Business Associations

Question 1

The issue is what kind of company was formed when the signed documents for forming an LLC were never signed or filed.

Answer 1

A limited liability company is created when (1) in a writing the parties agree and consent to forming a LLC; (2) there is at least one member; (3) the writing contains the name of the business along with language of “Ltd.” or “LLC” to evidence intent in formation of a LLC: and (4) the agreement is filed with the proper state agency (usually the secretary of state). If any of these requirements is lacking, the parties are presumed to have formed a general partnership. A general partnership is the default business organization and is formed when two or more people operate a business for profit. There are no formalities required other than two or more people creating a business relationship. Sharing in profits equally is evidence of a general partnership.

Question 2

The issue is whether one general partner had the authority to purchase the imaging machine without the consent of the other partners.

Answer 2

Each partner in a partnership is considered an agent of the partnership. Each agent has the authority to act on the partnership’s behalf when they have actual or apparent authority. Actual authority may be express or implied. Evidence of actual authority may be shown in a partnership agreement. Express authority allows a partner to carry out all duties associated with a partnership business. Implied authority is authority the partner reasonably believes they have to carry out the partnership business based on past dealings or duties associated with carrying out their express authority. Apparent authority is authority a partner reasonably believes they have because the other partners hold out the partner as having this authority so as to imply to a third party that the partner has actual authority. Partners may act as agents on behalf of the partnership business without consent of the other partners when the act is in the ordinary course of the partnership business. Any acts outside the ordinary course of the partnership business must be approved by all partners in a unanimous vote.

Question 3

The issue is whether a partner in a partnership can withdraw from the partnership at any time.

Answer 3

A partner in a partnership “at will” may withdraw from the partnership business at any time. A partnership is “at will” when the partnership is not created for a limited duration or for a specific undertaking. When a partner in an at-will partnership unequivocally expresses to the other partners their intent to dissociate from the partnership, it triggers dissolution of the partnership.

Question 4

The issue is whether a partner is entitled to receive a buyout payment for their interest in the partnership.

Answer 4

Traditionally, when a partner dissociates from the partnership, it triggers dissolution of the partnership. Upon dissolution, the partnership must begin “winding up” the partnership business which includes ending the business, settling up the current business of the partnership, and paying off debts and obligations before any partner is entitled to receive profits from the partnership business. Absent language in an agreement to the contrary, partners share in profits equally and share in losses the same as they do profits. However, under the Revised Uniform Partnership Act, a partnership may continue without the withdrawn partner if the parties agree to continue and to buy out the withdrawing partner and pay them their interest in the business. if the remaining partners agree to carry on the partnership business (absent the dissociating partner), this will stop the partnership from dissolving. The remaining partners must pay the dissociating partner their interest in the business.

Question 5

The issue is whether Parent breached any duties to HomeSolar with respect to HomeSolar’s no-dividend policy.

Answer 5

A shareholder who controls the majority of share of a corporation owes fiduciary duties to the minority shareholders. Fiduciary duties include the duty of care and the duty of loyalty. The duty of loyalty requires the controlling shareholder, officers, or directors to act as a reasonable business person would in similar circumstances. The business judgment rule provides a presumption that a controlling shareholder’s actions are reasonable. Officers make decisions on the day-to-day running of the corporation and the directors make decisions about the corporation’s governance. Shareholders have no right to dictate the day-to-day running of the corporation or the corporation’s governance, other than through voting for the directors to be named to the Board of Directors. The decision to issue dividends solely belongs to the directors. A controlling shareholder has no obligation to direct directors to issue dividends as long as the decision to not issue dividends affects each shareholder in the same way.

Question 6

The issue is whether Parent breached any duties to HomeSolar with respect to HomeSolar’s contract with SolarMaterials for the purchase of rare earth minerals.

Answer 6

The duty of loyalty requires that the controlling shareholder, officers, or directors prefer the corporation’s interests over its own interest, and that they do not engage in any self-dealing that harms the corporation. When the duty of loyalty is breached, the burden is on the controlling shareholder, officer, or director to prove that the transaction was fair. A controlling shareholder, officer, or director can avoid having to prove the transaction is fair if they have a majority of disinterested directors or a majority of disinterested shareholders approve the transaction.

