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

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. Acting individually, a partner has the actual authority to commit the partnership to usual and customary matters, unless the partner has reason to know that other partners might disagree. On the other hand, each partner has equal rights in the management and conduct of the partnership’s business. If there is a decision as to a matter outside the ordinary course of the partnership’s business, the decision requires the consent of all partners.

As a partner, Carol had the authority to purchase the imaging machine on behalf of the partnership without the consent of either Jean or Pat because the purchase was within the course of ordinary business. The partners had purchased state-of-the-art imaging equipment when they started the business, they agreed to run the practice in a manner consistent with other area practices, and the equipment was the same equipment that other practices in the area had purchased. Thus, purchasing the new machine is consistent with the partnership’s ordinary business.

As a partner, Jean has equal rights to manage and conduct the partnership’s business. However, it is unlikely that Jean has a claim against Carol for purchasing the machine without her consent because the purchase was in the ordinary course of the business and Jean did not make Carol aware of her concerns. Further, the three partners, including Jean, previously agreed the partnership would have imaging equipment that would allow it to be competitive with other similar practices in the community. Thus, Carol acted with proper authority when she purchased the imaging machine.

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 (including the dissociated partner) 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. A dissociated partner may maintain an action against the partnership to determine the buyout price and to compel the partnership to pay that amount to the partner. The action must be commenced within 120 days after the partnership has tendered payment or an offer to pay or within one year after written demand for payment if no payment or offer to pay is tendered.

In this case, Carol and Pat agreed to continue their participation in Radiology Services without Jean, however it does not appear that Jean, the dissociated partner, agreed to waive the right to terminate the partnership with them. Therefore, the partnership remained dissolved, and Jean cannot receive a buyout payment. On the other hand, if Jean agreed to waive the right to terminate the partnership, then Radiology Services must buy out Jean’s partnership interest. Jean asked Carol to give Jean her share of the value of the practice, and she can maintain an action against Radiology Services to determine the buyout price and compel it to pay that amount to her. She must commence this action within 120 days after Radiology Services has tendered payment or an offer to pay.

Thus, although Jean’s statements were sufficient to entitle her to receive a buyout payment from Radiology Services, it appears that the partnership remained dissolved, so Jean cannot receive a buyout payment.

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. The fairness test looks at the substance and procedure of the transaction. Substantively, the test asks whether the corporation received something of comparable value in exchange for what it gave to the director. Procedurally, it looks at whether the process followed by the directors in reaching their decision was appropriate. The interested directors have the burden of establishing both the substantive and procedural fairness of the transaction. A conflict-of-interest transaction in violation of the safe-harbor provisions may be enjoined or rescinded, and the corporation may seek damages from the directors.

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.

Question 36

The issue is whether the man properly withdrew from the partnership.

Answer 36

A partner has the power to dissociate from the partnership at any time, even if the dissociation is wrongful. For a partnership that is unlimited by time or undertaking, a partner’s dissociation is wrongful only when it is in breach of an express provision of the partnership agreement.

Question 37

Assuming that the man’s withdrawal was not wrongful, the issue is what was the legal effect of the man’s withdrawal from the partnership.

Answer 37

A partnership at will is an open-ended partnership that does not have a fixed termination based on a period of time or particular undertaking. A partnership at will is dissolved when a partner chooses to dissociate from the partnership by giving notice of his withdrawal. A dissociated partner generally does not have the right to participate in the management or conduct of the partnership business. A partner’s duty not to compete terminates upon dissociation. The dissociated partner’s other duties of loyalty and care terminate with respect to post-dissociation events, unless the partner participates in winding up the partnership’s business if the partnership itself dissolves. Finally, a person who is winding up the partnership business may dispose of and transfer partnership property and may discharge the partnership’s liabilities.

Here, the man’s email to the woman constituted a withdrawal from the partnership, and because there were not enough partners left for a partnership to continue, the partnership was dissolved and began to wind up. The man did not have the right to participate in the management or conduct of the partnership business. But, the man did have the power to wind up the business, so his duties of loyalty and care would not terminate. However, the man’s duty not to compete did terminate upon dissociation. Finally, as the person winding up the partnership business, the man could dispose of and transfer partnership property and discharge the partnership’s liabilities. Therefore, this is the legal effect of the man’s withdrawal from the partnership.

