Business Entities

Front 1

Corporations law

Back 1

• Corporations law = How you set up business entities, run them, dissolve them
o Fairly narrow area of law (formation, governance, dissolution)
o Largely state law (e.g., Delaware is a popular state of incorporation)
o Involves conflicts between
• Shareholders
• Directors (whom the shareholders elect)
• Managers
• Stakeholders (people impacted by the corporation, e.g., city the corporation is in, employees that are not managers)

Front 2

Corporate Law

Back 2

• Corporate law = Day-to-day operations are governed by regular laws
o Corporation is considered a person
• Can enter into Ks, sue others and be sued / CANNOT vote, marry, serve in military, etc.
o EX: Antitrust, banking, taxation, employment law

Front 3

AGENCY

Back 3

AGENCY

Front 4

Agency

Back 4

• One person (agent) acts on behalf of another (principal)
• Concept central to BA
• All employees, managers are agents of their company
o Tells who/what companies are responsible for
o Company is responsible for what its agents do
• Attorney is an agent of his/her client
• Important because customers want to know who is authorized to do business for a company
• Deciding who is an agent can help determine scope and size of company

Front 5

Gorton v. Doty

Back 5

• Teacher lends car to Coach to drive student to football game w/ explicit instructions not to let a student drive it
• Coach crashes the car and dies, and student (Gorton) is badly hurt
• Student sues teacher and wins
• Coach = Teacher’s agent, so she is liable for injuries caused by Coach

Front 6

Gorton Three Factor Test to Determine Who is an Agent (Sec. 1.01 of Rest. of Agency)

Back 6

Principal manifests assent that the agent shall act:
1. On P’s behalf
2. Subject to P’s control
3. Agent manifests assent / otherwise consents so to act

Front 7

Sec. 1.02:

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• If 3 elements in 1.01 are met, you are an agent
• Cannot just say you are an agent

Front 8

Sec. 1.03: Manifestation of assent

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• Can manifest assent through written words, spoken words, or other conduct
o Note: A lot of cases are about manifestation of assent
• Cmt. b re: Assent
o Conduct observable by others that expresses meaning
o Broader than concept of communication
o Relevant state of mind is that of a person who observes / otherwise learns of manifestation

Front 9

Sec. 1.04(1): Co-agency

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• Co-agents have agency relationships w/ the same principal
• Principal can have one or more agents (e.g., hire two people)

Front 10

Sec. 1.04(8): Sub-agency

Back 10

• Principal can give agent the authority to hire other agents
• Cmt. h: Sub-agent has 2 principals – the appointing agent and the principal while co-agents have
one common principal

Front 11

Sec. 1.04(9): Superior and subordinate co-agents

Back 11

• Superior co-agent can tell a subordinate co-agent what to do if principal says so

Front 12

Sec. 1.04(2): Disclosed, undisclosed, and unidentified principals

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• Disclosed: 3rd party knows A is acting for P and knows who that P is
• Undisclosed: 3rd party doesn’t know A is acting on someone’s behalf / 3rd party probably thinks
A is just doing his own thing
• Unidentified: 3rd party knows A is acting for someone, but doesn’t know the identity of P

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Key to agency is CONTROL

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When a company has control, it is more likely to be liable
• One part of the Gorton 3 factor test is P’s control of A

Front 14

A. Gay Jenson Farms v. Cargill

Back 14

• Warren sold seed to farmers and stored / bought grain farmers produced
• Warren sold grain to Cargill and got financing from Cargill (makes Warren Cargill’s agent)
• Cargill lends more $$ to Warren, which means Cargill’s power over Warren increases
o Eventually Warren is shipping 90% of grain to Cargill
• 1970s: Warren’s business is in trouble, so Cargill increases its supervision of him
• 1977: Warren owes millions to Cargill and farmers
• Warren’s records were falsified and Cargill sends an official to control Warren’s funds because he is going under
• Warren fails and farmers sue Cargill and win
• Cargill had gradually (w/o intending) made Warren its agent and was therefore responsible for Warren’s debts

