Business Association

Question 1

Agency

Tips

Answer 1

Agency was tested in Torts through vicarious liability

Agency law often comes up in the context of partnership—
* the liability of the partnership and the partners for the acts of either a partner or another agent (whether an employee or independent contractor)

Agency law in corporation
In agency-corporation, the liability of the corporation for acts of individual corporate officers, and the breach of the implied warranty of authority by those officers

Question 2

Agency Relationship-Formation

Rule

Answer 2

Fundamental to any liability is whether there was a principal-agent relationship. Agency is defined as the relationship that arises when the principal manifests an intention that the agent act on the principal’s behalf. An agency also requires capacity, consent, and control, and an agent must be otherwise not disqualified to act as an agent.
—
Fundamental to any liability is whether there was a principal-agent relationship. Agency is defined as the relationship that arises when one person (the principal) manifests an intention that another person (the agent) act on the principal’s behalf. In addition to this intention, an agency requires capacity, consent, and control, and an agent must be otherwise not disqualified to act as an agent.

Question 3

Capacity

Not stated rule/ principal and agent

Answer 3

Principal requires contractual capacity, including age and mental capacity.

Unlike a principal, an agent could be a minor or incompetent.

Question 4

Consent

Not stated rule

Answer 4

Each party must voluntarily consent to the agency relationship

Consent is voluntary

Question 5

Control

Not stated rule

Answer 5

This means the right of the principal to control the agent

The extent of the right to control is usually the major difference between an employee and an independent contractor: whether the principal has a significant right to control how the agent performs their work. The greater the control, the more likely agent is an employee rather than independent contractor.

Factors:
* Control of manner of accomplishing work
* Supply of tools
* Explicit direction

Question 6

Control part 2

Not Stated Rule / when contract is involved

Answer 6

The employee/independent contractor distinction among types of agents is generally not relevant where the issue is contractual liability of the principal - the principal is usually always liable on a contract made by an agent, unless they are an undisclosed principal.

Question 7

Frolic

Not Stated Rule

Answer 7

a substantial digression from the scope of their agency

Question 8

Detour

Not Stated Rule

Answer 8

it is an insubstantial digression

Question 9

Vicarious liability and type of authority

Not stated rule

Answer 9

The extent and type of authority is not an important issue where the employer is vicariously liable for the employee’s negligence.

Question 10

Type of Liability At Issue

Not rule

Answer 10

1. Negligence
2. Intentional Tort
3. Contractual

Question 11

Negligence for Independent Contractor

Agency - VL

Answer 11

A principal is vicariously liable for independent contractor’s negligence in two situations:
1. the independent contractor is engaged in inherently dangerous activities;
2. the duty is nondelegable:
- the duty of a property owner to keep it from being dangerous to those offsite, or
- the duty of a vehicle owner to keep the parts of the vehicle operating safely.

—
Independent contractor: where inherently dangerous activity or non-delegable duty

Tip:
If the agent is not engaged in an inherently dangerous activity or is not performing a non-delegable duty, you should then focus on the right to control, since then the principal is not otherwise liable for the negligence of an independent contractor.

Question 12

Negligence - Employee

Answer 12

The principal is vicariously liable for employee’s negligence if negligence occurred in activity within the course and scope of employment/agency (and not on “frolic”)
—
Employee: just apply vicarious liability – which exists if negligence occurred in activity within the course and scope of employment/agency (and not on “frolic”)

Question 13

Intentional Tort

Answer 13

Employers and other principals are generally not vicariously liable for an agent’s intentional tort (whether they are an employee or independent contractor), because intentional tortious conduct is not within the scope of agency, unless:
* force is authorized in the agency;
* friction is generated by the agency; or
* the agent is furthering the business of the employer—but all of these require some form of authority.

Tip: Always discuss types of authority If issue is whether the employment furthers the purpose of the principal

Question 14

Contractual

Not Stated Rule/Tip

Answer 14

Tip:
Where the agent is engaged to enter into contracts for the principal, you must discuss and analyze the three different types of authority

Question 15

Type of Authority

Answer 15

There are several types of the authority of an agent:
* actual authority (express and implied);
* apparent authority; and
* ratification.

Two types of authority:
1. actual express authority
2. actual implied authority

Question 16

Actual Express Authority

Answer 16

Actual Express authority means that the agent expressly has the authority from the principal to act.
–
The Agent expressly has the express direction or permission from the principal to act in the manner agent has acted.

Question 17

Actual Implied authority

Answer 17

Actual Implied authority means that the nature of the agent’s position implies authority from the principal to act in a particular matter — either from custom and usage, by acquiescence (including a failure to inquire), or because of emergency or necessity.
—
The nature of the Agent’s position implies authority to act in a particular matter – either from custom or usage, or by acquiescence (including a failure to inquire).

Question 18

Apparent Authority

Answer 18

Apparent authority requires that the principal communicates by some statement or act to a third party of the agent’s apparent authority to act on the principal’s behalf with respect to the third party.
—
Apparent authority requires that the principal communicates by some statement or act to a third party the agent’s apparent authority to act on behalf of the principal with respect to that third party.

e.g., If Andy had no business card showing that he was a partner and there had been no other holding out of Andy as a partner by TBA, TBA could argue that Andy lacked apparent authority to bind the partnership to any contract and the partners and partnership would not be liable.

Question 19

Ratification

Answer 19

Ratification requires that the principal agrees to be bound by the agent’s unauthorized acts, which requires actual knowledge of those unauthorized acts.

Question 20

Liability of the Principal and Agent to 3rd Parties on Contracts

not stated rule

Answer 20

When the agent does something wrong, and the issue is whether the principal and agent are each liable –> determine what type of principal:
1. Disclosed Principal
2. Partially Disclosed Principal
3. Undisclosed Principal

Question 21

Disclosed Principal

Answer 21

A disclosed principal in a transaction is one where the third party knows the principal’s identity. The agent is never liable to the third party on a contract entered into by an authorized agent on the fully disclosed principal’s behalf.

Question 22

Partially Disclosed Principal

Answer 22

A partially disclosed principal is one where the third party knows the fact, but not the principal’s identity.

Both the agent and principal are liable on a contract entered into by an authorized agent on the partially disclosed principal’s behalf.

Question 23

Undisclosed Principal

Answer 23

An undisclosed principal is one where the third party believes the agent is the contracting party and has no knowledge of the principal’s existence.
An agent is always liable to the third party on a contract entered into by an authorized agent on the undisclosed principal’s behalf.

An undisclosed principal is liable on the contract unless the agent acts for an improper purpose, or for the third party’s purpose.
—
An undisclosed principal is not liable on the contract when his agent acts for an improper purpose, or for the third party’s purpose. Otherwise, the undisclosed principal is also liable.

