BUSINESS ORGANIZATIONS OUTLINE I. INTRODUCTION a. Business- An organization with the goal of making a profit b. Types of Business Corporations i.

Proprietorship 1. Open up a business and start running it 2. Unlimited Liability 3. Business dies with him 4. Do not need to be approved by state 5. Single Taxation ii. Partnership 1. Two or more people who co-own a business for profit 2. Equal Control among partners 3. Unlimited Liability 4. Single Taxation iii. Limited Partnership 1. Limited partners put the money in but puts managers in control and have limited liability 2. Must register with state to approve organization iv. LLP 1. Limited Liability Partnership-Allows you to be active in decision making but limited liability 2. Must register with state to approve organization v. LLC 1. Preferred way to carry out a small business 2. Incorporated partnerships, limited liability 3. Single tax (best of both worlds) vi. S Corporation 1. Small business vii. Corporation 1. Limited Liability 2. Double Taxation AGENCY a. 1. Agency- Agency is the fiduciary relation which results from the manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and consent by the other so to act b. Why kind of issues arise in an agency? i. Is there an agency relationship? ii. When is the principal liable? c. Who is an Agent? i. Restatement (Third) 1 1. Control is a concept that embraces a wide spectrum of meaning, but: 2. Within any relationship of agency the principal initially states what the agency shall and shall not do, in specific or general terms. 3. Additionally, a principal has the right to give interim instructions or directions to the agent once the relationship has begun a. Incomplete because agent has a mind of his own b. So long as the principal may direct the result or ultimate objective of the agent relationship ii. Gorton v. Doty -Courts say getting students to game was her interest. Coach drove the kids on her behalf. 1

II.

d.

e.

f.

g.

1. Do not need to have a written contract between principal and agent but there must be a meeting of the minds, some sort of agreement iii. Agents sole source of income needs to be what principal is paying them iv. Controlling Creditor 1. Restatement 140: When does a creditor become a principal? a. Creditor becomes a principal at the point at which it assumes de facto control over the conduct of the debtor 2. A. Gay Jenson Farms Co. v. Cargill, Inc.-De facto control because Warrens financial dependence on Cargill. For control, look at contract; Right to control not how much they actually control Termination of an Agency Relationship i. Agreement of parties 1. The contract between principal and agent states when it will end ii. Agency at will 1. At common law, agency relationships presumed to be at will and thus terminable at any time by either party after notice a. Revocation-Principal revoked authority of agent to act b. Renunciation iii. Fulfillment of the purpose of the agency relationship 1. I.e. completion of the task iv. By operation of law 1. Termination occurs automatically; e.g., upon death of either agent or principal The Principal-Agent Problem i. The principal must allow agents to make decisions for her. 1. How can the principal ensure that the agents act in her best interest instead of their own? 2. Try to align principal interest with agent interest Review i. Agency relationship is consensual in nature ii. Based on the concept that the parties mutually agree: 1. Agent will act on behalf of principal 2. Agent will be subject to the principals direction and control iii. Agreement can be expressed or implied iv. Even if you expressly say your not an agent, but act as an agent, you are v. Corporations can be agents Liability of Principals (& Agents) for Contracts Made by Agents i. Restatement 144: 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 ii. The Agents Authority 1. Different kinds of authority, you can have more than one at a time a. Actual Authority (Express or Implied) i. Creation of Actual Authority- 26 1. Authority to do an act is created as to a third person by written or spoken words or any other conduct of the principal which, reasonably interpreted, caused the agent to believe that the principal desires him so to act on the principals account. ii. Requires a manifestation of consent from the principal to the agent iii. Expressed in words or implied in conduct 2

1. Implied is highly contextual, often depending on prior practices or industry customs a. E.g. Incidental authority, which includes the authority to do those things that usually accompany or reasonably necessary to the actions authorized iv. Agents reasonable belief is most important because agent is the one who is going to go out and do it v. Incidental authority 1. Contained within what they tell you to do 2. Reasonable to imply it b. Apparent Authority i. Creation of Apparent Authority- 27 1. Apparent authority to do an act is created as to third person by written or spoken words or any other 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 by the person purporting to act for him. ii. Authority the agent is held out by the principal as possessing iii. Comes from manifestation to leave the third party thinking he had more power than he did 1. Cargills manifestation by paying farmers with checks with Warren and Cargills name on them iv. Depends on what the agent believes c. Inherent Authority i. Restatement 8A-Inherent agency power is a term used in the restatement of this subject to indicate the power of an agent which is derived not from authority, apparent authority or estoppel, but solely from the agency relation and exists for the protection of persons harmed by or dealing with a servant or other agent. ii. Principle puts agent in a position and gives him actual authority to do some things but not other things. d. Ratification- 82 i. Ratification is the affirmance by a person of a prior act which did not bind him but which was done or professedly done on his account, whereby the act, as to some or all persons, is given effect as if originally authorized by him. e. Estoppel 8(b) (Equitable Doctrine) i. (1) a person who is not otherwise liable as a party to a transaction purported to be done in 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. 2. Mill Street Church of Christ v. Hogan-Bill had implied actual authority because he did a lot of similar jobs for the church and he always hired his brother and that was always okay. Also implied because that is the custom, last time he painted the church, he needed to hire someone. Apparent Authority because Bill has hired Sam before, so Sam has a reason to believe that Bill had the authority to hire Sam 3

again. Actualdepends on what BILL thinks. For apparent look at SAMS belief based on what the church actual said 3. Example Problems a. Paul tells Ann to hire a company to cut the grass. Ann does it. Is Paul bound by the contract? i. Yes, express actual authority b. Without express instructions, Ann hires a janitor to clean the building. Is Paul bound by the employment contract with the janitor? i. Implied ii. Apparent Rely on what Janitor has learned from Principal (Information that has been put out there by Paul, cant rely on what Ann thinks at all) c. Suppose Paul specifically instructed Ann not to hire a janitor, but that local custom gives apartment managers the power to hire janitors. Would Paul be bound by the contract? i. Yes under apparent authority. Paul gave her the title of manager and she is doing something managers usually do. 4. Dweck v. Nasser-Agent had express authority (Do what you want.I wont read it); Agent had implied actual authority (20 years, worked other cases for him); Other agent confirms that it was reasonable for agent to think what he did Apparent Authority3rd party heard that principle wouldnt read agreement, reasonable to think S. has the authority because S. settles all principle cases 5. 370 Leasing Corporation v. Ampex Corporation- Employees did not have actual authority, but they have apparent authority. Looking to third parties reasonable belief that salesman had authority to do deal. 6. Watteau v. Fenwick-Actual authority binds you whether you know the principal exists or not. The principal keeps the manager to look like hes the owner, so they have a benefit, they should take the detriment too. a. 194. Undisclosed principle is liable for acts of an agent done on his account, if usual or necessary in such transactions, although forbidden by the principle. b. 195. Acts of Manager Appearing to be Owner- An undisclosed principal who entrusts an agent with the management of his business is subject to liability to third persons with whom the agent enters into transactions usual in such business and on the principals account, although contrary to the directions of the principal ( 195-Inherent Authority) 7. Review Problem, Page 30 a. Agent does not have actual authority b. Agent does not have apparent authority, principal will not be bound c. No inherent authority (only in cases with an undisclosed principal) iii. Ratification 1. Botticello v. Stefanovicz- The wife is not bound, she didnt know he rented it with an option to sell (the details) so it cant be ratified 2. Can express or imply to ratify contract. Certain times it can be implied by silence. 3. Did principle do something to affirm the contract with full knowledge? 4. Must ratify deal as is. All or nothing for ratification. a. He didnt have authority, but it was a good deal, so ok 5. Analysis and Problems on Page 34 a. She ratified the contract by spending a check with the publishers name b. Better argument, must know what the check is for iv. Estoppel-R3d 2.05 4

