Business Organizations

Question 1

Forms of Business Organization:

Sole Proprietorship

Answer 1

• The individual and the business are one in the same
• Does not pay taxes as a separate entity
• For liability purpose the business and the individual are one in the same, thus legal claimants can pursue all aspects of the owner

Question 2

Corporations (Inc.)

Answer 2

• Two types: C corp and S corp
• Owned by stockholders
• Stockholders have limited liability
• Double taxation occurs, one at the entity level and one at the individual level
• Shareholders have limited involvement in the company’s affairs, the board of directors usually are involved in the company’s affairs

Question 3

A.P Smith Co. v Barlow

Answer 3

• INTRA VIRES are actions that the board of directors are allowed to take and ULTRA VIRES are actions the board of directors are not allowed to take
 ultra vires actions are usually when the board of directors goes beyond their allowed/ agreed upon responsibilities, less common as a cause of action today
• Held. In light of all of the foregoing we have no hesitancy in sustaining the validity of the donation by P. There is no suggestion that it was made indiscriminately or to a pet charity of the corporate directors in furtherance of personal rather than corporate ends. It was actually made to a preeminent institution of higher learning, was modest in amount, and well within the limitations imposed by the statutory enactments, and was voluntarily made in the reasonable belief that it would aid the public welfare and advance the interests of the P as a private corporation and as a part of the community it represents.
• It was a lawful exercise of the corporation’s implied and incidental powers that it came within the express authority of the pertinent state legislation

Question 4

General/ Limited Partnership

Answer 4

• Limited: like a general or sole pro. For tax purposes

* Has both limited and general partners

Question 5

Limited Liability Company

Answer 5

• Owners are called members
• Members have limited liability
• Tax treatment similar to partnership or sole pro.
o LLC is not a tax paying entity

Question 6

AGENCY PRINCIPLES

Creation of Agency Relationship:

Answer 6

• When analyzing agency issues there are 3 different potential players (1) THE PRINCIPAL (2) THE AGENT AND (3) THE THIRD PARTY

Question 7

RESTATMENT 2ND FOR AGENCIES:

Answer 7

1. Manifestation of consent by principal
   o Agency arises when there is a manifestation of consent by one person (principal) to another (agent)
   i. Consent does not have to be from a formal K, consent can be shown through actions
   o A Gay Jenson v Cargill Inc: ( when Cargill (principal) gives instructions for Warren (the agent) to act, they are exhibiting their consent, and Warren consented by acting; By directing Warren to implement its recommendations, Cargill manifested its consent that Warren would be its agent,)
2. Manifestation of consent by the agent so to act
   o A Gay Jenson v Cargill: (Warren complying with Cargill’s recommendations show his consent to act)
3. Agent shall act on the principal’s behalf and for the benefit of the principal
   o One party is acting primarily on behalf of the other
   o In most ordinary contracts, one party is not acting primarily on behalf of the other. Rather, each party has entered the contract to further its own interests.
   i. A Gay Jenson v Cargill: (Cargill had the right of first refusal, and bought most of Warren’s grain)
4. Subject to the principal’s control, and
   o Principal does not have to exert physical control so long as the Principal direct the result or ultimate objectives of the relationship
   o Control need not be total or continuous but there must be a sense that the principal is in charge
   i. Consent does not have to be from a formal K, consent can be shown through actions
   ii. The law typically looks at outward manifestations to assess consent, rather than inner, subjective thoughts.
   iii. Words or conduct can evidence consent and a reasonable person standard will be applied.
   a. I.e., has the would-be principal done or said something a person in the position of the would-be agent would reasonably interpret as consent that the agent should act for the principal? (and vice versa)
   iv. To have control, a P need not exercise physical control over the actions of its agent so long as the P may direct the result or ultimate objectives of the relationship.
   o Green v. H&R Block, Inc.,
   v. Restatement (Third) § 1.01 (comments):
   a. Control involves the principal initially stating what the agent shall and shall not do, in specific or general terms.
   b. A principal’s control over an agent will, as a practical matter, be incomplete because no agent is an automaton who perfectly executes commands.
   c. The power to give interim instructions distinguishes principals in agency relationships from those who contract to receive services provided by persons who are not agents.
   d. The control need not be total or continuous and need not extend to the way the agent physically performs, but there must be some sense that the principal is “in charge.”
   o A Gay Jenson v Cargill: (Cargill exerted control over Warren when they are proactive in how Warren runs his business because they want their grain business to prosper, Cargill’s right of entry to Warren’s property, and Cargill’s correspondence and criticism regarding Warren’s finances, officers’ salaries and inventory show Cargill’s control over Warren)
5. Consent by the agent so to act
   o A Gay Jenson v Cargill: (Warren complying with Cargill’s recommendations show his consent to act)

• Agencies can exist for limited orders of operation but not for others
o Ex: a store signs a lease with a principal, and the lease includes provisions that the store will collect rent from other stores in the outlet. The agency would only exist when the store is acting to collect rent for the principal, but not when the store is conducting day to day business function of their store

Question 8

A Gay Jenson v Cargill

Answer 8

o Cargill tries to argue that Warren was simply a supplier, however the court rejected this argument
o Factors indicating one is a supplier, not an agent: (1) supplier is to receive a fixed price for property irrespective of price paid (2) supplier acts in his own name and receives title to the property which is to transfer (3) supplier has an independent business in buying and selling similar property
o The court responded: The decision in this case should give no cause for such concern. We deal here with a business enterprise markedly different from an ordinary bank financing, since Cargill was an active participant in Warren’s operations rather than simply a financier. Cargill’s course of dealing with Warren was, by its own admission, a paternalistic relationship in which Cargill made the key *293 economic decisions and kept Warren in existence.

Question 9

FIDUCIARY DUTIES OF AGENTS

Restatement 2nd of Agency Duty of Care 379:

Answer 9

1. Unless otherwise agreed a paid agent is subject to a duty to the principal to act with standard care and with skill which is standard in the field
   o There is an implied authority that an agent has the authority to do what is reasonably necessary to get the assigned job done even if the principal did not spell it out in detail
   i. General Automotive v Singer: (Singer had broad powers of management and conducted the business activities of Automotive. In this capacity he was Automotive’s agent and owed a fiduciary duty to it; Singer had a side business using trade secrets learned from employment at Automotive by referring clients the Automotive turned down to other businesses for profit, and under his fiduciary duty to Automotive Singer was bound to the exercise of the utmost good faith and loyalty so that he did not act adversely to the interests of Automotive by serving or acquiring any private interest of his own)/ Quality Cardiovascular LLC v Casey: (the duty of loyalty adheres even where the employee’s position is that of any non-physician employee. Every employee has a duty not to use their employer’s trade secrets and confidential information to the detriment of the employee)

Question 10

Restatement 2nd Agency 387 – Duty of Loyalty

Answer 10

• “Unless otherwise agreed, an agent is subject to a duty to his principal to act solely for the benefit of the principal in all matters connected with his agency.”

Question 11

General Automotive v Singer

Answer 11

• By failing to disclose all the facts relating to the orders from Husco and by receiving secret profits from these orders, Singer violated his fiduciary duty to act solely for the benefit of Automotive. Therefore he is liable for the amount of the profits he earned in his side line business

Question 12

Common breaches of duty of loyalty include :

Answer 12

• Competition
o Abuse of p Agent might compete with principal. This violates duty even when agent acts on his own time or uses own supplies.
o Restatement (Second) § 393: Unless otherwise agreed, an agent is subject to a duty not to act or to agree to act during the period of his agency for persons whose interests conflict with those of the principal in matters in which the agent is employed.
• Abuse of Position
o Agent uses position to usurp business opportunity of the principal (General v Singer) OR
o Agent uses position to make personal profit from someone who has no relationship with principal

Question 13

Remedies for Breaches of Duty of Loyalty

Answer 13

• The proper remedy for a violation of the duty of loyalty is not based merely on damages to the principal.
• Rather, any benefits/profits of the agent arising out of the breach are held “in constructive trust” for the principal and must be turned over to the principal.

Question 14

Termination of Agency Relationship:

When does an agency relationship end?

Answer 14

• If the agreement states when the relationship ends, that’s when the agency is terminated
• If there is no agreement and it is thus an agency at will, then it is terminable at any time by either party after notice
• Upon fulfillment of the purpose of the agency relationship
• By operation of law (ex. automatic termination upon death of either principal or agent).
• Both principal and agent have the power to end the relationship simply by communicating to the other that the relationship is at an end.
• Like other agency manifestations, such communications are judged by an objective standard.
• Some duties extend beyond termination. In particular, a former agent remains subject to the obligation not to make use of confidential information learned during the course of the agency.

Question 15

PRINCIPAL’S LIABILITY IN CONTRACT

Answer 15

• When should principal be bound by the terms of a contract entered into between his agent and a third party?
• For instance, Pam owns property. Pam hires Alex as her agent. Alex negotiates the terms of an agreement with Tonya for Tonya to buy Pam’s property. When should Pam have to abide by the terms of the contract?