Question 24

Type of Principal and Agent Liability

Answer 24

A disclosed principal is liable on contract when his Agent acts for an improper purpose, or for the 3rd party’s purpose, UNLESS the 3rd party has notice that the Agent is not acting for the P’s benefit.

Both Agent and Principal ARE liable on contract to 3rd party when Agent acting for a partially disclosed principal OR an undisclosed principal.

An undisclosed principal is NOT liable on contract when his Agent acts for an improper purpose, or for the 3rd party’s purpose – otherwise, undisclosed principal is liable for contract properly entered into by agent.

Question 25

Agent’s Duties to Principal

Not Stated Rule

Answer 25

An agent holds three duties to the principal:
1. undivided loyalty to the principal;
2. strict obedience to the instructions of the principal; and
3. reasonable care (in light of local community standards and taking into account any agent’s special skill).

Question 26

Undivided loyalty

Answer 26

Dual representation: an agent cannot represent both parties to an agreement, unless both parties are fully advised as to the facts and agree to the dual representation.

Tip:
* The issue comes up for duty of loyalty
* Agent required license: where the particular service provided by the agent is one where the state requires a license, an unlicensed person cannot act as an agent.

Question 27

Strict Obedience to Instructions

Answer 27

The duty of obedience means strict obedience to the principal’s instructions. Any variance is a breach of this duty, unless the principal, with knowledge of the variance, ratifies the variance, which in time would lead to implied authority to vary the instructions.

Note:
* But variance can be ratified by principal –> do ratification analysis
* Multiple variances = implied authority

Question 28

Secret Limiting Instructions

Answer 28

Even if a principal gives an agent secret limiting instructions, if the agent acts beyond the scope of the limitation when dealing with a third party, the principal will still be bound by the agent’s actions and will be liable on the contract, although the principal can then sue the agent for breach of the duty of obedience.

Question 29

Reasonable care

Standard

Answer 29

The duty of reasonable care is the objective standard used to determine whether neligence exist in light of local community standards and taking into account any agent’s special skill.

Question 30

Termination by Actual Authority

Non-Stated Rule

Answer 30

An agent’s actual (express and implied) authority terminates when he or she knows or should have known of the termination.

Question 31

Termination by Apparent Authority -
Authority by Writing

Rule

Answer 31

Where there is a writing by the principal given to the Agent manifesting their authority that is meant to be shown to 3rd parties, the apparent authority will not be terminated with respect to the 3rd parties who see and rely on such writing until Principal communicates termination to 3rd parties

Question 32

Termination by Apparent Authority

Tip

Answer 32

When the principal has given the agent a writing manifesting his or her authority that is meant to be shown to third parties, the apparent authority created by the writing will not be terminated with respect to third parties who see and rely on such writing

Instead, the principal must communicate the termination of authority to the third parties

Death/incompetency ALWAYS revokes authority, whether or not known

Approach:
* First explain whether a reasonable person would likely believed Agent has authority from Principal to do that act

• Then state the Rule: Where there is a writing by the principal given to the Agent manifesting their authority that is meant to be shown to 3rd parties, the apparent authority will not be terminated with respect to the 3rd parties who see and rely on such writing until Principal communicates termination to 3rd parties
• Then analyze whether the principal communicated with the third party

Question 33

Principal’s Remedies for Agent’s Breach

Not stated rule

Answer 33

If there is a breach of any of these duties, consider the principal’s remedies:
1. damages;
2. accounting for the agent’s secret profits; and
3. withholding of compensation.

Question 34

Irrevocable Agency

Answer 34

Two kinds of agencies are irrevocable that cannot be unilaterally terminated by the principal:
1. Agency coupled with an interest (broker commission)
2. Power given as security (trustee under deed of trust)

—
Agency coupled with an interest (broker commission)
* immediately exercisable rights in the property
* a right to part of the proceeds of the sale as occurs with a broker’s commission

Power given as security (trustee under deed of trust)
* exercisable only on a default—such as the authority of the Trustee in deeds of trust

Question 35

Principal’s Duties to Agent

Answer 35

A principal has certain duties to an agent:
1. the duty to reasonably compensate the agent and to reimburse him for all expenses or losses reasonably incurred in discharging any authorized duties;
2. duties imposed by the contract; and
3. a duty to cooperate in carrying out the agency’s purpose.

Question 36

Agent’s Remedy from Principal’s Breach

Answer 36

If there is a breach of any of these duties, consider the agent’s remedies:
* damages for breach of contract (subject to a duty to mitigate); and
* an agent’s lien in any property the agent holds (such as a broker’s commission in proceeds from a real property sale).

Question 37

Partnership

Approach

Answer 37

1. Start with partnership formation
2. ONLY AFTER deciding entity is a partnership, then discuss type of partnership
   * GP
   * LP
   * LLLP
3. Limited partnerships, LLPs, and LLLP’s require formalities
   * Formal writing
   * Filing of documents with the Secretary of State

Question 38

Partnership Formation

rule

Answer 38

A partnership is an agreement between two or more persons to carry on as co-owners of a business for profit.

Question 39

Partnership Formation

tips

Answer 39

A partnership is an agreement between two or more persons to carry on as co-owners of a business for profit.

If it is not clear, then discuss some of the factors indicating a partnership may have been formed:
* common ownership of property;
* designation of the entity as a partnership; and
* higher degree of activity—such as both purchase and management of property.

Tip: IRAC each part of this rule

• This is different from a joint venture, which does not require carrying on a business but merely co-investment.
• No intent to form a partnership needs to be expressed for a partnership to be created—only the two elements of carrying on a business as co-owners (sharing control) and sharing profits

Question 40

Partnership Liability

Answer 40

A partnership is liable for any partner’s acts and omissions in the ordinary course of the partnership business or with the authority of the other Partners, to the same extent that the acting partner is liable.

Question 41

Partner’s Authority**

partnership liablity

right after partnership liablity

Answer 41

Authority may be actual authority, apparent, or ratified. A partner in a partnership has both apparent and implied authority to act on behalf of the partnership.

Actual authority includes the express and implied authority.

Express authority means the partner expressly has the authority from the partnership to act.

Implied authority means the nature of the partner’s position implies authority from the partnership to act in a particular matter from custom and usage, by acquiescence (including failure to inquire) or because of emergency or necessity.

[Apparent authority exists where a reasonable person in the third party’s shoes believes that the person had authority to act.]

Ratification requires that the partnership agrees to be bound by the partner’s unauthorized acts, which requires actual knowledge of the unauthorized acts.

—
Actual authority exists where a reasonable person in the agent’s position would believe he had the right to act on behalf of the business. This may be express, through an agreement, or implied, through actions or conduct.

Apparent authority exists where a reasonable person in the shoes of the third party believed that the person had authority to act.

Ratification occurs where no authority exists but the business has adopted the contract through action such as accepting its benefits. A partner in a partnership has both apparent and implied authority to act on behalf of the partnership.