1. Hoddeson v. Koos Bros.- Court holds the furniture store liable because guy is pretending to be agent. No actual or apparent authority. a. She must prove that the principal was careless, a reasonable person would believe that he was a salesman and that she detrimentally relied. v. Agents Liability on the Contract 1. What kind of principal do we have? a. Disclosed i. Disclosed principle, actual authority Principle is bound b. Undisclosed i. Undisclosed principle, no actual authority Agent is liable c. Partially disclosed/Unidentified i. Something secret about principle, agent is generally liable unless agreed upon otherwise ii. Someone has to be liable 2. Atlantic Salmon A/S v. Curran-Restatement 2nd 4 (2): Unless otherwise agreed, a person purporting to make a contract with another for a partially disclosed principal is a party to the contract. a. In this case, the parties did not otherwise agree that Curran was not liable, so he is liable here b. No apparent authority because principle didnt make manifestations, the agent (Curran) did c. Comes down to a policy matter: Are you going to make the 3rd party do own investigation or well hold the agent liable, 3rd party doesnt have to go investigate. Court says here 3rd party doesnt have to go investigate principle, you can hold agent liable. h. Liability of Principles for Agents Torts i. Servant Versus Independent Contractor 1. Employer/Employee (Master Servant Relationship) a. Employer is responsible for their employee if the employee is acting within the scope of their employment b. If servant commits INTENTIONAL tort (usually misbehaving) it is unfair to hold employer liable 2. Restatement 2. Master; Servant; Independent Contractor a. A master is a principal who employs an agent to perform service in his affairs and who controls or has the right to control the physical conduct of the other in the performance of the service. b. A servant is an agent employed by a master to perform service in his affairs whose physical conduct in the performance of the service is controlled or is subject to the right to control by the master c. 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 others right to control with respect to his physical conduct in the performance of the undertaking. He may or may not be an agent. 3. How do you tell if they are an IC or employee? a. Just because you call someone an independent contractor, doesnt make them that b. 219. When Master is Liable for Torts of his Servants c. 220. Definition of a Servant (Assume if you dont meet this definition that you are an independent contractor) i. A Servant is a person employed to perform services in the affairs of another and who with respect to the physical conduct in the 5

performance of the services is subject to others control or right to control ii. Factors to determine servant vs. independent contractor: 1. The extent of control which, by the agreement the master may exercise over the details of the work; 2. Whether or not the one employed is engaged in a distinct occupation or business; 3. The kind of occupation, with reference to whether, in the locality, the work is usually done under the direction of the employer or by a specialist without supervision; 4. The skill required in the particular occupation; 5. Whether the employer or the workman supplies the instrumentalities, tools, and the place of work for the person doing the work; 6. The length of time for which the person is employed; 7. The method of payment, whether by the time of by the job; 8. Whether or not the work is part of the regular business of the employer; 9. Whether or not the parties believe they are creating the relation of master and servant; and 10. Whether the principle is or is not in business 4. Humble Oil & Refining Co v. Martin-Master has control over responsibilities of servant. Humble had most of the control of business. 5. Hoover v. Sun Oil Company-Whether the oil company has retained the right to control the details of the day-to-day operation of the service station; control or influence over results alone being viewed as insufficient a. Doesnt matter if they exercise it, just if they have the right to do so b. Sun had no control over the details of day-to-day operation, so IC 6. Murphy v. Holiday Inns, Inc.-Owner had right to profit and risk of loss. Important factors the court looks at here: Daily activities, hiring and firing of employees, control over employees that were negligent. No agency relationship here. 7. Instrumentalities Test: Moving towards who is in control of area in which tort happened (Dunkin Donuts: Franchisor had control over food, etc. no control over security measures) a. Is there actual authority here? b. If no, was there apparent authority? i. Tort Liability and Apparent Agency i. Miller v. McDonalds Corp.-If a franchisor has the right to control the franchisee, then an agency relationship exists and the franchisor is vicariously liable for the acts of the franchisee. If a franchisor holds out a franchisee as to be its agent and other parties reasonably believe that the franchisee is acting as an agent, then an apparent agency exists and the franchisor is liable. ii. Analysis Questions on 58 1. 2. No, its a tort action, no apparent authority. Agency is enough for tort 2. 3. No, then brand name doesnt mean anything, probably less likely for torts if it controls j. Tort Liability: Scope of Employment (Employee versus Independent Contractor) i. 228 and 229 ii. People decided for intentional torts it may make sense to sue the agent and employee

iii. Ira S. Bushey & Sons, Inc. v. United States- Foreseeable that a drunken sailor might do damage. Contract from coast guard called for seamen to have to pass dry dock to get to ship. Court seems to think seamen getting drunk is very foreseeable. 1. If youre in a business where mishaps happen, its foreseeable 2. If its inevitable that this will happen, you should bear the cost 3. The seaman was under the control of the cost-guard iv. Clover v. Snowbird Ski Resort-Jury could find he acted within the scope of employment and that the deviation was not substantial enough to constitute a total abandonment of his employment. Court used purpose to serve master test, not whether employees conduct is foreseeable. You need to be way off your employment for the employer not to be liable v. More Modern Test Was there abandonment of Employment? vi. Manning v. Grimsley- Intentional tort, so employee will be held liable. Employer is liable when an employee assaults a third party in response to the third parties interference of the employees duties. 1. Deterrence: Hold the ball club liable because they are in a better position to deter other pitchers from doing this and they have the ability to absorb the cost k. Liability for Torts of Independent Contractors i. Principle is NOT liable for acts of IC unless he falls into 1 of 4 categories: 1. Principle retains control over the aspect of the work where the tort is concerned 2. He knows the agent is incompetent 3. Activity contracted is a nuisance per se 4. Non-delegable duty ii. Majestic Realty Associates, Inc. v. Toti Contracting Co.-Could have incompetent contractor but need more information. Nuisance per se Exception- Sufficient risk to public that principle needs to make sure that they are careful. Its inherently dangerous but not ultra-hazardous. a. Inherently dangerous-if you take precautions you can do it in a safe manner i. Here, so inherently dangerous that party cannot delegate liability b. Ultra hazardous- no matter what precautions you take, it will always be dangerous i. Distinction is important because liability is absolute for ultrahazardous. 1. Public policy dictates that the party hiring the contractor, although innocent of any direct negligence, should bear the burden of damages over a party that is completely innocent. l. AGENTS FIDUCIARY OBLIGATIONS i. Duties During Agency 1. Duty of care a. Standard is hard to meet b. Its not easy to bring a lawsuit c. Doing your job and not doing it all that well for no reason d. Violation depends on what you were asked to do 2. Duty of loyalty a. Favoring yourself over your principal b. Everything you do while youre supposed to be acting in the principals interest c. Almost always in breach if profiting solely because of position 3. Kickback is a third party who is giving you money while youre working on behalf of your principal 4. Grabbing and leaving 7

III.

a. Going to work with someone and then taking information from that person and starting your own business i. Such as stealing customers, hiring employees, taking trade secrets 5. Subtle distinctions between what is fair to the employer and what is not 6. Principal can give you permission to do things that would otherwise be a breach of duty 7. Some duties terminate at the end of agency some do not 8. Agents can compete with principal after relationship terminates (Confidential information duty does not terminate) 9. Case with intentional tort-Acts of the servant in the general scope of employment and in the masters interests or in view of furtherance of that business. Servants motive is usually material issue a. Test i. Geo ii. Time iii. Motive 1. Context 10. Reading v. Regem-Servant who unjustly enriches himself by virtue of his service must account for his profits to his master. Violates duty of honesty and GF. 11. General Automotive Manufacturing Co. v. Singer-Agents have a fiduciary duty to exercise GF and loyalty so to not act adversely to interest of his employer by serving or acquiring any private interest of his own ii. Duties During and After Termination of Agency: Herein of Grabbing and Leaving 1. Town &Country House & Home Services, Inc. v. Newbery- Owe limited amount of loyalty to previous employer after employment ends-such as trade secrets and confidential information. PARTNERSHIPS a. WHAT IS A PARTNERSHIP? i. UPA(1914) Section 6(1): A partnership is an association of two or more persons to carry on as co-owners a business for profit ii. Types of Business Organizations 1. Partnership 2. Limited Partnership 3. Limited Liability Partnership iii. Sources of Partnership Law 1. Governed by statute and common law a. UPA (1914) (More states enact this) b. UPA (1997) aka RUPA 2. Also principles of Agency iv. Agency Concepts in Partnership Law 1. Each partner is deemed to be an agent of the other (may be imputation of liability) 2. Each partner is a fiduciary of the other v. 2 Legal Theories 1. Partnership as Legal Entity a. An organization having a legal existence separate from that of is members; the RUPA considers a partnership a legal entity for nearly all purposes 2. Partnership as Legal Aggregate a. A group of individuals not having a legal existence separate from that of its members; the RUPA considers a partnership a legal aggregate for few purposes vi. Entity or Aggregate 8

vii.

viii.

ix. x.

xi. xii.

xiii.

