Business Associations Flashcards
Rule 10b-5
Rule 10b-5 forbids fraud or deceipt in connection with the purchase or sale of securities. A Rule 10b-5 plaintiff must establish: (1) defendant’s fraudulent conduct; (2) in interstate commerce; (3) plaintiff’s related purchase or sale of a security; (4) plaintiff’s reliance; and (5) damages.
1. Defendant’s Fraudulent Conduct
This element requires (a) materiality and (b) scienter.
a. Materiality
A statement or omission is material if a reasonable investor is substantially likely to consider it important in making the investment decision.
b. Scienter
Scienter requires defendant’s intent to deceive, manipulate, or defraud. Circuit courts have found recklessness to be sufficient.
2. Interstate Commerce
Defendant’s conduct must involve some means of interstate commerce (e.g., phone, mail).
3. Plaintiff’s Security Purchase or Sale
What matters is a plaintiff’s sale or purchase, not whether defendant sold or purchased securities. Applicable transactions include: (a) exchanges of stock for assets; (b) mergers; (c) contracts to sell.
But would-be purchasers or sellers who do not buy or sell due to fraud are excluded.
4. Plaintiff’s Reliance
Although reliance is an element of a Rule 10b-5 action, in nondisclosure actions and public misrepresentation actions reliance is presumed.
5. Damages
A private plaintiff must show defendant’s conduct caused plaintiff’s damages.
- Damages are the difference between: (a) price paid/received by plaintiff and (b) average share price in ninety-day period after corrective information is disseminated.
- Rescission is available in lieu of damages.
- Punitive damages are not available under rule 10b-5, but might be under State fraud claims.
**NOTE: **The government—but not a private plaintiff—may sue for aiding and abetting.
Insider Trading
The Supreme Court has recognized three theories of insider trading liability: (1) “classical” theory; (2) “tipper-tippee” theory; and (3) misappropriation theory.
1. Classical Insider Trading Liability
To sue for insider trading, one must demonstrate:
* defendant possessed material nonpublic information;
* defendant had a duty too keep the information confidential;
* defendant breached this duty by acting on or revealing the information;
* defendant had scienter (intent to deceive, manipulate, or defraud); AND
* disclosure of information caused damages.
2. Tipper-Tippee Liability
a. Tipper Liability
A person is liable under 10b-5 if:
* the person has a duty of trust or confidence not to use inside information for personal benefit;
* the person reveals inside information to a tippee;
* the tippee uses the information in connection with a securities transaction; AND
* the tip was made for any improper purpose (money, kickback, benefit of family or friend).
b. Tippee Liability
A tippee is liable if:
* he trades on the insider information; AND
* knows or should know the insider information was improperly disclosed.
3. Misappropriation Liability
The government can prosecute a person under Rule 10b-5 for trading inside information in breach of a duty of trust and confidence owed to the source of the inside information.
Section 16(b)
Section 16(b) requires surrender to the corporation of:
- any profit realized
- from the purchase and sale, or sale and purchase, of any equity security
- within a six-month period
- by any director, officer, or shareholder owning more than 10% of a class of the corporation’s stock.
HOWEVER, 16(b) only applies to a publicly held corporation that has:
- shares traded in a national exchange;
- more than $10 million in assets and 2,000 or more shareholders in any outstanding class; OR
- more than $10 million in assets and 500 shareholders who are not accredited investors (e.g., directors, officers, high-income/high net worth individuals).
Agency Contractual Liability
CONTRACTUAL CAPACITY
To form an agency relationship, a principal must have capacity to contract and thus must be:
1. eighteen or older; AND
2. mentally competent.
An agent must have minimal capacity and can be a minor.
AGENT’S LIABILITY FOR AGENT’S CONTRACTS
An agent is personally liable for contracts with third parties if:
1. The agent has no authority to make the contract yet does so.
2. Principal’s existence and identity is undisclosed or unknown.
3. All parties intend the agent be treated as a party to the contract.
PRINCIPAL’S LIABILITY FOR AGENT’S CONTRACTS
An agent’s ability to bind a principal to a contract turns on whether: (1) the agent had actual or apparent authority, or (3) the principal ratified agent’s unauthorized acts.
1. Actual Authority
Actual authority may be (a) express or (b) implied.
a. Express Actual Authority
Actual express authority is exists when the principal specifically grants such authority to the agent. Such a grant may be oral, but a writing is required if the Statute of Frauds applies.
b. Implied Actual Authority
Implied actuall authority exists when an agent reasonably believes he has such authority because:
reasonably necessary to accomplish agency goals), custom, or prior dealings.
c. Termination of Actual Authority
Actual authority may be terminated by:
1. Breach of agent’s fiduciary duty.
2. Lapse of a stated period, or a reasonable time if unstated.
3. Operation of law: By the death or incapacity of either party (unless durable power of attorney exists), or bankruptcy of the principal.