Question 7

The issue is whether Parent breached any duties to HomeSolar by denying HomeSolar the opportunity to apply for the governmental grant.

Answer 7

The duty of loyalty may also be breached by the usurpation of a corporation’s business opportunity. When self-dealing occurs, there is a safe harbor available, which requires that the interested party make a full disclosure to the corporation and then that either the majority of disinterested board members or majority of disinterested shareholders vote to approve the transaction. Additionally, the transaction must be fair to the corporation. The safe harbor is applicable. However, an additional element must be shown, which is that the business opportunity must be something that is within the range of possibilities for HomeSolar and that HomeSolar was positioned to respond to take that opportunity. Otherwise, the decision not to engage in that opportunity would be judged under the duty of care and protected by the business judgment rule as within the range of decisions available to a board of directors. The fiduciary bears the burden of proving there was no such breach. An opportunity that falls within the corporation’s line of business must first be presented to the corporation–it gets a right of first refusal. If the opportunity is not first presented to the corporation, the corporation can recover the opportunity from the fiduciary or seek damages.

Question 8

Agency relationship generally

Answer 8

An agency relationship is created when a principal manifests assent to an agent, the agent acts on the principal’s behalf, the agent’s actions are subject to the principal’s control, and the agent manifests assent or otherwise consents. A principal is an undisclosed principal if the third party has no notice of the principal’s existence.

Question 9

The issue is whether Ruth had actual or apparent authority to bind Scott to the contract with Wholesale.

Answer 9

A principal is subject to liablity on a contract the agent enters into on the principal’s behalf if the agent has the power (authority) to bind the principal to the contract. An agent has the power to bind the principal to a contract when the agent has actual or apparent authority, or the principal is estopped from denying the agent’s authority.

Actual authority may be either express or implied. Express actual authority can be created by specific detailed terms and instructions.

Apparent authority derives from the reasonable reliance of a third party on that party’s perception of the level of authority granted to the agent by the principal. Apparent authority is based on the principal’s manifestations to the third party. There can be no apparent authority created by an undisclosed principal.

A person who has not represented that an individual is authorized to act as an agent may be estopped from denying the existence of an agency relationship or an agent’s authority with respect to a transaction entered into by the agent. An undisclosed principal may not rely on instructions given to an agent that qualify or reduce the agent’s authority to less than the authority a third party would reasonably believe the agent to have under the same circumstances if the principal would have been disclosed.

Question 10

The issue is what legal relationship Fran, Gina, and Hank have.

Answer 10

A partnership is an association of two or more persons to carry on a for-profit business as co-owners. The key test applied to ascertain whether a business arrangement is a partnership is whether there is a sharing of the profits from the business; if so, such an arrangement generally is presumed to be a partnership, and persons who share in the profits are partners. However, a partnership does not exist between persons when one person receives profits in payment of a debt.

Question 11

The issue is whether Ivan is entitled to Gina’s share of the monthly net profits of Petals.

Answer 11

A partner has a transferable partnership interest, i.e., a partner may transfer the right to share in the profits and losses of the partnership and to receive distributions. The transfer of that partnership interest creates in the transferee a right to receive distributions to which the transferor would otherwise be entitled.

[Under RUPA, the transfer of all or any part of a partner’s interest is not a dissolution of the partnership. Thus, Gina’s gift to her son of her interest in the partnership does not dissolve the partnership.]

Question 12

The issue is whether Ivan is entitled to inspect the books and records of Petals.

Answer 12

A partnership must provide its partners and their agents with access to all of its records, but a transferee is not entitled to participate in the management or conduct of the partnership business or access partnership records. A transfer of a partner’s partnership interest does not make the transferee a partner unless the other partner or partners consent to making the transferee a partner.

Question 13

The issue is whether Fran is entitled to use the delivery truck on Sundays to take her children to their soccer games.

Answer 13

Property is partnership property if it is acquired in the name of the partnership. It is property of the partnership and not of the partners individually. A partner may use or possess partnership property only on behalf of the partnership.

Question 14

The issue is whether Cal violated his duty of loyalty to Prime by not making full disclosures to the Board regarding a partnership in which he has interest which Prime is considering for hire.