Question 42

Apparent authority of Partner

Answer 42

Each partner has power to bind the partnership to contracts for apparently carrying on in the ordinary course of partnership business. A partnership will not be bound if the partner acted without authority and the third party knew or had received notification that the partner lacked authority.

—
Apparent authority requires that the principal communicates by some statement or act to a third party of the agent’s apparent authority to act on the principal’s behalf with respect to the third party.

—
To the extent a third party reasonably believes a partner is acting for the partnership, that partner will have the apparent authority to bind to the partnership.

Question 43

Partner’s Action Authorized

Answer 43

Subject to any agreement between the partners, all partners have equal rights in the management and conduct of the partnership. Disagreements relating to ordinary matters connected with the partnership business may be decided by a majority of the partners—and a majority vote constitutes express authority. No act in contravention of the partnership agreement may be done without the consent of all the partners.

Question 44

Partner Duties to Each Other

Rule

Answer 44

Partners have a fiduciary duty to each other and to the partnership as a whole by acting in good faith and fairly toward each other.
—
Partners are in a fiduciary relationship/duty to each other and to the partnership as a whole.

—
Partners have a Fidicuary Duty to Each Other is Duty of Loyalty

Question 45

General Partnership

General provisions

Answer 45

1. All partners have equal rights in the management (majority rule) and conduct of the partnership
2. Disagreements relating to ordinary matters connected with the partnership business may be decided by a majority of the partners
3. No act in contravention of the partnership agreement may be done without the consent of ALL the partners
4. All partners contribute something to the partnership, and absent an agreement, profits and losses are divided equally
5. Any partner can bind partnership for contracts in the ordinary course of partnership business, in the absence of knowledge of third party of lack of authority [accomplished by apparent authority]
6. A partnership is also bound by a partner’s contractual or tortious acts after dissolution if the party with whom the partner deals does not have notice of the dissolution

Question 46

General Parntership

Rule

Answer 46

In a general partnership, all the partners contribute something to the partnership, and, absent agreement to the contrary, profits and losses are divided equally, and losses are shared in the same ratio as profits are divided, unless the express terms of the agreement provide otherwise.

Still, under apparent authority, any partner can bind the partnership for contracts in the ordinary course of partnership business, unless the third party knows of the lack of authority.

All partners are jointly and severally liable for all obligations of the partnership—contract or tort. Each general partner is personally liable for all partnership obligations, and if one partner is compelled to pay the entire obligation, he or she may seek indemnity from the partnership.

An incoming partner is not liable for any obligation incurred before their admission as a partner, except to the extent of the contributed property.

A partnership is also bound by a partner’s contractual or tortious acts after dissolution if the party with whom the partner deals does not have notice of the dissolution

Question 47

General partnership’s liabiltiy**

Answer 47

In a general partnership, all partners are jointly and severally liable for all partnership’s obligation, and if one partner is compelled to pay the entire obligation, it may seek indemnity from the partnership or contribution for others in the partnership.

Question 48

Limited Partnership

Info

Answer 48

1. Limited partnerships and limited liability partnerships require formalities, such as a formal written agreement and the filing of documents, usually some kind of a Certificate, with the State.
2. If they are improperly or defectively formed, the result is a general partnership—if the entity is in fact a partnership
3. In a limited partnership, unlike in a general partnership, only the general partner has the authority to bind the partnership and make management decisions, and thus is liable for all partnership obligations.
4. The limited partners merely contribute capital, and are liable only to the extent they risk their invested capital.
5. Even in limited partnerships, however, limited partners can vote on major issues, such as dissolution of the partnership or sale of all or the majority of assets of the partnership.

Question 49

Limited Partnership’s and LLP formation and liability**

model answer

Answer 49

To form a limited partnership/LLP, the general partner must sign the partnership agreement and must filed formal documents to the Secretary of State.

In a Limited Partnership/LLP, only the general partner has the authority to bind the partnership and make management decisions, and thus is liable for all partnership obligations. The limited partners are only liable to the extent of their capital contribution to the entity.

Question 50

Limited Partnership/LLP - Limited partners investment

Rule

Answer 50

In a limited partnership or an LLP, the partners’ liability is limited to their capital accounts in the partnership (the amount of their initial investment, plus or minus undistributed profits and losses), so, unless they act in a manner inconsistent with limited partners’ limitations on duties, they cannot be held individually liable.

Question 51

Partner’s Duty of Loyalty

Answer 51

A partner’s duty of loyalty is threefold:
(1) to refrain from dealing with the partnership as or on behalf of a party adverse to the partnership;
(2) to refrain from competing with the partnership; and
(3) to account for profits, property, opportunities, or other benefits derived by the partner in conjunction with the partnership business.
–
Competing with the partnership and usurping a corporate opportunity breach the duty of loyalty.
A partner who usurps a partnership opportunity or otherwise breaches a duty of loyalty must account to the partnership for any profits he earns as a result of the breach.

Question 52

Dissociation

Rule

Answer 52

Dissociation is the change in relationship among the partners caused by any partner ceasing to be associated in the carrying on of the business.

Dissociation can occur voluntarily, such as when all the partners decide to dissolve the partnership, or when a partner voluntarily withdraws (and gives notice of such withdrawal), and involuntarily, or is expelled from the partnership.

On dissociation, a dissociating partner is paid their capital account and share of profits.

Question 53

Dissociation

Approach

Answer 53

1. Is the change in the relationship among the partners caused by any partner ceasing to be associated with the carrying on of the business?
2. Can occur voluntarily – when partners decide to dissolve, or a partner voluntarily withdraws
3. Can occur involuntarily – when a partner dies of becomes adjudged incompetent or is expelled from the partnership
4. Does not necessarily cause the dissolution of the partnership
5. Dissolution can be avoided if the partnership continues and the remaining partners buy out the dissociated partner’s interest.
6. The purchase price will be based on the greater of the partnership’s liquidation value or the value of the partnership as an ongoing business without the dissociated partner.

Question 54

Dissociation Voluntarily vs. Involuntarily

Not Rule

Answer 54

On dissociation, a dissociating partner is paid their capital account and share of profits.

Dissociation can occur voluntarily:
* E.g., when all the partners decide to dissolve the partnership,
* E.g., when a partner voluntarily withdraws and gives notice of such withdrawal

Dissociation can occur involuntarily:
* E.g., a partner dies or becomes adjudged incompetent,
* E.g., partner is expelled from the partnership.

Question 55

Wrongful Dissociation - Dissociation Results in Breach

Rule

Answer 55

If the dissociation is the result of a breach of an express term of the partnership agreement, it will be a wrongful dissociation. A partner who wrongfully dissociates is liable to the partnership for any damages caused by the dissociation.

Question 56

Partnership Dissolution

Answer 56

An at-will partnership may be dissolved by any partner by his express will – “I quit.”