Front 15

Sec. 101, cmt. f – control

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• Control means that P initially tells A what to do or not to do in specific or general terms
• A must have the right to control P

Front 16

Sec. 101, cmt. g – “on behalf of”

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• A consents to do the work that the employer directs and to do it subject to the employer's instructions
• Actions “on behalf of” a principal do not necessarily entail that the principal will benefit as a result
• If a company hires someone, it wants to control what that person does
o BUT more control means more liability for what the agent does

Front 17

CATEGORIES OF AGENCY
Three parties involved:

Back 17

Principal, Agent, Third party

Front 18

Actual Authority (2 kinds)

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P gave actual authority to A / A reasonably believes he is acting for P
• P manifests consent to A to bind P
• P has stated the actual authority in very specific or detailed language
• Focus on perspective of A and P

Front 19

Section 2.02: Scope of actual authority

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o A can do acts designated or implied and any acts incidental to achieving P’s objectives
o A’s interpretation of what P would want him to do

Front 20

Actual Express (2.01)

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Explicit words or conduct / Actual authority that P has stated in very specific or detailed language
EX: Apple Board of Directors (P) authorizes Steve Jobs (A) to negotiate a contract w/ Jordy Nelson (3rd party)

Front 21

Actual Implied (2.01)

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Grows out of words or conduct taken in the context of the P and A relationship
• Cmt b: Two types of implied authority:
o A does what is necessary, usual, and proper to accomplish or perform A’s express responsibilities, OR
o A acts in a manner he reasonably believes P wishes him to act
EX: Steve Jobs (A) flies to Green Bay to meet Nelson (3rd party) and charges his ticket and car rental to Apple (P)
o When Apple told him to go make the deal, it was reasonable to assume he had to get there somehow

Front 22

Apparent (2.03)

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3rd party reasonably believes A has authority to act on behalf of P
• P has done something that makes 3rd parties think A has authority
o 3rd party has relied on what A was doing, so he/she is in need of protection
• Focus on perspective of the 3rd party
o Note: A LOT of agency is for the protection of third parties
• Can be created by written / spoken words or by any other conduct

Front 23

Inherent Agency Power (liability of undisclosed principal) [1 of 2]

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• Confusing / Somewhat of a catch-all provision to protect 3rd parties
o Usually 3rd party has no way of knowing that P would not be liable
• Ps can be liable for some acts of their As which, while unauthorized, are close to or incidental to that which they are authorized to do
o No actual or apparent authority
• Probably the only scenario in which this would occur is a “secret sale”

Front 24

Inherent Agency Power (liability of undisclosed principal) [2 of 2]

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• Does not appear in 3rd Rest.
o Replaced w/ “liability of undisclosed principal” in 2.06 (P is liable to 3rd party even if 3rd party doesn’t know A is acting on someone’s behalf)
• 3rd party must be justifiably induced to make a detrimental change in position
• Agent acting on P’s behalf w/o actual authority of P
• P had notice of A’s conduct and did not take reasonable steps to notify 3rd parties of the facts
• Cmt. c: Relatively small number of cases in which this type of agency occurs
• 2.06(2): P cannot rely on defense of limiting A’s authority / Cannot limit A from
doing something he is reasonably likely to do
(e.g., cannot tell A to buy bar supplies, but only certain ones)

Front 25

Watteau v. Fenwick [1 of 2]

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• Watteau and others bought a hotel (beerhouse) from Humble, but kept the sale a secret
o Appeared to everyone that Humble was still the owner
• W and others told Humble to buy everything from them except beer and water
• Humble disobeyed and bought cigars and Bovril (liquefied beef extract) from Fenwick (other supplier)
• Eventually Humble goes away and cigar and Bovril suppliers sue Watteau and others because they are owed money
• Fenwick and other suppliers win
• Humble did not have actual authority or apparent authority
o Court basically invented inherent agency power in order to do justice and protect 3rd parties (they deserve to get paid)