Answer 14

Directors of a corporation have a duty of loyalty to act in a manner that the director reasonably believes is in the best interest of the corporation. A director breaches this duty of loyalty by placing his own interest before those of the corporation. If a director profits at the corporation’s expense, it is a breach of the duty of loyalty.

Question 15

The issue is whether Cal has any defenses to a breach of loyalty claim.

Answer 15

A director who breaches his duty of loyalty has three safe harbor defenses: approval by disinterested directors, approval by shareholders, or fairness.

Disinterested Directors: A director is protected from liability if he made a disclosure of all material facts to the disinterested board of directors and the majority of the board approved the transaction.

Shareholder Approval: A director is protected from liability if he made a disclosure of all material facts to disinterested shareholders and the majority of the shareholders approved the transaction.

Fairness: A director is protected from liability if he could provide proof that the transaction was fair at the time of commencement.

Question 16

The issue is whether members of Prime’s board of directors (other than Cal) violated their duty of care by approving the Smart consulting contract without more information.

Answer 16

Directors owe a duty of care to a corporation. Directors must act with the care of an ordinary prudent person in a like position and similar circumstances, including being informed before making a business decision. Directors are protected by the business judgment rule which presumes that in making a business decision, the directors of a corporation acted in the best interests of the corporation. The party attacking a board decision must rebut the presumption that its business judgment was an informed decision.

Question 17

The issue is whether the six directors other than Claire received proper notice of the special meeting of the board.

Answer 17

Directors are entitled to notice of a special meeting. Unless the articles of incorporation or bylaws provide otherwise, notice must be provided at least two days prior to the meeting and should state the date, time, and place of the meeting. The notice need not describe the purpose of the special meeting.

Question 18

The issue is whether Claire received proper notice of the special meeting of the board.

Answer 18

Directors are entitled to notice of a special meeting, but a director’s attendance waives notice of that meeting unless the director promptly objects to lack of notice.

Question 19

The issue is whether there was a quorum present for the directors’ approval of the purchase.

Answer 19

For the board of directors’ acts at a meeting to be valid, a quorum of directors must be present at the meeting. A majority of all directors in office constitutes a quorum, unless the articles of incorporation or bylaws require a higher or lower number. A director must be present at the time that the vote is taken in order to be counted for quorum purposes, but presence includes appearances made through communications equipment that allows all persons participating in the meeting to hear and speak to one another.

Question 20

The issue is whether votes cast by the board members were sufficient for proper approval.

Answer 20

Typically, the assent of a majority of the directors present at the time the vote takes place is necessary for board approval. However, the articles of incorporation or bylaws may specify a higher level of approval.

Here, the articles and by-laws do not specify a higher level of approval. Therefore, a valid vote would be a majority of the directors present at the time the vote took place. The 4-3 vote approving the purchase included approving votes by Alan and Barb. However, Alan and Barb were not legally present at the meeting. As noted above, presence can include appearances by telephone, but such presence must allow all persons participating to hear each other. Here, Alan and Barb could hear the five directors but could not hear each other. Therefore, Alan and Barb were not legally present and their two approving votes do not count. Accordingly, striking those two votes, the remaining votes would equal two for approval of the purchase and three disapproving. Thus, the board of directors did not properly approve the purchase of the asset.

Question 21

The issue is when Solar Inc. came into existence by properly filing articles of incorporation with the Secretary of State.

Answer 21

In order to form a corporation, articles of incorporation must be filed with the state. The articles must include certain basic information, including the number of shares the corporation is authorized to issue. Unless a delayed date is specified in the articles, the corporate existence begins when the articles are filed.

Question 22

The issue is whether the woman is personally liable to the installer when the employment contract was entered into before incorporation.

Answer 22

When a person conducts business as a corporation without attempting to comply with the statutory incorporation requirements, that person is liable for any obligations incurred in the name of the nonexistent corporation.

When all of the statutory requirements for incorporation have been satisfied, a de jure corporation is created. Consequently, the corporation, rather than persons associated with the corporation, is liable for activities undertaken by the corporation. However, when a corporation has not been created, the entity may be treated as a general partnership. A partnership is an association of two or more persons to carry on a for-profit business as co-owners. In a general partnership, each partner is jointly and severally liable for all partnership obligations.

