given HI control over the architectural style

and type of furnishing, it did not give HI control of daily maintenance, which led to this

particular injury.o Franchisee holds the residual interest HIs position is more like that of a creditor. It gets a

fixed payment and small royalties, but it does not have a residual interest that wouldincentivize it to control daily operations.

Two separate reasons for creation of master-servant relationship : (1) control; (2) residualinterest (who has the risk of loss and return).

PLANNING : Franchisors options when franchisee is not running a solid operation:o (1) Positive incentives (carrots);

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o (2) Financial penalties (sticks);

o (3) Cancel the franchise;

o (4) Arbitration agreement.

(B) Tort Liability and Apparent Agency

Miller v. McDonalds Corp.; Ore. 1997; pg 58. P, a McDonalds regular, injures herself by biting into a sapphire in a Big Mac from a

franchised McDonalds store. McDonalds had a right to control the way food was prepared,and this was what led to the harm.

P sued McDonalds. The trial court granted SJ for D (no control). The court here reversed,finding issues of fact as to actual master-servant relationship as well as apparent agency.

For a master to be liable in tort through APPARENT AGENCY, the putative principal

must have held out the 3d party as an agent, and plaintiff must have relied on the

holding out.

o Apparent agency v. apparent agency

Apparent agency creates an agency relationship where no agency relationshipexisted before.

Apparent authority creates authority for an authorized agent when no authorityexisted before.

o Apparent agency is built on the reasonable belief of the 3d party that the franchisor is

controlling the store. Here, that belief is based on all the things that McDonalds does tomake people believe that all McDonalds are the same. (This is not about the relationshipb/w the franchisor and franchisee.)

o There was an issue of fact here as to whether the 3d party had a reasonable belief that

McDonalds owned the storea sign in the store that stated that that particular store wasindependently owned.

PLANNING : How could the franchisor protect itself in situations like this?o (1) Advertising that particular McDonalds are not owned by the company (however, this

takes away from the value of the trademark);o (2) Require insurance/indemnification clauses, as well as minimum net worth of

franchisees (however, it is expensive to monitor this anywhere other than up front).

(4) Fiduciary Duties of AgentsGenerally

Fiduciary duties of agents focuses on As duties to P, rather than the relationship b/w A, P,and T. How does A have to behave wrt P?

The AGENT HAS A DUTY TO ACT CAREFULLY AND LOYALLY.o Duty of Care (Negligent vs. Intentionally Bad Decisions) :

If a manager has decision-making authority and makes a very stupid, negligentbusiness decision, he does not face liability for that b/c it would stifle hisdiscretion to do his delegated tasks.

If the manager intentionally does something stupid, then the act was takendisloyally and the manager has breached a fiduciary duty.

This issue of where we draw the line b/w negligence, gross negligence, intl

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actions permeates this area of the law.o Duty of Loyalty :

The agent has the duty to act in the best interests of the principal (as if the assetswere As own assets).

Duty of loyalty is a broad, overarching prohibition, but when it is put in practice it

is actually a series of sub-doctrines to deal with common, recurring fact situations(we have to think about it at a very particularized level).

Why Create Such Duties ?o The law gives agents power (the principal can be bound by their actions); thus, we

impose duties on agents to ensure they take care of the assets they have control over.

Derivative Actions.o If a manager negligently burns down the employers office, the employer can sue the

manager (agent) for negligent injury of the principals property.

General Auto. Manu. Co. v. Singer; WI 1963; pg 83. Singer, skilled manager of auto manu operations, directed a large volume of business

attracted by him to other shops that had the equipment to do the work properly. He profitedthe difference b/w what GA would have charged and what the other shop charged, and hedid not disclose to GA that he was serving as a broker.

GA sued Singer for the lost profits by his breaching his fiduciary duty. Here, the court founda breach of Ds duty of loyalty.

An employee breaches his duty of loyalty to his employer by directing business away

and profiting from it, unless he obtains consent from the employer to do so.

o We are trying to protect the companys assets from being ripped off from its employees.

The assets are the potential business that GA could have invested in the machinery so thatit could perform itself, or that it could have served as a broker for itself.

o Even if the employee truly believes that the firm cannot do the work and simply turns the

business away (thereby not profiting from it), the employee must make a disclosure to thefirm and let the firm decide how it wants to react to the possibility of business.

o The remedy here is profit disgorgement. However, the court here allows Singer to keep

his share of gross revenues that he would have had had he acknowledged the business tothe firm.

Agent forced to perform work he does believe he can do Hypo .o Singer makes a disclosure, GA wants Singer to do the work, but Singer believes he

cannot do it (and that his reputation would be damaged).o

Singer would have to do the work, and he also cannot warn the potential client that hemight want to take the business elsewhere.o If the firm insists, Singers only option is to quit.

Suing on the K versus fiduciary duty .o Singers employment K states that Singer must devote his entire time and skill to the

business. Why not just sue on the contract?o Under the K, it is not entirely clear that he couldnt work for other businesses on his day

off.

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o Also, the remedy for breach of fiduciary duty, profit disgorgement, would be easier to

prove than expectation damages.

PLANNING : How could Singer deal with this problem effectively beforehand?o (1) Singer could bargain for more money such that it would offset the potential loss to his

reputation.

o (2) Can Singer bargain around the rule of duty of loyalty? YES. The law permits contracting around the duty of loyalty in small firms settings, but

it does not allow contracting around it in public company settings.

Duty of loyalty should be mandatory rule when there are either:

(A) Large asymmetries of information. At small firms, it is more likelythat all the parties are active and share the relevant information. At largefirms, though, passive investors are less likely to receive all information.

(B) Ks of adhesion. At small firms, parties are more likely to negotiate theterms of their relationship with each other.

If duty of loyalty were a mandatory rule, this might decrease the value of somesmall firms where they would o/w want to contract around it. So long as the two

characteristics above are not likely present, the law should allow that deal.Town & Country House & Home v. Newbery; NY 1958; pg 87.