Front 26

Watteau v. Fenwick [2 of 2]

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• Basic idea that undisclosed P is liable for debts incurred by A when acting within the scope of authority (is it something P would assume A would do?)
• Policy considerations:
o 3rd party ends up w/ more than it bargained for / had any reason to expect
• P has a deeper set of pockets than A
o Undisclosed P should not gain from the endeavor w/o exposure to the loss since he concealed his existence
o Undisclosed P is also in the best position to avoid the loss
EX: Westbrook (A) secretly sells advertising firm to Pete (P), but Westbrook stays on and continues to run it. Pete tells Westbrook not to contract w/ KU (3rd party), but Westbrook does. P is bound to KU. (Note: P can still sue A)

Front 27

Ratification (OK after the fact) (4.01) [1 of 2]

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A did not necessarily have the authority to bind P, but
afterward, P ratified the act and therefore, became obligated
• Creates an agency relationship regardless of whether such a relationship existed at the time of the act
• Ratification relates back so it is as if A had the authority to bind P before the unauthorized act
o 4.02: Effect of ratification
• Retroactively creates the effect of actual authority
• NOT effective if:
o Trick someone / Misrepresentation or other conduct by A that would make the contract voidable
o P ratifies to avoid a loss
o Diminishes rights or interests of persons (not parties to transaction) that were acquired in the subject matter prior to ratification

Front 28

Ratification (OK after the fact) (4.01) [2 of 2]

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• Ratification can be inferred from acts, words, conduct of P (e.g., not objecting) showing an intention to ratify and need not be made to A or the third party
o 4.01(2) Ratification can be accomplished by:
• Manifestation of assent that the act shall affect the person’s legal relations
• Conduct that justifies a reasonable assumption of consent
• Better for third parties if P ratifies the act
EX: Westbrook (A) negotiates a contract on behalf of Nelson (P) w/ Apple (3rd party). Westbrook sends it to Nelson, and Nelson contacts either Westbrook or Apple and says he likes it.

Front 29

CONTRACT IMPLICATIONS OF AGENCY (Ch. 6 of Rest. 3rd of Agency)

Back 29

• Power of As to contract on Ps’ behalf
• 6.01 to 6.03 explain most of the cases, but liability of undisclosed P (inherent agency power) fills a gap in which 3rd party does not know P exists
• It matters whether a business (P) is bound by contract when its A makes a contract

Front 30

6.01: Agent for disclosed P and A has actual or apparent authority

Back 30

o P and 3rd party are bound
o A is NOT bound unless A and 3rd party agree otherwise

Front 31

6.02: Agent for unidentified P and A has actual or apparent authority

Back 31

o P and 3rd party are bound
o A IS a party unless A and 3rd party agree otherwise

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6.03: Agent for undisclosed P and A has actual authority

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o Unless excluded by the contract, P is a party to the contract
o A and 3rd party are all parties to the contract
o P (if a party to the K) and 3rd party have the same rights, liabilities, and defenses as if P made the contract personally

Front 33

TORT IMPLICATIONS OF AGENCY (Ch. 7 of Rest. 3rd of Agency)

Back 33

• Even if P is liable, A is also liable
o Different from P’s liability in contract because whether A is liable depends on the type of authority A has at the time of the making of the contract
• 3rd Rest. terminology change
o Master → Employer
o Servant → Employee (Note: Not always going to be an employee)
o Independent Contractor → Non-employee agent

Front 34

Tort Liability of Principal

Back 34

Two types: vicarious liability and direct liability

Front 35

Vicarious liability [7.03(2)]

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• Requires no fault on the part of P
• P is vicariously liable to a 3rd party harmed by A’s conduct when:
(1) A is an employee
(2) A is acting within the scope of employment (7.07 respondeat superior rule)
OR
(3) A commits a tort while acting w/ apparent authority in dealing w/ a 3rd party on behalf of P
• Further expansion of P’s vicarious liability based on reasonable expectations of third parties