Question 16

Restatement (2d) § 144

Answer 16

a principal “is subject to liability upon contracts made by an agent acting within his authority if made in proper form and with the understanding that the principal is a party.”

Question 17

AUTHORITY OF AGENT

ACTUAL AND APPARENT AUTHORITY

Answer 17

Why the distinction matters?
• Whether there is actual authority or apparent authority, the result is essentially the same: P is bound to the contract that A entered into with T on P’s behalf.
• The distinction matters for purposes of:
• How one proves authority existed; and
• The liability of the agent.

Question 18

ACTUAL EXPRESS AUTHORITY ELEMETNS

Answer 18

• An objective manifestation by the P
• Followed by A’s reasonable interpretation of that manifestation
• Which leads the A to believe it is authorized to act for the

Question 19

ACTUAL EXPRESS AUTHORITY

Restatement 2nd 26

Answer 19

• Authority to do an act can be created by written or spoken words or other conduct of the principal which agent reasonably interprets as authority to act on the principal’s account.

Question 20

Restatement 2nd 33

Answer 20

• An agent is authorized to do, and to do only, what is reasonable for him to infer that the principal desires [the agent] to do in light of the principal’s manifestations and the facts [the agent] knows or should know at the time he acts.

Question 21

Restatement 2nd 34

Answer 21

• An authorization is interpreted in light of all circumstances, including:
o Situation of the parties
o General usages of business
o Facts known to agent about goals of agency
o Nature and subject matter of agency
o Formality of agency relationship
• The standards by which the P’s manifestation is analyzed require:
o that A’s belief be reasonable (objective standard); and
o that A actually hold that belief (subjective standard).
• The principal’s manifestation to the agent could simply be inaction if in the situation silence, reasonably interpreted, indicates consent.
• Example: For years, mechanics at P’s service station have offered a 10 percent discount to regular customers on major service jobs. P never explicitly authorized the practice, but has been aware of it and has not previously objected to it. The mechanics arguably have actual authority to offer the discount.

Question 22

Limiting Previously Granted Authority

Answer 22

• P can always cut back on previously granted authority.
• It does so by making a manifestation to A and seeing that the manifestation reaches A.
• Once A knows that P wants to remove some authority, A can no longer reasonably believe that it has the authority.

Question 23

ACTUAL IMPLIED AUTHORITY

Restatement 2nd 35

Answer 23

• Unless otherwise agreed, authority to conduct a transaction includes authority to do acts which are incidental to it, usually accompany it, or are reasonably necessary to accomplish it.

Question 24

APPARENT AUTHORITY

RSA (2d) § 8:

Answer 24

• Apparent authority is the power to affect legal relations of another person…arising from manifestations [of that other person] to…third persons.

Question 25

RSA (2d) § 27:

Answer 25

• Apparent authority is created by….conduct of the principal which, reasonably interpreted, causes the third person to believe that the principal consents to have the act done on his behalf…

Question 26

Creation of Apparent Authority:

APPARENT AUTHORITY ELEMENTS

Answer 26

• Direct communication by P to T*
o P sends T a letter stating A has authority to perform an act
o A principal’s communication can reach the third party directly or indirectly through an intermediary and still give rise to apparent authority.
 Example: Acting on instructions from Callie Collector, Callie’s personal secretary sends a letter to Auction House stating “On behalf of Callie, I am informing you that Barney will be bidding for Callie at your upcoming auction.”
• Inaction by P
o In P’s presence, A tells T that he is P’s agent and can act on her behalf. If P does not speak up and deny, A has apparent authority.
• Course of Conduct
o P allows its As to carry out a series of transactions over extended period of time, such that T would reasonably believe most recent transaction was authorized.
• Custom**
o T knows P placed A in certain position; and
o It is customary for an A in that position to have authority to enter into the type of agreement in question.
o A principal’s communication can reach the third party directly or indirectly through an intermediary and still give rise to apparent authority.
 Example: Acting on instructions from Callie Collector, Callie’s personal secretary sends a letter to Auction House stating “On behalf of Callie, I am informing you that Barney will be bidding for Callie at your upcoming auction.”
o Corporate officers’ authority is limited to matters arising in the ordinary course of business – not for contracts of “extraordinary” nature.
 How much risk is involved?
 How long will the action have an effect on the corp?
 How much would it cost to reverse the decision?
o If the circumstances put a 3rd party on notice of the need to inquire, the transaction was extraordinary, or the novelty of the transaction suggests fraud, then the belief of authority held by T will not be reasonable.

Question 27

Final Points

Answer 27

• Keep in mind that if the third party knows that the agent has no authority, then the principal is not bound to the contract.
• If the agent with apparent authority acted against the wishes of the principal in entering the contract, while the P is still bound to the contract, the P has a claim against A for breach of fiduciary duty.

Question 28

Liability of the Agent:

Answer 28

• If the agent had authority to enter the K, the agent will not usually be liable to the T except in certain circumstances (e.g., undisclosed principal).
• If the agent had no authority to enter the K or exceeded his/her authority (and P does not ratify K), the agent will be liable to T for breach of the warranty of authority.
• If the agent disobeyed instructions from P, but still had authority to bind P (e.g., apparent authority), P is liable on the K (not the agent), but the agent can be liable to P for breach of duty to obey.

Question 29

ESTOPPEL

Answer 29

• Estoppel is not technically a form of authority.
• Rather, it is a doctrine that (as applied in this context) prevents a P from arguing that no authority existed in A to bind P to a contract with T.
• A person who is not otherwise liable as a party to a transaction purported to be done on his account is nevertheless subject to liability to persons who have changed their positions because of their belief that the transaction was entered into by or for him, if
• (a) he intentionally or carelessly caused such belief, or
• (b) knowing of such belief and that others might change their positions because of it, he did not take reasonable steps to notify them of the facts.
• “Change of position” indicates payment of money, expenditure of labor, suffering a loss or subjection to legal liability.
• NOTE: The third party’s belief must be REASONABLE.

Question 30

ESTOPPEL ELEMENTS:

Answer 30

1. Acts or omissions by the principal, either intentional or negligent, which create an appearance of authority in the purported agent.
2. The third party reasonably and in good faith relies upon such appearance of authority
3. The third party changed her position in reliance upon the appearance of authority.

Question 31

RATIFICATION

Answer 31

• Ratification is authority granted after the K has been made (when A made K with no authority from P).
• P must manifest assent to affirm the K (either expressly or impliedly).
• If ratified, K treated as if originally entered by A on behalf of P with actual authority.
• P may only ratify if P had all material information at the time of ratification.
• If T manifests intent to withdraw prior to ratification (of there is a negative change in circumstances), P cannot ratify.

Question 32

PRINICPAL’S LIABILITY FOR AGENT’S TORTS

ANALYTICAL FRAMEWORK:

Answer 32

1. Is there an agency relationship between P and A
2. Is A the servant or independent contractor, no liability
3. If A is an independent contractor
   a. An independent contractor is a person who contracts with another to do something for him but who is not controlled by the other nor subject to the other’s right to control with respect to his physical conduct in the performance of the undertaking. He may or may not be an agent.”

Question 33

Restatement 2nd 219:

Answer 33

A master is subject to liability for the torts of his servants committed while acting in the scope of his employment

Question 34

ELEMENTS FOR PRINCIPAL’S LIABILITY FOR AGENT’S TORTS

Answer 34

1. Employee/Employer (master/servant) relationship
   o Employee vs Independent Contractor
   o Factors Considered: Restatement 2nd 220 – (1) the extent of control the master may exercise, (2) whether or not the one employed is engaged in a distinct occupation or business, (3) whether there is supervision and work is done by direction of employer or by a specialist without supervision, (4) the skill required in the occupation, (5) whether employer supplies instrumentalities, tools, and place for work, (6) length of time employee employed, (7) method of payment, hourly/salary vs payment for a job, (8) whether the work is of the regular business of the employer, (9) whether parties believe they are creating the relation of master/servant, (10) whether principal is or is not in business
   i. A servant is an agent whose physical conduct is controlled or subject to
   ii. An independent contractor is a person who contracts with another to do something for him but who is not controlled by the other nor subject to the other’s right to control with respect to his physical conduct in the performance of the undertaking. He may or may not be an agent.”
   iii.
   o Franchisor and Franchisee
   i. Agency will arise if the franchisor-principal has the requisite degree of control over the franchisee-agent
   • Miller v McDonald’s Corp. (the franchisor exhibited various degrees of control over the franchisee McDonald’s, such as providing standards for the restaurant, instructing the restaurant how to prepare the food, training employees, etc. therefore 3K (franchisor) would be liable for the McDonald’s customer biting a sapphire ring; the fact that 3K included a clause that said there is no agency does not destroy the agency because all of the other factors point towards an agency)
2. Employee must have been acting in the scope of employment
   o Restatement Agency (2d) § 219(1)
   i. “A master is subject to liability for the torts of his servants committed while acting in the scope of their employment.”
   o Restatement 2nd Conduct of servant is within scope of employment if: (1) Is of a kind he is employed to perform; (2) Occurs substantially within authorized time and space limits; and (3) Is actuated, at least in part, by a purpose to serve the master.
   i. ALMS v Baum: (a volunteer status does not preclude a finding that a master-servant relationship existed, the volunteer was not acting in the scope of his employment because he left the camp, without direction from anyone from the McDonald’s House, and went to a bar, the accident did not occur within the time or place the volunteer would be performing his duties as camp leader and at a time when no official camp business was taking place, he went to the bar to socialize and not to benefit the McDonald’s House, so the McDonald’s house will not be liable for any injuries from the volunteer’s car wreck)