4. Changed circumstances where it is clear the agent’s services are no longer needed, such as a significant change in the market, law, or subject matter.
5. Happening of a specified event.
6. Either party may usually unilaterally terminate at will with notice.
2. Apparent Authority
An agent has apparent authority sufficient to bind the principal if:
1. the principal has imbued the agent with the appearance of authority; AND
2. a third party reasonably relies on that authority.
Even after termination of actual authority, an agent may bind the principal up until a third party receives actual notice or constructive notice of the termiination.
3. Ratification
Even without actual or apparent authority agent may bind a principal who:
1. subsequently engages in conduct that approves the agent’s action;
2. has contractual capacity; AND
3. knowledge of all material facts or terms.
Principal’s Liability for Agent’s Torts
General Rule
A principal is liable for an agent’s torts committed within the scope of the agency relationship. An act is within that scope if:
1. it was of the kind the agent was hired to perform;
2. the tort occurred on the job; OR
3. the agent intended to benefit the principal.
Intentional Torts
A principal is NOT liable for an agent’s intentional torts, UNLESS:
- the principal specifically authorized the tortious conduct;
- the conduct was the natural result of the agency (e.g., bouncer); OR
c. The tortious act was motivated by a desire to serve the principal.
Frolic Exception vs. Mere Detour
- Frolic: A principal is not liable for agent’s torts committed when an agent substantially deviates from planned conduct such that she is acting for her own purposes.
- Mere Detour: A small deviation from planned conduct is permissible and within the scope of the agency relationship.
Principal’s Liability for Independent Contractors’ Torts
Genearlly, a principal is NOT liable for the torts of an independent contractor.
Agent or Independent Contractor?
An independent contractor is someone who renders performance for the principal in a manner and method not subject to the principal’s control. To determine whether someone is an employee, courts consider factors such as:
- The level of skill required to perform the work;
- Who supplies the instrumentalities used;
- The duration of the relationship; AND
- Whether the work is part of principal’s regular business.
No single factor is determinative.
Exceptions
A principal is liable for an independent contractor’s torts when the underlying contact involves:
- Ultrahazardous activity;
- Nondelegable duties;
- Negligent hiring of the independent contractor; OR
An independent contractor may be treated as an agent under an estoppel theory if principal held the contractor out as an agent.
Forming a Partnership /
Adding New Partners
A partnership exists when two or more persons or entities carry on as co-owners of a business for profit. No formalities are required to form a general partnership: only the intent to carry on as co-owners of a business for profit.
A. Assessing Intent
Profit Sharing –Most Important Factor
The most important factor as to whether a partnership exists is the sharing of profits. Profit sharing raises a presumption of partnership UNLESS the profit share was received as:
- payment of a debt;
- wages or compensation for services rendered;
- rent payment;
- an annuity or other retirement benefit;
- interest on a loan; OR
- for the sale of goodwill of a business.
Other Factors
In addition to profit sharing, other important factors include:
- a person’s right to partake in control of the business (even if control is never exercised);
- sharing of losses;
- property held in joint tenancy or in common;
- parties’call their relationship a partnership;
- venture requires extensive activity; AND
- sharing of gross returns.
B. Writing Usually Not Required
Although no writing is generally required to form a partnership, the Statute of Frauds requires partners to execute a writing if they wish to remain partners more than one year.
C. Partnership by Estoppel
When a person holds himself out as a partner or consents to being represented by another as a partner, he is liable to third parties who extend credit to the actual or apparent partnership in reliance on that representation.
D. Partner Capacity
Anyone with contractual capacity (not a minor; of sound mind) may be a partner. A would-be partner who lacks capacity is liable only to the extent of his capital contribution, but the partnership with such person is NOT void.
E. Legality of Purpose
A partnership formed for an illegal purpose is void, so courts will not compel an accounting or a settlement of a void partnership’s affairs.
F. New Partners
Unless otherwise agreed, no one can become a partner without express or implied consent of all partners.
Rights of General Partners
A. Management
All partners have an equal right to participate in the management of the partnership unless the partnership agreement provides otherwise.
B. Distribution
Partners have whatever rights are granted in the partnership agreement as to distribution of profits. If the agreement is silent, partners share profits (and losses) equally.
C. Remuneration
Partners have no right to remuneration for their services to the partnership except for winding up the partnership business.
D. Indemnification
A partner has a right to be indemnified by fellow partners for expenses reasonably incurred on behalf of the partnership.
E. Contribution
A partner has a right to contribution from fellow partners where the partner has paid more than his share of a partnership liability.
F. Inspection
A partner has a right to inspect and copy the partnership books.