Front 36

Vicarious Liability: 1st prong: A must be an employee

Back 36

• P controls or has the right to control manner and means of A’s performance of work
o Right to control is enough, even if an employer does not exercise the right
o Distinguishes employees from non-employee agents (independent contractors)
o Factual question
• Employee agent (servant)
o EX: Worker at the GAP; gas station franchise owner (debatable)
• Non-employee agent (independent contractor)
o EX: Real-estate broker; gas station franchise owner (debatable)
• Non-agent
o EX: Contractor; taxi driver

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Vicarious Liability: 2nd prong: A acted within the scope of employment

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• What was A doing when the tort occurred?
o Performing work assigned by employer
o Subject to employer’s control
o NOT independent course of conduct not intended to serve employer

Front 38

Bushey & Sons, Inc. v. U.S., 2d Cir. [1 of 2]

Back 38

• Coast Guard vessel in dry dock in need of repair
• Bushey owns the dry dock
• All seamen are told to remain on-board, but they can come and go
• Lane (a seaman) leaves and comes back wasted
o He turns the wheels on the dry dock wall, opens the intake valve, sinks the ship, and breaks half of the dry dock
• Bushey sues the U.S. and the U.S. argues that Lane’s actions were outside of the scope of employment

Front 39

Bushey & Sons, Inc. v. U.S., 2d Cir. [2 of 2]

Back 39

• Judge disagrees and establishes a broad “scope of employment” test
o “A business enterprise cannot disclaim responsibility for accidents which may fairly be said to be characteristic of its activities”
o Abolished “purpose / intent to serve” test (why A committed the actions)
o Established “characteristic of risk” test and the idea of foreseeability
• Some harm is foreseeable, even if the particular type of harm was unforeseeable
• Tort is generally foreseeable consequence of the enterprise undertaken by the employer or is incident to it
• Employee’s conduct is not so unusual or startling that it seems unfair to include the loss resulting from it in the employer’s business costs

Front 40

Direct liability (less important) [7.03(1)] [1 of 2]

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• Generally involves fault on the part of P
• Usually involves non-employee agents (independent contractors)
• 7.03(1): A principal is subject to direct liability to a 3rd party harmed by an agent’s conduct when:
(1) A acts w/ actual authority OR P ratifies A’s conduct, and
• A’s conduct is tortious, OR
• A’s conduct, if that of P’s, would subject P to tort liability
***Basically, P who retains control over the aspect of the activity in which a tort occurs is liable
EX: P hires A to deliver newspapers for him and directs A to deliver papers in the midst of a terrible ice storm when both know that driving conditions are hazardous. A skids on an icy road and injures T. P is subject to liability to T because P directed A to act in a negligent manner.

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Direct liability (less important) [7.03(1)] [2 of 2]

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(2) P is negligent in selecting, supervising, or otherwise controlling A, OR
• Covers situations in which P hires an incompetent contractor
(3) P delegates performance of a duty to use care to protect other persons or their property
to A, who fails to perform the duty
• All of these cases are about ultrahazardous activities
• Company wants to do something dangerous, so it hires someone to do it
• Ultrahazardous or inherently dangerous activity is NON-DELEGABLE
• Usually a non-employee agent because P lacks the control needed for vicarious liability

Front 42

Ira S. Bushey and Sons, Inc. v. US

Back 42

• Drunken sailor case. He was drunk and decided to open the valves that controlled the flooding of the tanks on one side of the drydock.
• An employer is still vicariously liable for an employee’s negligent acts even if an employee’s conduct is not motivated by serving the interests of his employer, if the employee’s conduct was reasonably foreseeable and within the scope of his employment.