• If elements are met the master will be vicariously liable for the servant’s misconduct, even when master:
o Does not authorize servant’s misconduct
o Forbids the servant’s misconduct OR
o Used all reasonable means to prevent the servant’s misconduct
• Typically P’s are not liable for A’s intentional torts- usually these are outside the scope of employment because no intent to serve employer can be shown.
• But there are exceptions when employee’s job is such that some part of the tort might be characterized as being done with intent of serving the employer.
o Example: Seeking to remove an unruly patron, bar’s bouncer applies an overly aggressive wrist lock.

Question 35

Pivotal Inquiries

Answer 35

• Pivotal inquiries tend to be:
o Was A motivated at least in part by a desire to serve the master?
o The similarity in the quality of the act done to the quality of the act authorized (such that use of force is “not unexpectable”).
o Court might conclude act was foreseeable if in response to conduct that presently interferes with agent’s ability to carry out the assigned task.

Question 36

PARTNERSHIPS

Revised Uniform Partnership Act (RUPA) 103:

Answer 36

• Effect of Partnership Agreement: Except as otherwise provided, relations among the partners and between the partners and the partnership are governed by the partnership agreement

Question 37

Uniform Partnership Act (UPA) 6:

Answer 37

• A partnership is an association of 2 or more persons to carry on as co-owners a business for profit
o UPA 7: In determining whether a partnership exits… the receipt by a person of a share of the profits prima facie evidence that he is a partner
o In Re Estate of Fenimore: (Mrs. Serge argued there was no partnership but rather a loan and Villabona argued there was a partnership, Rule: UPA 40: In settling accounts between the partners after dissolution: where a partner has become bankrupt or his estate is insolvent the claims against his separate property shall rank in the following order: 1. Those owing to separate creditors, 2. Those owing to partnership creditors, 3. Those owing to partners by way of/ UPA 15: All partners are jointly severaly liable for all debts, obligations and liabilities of the partnership. If this was a partnership between Mrs. Serge and her brother then the creditors would get paid first, according to the UPA.)
o OCGA 14-8-7: “In determining whether a partnership exists:
 (4) The receipt by a person of a share of the profits of a business is prima facie evidence that he is a partner…; however, no such inference shall be drawn if profits were received in payment of the following:…
 (a) A debt, whether by installments or otherwise;
 (b) Wages, salary, or other compensation to an employee or independent contractor;
 (c) Rent to a landlord;
o UPA § 40(i) / OCGA 14-8-40: In settling accounts between the partners after dissolution:
 Where a partner has become bankrupt or his estate is insolvent the claims against his separate property shall rank in the following order:
 Those owing to separate creditors,
 Those owing to partnership creditors,
 Those owing to partners by way of contribution.
o UPA § 15 / OCGA 14-8-15: All partners are jointly and severally liable for all debts, obligations and liabilities of the partnership.

Question 38

How to Form a Partnership:

Answer 38

• No formal writing is needed, merely that 2 or more persons carry on as a business for profit
• They do not have to intend to form a partnership or understand its legal consequences
o Partnership is the default business organization when more than one person engages in business for profit.
o Inadvertent Partnership
o RUPA (1997) § 202(a): “[T]he association of two or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership.”

Question 39

Partnership v. Other Type of Relationship

Answer 39

• Some common scenarios arise:
• Someone lends a partnership money pursuant to an agreement that gives lender certain degree of control over the partnership. Merely a lender or partner in p’ship?
• An employee of the partnership wants to participate in profit sharing, and so employer and employee enter an agreement to that effect. Merely an employee or partner in p’ship?
• A tenant rents retail space from commercial property owner and his rent includes a percentage of his profits. Merely landlord and tenant or partners in p’ship?

Question 40

Things courts will look at when resolving disputes over profit-sharing:

Answer 40

• Control: The more an alleged partner participates in management decisions or exercises control over the business, the more likely is a finding of p’ship.
• Sharing Losses: Express agreement to share losses (or course of conduct that implies a loss-sharing agmt) is strong evidence of p’ship.
• Contributions of Property: If a party has contributed property to the business, that contribution favors p’ship characterization.
• Profit Share: If a profit recipient receives no other remuneration from the business other than sharing profits, that fact favors p’ship characterization.
• Parties’ Own Characterization: Parties’ own labels are never dispositive. But in close situations some courts look to how the owners have characterized their relationship

Question 41

Specific Duties of Partners (UPA)

Answer 41

• UPA 20: Obligation to render on demand true and full information of all things affecting the partnership
• UPA § 21: Account for profits from “any transaction connected with the formation, conduct, or liquidation of the partnership” or “from any use of partnership property.”
• UPA § 22: Each partner has a right to a formal accounting.

Question 42

Duty of Loyalty:

Answer 42

• RUPA 409(b)
o The fiduciary duty of loyalty of a partner includes the duties:
1. To account to the partnership and hold as trustee for if any property, profit, or benefit derived by the partner (usurping a business opportunity that belonged to the partnership)
• In the conduct and winding up of the partnership business or
• From use by the partner or partnership property or
• From appropriation of a partnership opportunity
o Meinhard v Salmon: (joint ventures typically fit the definition of a partnership, so partnership law is applied, Joint adventurers owe to one another the duty of finest loyalty, therefore Salmon had a duty of loyalty to Meinhard to include him in the development agreement between him and a third party. Had Salmon disclosed the deal to Meinhard there would have been no breach, through disclosure (and consent) opportunity is equalized.) / RUPA 404: suggests notice/disclosure is not enough, also need consent.
2. To refrain from dealing with the partnership in the conduct or winding up of the partnership business as or on behalf of a party having an interest adverse to the partnership; and
3. To refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership
*If the partner’s own interest is furthered by conduct, that is reflective of whether duty is breached (RUPA 409(e))
• Meinhard v Salmon: (By secretly entering into a deal with a third party Salmon excluded his co-adventurer, Meinhard, from any chance to compete, from any chance to enjoy the opportunity for benefit that had come to him alone by virtue of his agency)

Question 43

• RUPA 105 (opting out of the duty of loyalty

Answer 43

o (c)(5) The partnership’s agreement may not alter or eliminate the duty of loyalty, except as provided in subsection (d)
o (d)(1) The partnership agreement may specify the method by which a specific act or transaction that would otherwise violate the duty of loyalty may be authorized or ratified by one or more disinterested and independent persons after full disclosure of all material facts
o If not manifestly unreasonable the partnership agreement may alter certain aspects of the duty of loyalty or identify specific categories of activities that do not violate the duty of loyalty

Question 44

Duty of Care:

RUPA 409:

Answer 44

• A partners duty of care to the partnership and the other partners in the conduct and winding up of the partnership business is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or knowing violation of the law

Question 45

RUPA 105 (opting out of the duty of care)

Answer 45

• If not manifestly unreasonable, the partnership agreement may alter the duty of care, but may not authorize conduct involving bad faith, willful or intentional misconduct, or a violation of the law

Question 46

RIGHTS OF PARTNERS IN MANAGEMENT

Answer 46

• Each partner has a right to:
o Information about the partnership business
 UPA 19 gives partners access to partnership books and records
 UPA 20 states partners shall render on demand true and full information, i.e. anything affecting partnership to any partner
 UPA 18 gives partners equal rights in the management of the partnership (which would be hard to do without information)
o Be involved in conducting partnership business (UPA §§ 18(e) & 25(2)(a))
o Bind the partnership to third parties (UPA §§ 9(1) & 18(b))
o Participate in partnership decision-making, including vetoing certain matters (UPA §§ 18(e), 18(g), 18(h), & 9(3))

Question 47

Right to Inform

Answer 47

• §19 gives partners access to p’ship books and records.
• §20 states partners shall render on demand true and full information re: anything affecting p’ship to any partner.
• §18(e) gives partners equal rights in the management of the p’ship (which would be hard to do without information).

