Business Associations

Question 1

Agency Relationship

Answer 1

An agency relationship exists when a principal authorizes an agent to act on her behalf and represent the principal. Formation of the relationship requires an agreement that the agent will act for the benefit of the principal and is subject to the principal’s control.

Mnemomic - “ABC” (Agreement-Benefit-Control)

Question 2

Actual Authority

Answer 2

Actual authority can be express or implied. Actual express authority is specifically granted to the agent by the principal and may be oral or in writing. Actual implied authority exists when the agent reasonably believes the action taken is required by their duties, they have acted the same way previously, or it is customary.

Question 3

Termination of Actual Authority

Answer 3

Actual express or implied authority may be terminated by a breach of the agent’s fiduciary duty, lapse of time, by operation of law, or changed circumstances.

Question 4

Apparent Authority

Answer 4

Apparent authority exists when the principal has provided the agent with the appearance of authority on which a third party reasonably relies. The principal may still be bound even if the agent acted outside their scope of actual authority unless the third party has actual or constructive notice of the termination.

Question 5

Ratification

Answer 5

Ratification occurs when the agent takes action without proper authority and the principal subsequently engages in conduct that approves the agent’s action. Once ratified, the agent is no longer liable.

Question 6

Principal’s Liability for Agent’s Torts

Answer 6

A principal is liable for an agent’s torts that are committed within the scope of the agency relationship. An act is within the scope of the relationship if the conduct was of the kind the agent was hired to perform, the tort occurred on the job, or the agent was acting for the benefit of the principal.

Question 7

Frolic and Detour

Answer 7

A principal is not liable for torts committed by an agent while the agent is substantially deviating from the planned conduct and is acting for their own benefit (frolic). However, a small deviation from the planned conduct (mere detour) is permissible and the principal will still be liable.

Note - if you see this on an exam be sure to argue both since it will be a close call

Question 8

Principal Liability for Independent Contractors

Answer 8

A principal is not generally liable for the torts of an independent contractor unless the conduct involves an ultra-hazardous activity, non-delegable duties, negligent hiring of the independent contractor, or the principal holds the independent contractor out as an agent.

Note - unlike an agent, a principal does NOT have control over the manner and method by which an independent contractor performs

Question 9

Intentional Torts of Agent

Answer 9

A principal is not liable for the intentional torts of an agent unless they were specifically authorized, a natural result from the nature of employment, or the tortious act was motivated by a desire to serve the principal.

Question 10

General Partnership

Answer 10

A general partnership (GP) is created when two or more people carry on a business for profit. There are no formalities to form a GP; the main test is the sharing of profits. The partners are personally liable for the debts of the partnership.

Notes - incoming partners are not liable for the debts incurred prior to joining the partnership, but their contribution in joining can be used to satisfy prior debts; outgoing partners remain liable until there is a dissociation or other release of liability

Question 11

Management and Control (GP)

Answer 11

Each partner is entitled to equal management and control of the partnership. Ordinary business decisions are controlled by a majority vote, extraordinary decisions require a unanimous vote.

Question 12

Fiduciary Duties of Partners

Answer 12

Partners owe duties of care and loyalty, a duty to disclose, and a duty to account.

Question 13

Profits and Losses (Partnership)

Answer 13

The default rule is that profits are shared equally and losses follow profits. However, the partnership agreement can modify the default rule.

Question 14

Duty of Care (Partnerships)

Answer 14

Partners owe a duty to use reasonable care.

Question 15

Duty of Loyalty (Partnerships)

Answer 15

Partners owe a duty of loyalty to put the partnership’s interests over their own and avoid conflicts of interest. Conflicts of interest include self-dealing, usurping a business opportunity, or competing with the partnership.

Question 16

Duty of Disclosure (Partnerships)

Answer 16

Partners must disclose any material fact regarding partnership business and have a right to inspect and copy the books.

Question 17

Remedy for Breach of Duty by a Partner

Answer 17

Partners can bring actions against other partners for losses caused by their breach and may disgorge a breaching partner of profits.

Question 18

Equal Dignity Rule

Answer 18

If an agent signs a contract that requires a writing (SOF), the agency agreement must also be in writing.

Question 19

Dissociation of Partner

Answer 19

Dissociation occurs when a partner ceases to be a partner in a partnership. It may be voluntary or involuntary and does not necessarily terminate the partnership unless there are only two partners.

Question 20

Dissolution of Partnership

Answer 20

Dissolution occurs when the partnership is no longer active and the business of the partnership is wound up. Voluntary dissolution occurs when the partnership is formed for a specific purpose which has been accomplished, the agreement specified an end date, all partners agree, or an at-will partner provides notice to the other. Involuntary dissolution can occur when the partnership is engaged in an unlawful activity or by court order.

Question 21

Priority of Debts Upon Dissolution

Answer 21

Upon the termination of the partnership, partnership assets will be distributed first to outside creditors, then to inside creditors (partners who loan the partnership money), capital contributions from partners, and the remaining assets will be divided among the partners based on their ownership percentage. If the partnership has outstanding creditors, those liabilities will be divided and assigned to each partner based on their ownership percentage.