1. Separate legal entity: a. To sue and be sued b. To have judgments collected against its assets, and individual partners assets c. To own partnership property d. To convey partnership property e. To keep its own books f. File its own federal/state tax returns 2. Aggregate: a. Partnership pays no federal income tax b. Joint an several liability of partners Partnership Formation 1. Duration of Partnership a. Partnership for a term b. Partnership at will. Partnership agreements can be oral unless Statute of Frauds requires a written agreement. Practically, agreements should be in writing. c. Partner will always have power to leave (if you leave wrongfully though you may have to pay damages) 2. Capacity. Partners must have legal capacity a. Corporations. UPA permits corporations to be a partner Limited Partnership 1. Partnership that has two types of partners a. 1 or more general partner i. Manage the partnership and have unlimited liability ii. A general partner who is usually charged with operation and day to day management of the partnerships affairs and business, taken on personal liability iii. Could be corporation b. 1 or more limited partners i. No liability for partnership debts beyond investment in partnership ii. Limited partner is shielded from such liability and traditionally is not as involved in the day to day affairs of the limited partnership iii. If something happens, money will come out of partnership first then goes to limited partners Partnership is formed by an agreement of the partners and must comply with requirements of contract law UPA 7. Rules for determining if partnership exist(4) the receipt by a person of a shard of the profits of a business is prima facie evidence that he is partner in the business, BUT no such inference shall be drawn id such profits were received in payment: a. (a) as a debt b. (b) as wages of an employee or rent to a landlord c. (d) as interest on a loan Fenwick v. Unemployment Compensation Commission-Sharing of profits is prima facie evidence of partnership but no interference drawn if profits received in payment Martin v. Peyton-Respondents ensured that they had some control over the operations of Halls business, the controls they bargained for were to ensure that their investment was secure. Hall still was able to control the day-to-day affairs. Partnership Characteristics 1. Factors to indicate co-ownership: a. Control 9

b. Labeling c. Sharing agreement (equal vote or control not necessary) d. Contribution e. Profit Sharing 2. Joint ownership alone does not automatically indicate a partnership 3. Neither sharing gross returns nor contributing capital to a business, independently, is sufficient to create a partnership 4. Best Test: Is it the intent of the parties to carry on, as co-owners a definite business? 5. How to distinguish partnership from employee/employer relationship? a. Intent of the parties-but not definitive b. Language of agreement c. Conduct of parties toward 3rd parties d. Who bears risk of loss? e. Treatment of profits and losses-sharing profits is prima facie evidence of partnership b. PARTNERS FIDUCIARY OBLIGATIONS i. Legal Consequences of Partnership Generally 1. Liabilities a. Each partner is jointly and severally liable for partnership debts b. Each partner has power to create obligations and liabilities for the partnership. If partnership assets are not sufficient, partners are personally liable for that debt. 2. Control a. Each partner has ability to participate in control and management of the partnership b. Under RUPA, each partner is entitled to 1 vote, no matter how much capital he contributed c. Other voting rules may be established by agreement 3. Tax Treatment a. Partnerships are not taxed on their income, Rather, tax liability or credits for profits or losses of the partnerships are passed through to partners to include on their personal tax returns 4. Fiduciary Duties a. Partners owe fiduciary duties to each other and to the partnership 5. UPA 20. Duty of partners to render information a. Partners shall render on demand true and full information of all things affecting the partnership to any partner c. Fiduciary Obligations i. Fiduciary Duties-UPA 21. Partner Accountable as a Fiduciary 1. Every partner must account to the partnership for any benefit, and hold as trustee for it any profits derived by him with consent of the other partners from any transaction connected with the formation, conduct, or liquidation of the partnership or from any use by him of its property ii. RUPA 404. General Standards of Partners Conduct 1. The only fiduciary duties a partner owes to the partnership and other partners are the duty of LOYALTY and duty of CARE set forth in subsections (b) and(c) a. Duty of Loyalty Generally: Take advantage and disadvantage partnership. Duty to make full and fair disclosure to other partners. b. Duty of Care Generally: . Much less important. Usually hurt co-partners, corporation or shareholders and did no good to you. Decision made by 10

officer or partner that turns out to be a bad decision usually does not make partner liable. Business judgment rule-If a director gets sued for a decision he made, courts are going to assume they acted on good faith and made an honest mistake. iii. 404(b) Duty of Loyalty Requirements 1. Not to appropriate partnership property, including a partnership opportunity; 2. Not to act as an adverse party to the partnership; and 3. Not to compete with the partnership in the conduct of the partnership business before the partnership is dissolved iv. 404(c) Duty of Care Requirements 1. A Partnerships duty of carein the conduct and winding up of the partnership business is limited to refraining from engaging in a. Grossly negligent or reckless conduct, b. Intentional misconduct, or c. A knowing violation of the law v. Agreements 1. Fiduciary duties can be altered by agreement 2. BUT, partners may not agree to: a. Unreasonably restrict a partners access to books and records of the partnership b. Eliminate the general duty of loyalty c. Unreasonably reduce the duty of care d. Eliminate the obligation for good faith and fair dealing (but may set standards for measuring) e. Vary the power of a partner to dissociate f. Vary the right of a court to expel a partner under specific circumstances vi. Organizational Opportunities 1. Business opportunity belong to the firm rather than the individualAgency restatement 387: 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. a. Disclosure may be enough b. Partnership has property interest in it. Person who takes it for themselves is liable to partner. vii. Meinhard v. Salmon-Joint adventurers owe to one another the duty of the finest loyalty, while the enterprise continues. The fact that Defendant was in control as the manager charges him with the duty of disclosure, since only through disclosure could opportunity be equalized. The subject matter of the new lease was an extension of the subject matter of the old one. 1. Basically says never think of self-interest while partnership is ongoing. d. Opting out of Fiduciary Duties i. Perretta v. Prometheus Development Company, Inc-Fiduciary duty problem here is duty of loyalty because its an issue of self-dealing he wants to buy out limited partners at lowest possible price while partners want to be bought out at highest possible price or not at all. Provision that allows an interested partner to count its votes in ratification vote would be manifestly unreasonable. 1. Partnership may vary or permit ratifications of violations on duty of loyalty if not manifestly unreasonable. CA law will not allow interested parties to count their votes in ratification e. Grabbing and Leaving 11

i. Meehan v. Shaughnessy-Breach of fiduciary duty by unfairly acquiring consent from clients to remove cases on company letterhead. Needed to tell the firm they are leaving when asked-cant lie. (Here, they lied) (Duty to render information on demand) f. Expulsion i. Lawlis v. Kightlinger & Gray-Expulsion must be in good faith for dissolution to occur without violating partnership agreement. Good faith and followed agreement here. g. PARTNERSHIP PROPERTY i. UPA 25 1. Ps interest in specific partnership property a. Cash in the bank, machinery, real estate, any sort of real or personal property that belongs to the partnership b. Tendency in Partnership Rights i. All partners have an equal right to use the property for partnership purposes but no one has a right to use it for other than partnership purposes 2. Ps interest in partnership a. No one partner can sell his one interest in the property. All partners must agree. b. What happens when one partner dies? Property reverts to other partners c. Specific property cannot be separately attached but each partners interest in the partnership (Right to distributions, economic right) can be attached 3. Ps right to participate in management a. Cannot be transferred separately from becoming a partner. Only if a partner stops becoming a partner, partnership dissolved, new partnership. His right is never transferred. b. UPA presumes when one partner leaves, partnership dissolves. But this doesnt happen n reality. Put a seamless transition into the partnership agreement to avoid this. ii. Putnam v. Shoaf- The partnership owns the property or asset. Putnam conveyed all of her interest in the partnership so she has no interest in the lawsuit. A co-partner may only convey an undivided interest in the value or deficit of the partnership, and the transfer agreement to Shoaf cannot be changed. (Treating partnership as an entity) h. RIGHTS OF PARTNERS IN MANAGEMENT i. Generally 1. 20 UPA- Right to information 2. 18(e) of the UPA provides that in the absence of an agreement to the contrary, all partners have equal rights in the management and conduct of the partnership business. And 18(b) provides that any difference arising as to ordinary matters connected with the partnership business may be decided by a majority of the partners. a. Order from the minority partner would not bind the partnership if the supplier is made aware of the limitation. If there is apparent authority, it is binding. 3. Certain extraordinary decisions require unanimous votes 9(3) a. Taking on a new partner b. Assign partnership property ii. National Biscuit Company v. Stroud-Partners have equal rights in the management and conduct of the partnership business. He still had actual authority even though other partner tried to diminish his authority. Buying bread is ordinary, within scope.