Question 48

Right to Bind Partnership:

• UPA 9 / OCGA 14-8-9

Answer 48

o Every partner is an agent of the partnership for the purpose of its business, and the act of every partner… for apparently carrying on in the usual way the business of the partnership of which he is a member binds the partnership unless the partner so acting has in fact no authority to act for the partnership in the particular matter, and the person with whom he is dealing has knowledge of the fact that he has no such authority (A partner who has actual authority binds the pship within the scope of the authority, regardless of what appears to the third party

Question 49

• UPA 9(2) / OCGA 14-8-9

Answer 49

o An act of the partner which is not apparently for the carrying on of the business of the pship in the usual way does not bind the pship unless authorized by the other partners in the pship agreement, at the time of the transaction or at any other time

Question 50

• UPA 9(4) / OCGA 14-8-9

Answer 50

o No act of a partner in contravention of a restriction authority shall bind the pship to person having knowledge of a restriction on authority shall bind the p’ship to persons having knowledge of the restriction.

Question 51

Taking §9(1), §9(2), and §9(4) together:

Answer 51

▫ (a) A partner who has actual authority binds the p’ship within the scope of that authority, regardless of what appears to the third party.
▫ (b) A partner that lacks actual authority can still bind the p’ship only by satisfying the rule that it reasonably appeared the act was for carrying on the business of the p’ship in the usual way.
▫ (c) Regardless of (b), the p’ship is not bound if (1) the partner acts without actual authority and (2) at the time of the act, the third party knows of the lack of authority.
▫ §9 can provide authority and bind a p’ship even if P’s act is wrongful.

Question 52

• UPA § 18(b) / OCGA 14-8-18(2):

Answer 52

o Every partner can spend money or incur debts and be indemnified by the partnership if “reasonably incurred” in “ordinary and proper” conduct of business.

Question 53

Right to participate in Decision Making:

Answer 53

• When partners disagree
o The partners resolve disagreement by vote
o Each partner has one vote, regardless of how much each partner has contributed or works in the business (§18(e)); and
o Some disputes are resolved by majority vote and some require unanimity (§18(h) & §9(3))
 Majority vote for “ordinary” matters but no act may be done in contravention of the p’ship agreement without unanimous vote.
 See next slide for other “extraordinary” matters requiring unanimous vote.

Question 54

Acts requiring Unanimous Vote of all Partners:

• Extraordinary Acts (UPA 9(3) / OCGA 14-8-9

Answer 54

• Extraordinary Acts (UPA 9(3) / OCGA 14-8-9
o Assign partnership property in trust for creditors
o Dispose of goodwill of business
o Do any other act that would make it impossible to carry on business
o Submit a partnership claim to arbitration
o Confess a judgment
o Other (UPA §18(g) & (h)/ OCGA 14-8-18)
 Admission of a new member to the partnership
 Acts in contravention of the p’ship agreement
 Some cts also interpret this as including acts outside the ordinary scope of the p’ship business

Question 55

Partners Liability to Creditors:

Answer 55

• All partners are personally liable for all debts and obligations of the pship
• This liability is automatic, strict, and vicarious and applies regardless of whether a particular partner participated in or approved the conduct that creates the obligation
• OCGA14-8-15 – liability of partners is joint and several

Question 56

HOW PARTNERS MAKE MONEY

Profit:

Answer 56

• UPA (18) / OCGA 14-8-18: Each partner shares equally in the profits and surplus remaining after all liabilities are satisfied. Each partner must contribute toward the losses, whether of capital or otherwise, sustained by the p’ship according to his or her share in the profits.
• UPA § 18(f) / OCGA 14-8-18(6): No partner is entitled to remuneration for acting in p’ship business, except that a surviving partner is entitled to reasonable compensation for winding up p’ship affairs.

Question 57

PARTNERSHIP PROPERTY

Property Ownership v Partnership

Answer 57

• RUPA § 202(a):
o [T]he association of two or more persons to carry on as co-owners a business for profit forms a p’ship, whether or not the persons intend to form a p’ship.
• UPA (1914) § 7(2) and RUPA (1997) § 202(c)(1):
o “Joint tenancy, tenancy in common, tenancy by the entireties, joint property, common property or part ownership does not of itself establish a partnership, [even if] the co-owners share profits made by the use of property.”

Question 58

Ownership of Partnership Property:

Answer 58

• UPA 25: A partner is a co-owner with his partners of specific partnership property holding as a tenant in partnership.
o The partner has the right to use the assets of the p’ship in furtherance of p’ship business, but no P has the right to use p’ship property for other purposes without consent of the partners.
• OCGA 14-8-8
o Property is presumed to be partnership property where:
 It is included as such in the pship agreement
 It is acquired in the pship’s name; or
 It is purchased with pship funds (even if title is in the name of the individual)
o Property is presumed to be property of the individual where:
 It is acquired in the name of an individual partner and
 It is acquired without use of pship funds (even if the property was used for pship purposes

Question 59

Selling Membership as a Partner

Answer 59

• UPA (1914) § 18(g) (and RUPA § 401(h)): No person can become a member of a partnership without the consent of all of the partners.

Question 60

Assigning Rights to Partnership Property:

• UPA (1914) §25 / OCGA 14-8-25:

Answer 60

o (1) A partner is co-owner with his partners of specific partnership property holding as a tenant in partnership.
o (2) The incidents of his tenancy are such that:
o (b) A partner’s right in specific partnership property is not assignable except in connection with the assignment of all rights of all partners in the same property.

Question 61

Assigning Partnership Interest:

Answer 61

• UPA 26: A partner’s interest in the pship is his share of profits and surplus
• UPA 27
o Assignment of pship interest only entitles assignee to partner’s share of the profits
o Assignment of pship interest does not of itself entitle the assignee, during the continuance of the pship to:
 Interfere in the management or administration of pship transactions, or
 Inspect pship books
o It merely entitles the assignee to receive the profits owed to the assigning partner

Question 62

DISSOLUTION: THE RIGHT TO WITHDRAW

Answer 62

• A partner will always have the power to withdraw, but may not always have the right to withdraw
• That means the partner can always withdraw and cause a dissolution, but if the partner did not have the RIGHT to do so (and therefore the withdrawal was “wrongful”), there will be some negative consequences for the withdrawing partner.
▫ UPA 29: defines a dissolution simply as the change in relationship of the partners caused by any partner ceasing to be associated in the carrying on” of the firm’s business.
• After dissolution, the p’ship must be wound up, absent agreement among the partners to carry on the business.
• Assuming the business will not be continued, the winding up process generally contemplates the firm’s assets will be distributed to the partners.

Question 63

OCGA 14-8-31:

Answer 63

• Dissolution is caused:
o By termination of definite terms or undertaking specified agreement
o By express will or withdrawal of a partner
 Wrongful Withdrawal:
 OCA 14-8-38: describes wrongful termination as termination either in contravention of the pship agreement or as a result of other wrongful conduct of a partner.”
 OCGA 14-8-37 and 38
• Responsible to pship for damages
• Not allowed to participate in winding up
• Partners who did not cause wrongful dissolution can continue the business if they all agree and pay the partner who caused wrongful dissolution value of interest less damages
• Goodwill not included in valuing the interest of the partner who wrongfully dissolves
• A partner cannot act in bad faith and violate fiduciary duties by attempting to appropriate to his own use the new prosperity of the pship without compensation to other partners
o Page v Page: (two brothers had an oral partnership agreement, and one brother owns the company, which is the partnership’s creditor. This brother wanted to dissolve the pship because it was becoming profitable (it wasn’t profitable at first). This is a wrongful withdrawal because the brother with a better financial standing wanted to take advantage of his brother’s financial troubles and freeze out the pship for his own business use)
o By expulsion of partner in accordance with terms of the agreement
 Expulsion in bad faith means that partners cannot expel another partner for self-gain
• Bohatch v Butler and Binion: (the firm did not owe Bohatch a duty not to expel her for reporting suspected overbilling by another partner because the other partners did not acquire any self-gain)
o By an event that makes it unlawful for the business of the pship to be carried on
o By the death of any partner, unless there is a written agreement between the partners expressly providing otherwise
o By decree of court
 UPA (32) / OCGA 14-8-32: Dissolution by court –
• A partner is shown to be of unsound mind
• A partner becomes in any other way incapable of performing his part of the pship K
• Improper partner conduct that affects prejudicially the carrying on of the business
o Giles v Giles Land Co. (it was impossible for the partnership to operate due to Kelly’s threats, inability to communicate, and disagreeing with otherwise unanimous pship business decisions.)
• Partner willfully or persistently commits breach of pship agreement or otherwise so conducts himself such that it is not practicable to carry on business with him OR
o Giles v Giles Land Co.: (Kelly was making threats that each of the other partners would die, and he would be the last man standing. Further, the partners could not communicate directly with Kelly, only through his attorney. Kelly also did not attend important pship meetings, or sign on important pship documents.)
• Other equitable circumstances
o In other circumstances as provided by the agreement between partners

Question 64

DISSOLUTION: SHARING LOSSES

If Partners continue business:

Answer 64

• Technically creates a new partnership
• Creditors of former partnership automatically become creditors of new partnership
• Departing partner entitled to accounting
• Departing P remains liable on all firm obligations incurred by p’ship while he was a member of firm unless released by creditors.
• The continuing Ps must obtain a discharge of the withdrawn partner or appropriately hold him harmless from all present or future p’ship liabilities.
• If a new P joins firm when it continues after dissolution, new P is also liable for firm’s old debts, but such liability can only be satisfied out of p’ship property.