The employees of a cleaning service quit, started their own cleaning service, and solicitedsome of the customers of their old employer for their new cleaning service.

The old employer sued on the theory of unfair competition for drawing away thosecustomers. This is a duty of loyalty issue, and the court held that the new company should beenjoined from taking away more customers and should give up some of its profits.

The duty of loyalty is breached when a (former) employee of X uses Xs customer list (a

trade secret) to benefit its own new company.

o This is another example of how the duty of loyalty stops people from ripping off assets of

the firm. Here, the asset is the customer list of the firm, a trade secret. How far can separated employees go ?

o They put up signs in all the old neighborhoods where they used to work, saying they are

former of employees of the old firm and that they would give them their desired service .This would breach their duty of loyalty, b/c identifying those neighborhoods was part ofthe work in the first place.

o The law, though, would allow an entirely separate business to follow that business around

and pick off its customers, b/c in that instance there is no prior connection to the firm;there is no reason for the competitors here to be loyal to that firm. Also, because oureconomy is driven by competition, we do not want to stifle it by preventing this sort ofcompetition b/w competitors with no prior employee-employer relationship.

3. PARTNERSHIPS The role of taxes in partnership

o In a partnership, we pass through income tax to the partners.

o Therefore, there is no income tax at the entity level (instead, the individual partners pay

tax as a part of their income).o Now, any form of unincorporated entity can elect partnership tax treatment w/o

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partnership form organization.

(1) Formation of PartnershipsUNIFORM PARTNERSHIP ACT (UPA)

A partnership is an association of two or more persons to carry on as co-owners a business

for profit. UPA 6(1). A share of the profits is prima facie evidence of partnership, UPA 7(4), unless they are for

wages,Fenwick, or interest on a loan, Martin v. Peyton.

Fenwick v. Unemployment Compensation Commission; NJ 1945; pg 91.

Fenwick owns a beauty shop where Cheshire is the receptionist. Cheshire wants a raise, butFenwick instead wants to make her a partner, who would get a share of 20% of profits (ifany arose). They execute the deal, which does not change Cheshires relationship to the firmin any other way.

Unemployment agency claims that the firm has 8 employees (minimum amount in order topay unemployment tax), but Fenwick claims that she is a partner, hence there are only 7

employees. The court here finds that Cheshire is not a partner, so tax must be paid.

Factors that indicate the EXISTENCE OF A PARTNERSHIP:o (1) Parties intention;

o (2) SHARING OF PROFITS/LOSSES;

o (3) Ownership/control of the businesss property;

o (4) ALLOCATION OF THE CONTROL of the business;

o (5) Language of the agreement (when the dispute is b/w the parties, notfor 3d party

claims); ando (6) Conduct towards 3d parties.

o

Here, Cheshire does have a small share of the profits, but she has absolutely no controlrights. Those profits appear to serve as wages to an employee, which implies that a mereshare of profits is not enough to create partnership. 7(4)(b). This finding of wages to anemployee is likely in part b/c Cheshire does not have any control rights; she appears to bean employee.

PLANNING :o How to make this deal appear as a partnership despite lack of control rights?

The UPA allows partnerships to contract around the default rule of equal controlrights. 18(e).

Thus, an attorney could state that each partner has a voting right for control equalto its share of profits.

Because she had a 20% share of profits, and he had a 80% share, he would havetotal control; thus, as to practical effect this changes nothing, but it could turn thedecision of the court.

o How to deal with future dissolution .

DISSOLUTION is the change in the relation of the partners caused by anypartner ceasing to be associated in the carrying on . . . of the business. UPA 29.

Partnership at will :

No specified term how long it will last.

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Whenever a partner says I dissolve, that is an event of dissolution.

The agreement must specify what happens to the partnership property inthe event of dissolution. Here, an attorney would want to specify thatFenwick contributed all of the property, and that in the event ofdissolution he would get all the property back. That would then make the

agreement look more like a partnership. Most rules are default rules for partnerships . Why would the law allow this in such context?

o We like the ideas of parties structuring their relationships in the way they like best b/c we

think it will make the deals more efficient and help them properly structure theirtransactions.

o We are less concerned of the problem of it being contracted around b/c most of the

owners are active managers in the company.

Martin v. Peyton; NY 1927; pg 96.

KNK was having capital problems, so Hall, its managing partner, went to PPF (individuals)to receive a large loan of negotiable securities. In compensation for the loan, PPF (called

trustee by the agreement) were to receive 40% of KNKs profit; an option (a right thatthey do not have to exercise) to buy 50% of the firm; the right to inspect the books; the rightto veto speculative transactions; consulted on important decisions; Hall is made managingpartner; every partner gave them a signed resignation which PPF would only use if it feltneed to do so).

KNK takes the loan and loses all the money by engaging in contractually forbidden foreigncurrency speculation. Other lenders find KNK insolvent, so those other lenders go after PPF,arguing that they are partners and therefore liable.

Because they have ONLY PASSIVE CONTROL and limited residual interests , the

LENDERS DO NOT RISE TO THE LEVEL OF PARTNERS.

o Who has the control rights ?

The loan agreement provides that Hall will be the managing partner.

Was Hall an agent of PPF?

While PPF does have a lot of leverage on Hall (b/c they have all thesigned resignation letters), they do not have the legal right to control him(they only have negative control rights).

o Who has the residual interest ?

While PPF does receive a large share of profits, they can argue under UPA 7(4)(d), which states that a share of profits is prima facie evidence of partnership,unless it serves as interest on a loan (though the amount of the payment mayvary).

Additionally, PPF has an option to buy 50% of the firm (to the extent there areprofits, they can benefit from them), but they do not share in the risk of loss.

Analogy to Cargill.o Like the lenders in Cargill, PPF here had the negative control rights of checking the

books and veto rights.o This decision can be reconciled with Cargillb/c it takes place in NY, the financial center

of the country, where we care more about encouraging investment than we care aboutprotecting individuals like farmers.

