Business Organizations and Partnerships

Question 1

A. Corporation formation and structure:

Answer 1

A corporation is a legal entity that exists separate from its owners, thus shielding the owners and managers from personal liability for the actions of the corporation.

Question 2

1. Corporate formation

A de jure corporation

Answer 2

A de jure corporation meets all of the mandatory statutory requirements including that the incorporators (need at least one incorporator) sign and file an articles of incorporation with the secretary of state that includes:

Initial agent’s for the corporation name

Street address for corporation’s initial registered office

Corporation’s name

Authorized number of shares (maximum allowed)

Name and address of each incorporator

Memorization tip: Remember “I SCAN” to include all of the information required on the articles of incorporation.

Question 3

A de facto corporation

Answer 3

A de facto corporation exists where there is actual use of corporate power and a good faith, but unsuccessful, attempt to incorporate under a valid incorporation statute.

1. Limited liability: The law will treat the defectively formed corporation as an actual corporation and the shareholders will not be personally liable for corporate obligations.
2. Determination: The state may deny corporate entity status in a quo warranto proceeding, but third parties may not attack the corporate status.

Question 4

Corporation by estoppel:

Answer 4

A person who deals with a business entity believing it is a corporation, or

one who incorrectly holds the business out as a corporation, may be estopped from denying corporation status.

This applies on a case-by-case basis and only in contract (reliance on corporate status), not to tort cases.

Question 5

Piercing the corporate veil:

Answer 5

Generally, a corporate shareholder is not liable for the debts of a corporation, except when the court pierces the corporate veil and disregards the corporate entity, thus holding shareholders personally liable as justice requires. It is easier to find liability in closely held corporations (those with few shareholders that make the decisions).

1. The veil can be pierced for the following reasons:
   a. Alter ego: Where the shareholders fail to treat the corporation as a separate entity, but more like an alter ego where corporate formalities are ignored and/or personal funds are commingled.
   b. Undercapitalization: Where the shareholders’ monetary investment at the time of formation is insufficient to cover forseeable liabialities; some courts in close corporations look at future debts if forseeable.
   c. Fraud: Wehere a corporation is formed to commit fraud or as a mechanism for the shareholders to hide behind to avoid existing obligations.
   d. Estoppel: Where a shareholder represents that he will be personally liable for corporate debts.
2. Effect of piercing the corporate veil: Active shareholders will have personal joint and several liability.

Issue-spotting tip: Where piercing the corporate veil is at issue, the facts often will also raise the issue of promoter liability for pre-incorporation contracts and breaches of fiduciary duties by directors. This issue often arises in situations where there are few shareholders and courts are more likely to pierce the corporate veil for tortious acts and not for contract issues.

3. Deep Rock Doctrine: When a corporation is insolvent, third party creditors may be paid off before shareholder creditors, thus subordinating the shareholder claims.

.

Question 6

2. Corporate powers
   a. Purpose:
   b. Ultra vires acts:
   c. Acquire debt:

Answer 6

a. Purpose:

It is presumed that all corporations are formed for any lawful business purpose unless the articles define a limited, specific purpose.

b. Ultra vires acts:

If a corporation has a limited stated purpose and it acts outside its stated business purpose, it is acting “ultra vires.”

1. Modernly, ultra vires acts are generally enforceable.
2. Ultra vires acts may be raised when:
   (1) the ultra vires act causes the state to seek dissolution,
   (2) the corporation sues an officer, or
   (3) a shareholder sues to enjoin the proposed act.

Issue-spotting tip: Any time an essay identifies the purpose of the corporation, or places a restriction on corporate activities, consider whether ultra vires is an issue. While ultra vires is usually not an effective defense, on an exam it is important to spot the issue and complete the analysis if the facts give rise to it.

c. Acquire debt:

Corporations may borrow funds from outside sources to pursue the corporate purpose. Lenders do not acquire an ownership interest in the corporation. Debts may be secured (a bond) or unsecured (a debenture).

Question 7

d. Issue shares of stock in the corporation

Answer 7

1. A stock subscription agreement is a contract where a subscriber makes a written promise agreeing to buy a specified number of shares of stock.

a. A post-incorporation subscription creates a contract between the subscriber and the corporation.
b. A pre-incorporation subscription is irrevocable for six months unless otherwise stated in the agreement or all subscribers agree to revocation.

2. Shares of stock are equity securities that give the shareholder an ownership interest in the corporation.

a. Quantity of shares available:

The articles of incorporation authorize the number of shares available to be sold. Shares that are sold are issued and outstanding. Shares that have yet to be sold are authorized but unissued.

b. Types of shares:

The articles of incorporation can provide that different classes of stock shares are available (common or preferred).

*** Common stocks are shares of ownership in a corporation that afford their holders voting rights. They vary from preferred stocks in two key ways. Shareholders who own preferred stocks receive dividend payments before shareholders of common stocks, but preferred stocks do not come with voting rights. ****

• Preferred shares must state:*
  i. The number of shares in each class,
  ii. A distinguishing name/classification for each class, and
  iii. The rights, preferences, limitations, etc., of each class.

c. Consideration is required in exchange for stock shares; ot can include any tangible or intangible property or benefit to the corporation, such as cash, an exchange for services rendered, or cancellation of a debt owed, etc.

Jurisdictions are split as to whether to include the exchange for future services or an unsecured debt (e.g., the RMBCA does allow these; CA does not).

• i. Traditional par value approach:* price is the stated minimum issuance price and stock may not be sold for less than par value.
• ii. Board’s good faith:* No par means there is no minimum issuance price for the stock; generally the board of directors’ good faith determination of the price is conclusive.
  iii. Treasury stock is stock that was previously issued and had been reacquired by the corporation. It can be resold for less than par value and is treated like no par stock.

3. Preemptive rights refer to the right of an existing shareholder to maintain her percentage of ownership in a corporation when there is a new issuance of stock for cash.

Modernly, unless the articles provide otherwise, a shareholder does not have preemptive rights.

Question 8

3. Pre-incorporation actions by a promoter:

Answer 8

Promoters are persons acting on behalf of a corporation that is not yet formed. Prior to incorporation it is common for a promoter to raise capital and contract for a location, business materials, equipment, etc.