Question 65

Rules for Distribution:

UPA 40 / OCGA 14-8-40

Answer 65

• Subject to a contrary agreement, upon dissolution liabilities of the pship should be paid in the following order

1. Those owing to creditors other than the partners
2. Those owing to partners other than for capital and profits
3. Those owing to partners in respect of capital
4. Those owing to partners in respect of profits

Question 66

Capital Accounts:

Answer 66

• The bookkeeping devise that tracks the amount the pship owes each P “in respect of capital” are called capital accounts
• Contributions to the pship and profits allocated to a P that are not distributed all increase a P’s capital account
• Distributions to a P and losses of the p’ship allocated to a P decrease that P’s capital account
• When the p’ship dissolves and winds up, each P is to receive the amount in his capital account.
• But if the p’ship has lost money or its assets have depreciated, then the sum of all the capital accounts will exceed the p’ship’s net worth.
• In these situations, Ps may have to contribute money to the p’ship to adjust the capital accounts so losses are shared appropriately

Question 67

Capital Losses:
UPA 18(a) / OCGA 14-8-18(1)

Answer 67

• Each partner shall be repaid his contributions, whether by way of capital or advances to the partnership property and share equally in the profits and surplus remaining after all liabilities, including those to partners, are satisfied; and must contribute towards the losses, whether of capital or otherwise sustained by the partnership according to his share in the profits.
o When one party contributes money and the other contributes services, then in the event of a loss, each would loss capital (one would lose money and the other would lose labor)
o Kovacik v Reed (Kovacik invested 10,000 to the pship as capital and Reed did not put up any, however they agreed that Reed would superintend and estimate the jobs, and they would share losses on a 50-50 basis. Where one adventurer contributes money and the other services, the one who contributed money cannot recover from the one who contributed)
 Courts do not apply the Kovacik rule where:
 The service partner was compensated for his work
 The service partner made a capital contribution, even if that contribution was nominal

Question 68

CORPORATIONS

What is a Corporation

Answer 68

Legal fiction with 6 characteristics:
• Formal creation as prescribed by state law
 One creates a corp. by filing articles of incorporation with appropriate government office in chosen state of incorporation
• Set out the corporation’s essential rules of the road
• Once accepted by Secretary of State, initial directors hold organizational meeting at which corp. bylaws are adopted
• Legal personality
o The corporation is an entity wholly separate from the people who own it and work for it.
o Allows for partitioning of business assets from personal assets of the shareholders, managers, and other corporate constituents.
• Separation of ownership and control*
o Although stockholders nominally own corp, they have virtually no decision-making powers
 Just have right to elect the firm’s directors and to vote on an exceedingly limited (though important) number of corporate actions.
o Management of the firm is vested by statute in the hands of the board, who in turn delegate the day to day to its officers, who in term delegate some responsibilities to employees.
• Freely alienable ownership interests*
• Indefinite duration*
o A corp is commonly said to have a perpetual duration.
o In actuality, the corp has an indefinite legal existence, terminable only in certain circumstances:
 voluntary dissolution (requires a recommendation of the board that is approved by a vote of the SHs),
 merger or consolidation with another corp,
 insolvency liquidation in bankruptcy, or
 involuntarily – ex. due to oppressive behavior by controlling SHs
• Limited liability*
o SHs of a corporation are not personally liable for corp obligations and thus put at risk only the amount of money that they invested in buying their shares.

Question 69

Publicly Held Corporation

Answer 69

characterized by a public secondary market in which shares of the company are listed for traded. Typically have a lot of share holders (ex. IBM or Microsoft)

Question 70

Closely Held Corporation

Answer 70

characterized by the absence of a secondary market for its stock. Often a relatively small number of shareholders who actively participate in the firm’s management. Displays many characteristics of partnerships (some are in a sense, incorporated partnerships)

Question 71

Internal Affairs Doctrine

Answer 71

• Only one state should have the authority to regulate a corporation’s internal affairs
• The local law of the state of incorporation will be applied
• Relates to matters secular to the corporations relationship with its shareholders
o Lidow v The Superior Court of Los Angeles County: (wrongful termination does not fall in the scope of the internal affairs doctrine, therefore California law will apply, not Delaware, even though the corp. was incorporated in Delaware. Further, Ca had a strict public policy to protect whistleblowers, therefore Ca had a greater interest in the case.)

Question 72

Bond Holders:

Answer 72

• The bondholder is entitled to receive a stream of payments in the form of interest over a period of years
• At the end of the bond’s prescribed term (i.e., at maturity), the bondholder is entitled to the return of the principal
• Creditors; not owners

Question 73

Shareholders:

Answer 73

• Equity securities (a.k.a. shares) represent “the units into which the proprietary interests in the corporation are divided”
• Residual claimants: equal right to participate in distributions of the firm’s earnings and, in the event of liquidation, to share equally in the firm’s assets remaining after all prior claims have been satisfied
• A limited right to participate in corporate decision making by electing directors and voting on major corporate decisions
• Owners

Question 74

Common Stock:

Answer 74

• The class of stock that does not enjoy special treatment
• Right to vote and receive distributions contingent upon claims of creditors and rights of preferred (if any)
• Greatest potential for reward because (a) the stock has voting power and (b) the stock can appreciate

Question 75

Preferred Stock:

Answer 75

• A class of stock that is treated more favorably than other classes of stock
• Hybrid between debt and equity
• Usually non-voting
• Usually redeemable at a fixed price (so no participation in the up-side like common)
• Has certain preferences (ex. dividend preference) over common

Question 76

Preferences of Preferred Stock:

Answer 76

• Has certain preferences over common stock
• Dividend preference – requires preferred stockholders be paid dividends before any dividends can be paid to common stockholders
o Can be cumulative or not
• Liquidation preference – requires a fixed price to be paid to preferred stockholders before any liquidation distributions are paid to common stockholders

Question 77

Authorized Shares:

Answer 77

Authorized Shares:

Question 78

Issued Shares:

Answer 78

o The shares that are issued

Question 79

Outstanding Shares:

Answer 79

o The number of shares the corporation has sold and not repurchased.

Question 80

Par-Value:

Answer 80

o The minimum price per share

Question 81

DIVIDENDS

Answer 81

o A distribution is a payment by the corp to a shareholder depending on how many shares the shareholder owns.
o A dividend is a special type of distribution, a payment to shareholders by the corp out of its earnings in proportion to the number of shares owned by the shareholder.
o Corporations are not required to issue dividends; they have the discretion whether or not to issue dividends

When dividends are prohibited: Corp cannot issue dividends if they are insolvent

Question 82

MBCA 6.40

Answer 82

spells out when a corp cannot declare a dividend and 8.33 imposes liability on Ds for making distributions in violation of 6.4
• No distribution may be made of:
o (i) the corp would not be able to pay its debts as they become due in the usual course of business or
o (ii) the corp’s total assets would be less than the sum of (a) its liabilities plus (b) (unless the articles permit otherwise) the amount that would be needed if the corp were to be dissolved to satisfy the preferential rights upon dissolution of preferred shareholders.

• Preferred Stock: are paid first if dividends are issued. However, this does not always mean preferred stock-holders will be paid the most, just that they will be paid first
• Preferred Participating Stock: not only gets paid first, but also gets paid again after the common stockholders are paid
• Preferred and Cumulative Stock: accrue over years in which there was no dividend. Cumulative dividends must be paid before any dividend is paid in common stock

Question 83

The incorporation Process:

Answer 83

1. Select a state for incorporation
2. Draft the Articles of Incorporation (and By-Laws)
   • Must include –MBCA § 2.02(a)
   o Name of corporation (meeting statutory requirements), number of authorized shares,
   o registered corporate office (street and mailing address) and agent (name), and
   o identity and address of incorporators.
   • May include – MBCA § 2.02(b)
   o Initial directors, purpose, limitation of director liability to corporation, par value, etc.
3. File the Articles of Incorporation with Secretary of State (and tender filing fee)
4. Organizational Meeting (MBCA § 2.05)
5. Finalize Directors (MBCA § 2.05)
6. Adopt By-Laws (MBCA § 2.06)
   a. MBCA 2.06: The incorporators or board of Ds of a corp shall adopt initial bylaws for the corp.
   b. The bylaws of a corporation may contain any provision for managing the business and regulating the affairs of the corp that is not inconsistent with law or the articles of incorporation.
7. Appoint Officers (MBCA § 2.05)

Question 84

Articles of Incorporation

Answer 84

• MCBA 2.02(a) - Must Include
• Name:
o The name must include the word corporation, company, incorporated, or limited or an abbreviation of one of those words
o The name may not be the same or deceptively similar to the name of another business entity that is authorized to transact business in the state
• Authorized shares
o Articles must authorize the issuance of at least one class of shares that have unlimited voting rights (MCBA 6.01)
 If there will be different classes of stock, those must be authorized in the Articles. (MBCA §6.01(c))
o Note that a statement of purpose is NOT required.