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iii. Summers v. Dooley-Any difference arising to the ordinary matters connected with the partnership business may be decided by a majority of the partners. Decision not made by majority and hiring 3rd person was out of scope of ordinary business 1. Must be unanimous to do something against the partnership agreement! iv. Day v. Sidley & Austin-Members of a partnership do not violate a fiduciary duty to one partner simply because that partner believes that their position was de-valued in any manner. If the other partners are following the agreement provisions and they are exercising their rights in a manner that is beneficial for the partnership over their personal interests, then they are meeting duty. Alleges partners violated duty of loyalty. i. PARTNERSHIP DISSOLUTION i. Generally 1. A dissolution is simply the change in relationship of the partners caused by any partners ceasing to be associated in the carrying on of the firms business UPA 29 (not the same as going out of business) 2. Winding up: The process of shutting down post-dissolution. Distributing parts and selling assets. 3. Business continued per Article 7 a. Purchase of disassociated partners interest 701 b. Disassociated partner not automatically released 703 4. Business dissolved per Article 8 a. Events of dissolution, must be wound up ii. Dissolution: Effect on Partnership 1. After dissolution, the partnership must be wound up, absent agreement among the partners to carry on the business a. Assuming that the business will not be continued, the winding up process generally contemplates that the firms assets will be distributed to the partners 2. Authority of partners to act on behalf of partnership terminated except in connection with winding up of partnership business UPA (1914) 33; UPA (1997) 804 iii. Continuation per agreement: Effect on Partnership 1. Technically creates new partnership (confusing treatment in Putnam v. Shoaf) 2. Creditors of former partnership automatically become creditors of new partnership 3. Departing partner entitled to accounting a. Fair value of partnership b. Interest from date of dissolution in event of unreasonable failure to pay 4. Departing partner remains liable on all firm obligations unless released by creditors. UPA (1914) 36; UPA (1997) 703 5. If a new partner joins the firm when it continues after a dissolution, the new partner is also liable for the firms old debts, but such liability can only be satisfied out of partnership property a. New partner cannot be held personally liable for the old debts, unless he or she expressly agrees to be so held. iv. The Right to Dissolve 1. There always exists the power, as opposed to the right, to dissolution Collins v. Lewis a. Dissolution by act of one or more partners b. Dissolution by operation of law c. Dissolution by court order 2. Causes of Dissolution 13

a. 31 of UPA i. Partnership at will, any partner can leave at any time 1. *Lawful vs. Unlawful ii. Partners by term automatically dissolve when term is up. Could turn into partnership at will 1. *Term could be implicit or explicit (Only found term in Owen; not Page or Collins) iii. If partners kick someone out or someone dies, dissolves b. 32 of UPA Dissolution by Decree of Court (Subjective things parties fight about) i. Misbehaving partner (c) or (d) ii. Cant perform duties, unsound mind iii. Bankruptcy iv. Business becomes unlawful c. Rightful vs. Wrongful Dissolution i. Rightful 1. Permitted by the partnership 2. Expel a partner ii. Wrongful 1. One in contravention of partnership agreement 2. Effects damages 3. UPA 38 3. Good Will of Business a. Company name, any intellectual property, etc. b. What the business itself is worth minus the assets 4. Owen v. Cohen-32, cause for judicial dissolution. A partner may move for a dissolution when another partners conduct negatively affects the business or another partner willfully or repeatedly breaches the partnership agreement. 5. Collins v. Lewis-The petition for dissolution should not be granted because the party petitioning for the dissolution is the only party that is not abiding by the partnership agreement. 6. Owen v. Collins. Owen partner was allowed out, why not in Collins? a. Who is trying to get out of it i. D. in Owen is not doing work, stealing money ii. D. in Collins is grossly mismanaging it. Jury here said he is not really mismanaging it b. Whether they could keep running the business for a profit i. Owen- if D. continues like this, they will not be able to make a profit ii. Collins they are capable of making a profit if P. stops interfering c. Good faith v. Bad faith 7. Page v. Page-A partnership can be dissolved by the express will of any partner when no definite term or specific undertaking is specified, providing that the partner making a good faith judgment. Partnership can be dissolved regardless of profitable or unprofitable but cannot freeze out a co-partner for own use. Power to dissolve by express notice, but if in bad faith for freeze out, partner is liable. v. The Consequences of Dissolution 1. After dissolution, 4 things that can happen according to UPA a. Wind up and distribute assets

14

b. By Agreement: plan to continue partnership and a buyout provision for partner who is leaving or get insurance on partner if you think he might die to pay his estate (assuming he had a right to leave) c. Continue by Statute d. Remaining partners could buy the assets 2. Prentiss v. Sheffel-Absent bad faith or a prior agreement that states otherwise, Plaintiffs are entitled to bid on their own former assets during a judicial sale. 3. Pav Saver Corporation v. Vasso Corporation-Party who did not cause the dissolution wrongfully may continue the business and with the partnerships property (UPA 38). The partnership agreement stated that the partnership was for a permanent length of time, and therefore the business is entitled to the intellectual property to continue; otherwise the business is worthless. a. Breaching partner does not usually get a say in winding up. Remaining partners have right to continue business under the same name. j. SHARING LOSSES/BUYOUT AGREEMENTS i. Sharing of Losses 1. Kovacik v. Reed-Neither party is liable for any loss sustained to the other. Where one party contributing $ and the other contributes service then in the event of a loss each would lose his own capital one his $ the other his labor. ii. Buyout Agreements 1. Agreement that allows a partner to end his relationship with the other partners and receive a cash payment, or series of payments, or some assets of the firm, in return for his interest in the firm. 2. Exit and Entrance Strategies: Buy and Sell Agreements a. Worst Case Scenarios i. No buy sell agreement 1. One of the two owners dies 2. Other bad scenarios a. Divorce, bankruptcy, disability, disappearance b. Purposes of buy-sell agreements i. Pre-Nuptial agreement for business ii. Business continuation iii. Creates a market for interest iv. Helps establish value v. Creates liquidity for leaving partner (Death, retirement, or disability) vi. Heals ensure business succession vii. Minimizes disputes c. Types of buy sell agreements i. Redemption Agreements 1. Entity buys back plaintiffs interest ii. Cross purchase agreements 1. Joint owners buy iii. Hybrid Agreements 1. First option in entity 2. Second option in other owners 3. Third, entity must purchase d. Elements to consider i. Who should be the purchaser ii. Restrictions on transferability iii. Appropriate triggering events 15

iv. Responses to triggering events v. Determination of purchase price vi. Payment of purchase price vii. Funding and security for payment e. Elements-Purchaser i. All Partners 1. All partners are parties 2. Each should view self as potential seller or purchaser ii. Partnership entity as a party f. Triggering events i. Mid-life crisis ii. Termination of employment (voluntary or involuntary) iii. Disability iv. Retirement v. Competing with entity vi. Involuntary transfers- divorce & bankruptcy vii. Breach of agreement g. Elements-Response to trigger i. Mandatory purchase and sale ii. Buyer has option to purchase iii. Seller can force sale iv. Non/delayed 1. Start up/capital intensive 2. Make exiting partner/seller wait h. Purchase Price i. Periodically evaluate ii. Valuation formulas iii. Outside appraisal i. Purchase Price formulas i. Book value 1. Generally unreliable ii. Earnings/cash flow based 1. Historical 2. Discounted future 3. Industry Conventions a. Rules of thumb j. Terms of Payment and Source of Funds i. Elements-Payment Terms 1. Lump sum payment 2. Installment payments 3. Source of funds a. Insurance b. Future earnings ii. Valuation Adjustments 1. Lack of marketability 2. Lack of control/minority interest 3. Control premium 3. G&S Investments v. Belman-Entitled to utilize the buyout provision because partner died before a court-ordered dissolution. Parties must be bound by agreements in which they enter 16

IV.

a. The buyout formula: By the addition of the sums of the amount of the resigning or retiring general partners capital account plus an amount equal to the average of the prior three years profits and gains actually paid to the general partner, or as agreed upon by the general partners, provided said agreement sum does not exceed the calculated sum in dollars b. Must have at least one general partner (General partner in general partnership has unlimited liability) k. LIMITED PARTNERSHIPS i. Generally 1. Limited Partners have fewer rights and fewer obligations 2. Can only be created by filing a limited partnership certificate at the state agency 3. Must have a general partner (could be a corporation) with unlimited liability 4. Unless specified, duration is indefinite 5. Limited partners can sell interest without legally causing dissolution ii. Holzman v. De Escamilla-Although plaintiffs are listed as limited partners, their conduct made them as accountable as general partners, they took part in controlling the business, and that control holds them liable as general partners. a. Could loose limited liability status by exercising control 1. Begin to look like corporation (LLC) (everyone has limited liability) CORPORATIONS a. Generally i. Right to own property, sue and be sued ii. Shareholders do not have a vote on how to manage business, hire board of directors for that iii. Person who files is known as the incorporator iv. Certificate must include name of company, number of shares available, purpose of corporation, etc. b. LIMITED LIABILITY i. Generally 1. MBCA 6.22(b): Unless otherwise provided in the articles of incorporation, 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. 2. The dark side of limited liability a. Externalities i. Allows Carltons of the world to avoid some of the social cost of their activities b. Encourages excessive risk-taking 3. Must incorporate, register with state, figure out shares, select initial directors, bylaws, etc. 4. After procedural requirements, shareholders then have limited liability 5. Generally all you will loose if you invest is amount you invested ii. Walkovszky v. Carlton- The court will only pierce the corporate veil and hold the stockholders liable if it can be shown that the stockholder was conducting business in his individual capacity. The corporate veil may not be disregarded just because the assets of the corporation, together with the liability insurance, are insufficient to assure recovery. Leave it to the legislature. Walkovsky, who also wants all corporations to be liable, is asking for enterprise liability so all treated as one corporation. Like PCV, BUT must show disrespect for corporations vis a vis the corporations. 17