Question 9

a. Liability for promoter contracts:

Answer 9

1. Promoters are personally liable for pre-incorporation contracts until there has been a novation replacing the promoter’s liability with that of the corporation or there is an agreement between the parties that expressly states that the promoter is not liable.

Right to reimburesment: The promoter may have the right to reimbursement based on quasi contract for the value of the benefit received by the corporation, or on the implied adoption of the contract.

2. A corporation is not generally liable for, or bound to, preincorporation contracts.

Except that a corporation will be liable where the corporation expressly adopts the contract or accepts the benefits of the contract (note that the promoter is also still liable unless there has been a novation).

Question 10

b. Promoter duties:

Answer 10

A promoter has a fiduciary relationship with the proposed corporation requiring good faith. Promoters cannot make a secret profit on their dealings with the corporation.

Promoter liability (pre-incorporation) fact triggers: • Rent contract entered into before incorporation • Equipment contract entered into before incorporation • De facto company because of failure to properly incorporate • Piercing the corporate veil

Question 11

B. Corporation management, directors, and officers

1. Corporate management structure:

Answer 11

a. Director required: All corporations must have at least one director, though they may have as many directors as they wish (including variable numbers).

b. Articles of incorporation are filed with the state to establish the corporation, and any provisions contained in the articles will govern the corporation.

c. Bylaws: Management of the corporation is conducted in accordance with the articles of incorporation and any corporate bylaws adopted by the board, which typically contain management provisions.

d. Election of the board of directors: The initial board is elected at the first annual meeting and each year thereafter unless terms are staggered.

e. Officers and committees are appointed by the board of directors to implement the board decisions and carry out operations.

f. Officer authority: Officers have authority to act on behalf of the corporation based on agency law principles. An officer’s authority to bind the corporation may be express, implied, or apparent. (See Agency, section II.C.)

g. Removal:

1. Director: A director can be removed with or without cause by a majority shareholder vote, unless the articles state removal only with cause permitted.
2. Officer: The board may remove an officer with or without cause.

h. Resignation of an officer or director is allowed at any time with notice.

Question 12

2. Actions of the board of directors

Answer 12

a. Meetings:

The board of directors must hold meetings, which can be regular meetings in accordance with the bylaws without notice, or special meetings requiring at least two days’ notice.

1. Quorum requirement: A quorum, which is a majority of the board of directors, must be present at the time a vote is taken for board action to be valid, unless the bylaws or articles allow otherwise (but can be no fewer than one-third of the board members).

a. Presence: Presence can be by any means of communication so long as all members can hear each other and the means is not prohibited by the articles or bylaws (but members with conflicts don’t count toward the quorum).

b. Withdrawal allowed: But, unlike shareholders, a director may break quorum by withdrawing from a meeting before the vote is taken.

c. Dissenting members: A member is deemed to assent to an action unless she objects at the beginning of the meeting (or when she arrives), her dissent or abstention is recorded in the minutes, or she delivers a written notice of such before the meeting is adjourned.

b. Actions without meetings:

An action may be taken without a meeting if all directors sign a written consent describing the action taken and include that in the minutes or file it with corporate records.

c. Delegation:

The board may delegate authority to a committee, or an officer.

Question 13

3. Duties of directors and officers:

A director or officer owes the duty of care, duty of loyalty, and duty of disclosure to the corporation.

a. Duty of care:

Answer 13

A director or officer owes the corporation a duty of care to act in good faith as a reasonably prudent person in a manner he reasonably believes is in the best interest of the corporation.

1. The business judgment rule (BJR) applies the standard of care imposed for business judgments and provides the presumption that the directors or officers will manage the corporation in good faith and in the best interests of the corporation and its shareholders. The BJR is violated when a director’s or officer’s conduct is unreasonable.

Reliance on others: It is not unreasonable for a director to rely on information from officers, legal counsel, commit tees, etc. the director reasonably believes to be reliable and

Duty of care fact triggers: • Corporation changes to less profitable line of business • Large expenditure when a merger is pending • Officer misrepresents financials to induce contracting • Subsidiary corp. sells items at cost to corporate owner • Failure to investigate business opportunity/sale of company • Issuing stock as a gift • Officer makes business decision on personal bias • Director takes inventory without paying

Question 14

b. Duty of loyalty:

A director or officer owes a duty of loyalty to the corporation. A director must put the interests of the corporation above his own interests. The duty of loyalty arises three ways:

Answer 14

1. Conflict of interest (self-dealing):

A director or officer has a conflict of interest when he (or a corporation he owns or has a relationship with, or his family member) enters into a contract with the corporation or has a beneficial financial interest in a contract.

a. Self-dealing contracts are presumed unfair and voidable.
b. Conflict can be cured if:
i. Authorized by disinterested board members after material disclosure; or
ii. Approved by majority of disinterested shareholders after material disclosure; and
iii. The transaction is fair to the corporation.

Duty of loyalty (conflict of interest) fact triggers: • Directors vote to sell company or give a profitable contract to a director’s or owner’s company or relative • Directors change business model to benefit corporate owner • Director or officer buys stock based on insider info • No proper investigation or inquiry to reveal self-dealing • Director or relatives benefit from a corp. acquisition • Any time a director has any personal interest in a transaction

2. Usurping a corporate opportunity:

A director or officer may not personally act on a business opportunity without first offering it to the corporation where the corporation would expect to be presented the opportunity.

a. The director or officer may take the opportunity only after good faith rejection of the opportunity by the corporation if there was full disclosure of all material facts to a disinterested board majority.
b. Remedy: If the director or officer usurps a corporate opportunity, then the corporation may compel the director/officer to turn over the opportunity or disgorge profits (construc tive trust equitable restitution theory).

Duty of loyalty (usurp corp. opportunity) fact triggers: • Officer takes a business opportunity as a side job • Officer takes opportunity to make a windfall on a deal himself • Any time a director learns of a business opportunity • Director or family member is on other side of a deal from corporation

3. Unfair competition:

A director or officer may not unfairly compete with the corporation.

Question 15

c. Duty to disclose:

Answer 15

Directors and officers have a duty to disclose material information relevant to the corporation to board members.

Exam tip: When the duty of care is implicated, the duty of loyalty is usually also in issue. When analyzing the duties owed by a director or officer, always analyze the conduct of each party separately.