G. Sue and Be Sued
Generally, a partner may sue his partnership and the partnership may sue a partner in an action at law or in equity.
General Partner Liability
General Rule
In a general partnership, each partner is jointly and severally liable for all obligations of the partnership, whether arising in tort or contract. This means a partner that pays the partnership’s whole obligation is entitled to indemnification from the partnership or pro rata contributions from the other partners if the partnership cannot indemnify. HOWEVER, a judgment is not personally binding on a partner unless:
- the partner has been served; AND
- partnerships are (a) exhausted, (b) excused by agreement; (c) excused by court order; OR excused by partnership’s bankruptcy.
New Partners
A newly admitted partner is not personally liable for partnership obligations arising before their admission. They can only lose the amount of their investment in the partnership.
Dissociating Partners
An outgoing or dissociated partner remains liable for obligations arising while they were a partner unless there has been payment, release, or novation. An outgoing partner can also be liable for acts done after dissociation.
Partner’s Authority to Bind Partnership
A partner may bind the partnership if exercising: (1) actual authority; OR (2) apparent authority.
Express Actual Authority
A partner has express actual authority to bind the partnership upon receiving said authority from the partners. Acts within the ordinary course of business (i.e., acts normal and necessary for managing the business) must be approved by a majority vote of partners. Acts outside the ordinary course must be approved unanimously. If the partnership agreement is silent, a partner has authority for usual and customary matters, UNLESS the partner knows that: (a) other partners might disagree; OR (b) for some other reason consultation with fellow partners is appropriate.
Implied Actual Authority
A partner has implied actual authority to bind the partnership when he has to take actions that are reasonably incidental OR necessary to achieve the partner’s authorized duties.
Apparent Authority
Even if a partner lacks authority, a partner may still bind the partnership if the third-party did not know or have notice that the partner lacked authority. For acts outside the scope of business, the partnership must have manifested that the partner had authority in order to be binding.
Duties of Partners
A partner owes four duties to the partnership: (1) duty of care; (2) duty of loyalty; (3) duty of disclosure; AND (4) duty of obedience.
Duty of Care
The duty of care requires refraining from grossly negligent conduct, reckless conduct, intentional misconduct, or a knowing violation of law. Examples include: violating a partnership policy; failing to thoroughly investigate facts before entering into a contract; and acting outside the scope of the business without consent from the other partners.
Duty of Loyalty
The duty of loyalty requires:
- accounting to the partnership for any benefit derived from conducting the business, using partnership property, OR appropriating a partnership opportunity;
- avoiding conflicts with interest;
- avoid self-dealing/placing personal interest over those of the partnership;
- refraining from usurping a business opportunity; AND
- refraining from competing with the partnership.
Duty of Disclosure
A partner also has a statutory duty to provide complete and accurate information concerning the partnership. This means they must provide:
- without demand, any information reasonably required for the proper exercise of the partner’s rights and duties; AND
- on demand, any other information concerning partnership (UNLESS unreasonable or improper under the circumstances).
Duty of Obedience
The duty of obedience requires the partner to obey reasonable directions of the partnership and only act within their scope of authority.
Partnership Property
Partnership Property vs. Partner’s Separate Property
Rules applied to determine whether property is partnership property include:
- Property is partnerhip property if it is acquired in the partnership’s name;
- Property is partnerhip property if it is acquired in a partner’s name AND it is apparent from the document they are acting for a partnership;
- Property is presumptively partnership property if bought with partnership funds (both cash and credit), regardless of the name on the title;
- Property is presumptively NOT partnership property if: (a) it’s in the name of partner(s); (b) the instrument transferring title does NOT indicate partner is acting for a partnership; AND (c) partnership funds were NOT used.
Other common law criteria showing property is partnership property include:
- partnership’s use of property to conduct or close relationship with partnership’s business;
- entry of property in books as partnership asset;
- partnership funds used to improve or maintain property.
Rights in Partnership Property
A partner is not a co-owner of partnership property; a partner has no transferrable interest in partnership property; and partnership property can only be used for partnership purposes.
Partner’s Ownership Interest in Partnership
(his “Partnership Interest”)
A partner’s owernship interest in the partnership is the partner’s personal property. That interest consists of:
- management rights (e.g., right to participate in business management, to obtain information about partnership, to be recognized as a parter); AND
- financial rights (e.g., right to share of partnership profit distributions).
Unless otherwise agreed, management rights are NOT transferrable, and financial rights are transferrable.
Dissociation from Partnership
When a partner dissociates from a partnership, the partner withdraws from the partnership. Dissociation does NOT necessarily cause a dissolution and winding up of the partnership. A partner becomes dissociated by:
- oral or written notice of the partner’s **express will **to withdraw;
- happening of an agreed event;
- valid expulsion of the partner;
- the partner’s bankruptcy or appointment of a receiver for a partner;
- the partner’s death or incapacity to perform partnership duties;
- court decision that the partner is incapable of performing a partner’s duties; OR
- termination of partnership.