1. Perfectly fine to incorporate multiple companies (If something happens in one, all of them dont go bankrupt) 2. Plaintiff tried to say all 10 corporations were part of a single enterprise a. Fails because this would only allow him to get money in other corporations but we dont know if there is money in the other corporations. And he does not allege enough facts to prove that they are all part of a single enterprise. Distinction between veil piercing and enterprise liability. b. Enterprise liability-Only a larger corporate entity would be held financially responsible c. W. is short of enterprise liability. Plaintiff have to show: i. Money being shared between corporations, trading drivers, companies interact with each other without a third party transaction. Acting for the good of the whole. ii. Carlton did not respect the separate identities of the corporations (Assignment of drivers, use of bank accounts, ordering of supplies, etc.) 3. For piercing the corporate veil, show alter-ego, fraud, lack of respect for corporation by not holding corporation separate from himself, assets are his 4. Not improper to incorporate your business for the express purpose of avoiding personal liability but cant take money out of the corporation that doesnt respect the corporation. If you take money out, must still pay tax. If you treat assets as your assets, you also take personal liability. 5. TEST from Walkocszky for piercing the corporate veil or enterprise liability (similar test but where the money is different) a. Unity of interests and enterprises b. Some sort of fraud or injustice iii. Sea-Land Sevices, Inc v. Pepper Source- Corporate veil will be pierced where there is a unity of interest and ownership between a corporation and an individual and where adherence to the fiction of a separate corporate existence would sanction a fraud or promote injustice. There can be no doubt that the unity of interest and ownership part of the test is met here. The second part of the test is more problematic. An unsatisfied judgment, by itself, is not enough to show that injustice would be promoted. On remand, SL is required to show the kind of injustice necessary to evoke the court's power to prevent injustice. 1. Fraud is a crucial part of the PCV analysis. This additional injustice must be found. If dont PCV, look at whether promoting injustice through fraud, unjust enrichment, etc. 2. Reverse piercing the veil because Marchese doesnt have money, but the corporations he owns does. If there is another creditor in one of the corporations, leads to problems. iv. Factors court looks at when piercing the veil: 1. The failure to maintain adequate corporate records or to comply with corporate formalities 2. The commingling of funds or assets 3. Undercapitalization 4. One corporation treating the assets of another corporation as its own v. Van Dorn Test: 1. A corporate entity will be disregarded and he veil of limited liability pierced when two requirements are met: First, there must be such unity of interest and ownership that the separate personalities of the corporation and the individual or 18

other corporation no longer exist; and second, circumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice. a. Injustice here is they didnt get paid, plaintiff got stiffed; blatant tax fraud, taking money out as corporate deductions. vi. Roman Catholic Archbishop of San Francisco v. Sheffield-No proof that Archbishop had any dealings with the Canons Regular of St. Augustine for it to be liable under the alter ego doctrine. Furthermore, when a parent corporation controls several subsidiaries, the corporate veil of one subsidiary may not be pierced to satisfy the liability of another. The alter ego theory cannot be applied simply because the plaintiff wont be able to collect. (Arguing enterprise liability) c. SHAREHOLDER DERIVATIVE ACTIONS i. Generally 1. A person who thinks a corporation should sue someone for a wrong done to it, a shareholder has to go to board of directors and ask them to take the right action. 2. Board can remove president even if he has a contract for no cause 3. Wrong must have affected shareholders individual rights 4. Corporations dont sue themselves so shareholders are given derivative right to sue on behalf of the corporation 5. Derivative suits have a history of being abused, especially during the depression 6. Likely not to be valid suit 7. Director of corporation usually settles (puts a lot of restrictions on when these could be brought) 8. Big Hurdle: Security for expenses statute a. Required to pay corporation legal expenses if the suit turns out to be meritless (post security) b. About 1/3 of states enacted this 9. Rules about how much stock you have to own in order to bring suit 10. Derivative suits allow shareholders to hold directors accountable. SC called it a remedy born of stockholder helplessness. On the other hand there is a large potential for abuse. 11. In a derivative suit, any recovery goes to corporate treasury, whether by settlement or trial victory. So lawyer is real party in interest because he can get a contingent fee out of any recovery ii. Shareholder Direct Rights 1. In basic corporations, shareholders cannot tell the board what to do but has some rights 2. Voting rights a. Every corporation is required to have at least one annual meeting. Generally elect directors. Shareholders can vote. In some cases, shareholders have right to vote on extraordinary matters, things that would change type of investment you have such as mergers, sale of all assets, dissolving corporation. Can also vote to adopt/appeal bylaws, remove directors for cause. 3. Rights to sue to protect other rights a. Derivative suits against officers for breach of fiduciary duties. b. Shareholder can sue on behalf of corporation to make the corporation sue someone else. c. Remedy is put back in corporate treasure. 4. Right to information iii. Direct and Derivative Suits 19

iv.

v.

vi.

vii.

viii.

ix.

1. Direct a. Brought by the shareholder in his or her own name b. Cause of action belonging to the shareholder in his individual capacity c. Arises from an injury directly to the shareholder 2. Derivative a. Brought by shareholder on behalf of corporation b. Cause of action belongs to the corporation as an entity c. Arises out of an injury done to the corporation as an entity 3. Traditional Tests a. Who suffered the most direct injury? i. If corporation, suit is derivative b. To whom did defendants duty run? i. If corporation, suit is derivative Eisenberg v. Flying Tiger Line, Inc.-Plaintiff does not have to post security because the suit is not a derivative. Plaintiffs suit is to prohibit the loss of voting rights. His cause of action is not on behalf of the corporation or on behalf of all shareholders. Delawares Alternative 1. In Tooley, Delaware SC adopted a two-pronged standard for determining whether a stockholders claim is derivative or direct: a. Who suffered the allege harm. The corporation or the suing stockholder? b. Who would receive the benefit. Of any recovery or other remedy, the corporation or the stockholders? Examples 1. ABC Corp entered into a contract with Jane Jones. Jones breached the K, but ABC corp has not sued her for breach. May a shareholder of ABC sue jones? a. No. Jones owed no duty to shareholder as such b. Jones breach did not injure the shareholder directly c. Recovery would go to ABC, hence it would have to be brought as a derivative action 2. ABC corps treasurer embezzles all its money and absconds. Shareholders stock is now worthless. May a shareholder of ABC corp sue treasurer directly? a. No, not enough for a shareholder to allege that challenged conduct resulted in a drop in the corporations stock market price. Because your loss is derivative of the corporations loss, only the corporation can sue. b. If its monetary, it must be something different then every other shareholder experiences. Security for Expenses Statutes 1. NY provides that a shareholder who brings a derivative suit and who owns less than 5% of the stock or stock worth $50,000 is liable for the corporations reasonable expenses if suit fails 2. Policy Concerns a. Derivative suit really belongs to corporation b. May have been a good business reason not to sue Business Judgment Rule 1. Under the duty of care they assume that the director was acting in the best interest of the corporation but not duty of loyalty because then assume they are self interested. Requirement of Demand on Directors 1. The Corporation a. Shareholders Board of Directors Management Employees 20

2.

3.

4.

5.

6.

7.

8.

i. Shareholders own the company, participate in the profits of the enterprise. Limited involvement in the company affairs b. BOD-Elected by the shareholders c. Management is appointed by board, no input to board Board Functions a. Select, evaluate, replace senior management b. Oversee: Strategies, management of corporate resources c. Review, approve major plans and actions d. Other functions prescribed by law Corporate Officers a. Officers serve at the pleasure of the board of directors b. Act as agents for the corporation i. Have fiduciary duties of agents, plus c. In most states, one can be both officer and director Fiduciary Duties a. Directors and officers are fiduciaries of the corporation b. Duty of care: Directors/ officers are expected to act in good faith and the best interest of the corporation i. Failure to exercise due care may subject individual directors or officers personally liable c. Duty of loyalty: Subordination of personal interests to the welfare of the corporation i. No competition with Corporation ii. No corporate opportunity iii. No conflict of interest iv. No insider trading v. No transaction that is detrimental to the minority shareholders Derivative Litigation-Demand Requirement a. Basic issue regarding demand b. When, if ever, should the corporation, acting through the board of directors or a committee of directors, be permitted to prevent or terminate a derivative action? i. Put another way, who gets to control the litigation the shareholder or the corporations board of directors? Reasons For demand Requirement a. Cause of action belongs to corporation i. Like all assets, litigation under control of BOD b. Shareholder may have interests diverse from those of corporation i. Shareholders lawyer often real party in interest c. Therefore BOD should have some say (argued) What is the demand a. Typically a letter from shareholder to the board of directors i. Must request that the board bring suit on the alleged cause of action ii. Must be sufficiently specific as to apprise the board of the nature of the alleged cause of action and to evaluate its merits iii. Remedy When is demand excused? a. Shareholders must make demand before filing suitunless its futile b. Delaware legal standard for demand futility 21