Question 57

Act that would cause Dissolution

Not Rule

Answer 57

Acts that will cause dissolution:
1. Some acts of dissociation
2. The express will of at least half of the remaining partners to wind up the business
3. Express consent of all partners to wind up the business
4. Expiration of the term

—-
Certain other acts will also cause the dissolution of the partnership, but the ones most likely to be tested are some acts of dissociation, including:
* within 90 days after a partner’s death, bankruptcy or wrongful dissociation, the express will of at least half of the remaining partners to wind up the business;
the express consent of all partners to wind up the business; or
* the expiration of the partnership term.

Question 58

Avoiding Dissolution by Dissociation

Rule

Answer 58

Dissociation often may, but does not necessarily, cause the dissolution of the partnership. Dissolution can be avoided if the partnership continues, and the remaining partners buy out the dissociated partner’s interest. The purchase price will be based on the greater of the partnership’s liquidation value or the partnership’s value as an ongoing business without the dissociated partner.

Question 59

Limited Liability Companies

Answer 59

A Limited Liability Company is an entity that is taxed like a partnership (profits and losses are not taxed at the corporate level but flow through to the members), but the members enjoy limited liability like shareholders and directors of a corporation. LLC’s are primarily governed by operating agreements that control most aspects of business and management. An LLC is an entity distinct from its members.

Question 60

LLC Principles

Answer 60

1. Taxed like a partnership, but enjoy limited liability like shareholders and directors of a corporation
2. Primarily governed by operating agreements that control most aspects of business and management
3. An LLC is an entity distinct from its members
4. Management is presumed to be by all members, but the articles may provide for management by a committee of members, by one member, or by an outside manager.
5. If management is by the members, a majority vote is required, and each member is an agent of the LLC.
6. Profits and losses are allocated on the basis of the contributions.
7. An assignment of a member’s interest transfers only the right to profits and losses, but not management or voting rights. Membership transfer requires unanimous consent of the members.
8. Disassociation (death, retirement, resignation, bankruptcy, termination of a member) causes dissolution, but the remaining members can file a notice of continuation to avoid cessation of business.

Question 61

LLC Formation

Answer 61

An LLC is formed by filing Articles of Organization with the Secretary of State. They must include:
(1) a statement that the entity is an LLC;
(2) the name, which must include “LLC” or “Limited Liability Company;” the street address of the office and the registered agent for service of process; and the names of all the members.

—-

Defective formation => probably general partnership

Question 62

Corporate Formation

Information

Answer 62

1. Formed by filing Articles with Secretary of State
2. An incorporator is the person who signs the Articles of Incorporation
3. A corporation is presumed to be formed for a lawful purpose and any business outside of the corporation’s stated purpose is deemed ultra vires.

Question 63

Corporate Formation

rule

Answer 63

The corporation is formed by incorporator signing the Articles of Incorporation and filing Articles of Incorporation with Secretary of State.

Question 64

Ways Corporations are Formed

Answer 64

1. De Jure
2. De Facto
3. Corporation by Estoppel

Question 65

De Jure

Answer 65

in accord with the formation statutes

Question 66

De Facto

Answer 66

Requires an available statute for valid incorporation, a colorable compliance and good faith and the corporation must act like a corporation

—
* “good faith” - members do not know that the incorporation was defective
* “the corporation must act like a corporation” - conducting business in the corporate name with some exercise of corporate privileges

Question 67

Corporation by Estoppel

Answer 67

Persons who treat an entity like a corporation are estopped from later claiming it was not – this is an apparent authority principle

Question 68

Ultra Vires

Answer 68

A corporation is presumed to be formed for a lawful purpose and any business outside of the corporation’s stated purpose is deemed ultra vires. A corporation may limit the purpose by providing a business purpose in its Articles of Incorporation.

Question 69

Common law Ultra Vires remedies

for contract

Answer 69

At common law, an ultra vires contract is illegal and unenforceable.

Question 70

Modern Rule - Remedies for Ultra Vires Activities

Answer 70

Under modern rule, which California follows, three remedies for an ultra vires act are:
(1) a shareholder can sue to enjoin the ultra vires act;
(2) the corporation can sue officers and directors for damages arising from the ultra vires act; and
(3) the state may seek dissolution of the corporation (but not removal of directors)

Directors cannot generally be removed by the court for causing the corporation to perform an ultra vires act, although causing the performance of such an act may well violate the directors’ duty of care, subjecting them to a suit for damages.

Question 71

Injunction

remedy for ultra vires

Answer 71

[Injunctions are equitable actions and an equitable.] Court will not enjoin an action that would harm an innocent third party, [such as a third party entering into an ultra vires contract with a corporation not knowing that the contract was ultra vires].

Question 72

Suit Against Officers, Directors and Board

remedies for ultra vires

Answer 72

A shareholder sued against the directors for breach of duty of care for authorizing an ultra vires act. Directors are fiduciaries who owe the corporation the duty to act with the care that an ordinarily prudent person in a similar position would exercise under such circumstances. Taking on business outside the scope of the corporate’s stated purposes violates this duty.

Question 73

Dissolution

rememdies for ultra vires

Answer 73

A state may dissolve a corporation if it violates regulatory law or is found committing fraud.

Question 74

Piercing the Corporate Veil**

not stated rule

Answer 74

There are three main theories to justify piercing the corporate veil:
(1) the corporation is the alter ego of individuals—which requires a failure to observe corporate formalities (keeping adequate minutes and books and records, etc.) and a basic injustice so that equity would require that shareholders be liable for the damage caused;
(2) inadequate capitalization at the time of incorporation (amount of adequate capital is sufficient to pay debts when due); and
(3) avoidance of existing obligations at the time of incorporation, or fraud on creditors or other third parties at the time of incorporation.

Question 75

Three main theories to Pierce Corporate Veil

Answer 75

1. The corporation is the alter ego of the individuals – requires a failure to observe corporate formalities, and a basic injustice so that equity would require that shareholders be liable for the damages caused.
2. Inadequate capitalization at the time of incorporation
3. Avoiding Existing Obligation at time of incorporation, or fraud on creditors or other 3rd parties at time of incorporation

Question 76

Alter Ego

Answer 76

A corporation is the alter ego of its individual shareholders when there is a failure to observe corporate formalities, such as keeping adequate minutes and books and records, and respecting the corporate form, and a basic injustice so that equity would require that shareholders be liable for the damage caused.

Question 77

Corporate formalities

Not Stated Rule

Answer 77

• keep adequate minutes,
• books, and records
• respect corporate forms

Question 78

Inadequate capitalization

Not Stated Rule

Answer 78

Not enough funds to start corporation at the time of incorporation

Question 79

Deep Rock Doctrine - Equitable subordination**

Answer 79

The Deep Rock Doctrine provides that, where the corporation is insolvent and one or more shareholders also have claims as creditors of the corporation, a court has discretion to subordinate the shareholder’s claims to any class of creditors.