Question 16

4. Rights of directors and officers

Answer 16

a. Compensation:

A director or officer is entitled to fair compensation, the rate of which the board of directors determines (it is not a conflict for the board to set reasonable director compensation unless the articles or bylaws state otherwise).

b. Indemnification:

1. Mandatory: A director or officer is entitled to indemnification for expenses incurred on behalf of the corporation, and for expenses incurred if he prevails in a proceeding brought against him by the corporation.

2. Discretionary: The corporation may indemnify directors or officers for unsuccessful proceedings against them if the directors or officers acted in good faith and they believed their actions were in the best interest of the corporation, unless the directors or officers are liable due to an improper financial benefit.

c. Inspection:

A director or officer has a right to a reasonable inspection of corporate records or facilities.

Question 17

5. Liability of directors and officers:

Answer 17

The articles of incorporation can provide for indemnification of a director or officer for liability while acting as a director or officer except for when the director or officer received an unfair financial benefit or committed intentional wrongful acts or crimes.

Question 18

C. Shareholders

1. Rights of shareholders
   a. Meetings

Answer 18

Meetings are typically where shareholders convene and vote on corporate management issues. There are two types of meetings:

1. General meetings or annual meetings occur once a year and are where most shareholder voting occurs (10-60 days notice required).
2. Special meetings can be held upon reasonable notice of the time, place, and business to be discussed (10-60 days’ notice required and purpose).

Question 19

b. Voting:

Shareholders have only indirect corporate power through the right to vote to elect or remove members of the board and approve fundamental changes in the corporate structure, such as mergers, dissolutions, etc.

Answer 19

1. Right to vote:

The right to vote attaches to the type of stock held by the shareholder. A corporation can have two types of stock: common and preferred. If the articles do not specify voting rights, both classes of stock may vote. Usually each outstanding share is entitled to one vote.

*Outstanding shares are shares corporation issued and hasn’t reacquired

2. Voting by proxy:

A shareholder may vote in person or by proxy. A proxy is a signed writing (can be electronic) authorizing another to cast a vote on behalf of the shareholder.

a. A revocable proxy is an agency relationship between the shareholder and the proxy.
b. An irrevocable proxy occurs when the proxy is coupled with interest. The irrevocable proxy must be so labeled. The interest can relate to an interest in the shares (e.g., creditor or prospective purchaser) or an interest in the corporation (e.g., performance of services or granting credit in exchange for proxy rights).

3. Quorum:

For an action to pass there must be a quorum, which is a majority of outstanding shares represented (in person or by proxy) at the meeting. Quorum is based on the number of shares, not shareholders.

a. Majority vote: If a quorum is present, a majority of votes cast validates the proposed shareholder action.
b. Except votes regarding a fundamental change require a majority vote of all outstanding shares to validate the pro posed action. (A higher standard.)

4. Vote calculation:

Two methods are employed:

a. Straight voting: Each shareholder casts one vote per share held. Therefore, a shareholder with more than 50% of the shares controls the vote.

b. Cumulative voting for directors allows a shareholder to multiply the number of shares held by the number of directors to be elected and then cast all votes for one or more directors.

5. Unanimous written consent:

Shareholders may also take action with unanimous written consent of all shareholders.

Question 20

c. Inspection:

Answer 20

A shareholder has a right to inspect the corporate books (articles, resolutions, shareholder meeting minutes, etc.) upon a showing of a proper purpose with five days’ written notice.

As to accounting or shareholder records or board minutes, the demand must be made in good faith and describe with reasonable particularity the purpose for the inspection, and the records must be directly connected to the stated purpose.

Question 21

d. Dividends are the distribution of cash, property, or stock that a shareholder may receive from the corporation.

Answer 21

1. Discretionary:

Dividends are given at the board’s discretion. But a distribution is not permitted if it would lead to insolvency or is not allowed in the articles.

2. Types of dividend distribution:

a. Preferred with dividend preference: Paid first to preferred with dividend preference as to stated amount, then remaining amount is paid to common stock.

b. Preferred and participating: Paid first to preferred and participating as indicated in preferred amount, then remaining amount is paid to common stock. (Preferred and participating stockholders also get a share of the dividends paid to common stock holders, if any.)

c. Preferred and cumulative: Paid first to preferred and cumulative as indicated for number of years not paid in the past, then remaining amount is paid to common stock.

d. Cumulative if earned: Dividends cumulate only if the corporation’s total earnings for the year are more than the total amount of preferred dividends that would need to be paid out for the year.

e. Common stock (nonpreferred): Paid last and all shares are paid in equal amount.

Question 22

2. Shareholder agreements
   a. A voting trust

Answer 22

a. A voting trust occurs when shareholders agree in writing to transfer their shares to a trustee who votes and distributes dividends in accordance with the voting trust. Often seen in closely held corporations. (valid for ten years)

Question 23

b. A voting agreement

Answer 23

b. A voting agreement is a written agreement where the parties agree to vote their shares as agreed. Often seen in closely held corporations.

Question 24

c. A management agreement

Answer 24

c. A management agreement occurs where the shareholders agree to manage the corporation in an agreed-upon way as set forth in the articles or bylaws. (valid for ten years)

Question 25

d. Restrictions on stock transfers

Answer 25

d. Restrictions on stock transfers are generally upheld if reasonable—for example a right of first refusal—but absolute restraints are not reasonable. A third party will only be bound if the restriction is conspicuously noted or the third party had knowledge.

Question 26

3. Shareholder suits
   a. Direct suit:
   b. Derivative suit:

Answer 26

a. Direct suit:

A shareholder may bring a suit for breach of fiduciary duty owed to the shareholder (not the corporation itself but the shareholder).

b. Derivative suit:

A shareholder may bring a derivative suit on behalf of the corporation for harm done to the corporation. The share holder bringing the suit must:

1. Own stock at the time the claim arose.
2. Adequately represent the corporation.
3. Make a demand on directors to bring suit or redress the injury and the demand is rejected (corporation has 90 days to respond unless waiting that long would cause irreparable injury).

The demand requirement used to be excused if doing so would be futile, but it is required modernly.

Issue-spotting tip: When a shareholder derivative suit is at issue, also look for the issues of breach of loyalty, breach of care, or disgorging of profits under 16(b).

Question 27

4. Shareholder duties

Answer 27

a. General rule:

A shareholder owes no fiduciary duty to the corpo ation or other shareholders.

b. Modern trend:

Controlling shareholders owe a fiduciary duty (duty of care and duty of loyalty) to the corporation and minority shareholders.