When a person makes an unsuccessful effort to comply with the incorporation requirements, that person may be able to escape personal liability under either the de facto corporation doctrine or the corporation by estoppel doctrine. Under either doctrine, the owner must make a good-faith effort to comply with the incorporation requirements and must operate the business as a corporation without knowing that the requirements have not been met. If the owner has done so, then the business entity is treated as a de facto corporation, and the owner, as a de facto shareholder, is not personally liable for obligations incurred in the purported corporation’s name. Note, however, that the RMBCA has abolished the de facto corporation, as have many jurisdictions that have adopted the RMBCA.

Alternatively, under corporation by estoppel, a person who deals with an entity as if it were a corporation is estopped from denying its existence and is thereby prevented from seeking the personal liability of the business owner. This doctrine is limited to contractual agreements.

Question 23

The issue is whether Parent breached its duties to HomeSolar with respect to HomeSolar’s no-dividend policy.

Answer 23

A controlling shareholder, such as a parent corporation, generally does not owe fiduciary duties to the corporation or other shareholders. However, decisions by a majority shareholder or control group may be reviewable by a court for good faith and fair dealing toward the minority shareholders under the court’s inherent equity power. Business dealings between a controlling shareholder and the controlled corporation that do not involve self-dealing are analyzed using the business judgment standard. The business judgment rule is a rebuttable presumption that the controlling shareholder reasonably believed that his actions were in the best interests of the corporation. A typical decision protected by the business judgment rule includes whether to declare a dividend and the amount of any dividend.

Question 24

The issue is whether Parent breached its duty of loyalty to HomeSolar with respect to the SolarMaterials contract for the purchase of rare earth minerals.

Answer 24

If a parent corporation causes its subsidiary to participate in a business transaction that prefers the parent at the expense of the subsidiary, it can involve self-dealing and a breach of loyalty. A parent corporation that engages in a conflict-of-interest transaction with its own corporation, also known as “self-dealing,” has violated the duty of loyalty unless the transaction is protected under the safe-harbor rule. The business judgment rule does not apply in a conflict-of-interest transaction. There are three safe harbors by which a conflict-of-interest transaction may enjoy protection: (i) disclosure of all material facts to, and approval by a majority of, the board of directors without a conflicting interest; (ii) disclosure of all material facts to, and approval by a majority of, the votes entitled to be cast by the shareholders without a conflicting interest; and (iii) fairness of the transaction to the corporation at the time of commencement. The fairness test looks at the substance and procedure of the transaction. With regard to a parent corporation engaged in self-dealing, the main concern under the fairness test is whether the benefit is comparable to what might have been obtained in an arm’s length transaction. Procedural fairness is generally not at issue unless there has been a change in control.

Question 25

The issue is whether Parent breached its duties to HomeSolar by denying the opportunity to apply for the government grant.

Answer 25

The MBCA does not directly address the usurpation of corporate opportunity by a parent corporation; however, a director’s duty can be applied in this situation. A director may violate his duty of loyalty by usurping a corporate opportunity rather than first offering the opportunity to the corporation. In determining whether the opportunity is one that must first be offered to the corporation, courts have applied the “interest or expectancy” test or the “line of business” test. Under the “interest or expectancy” test, the key is whether the corporation has an existing interest or an expectancy arising from an existing right in the opportunity. An expectancy can also exist when the corporation is actively seeking a similar opportunity. Under the broader “line of business” test, the key is whether the opportunity is within the corporation’s current or prospective line of business. Whether an opportunity satisfies this test frequently turns on how expansively the corporation’s line of business is characterized.

Question 26

The issue is whether an undisclosed principal or the principal’s agent is liable on a contract with a third party.

Answer 26

An agent has the power to bind the principal to a contract when the agent acts with actual or apparent authority. Actual authority exists when the principal makes a manifestation that causes the agent to reasonably believe that the agent is authorized to act on the principal’s behalf. Apparent authority exists when a third party reasonably relies on manifestations by the principal concerning the agent’s authority to act on the principal’s behalf.

A principal is an undisclosed principal if the third party has no notice of the principal’s existence. An agent who enters into a contract on behalf of an undisclosed principal becomes a party to the contract. Thus, when the agent does not inform a third party of the identity or the existence of the principal, the agent becomes liable to the third party on the contract.

Question 27

The issue is whether a partially disclosed principal or the principal’s agent is liable on a contract with a third party.