A corporation is insolvent if either: (1) the corporation would not be able to pay its debts as they became due; or (2) the total assets would be less than total liabilities.

—
“Deep Rock” doctrine - Equitable Subordination: where the **corporation is insolvent **and one or more shareholders also have claims as creditors of the corporation, a court has **discretion to subordinate the shareholder’s claims ** to any class of creditors, including unsecured creditors.

—-

Deep Rock Doctrine is used to determine whether shareholders may have provided support to incorporate the company, making them creditors.

Insolvency:
* Inability to pay debt when due

Order of Paying debts
* Creditor
* Unaccredited creditors
* Shareholders

Question 80

Avoiding Existing Obligation at time of incorporation, or fraud on creditors or other 3rd parties at time of incorporation

Tip

Answer 80

This last theory is easier to show in tort cases than in contract cases, since a contracting party has the opportunity to investigate whom they are dealing with.

Question 81

Promoter

Definition

Answer 81

A promoter is one who acts on behalf of the corporation in formation.

Question 82

Two Types of Contract -
Promoter Liability

Answer 82

There are two kinds of contracts that are tested:
1. subscriptions, and
2. ordinary pre-incorporation contracts

Question 83

Stock Subscriptions

Answer 83

1. Promoters enter into contracts with persons who are interested in becoming shareholders
2. Upon incorporation, promoters owe fiduciary duties to the corporation and shareholders. The duty is one of fair disclosure and good faith.
3. A promoter who profits on the sale of property to the corporation may be liable to the corporation for the profit, or may be forced to rescind the sale, unless the promoter has disclosed all of the material facts of the transaction.

Question 84

Disclosure

Answer 84

1. If the transaction is disclosed to, and approved by, an independent board of directors, there is no breach of fiduciary duty.
2. If the board is not completely independent, the transaction must be approved by the shareholders and subscribers to the stock of the corporation.
3. Disclosure must be to all shareholders, and must include those persons contemplated as part of the initial financing.
4. Thus, if the promoters only disclose their acquisition, for profit, of shares to some of the prospective shareholders, this is a breach of their fiduciary duty.

Question 85

Liability of Promoter’s Act on Behalf of Pre-incorp. Corporation to 3rd Party

Answer 85

If the promoter acts on behalf of a corporation knowing none has been formed, the promoter is jointly and severally liable for any liabilities, even after formation, unless the 3rd party enters a novation that expressly relieves the promoter of liability

Question 86

Pre-incorporation***

Information

Answer 86

1. Commonly, before the actual incorporation occurs, arrangements must often be made pre-incorporation for leasing space, buying equipment and supplies, etc.
2. If the promoter acts on behalf of a corporation prior to incorporation, thus knowing it has not yet been legally formed, the promoter remains persoally liable for any of these liabilities, even after formation, unless the third party enters a novation with the corporation that expressly relieves the promoter of liability.
3. The corporation is not bound by, or liable for, any pre-incorporation acts or contracts of the promoter, unless it either enters into a new contract, or expressly or impliedly assumes liability by, for example, using the space or equipment that was the subject of the pre-incorporation contracts.

#3 is okay

Question 87

Promoter’s liability for Preincorporation Contracts

important rule

Answer 87

If the promoter acts on behalf of a corporation prior to incorporation, the promoter remains personally liable for any of these liabilities, even after formation, unless the third party enters a novation with the corporation that expressly relieves the promoter of liability.

Question 88

Corporation’s Liability for Promoter’s Preincorporation Contracts

very important rule

Answer 88

Corporation is not bound by the promoter’s pre-incorporation acts unless corporation accepts liability, or impliedly does so by using subject of the contract

Question 89

Shareholder’s Liability to Preincorporation Contract

Answer 89

Because, corporation are legal entities separate and apart from their shareholders, shareholders are usually not liable for preincorporation contract unless the corporate veil is pierce.

Question 90

Issuance of Securities

Corporate Formation

Answer 90

Formation also requires the issuance of securities to the shareholders.

Question 91

Equity Securities

Answer 91

Equity securities means common stock, which can be issued for valid consideration of any tangible or intangible property or benefit to the corporation, but many states still prohibit issuance of stock for promissory notes or future services

Question 92

Debt Security

Answer 92

Debt securities include a bond, which is secured by corporate assets, or a debenture, which is unsecured.

Debt security, including preferred stock, is not a form of ownership.

Preferred Stock:
1. Annual repayments
2. Amounts to repay deposited into “sinking fund”

A creditor who holds preferred stock is often repaid in annual installments, but the amounts needed to repay the preferred stock is often deposited into a sinking fund at least quarterly.

A creditor who holds preferred stock is often repaid in annual installments, but the amounts needed to repay the preferred stock is often deposited into a sinking fund at least quarterly.

Question 93

Power of shareholders

Corporate Goverance

Answer 93

The basic structure of corporate governance starts with the power of shareholders. The powers include:
* Elect and remove directors
* Amend articles, and bylaws
* Must vote on fundamental corporate changes – sale of all assets, mergers
* May vote in-person or by proxy, but not by absentee voting

Question 94

Procedure for Shareholder Meeting

Answer 94

There must be at least 10 days’ notice, but no more than 60 days, for the shareholder’s meeting and the notice must provide the time, date, place, and purpose of the meeting. At least a quorum of the shareholders must be in attendance to hold the vote.

Question 95

Vote by Proxy

Answer 95

A proxy is revocable unless expressly irrevocable and coupled with an interest. In any event, a proxy may only last for eleven months.

Interest includes:
* A pledge;
* a purchaser of the shares;
* a creditor; or
* a party to a voting agreement

Question 96

Quorum

Answer 96

Any valid vote requires a quorum.

—

Quorum – majority in interest of issued/outstanding shares

E.g., if one person owns 51% of the shares, if only that one person shows up to vote, there is a quorum.

Question 97

Cumulative voting

Answer 97

1. Shareholders can take all the votes they have for all the director positions, and vote them all toward one position.
2. Allows minority representation on Board.
3. The Articles may also permit cumulative voting

Question 98

Votes to Ordinary Matter v. Significant Matter

Answer 98

Most votes, other than major corporate matters such as merger and sale of substantially all of the assets, require a majority in interest of the shareholders voting.

Question 99

Shareholder Agreement/Voting Trust

Answer 99

Shareholder agreement, either in the form of a voting agreement or a voting trust, can involve any aspect of the exercise of corporate powers or management. It must either be set out in the articles of incorporation or bylaws, or be in a written agreement signed by all the shareholders. It does not impose personal liability on shareholders. However, it cannot override statutory requirements, such as that the directors be elected annually.