Question 85

Bylaws

Answer 85

• MBCA 2.06: The incorporators or board of Ds of a corp shall adopt initial bylaws for the corp.
o The bylaws of a corporation may contain any provision for managing the business and regulating the affairs of the corp that is not inconsistent with law or the articles of incorporation.

Question 86

Pre-incorporation Liability

Answer 86

Liability for Pre-Incorporation Activity
• Promoter
o Someone who purports to act as an agent of the business prior to its incorporation
• Legal Issues
o Once the articles are filed, does the corp become a party to the K?
 Yes, but not automatically, the corp must adopt the terms of the K
o Once the articles are filed, is the promoter liable if the corporation breaches the K?
 MBCA 2.04 – All persons purporting to act on behalf of the corp, knowing there was no incorporation, are jointly and severally liable for all liabilities created while so acting
 When corp adopts the K
• Promoter could escape liability through novation or if the terms of the K explicitly state that the promoter will not be liable for the corp (interpreting the intent of the parties may have to be used because Ks rarely explicitly state the promoter will not be liable)
o If articles are not filed, is the promoter liable on the K?
 Yes. MBCA § 2.04.
 Absent an agreement to the contrary, the promoter remains liable on the contract if the corporation never comes into existence.
 De jure corporation is one that is properly formed
 If not properly formed, the court could find a de facto corp (when the court treats an improperly formed corp as properly formed) if:
• Two Part test: (1) there was a good faith effort to incorporate the business and (2) the putative SHs carried on the business as though it were a corp, especially with respect to the transaction in question.

Question 87

LIMITED LIABILITY CORPORATIONS

Answer 87

Limited liability for shareholders
• MBCA 6.22 / OCGA 1-2-622
1. Unless otherwise provided in the articles of incorporation, a shareholder of a corp, a shareholder of a corporation is not personally liable for the acts or debts of the corporation except that he may become personally liable by reason of his own acts or conduct”

Question 88

Piercing the Corporate Veil

Answer 88

• The shield of limited liability is broad but not absolute. In certain limited exceptions, the court will pierce to corporate veil, and hold the shareholders liable for liabilities of the corp.
• Exception is only to be permitted in egregious case (i.e. not used often, only in extreme cases)
• On rare occasions, the court will disregard thee corporate entity and hold shareholders personally liable if necessary, to prevent fraud, injustice, or inequity
• To convince a court to pierce, a third party must convince the court that
• PCV: SH is personally liable for debts of corporation. Veil can be pierced when SH is individual or a corporation.
• Reverse Pierce: Corporate entity is liable for personal debts of owner.
• Enterprise Liability: Sometimes multiple corporations all engaged in related activities (sister corporations) will be treated as one entity and each will be liable for the liabilities of the other.

Question 89

PIERCING THE CORPORATE VEIL ELEMENTS

Answer 89

1. The shareholder abused the corp. form by disregarding the separateness of legal entities; and
    Factors used by the court include undercapitalization, co-mingling corporate and personal funds, failure to follow corporate formalities, and the corporation not issuing dividends
   • Dewitt Truck Bros v w. Ray Fleming Fruit: (the corporation did not have the funds it took to operate, i.e. undercapitalization, Dewitt mixed his funds and the corp funds, the corp did not issue dividends, and the corp. never had a board meeting and directors did not even know they were directors)
    The totality of the circumstance must be evaluated to determine whether a subsidiary may be found to be the alter ego or mere instrumentality of the parent corporation
    There must be a showing of substantial domination. Factors to be considered are whether: the parent and subsidiary have common directors or officers, the P and S have common departments or offices the P and S file consolidated financial statements and tax returns, the P finances the S, the P caused the incorporation of the S, the S operates with grossly inadequate capital, the S receives no business unless given by P, the P uses the S’s property as its own, the S does not observe the basic corporate formalities
   • In Re Silicone Gel Breast Implants: (Bristol Meyers CO. is the sole shareholder of Medical Engineering Corp., which is a major supplier of breast implants, but has never itself manufactured or distributed breast implants. Bristol had control over MEC, MEC submitted budgets for approval to Bristol, Bristol set the employment and wage scales, Bristol’s name and logo were contained on the package inserts of MEC products, MEC’s board members could be outvoted by Bristol board members, Bristol and MEC filed consolidated tax returns, Bristol used MEC’s resources as its own, therefore MEC was Bristol’s alter ego.)
2. The improper used caused injury to the claimant

Question 90

Dewitt Truck v W. Ray

Answer 90

• The court used factors to determine if piercing the corp veil would be appropriates
• One factor is undercapitalization, which is when the corporation does not have enough funds to operate the business, co-mingling personal and corporate funds, failure to follow corporate formalities (the corp never had a board meeting, and the directors did not even know they were directors), and the corp did not issue any dividends

Question 91

ENTERPRISE LIABILITY

Answer 91

• A group of related entities is treated as one functioning unit regardless of how it is set up for legal purposes.
• Factors:
o common “control” of the enterprise;
o economic integration of the entities;
o financial & administrative interdependence; and
o the widely-held notion that form should not govern over substance.

Question 92

WHO MAKES DECISIONS FOR THE CORPORATION

Answer 92

• The board of directors and its delegates decide virtually everything
• The default rule is that there must be a separation of ownership and control
o This is why the shareholders do not make decisions

Question 93

Board of Directors

Answer 93

• MBCA 8.01(b)
o All corporate power shall be exercised by or under the authority of, and the business and affairs of the corporation shall be managed by or under the direction of, the board of directors
• Agents
o Directors manage and control the corp’s business in their collective capacity acting as a board (unlike officers, individual directors are not agents of the corp)

Question 94

Functions of the Board of Directors

Answer 94

• Review financials
• Set long term strategic goals
• Approve major debt financings
• Dividend Policy
• Monitor competition
• Elect, evaluate, and replace senior management (i.e. officers)

Question 95

How BOD takes action under the MBCA:

Answer 95

• In general, BoD acts by majority vote as one body at properly noticed directors’ meeting at which a quorum of Ds is present.
o BoD meeting (MBCA § 8.20)
o Action without a meeting (MBCA § 8.21)
o Notice & waiver (MBCA §§ 8.22 & 8.23)
o Quorum at meeting (MBCA § 8.24)
o Majority vote at meeting (MBCA § 8.24)
o BoD committees (MBCA §8.25)

Question 96

Board Meetings

Answer 96

• MCBA 8.24: must have a minimum portion of the members of the board (a quorum, majority of directors must be in attendance or no decisions can be made) present at the meeting in order for valid board action to occur
• If there exists a quorum at the beginning of a board meeting, but one or more directors leave early, this will destroy the quorum and the board can nno longer conduct business at the meeting
o This is opposite for shareholders meeting, where if there is quorum at the beginning then quorum is sound throughout the entire meeting, regardless if any shareholder leaves early
• MBCA 8.22: Regular meetings can be held without notice
o Special meetings must be preceded by at least 2 days’ notice of the date, time, and place unless Articles or Bylaws provide otherwise
• MBCA 8.21: If no meeting, action can only be taken by unanimous written consent of all board members
• MCBA 8.23: a director may waive notice either: in a signed writing filed with the corporation; or
o (ii) by attendance/participation at the meeting unless
 he objects to the transaction of business at the beginning of meeting; and
 does not vote.
• MCBA 8.20: Directors can participate in meetings through the use of any means of communication by which all directors participating may simultaneously hear each other

Question 97

Limits on Authority

Answer 97

• Decisions about dividends and other distributions are within the discretion of the board
o Exception: Board is not authorized to make distributions if, after doing so, (1) the corp could no longer pay its debts as they become due in ordinary course or (2) corp’s assets would be less than liabilities

Question 98

Authority of Officers

Answer 98

Officers can elect and remove directors through corp
• Officers are agents of the corp
• The limits of their authority extend to what actual authority (express or implied) has been set forth in the Bylaws or prescribed by the board.
o Officers have implied authority to enter into transactions reasonably related to performing the duties for which they are expressly responsible.
• Even if no actual authority, a corp may still be contractually liable for a K entered into by an officer if:
o The board subsequently ratified the transaction (rendering it retroactively authorized and binding on the corp); or
o The officer had apparent authority.