Wrongful Dissociation
A partner is wrongfully dissociated if:
- the dissociation breaches express term of partnership agreement; OR
- the partner withdraws, is expelled, or becomes bankrupt before the end of a term partnership.
A partner who wrongfully dissociates is liable to the partnership for dissociation-induced damages.
Consequences of Dissociation for Partnership
Depending on its nature, a dissociation will result in:
- the partnership dissolves and its business winds up (business is “liquidated,” i.e., sold off); OR
- the partnership continues, and the dissociated partner is entitled to a buyout of their owernship interest.
Dissolution Caused by Dissociation
Dissolution is REQUIRED when:
- an event in agreement requires winding up;
- business becomes illegal;
- judicial decree requires it;
- unanimous consent of partners in term partnership;
- expiration of term partnership; OR
- a partner dissociates by express will in at-will partnership.
In a term partnership, if one partner dissociates wrongfully or because of a partner’s death or bankruptcy, dissolution and winding up of the partnership are required only if:
- at least half the remaining partners agree to wind up
- **within 90 days **after the dissociation.
Consequences of Dissociation for Partner
Upon dissociation, a partner loses his right to participate in management.
Generally, the partnership must buy out the dissociated partner’s ownership interest at liquidation or going-concern value and indemnify them against (a) known pre-dissociation liabilities and (b) post-dissociation liabilities not incurred by the dissociating partner’s acts. HOWEVER, a partner who wrongfully dissociates before a partnership term expires (or undertaking is completed) is NOT entitled to buy out payment UNTIL the term expires (or undertaking is completed), UNLESS partner can show earlier payment will not cause undue hardship to the partnership business. Interest must be paid on the buyout price from the date of dissociation to the date of payment.
Liability of Dissociated Partner
Generally, a dissociated partner is liable for pre-dissociation partnership obligations UNLESS creditor agrees to relase partner.
A dissociated partner is liable for** post-dissociation partnership liabilities** if:
- **within two years **after the dissociation;
- other party entering the transaction reasonably believed the dissociated partner was still a partner; AND
- other party **did not have notice **of the partner’s dissociation.
Liability of Partnership for Dissociated Partner’s Liabilities
A partnership can be bound by an act of a dissociated partner if:
- act occurs **within two years **after the dissociation;
- act would have bound the partnership before dissociation;
- other party entering the transaction reasonably believed the dissociated partner was still a partner; AND
- other party **did not have notice **of the partner’s dissociation.
Dissolution of Partnership
Generally
Dissolution generally requires the partnership business to be wound up. Partnership assets are applied to the discharge of partnership liabilities.
- If the assets are insufficient, individual partners are required to contribute (“pay in”) in accordance with their loss shares.
- If there are excess assets, they are distributable to the partners in cash in accordance with their profit shares.
Events That Trigger Dissolution
The following events trigger dissolution:
- In a partnership at will, **notification by any partner of an express will **to withdraw as a partner;
- In a partnership for a definite term or particular undertaking: (a) expiration of the term or completion of the undertaking; (b) unanimous consent; OR (c) **within 90 days **after a partner’s death, bankruptcy, or wrongful dissociation, at least half of the remaining partners wish to dissolve;
- The happening of agreed-to event;
- Partnership becomes unlawful to continue;
- Issuance of a** judicial decree on application by a partner** by a partner that: (a) economic purpose of the partnership is likely to be frustrated; (b) a partner’s has made it not reasonably practicable to carry on the business; or (c) the business cannot practicably be carried on in conformity with the partnership agreement;
- Issuance of a judicial decree on application by a transferee of a partner’s interest that it is equitable to wind up the partnership (a) after the term expires or the undertaking is completed in a partnership for a definite term or particular undertaking, or (b) at any time in a partnership at will; AND
- The passage of 90 consecutive days in which there are not at least two partners.
Partnership After Dissolution But Before Winding Up
The partnership continues to exist after dissolution until the partnership is wound up. At any time before winding up is complete, the partners may decide to** waive the dissolution **and continue the partnership by unanimous vote of the partners who have not wrongfully dissolved.
Who May Wind Up
Generally, all living partners have a right to participate in the winding up of the partnership’s business EXCEPT (a) partners who have **wrongfully dissolved **the partnership and (b) bankrupt partners. If all partners have died, the legal representative of the last surviving partner may wind up.
Priority of Distribution
Each level must be fully satisfied before the next level. In order, partnership must pay:
- outside creditors (those other than partners);
- inside creditors (creditors for liabilities other than for capital and profits);
- partners for capital contributions; AND
- partners for their share of profits.