A controlling shareholder is one with enough voting strength to have a substantial impact on the corporation (not always 50% or more).

1. Sale of controlling shares to a looter: Controlling shareholders cannot sell control of the corporation to a looter if they know, or have reason to know, that the buyer intends to harm the company.

2. Sale of controlling shares at a premium may be allowed where the transaction is made in good faith and is fair. However, a controlling shareholder may not sell her controlling shares and receive a personal benefit for the sale of a corporate asset or corporate office.

Issue-spotting tip: Whenever a controlling shareholder sells shares, consider whether these issues are raised. The analysis is very fact dependent and many facts will be available to use in the analysis. For example, consider how high a premium is paid over trading value for the controlling shares, and if there are any side deals regarding the transaction. Analyze overall fairness.

Question 28

5. Shareholder liability:

Answer 28

Shareholders are not personally liable for the actions of the corporation.

a. Except professional corporations: Typically, licensed professionals may incorporate but remain personally liable for malpractice (e.g., lawyers, doctors).

Question 29

D. Federal securities laws

1. Section 16(b) short-swing profits:

Answer 29

Any short-swing trading profits received within a six-month period by a corporate insider must be disgorged to the corporation. Requirements of 16(b):

a. Corporation must be:

1. Listed on a national exchange, or
2. Have $10 million or more in assets and at least 2,000 share holders (or at least 500 if the shareholders are not accredited investors). Accredited investors include high income or net worth individuals and officers and directors of the issuer.

b. Corporate insiders are officers, directors, and shareholders that own more than 10% equity stock in the corporation.

1. Officers and directors must be in their positions at the time of either the purchase or the sale of shares.
2. Over 10% shareholders must be in that position at the time of both the purchase and the sale of the shares.

c. Trading is making a profitable purchase and sale (or sale and purchase) of company equity stock within a six-month period.

d. Remedy: The insider must disgorge the profit back to the corporation.

Issue-spotting tip: 16(b) may be at issue any time a director, officer, or shareholder buys or sells company stock. Section 10b-5 may also be at issue.

Question 30

2. Section 10b-5 disallows insider trading and provides liability for any person who employs fraud or deception in connection with the purchase or sale of any security by means of any instrumentality of interstate commerce.

In other words, trading securities based on nonpublic corporate information is not permitted.

a. Fraud (misrepresentation) prima facie case requirements

Answer 30

1. Intent (can be recklessness) to defraud, deceive, or manipulate.

2. Material misrepresentation or omission: Information is material where there is a substantial likelihood that a reasonable investor would consider it important in making an invest ment decision. Omission or failure to disclose only applies if the party has a duty to disclose.

3. Reliance: There must be actual reliance on the misrepresentation or failure to disclose. (Typically a failure to disclose is relied upon anytime one buys or sells securities as a result of a material omission.)

4. Purchase or sale of securities (in connection with).

5. Interstate commerce: The trade must involve the use of some means of interstate commerce, such as a telephone, mail, email, national securities exchange, etc.

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

Question 31

b. 10b-5 may be violated in the following four ways:

Answer 31

1. Direct trading by an insider

a. Insider is a director, officer, shareholder, employee, or any other holder of material, nonpublic corporate information.

Insiders can include temporary holders of information such as underwriters, accountants, lawyers, etc., but individual hired for an independent purpose, such as a person hired to print announcements, will not qualify as an insider.

b. An individual classified as an insider has a duty to disclose the material, nonpublic information or refrain from trading. Failure to disclose satisfies the required fraud element of making a material omission.

2. Tippers (those providing insider information) are liable if the information was shared for the improper purpose of personal gain.

a. Personal gain can include money, a gift, or an increase in reputation.
b. The tipper does not have to trade in securities himself to be liable, so long as the insider information is used by another to trade.

3. Tippees (those receiving insider information) are liable only if the tipper breached a fiduciary duty, the tippee knew (scienter) the duty had been breached, and the tipper personally benefitted.

4. Misappropriators (those obtaining corporate private information through other means) may be in breach of a duty owed to the source of the information, though typically are not in a position with a duty to disclose. (E.g., an eavesdropper or lawyer who received information for a proper purpose but then traded.)

10b-5 fact triggers: • Officer gives a misleading press conference/statement. • Remark overheard in public, intentionally or not intentionally. • Officer gives inside info to lawyer who then trades or tips.

Look for a professional responsibility crossover.

Exam tip:

10b-5 may be at issue whenever there is a stock transaction. There is a two-step analysis:

1) Determine if the party is in a position to be liable under 10b-5 as a direct insider, tipper, tippee, or misappropriator.
2) Establish the prima facie case. A party may be subject to 10b-5 liability in more than one way—for example, as both a tippee and a tipper, or as direct violator and a tipper. It is important to analyze each potential violation separately. Also, look for multiple parties in the ques tion to violate 10b-5. Section 16(b) may also be at issue.

Question 32

3. The Sarbanes-Oxley Act sets standards for publicly traded companies by creating a board that oversees public accounting firms that perform audits and create rules pertaining to corporate financial reporting.

Answer 32

a. There are enhanced reporting requirements, including:

1. An audit board must be established by each corporation to oversee work performed by the registered public accounting firm.
2. Senior executives must take individual responsibility for the accuracy of financial reports.
3. If a filing is inaccurate and the corporation has to restate financial reports, the CEO and CFO must reimburse the corporation for any incentive-based compensation received during the 12 months after the inaccurate reports were filed.

b. Criminal penalties: The act provides criminal penalties for:

1. Destroying or altering corporate documents and/or audit records is punishable by a $5 million fine and up to 20 years in prison.
2. Securities fraud is punishable by up to 25 years in prison.
3. Statute of limitations is the later of 2 years after discovery or 5 years after the action accrued.
4. Whistleblowers are afforded protection.

Question 33

E. Corporate fundamental changes

1. Fundamental changes to the corporate business or structure must be approved by a majority shareholder vote.

Typical procedure to make a fundamental change:

Answer 33

a. Board adopts a resolution.
b. Written notice is given to shareholders (10-60 days before next shareholder meeting where vote will occur).
c. Shareholders approve the change by majority vote (some jurisdictions require the vote to be by a majority from all votes entitled to be cast, which is a higher standard than the typical quorum rule).
d. The change is updated in the articles, which are filed with the state.