i. Plaintiff must allege particularized facts creating a reasonable doubt that the board is able to decide the issue in good faith: 1. Majority of board has material financial or familial interest 2. Majority of the board lacks independence (domination and control by wrongdoers) 3. Challenged transaction not product of valid exercise of business judgment ii. For derivative claims, court is going to look at when its excused iii. If your not gong to make demand, must alleged with particularity that its excused, reasonable doubt 9. Burden of Proof a. Plaintiff has burden of proving that demand is excused; b. If demand is required, and Board refuses demand, i. Board gets the benefit of the business judgment rule ii. Plaintiff has burden of proving that demand was wrongfully refused 10. What are the basis for not making an independent decision? a. Majority will make more money Material financial or familial interest b. Majority of board cant act independently c. Underlying transaction not valid exercise of business judgment 11. Grimes v. Donald- Plaintiff waived his right to contest the independence of the Board once he demanded that they invalidate the employment contract. A pre-suit demand is a tool to avoid further litigation, but it would not serve that function effectively if Plaintiff was allowed to bifurcate his claims and claim the demand was excused for one set of claims. a. Grimes made demand so not excused, but can show wrongful refusal. But that will be pretty hard. i. Wrongful refusal will be decided by business judgment rule: court will assume they acted in best faith of corporation 1. Derivative goes away 2. Direct, prove demand 12. Marx v. Akers-Self-dealing. Board sets compensation for executives (they could set for employees, but usually dont). Demand was excused because the Defendant Directors have an interest in their own compensation. However, plaintiff did not demonstrate with particularity what accounting decisions or any other facts that would establish the excessiveness of the raises. 13. Problem on 237-238: a. Derivative Suit b/c its a right of the corporation b. Demand excused because its a majority of directors c. Demand required on its face unless they can prove she has domination or control over them. She is a minority. d. Probably be required. They violated their duty of care by not doing anything. A little bit more doubt but demand is probably required. x. The Role of Special Committees 1. Auerbach v. Bennett-Once the special committee was deemed to be impartial and disinterested in the issue at hand, their decision is entitled to deference by the business judgment rule. Therefore, it is acceptable to inquire into the special committees independence, but the court will not interfere with their business judgments. Special committee gets same deference board would get. a. Factors the court looked at to determine if they were interdependent: they werent on the board at the time and neither one has any prior affiliation 22

with the firm. (INDEPENDENCE OF MEMEBERS AND PROCEDURES-how many times did they meet, did they interview people, how long is there report) 2. Zapata Corp. v. Maldonado- The court applied a two-step test to determine if the Committee should be permitted to dismiss the litigation. First, Defendant corporation has the burden to prove that the Committee is independent and is exercising good faith and reasonable investigation. Second, the court should apply their independent business judgment. 3. In re Oracle Corp. Derivative Litigation-SLC has not met its burden of proving an absence of a material dispute of fact about its independence where its members are professors at a university that has ties to the corporation and to the defendants that are the subject of a derivative action that the committee is investigating. 4. Rule Overview for Special Litigation Committees a. Shareholder brings litigation against corporation. Board appoints two people to be special limitation committee. b. In NY court reviews special litigation committee: i. Was the committee independent? 1. Were they properly selected? 2. Did they make a good faith investigation? ii. Discontinue decision 1. If it is a proper SLC (satisfies #1) granted business judgment rule and court wont look at #2 2. Burden on plaintiff to show problem with SLC c. Zapata Two-Step (Delaware) i. Was SLC properly selected, conduct good faith investigation? ii. Decision to discontinue, was that right or wrong? 1. Delaware will look at both steps!! 2. Corporation must show that SLC is independent (burden) a. What constitutes independence? i. DE: Independent unless plaintiff can show the directors are beholden to a material interest. ii. Director must be dominated or controlled by another person to not be independent. Economically consequential relationship. Personal friendship was not seen as controlling. Look to see if director is capable of making decision with ONLY best of corporation in mind. Dont need total domination control anymore (Oracle) d. ROLE AND PURPOSE OF CORPORATIONS i. A.P. Smith Mfg. Co v. Barlow-Plaintiff can give money to charities providing that the total does not exceed the statutory maximum of 1% of capital and surplus, and the institution receiving the money does not own more than 10% of the company stock. 1. Corporate gift-giving increases the goodwill of the corporation, and public policy should be to encourage corporations to provide to charities in the same manner as individuals are encouraged to give. 2. May have a problem if board wants to give employees wife pension benefits if there were no benefits available at the time he started his employment. ii. Dodge v. Ford Motor Co.-Plaintiffs are entitled to a more equitable-sized dividend, but the court will not interfere with Defendants business judgments regarding the price set on the manufactured products or the decision to expand the business. The purpose of the 23

V.

corporation is to make money for the shareholders, and Defendant is arbitrarily withholding money that could go to the shareholders. iii. Shlensky v. Wringley-A shareholder's derivative suit can only be based on conduct by the directors which borders on fraud, illegality, or conflict of interest. P is attempting to use the derivative suit to force a business judgment on the board of directors but there is no showing of fraud, illegality, or conflict of interest. 1. Court is applying business judgment rule- court steps in and says good will in community is worth something so profits are benefitting from not putting the lights in. 2. Why is this different from Ford- Negligence will not be found because you are not conforming to the rest of the industry LIMITED LIABILITY COMPANIES a. Generally i. Enacted by state statues ii. Cross between partnership and corporation 1. Tax advantages of partnerships 2. Limited liability of corporations iii. None of the restrictions (e.g. number and type of shareholders) applicable to S corporations iv. Funding-Same as partnerships 1. Members typically contribute capital v. Liability-Same as shareholders 1. Members stand to loose capital contributions but not personal assets vi. Tax Consequences-same as partnership 1. Income passes through members 2. LLC does not pay taxes vii. Formation 1. File articles of organization in the designated state office a. Choose and register name b. Designate office and agent for service of process 2. Draft operating agreement- the basic contract governing the affairs of a limited liability company and stating the various rights and duties of the members viii. Members Interest 1. Financial interest a. i.e. right to distributions and liquidation participation b. Profit and loss sharing i. Absent contrary agreement, statutes allocate profits and losses on the basis of the value of members contributions. Awarded to how much you put at risk. ii. Compare partnership laws equal division c. Withdrawal i. Member may withdraw and demand payment of his/her interest upon giving the notice specified in the statute or the LLCs operating agreement 2. Management rights a. Management i. Absent contrary agreement, each member has equal rights in the management of the LLC ii. Most matters decided by majority vote iii. Significant matters require unanimous consentadmission of new member, dissolution, etc. 24

b. Manager-managed LLC option available i. Can be structured as a board of directors, a CEO or both ii. Must be specified in articles of organizations ix. Assignment of LLC Interest 1. Unless otherwise provided in the LLCs operating agreement, a member may assign his financial interest in the LLC 2. An assignee of a financial interest in an LLC may acquire other rights only by being admitted as a member of the company if all the remaining members consent or the operating agreement so provides 3. Analogous to partnership rules x. Fiduciary Duties 1. Manager-managed LLCs a. The managers of a manager-managed LLC have a duty of care and loyalty b. Usually, members of a manger-managed LLC have no duties to the LLC or its members by reason of being members c. All members of a member-managed LLC have a duty of care and loyalty 2. Derivative Actions a. Member may bring an action on behalf of the LLC to recover a judgment in its favor if the members with authority to being the action refuse to do so b. Formation i. Water, Waste, & Land, Inc. d/b/a Westec v. Lanham-Company had a registered LLC but did not have it on their business card. They know Im doing this for a business, but they dont know anything about the company, its partially disclosed. It is important if its an LLC or not because they would have been better off if it was a partnership cause then they can go after them if they are broke, here they cannot c. PIERCING THE LLC VEIL i. 302. LLC liable for members or managers actionable conduct: 1. A LLC is liable for loss or injury cased to a person, or for a penalty incurred, as a result of a wrongful act or omission, or other actionable conduct, of a member or manger acting in the ordinary course of business with the company or with authority of the company ii. 303. Liability of Members and Managers 1. (b) The failure of a limited liability company to observe the usual company formalities or requirements relating to the exercise of its company powers or management of its business is not a ground for imposing personal liability on the members or managers for liabilities of the company. iii. To what extent should the corporate law rules apply to LLCs 1. Sometimes statute answers this 2. Corporate Law Standard? a. Courts will pierce the corporate veil if (1) an entity ignores corporate formalities and acts as the alter ego or instrumentality of a shareholder and (2) the liability limitations of the corporate form results in injustice or is fundamentally unfair. iv. Kaycee Land and Livestock v. Flahive-In the absence of fraud, you can still piece corporate veil. Treat LLCs the same as we treat corporations. The various factors to justify piercing the LLC veil would not be identical because of the differences in organizational formalities, though. d. LLC Fiduciary Obligations i. McConnell v. Hunt Sports Enterprises-Limited liability partnership involves same fiduciary relationship as a partnership. Normally this relationship would preclude direct 25

VI.