Front 43

Majestic Realty Associates, Inc. v. Toti Contracting, 1959

Back 43

• Wrecking ball case
• Patterson, N.J. parking authority hired Toti to demolish a building, but Toti’s employee accidentally demolished half of Majestic’s building
• Reason the case went to court: Question of whether Majestic can sue Toti or Patterson parking authority
• Court said parking authority was liable in tort for Toti employee’s actions even though Toti is an independent contractor

Front 44

Torts vs. Contracts

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• Contracts: A is not automatically liable unless there is an unidentified P
o A who makes a contract is not a party to the contract and is not liable for the contract unless A and the 3rd party agree otherwise
• Torts: A is liable regardless of his or her authority
o 7.01: Unless an applicable statute provides otherwise, an actor remains subject to liability even though he acts as an agent or an employee, w/ actual or apparent authority, or within the scope of employment
• Exception: Federal Tort Claims Act – Limits actions against gov’t employees if the activity was within the scope of their employment

Front 45

DUTIES OF A’s AND P’s TO EACH OTHER

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• There are fiduciary obligations when A is acting on behalf of P
• Duties of P to A are less important

Front 46

A’s Duties to P: General Fiduciary Principal (8.01)

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A has a fiduciary duty to act loyally for P’s benefit in all matters connected w/ the agency relationship
• All A’s owe their P’s a duty of loyalty
• A may not put his own interests / the interests of a 3rd party ahead of P’s interests
EX: A receives payment (e.g., tip, kickback, bribe) from a 3rd party in connection w/ some transaction between P and the 3rd party → Breach of duty of loyalty
• Fiduciary duty = Duty of utmost good faith, trust, confidence, and candor owed by the fiduciary to the beneficiary
o Duty to act w/ the highest degree of honesty and loyalty toward another person and in the best interests of the other person

Front 47

A’s Duties to P: Duties of Loyalty: 8.02: Material benefit arising out of position

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o Duty not to acquire a material benefit from a 3rd party in connection w/ transactions on behalf of P or through use of A’s position
o Cmt: By getting something extra, you take away from P / If anyone should benefit from a turn of good fortune, it should be P
EX: P owns a racehorse and hires A and pays him $500 to ride the horse in a race. A 3rd party offers A $5,000 if he wins the race, but neither tells P. A rides the horse, wins, and gets the $5,000 from the 3rd party → A breached his duty to P (Note: 3rd party is also liable)

Front 48

A’s Duties to P: 8.03: Acting as or on behalf of an adverse party

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o Duty not to deal w/ P as or on behalf of an adverse party in a transaction connected w/ the agency relationship
o Cannot be on both sides of a transaction
o Conflict of interest
EX: P hires A to sell a house and A sells house to himself secretly. Even if A pays full price, he breaches a duty to P. A should disclose it and get P’s consent.

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A’s Duties to P: 8.04: Competition

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o A should refrain from competing w/ P or assisting P’s competitors throughout the duration of the agency relationship BUT A may take action (not otherwise wrongful) to prepare for competition following the termination of the relationship

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A’s Duties to P: 8.05: Use of principal’s property / Use of confidential information

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A has a duty:
o Not to use P’s property for A’s own purposes or those of a 3rd party
o Not to use or communicate P’s confidential information for A’s own purposes or those of a 3rd party
• Overlap w/ trade secret law
• Includes information w/o commercial or economic value that A gets in the course of the agency relationship
• Not an absolute duty of confidentiality
o A may reveal information to protect a superior interest of A or 3rd parties (e.g., law enforcement)
o EX: Joe works for Custom Cupcakes as a consultant and manufacturer representative. A customer calls and wants one million cupcakes, but Joe knows Custom cannot fill the order. Joe takes the job, sends it to other shops, and gets commission ($50,000 in profits). Custom can sue Joe and win even though they couldn’t have made all of the cupcakes
→ Material benefit arising out of position AND competition

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Remedy for violation of a duty:

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o Disgorgement (pay money back)
o Absence of loss to P
o May be a windfall
o Prophylactic rule
o Constrain the conflict of interest inherent in secret profit transactions