Answer 27

A principal is a partially disclosed principal if the third party has notice of the principal’s existence but not the principal’s identity. Unless the agent and the third party agree otherwise, an agent who enters into a contract on behalf of a partially disclosed principal becomes a party to the contract.

Question 28

The issue is whether the owner ratified the contract. [agency principal]

Answer 28

A principal can ratify an act that was done on the principal’s behalf. There are four requirements for ratification: (i) the principal must ratify the entire contract; (ii) the principal and the third party must have legal capacity to enter into the contract; (iii) the ratification must occur before the third party withdraws from the contract; and (iv) the principal must know the material facts of the transaction.

Question 29

The issue is whether the conversion from a partnership to a limited liability partnership (LLP) relieves the LLP of obligations incurred by the partnership.

Answer 29

The filing of a statement of qualification, which transforms a partnership into an LLP, does not create a new partnership. An LLP is a partnership in which a partner’s personal liability for obligations of the partnership is eliminated. In other respects, an LLP is governed by the same rules as a partnership.

Question 30

The issue is whether the man and the woman can be held personally liable for obligations that pre-existed their conversion to an LLP.

Answer 30

A partner is jointly and severally liable for all partnership obligations. Though a limited partner in an LLP is not personally liable for an obligation of an LLP, limited liability partnership status is generally only effective on the date that the statement of qualification is filed with the state and not before.

Question 31

The issue is whether the investor who became a partner in an existing LLP can be held personally liable for the judgment incurred by the former partnership.

Answer 31

A person admitted as a partner into an existing partnership is not personally liable for any prior partnership obligations. However, any capital contribution made by an incoming partner to the partnership is at risk for the satisfaction of such partnership obligations.

Question 32

The issue is whether the LLP is liable to the bank on the loan because the man acted with apparent authority.

Answer 32

A partner is an agent of the partnership for the purpose of its business and can contractually bind the partnership when the partner acts with either actual or apparent authority. A partner’s act that was authorized by the partnership binds the partnership. Actual authority includes both express authority and implied authority. Express authority can arise from the partnership agreement itself, an authorization of the partners, or a statement of authority filed with the state.

A partner’s act that was not authorized by the partnership may nevertheless bind the partnership under the principle of apparent authority. For apparent authority to apply, the partner must perform the unauthorized act in the ordinary course of apparently carrying on either the partnership business or business of a kind carried on by the partnership. However, the third party with whom the partner was dealing cannot hold the partnership liable when that party knew or had received notification that the partner lacked authority. For the partnership to escape liability, the third party generally must possess actual knowledge of the partner’s lack of actual authority.

Question 33

The issue is whether the woman is personally liable to the bank on the loan.

Answer 33

A limited liability partnership (LLP) is a partnership in which a partner’s personal liability for obligations of the partnership is eliminated. To enjoy LLP status, the partnership must file a statement with the state. In other respects, an LLP is governed by the same rules as a partnership. A limited partner in an LLP is not personally liable for an obligation of an LLP, regardless of the type of obligation. However, a limited partner is personally liable for his own personal misconduct.

Question 34

The issue is whether the man is liable for breaching his fiduciary duties.

Answer 34

A partner owes the partnership and the other partners two fiduciary duties—the duty of loyalty and the duty of care. Under the duty of loyalty, a partner is prohibited from using partnership property or business to derive a personal benefit without notifying the partnership. Under the duty of care, a partner is prohibited from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law.

Here, the man breached both the duty of care and the duty of loyalty by knowingly exceeding his authority and incurring a $25,000 debt, misappropriating the funds for his own personal use, and misrepresenting the scope of his authority when the loan officer specifically asked if the man was authorized to borrow such a large amount on behalf of the LLP.

Question 35

The issue is to whom the man is liable for violating a duty.

Answer 35

A partnership may pursue a legal action against a partner for breach of the partnership agreement or for violating a duty owed to the partnership that caused the partnership harm. A partner may pursue a legal action against the partnership or another partner to enforce the partner’s rights under the partnership agreement or the RUPA.

Here, either the LLP or the woman can pursue a legal action against the man for incurring a $25,000 debt and misusing the funds for his personal gain in violation of his duties and in violation of the statement of partnership authority. In addition, the woman may seek an accounting as to the partnership business.