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(2) Fiduciary Obligations of PartnersMeinhard v. Salmon; NY 1928; pg 109.

Gerry leased a hotel to Salmon for 20 yrs. Salmon was required to renovate it using $200K.Salmon went to Meinhard to arrange for receiving half the renovation money from him in

exchange for: Ms getting a share of profits, Ms sharing any losses equally, but S has all thecontrol rights. At the end of the lease term, Gerry offers Salmon an opportunity to getinvolved in a skyscraper project on the same property.

Meinhard learns later of this new lease, and he sues Salmon for breach of fiduciary duty ofloyalty. Cardozo holds that Salmon did breach his duty to his partner; the remedy is eitherhalf the lease in trust, or the shares minus one in the project (so that Salmon would retaincontrol, as before).

PARTNERS OWE EACH OTHER A DUTY OF LOYALTY to share all information

about opportunities that come to the partnership during its duration.

o The law must protect partners like M, who are not held out to those who come in with

development opportunities. Otherwise, the managing partner could reap all the benefits.o It does not matter that we are unable to know whether M would have actually agreed to

be a part of the new deal. Even though Ss failure to disclose the information was notpurposively to deprive M of the opportunity, it is still a breach of fiduciary duty.

Types of partnerships (duration):o (1) Partnership at will. Any partner can terminate at any time.

o (2) Term partnership. Ends at the end of a proscribed term (a number of years, or the

length of a single project).

What is the term of the partnership ?o Salmons position is that the partnership is for the term of the 20 yr lease on the building.

o Meinhard argues that the partnership is also for a term, but the term is anything that is

related to the property. Under this view, the opportunity brought in by Gerry belongs tothe partnership, and there is a fiduciary duty to Meinhard wrt this opportunity.

o The court may determine the term by looking at the intention of the partners when they

entered into business together.

Business Phases here .

o Old businessDissolution(winding up)TerminationNew business.

BUSINESS OPPORTUNITY DOCTRINE. When does a fiduciary have an obligation tooffer an opportunity that comes to them to their firm? Two important question to ask:o (1) What types of businesses are w/in the FIRMS LINE OF BUSINESS?

What is the relationship b/w the opportunity and the firms current business

practices and possibilities (i.e. is this an area where the firm could expand into inthe future)?

Does the firm have the financial capability to do this (or could it obtain thatcapability through loans)?

Does the firm have experience or knowledge about this business?

Here, was this partnership in business to develop and benefit from this particularpiece of property indefinitely, or was its scope merely the single project?

o (2) If it did fall in the line of business, DID THE PARTIES CONTEMPLATE that

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officer/manager would offer it to the firm?

Who is the person who received it? If partner, then it is likely it was contemplatedit would be offered to the firm.

Did the opportunity come to them in an official or an individual capacity?

Did the manager use the firms facilities (meetings in the office, calls on firm

phone)? Comparing Singer.

o In Singer, the opportunity was held to be within the scope of the business, so the

employee had to disclose it to the employer.o The decision in Meinhardis harder b/c the corporation in Singerhad an indefinite

duration, but the partnership here is limited by some, unclear, term.

Lawlis v. Kightlinger & Gray; Ind. 1990; pg 125.

Lawlis was a partner at a law firm in Indianapolis. He became an alcoholic but hid hisillness from the partnership for a year. When he tells them about it, they entered into anagreement providing that he would have time off for treatment but there would be no second

chances. He later had a relapse, but the firm gave him another chance. He goes sober, thenhe demands his full status back. He is then expelled from the firm.

Lawlis sues that he was wrongfully expelled. The court disagrees.

The PARTNERSHIP MAY EXPEL one of its partners per the authority conferred to it

in its agreement so long as that expulsion is in good faith.

o Here, the partners actually allowed L multiple opportunities and were understanding of

his situation while he was suffering from alcoholism. See also UPA 31(1)(d)(explaining how dissolution may be caused by bona fide explusion).

A no cause (guillotine) provision in a partnership agreement should be

enforceable; this allows partnerships to contract out of fiduciary duties.

o Allowing partnerships to contract around fiduciary duties is likely efficient b/c there are

not large asymmetries of information and there will not be contracts of adhesion. Theparties are bargaining b/w themselves ex ante, and they are bargaining with the advantageof (near) full information.

(3) Rights of Partners in ManagementNational Biscuit Co. v. Stroud; NC 1959; pg 140.

Stroud and Freeman owned a grocery store as a partnership. They bought bread from NBC.Stroud told NBC that they should stop shipping bread and that he would no longer beresponsible for paying for such bread. Freeman requested the bread still to be delivered. Thebread was delivered despite Strouds request.

NBC sued Stroud b/c the partnership agreement stated that Stroud would hold all liability ondissolution. The court here found Stroud incapable of preventing the shipment and thereforeliable.

When there is EVEN NUMBER OF PARTNERS, one partner cannot place restrictions

on the other for matters of ordinary business.

o Generally, any difference b/w partners as to ordinary matters of the business may be

decided b/w a majority of the partners.o When there is an even split, there is no majority, so an even split cannot limit the other

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half from acting w/in the expectations of ordinary business.

PLANNING : How could Stroud have gotten around this problem?o The partnership agreement could have required unanimous consent for daily business

decisions, and this would eliminate actual authority for the one partner.o But, in order to prevent partnership apparent authority,see UPA 9(1), there would also

have to be some way to promote the fact to all 3d parties that both partners must consentto any business decision.

Summers v. Dooley; ID 1971; pg 142.

Summers and Dooley have equal stakes in a trash collection partnership. Dooley couldntwork, so he hired his own replacement. S decides they need to hire a 3d person (Ddisagrees). S pays the 3d person.

S then sues D to force him to pay for part of 3ds salary. The trial court found that S shouldget partial payment, but not entire payment for 3d party. Affirmed here.