Question 34

2. Types of fundamental changes

Answer 34

a. Merger occurs when one corporation acquires another corporation.

Typically requires shareholder approval.

1. Exception for shareholder approval: Shareholder approval of the surviving corporation is not needed where the change is not significant (this occurs when the articles will remain the same, shareholders hold the same number of shares, and the voting power of the shares issued will not be more than 20%).
2. Short-form merger allowed where a 90%-owned subsidiary is merged into the corporate owner (no approval needed by subsidiary).

b. Share exchange occurs where one corporation purchases all shares of one or more classes of another corporation in exchange for other securities (only a fundamental change for the corporation with shares purchased; purchasing company doesn’t need shareholder approval).

c. Asset sale occurs where a company sells all or substantially all of its all of its assets (75%) to another corporation (only a fundamental change for the corporation being sold; purchasing company doesn’t need shareholder approval).

d. Conversion occurs when one entity changes corporate form—for example, from a corporation to a LLC.

e. Amendment of articles or bylaws after shares have been issued requires approval of the directors and shareholders and the amendment must be filed with the state (no shareholder approval needed to delete names of directors or agents, change company name or corporate abbreviations (e.g., Inc. to Corp.), or to change the number of shares in share split if only one class); if more than one class of shares, then each class can vote as a group.

f. Dissolution and winding up: The last phase of a corporation is the period from the dissolution, which occurs when the corporation ceases to exist, and through the winding up period where remaining corporate affairs are settled.

1. Voluntary dissolution occurs when a corporation chooses to take the action to dissolve. This requires a majority vote by the directors and shareholders. Fundamental change procedures must be followed.

2. Administrative dissolution occurs when the state forces a corporation to dissolve because of administrative failures, such as the failure to pay fees or penalties, declare annual statement, maintain an agent for service, etc.

3. Judicial dissolution occurs on grounds of fraud, ultra vires action, or a defective corporation; or in an action brought by shareholders where there is misconduct; or by creditors for an unsatisfied judgment.

Question 35

3. Dissenter appraisal rights:

Answer 35

Shareholders who dissent from a proposed fundamental change may have the right to have the corporation purchase their shares.

a. Exceptions:

Appraisal rights are not available to holders of shares of public companies (those listed on a national securities exchange) or large companies with at least 2,000 shareholders and a market value of $20 million.

b. Requirement:

Shareholder must give written notice of objection and intent to demand payment before a vote is taken, cannot vote in favor of proposed action, and must demand payment in writing after the vote.

c. Appraisal: Shareholder receives fair market value and interest.

Question 36

II. AGENCY:

An agency relationship exists when a principal authorizes an agent to act on her behalf and represent the principal in dealings with third parties.

A. Formation of principal-agent relationship requires:

Answer 36

1. Agreement between both parties that the agent’s conduct must be for the principal’s benefit, and the principal has the right to control the agent.

Memorization tip: Remember ABC: Agreement-Benefit Control

a. Distinguish from an independent contractor:

A principal has the right to control the method and manner in which an agent performs, but does not control this with an independent contractor.

b. Subagents and borrowed agents must meet the same agency requirements of agreement, benefit, and control.

Exam tip: On an essay question, look for one of the required elements to be missing since that is typically the case.

2. Capacity

a. Principal must have capacity to contract (not be a minor) and must be mentally competent.
b. Agent must have minimal capacity, so an agent must be mentally competent but can be a minor.

3. All contract formalities not required:

An agency relationship does not require consideration or a writing, unless the Statute of Frauds requires a writing (e.g., a contract regarding real property).

Question 37

B. Duties of principal and agent and remedies for breach

1. Principal duties

Answer 37

a. The principal owes the agent all duties imposed by their contract, such as compensation, cooperation, indemnity, and reimbursement, and any other contractual duties imposed.
b. Remedy for breach: Where the principal is in breach, the agent may do any of the following:
1. Terminate the agency and refuse to perform further.
2. Seek contract damages and/or an accounting (must mitigate damages).
3. Seek a possessory lien for money due.

Question 38

2. Agent duties

Answer 38

a. The agent owes the principal the fiduciary duties of:

{CLOCK}

1. Duty of care to act as a reasonably prudent person would act under similar circumstances (local community standards).
   a. The business judgment rule (BJR) applies in some jurisdictions where the agent’s duties are in a business setting and provides the presumption that the agent will act in good faith and in the best interests of the principal.
2. Duty of loyalty: An agent owes a duty of loyalty to the principal. An agent must put the interests of the principal above his own interests.
   a. No conflict of interest (No self-dealinf; No usurping the principal’s business opportunity; No making secret profits)
   b. No commingling funds
3. Duty of obedience to follow all reasonable instructions given by the principal
4. Duty to communicate relevant information that would affect the principal
5. Any other express contractual duties.

Remedy for breach:

Where the agent is in breach, a principal may do any of the following:

1. Discharge the agent.
2. Withhold compensation from the agent.
3. Seek an accounting or contract remedies, such as an action to disgorge profits, rescission, constructive trust, etc. (must mitigate damages).
4. Seek tort damages for intentional or negligent performance.
5. Seek indemnity for liability to third parties occasioned by the agent’s wrongful actions beyond the agency scope.

Question 39

c. Subagent duties

Answer 39

The Subagent duties depend on whether or not the subagent is acting with authority.

a. Acting with authority: The subagent owes the principal the same duties owed by an agent.
b. Acting without authority: The subagent only owes duties to the agent. The agent is liable to the principal for the subagent’s breach.

Question 40

The agent is personally liable for contracts with third parties in the following cases:

Answer 40

1. The agent is acting with no authority from the principal (acts with implied warranty of authority when none exists).
2. Principal’s identity is not revealed (partial disclosure because principal’s existence is known or should reasonably be known).
3. Principal’s existence and identity is undisclosed/unknown.
4. All of the parties intend that the agent be treated as a party to the contract.

Question 41

C. Principal’s liability for agent’s contracts

The agent’s actions will bind the principal if the agent was acting under the actual or apparent authority to act for the principal.

Types of authority:

Answer 41

1. Actual express authority is specifically granted to the agent by the principal. It may be oral, but a writing is required if the Statute of Frauds applies. 2.