Question 38

The issue is what duties the man breached by purchasing the building.

Answer 38

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 required to refrain from (i) competing with the partnership business, (ii) advancing an interest adverse to the partnership; and (iii) usurping a partnership opportunity or otherwise using partnership property or business to derive a personal benefit, without notifying the partnership. A partner is also required to refrain from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law. As stated above, when a partner is engaged in winding up the partnership business, these duties are generally applicable, with the exception of the noncompete aspect of the duty of loyalty. A partner must perform the windup consistently with the contractual obligation of good faith and fair dealing.

Question 39

The issue is whether filing a statement of qualification with the Secretary of State was sufficient to convert the partnership from a general partnership to an LLP.

Answer 39

Under the UPA, a general partnership can make an election and become a limited liability partnership–if the partners approve the conversion by a vote equivalent to that necessary to amend the partnership agreement and the partnership then files a statement of qualification that specifies the name of the partnership [must include LLP], its principal office, and its election to be an LLP. Can also convert by forming a new LLP and transferring the assets of the old general partnership to the LLP.

Question 40

The issue is whether Alice and Carla have any legal basis to object to Bob’s co-ownership of the Metro Inn.

Answer 40

While an operating agreement by an LLC is generally not required, many LLCs adopt an operating agreement that governs any and all aspects of the entity’s affairs. The operating agreement generally takes precedence over contrary statutory provisions. Generally, members of an LLC owe each other and the LLC a duty of loyalty. The duty of loyalty includes the duties to refrain from dealing with the company on behalf of one with an adverse interest in the company, and to refrain from competing with the company. The operating agreement may amend this duty so long as the amendment is not manifestly unreasonable.

Question 41

The issue is whether Alice, Bob, or Carla could be personally liable to the designer under the theory of piercing the corporate veil.

Answer 41

A member of an LLC is generally not liable personally for the LLC’s obligations. If a plaintiff can pierce the veil, however, the members of the LLC may be held personally liable. There must exist some circumstances that would justify piercing the veil on equitable grounds, such as undercapitalization of the business, commingling of assets, confusion of business affairs, or deception of creditors. Courts rely on various theories to pierce the corporate veil, including the “mere instrumentality” test, wherein a member would have to show that (i) the members dominated the entity in such a way that the LLC had no will of its own, (ii) the members used that domination to commit a fraud or wrong, and (iii) the control and wrongful action proximately caused the injury. Under the “unity of interest and ownership” test, a petitioner must demonstrate that there was such a unity of interest and ownership between the entity and the members that, in fact, the LLC did not have an existence independent of the members and that failure to pierce the veil through to the members would be unjust or inequitable.

Question 42

The issue is whether Alice, Bob, or Carla could be personally liable to the designer under the theory of improper dissolution.

Answer 42

When members agree to voluntarily dissolve an entity, the entity must wind up its affairs and liquidate its business. Only after the entity’s debts and obligations to creditors have been paid may the members receive a portion of the liquidated value of the LLC. Those responsible for winding up can be liable for improper distributions.

Question 43

The issue is whether the bonus payment made to Danielle, which was approved by a majority of the board of directors, was proper.

Answer 43

[rules for calling special meeting of directors - 2 days notice, purpose, time/place of meeting]

[duty of loyalty rules]

In order for the board to properly ratify an otherwise interested deal with a director, or other person who owes a duty of loyalty to the company, a quorum of the directors that have no interest in the deal must vote and approve the deal.

[Here, all 3 directors were present. Brian is the only truly disinterested director, but the vote requires 2 directors, so the 3rd director who has no direct interest in the outcome votes. This provides a split decision, because Danielle, an interested party, cannot vote, thus the payout to Danielle should not have been approved. Since Danielle did vote, she violated her duty of loyalty by self-dealing. The 3rd director may have violated her duty of loyalty, because she is controlled by Danielle.]