Because S does not have the actual authority to unilaterally change the terms of the K

(there is no majority), he cannot bind the partnership and D is not liabile.

Actual vs. Apparent Authority .o Because this is a case b/w partners but no 3d party, all that matters is actual authority.

o Because S did not have a majority, he did not have actual authority, so D is not liable for

Ss decision.

Firing of Grocery Store Employee Hypo .o A, B, and C own grocery as partnership. C hires his son D. A and B want to fire D.

o What can they do?

(1) Dissolve the business. If they have the cash, they could buy out Cs share.

(2) Fire D using their majority power under UPA 18(h).o What if C negotiated for complete control in the meat department? In that situation, they

would need all the partners consent to go against the partnership agreement. 18(h)

Day v. Sidley & Austin; DC 1975; pg 146.

Day was a senior partner at Sidley. Sidley wants to merge with another new firm, Liebman.Negotiations are carried on exclusively at executive committee level, and when theinformation reaches the partners, there is some fallout. Day had chaired the DC office ofSidley, but after the merger he became co-chair of the office.

Day sued claiming that he had a contractual right to be the sole chair of the DC office andthat Sidley had breached contract stating that no partner would be worse off. His claims weredismissed here.

Because Days managerial authority had already been delegated to the executive

committee, he was not made any worse off by the merger, so his claims fail.o Executive committee has the real power .

At Sidley, many of the important policy decisions were delegated by theagreement to the executive committee (e.g., partners participation (share ofprofits); required balances of partners; admission and severance of partners).

The partners who together have a majority of all voting shares can then only ratifyor decline those decisions by the executive committee.

The power at large partnership is delegated to a small group of partners.

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There are good efficiency reasons for doing that, but such contracting aroundeliminates many of the default rules for partnership.

o Here, there was no breach of fiduciary duty, b/c the remaining partners did not acquire

any more power within the firm as a result of withholding the information about thepotential merger.

The BASIC FIDUCIARY DUTIES OF PARTNERSHIPS are partners:o (1) Must account for any profit acquired in a manner injurious to the interest of the

partnership;

o (2) Cannot acquire for himself a partnership asset w/o consent;

o (3) Cannot compete w/ partnership w/in scope of business.

Note how far this narrow understanding of fiduciary duties for partners has comefrom Cardozos utmost loyalty in Meinhart.

What really protects you as a partner in private practice is having clients. Because, your shareof profits will not be lowered more than it should be when you could walk away with clients.

(4) Partnership Dissolution

The CAUSES OF DISSOLUTION are listed in UPA 31. Dissolution is caused:o RIGHTFULLY (w/o violation of the parties agreement), by:

End of the definite term or undertaking in the agreement;

Express will of any partner when partnership-at-will; OR

Good faith expulsion of any partner in accordance with the powers conferred bythe partnership agreement.

o WRONGFULLY (in contravention of agreement),

By the express will of any partner at any time.

This leads to breach of K and right to damages under UPA 38.

o AUTOMATICALLY,by Death of any partner;

Bankruptcy of any partner or the partnership; OR

Decree of court under 32.

Continuation agreement states that when the partnership automatically dissolves for whateverreason (b/c one partner leaves or another comes in), the partnership continues on as before.

Owen v. Cohen; Cal. 1941; pg 152.

Owen and Cohen go into business together running a bowling alley. Owen puts forward thecapital to start it up. Cohen belittles and mistreats Owen, and Owen wants to get out of thebusiness.

Owen files a suit seeking dissolution and share of partnership assets. Trial court holds thatdissolution is proper, and that company assets should pay off Owens loan and then be splitb/w the two.

A partner can apply to a court for dissolution when the other partner has engaged in suchconduct that tends to affect prejudicially the carrying on of the business.

A COURT SHALL DECREE A DISSOLUTION whenever: 32(1)

o (1) Partner has been declared a lunatic;

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o (2) Partner has carried on conduct that tends to affect prejudicially the carrying on

of the business;

o (3) Partner willfully or persistently breaches the partnership agreement (or

conducts himself in such a way that it is not reasonably practicable to carry on the

business with him);

o (4) The business of the partnership can only be carried on at a loss; ORo (5) Other equitable circumstances.

o Here, Cohen repeatedly breached and undermined Owen, so there are several subsections

which merit dissolution.o The court here overrides the part of the agreement that the loan should only paid out of

profits, b/c Cohen appeared to have willfully and persistently breached the partnershipagreement. Thus, the court finds that the loan should be paid off in full out of thedissolved assets.

Proper use of automatic dissolution .o Going to court and seeking judicial dissolution was a smart move here, b/c o/w the

dissolution likely would have been a wrongful one,see UPA 31, b/c the court would

have likely read in the duration of the partnership as the amount of time necessary to payoff the loan. Using this approach, though, the dissolution was automatic, and avoidedpotential negative effects for Owen.

Collins v. Lewis; TX 1955; pg 155.

C and L are partners in building a cafeteria. Term of 30 yrs. Lewis is to manage the caf;Collins is to put up the money. Collins is to be repaid for his loan at a rate of $30K the firstyear and $60K thereafter. There were building delays, so Collins put up over $600K. Uponopening, there were operational problems.

Collin sues for dissolution and seeks foreclosure on the debt owed by Lewis. Lewis wins atjury trial; Collins must continue to make money available. Affirmed here.

Bad performance and inability to make a profit is not sufficient alone to dissolve a term

partnership.

o Collins does not have the right to a dissolution by a decree of the court, but he does have

the option of wrongful dissolution,see UPA 31(2).

If Collins were to go that route, he would receive his share of the value of theproperty, minus any damages proven by Lewis, minus the value of any intangibleassets (good will),see UPA 38. Clearly, wrongful termination would notlikely be a good option for Collins.