—
It can provide for election of directors and officers, but cannot override statute requiring annual election

Binding on purchasers who buy with knowledge of the voting agreement

Shareholders may enter into a shareholders’ agreement

Question 100

Transfer Restriction

Answer 100

The corporation may restrict the transfer of shares for any reasonable purpose, and restrictions may include a first right of refusal, a buy-back provision, transfer approval, and prohibition of transfer to particular persons or groups.

A transferee is bound by the restriction if he has knowledge of it or the restriction is conspicuously noted on the certificate.

Question 101

Directors Oust Fellow Director

Answer 101

Directors do no have the power to remove fellow directors unless the corporation’s articles or bylaws provide so.

Alternatively, Directors may petitioned the court to remove fellow director for inappropriate and harmful acts to corporation as long they have sufficient evidence to prove their case.

Question 102

Distributions to Shareholders

Rule

Answer 102

Distributions can be in the form of dividends to shareholders, redemption or repurchase of outstanding shares, or liquidating distributions after dissolution of the corporation.

Question 103

Board’s Discretion on Distribution

Answer 103

Distributions are within the Board’s discretion but are limited by solvency requirements. Thus, distributions are not permitted if either:
(1) the corporation would not be able to pay its debts as they became due; or
(2) the total assets would be less than total liabilities.

Distributions are also limited by any restrictions in the articles.

—-
Absent an abuse of discretion, corporations cannot be compelled to issue or pay dividends, or any other type of distribution, such as repurchases or redemptions.

The decision to redeem or repurchase some stock does not mean the directors can be compelled to redeem or repurchase other stock

Question 104

Rights of Inspection

Answer 104

Shareholders have a qualified right to inspect corporate books and records - for a proper purpose reasonably related to their interest as a shareholder.

—
They may inspect such records for a proper purpose—one reasonably related to their interest as a shareholder, including investigating possible director or management misconduct, seeking support for a shareholder initiative, and waging a proxy battle.

E.g., Records – board minutes, financial records

Question 105

Proper purpose related to shareholder’s interest

Answer 105

• Investigating director / officer misconduct
• Waging a proxy battle
• Seeking support for shareholder initiative

Question 106

Agency & Corporate Liability

Tip

Answer 106

When considering the authority of a corporate officer to bind the corporation, consider and analyze all three types of agency.

Question 107

Express Authority

Agency & Corporate Liability / Not stated rule

Answer 107

When the Board of Directors passes a resolution giving an officer the authority to do an act on behalf of the corporation

Question 108

Implied authority

Agency & Corporate Liability / Not stated rule

Answer 108

For implied authority, consider what a reasonable person would expect is within the normal day-to-day authority of that officer.

A corporate officer has implied authority intrinsic to his position to bind the corporation to minor day-to-day obligations. [Officer’s Implied authority depends on the office.]

President has the authority to manage day-to-day affairs, hire employees;
CFO has authority to sign checks

Question 109

Apparent authority

Agency & Corporate Liability / Not stated rule

Answer 109

officer has apparent authority with 3rd persons if ordinary course of business

Question 110

Corporate Officer Exceeding Authority

Answer 110

officer can be sued by EITHER CORPORATION OR THIRD PARTY for implied warranty of authority
—
When a corporate officer exceeds his or her authority, and depending on whether the third party is liable to the corporation on the contract, that officer may be liable either to the corporation or to the third party on the contract based on a breach of their implied warranty of authority

Question 111

Two ways to Shareholders Can Sue

Shareholders’s Lawsuits

Answer 111

A shareholder may sue the directors by either:
1. A direct action
2. derivative suits

Question 112

Shareholders’ Direct Suits

Answer 112

For breach of duty directly owed to the shareholder by an officer or director or by a majority of shareholders (such as failure to declare a dividend).

The suits are filed for:
* A controlling or majority shareholder for breach of fiduciary duties involving sales to looters, oppression, or sale of corporate office
* failure to declare a dividend

—

• Oppression involves acting so as to “freeze out” the minority from corporate decisions and benefits, and devalue their shares.

Question 113

Majority / [Controlling] Shareholders Fidicuary Duties to Minority Shareholders**

Answer 113

Majority / [Controlling] shareholders have a fiduciary duty to minority shareholders to not:
1. act oppressively or illegally or with fraud.
2. sell to looters.
3. sell at a premium over the market price of the shares if it was paid to sell a corporate office (such as replacing the Board of Directors) for private gain.

—

A majority shareholder owns more than 50% of the voting interest.

A controlling shareholder owns a large segment of the voting interest, where no other person individually owns a significant amount.

If breach, used shareholder’s direct suits

Question 114

Fidicuarty duty not to act oppressively or illegaly or with fraud.

Answer 114

Majority shareholders have a fiduciary duty to minority shareholders to not act oppressively, or illegally, or with fraud. Oppression involves acting so as to “freeze out” the minority from corporate decisions and benefits, and devalue their shares.

Question 115

Fiduciary Duty to not sell to looters

Duties of Controlling Shareholders

Answer 115

• Someone who buys the stock and then sells off all the assets for personal gain, leaving the shell and causing all the employees to lose their jobs.
• There is liability if the shareholders did not undertake a reasonable investigation once they are aware of facts suggesting that the prospective buyer is a looter

—

Looters - someone who buys the stock and then sells off all the assets for personal gain, leaving the shell and causing all the employees to lose their jobs.

Question 116

Duty not to Sell Corporate Offices

Duties of Controlling Shareholders

Answer 116

• Sale of controlling or majority stock at above-market price and agreement to replace the Board of Directors for private gain.

Question 117

Derivative Suits**

Answer 117

[A derivative suit is usually brought against directors or officers for breach of their duties of loyalty and care.]

A derivative suit is brought in the name of the corporation against the directors for violation of a duty to the corporation. A dervative suit requires:
(1) standing - ownership of the stock at the time of the wrong or by operation of law from someone who owned it at the time of the wrong; and
(2) a written demand and inaction for 90 days unless the demand would be futile (because all or a majority of the whole board was in breach); and
(3) the corporation is a named but nominal defendant, because the directors failed to have the corporation correct the wrongs.

Normally used for suits against directors / officers for breach of duties of loyalty and care

Question 118

Standing

Derivative Suits

Answer 118

ownership of the stock at the time of the wrong or by operation of law from someone who owned it at the time of the wrong

Question 119

Directors - Voting

Rule

Answer 119

Directors vote on general direction of the company, and approve significant actions or incurring of liabilities, and they elect the officers.

If a quorum is present, only a majority of those *disinterested directors * present is required.

A quorum is a majority of eligible directors.

The major issues involving directors are the right to vote and their fiduciary duties to the corporation.

Question 120

Director Violate Fidicuary Duty

Approach

Answer 120

1. Address the requirements for a derivative suit
2. Discuss the breach of director duties, if the call of the question asks whether a shareholder can sue.
3. There are two major fiduciary duties that should always be considered:
   * the duty of care, and
   * the duty of loyalty.