Question 44

The issue is whether Brian has sufficient grounds to seek judicial dissolution of the corporation.

Answer 44

A shareholder may seek to dissolve a corporation. In order to do so, he must first give the board notice of why he would be suing for dissolution, and then give the board 90 days to remedy the problem or to bring suit themselves in order to remedy the problem. The shareholder does not need to notify the board prior to bringing the suit to dissolve the corporation if the notification would be futile. A proper ground for seeking the dissolution of a corporation is fraud on the part of the directors of the corporation. Additionally, a shareholder plaintiff must have been a shareholder at the time of the alleged injury and throughout the shareholder suit. Any shareholder is entitled to the right to inspect the financial records of the corporation at anytime. The failure to provide adequate rights of inspection to shareholders with a proper purpose and who give notice is a breach of the fiduciary duty the corporation owes to its shareholders.

Question 45

The issue is whether the directors breached the duty of care.

Answer 45

With respect to the duty of care, directors have a duty to act with the care that a person in a like position would reasonably believe appropriate under similar circumstances. The director is presumed to have the knowledge and skills of an ordinarily prudent person, and is required to use any additional knowledge or special skills that he possesses. Normally, the party alleging a violation of the duty of care must rebut the business judgment rule, but given that the directors were each financially interested in this transaction, the business judgment rule will not apply.

Here, there is a strong argument that the directors negligently failed to inform themselves about the sale of the tower. The directors decided to sell the tower at a board meeting that lasted 10 minutes. The only document they reviewed was a two-year-old appraisal, and they did not discuss its applicability to the current market. They also did not consider looking for other purchasers or conducting another market test. Thus, the directors likely breached their fiduciary duty of care in authorizing the sale of the tower because they did not become adequately informed prior to their decision.

Question 46

The issue is whether there is any agency theory under which the foreman could hold the telephone company liable for its employee’s acts.

Answer 46

A principal is liable for a tort committed by an agent with apparent authority when the agent’s appearance of authority enables him to commit a tort or conceal its commission. For apparent authority to exist, a third person must believe that the agent acted with actual authority, and such belief must be reasonable and be traceable to a manifestation by the principal.

Here, the telephone company claims that the employee did not have apparent authority because the company did not make any express manifestations to the foreman that the employee had authority to authorize the foreman’s crew to stretch the cable. However, the foreman could make a strong argument that it reasonably believed that the employee had actual authority to make the authorization, given that the telephone company sent the employee to the scene of the incident, and the employee arrived at the scene in the telephone company’s vehicle. These details would justify the foreman’s belief that the employee had actual authority to respond to the scene and authorize the stretching of the cable. Accordingly, the telephone company will be unsuccessful in arguing that there is no agency theory under which the foreman could hold it liable.

Question 47

The issue is whether Ethan can block a merger by voting against it when he is outnumbered.

Answer 47

When a corporation wants to merge or change in any other fundamental way, they must first pass a resolution as a board, call a shareholders meeting, allow the shareholders to vote on the resolution, and then a majority of the votes cast determines whether or not the corporation can merge or make a fundamental change. A fundamental change is one not accounted for in the articles of incorporation or in the bylaws.

Question 48

The issue is whether a minority shareholder in a closely-held corporation has a right to demand that he receive payment in cash for his shares equal to their fair market value when the corporation approves a fundamental change that the shareholder opposes.

Answer 48

Closely-held corporations have few shareholders and its shares are not publicly traded. Therefore, there is no ready market for the corporation’s shares. As such, minority shareholders have appraisal rights. That is, a minority shareholder has the right to demand cash payment for his shares equal to their fair market value if the corporation approves a fundamental change that the shareholder opposes. To enforce appraisal rights, the shareholder must vote against the fundamental change. Once the vote has taken place and the fundamental change has been approved, the shareholder can make a demand on the board to have his stocks repurchased. The board of directors will determine what the fair market value of the shares is and will issue a payment to the shareholder of the cash equivalent. If the shareholder disputes the fair market value determined by the board, the shareholder may bring suit to have the court determine the fair market value.

Question 49

The issue is whether the man is an employee of the woman.