PLANNING : What protection should Collins have put in the partnership agreement?o (1) Shorter term. However, this would likely still require being locked in during the start-

up, which is the most risky period.o (2) A cap on funds to be contributed (e.g. Collins would put in $300K but not a penny

more). However, Lewis in return would probably want some kind of compensationduring the period, b/c he could potentially not get any pay for his work.

Page v. Page; Cal. 1961; pg 160.

Brothers invested equal amounts at outset of linen supply business. It was not profitable atfirst, but then a military base opened nearby, which provided business. HB, a corporation

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wholly owned by P, wanted to foreclose on a demand note of $47K in order to dissolve thepartnership.

Lower court held that partnership was for term of period to repay the note; reversed here b/cno way to find implied term in the agreement. Thus, HB has the right to dissolve thepartnership.

When a partnership merely hopes that it will pay off its expenses, it is not necessarily apartnership for the term of the debt, but rather is a partnership at will (so long as no

implied term in the agreement).

o Thus, HB can dissolve the company, b/c there was no way to find an implied term within

the agreement. Thus, one of the partners has the right to dissolve the business and takecontrol of the business as soon as it becomes profitable.

o However, any sort of dissolution must satisfy the requirement of being done in good

faith, otherwise it would be a violation of the fiduciary duty of the partner.

This would be a violation of the business opportunity doctrine (the differencehere, though, is that the business opportunity is a prospective one).

Cf. Singer, supra (holding that mechanic could not appropriate business to himself

by serving as a broker at his employers business). PLANNING : How could HB take over the business legally?

o He could buy out his brothers share. He would need to come up with a reasonable

valuation of his brothers interest.

(A) Hire a professional appraiser.

(B) HB could pick a price and then tell his brother either that he could by him outfor it, or HB could buy George out for it (however, a problem could arise ifGeorge doesnt have any money).

(C) Put it on the market and see what the market values it.o Take his brother to court for dissolution .

o Buy-sell agreement . Put in the contract what happens in the event of dissolution. A buy-

sell agreement decides beforehand what method to use to value the company in the eventof a situation like this.

Prentiss v. Sheffel; Ariz. 1973; pg 163.

Two partners, S and I, own majority of partnership. P owns a minority share. S and I believethat P is not contributing his share operationally, and P is unable to contribute his share ofthe next capital payment. S and I sought dissolution in court. The lower court found apartnership at will and that it was dissolved by the freeze-out of P of the management andaffairs of the business. The trial court ordered liquidation by sale, and S and I bought thecompany. P was upset that his former partners could purchase the business, so he appealed.

The court here found no bad faith by S and I and no injury to P, so affirmed. When a partnership at will is dissolved in good faith, the partners should be allowed to

bid on the business at the judicial sale auction.

o The majority partners were not trying to steal a partnership asset from P. This was a

partnership at will, so they can dissolve for any reason or no reason so long as they arenot operating in bad faith. Here, they were not operating in bad faith, because they merelydid not get along with the minority partner.

o The minority partner actually benefited from the majority partners being able to bid up

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the price of the business, b/c it increased the value of his 15% share that was being paidoff. However, minority partner argues that b/c the majority have a bigger equity interest itis easier for them to be able to buy the business. The court says tough luck.

The best way to prevent being frozen out as a minority partner is to contract for a termpartnership. However, this would lock a minority partner into a longer-term commitment

(which might not be desirable if the minority partner wants to be able to cash out).o Cf. closely-held corporate section, where minority shareholders sometime want to be able

to be bought out.

Another way that the majority partners could have dealt with this would have been to allowthe minority to participate but recognize that such participation does not give the minority aright of control. (So long as the minority is not excluded from operational discussions, hewill not have been frozen out.)

(5) Limited PartnershipsLPs Generally

o Formation .

To form a limited partnership, one must file a certificate of limited partnershipwith the Secretary of State.

When it has been accepted, you have formed a limited partnership.

If you think you have formed a limited partnership and have not b/c of failure ofacceptance, you have actually formed a general partnership.

o Management .

Limited partnership agreement , a K b/w the parties, is usually quite detailed inallocating management responsibilities to the general partners.

Limited partners put in cash or other consideration, but have very limited or nocontrol rights.

o Liability .

General partners have liability.

Limited partners have limited liability (b/c they do not have control); all they haveat stake is what they put into the firm, not their personal assets.

A claim would be first against the entity, and second against the general partners.

It has become common to create a corporation as the general partner (injecting thecorporate form b/w the shareholders and liability; this insulates the shareholdersfrom potential liability to creditors of the LP). This creates incentives toundercapitalize the corporate general partner.

If lenders choose to do business with entities with little or no assets in

them, there is a risk that the sophisticated creditor is assuming (a riskbeing assumed for a price, likely b/c of an increased interest rate). The lawis therefore not too sympathetic to sophisticated creditors, who choose todo business with the firm.

However, the law is sympathetic to people who are injured by this kind ofLP by no choice of their own and have claims in tort.

o Fiduciary Duty .

The general partner has a fiduciary duty to the firm and to the LPs, b/c the LPs

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have entrusted their assets to the management of the LPs.

This includes the duty of care and the duty of loyalty.

The law allows contracting out, just as in the partnership setting (b/c we are notconcerned w/ asymmetric info or Ks of adhesion); however, this perhaps shouldnot be the case with private equity firms, which are very sophisticated LPs.

Limited partners do not have a fiduciary obligation , b/c they are not managingother peoples money.

o Dissolution .

LP agreements specify what constitutes an event of dissolution (it is required inorder to be approved by the Sec. of State). There will also, though, likely be acontinuation provision (specifying what happens in event of bankruptcy, etc., andhow the entity will continue on).

There are default rulesthe Revised Uniform Limited Partnership Act (RULPA,a model code, which many states have adopted). RULPA incorporates byreference UPA. It also incorporates the RS of Agency. Many states, though, haveadopted different versions of RULPA.