competition btwn members of the company. However, terms of the operating agreement allow members to compete w/ business of the company (Members may compete). In competing, appellees didnt engage in any acts that would constitute wrongful behavior. There is no evidence that McConnell acted in a secretive manner or that he tortuously interfered w/ prospective business relationship. OFFICERS & DIRECTOS DUTIES (No statutory authority, spelled out in case law) a. Generally i. Directors are elected by shareholders so they have 2 main duties to them: loyalty and care ii. Most director who get in trouble get in trouble for violating the duty of loyalty iii. Courts scrutinize this very carefully iv. Courts are reluctant to interfere with wrong decisions because directors make mistakes too b. DUTY OF CARE i. Generally 1. Reasonable person in similar circumstances 2. DE Standard Must show gross negligence 3. Courts will evaluate claims under business judgment rule 4. BJR will protect ANY decision UNLESS its tainted by bad faith, self-dealing, waste 5. BJR will not cover inaction 6. Everyone on the board of directors doesnt have to know everything about the firm 7. Attorneys or accountants may be held more strictly to the law 8. TO OVERCOME DUTY OF CARE: Must show you informed yourself and the board deliberated about it ii. Kamin v. American Express Company-Court said no claim of fraud, self-dealing, bad faith or oppressive conduct in the complaint. Majority was not self-interested or benefiting from this. This was a business decision. 1. The courts will not impose liability for dumb decisions. Even if evidence of clear self-dealing by the four directors, the Court would toss this out since cant prove those 4 dominated and controlled the other directors. iii. Smith v. Van Gorkom- Court found that the directors were grossly negligent, because they quickly approved the merger without substantial inquiry or any expert advice. For this reason, the board of directors breached the duty of care that it owed to the corporation's shareholders. As such, the protection of the business judgment rule was unavailable. 1. The decision also clarified the directors' duty of disclosure, stating that corporate directors must disclose all facts germane to a transaction that is subject to a shareholder vote. iv. Francis v. United Jersey Bank- Liability requires finding that she had a duty to the clients and that she breached that duty and that her breach was a proximate cause of their losses. Wouldnt be part of the loss unless she was proximate cause of it. 1. She had a duty of care in managing the business. She did not have to know every detail of day-to-day operations, but she needed to have a baseline understanding of the finances and important activities. If she did not understand the activities, then she was obligated to consult counsel for advice. Therefore, her lack of care was a proximate cause of the damages to the company and the third parties who relied upon the company. Because of the nature of the business (holding assets of third parties), she was liable to the third parties for any damages. v. Director finds out something that may be illegal activity, must object to the board, need to be written in the minutes of a board meetingmake a record that you objected. If that doesnt work, resign, threaten to sue, report to IRS, justice system. Not supposed to 26

inform authorities or start a lawsuit as soon as you suppose wrongdoing. Object first and give them a chance to explain. c. DUTY OF LOYALTY: DIRECTORS & MANAGERS i. Generally 1. Engages in behavior to put person interest over that of the corporation 2. Breached when benefited director 3. Scrutinized carefully, see if actual decision is fair to corporation 4. Not given benefit of business judgment rule ii. Bayer v. Beran-It was fair to the company because sh did not receive more money then anyone else, company received all the benefits and actually thrived, advertising was legitimate and useful, had been well thought out through studies, etc. Would have received BJR but personal transaction of a director deserves rigorous scrutiny. 1. Didnt have a board meeting where they disclosed to everyone that she was the presidents wife, but court says this is okay d. DUTY OF LOYALTY: CORPORATE OPPORTUNITY DOCTRINE i. Broz v. Cellular Information Systems, Inc.-Defendant did not personally take advantage of a corporate opportunity for Plaintiff. Seller did not consider CIS to be a legitimate bidder for the license due to their financial condition, and when seller approached Defendant about the purchase, they were approaching him in his own capacity. Defendant never hid the transaction from other CIS board members, and they testified that CIS would have no interest in the license. Defendant also had no fiduciary duty to a company that had yet to acquire CIS at the time of his purchase of the license. ii. Corporate Opportunity: Delaware Test? 1. A corporate opportunity exists where: a. Corporation is financially able to take the opportunity b. Opportunity is in the corporations line of business 2. Corporation has an interest or expectancy in the opportunity 3. Embracing the opportunity would create a conflict between directors self-interest and that of the corporation iii. Simple Roadmap of a COD dispute 1. Is prospect a corporate opportunity? a. If no, no breach 2. Does fiduciary disclose? a. If yes, ask about corp. rejection b. If no, then breach if fiduciary appropriates 3. Does corporation properly reject? a. If yes, no breach 4. If no, a. Breach if fiduciary appropriates b. No breach if fiduciary does not appropriate e. DUTY OF LOYALTY: DOMINANT SHAREHOLDERS i. Generally ii. Shareholders that have substantial control over a corporation iii. Ability to put people on the board of directors to vote the way they want (control the corporation) So not on the board, but influencing the board to benefit them iv. Has the dominant shareholders done something inappropriate to the minority shareholders? 1. Conflict of interest (self-dealing) is present, what standard of review? a. Intrinsic Fairness Standard (High Standard) i. High degree of fairness (Objectively fair); and 27

ii. Burden of proof shifts to controlling shareholder to show transaction was fair b. Analysis i. Is there a conflict of interest? ii. If yes, can it be cleansed? iii. What is cleansed? 1. Majority of disinterested informed directors approve the transaction (conflicted person does not vote) 2. If a majority of the board has an interest, take all without an interest and take a vote 3. ONLY disinterested get to vote 2. No conflict of interest, standard of review? a. Business judgment rule (lower standard)-?? b. Burden of proof on plaintiff v. Sinclair Oil Corp. v. Levien-Dominate shareholder did not breach fiduciary duty in: (1) having sinvin issue dividend, they got a benefit, but minority shareholders did too, so the court applied the business judgment rule;(2) corporate opportunities (business judgment rule, wasnt taking an opportunity for a subsidiary, just determining which is better) no self interest for (1) or (2), so not conflict of interest; (3) Intrinsic fairness standard applies because there is self dealing in allowing a subsidiary to breach contracts with Sinvin f. OBLIGATION OF GOOD FAITH i. Why is finding that directors acted in good faith so important to directors? 1. Standards for being a director include acting in good faith 2. Most states required to show directors acted in good faith 3. Provides indemnification a. Directors who act in good faith are entitled to indemnification for legal expenses. See DGCL 145 b. Directors who relied in good faith on corporate books and records are protected from shareholder claims. See DGCL 141(e). ii. Examples 1. Unintentional act in not advancing corporations best interest a. Good faith. Unintentional act. 2. Intent to violate the law a. Bad faith 3. Intentionally failing to act in a face of a duty to act (disregard duty) a. Bad faith. Business judgment rule doesnt apply to not acting at all. g. DISCLOSURE AND FAIRNESS i. Securities Markets 1. Primary Market a. Issuer of securities-i.e. the company that created the security- sells them to investors (Initial public offering by a corporation) 2. Secondary Markey a. Investors trade securities among themselves (example- NYSE) 3. Federal Securities Laws a. Securities Act of 1933 (Securities Act) i. Generally applied to Primary Market (issuer) ii. Purpose- To protect investors by promoting full disclosure of information necessary for informed investment decisions b. Securities Exchange of 1934 (Exchange Act) i. Generally applies to Secondary Market 28

ii. Requires publicly held companies to disclose information continually about their business operations, financial conditions, and managements ii. What is a Security? 1. Securities Act definition 2(1): Any note, stock, treasury stock, security future, bond, debenture, evidence of indebtness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preoganization, certificateetc. 2. Robinson v. Glynn-Investment contract is not a security. Robinson had a lot of control and that is not indicative of a passive investment. Security Exchange act protects passive investors and have no control of operation of business, not a person involved in a failing business. Robinson was a knowledgeable executive protecting his interest and position in the company a. Robinson next tried to say that his membership interest in Geophone was also a stock. Common stock attributes: i. The right to receive dividends contingent upon an apportionment of profits ii. Negotiability iii. The ability to be pledged or hypothecated iv. The conferring of voting rights in proportion tot eh number of shares owned v. The capacity to appreciate in value b. Robinson did NOT have these attributes of stock (if someone claims stock, look at ^) c. If you are not passive, it is NOT a security!! iii. Registration Process 1. Securities Act of 1933 (Securities Act) a. 5- Issuing company of securities must register the securities with SEC i. Cannot offer for sale without filing registration statement with SEC; and ii. Offering document (Prospectus) must be deliver to prospective buyer before sale 2. Exemption from Registration a. Securities Act under 4 i. Private Placements (4(2)) and sale of securities other than issuer, underwriter or dealer (4(1)) b. Regulation D (Rules 501-506) 3. Doran v. Petroleum Management Corp.-Defendants bear the burden of the affirmative defense that an offering was private. This was not a private placement. a. Rule: To constitute a private offering and thus be exempt from the registration requirements of the Securities Act of 1933, the offeree in a sale must be furnished with or have access to information about the issuer that a registration statement would have disclosed. 4. Private Placement Exemption under 4(2) of the Securities Act a. Characteristics that define private placement: i. The number of offerees and their relationship to each other; ii. The number of units offered; iii. The size of the offering; and iv. The manner of the offering. b. Closer the relationship to the buyer, less is required in determining if they have enough information; typically offered to sophisticated individuals 29