Front 52

8.06: Principal’s consent

Back 52

o P’s consent will take care of a breach of duty under 8.01 – 8.05 AS LONG AS:
• In obtaining P’s consent, A:
o Acts in good faith
o Discloses all material facts that A has reason to know / should know would reasonably affect P’s judgment, AND
o Otherwise deals fairly w/ P
• P’s consent concerns either a specific act(s) / transaction(s) of a specified type that could reasonably be expected to occur in the ordinary course of the agency relationship

Front 53

8.07: Duty created by contract

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A has a duty to act in accordance w/ the express and implied terms of any K between A and P

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8.08: Duties of care, competence & diligence

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o Subject to any agreement w/ P, A has a duty to act w/ care, competence, and diligence normally exercised by As in similar circumstances
o Should take into account A’s special skills or knowledge in determining whether A acted w/ care, competence and diligence
• If special skills or knowledge, duty is higher
• Have to act w/ such care, competence normally exercised by agents w/ such special skills or knowledge
o Does not matter if A lies about special skills or knowledge UNLESS A can show that P knew A was lying

Front 55

8.09: Duty to act only within the scope of actual authority & to comply w/ P’s lawful instructions

Back 55

o A has a duty to act within scope of actual authority
o A has a duty to comply w/ all of P’s lawful instructions
o Basically, A must obey all reasonable instructions of P, unless they are illegal
EX: A, a real estate broker, does not have to comply w/ P’s instructions to discriminate based on race when showing P’s property

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8.10: Duty of good conduct

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o Duty to act reasonably (within the scope of the relationship) and refrain from conduct likely to damage P’s enterprise
o A should not ruin P’s reputation
EX: A should not make disparaging remarks about the quality of P’s merchandise at a social function

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8.11: Duty to provide information (A.K.A Duty of full disclosure)

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o A must use reasonable effort to provide P w/ facts that A knows / has reason to know / should know when:
• A knows / has reason to know that P would want to have the facts OR the facts are material to A’s duty to P, AND
• Facts can be provided to P w/o violating superior duty owed by A to another person
o Superior duty = e.g., law enforcement order
o Duty to inform P of all facts relevant to a transaction that A reasonably believes P would want to know
o Overlaps w/ duty of care and duty of loyalty

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8.12: Duties re: P’s property – Segregation, recordkeeping & accounting

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o Duties (subject to any agreement w/ P):
• To NOT deal w/ P’s property so that it appears to be A’s property
• To NOT mingle P’s property w/ anyone else’s, AND
• To keep and render accounts to P of $$ / other property received / paid out of P’s account
o Duty to account for money / property received as A for P

Front 59

P’s Duties to A

Back 59

• Shorter and less important

Front 60

8.13: Duty created by contract

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P has a duty to act in accordance w/ the express and implied terms of any K between P and A

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8.14: Duty to indemnify

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o Duty to indemnify A:
• In accordance w/ terms of a K between them, AND
• Unless otherwise agreed . . .
o When A makes a payment
• Within the scope of A’s actual authority
• That is beneficial to P, unless A acts officiously in making the payment
o When A suffers a loss that fairly should be borne by P in light of their relationship

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8.15: Duty to deal fairly & in good faith

Back 62

o P has a duty to deal w/ A fairly and in good faith
o Includes duty to provide A w/ information re: risks of physical harm or pecuniary loss that P knows / has reason to know / should know are present in A’s work but are unknown to A

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PARTNERSHIPS

Back 63

PARTNERSHIPS

Front 64

Partnership

Back 64

Voluntary association of 2 or more people who jointly own and carry on a business for profit
• Traditionally, a partnership if the people agree to share proportionally in the business’s profits / losses [RUPA § 101]
o Can set up w/o intending to set it up
o A lot of cases about whether there in fact was a partnership
• Partners are agents of each other
• Each partner is an agent of the partnership for the purpose of its business

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Types of Partnerships

Back 65

General Partnership: All partners participate fully in losses even though monetary contributions may vary
• Bare bones
• All partners are liable for something one partner does → Very risky