Holzman v. De Escamilla

The general partner is DE; the limited partnership entity is Hacienda farms; the LPs areR&A. The farm grows crops, and while DE is the GP, it turned out that R&A were actuallyin charge. They could draw on the firm bank accounts w/o consent of DE, could veto DEsuse of account, and even forced DE to resign.

Trustee brought suit against R&A claiming that they should be liable as general partners b/cthey were in control of the business. Court found R&A GPs; affirmed here.

A nominally limited partner who exercises control becomes liable as a general partner

for the activities of the limited partnership.

o Because R&A could withdraw all of the assets of the firm w/o even the knowledge of the

GP.

LPs not attractive for active investors .o Limited partnerships are not an attractive alternative for investors who wanted to be able

to control the management of their investment.o State legislatures noticed this, so many have enacted RULPA 303(a), which expands

the amount of control that LPs can exercise w/o becoming general partners: A limitedpartner is liable only to persons who:

(1) Transact business with the limited partnership; and

(2) Reasonably believe, based upon the LPs conduct, that the limited partner is ageneral partner.Id.

PLANNING . How could R&A have gained control w/o liability here?o They could have placed a corporation as the GP, and could have appointed themselves as

the board of directors and the officers.o Who suffers from such a structure? Third parties plaintiffs/creditors.

4. THE NATURE OF CORPORATIONS(1) Corporations Generally

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Formation .o File articles of incorporation (or certificate of incorporation, or the corporate

charter) with the Secretary of State.

The formation document in which we put the basic terms of the K b/w thecorporate entity and the shareholders

Can be fairly limited at first: Location,

Number of shares,

Who initial board is,

Who initial officers are.

Can only be amended by:

A recommendation by the board of directors,

Followed by the approval of shareholders (SHs).o A second document, the corporate by-laws, must be drafted (though these need not

always be filed.

Mostly housekeeping rules (time and place of meetings).

May be amended eitherby a majority vote of the shareholders orthe board ofdirectors.

Liability .o There is limited liability for the SHs (only liable for the amount of their investment).

Control .o SHs have limited control rights .

They delegate their control rights to the body that manages the corporation, theboard of directors. The board in turn delegates most day-to-day control rights tothe management, called the officers.

Fiduciary Duties .o Officers and directors have fiduciary duties to both the entity and the SHs b/c they

manage other peoples money.o SHs do not have fiduciary duties (with limited exceptions to be elaborated on later), b/c

they do not manage others money. Shareholders may act in their own self-interest.

Dissolution .o A corporation is dissolved only when:

Board makes a recommendation to the shareholders that they do so, and

SHs approve it.o Otherwise, the corporation lasts forever (it is not for a term or at will).

(2) Promoters and the Corporate Entity Promoters engage in transactions before the corporation is formed that prepare for the

formation of the corporation.

What happens when a 3d party sues on Ks that promoter has entered into on behalf of thenot-yet-formed corporation?o (1) Can the corporations become a party to the K? Yes, if ratification by board.

A corporation acting through its board may ratify the K and become liable to the3d party.

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o (2) May the agent still be liable after the board ratifies?

The promoters name is on the K, so the promoter will still be liable to the 3dparty, even though the corp. has ratified, unless the K specifically provides that,once the corporation (principal) ratifies it the promoter (agent) is no longer liable.

o (3) What if the corporation is never formed (i.e. there is no de jure corporation)?

The investors who decided not to form the corporation would be a generalpartnership. If any of their names were on the K, then the GPs would be liable onthe K. Note that this does not always seem fair.

When does the law permit these wannabe SHs to use the protections of thecorporate form?

(A) CORPORATION. When the shareholders:o (1) Tried in good faith to file and create a corporation;

o (2) Had a legal right to create a corporation; AND

o (3) Acted as if they formed a corporation.

o De facto corporations is a common law defense, so it is available

in some situations, so long as it has not been eliminated by statute.o Ex.: The lawyer forgets to file the corporate documents and then

the de facto shareholders go into debt.

(B) CORPORATION BY ESTOPPEL:

o (1) 3d party thought it was dealing w/ a corp.; AND

o (2) 3d party would receive a windfall gain (would be able to

collect when usually not) if permitted to deny it.

o Also a CL doctrine that may be eliminated by statute.

These two doctrines can overlap, but they do not have to:o Estoppel will not apply in a tort claim where the driver of an

attempted corporation vehicle injured a 3d party, b/c 3d party did

not think it was dealing w/ a corporation.

Southern-Gulf Marine Co. v. Camcraft, Inc.; La. 1982; pg 202.

Camcraft is the 3d party that signs a K w/ Barrett, the promoter, who was acting on behalf ofa yet-to-be-formed corporation called Southern-Gulf. SG was supposed to be incorporated inTX, but it was actually incorporated in Caymans, but then Camcraft accepted thatincorporation. Camcraft defaulted on the ship. SG sues

SG was a TX corporation by estoppel, because Camcraft believed that it was dealing

with a corporation, and it would receive a windfall of being able to sell the boat tosomeone else for a gain.

(3) The Corporate Entity and Limited LiabilityWalkovszky v. Carlton; NY 1966; pg 207.

Carlton is stockholder of 10 corporations, each of which has 2 cabs registered in its name,and each of which has the minimum auto liability insurance required by law on any one cab.Walkovszky was injured by one of the cabs.

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P sues the corporation, but it is undercapitalized, so he seeks to pierce the corporate veiland go after Carltons personal assets. Dismissed by trial court; affirmed here (though thecourt acknowledges that a claim could be stated so long as it states w/ specificity howCarlton was doing business in his individual capacity).

The courts may PIERCE THE CORPORATE VEIL based upon the following factors:

o (1) The SH co-mingling his assets with those of the corp;o (2) The corporation is undercapitalized; and

o (3) The corporate formalities are not followed.

Appointing a board;

Filing articles of incorporation;

Creating by-laws;

Having director meetings, and

Having shareholder meetings/votes.