2. Actual implied authority: The agent reasonably believes the princi pal gave him authority because of necessity (task reasonably neces sary to accomplish agency goals), custom, or prior dealings.

a. Termination of authority:

Actual express or implied authority may be terminated by any of the following:

1. Breach of agent’s fiduciary duty.
2. Lapse of a stated period, or a reasonable time if none is stated.
3. Operation of law: By the death or incapacity of either party (unless durable power of attorney exists), or bankruptcy of the principal.
4. Changed circumstances where it is clear the agent’s services are no longer needed, such as a significant change in the market, law, or subject matter.
5. Happening of a specified event.
6. Unilateral termination by either party since agency is usually terminable at will with notice (but, can’t terminate if agent has an interest in the subject matter or a power is given for security—i.e., consideration provided).

Memorization tip: Use the mnemonic BLO–CHU to memorize the six ways an agency can terminate. Blow bubble–chew gum.

3. Apparent authority: The agent’s actions will bind the principal when the principal has provided the agent with the appearance of authority, on which a third party reasonably relies. The analysis centers on what occurred between the principal and the third party.

a. Notice requirement:

Where an agent’s actual authority has terminated (unless by death or incapacity), she continues to have apparent authority to transact with known third parties with whom she has previously transacted on the principal’s behalf until the third parties receive actual or constructive notice of the termination.

b. Written authority:

An agent may have “lingering authority” where an agent’s actual authority has been terminated, but if a third party relies on written authority of the agent, the agent’s apparent authority is not terminated.

1. Death of principal: traditionally, death or incapacity of the principal terminated all authorities; modernly, authority is NOT terminated.
   c. Agent exceeds actual authority (also called inherent authority):

The principal may still be bound if the agent is in a position that would normally allow the agent to take such action (e.g., cor porate officer), or if the principal previously allowed the agent a similar excess of authority.

4. Ratification:

Ratification occurs when an agent takes action without proper authority, and the principal subsequently engages in conduct that approves the agent’s action. The principal will be bound where he has capacity, knowledge, of all materials facts, and accepts the agent’s transaction. Agent no longer liable if this occurs.

5. No authority:

Where the agent acts without actual or apparent authority, the principal is not liable on the contract and the agent is personally liable.

Question 42

D. Principal’s liability for agent’s torts:

A principal is liable for an agent’s torts that are committed within the scope of the principal-agent relationship.

1. Scope of principal-agent relationship:

Answer 42

An act is within the scope of the relationship if the conduct was of the kind the agent was hired to perform, the tort occurred on the job, and/or the agent intended his action to benefit the principal.

a. Except frolic or mere detour:

A principal is not liable for torts committed by an agent while the agent is substantially deviating from the planned conduct such that she is acting for her own purposes (frolic). However, a small deviation from the planned conduct (mere detour) is permissible, and the agent will still be within the scope of the agency relationship.

Exam tip: When the issue of frolic or mere detour occurs on an essay question, be prepared to argue the issue both ways since it will be a close call.

Question 43

2. Independent contractors:

Answer 43

A principal is not generally liable for the torts of an independent contractor.

a. Independent contractor definition:

A principal does not control the manner and method by which an independent contractor performs, but does have the right to control the manner and method by which an agent performs.

b. Exceptions: A principal is liable for the torts of an independent contractor when the conduct involves:
1. Ultrahazardous activity,
2. Nondelegable duties,
3. Negligent selection of the independent contractor, or
4. If estoppel applies where the principal held the independent contractor out as an agent.

Question 44

3. Intentional torts:

Answer 44

A principal is not liable for the agent’s intentional torts, except where the conduct was:

{AND}

a. Specifically authorized by the principal (e.g., force is authorized),
b. Natural result from the nature of the employment (e.g., a bouncer), or
c. The tortious act was motivated by a desire to serve the principal.

Question 45

III. PARTNERSHIP:

There are two types of partnership, general and limited.

A. General partnership

1. Definition:

Answer 45

A partnership is an association of two or more persons who are carrying on as co-owners of a business for profit, whether or not the parties intend to form a partnership.

Exam tip: On the bar exam, determining if the parties are partners is often a close call. Argue both ways.

Question 46

2. Formation

Answer 46

a. No formalities required: There are no formalities required to form a general partnership (based on contract and/or agency laws) so a partnership is found based on the intent of the parties to carry on a business as co-owners.

Intent of the parties can be established by:

1. Contribution in exchange for profit: The contribution of money or services in exchange for a share of profits creates a presumption that a general partnership exists. The exchange for profit is the key factor here, so an exchange for payment of a debt, rent, etc., will not create the presumption.

2. Common ownership: Other indications (but not presumptions) that a partnership exists include title to property held as joint tenants or tenants in common, the parties designate their rela tionship as a partnership, or the venture undertaken requires extensive activity by the partners.

3. Sharing of gross revenue does not necessarily indicate the parties are partners.

4. The absence of an agreement to share losses is evidence that the parties did not intend to form a partnership.

b. California has adopted (along with majority of states) the Revised Uniform Partnership Act (RUPA) but partners may still agree in their partnership agreement to rules not governed by RUPA and then RUPA only governs those rules not provided for in the agree ment. However, certain RUPA provisions cannot be waived, such as the duty of loyalty.

c. Partners have a fiduciary, agency-like relationship:

Partners are bound by contracts entered into with authority by their co partners, and are liable for torts committed by their co-partners within the scope of the partnership.

Question 47

3. Partnership assets
   a. Titled property (under RUPA)

Answer 47

1. Property is deemed a partnership asset if:
   a. Titled in partnership name, or
   b. It is titled in a partner’s name and the instrument transferring title identifies the person’s capacity as a partner, or the existence of the partnership.
2. Property is presumed (rebuttable) a partnership asset if purchased with partnership funds, cash or credit, regardless of how title is held
3. Property is not a partnership asset and is presumed (rebuttable) separate property if:

Property held in the name of partner does not indicate the person’s capacity as a partner or mention the partnership and was not purchased with partnership funds, even if it is used for partnership purposes (e.g., car).

Question 48

b. Untitled property (ownership follows common law principles)

Answer 48

1. Property is partnership property based on the parties’ intent.

Courts are more likely to find that the parties intended the property to belong to the partnership if:

a. Partnership funds were used to acquire, improve, or maintain the property.
b. There is a close relationship between the property and the partnership business operations or property used by partnership business.
c. The partnership lists it as an asset in its books.