Answer 49

In determining whether an employment or independent contractor relationship exists, courts consider numerous factors, including (1) exclusive control over the employee, where the employer has the power to dictate the manner in which an employee performs; the power to prescribe job duties, job description, uniforms, instructions on how employee’s are to operate and work; (2) evidence that the individual is on payroll with the company is proof that the individual is an employee; (3) whether the employee receives benefits from the company; (4) whether there is an employment contract defining the relationship; (5) hours and scheduling, including whether the employee is able to dictate their schedule or subject to the employer’s direction; and (6) training–whether the individual was trained by the employer.

Question 50

The issue is whether the partner is entitled to reimbursement for his downpayment on the truck bought for the partnership.

Answer 50

RUPA’s default rules allow partners to seek compensation for partnership property purchased in the name of and for the partnership. A partner can seek direct contribution from the partnership or even the other partners. The latter is more likely here because of the low balance of the partnership funds. However, if a partnership has outstanding obligations to other parties, the partnership must first satisfy those obligations before distributing assets to its own partners.

[Here, Aldo did purchase the truck for the partnership because it was in the partnership’s name and in furtherance of the partnership’s operations. Thus, ordinarily, Aldo would be entitled to reimbursement for assets purchased for the partnership. But if the partnership is unable to pay the dealership for the truck, Aldo cannot seek reimbursement from the partnership until the dealership is paid. Partnerships are bound to pay their outstanding obligations to other creditors before they can make distributions to their own partners. Thus, if the partnership really was unable to pay the purchase price of the truck, then Aldo would not be entitled to reimbursement.]

Question 51

The issue is wheter the partner is entitled to be paid for the value of his services.

Answer 51

Generally, partners are not entitled to compensation from the partnership for the services they provide, unless the partnership agreement says otherwise. Instead, a partner is entitled to receive distributions and share in the profits of the partnership. Partners are generally entitled to equal distributions of the profits, if the partnership agreement does not say otherwise.

Question 52

The issue is whether the partnership is bound on the land sales contract.

Answer 52

While a partner may act unilaterally to bind partners in the normal course of business, under RUPA, it will require unanimous partner agreement in order for one partner to engage in a contract involving an extraordinary change to the business or an extraordinary transaction outside the normal scope of the partnership business.

Question 53

The issue is whether the shareholder’s porposed resolution is a proper subject for submission to Retailer’s shareholders for their vote.

Answer 53

Corporations are owned by shareholders but governed by the board of directors. Shareholders are permitted to vote on fundamental changes to the corporate structure or sales of substantially all the corporate assets, but shareholders are not permitted to dictate corporate policy through shareholder votes. Instead, shareholders can influence corporate policy by electing directors that will implement corporate policy that reflects their views.

Question 54

The issue is whether the brother’s letter withdrawing from the LLC was sufficient to dissolve the LLC and force the winding up of its business.

Answer 54

An LLC may dissolve upon the occurrence of various events, including consent of all members, passage of 90 days without members, by court order, or by the happening of a dissolution-causing event per the operating agreement. Dissociation alone does not cause dissolution. A member can withdraw or dissociate at any time and without reason, even if doing so violates the operating agreement, by providing notice to the LLC. Written notice is not required under the ULLCA. Dissociation does not discharge the member’s interest or liability and does not necessarily trigger dissolution and winding up. The dissociated member relinquishes his right to participate in the LLC. A dissociated member is not entitled to receive payment for the member’s pro rata share of the LLC’s net assets. Instead, the dissociated member remains entitled to receive distributions authorized by the LLC, but otherwise cannot force the LLC to make payments to him.

Question 55

The issue is whether shareholders have the authority to amend a corporation’s bylaws with respect to director nominations.

Answer 55

Shareholders have the power to amend a corporation’s bylaws under state law. A corporation’s bylaws for the management of the corporation’s business or regulation of its affairs are enforceable, so long as the bylaws do not conflict with state law or the articles of incorporation. The nomination of directors and the procedure for nominating directors are common provisions in the bylaws and are consistent with regular corporate practice. Therefore, the investor’s proposed amendment to the bylaws is not inconsistent with state law.