In order to receive corporate form benefits, SH must respect separateness & formalities.o The law grants special protection to personal assets through the corporate form. In order

to benefit from that protection, SH must respect the separateness of the corporation.o SH cannot co-mingle corporate and personal assets; SH cannot ignore the formalities.

o If SH does not respect that separateness, then the law sees through the corporate form and

to the personal assets.

Enterprise liability. P could also pierce through the single corporation by alleging that

it was operated as part of a larger single enterprise.o P could have potentially gone after the collective assets of the entire enterprise by

alleging that C1-C10 were all effectively part of a single large entity.o Under this theory, he could not have gone after Carltons personal assets.

o He would need to show that this business was not operated as 10 separate, small

businesses, but as one larger business.

To prove this, he should show things like one garage, all the maintenance done atthat garage, the employees move throughout each cab company, etc.

What are the alternatives for preventing this problem ?o (1) Legislatively require a greater minimum capitalization level for each individual

corporation;o (2) Legislatively require a greater minimum level of liability insurance;

o (3) Pierce the corporate veil.

The problem w/ piercing the corporate veil is that it would discourage investment.

The law could, however, hold investors liable on apro rata basis (shareholdersare only liable for their proportion ownership in the company), but then thiswould cause collection problems.

There is definitely a trend towards limiting liability.

Sea-Land Services v. Pepper Source; 7th Cir. 1991; pg 212.

SL shipped items for PS, which is owned entirely by Marchese. M has several othercompanies that he wholly owns, and he jointly owns Tienet w/ Andre. PS stiffs SL on the bill.

SL tries to pierce the corporate veil to M, and reverse-pierce the corporate veil to the othercorporations. Trial court granted SL SJ. Reversed here, but then injustice found on remand,

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and affirmed.

The CORPORATE VEIL WILL BE PIERCED when: (Van Dorn test)

o (1) There is unity of interest and ownership; AND

Lack of corporate formalities;

Co-mingling of assets;

Use by one corp. of another corp.s assets; Inadequate capitalization.

Here, the first prong of the test is easily satisfied: there have been no meetings, hecharges his own personal expenses to the corporation, bylaws were never passed,they were all run out of the same office.

o (2) Doing o/w would sanction fraud or promote injustice.

Injustice requires showing some wrong beyond the creditors inability to

collect.

This prong is more problematic here. Fraud cannot be proven at SJ stage (b/c it isan issue of fact); SL therefore must prove substantial injustice.

Why would P desire to reverse-pierce the corporate veil ?o SL could only get to insurance policies against those companies if it had a claim against

those corporations (SL could access everything else with a claim against Marchese b/cSL would then own all the stock in those corporations).

Harm to passive investors, too .o One problem with piercing the corporate veil is that passive investors in companies like

Tienet will also have their veil pierced, even if they were not the ones who were abusingthe corporate form.

PLANNING.o It is important as a corporate lawyer to remind clients who are owners of small

corporations that the formalities must be followed in order to benefit from the limited

liability of the corporate form.o Failure to do this may result in malpractice against a corporate attorney.

(4) Shareholder Derivative Actions(A) Direct and Derivative Suits Generally

Principal-agent model of corporation.

This is a conceptual model that does not imply agency liability.

SHs are the principals , and the directors and managers who run the company are agents.

For publicly traded companies, the SHs will be diffuse.o For this reason, SHs have ownership, but they do not have real controlthey do not tell

the directors/managers what to do.o SHs have a vote over directors, but usually managers control who are nominated , so SHs

do not have that much control there.

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Principal-agent problem .o SHs want management to maximize profits .

o Managers want to maximize their own utility , though (which involves labor/leisure

choice; own salary; sharking from firm; etc.).o This creates a potential divergence of interests.

Good corporate governance means that management incentives are aligned with SHincentives.o (1) The board can act as a management alignment tool by hiring non-management

directors (to sit on salary committee, audit committee, etc.).o (2) SHs can act to keep divergence of interests to a minimumthey may monitor

corporate management by staying informed and

(i) Voting when the opportunity arises,

(ii) Selling shares, or

(iii) Suing on behalf of the corporation.

Shareholder derivative suits.o The suits in (iii) are called derivative suits, b/c they are derivative of the corporations right

these are suits by a SH on behalf of the corporation to recover for the corporation.o Direct vs. derivative suits .

o Direct suits arise from the individual SHs right to sue.

o Derivative suits are by a SH on behalf of the corporations rights.

What type of protections should be put up around derivative suits in order to allow thecorporation to determine whether or not to sue?o A corporation (acting through its board) might not choose to sue itself for two reasons:

(1) Poor business decision (the lawsuit might be overly expensive compared to thelikelihood of recovery, or it might detract from PR and goodwill); OR

The corporation should not sue and needs ways to discourage these suits. Ways of discouraging these SH suits:

o Bond posting requirement (for corporate legal fees if loss,see

Cohen, post.o Contemporaneous ownership requirement to make sure the SHs are

real parties in interest. (SH must have owned shares at the time ofthe alleged illegality as well as when the suit was filed.)

o Demand requirement and special litigation committees.

(2) Personal self-interest (e.g. the culprit was related to a board member).

SHs should be able to sue.Cohen v. Beneficial Ind. Loan Corp.; S. Ct. 1949; pg 232.

BILC was DE corp. doing business in NJ. Shareholder Cohen alleged that managers anddirectors of BILC were engaged in continuing and successful conspiracy to enrichthemselves at expense of the company.Cohen owns about 0.01% of outstanding stock.

SH sues derivatively in federal court (diversity) for fraud, mismanagement, and waste (i.e.when the corporation gives assets away unreasonably). NJ statute required SH derivative Psholding < 5% of stock or < $50K to post a bond that would pay for Ds reasonable fees.BILC moved to require a bond to be posted by Cohen. Court here requires federal diversity

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courts to apply NJ statute.