who do not need a lot of information. SEC really just protecting passive investors to make sure they get enough information. h. INDEMNIFICATION AND INSURANCE i. Generally 1. Good faith requirement to indemnify directors 2. Can agree to indemnify more than is required by act 3. 145(c) DE corporation law. Must indemnify director if director is successful in the lawsuit (Waltuch) ii. Liability Limitation Statutes 1. DGCL 102(b)(7) provides that a corporations articles of incorporation may (but need not) contain: a. A provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty (of care) as a director 2. Noteworthy points a. Applies only to directors i. Although officers also are subject to a duty of care, they are denies exculpation by charter provisions b. Distinguishes self-dealing (improper personal benefit) and bad faith from duty of care iii. Indemnification Statutes 1. At common law, corporate employees were entitled to indemnification for expenses incurred on the job, including certain legal liabilities, but directors were not. 2. Today, all states have statutory provisions authorizing directors indemnification to some degree 3. Delaware Law a. As to suits by shareholders or third parties, 145(a) authorizes the corporation- a corporation shall have power-to indemnify the director or officer for expenses plus judgments, fines, and amounts paid in settlement of both civil and criminal proceedings 4. Delaware Law: Coverage: a. If the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interest of the corporation b. If the director or officer was held liable o the corporation, he may only be indemnified with court approval 5. Delaware Law: Mandatory versus Permissive Indemnification a. Under 145(c), the corporation must indemnify a director or officer who has been successful on the merits or otherwise b. As for directors and offices who are unsuccessful, check whether indemnification is allowed by 145(a) or (b) c. If so, the corporation may-but need not- indemnify the director or officer. 6. Delaware Law: Advancement of Expenses a. Under 145(e), the corporation may advance expenses to the officer or director provided the latter undertakes to repay any such amount if it turns out he is not entitles to indemnification 7. Delaware law: Indemnification by Agreement a. 145(f) authorizes the corporation to enter into written indemnification agreements with officers and directors that go beyond the statute: statutory indemnification rights "shall not be deemed exclusive of any other rights" 30

VII.

to indemnification created by "bylaw, agreement, vote of the stockholders or disinterested directors or otherwise." iv. Waltuch v. Conticommodity Services, Inc.(del)-Plaintiff was successful on the merits because defendant settled. Section: 145(c) affirmatively requires companies to indemnify officers when the successfully defended themselves. As long as the charges were dismissed, Plaintiff should be considered vindicated. Therefore Plaintiff was entitled to the $1.2 million spent on legal expenses. v. Citadel Holding Corporation v. Roven(del)- Not deciding whether he is entitled to be indemnified, but does the company have to ADVANCE him the litigation expenses. The lawsuit at issue, if he looses, he will not be entitled to indemnification. The contract also says we will advance you but if your not indemnified, you may have to pay it back later. 1. Defendant was required to advance Plaintiff the cost of the legal expenses, and is now responsible for the interest that has accrued. 2. Would he be indemnification if he wins the 16(b)? a. If he is successful on the merits, Citadel MUST pay it. 145(c) b. Doesnt matter what the agreement says, if the director wins, he is indemnified! 3. If you loose in DE, only be indemnified if you acted in good faith PROBLEMS OF CONTROL a. Generally i. How do we get money out of the corporation? 1. Salary 2. Dividends ii. Shareholders (owners) elect directors (oversee on behalf of shareholders) who appoint officers (run the corporation on a day to day basis) b. CONTROL IN CLOSELY-HELD BUSINESS i. Generally 1. A lot routinely do not pay dividends to shareholders 2. Profit=Income-Expenses 3. Close corporation, more heightened fiduciary duties ii. McQuade v. Stoneham-Contract is illegal and void so far as it precludes the board of directors, at the risk of incurring legal ability, from changing officers, salaries, or policies or retaining individuals in office, except by consent of the contacting parties. iii. Clark v. Dodge-The agreement to keep plaintiff as a director with set percentage of profits is valid. The only shareholders were D. and P., and therefore the agreement between the two did not have any, or at least negligible, consequences on the public. 1. If all shareholders agree to this, we dont care 2. McQuade will be controlling when there agreements are between shareholders who do not have 100% ownership of a company. iv. Galler v. Galler- The agreement providing spouses would be elected to board, equal representation on board an annual payout to spouses was valid and Plaintiff should be entitled to specific performance and money that was owed under the agreement. Galler Drug was a closely held corporation, and therefore subject to different circumstances than a shareholder of a large corporation. The court cited a number of prior cases, including Dodge v. Clark, to support the premise that because this agreement did not harm the public and was fair to the parties of the agreement, there is no offense to any public policy concerns. 1. Absence of a objecting minority interest, so it is okay 2. Modern view: Agreements requiring the appointment of particular individuals as officers or employees of the corporation are enforceable, at least for closely held corporations, as long as they are signed by all shareholders (and, perhaps, in 31

situations in which any non-signing minority shareholders cannot or do not object). v. Ramos v. Estrada- The agreement--which said they will vote the way they have previously agreed and Estrada goes to the meeting and defers, therefore violating the agreement. According to the agreement, Estrada must sell back her shares--was valid despite the fact that the corporation at issue was not a close corporation. California close corporation laws allow for such a shareholders voting agreement. This kind of agreement is fine among the shareholders, and were going to enforce it. 1. Put buy/sell agreement in pre-nup for company in case dispute or death c. ABUSE OF CONTROL d. Wilkes v. Springside Nursing Home, Inc.-Shareholders have a duty of loyalty to other shareholders in a close corporation, and in this case the duty owed to Plaintiff by Defendants was violated. Therefore Plaintiff is entitled to lost wages. In close corporations, a minority shareholder can be easily frozen out (depriving the minority of a position in the company) by the majority since there is not a readily available market for their shares. Although this is traditionally an issue of management, the test for close corporations, should be whether the management decision that severely frustrates a minority owner has a legitimate business purpose. In the case at issue, Defendants decision would assure that Plaintiff would never receive a return on the investment while offering no justification. Open to minority stockholders to demonstrate that the same legitimate objective could have been achieved through an alternative course of action less harmful to the minoritys interest. e. Ingle v. Glamore Motor Sales, Inc.-Defendants do no owe Plaintiff a duty to keep Plaintiff indefinitely as an employee as a result of his minority shareholder status. Traditionally, an employee is an at-will employee if he does not have an employment agreement that gives a duration for the employment. This situation does not change when an employee attains shareholder status, especially when there is a provision in the shareholder agreement that allows the majority shareholder to buy back Plaintiffs share if he is terminated for any reason. Plaintiff never asserted that the buyback amount was unfair, and therefore he suffered no harm. f. Brodie v. Jordan-The remedy for freeze-out of a minority shareholder is to restore the
minority shareholder those benefits which she reasonably expected but has not received because of the fiduciary breach. (Expectations of co-ventures) The Superior Court judge abused his discretion by creating a remedy that placed the plaintiff in a significantly better position that she would have enjoyed absent the wrongdoing, and well exceeded her reasonable expectations of benefit from her shares. On remand, the judge may determine Ps reasonable expectations of ownership, money damages for deprivations, injunctive relief to allow her to participate in company governance, and consider the fact that the P has enjoyed no economic benefit from her shares. In this case, the Court assumes liability and the whole discussion regards the proper ,remedy. An understanding that the widow is owed some type up remedy, and the question is what type or remedy upon remand to restore to her, as minority shareholder, the benefits she reasonable expected to receive.

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REVIEW CLASS -Piercing the corporate veil -Equitable doctrine -Unity of interest and ownership (alter ego) -More likely to be a wholly owned company, or one person mostly owns and dominates it -Owner doesnt pay attention to corporate formalities -May treat corporate assets as his own -If you take money out, but then if the company owes money you say its from the corporation, not me. You cant do that -Injustice-if you allow shareholder to be shielded from liability it would be unjust -Just because the corporation doesnt have enough money isnt injustice, youre the cause of the corporation not having money. That is injustice. -Difference between LLC and LLP -LLC -You can do this in every state -More like a corporation (corporation rules) -LLP -May not exist in every state and if they do may not offer full limited liability (maybe only tort) -More like a partnership (partnership rules) -Partnership applies if you start acting like partners -Both -Partnership taxation benefits -Limited liability -Gratuitous Agent -Someone who is not getting paid to be an agent but acts as an agent -Still liable if principal is relying on you

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