Question 121

Duty of Care**

Answer 121

Directors owe a duty of care to the corporation. The duty of care requires that the directors act: (1) in good faith (2) with the care that an ordinarily prudent person in a similar position would exercise under such circumstances; (3) in a manner the director reasonably believes to be in the corporation’s best interests.

Directors who meet this standard are not liable for decisions that, in hindsight, turn out to be erroneous. This rule of non-liability is called the business judgment rule.

—
* The person challenging the action has the burden of proving the breach of duty.

• Ordinary prudence:
  * can include relying on information and statements prepared by corporate officers and employees, legal counsel, accountants and other professionals, or a committee of the board, if the director reasonably believes such persons are competent and merit confidence.
  * can mean relying on directors of the board, and other executive positions, as long as those individuals seemed to have the proper qualifications.
• When discussing this duty of care, please first discuss the three required elements, and only then discuss whether the business judgment rule applies. Note that the business judgment rule ONLY applies to the duty of care, not any other duty.

—

[IRAC each part]

Question 122

Ordinary prudence

subrule of 2nd element - duty of care

Answer 122

Ordinary prudence can include relying on information and statements prepared by corporate officers and employees, legal counsel, accountants and other professionals, or a committee of the board, if the director reasonably believes such persons are competent and merit confidence.

Question 123

Business Judgment Rule

Answer 123

If duty of care complied with, then no liability for erroneous decisions.

Business judgment rule ONLY applies to the duty of care, not any other duty.

Question 124

Duty of Loyalty**

Answer 124

The duty of loyalty involves three major areas:
* conflict of interest;
* usurpation of corporate opportunity; and
* insider trading.

Question 125

Conflict of Interest**

Rule - conflict+cure

Answer 125

A director has a conflict of interest if she knows that she or a related person is a party to the transaction, has a beneficial financial interest in the transaction, or is a director, partner, agent or employee of an entity with whom the corporation is transacting business and the transaction is of such importance it would normally need board approval.

A transaction with a potential conflict of interest will not be enjoined or result in damages if: (1) approved by a majority of disinterested directors; (2) approved by a majority of disinterested shareholders; or (3) at the time, it was fair to the corporation.

—
Conflict of interest: Director / Related Person:
* Is a party to transaction, OR
* Has a beneficial financial interest in transaction, OR
* Is employee of entity with whom corporation is transacting business

Defenses:
* Approval by disinterested shareholders; OR
* Approval by disinterested directors; OR
* Fair to corporation

Question 126

Usurpation of corporate opportunities**

Answer 126

[A director has a duty of loyalty to the corporation. One form of breaching the duty of loyalty is to usurp a corporate opportunity.] Usurpation of corporate opportunity provides that, if the corporation has an interest or expectancy in the business opportunity, a director or officer cannot take that opportunity for himself. The closer the opportunity to the corporation’s line of business, the more likely it is a corporate opportunity.

Question 127

Defense - Disinterest

defense to corporate opportunity

Answer 127

A defense against usurping corporate opportunity is that the corporation would not have an interest in the opportunity.

Question 128

Common Law Insider Trading**

Answer 128

[In addition to federal securities law,] a director has a common law duty of loyalty to shareholders not to engage in insider trading—purchasing or selling stock with undisclosed knowledge of a special circumstance significantly impacting the value of the stock.

If plaintiff did not purchase or sell stock, they cannot prevail for common law insider trading.

Question 129

Indemnification of Directors and Officers

Duty of Loyalty Analysis

Answer 129

1. A director is entitled to indemnification from the corporation for expenses in defending a lawsuit if the director prevails.
2. If the director does not prevail, indemnification depends on the nature of the lawsuit in some states, but generally, there is no indemnification permitted.

Question 130

Dissolution (for Corporation)

Answer 130

Three major ways to dissolve a corporation:
1. Voluntary dissolution by corporate act
2. Adminstrative dissolution
3. Judicial dissolution

Question 131

Voluntary dissolution by corporate act

Dissolution

Answer 131

Shareholders and directors both vote to dissolve the corporation.

—
The standard procedure for fundamental corporate change is followed, including dissenters’ rights.

A corporation that is dissolved may not carry on its business, but may wind up and liquidate its affairs. This includes collection of assets, discharging liabilities, and distributing remaining property among shareholders.

A claim can be asserted against a dissolved corporation to the extent of its undistributed assets, and against the shareholders for the pro rata share of the claim, to the extent of assets distributed to him or her.

To bar claims sooner, the corporation may notify its known creditors in writing of the dissolution, and set a deadline of not less than 120 days by which the claim must be received.

If a claim is received and rejected, the creditor has 90 days to file suit. To bar unknown claims, the corporation must publish a notice of dissolution in a newspaper in the county of the corporation’s principal place of business.

A claim not brought within 5 years after publication is barred.

Question 132

Administrative dissolution

Dissolution

Answer 132

Brought by State for failure to :
* pay corporate fees or penalties for 60 days after their due date;
* deliver the annual statement by domestic stock corporation listing officers, directors, place of business and agent for service of process;
* maintain an agent for service of process; and
* notify the state of a change in the agent for service of process for 60 days.

If the corporation fails to correct the grounds for 60 days after notice from the state, the corporation is dissolved, but it can apply for reinstatement for two years.

Reinstatement relates back to the date of dissolution.

Question 133

Judicial dissolution**

Dissolution

only one to be tested

Answer 133

Four ways to bring judicial dissolution:
1. The state attorney general dissolve corporation on grounds of fraud or ultra vires act;
2. The shareholders dissolve the corporation on grounds of:
a. The directors are deadlocked and irreparable harm to the corporation is threatened;
b. The directors or shareholders have acted or will act fraudulently, illegally, or with oppression;
c. Shareholders are deadlocked and failed to elect one or more directors for the past consecutive two annual meetings; or,
d. The corporation’s assets are being wasted or misapplied for non-corporate purpose.
3. The creditors dissolve the corporation if their claim is reduced to judgment and remains unpaid, the corporation admits the claim is due and owning and the corporation is insolvent.
4. The corporation request court to supervise what began as a voluntary dissolution.

—
Judicial dissolution can be brought four ways.

1. The attorney general can seek dissolution on grounds of fraud or ultra vires acts.
2. Shareholders may seek dissolution on the grounds that:
   
   • the directors are deadlocked and irreparable injury to the corporation is threatened;
   • the directors or shareholders have acted or will act fraudulently, illegally, or with oppression;
   • the shareholders are deadlocked and failed to elect one or more directors for two consecutive annual meetings; or
   • corporate assets are being wasted or misapplied to noncorporate purposes.
3. Creditors can seek dissolution if the claim is reduced to judgment and remains unpaid or the corporation admits the claim is due and owing, and the corporation is insolvent.
4. The corporation can ask the court to supervise what began as a voluntary dissolution.

The corporation or other shareholders may elect to purchase the petitioning shareholders’ shares.