Question 56

The issue is whether board-approved bylaws on a particular subject preempt subsequent conflicting bylaw amendments by shareholders.

Answer 56

As discussed above, shareholders have the power to amend the bylaws. The board of directors can also amend the bylaws unless the articles of incorporation or a vote by the shareholders limits this power. Shareholder-approved bylaws can amend or repeal existing bylaw provisions, regardless of whether the bylaw was initially approved by the shareholders or the board of directors. However, a shareholder-approved bylaw dealing with director nominations may not limit the board’s power to amend, add, or repeal to ensure an orderly process. Thus, if shareholders approve a bylaw amendment that limits further board changes, the board could only amend or add to the bylaw to safeguard the voting process; it could not repeal the shareholder-approved bylaw.

Investor’s proposal includes a provision that the proposal would supersede any conflicting proposal and a provision that limits the board’s ability to amend or repeal the bylaw. So, if the shareholders approve investor’s proposal, the proposal would supersede the board’s bylaw and prevent the board from amending the new bylaw. Although the board could amend or add to the bylaw, it may only do so to safeguard the voting process and may not repeal the shareholder-approved bylaw.

Question 57

The issue is whether a suit challenging both management’s refusal to include a proposed bylaw amendment and the board’s amendment of the bylaws dealing is a direct or derivative suit.

Answer 57

A shareholder may bring a direct or a derivative action against the corporation in which the shareholder owns stock. In a direct action, the shareholder is vindicating his own rights and is not required to make a demand on the board of directors before proceeding with the litigation. By contrast, in a derivative action, a shareholder brings suit on behalf of the corporation and is typically based on a breach of fiduciary duties by the board of directors. To bring a derivative action, the shareholder must have standing and must make a written demand upon the board of directors. To have standing, the shareholder must have been a shareholder at the time of the wrong and at the time the action was filed, and continue to be a shareholder throughout the litigation. The shareholder is required to make a written demand upon the board of directors unless the demand would be futile. Not all jurisdictions recognize the futility exception, however. In states that do not recognize the futility exception, demand must be made upon the board in all cases.

Question 58

Partner Dissociation/Dissolution

Answer 58

A partner has the power to dissociate from the partnership at any time, even if the dissociation is wrongful. For a partnership that is unlimited by time or undertaking, a partner’s dissociation is wrongful only when it is in breach of an express provision of the partnership agreement. A partner who wrongfully dissociates is liable to the partnership and the other partners for damages caused by the dissociation. In addition, a dissociated partner generally does not have the right to participate in the management or conduct of the partnership business and cannot participate in winding up the business.

Dissociation may, but does not necessarily, result in dissolution of the partnership and the winding up of its business. Wrongful dissociation creates a possibility of dissolution, if, within 90 days of dissociation, a majority of the remaining partners express a will to wind up the business. If the partnership does not dissolve and wind up, the wrongfully dissociated partner is not entitled to payment of any portion of the payout until the expiration of the term or completion of the undertaking, unless the partner proves to the court that earlier payment will not cause undue hardship to the business of the partnership.

A partnership at will is an open-ended partnership that does not have a fixed termination based on a period of time or particular undertaking. It is dissolved when a partner chooses to dissociate from the partnership by giving notice of his withdrawal. Any partner who has not wrongfully dissociated may participate in winding up the partnership’s business. He may also may dispose of and transfer partnership property and may discharge the partnership’s liabilities.

Once a partnership has been dissolved, but before the winding up of its business is complete, the partnership may choose to resume carrying on its business as if dissociation had never occurred. To do so, all partners (including any properly dissociated partners) must agree to waive the right to terminate the partnership. A person winding up the partnership business may preserve the business or property as a going concern for a reasonable time to maximize its value.

Question 59

The issue is whether Adam will be held liable for partnership debts incurred during the winding-up process after his withdrawal.

Answer 59

The partnership is not terminated until the partnership business is wound up. After dissolution, the partnership is bound by a partner’s act that is appropriate for winding up the partnership. Each partner is liable to the other partners for his share of partnership liability incurred by such post-dissolution acts.