Question 22

Limited Partnership (LP)

Answer 22

A limited partnership (LP) is a partnership that has at least one general partner and one limited partner. The limited partner is liable for the obligations of the partnership only to the extent of his capital contribution and is not entitled to management or control of the partnership.

Note - distinguish from LLP, where limited partners still actively manage; in an LP the limited partner just puts up money

Question 23

Formation of a Limited Partnership

Answer 23

To form a limited partnership, the partners must file a certificate of limited partnership with the secretary of state.

Question 24

Limited Liability Partnership (LLP)

Answer 24

A limited liability partnership (LLP) is a form of partnership where none of the partners are personally liable for the obligations of the partnership.

Question 25

Formation of a Limited Liability Partnership

Answer 25

To form a limited liability partnership, the partners must file a statement of qualification with the secretary of state and identify the name of the partnership, which must include a specific indication of the LLP status (i.e., name ends in “LLP).

Question 26

Limited Liability Corporation (LLC)

Answer 26

A limited liability corporation (LLC) is a business entity that has the limited liability of a corporation and the tax advantages of a partnership. In a member-managed LLC, members (owners) are responsible for the LLC’s day-to-day operations. In a manager-managed LLC, members appoint or hire a manager or managers to run the business.

Question 27

Formation of a Limited Liability Corporation

Answer 27

To form a limited liability corporation, the members must file articles of organization with the secretary of state.

Question 28

De Jure Corporation

Answer 28

A de jure corporation meets all of the statutory requirements for incorporation, including the filing of the articles of incorporation with the secretary of state. In a de jure corporation, shareholders are shielded from personal liability.

Question 29

Articles of Incorporation

Answer 29

The articles of incorporation must contain the name of the initial agent, street address of office, corporation name, authorized number of shares, and the name and address of each incorporator.

Menomic - “I SCAN”

Question 30

De Facto Corporation

Answer 30

A de facto corporation is one that failed to become a de jure corporation due to an unsuccessful effort to comply with incorporation requirements. Like a de jure corporation, a de facto corporation shields shareholders from personal liability. A de facto corporation only exists if the business owner made a good-faith effort to comply with the incorporation requirements and acted as though the corporation existed without knowledge of the unsuccessful efforts.

Question 31

Piercing the Corporate Veil

Answer 31

Corporate shareholders are not generally liable for the debts and liabilities of the corporation. However, certain actions by the corporation may lead the court to “pierce the corporate veil” (PCV) and hold shareholders personally liable as justice requires.

Question 32

General Partnership Liability for Partner’s Act

Answer 32

A partner’s act that was authorized by the partnership, including entering a contract, binds the partnership. A partnership may also ratify a contract that was entered into without authority.

Question 33

Test for Piercing the Corporate Veil

Answer 33

No bright-line rule exists for PCV; courts generally look to the totality of the circumstances. Factors include:
1. Alter ego, where the shareholders fail to treat the corporation as a separate entity;
2. Undercapitalization, where the shareholder’s monetary investment at the time of formation is insufficient to cover foreseeable liabilities;
3. Fraud, where a corporation is formed to commit fraud or hide from existing obligations; and
4. Failing to follow corporate formalities, such as holding board meetings
5. Self-dealing with the corporation
6. Using corporate assets for personal purposes

Question 34

Ultra Vires

Answer 34

If a corporation has a limited purpose and acts outside that stated purpose, shareholders may sue to enjoin the proposed action.

Question 35

Pre-Incorporation Promoter Liability

Answer 35

A promoter is a person who works to establish a corporation prior to formal inception. They are personally liable for pre-incorporation contracts unless a post-formation novation relieves them of liability. The corporation is not generally liable for pre-incorporation contracts unless the corporation expressly adopts the contract or accepts the benefit.

Question 36

Board of Director Meetings

Answer 36

The board of directors must hold meetings, which can be regular meetings in accordance with the bylaws or special meetings with at least two days’ notice.

Question 37

Quorum for BOD

Answer 37

In order for the board of directors (BOD) to act, they must have a quorum (majority) present at the time the vote is taken.

Question 38

Duty of Care (Directors)

Answer 38

Directors have a duty to act with the care of an ordinary prudent person in a like position and similar circumstances and to make decisions in good faith. This requires directors to keep themselves reasonably informed.

Question 39

Corporation by Estoppel

Answer 39

If a person treats a business as if it were a corporation, they cannot later claim that it was not a corporation.

Question 40

Business Judgment Rule

Answer 40

The business judgment rule (BJR) is a rebuttable presumption that insulates directors from liability for decisions that were made in good faith and they reasonably believed were the best interest of the corporation. A director who breaches his duty of care and acts unreasonably will not be protected by the BJR.

Question 41

Duty of Loyalty (Directors)

Answer 41

A director owes a duty of loyalty to the corporation and must put the interests of the corporation ahead of his own. A director may not engage in self-dealing, usurp a corporate opportunity, or compete with the corporation.

Question 42

Duty to Disclose (Directors)

Answer 42

Directors have a duty to disclose material information relevant to corporate matters.