Question 134

Securities Regulation

Answer 134

Federal law controls certain aspects of the issuance, purchase and sale of stock. The three main laws you must know are Rule 10b-5 (promulgated under the Securities Exchange Act of 1934), Section 16(b) (of the Securities Exchange Act of 1934), and the 2002 Sarbanes-Oxley Act.

Question 135

Two Types of 10-5

Answer 135

There are two major, different types of violations under Rule 10b-5.

• One involves basic fraud in the purchase or sale of securities, while the other involves insider trading.
• Rule 10b-5 applies to corporations that are either traded on a national exchange or have at least 500 shareholders and $10 million in assets.

Question 136

10b-5 - Fraud

Answer 136

It is unlawful, in connection with the purchase or sale of a security, to employ interstate commerce or the mails, or a national securities exchange, to:
1. employ any device or scheme to defraud;
2. make any untrue statement of material fact or omit to state a material fact; or
3. engage in any act or business practice that would operate as a fraud or deceit on any person.

[include analysis of common law representation from Tort if an insider makes false statements in connection with the purchase or sale of stock, and common law insider trading if the insider buys or sells stock and fails to disclose the inside information.]

—-
The fraud must be material—if a reasonable investor would consider the misstated or omitted fact to be important—and there must be scienter: the intent to deceive, manipulate, or defraud.

The term “in connection with the purchase or sale of a security,” is interpreted broadly, but it still excludes potential purchasers who did not buy and potential sellers who did not sell, but includes insiders who buy or sell.

A nontrading defendant, such as a market analyst who publishes false information, can be held liable to plaintiffs who buy or sell based on their reliance on the false information.

Both 10b-5 fraud and common law misrepresentation require plaintiff to actually purchase or sell stock in reliance on false / misleading statement or omission

Question 137

Insider Trading**

Answer 137

A person commits insider trading if he or she purchase or sell stock with knowledge of nonpublic information that was not disclosed and breaches a duty of trust and confidence owed to the issuer, the issuer’s shareholders, or another person who is the source of the nonpublic information.

duty of loyalty violation, especially for attorney

Question 139

4 types of liable persons for Insider Trade**

Answer 139

Insider – liable only if insider buys or sells stock using inside information

Tipper – liable if he tips for an improper purpose

Tippee – liable if he knows tipper violated duty

Misappropriator - liable if he trades on information from confidential relationship

Question 140

Insider

Answer 140

They are those connected to the issuer, such as shareholders, directors, employees and officers, CPA’s, attorneys, and bankers.

An insider is certainly liable if they use or disclose information for their personal benefit—by buying or selling stock with knowledge of the inside information.

Question 141

Tipper

Answer 141

–> An insider gives a tip of inside information to someone else who trades on the information.

a tipper is liable if the tip was made for any improper purpose, including benefiting another person.
—
Tip: So it is often the case that you will discuss someone as both an insider and a tipper

Question 142

Tippee

Answer 142

Tippees are those who trade based on inside information from an insider.

They are liable if the tipper breached a duty of nondisclosure, and the tippee knows the tipper was breaching their duty of nondisclosure.

Question 143

Misappropriators

Answer 143

Misappropriators are those who trade in breach of a duty of confidentiality owed to the source of the non-public information.

The Securities Regulations include attorneys, bankers, brokers, and similar persons as those who owe such a duty, including those persons who are within the parent-child relationship.

—

The government can criminally prosecute misappropriators.

It is not uncommon to have to discuss someone who received a tip as both a tippee and a misappropriator.

Question 144

Remedies

Insider Trading - Security Law

Answer 144

Individual plaintiffs can sue under federal law for rescission or damages (difference between price paid or received and average share price in the 90 days after the corrective information is disseminated), but not punitive damages (which may be available under state fraud law).

Question 145

Section 16(B)

Rule

Answer 145

Any profit realized by a shareholder of more than 10% of the stock, or by any director or officer, from any purchase and sale within a period of less than six months, must be disgorged to the corporation. This rule applies to corporations that are either traded on a national exchange or have at least 500 shareholders and $10 million in assets. Purchases or sales made before becoming an officer or director are excluded, but those made within six months after ceasing to be an officer or director are included.

—

Question 146

“10% shareholder” under section 16(b)

subrule

Answer 146

To be considered a 10% owner for purposes of section 16(b), both parts of the transaction must qualify as a 10% shareholder transaction. That is, the shareholder must own 10% both immediately before the purchase and immediately before the sale.

—
e.g., analysis that Aco not within Rule 16(b)
Corporation Winter - 1987
Here, immediately before the December 1 purchase of 120,000 shares of Tco, Aco owned no Tco stock. So, despite selling the shares when Aco was 12% shareholder, the purchase and sale here are not within the ambit of section 16(b), and Aco can keep its profit.

—

For the rule to apply to holders of more than 10% of the stock, they must own that amount at the time of each purchase and sale, so purchases to get over the 10% amount do not count.

• 10% means 10% at the time of EACH purchase and sale, so purchases to initially get over 10% do not count

Question 147

Profit Measured under Rule 16(b)

Answer 147

Profit is measured by the difference between the transaction with the highest sales price and the transaction with the lowest purchase price during the six month period.

Question 148

Sarbanes-Oxley Act of 2002

Answer 148

Tries to eliminate the relationship between the auditor and the officers

Qualifying corporations have to establish an audit committee made up of independent Board members – none can be otherwise employed by or affiliated with the company

Audit committee is to oversee the appointment, compensation and work performed by the registered public accounting firm it employs to perform its audits

Question 149

Audit Rules

Sarbanes-Oxley Act of 2002

Answer 149

Each such company must establish an audit committee made up of independent Board members—none can be otherwise employed by or affiliated with the company. The audit committee is to oversee the appointment, compensation, and work performed by the registered public accounting firm it employs to perform its audits.

The CEO or CFO of the company must certify, for filed audit reports, that the officer has reviewed the report, it is true and does not contain any material omissions, fairly presents the financial position of the company, and has established internal accounting controls and evaluated them in the prior 90 days.

If a company is required to restate its reports due to misconduct in the reports, the CEO and CFO must reimburse the company for all bonuses and incentive-based compensation, and all profits from sales of stock, received in the 12 months after the erroneous report was filed.

A company cannot make personal loans to any director or executive officer unless such loans are made in the ordinary course of business, and on the same terms as to everyone else.

Question 150

Criminal Penalties for messing with audit

Sarbanes-Oxley Act of 2002

Answer 150

There are also criminal penalties for destroying or altering documents, for destruction of corporate audit records, and for securities fraud, and the Act creates a private cause of action for persons discharged because they provided information to employers or the government regarding conduct they believed to violate federal securities laws.

Question 151

Remedies

Sarbanes-Oxley Act of 2002

Answer 151

Remedies include reinstatement, back pay, attorney fees and costs.