Question 49

4. Partnership rights and duties
   a. Partnership rights

Answer 49

{UTOPIC}

1. Use of property: A partner can only use the partnership prop erty for the benefit of the partnership.

2. Transferability: A partner is not a co-owner of partnership property and has no transferable interest in it.

a. Except a partner’s own share of partnership profits and surplus is transferable since they are his own personal property.

3. Ownership: Property acquired by the partnership is property of the partnership itself and not of the partners individually.

4. Profits and losses: The default rule is that profits are shared equally and losses are shared in the same proportion as profits.

For example, if the partners agree to share profits 60/40, then both profits and losses are calculated at this rate; if the partners agree only to share losses 60/40 then profits are still shared equally.

5. Indemnity: A partner may be indemnified for liabilities and expenses incurred on behalf of the partnership.

6. Control: Each partner is entitled to equal control (vote) and management of the partnership, and receives no salary for services performed (except compensation to wind up the part nership is allowed). Ordinary business decisions are controlled by majority vote; extraordinary decisions require consent of all partners.

Question 50

b. Partnership duties

Fiduciary relationship: Partners are fiduciaries of each other and the partnership.

Partners have the following fiduciary duties:

Answer 50

1. Duty of care to use reasonable care.
   a. The business judgment rule applies where the partner’s duties are in a business setting (in most jurisdictions).
2. Duty of loyalty to further the partnership interests over his own interests.
   a. No conflicts of interest:
   i. No self-dealing,
   ii. No usurping a partnership business opportunity,
   iii. No making secret profits (implies a duty to account), and
   iv. No competing with the partnership.
3. Duty to disclose: Partners must disclose any material fact regarding partnership business (all partners can also inspect and copy the books).
4. Duty to account: Partners can bring actions against other partners for losses caused by breach and may disgorge a breaching partner of profits.
5. Duty of obedience: Partners are agents of the partnership and must act in accordance with their authority as a partner.
6. Duty of good faith and fair dealing: implied (as in contracts).

Question 51

5. Partnership relations with third parties

Answer 51

a. Debts:

General partners are personally liable for the debts of the partnership. (Although limited partners are not; see Limited Partnerships, below.)

b. Contracts:

Each partner is an agent of the partnership for the purpose of conducting its business. The partners’ authority to bind the partnership when dealing with third parties follows agency law principles:

1. Actual Authority: Where the partner reasonably believes she has authority to act based on the partnership agreement or a vote by the partners, the partnership will be bound.
2. Apparent Authority: Any partner may act to carry out ordinary partnership business and doing so will bind the partnership.
   a. Except if the partner had no authority to act for the partnership in the matter and the third party actually knew or received proper notice that the partner lacked such authority.
3. Estoppel: If a person represents to a third party that a general partnership exists, she will be liable as if it does exist.
   c. Torts:

The partnership members are joint and severally liable for torts committed by a partner in the scope of the partnership.

Question 52

6. Partnership liability
   a. Civil liability

Answer 52

1. Contracts:

The partners are liable for all contracts entered into by a partner that are within the scope of partnership business and/or are made with authority of the partnership.

2. Torts:

The partners are liable for all torts committed by any partner or partnership employee that occur within the course of partnership business or are made with authority of the partnership.

3. Joint and several: Partnership liability is joint and several for all obligations. Each partner is personally liable for the entire amount of partnerhsip oblogations. However, a partner paying more than his share may seek contribution or indemnity from the other partners.

Question 53

b. Liability of incoming partners:

Answer 53

Incoming partners are not person ally liable for debts incurred prior to joining the partnership, but any money paid into the partnership by an incoming partner can be used by the partnership to satisfy prior debts.

Question 54

c. Liability of outgoing (dissociated) partners

Answer 54

1. A dissociating (outgoing) partner remains liable for partnership debts incurred prior to dissociation unless there has been novation or release of liability.
2. A partnership can be bound by an act of a dissociated partner (and the dissociated partner may be liable for acts) under taken within _two year_s after dissociation if:
   a. The act would have bound the partnership before dissociation,
   b. The other party reasonably believed the dissociated partner was still a partner, and
   c. The other party did not have notice of dissociation.
   i. If a notice of dissociation is filed with the state, all parties are deemed to have received notice within 90 days of the filing.

Question 55

7. Dissociation, dissolution, and winding up
   a. Dissociation

Answer 55

a. Dissociation occurs when a partner ceases to be a partner in the partnership.
1. Dissociation does not necessarily terminate the partnership (unless there are only two partners).
2. Dissociation may be voluntary, or involuntary where the other partners expel a partner.
3. The partnership must purchase a dissociated partner’s interest in the partnership.
4. A dissociated partner may still bind the partnership and may remain liable for partnership (see section III.A.6.c.2, above).

Question 56

b. Dissolution

Answer 56

b. Dissolution occurs when the partnership stops being active and the partnership business is wound up. A partnership may dissolve for several reasons:
1. Voluntary dissolution occurs when a partnership is formed for a specific purpose and the objective is achieved, or the agreement specified an end date, or when all partners agree, or in an at-will partnership when one party notifies the other.
2. Involuntary dissolution can occur when the partnership is engaged in an unlawful activity, or by court decree at the request of a partner.

Question 57

c. Winding up

Answer 57

c. Winding up is the period between the dissolution and termination of the partnership in which the remaining partners liquidate the partnership’s assets to satisfy creditors, an accounting is made, and the remaining assets are distributed to the partners.
1. Compensation: Partners receive compensation for winding-up activities.
2. Old business: The partnership and general partners remain liable for all transactions entered into to wind up old business with existing creditors.
3. New business: The partnership and general partners remain liable on new business transactions until notice of dissolution is given to creditors or until 90 days after filing a statement of dissolution with the state.

Question 58

d. Priority of distribution.

Answer 58

1. Creditors, including partners who are creditors.
2. Partners who have loaned money to the partnership or are entitled to compensation for winding-up activities.
3. Capital contributions by partners.
4. Profits and surplus, if any remain, are shared equally amongst the partners unless there is an agreement otherwise.

Note: If the partnership does not have enough assets to repay a partner’s capital contribution, the other partners will need to put in an equal share to satisfy that debt. Further, a partner who pays more than her share of partnership debts is entitled to contribution from the partners.