Question 43

Self-Dealing Cure (Directors)

Answer 43

Self-dealing contracts are presumed unfair. The conflict can however be cured if the director fully discloses the details to the board and it is authorized by a majority of disinterested board members or if they can show the transaction was fair to the corporation.

Question 44

Usurping Corporate Opportunity

Answer 44

A corporate opportunity exists if the corporation has a similar interest in the opportunity or is something the business might be interested in pursuing. A director may only engage in the opportunity after there was a full disclosure and a majority of disinterested officers rejected the opportunity.

Question 45

Removal of Directors

Answer 45

A director may be removed from the board by court order for fraud or gross abuse of authority or by a majority vote of the shareholders for any reason.

Question 46

Shareholder Meetings

Answer 46

Shareholder meetings are required to take place annually. Shareholders will elect the board members and vote on corporate management issues. Special meetings can also be held upon reasonable notice of the time, place, and business to be discussed.

Question 47

Shareholder Voting Rights

Answer 47

Shareholders have a right to vote to elect or remove members of the board and approve fundamental changes in corporate structure, such as mergers and dissolutions. The right to vote attaches to the type of stock held by the shareholder. A shareholder may also vote by proxy, which is a signed writing authorizing another to cast a vote on their behalf.

Question 48

Shareholder’s Right of Inspection

Answer 48

A shareholder has a right to inspect and copy corporate records upon five days’ written notice and demonstration of proper purpose. A proper purpose is one that relates to the shareholder’s interest in the corporation.

Question 49

Dividends

Answer 49

Dividends are the distribution of profit paid to shareholders. Shareholders are not entitled to dividends as they are given at the board’s discretion. However, when a board acts in bad faith and refuses to declare a dividend in bad faith, a shareholder may seek a court order.

To prevail in a suit to compel a dividend, the shareholder must prove the existence of i) funds legally available for the payment and ii) bad faith on the part of the directors in their refusal to pay.

Question 50

Shareholder Direct Suit

Answer 50

A shareholder may bring a suit for breach of fiduciary duty owed to the shareholder.

Question 51

Derivative Suit

Answer 51

A shareholder may bring a suit on behalf of the corporation for harm done to the corporation. Any recovery belongs to the corporation. Standing to bring the suit requires that the plaintiff own stock at the time the claim arose and must have made a written demand on the BOD to act at least 90 days before filing suit, unless the demand would be futile.

Question 52

Fiduciary Duty of Shareholders

Answer 52

Modernly, controlling shareholders owe a fiduciary duty to the corporation and minority shareholders owe the duty of care and loyalty. A controlling shareholder is one with enough voting strength to have an impact on the corporation (not always 50% or more).

Question 53

Deeprock Doctrine

Answer 53

When factors exist that would permit the corporate veil to be pierced, amounts owed by a corporation to the shareholder may be subordinated to those owed to third-party creditors.

Question 54

16(b) Short-Swing Profits Rule

Answer 54

Any short-swing trading profits received within a six-month period by a corporate director, officer, or shareholder who owns more than 10% of the corporation must be disgorged to the corporation. To be subject to this rule, the corporation must be publicly traded or have $10M in assets and at least 2,000 shareholders.

Question 55

Section 10b-5

Answer 55

Section 10b-5 prohibits trading securities based on nonpublic corporate information. 10-b5 may be violated by direct trading by an insider, tippers, tippees, or misappropriators. A prima facie case requires intent, material misrepresentation or omission, reliance, and the purchase or sale of stock by means of interstate commerce.

For a 10b-5 analysis, first establish the party is in a position to be liable as one of the first four options. Then establish the prima facie case.

Question 56

Elements of Prima Facie Case for 10b-5

Answer 56

1. Intent (can be recklessness) to defraud, deceive, or manipulate;
2. Material misrepresentation or omission: information is material where there is a substantial likelihood a reasonable investor would consider it important in making an investment decision (omission only applies if party has a duty to disclose);
3. Reliance: there must be actual reliance on the misrepresentation;
4. Purchase or sale of securities; and
5. Interstate commerce: the trade must involve the use of some means of interstate commerce like phone, mail, or the national securities exchange

Question 57

Damages for 10b-5

Answer 57

Damages are calculated as the difference between actual proceeds and what should have transpired based on the real value of the stock. These profits must be disgorged to the company.

Question 58

Parties Subject to 10b-5

Answer 58

1. Insider - a director, officer, shareholder, employee, or other holder of material, nonpublic information
2. Tippers - people who provide inside information; liable if the information was shared for the improper purpose of personal gain
3. Tippees - people who receive inside information; only liable if the tipper breached a fiduciary duty, the tippee knew the duty had been breached, and the tipper personally benefitted
4. Misappropriators - those obtaining corporate private information through other means (e.g., eavesdropping, lawyer who received info for a proper purpose and then used it to trade); may be in breach of duty to the source of the information, though typically no duty to disclose

Question 59

Indemnification (GP)

Answer 59

When a partner incurs personal liability in the ordinary course of conducting partnership business, the partnership is required to indemnify the partner for such liability.