State statutes requiring shareholders to post bonds for Ds defenses must be applied in

federal diversity courts.

The purpose of requiring a bond is to discourage strike suits. These are suits brought byshareholders for their nuisance value or so they could attempt to force corporations to

settle frivolous claims. These bond-posting statutes must be considered substantive rather than procedural b/c it

creates new liability where one did not exist before. Also, if the federal courts did notapply those statutes, it would encourage forum shopping for Ps who did not want to file abond to seek out federal court.

Delaware does not have a bond-posting statute.o DE has chosen no bond-posting requirement to spur derivative litigation.

o DE is home to about 2/3 of the corporations in the US.

o There is a tremendous amount of derivative litigation that is funneled into DE trial courts.

o DE has developed the Court of Chancery to handle its expertise .

o For this reason, DE law is disproportionately important in corporate law, b/c it is highly

persuasive and influences the law of other states.

Eisenberg v. Flying Tiger Line, Inc.; 2d Cir. 1971; pg 236.

Eisenberg is a former SH of Flying Tiger (FT). FT adjusted the capital structure of thecompany (it retired some securities and debt claims and replaced them with new securitiesand debt claims): (1) FT 100% FTC 100% FTL. (2) FT + FTL = FTL. (3) FTC 100% FTL. After the merger, the public SHs own shares of FTC, but the operating assetsare with FTL. FTC is now a holding companyit holds stock of other companies andprovides management services. Now, FTL, which has the operating assets, is regulated as anairline, and FTC, the holding company, can participate in other, unregulated businessventures. Finally, FTL changes name to FT, which has brand value.

P brings claim against company for having his stock and voting rights changed as a result ofthe merger. Instead of having the right to vote in electing the board of directors for the entitythat controlled both the management and operating assets, he only has control rights over anentity that has management services, but not operating assets. In essence, he alleges hiscontrol rights are diminished. He argues that his claim is direct, not derivative. The courtagrees it was direct, so it should not have been dismissed for failure to post a bond.

A lawsuit is DERIVATIVE when it challenges acts of the management on behalf of the

corporation.

o A derivative claim is that the corporation is harmed (recovery goes to the corporation).

It is DIRECT when it challenges the right of the present management to exclude SHs

from proper participation.o A direct claim is that the SH personally was harmed (e.g. voting rights have been

decreased, so shareholder is personally hurt).o Eisenberg had lost voice in any potential future merger . Suppose US Airways wanted to

merge with FT. The board and SHs of US Air would have to approve the merger. Also,the board and SHs of FT would have to approve, but the board would be appointed by theFTC board and its shareholders are the FTC board.

TOOLEYTEST: To determine whether SHs claim is derivative or direct, consider:

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o Who suffered the alleged harm , the corporation of the suing stockers, individually;

and

o Who would receive the benefit of any recovery or other remedy , the corporation or

SHs, individually? Tooley v. Davidson (Del. 2004).

Where SH only seeks declaratory judgment and no monetary recovery will go to

the corporation, the claim may be direct.Bennett. Subsidiary/Parent Corporations .

o A subsidiary corporation is a company whose voting stock is at least 50% owned by

another corporation. Thus, the subsidiary (sub) is clearly controlled by the parentcompany.

o A wholly owned subsidiary is one in which the parent owns 100% of stock.

Merger defined . A merger is when one corporation is absorbed into another, and when thatcorporation assumes all the assets and liabilities of the latter.

Who pays when the corporation is sued?o Direct suits : the corporation usually indemnifies officers and directors.

o Derivative suits : there is no indemnification of officers and directors (they pay

personally). The corporation is essentially suing itself, and it would not make sense forthe corporation to pay itself.

o Incentive to settle in derivative actions .

Ds are not reimbursed by corporation. Ps do not have the assets to financesprotracted litigation. Judges have busy dockets.

There is still value in derivative suits, though:

(1) Deterrence. Such suits discourage officers from abusing theirpositions.

(2) Compensation for harm done to Ps.

(3) Public good is created when courts decide the law in derivative cases

(they make up a large portion of corporate law cases). (4) It gives judges an opportunity to shape the norms of corporate conduct,

and that message gets echoed from lawyers to clients.

Alternatives to lawsuits :

Markets punish corporate misconduct.

Board of directors can punish corporate misconduct by ousting peoplewho dont do a good job or engage in misconduct.

Regulators , such as the SEC, can control corporate wrongdoing.

Who receives the recovery in derivative suits?o Usually recoveries in derivative suits go to the corporation.

o Where corporation would be likely to abuse that recovery again , P will receive his or her

pro rata share. See Lynch v. Patterson (P, 1 of 3 shareholders in corporation, recoveredmonies that other two had been overpaying themselves, even though it was a derivativeaction, b/c o/w those two would have had control of that money).

(B) The Demand Requirement

Because a derivative suit is one in the corporations name, shouldnt the board get to decidewhether derivative litigation is brought? In general yes, unless we are suspicious the board is

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not doing the right thing.

See Sch. A (Demand Requirement Flow Chart).

Grimes v. Donald; Del. 1996; pg 241.

DCS approves an employment agreement with its CEO, Donald. The agreement gives him

extensive benefits and control of the company. It also allows him unilaterally to decide thatthe Board has interfered w/ his management capabilities, in which case he gets an incrediblygenerous severance package.

SH Grimes sues to invalidate this agreement as well as any ongoing compensation as a resultof it. He alleges: (1) abdication by the board of its duty to run the company; (2) that the boardbreached its duty of care; (3) the board committed waste. The court here find there was noabdication, and that the demand was not wrongfully refused.

ABDICATION only exists when the Board gives up its ultimate freedom to direct the

strategy and affairs of the company.

o For abdication to occur , the board must enter into agreement that formally excludes it

from exercising its statutory powers.

This is a mandatory rule. The board cannot give up its responsibility to manageand direct the business and a

corporations outline (holt) (prof. thomas)

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