Question 59

B. Limited partnership

1. Definition:

Answer 59

A limited partnership is a partnership that has at least one general partner and at least one limited partner, which creates a two-tiered partnership structure with differing rights, duties, and liabilities for general and limited partners.

The main difference is that a limited partner is liable for the obligations of the partnership only to the extent of his capital contribution and is not entitled to manage or control the partnership business.

Question 60

2. Formation:

Answer 60

To form a limited partnership the partners must:

a. File a limited partnership certificate of formation, signed by all general partners, with the state;
b. Identify the name of the partnership, which includes the words “limited partnership”;
c. Provide the names and addresses of the agent for service of process and of each general partner; and
d. Maintain records: In the state of organization the limited partnership must have an office containing records of the certificate, any partnership agreements, the partnership’s tax returns for the three most current years, etc. There must also be a record of the amount

Exam tip: A limited partnership that is not properly formed (for example, if the certificate is not filed) will be deemed a general partnership.

Question 61

3. Partnership rights and duties

Answer 61

a. General partners in a limited partnership have the same rights and duties as noted above in the general partnership (see section III.A.4, above).

1. Indemnity: A general partner is not entitled to a salary for services performed for the partnership, but the partnership must indemnify a general partner for liabilities incurred as a result of partnership activities.

b. Limited partners generally have no right to act on behalf of the partnership and owe no fiduciary duties to the partnership and are free to compete with the partnership and have interests adverse to those of the partnership unless an agreement provides otherwise. Limited partners have a right to a full accounting and to inspect the partnership books.

c. Both general and limited partners have the following rights:

1. Distribution: Distributions are made on the basis of the partner’s contribution. However, a contribution can be in the form of any benefit bestowed on the partnership including money, property, services, etc.

2. Consent: A partner’s contribution obligation is only excused by the consent of all partners, and is not excused by death or disability.

3. Transferability: A partner’s right to distributions is personal property that may be transferred.

4. Dissolve: Right to apply for dissolution of the limited partnership.

Question 62

4. Partner liabilities

Answer 62

a. General partners in a limited partnership are subject to the same liabilities as a regular general partner (see section III.A.6, above).
b. Limited partners are not liable for the obligations of the partnership itself beyond their capital contributions and generally have no right to manage the business, though they may. However, a limited partner may be found liable as a general partner if a third party has reason to believe the limited partner is actually a general partner.

Question 63

5. Dissolution
   a. A limited partnership will dissolve:

Answer 63

1. At the time specified in the limited partnership certificate.
2. Upon written consent of all general partners and of limited partners holding a majority interest.
3. Upon dissociation of a general partner, unless the agreement provides otherwise, or the partners appoint a new general partner within 90 days.
4. After 90 days upon dissociation of the last limited partner.
5. Upon judicial decree of dissolution.

Question 64

b. Winding up:

Answer 64

The limited partnership will continue to exist for the purpose of the winding-up activities.

Question 65

c. Priority of distribution:

Assets are distributed in the following order:

Answer 65

1. Creditors, including outside creditors and partner loans.
2. Partners and former partners in satisfaction of distribution previously required under the limited partnership agreement.
3. Capital contributions by partners must be paid.
4. Partners for the amount due under the partnership agree ment, or if not specified then in proportion to their distribution share.

Exam tip: Partnership has only been tested four times since it was added to the California bar exam in 2007. However, in other states that test partnership, 90% of exams focus on general partnerships.

Question 66

LLP—LIMITED LIABILITY PARTNERSHIPS

A. Definition:

Answer 66

An LLP is a form of partnership where the partners are not personally liable for the obligations of the partnership.

Question 67

B. Formation:

Answer 67

To form an LLP a partnership must:

1. File a statement of qualification with the secretary of state executed by at least two partners,
2. Identify the name and address of the partnership, and
3. Have a partnership name ending in “LLP” or “RLLP” (if formed under RUPA).

Question 68

C. Liability of limited liability partners

Answer 68

1. LL partners have no personal liability for the partnership:

All partners are not personally liable for the debts and obligations of the partnership, whether contract, tort, or otherwise.

Note: This is different than a limited partnership where only the limited partners are not personally liable, but the general partner is liable.

2. An LL partner will still have personal liability for his own wrongful acts.

Question 69

D. Fiduciary obligations:

Answer 69

Partners owe LLP duties similar to those a director owes to a corporation, including a duty of care and duty of loyalty.

Question 70

E. Dissociation and dissolution

Answer 70

Dissociation and dissolution operate similarly to a limited partnership.

Question 71

V. LLC—LIMITED LIABILITY COMPANIES

A. Definition:

Answer 71

An LLC is a business entity that has the limited liability of a corporation combined with the tax advantages of a partnership.

Question 72

B. Formation:

Answer 72

To form an LLC the members must:

1. File articles of organization with state.
2. Identify the name of the LLC, and the address of the registered office and agent, and
3. The LLC may also adopt an operating agreement identifying how the LLC is to be managed. In the absence of an agreement, the members will have an equal right to manage and control.

Question 73

C. Rights and duties of LLC members

Answer 73

1. LLC member rights
   a. Profits and losses:

Sharing of profits and losses are based on contributions unless an operating agreement provides otherwise (RULLCA follows equal shares rule).

b. Management and control:

Members typically control the LLC, but the articles may provide for another type of management.

c. Transferability:

Management interests are not freely transferable and members can only transfer their right to receive profits and losses, so an LLC has limited liquidity.

2. LLC member fiduciary duties: Members owe the LLC and other LLC members the duty of care and duty of loyalty.

Question 74

D. Liability of LLC members:

Answer 74

LLC members are not personally liable for the obligations of the company itself beyond their own capital contributions; however courts may pierce the LLC veil of limited liability (as they do in corporations for alter ego, inadequate capitalization, or fraud– but not for lack of formalities).

Question 75

E. Dissolution:

Answer 75

There is a split of authority on what terminates an LLC.

1. Traditional rule: Dissociation of any LLC member, such as by death, retirement, resignation, bankruptcy, etc., generally causes dissolution; or
2. Modern trend: Dissolution is only caused by one of the following:
   a. An event specified in the operating agreement,
   b. Consent by all members,
   c. 90 days with no members,
   d. Judicial decree (unlawful actions, fraud, etc.), or
   e. Administrative decree (failure to submit annual fee or report).