Question 99

Collective Powers of Shareholders

Shareholders in their collective capacity have the power to:

Answer 99

• Elect directors
• Remove directors
• Amend bylaws
• Approve fundamental changes such as
o amendment of the articles of incorporation
o merger
o sale of substantially all of the assets or
o dissolution
• MBCA 7.01: Annual meetings are typically prescribed in the bylaws
• MBCA 7.02 – Special Meetings: : Special meetings may be called by the Board, other persons authorized in the bylaws or articles, or by the holders of not less than 10% of the votes entitled to be cast on the issue (articles and bylaws can fix lower or higher %, but no more than 25%).
• MBCA 7.05: Notice of Meeting
o Corp must notify shareholders of annual and special shareholder meetings
 Date, time, and place
 Purpose if special meeting
 No fewer than 10 days and no more than 60 days
• MBCA 7.06: Waiver of Notice
o Written waiver required Unless shareholder attends and doesn’t object to conducting business

Question 100

Record Date

Answer 100

• MCBA 7.07: The bylaws may fix or provide the manner of fixing the record date
o A record date may not be ore than 70 days before the meeting or action requiring a determination of shareholders

Question 101

Quorum Requirement for Shareholder Meeting

Answer 101

• MBCA 7.25: Presence of quorum is required to transact business.
o Majority of the votes entitled to be cast constitutes a quorum. Articles may provide for a greater quorum, but not lower.
• Once a quorum is present, it does not cease to exist because persons leave meeting. [NOTE: This is opposite of rule for Board.]

Question 102

Voting Rights of Shareholders

Answer 102

• Only shareholders on the record date are entitled to vote
• MCBA 7.21: Unless provided otherwise in statute or in the articles, each shareholder who is entitled to vote may cast one vote for each share owned

Question 103

Voting by Proxy

Answer 103

• MCBA 7.22: A shareholder may vote in person or by proxy. [NOTE: This is opposite rule than for Ds.]
o A proxy may be appointed by signing an appointment form or by electronic transmission.
o Proxy becomes effective when received by secretary or other officer authorized to tabulate votes.
o Proxy is valid for up to 11 months unless longer time expressly provided in the appointment.
o Proxy not revoked by death or incapacity of SH who had granted it unless notice is received by secretary before proxy exercised.
o A proxy is irrevocable only if coupled with an interest, meaning proxy benefits not just the SH but also the proxy-holder.

• If proxy is revocable, shareholder can revoke it by:
o Delivery of written statement to the corporate secretary revoking
o Subsequently giving proxy to another or
o Personally voting at the shareholders meeting

Question 104

Vote required to Approve Action

Answer 104

• MCBA 7.25: A matter is approved if voters casting in favor is greater than votes cast against
o I.e., Action approved where votes cast in favor > votes cast against.
o DGCL § 216
o A decision must be approved by the vote of a majority of the shares present
o What is the difference?

Question 105

Voting without Meeting

Answer 105

• MBCA 7.04:
o Shareholders can vote without a meeting by unanimous written consent
o Articles can provide for less than unanimous written consent but not less than minimum votes required to take action if all shareholders were present and voted
 Articles cannot authorize less than unanimous voting if (a) cumulative voting is authorized and (b) the vote is for the election of directors

Question 106

Voting Rules for Electing Directors

Answer 106

• MBCA 7.28: Default rule is plurality of votes cast that are entitled to vote at a meeting at which a quorum is present
• Cumulative voting
o Articles must specify this optional system for electing directors
o Multiply the # shares entitled to be cast by the # of directors being elected
• Voting by groups
o Potentially applicable when corp has multiple classes of stock
• Straight: Total votes a SH may cast must be divided up with no one candidate able to receive more votes from a SH than the number of shares owned by that SH.
• Cumulative: Total votes a SH may cast may be packaged in any manner desired by SH.
• Example: Sam is SH owning 20 shares in ABC, Inc. At the annual meeting of SHs, the SHs will elect 2 Ds.
• Straight: Sam will have 40 votes to cast. But in election for first D, he can only cast up to 20 votes and in election for second D, he can only cast up to 20 votes.
• Cumulative: Sam will have 40 votes to cast at the election and may cast all 40 votes for a single candidate.

Question 107

Cumulative Voting

Answer 107

• Formula : number of shares needed = (number of shares voting X number of directors wish to elect) / (number of directors to be elected + 1) +1
o X= + 1
o N = total number of directors to be elected
o DN = number of directors a shareholder wishes to elect
o TN = total number of voting shares outstanding
o X = number of shares needed to elect the desired number of directors
• Most states allow cumulative voting on an opt in basis

Question 108

Tenure on Board

Answer 108

• Directors usually hold positions for 1 year and are elected each year at the annual SH meeting.
• Corp’s articles or bylaws may provide for staggered terms for board.
• Ex. A corp with 15 Ds might have 3-year terms for each D, with 5 seats up for election each year.
• MBCA 8.08: shareholders may remove directors with or without cause (unless Articles provide for only removal with cause)
• If cumulative voting is not authorized, can remove if the number of votes to remove exceeds the number of votes not to remove
• If cumulative voting is authorized, cannot remove a director if the number of votes sufficient to elect the director were voted against his removal

Question 109

VOTING TRUSTS, VOTING AGREEMENTS, AND OTHER SHAREHOLDER AGREEMENTS
Contrasting Close and Public Corporation Shareholders:

Answer 109

• Public Corporation shareholders:
▫ Usually own small % of shares as part of diversified portfolio
▫ Interested in share price
▫ Have little influence on Board of Directors or management
▫ If dissatisfied, typically follow the Wall Street Rule: “It’s easier to switch than fight”

Question 110

• Close Corporation shareholders:

Answer 110

▫ Often undiversified
▫ Interested in the company’s performance and dividends, not share price
▫ Personality conflicts can lead to deadlock or oppression

Question 111

Locked in and Frozen Out:

Answer 111

• Locked in as shareholders:
o Close corporations often restrict share transfers
o Even if no formal restrictions, there is no secondary market for the shares
o Other potential problem – Deadlock
• Risk of being Frozen Out of decision making and compensation
o Minority shareholders may have no control over company’s activities
o May be denied compensation if denied employment

Question 112

Private Ordering – Contracting Around the Default Rules of Voting

Answer 112

• Different classes of stock (with differing voting rights)
• Irrevocable proxies
• Voting Trust arrangements
• Vote Pooling agreements (Ringling)
• Other Shareholder Agreements

Question 113

Voting Trusts:

Answer 113

• A voting trust is an agreement among shareholders under which all of the shares owned by the parties are transferred to a trustee, who becomes the nominal, record owner of the shares and entitled to vote the shares in accordance with the trust arrangement
• Advantages?
o No possibility of shareholder deadlock, since everybody puts their shares in the trust and trustee votes
• Disadvantages?
o Loss of control
o Duration – MBCA & most states limit to 10 yrs

Question 114

VOTING TRUSTS ELEMETNS – MBCA 7.30

Answer 114

• Written agreement signed by all shareholder beneficiaries and trustee
• Must register with corporation:
o copy of voting trust agreement
o list of shareholder beneficiaries
o list of stock placed in trust
• Voting trust duration cannot exceed 10 years
o May extend duration for additional 10 year term

Question 115

Ringling Bros. v Barnum and Bailey

Answer 115

• Involved an agreement between shareholders to elect certain directors without the use of a formal voting trust
• Mr. Hayley did not vote according to the agreement between her and Edith, so Edith files suit because he breached the agreement
• The court rules that vote pooling agreement used here is valid and that Hayley’s votes will not be counted at all
o An alternative remedy for this would be specific performance, which would force Hayley’s votes to comply with the voting agreement

Question 116

McQuade v Stoneham

Answer 116

• Agreement had 4 key provisions:
o McQuade, McGraw, and Stoneham to be elected directors
o McQuade, McGraw, and Stoneham to be appointed to specified officer positions
 This provision is problematic because it restricts what the directors can do
o McQuade, McGraw, and Stoneham to be paid specified salaries
 This provision was problematic because it restricts what the directors can do
o No fundamental changes in corporate governance structure unless parties all agree
 This provision is problematic because it restricts what the directors can do
• The court does not like when directors bind the decision making of the board, also they had outside directors so there is a sense that the outside directors have an allegiance to Stoneham
• Good planning could have avoided this result:
o Get agreement that McQuade will be elected a director;
o Appoint McQuade as Treasurer at outset; and
o Either:
 Have bylaws state that officers may be removed only for cause or by unanimous vote of the directors (and require unanimous director or SH vote to amend bylaws); or
 Alternatively, employment contract coupled with stock buy-out provision.
• Since McQuade case, some jurisdictions have modified their corporate code to allow for Shareholder Management Agreements in closely held corporations

Question 117

DIRECTOR’S FIDUCIARY DUTIES

• Duty of Care

Answer 117

o Regulates diligence in performing tasks

o Liability is limited by the BJR

Question 118

• Duty of Loyalty

Answer 118

o Regulates self-dealing transactions

o No BJR shield

Question 119

Fiduciary Duties:

Answer 119

• Tug-of-war between management discretion/authority and management accountability.
o Management authority: Giving SHs and courts significant oversight would undermine the premise that specialized management should have broad discretion.
o Management accountability: But entrusting management to non-owners suggests a need for substantial accountability because, as non-owners, managers may be lazy or faithless.
• Corporate fiduciary law helps to resolve this tension

Question 120

Shlensky v Wrigley

Answer 120

• Wrigley (who owned 80 percent of the stock) did not want to install lights for night baseball games, however night games are proven to bring in more revenue
• Wrigley did not want to affect the surrounding neighborhoods with the lights and night games and he also wanted a new stadium to built instead of installing lights
• Courts do not want to get involved in business matters between the board and shareholders; further court holds that there is a presumption that directors are acting in good faith unless fraud, illegality, bad faith, or conflict of interest is involved

Question 121

Smith v Van Gorkom

Answer 121

• Legal Effect of Merger? - DGCL § 259(a)
o “When any merger … shall have become effective …, for all purposes of the laws of this State the separate existence of all the constituent corporations … except the one into which the other … constituent corporations have been merged … shall cease”
• Court held that the Board lacked valuation information adequate to reach an informed business judgment as to the fairness of $55 per share for the sale of the company, and the business judgment rule should not be used to rule in favor of the director Ds. Van Gorkum was acting in self interest and in bad faith
• Reliance on corporate Officer
o DGCL § 141(e) provides a defense for directors who rely on reports from officers.
• To get protection for relying on an expert or officer:
o The opinion of the expert/officer must be actually relied upon; and
 Ex. If expert produces report but board members don’t actually read it, then cannot rely.
o Reliance must have been reasonable.
 Ex. Not reasonable if the area on which expert/officer is opining is not within his/her area of expertise.
 Ex. Not reasonable if the Ds know or should know the expert is wrong or uninformed.
• Why accountability trumped authority in this case
o Magnitude of decision (merger = final period transaction)
o Process was so severely flawed as to suggest the board had been captured by Van Gorkom

Question 122

Duty of Care:

Answer 122

• The standards sound a lot like negligence. But this is where the business judgment rule comes into play.
• The business judgment rule is a rebuttable presumption that Ds in performing their functions are honest and well-meaning and their decisions are informed and rationally undertaken.
o Shilensky v Wrigley: (the court ruled that Wrigley’s decision to not install night lights for the baseball stadium was not actionable because the business judgment rule says he was performing his functions honestly, and not violating his duty of care)
• To overcome the BJR, the challenger has the burden to prove
o Fraud, bad faith, illegality, or conflict of interest (i.e., no good faith);
o Failure to become informed in decision-making (i.e., gross negligence);
o Lack of rational business purpose (e.g., waste); or
o Failure to oversee the corporation’s activities (i.e., inattention)

Question 123

Standard of Liability:

Answer 123

MBCA 8.31
• A director shall not be liable…unless the party asserting liability…establishes that:
o Action not in good faith;
 If challenger shows fraud, conflict of interest or condoning of illegality, these are all examples of what would overcome the presumption of good faith
o Did not reasonably believe she was acting in the best interest of the corporation;
 A challenger could show something was not in the best interest of the corporation if the action of the Ds lacked any rational business purpose, such that it amounts to a waste of corporate assets.
• Irrationality = decision with no business justification
• Waste = transaction is no one-sided that no business person of ordinary sound judgment could conclude the corporation has received adequate consideration
o Not adequately informed;
 Ds must make reasonable efforts to inform themselves – focus is on procedure and liability is typically based on concepts of gross negligence. (Smith v. Van Gorkum)
o Lacked objectivity or independence;
 A D can lack independence because of his own familial, financial, or business relationship with someone having a material interest in the challenged conduct OR
 A D may lack independence due to the D’s domination or control by another person having a material interest in the challenged transaction.
o Failed to devote ongoing attention or oversight when needed; or
 Duties of good faith
o Receipt of financial benefit or other breach of duty to deal fairly with corp or its shareholders.
• Note that in order for the BJR to apply, there needs to have been an action or an affirmative decision not to take action; In other words, there must be a business judgment
• If P fails at establishing one of MBCA § 8.31 standards, then the BJR protects the decision from judicial review.
• If P succeeds at establishing one of the MBCA § 8.31 standards, this rebuts the BJR but does not necessarily establish liability.
o The burden likely shifts to the D, who could, for instance, show that the decision was fair to the corporation or there were no damages.

Question 124

Protecting Directors from Liability Cont.

Exculpatory Provisions

Answer 124

• Delaware: § 102 (b) (7)
• MBCA § 2.02 (b)(4)
o The Articles may include a provision eliminating or limiting liability of a D for money damages to the corp or its shareholders for any act taken (or failure to take action) except liability for:
 The amount of a financial benefit to which D is not entitled
 An intentional infliction of harm on corp or SHs
 An unlawful distribution or
 An intentional violation of criminal law
• OCGA § 14-2-202(b)(4)
Directors can be protected from Liability through:
• Exculpatory Provisions
• Business Judgment Rule
• Indemnification
o MBCA § 8.51 – § 8.56
• Directors and Officers Insurance
o MBCA § 8.57

Question 125

DUTY OF LOYALTY – COMPETION

Duane Jones v Burke

Answer 125

• Duane Jones Inc., an advertising company, began to experience hard times. Several of the company’s officers began a new competing agency, and lured Duane Jones Inc. key employees and clients
• Ds and Os cannot engage in competing business if doing so adversely effects the corp or involves use of his/ her corporate position to gain an advantage

Question 126

DUTY OF LOYALTY – USURPING BUSINESS OPPORTUNITY

BUSINESS OPPORTUNITY DOCTRINE

Answer 126

Objectives:
• To deter misappropriations of new business prospects “belonging to” the corporation
• Strike a balance between corporation’s need to maximize profits & expand with directors’ interests in business opportunities
Target/Defendants:
• Officers & Directors
• Dominant Shareholders

Question 127

Broz v Cellular Info Systems Players

Answer 127

• Broz is involved with two companies who are in the cellular business, and he was approached by a Mackinac Cellular Corp. about acquiring its license
This case sets out the test to determine when a corporate entity exits:
A corporate opportunity exists where:
1. Corporation is financially able to take the opportunity
a. Financial Inability
b. Some courts view financial inability as a relevant consideration to the question of whether or not the investment will be defined as a corporate opp.
i. Burden of proof on plaintiff as part of burden of proving it is a corp opp.
c. Other courts view financial inability as irrelevant to determining whether it is a corporate opp.
i. These courts will consider it as a defense presented by the defendant fiduciary.
d. Still other courts do not find financial inability compelling as part of the analysis – the corp could have raised the funds (ex. borrowing money or issuing new stock).
i. This argument tempts managers to not exercise his best efforts to bring the corp the opp.
e.
2. Opportunity is in the corporation’s line of business
a. If the opportunity is closely related to the corporation’s existing or prospective business activities.
3. Corporation has an interest or expectancy in the opportunity
a. Opp to which the firm has a better legal claim – often based upon a contractual right – or opp which, in the ordinary course of things, would come to the corp
i. Ex. Corp had been negotiating to acquire the opp or the corp needed a particular investment, but the fiduciary ended up taking the opp
4. Embracing the opportunity would create a conflict between director’s self-interest and that of the corporation
*Court also considered in what capacity the director learned of the opportunity – individual capacity or through his role as a director?

Question 128

In Re Ebay Inc. Shareholders Litigation

Answer 128

• Goldman Sachs worked for ebay to underwrite an initial public offering of common stock (essentially buying ebay’s stock and then selling it)
• Goldman Sach’s rewarded ebay by allocating to the directors of ebay thousands of IPO shares
• Issue is whether ebay directors usurped a business opportunity by buying the stocks from Goldman Sachs
• Court ruled that Goldman Sachs was in the line of business of ebay and that there was a breach of duty

Question 129

Business Opportunities:

Answer 129

MBCA 8.70
• MBCA §8.70 deals with procedure of how corporation exercises its “right of first refusal”
• MBCA §8.70 does not define “business opportunities” but allows courts to develop common law standards
o Most jurisdictions use “line of business” or “interest/expectancy” test or both
o Some jurisdictions also consider other factors, including capacity, financial ability & fairness
• A director will not be liable for breach of duty of loyalty if before the director takes advantage of the “business opportunity”
o the corporation’s interest in such opportunity is disclaimed either:
 By qualified directors using procedures complying with MBCA § 8.62; or
 By qualified shareholders using procedures complying with MBCA § 8.63;
o And director makes prior disclosure of all material facts then known to him about the opportunity

Question 130

Analysis:

Answer 130

1. Is the opportunity one that “belongs to” the corporation?
2. If so, Director must disclose the existence of the corporate opportunity to corporation
3. Corporation has right of first refusal on project
4. Remedies: Gains held in constructive trust, injunctive relief, & punitive damages.
5. How to Cleanse Transaction
   • Step 1: Disclose
   • Step 2: How do you make sure you have cleansed the transaction after disclosure?
   o Disinterested approval/authorization by the board of directors
   o Disinterested approval/authorization by shareholders