Limited Partnership: Partnership made up of:
• General partner(s): 1 or more persons who control the business and are personally liable for partnership’s debts, AND
• Limited partner(s): 1 or more persons who contribute capital and share profits but who cannot manage the business and are liable ONLY for the amount of their contribution
• Partners can be humans or entities (e.g., corporations)

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Partnerships vs. Corporations: Taxation

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o Partnership: All partners are taxed for their share of profits on their own individual tax
returns
o Corporation: “Double taxation”
• Shareholders are taxed individually on dividends, shares
• Corporation is taxed at an entity level

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Partnerships vs. Corporations: Liability

Back 67

o Types of entities:
• Sole prop.
• Agency
• Partnership
o Comes early on in the spectrum because it is more flexible and a lot of companies grow out of this
• LLC (partnership + corporation) and Other hybrids
• Corporation
o Think about the difference between the types of entities
• Liability vs. control
o Corporation = less liability, but also less control
• Shareholders are only liable for what they put in
• Corporation as an entity is responsible for its own debts

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Partnerships vs. Corporations: Transferability

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o Cannot just give your partnership interest (limitations on who can fill your shoes)
o Corporation: Can buy / sell shares of stock fairly easily

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Partnerships vs. Corporations: Life

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o Corporation: Indefinite life
o Partnership: Can arrange whether the business will continue upon the leaving / death of a partner (not an indefinite life)

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Partnerships vs. Corporations: Flexibility (How business is run, what kind of records are kept)

Back 70

o Partnerships have an advantage here
o Corporations have a lot more details to worry about it

Front 71

Partnerships vs. Corporations: Centralized Management

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o Characteristic of a corporation
• Shareholders elect directors, who then appoint managers
• Managers make decisions about day-to-day operations
• Shareholders have indirect control
• Separation of ownership and control

Front 72

Partnerships vs. Corporations: Expenses

Back 72

o A lot of added costs w/ a corporation (taxation, centralized management, many details to worry about re: recordkeeping)

Front 73

Sources of Partnership Law

Back 73

• NCCUSL
• Uniform Partnership Act (UPA)
• Revised Uniform Partnership Act (RUPA)
o Adopted by 2/3 of states, including KS
• Can only sue under the KS law that largely draws on RUPA
o Other states use UPA
• Also some federal law
Note: Restatement is NOT the law / It is the black-letter law that people who put it together think exists

Front 74

RUPA § 101(6)

Back 74

Partnership is an association of 2 or more persons to carry on as co-owners of a business for profit

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PARTNERSHIP FORMATION

Back 75

PARTNERSHIP FORMATION

Front 76

RUPA § 202(a): Formation of a Partnership

Back 76

• Association of two or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership
• Subjective intent does not matter so long as you meet the definition of “partnership”
(Sec. 202, cmt. 1)
o Can inadvertently create a partnership despite expressed subjective intent NOT to do so
• All of the duties from agency come in as soon as you form a partnership (extensive list of duties)
NOTE: Need to know if you are in a partnership because you cannot allocate the risk!!

Front 77

RUPA § 202(c): 3 Rules to Determine Whether a Partnership Was Formed [1 of 2]

Back 77

Joint tenancy, tenancy in common, common property, etc. DO NOT by itself establish a partnership
2. Sharing of gross returns DOES NOT by itself establish a partnership, even if persons sharing them have a joint / common right or interest in property from which returns are derived
3. Protected categories / A person receiving a share of profits from a business creates a rebuttable presumption that the person is a partner UNLESS profits were received in payment of / for:
o Debt
o Employee / Independent contractor wages
o Rent
o Annuity / Retirement or health benefit
o Interest / Other charges on a loan
o Sale of goodwill of business / other property
Note: If you meet one of these categories, you rebut the presumption and then the burden is on the other side to show it was a partnership

Front 78

RUPA § 202(c): 3 Rules to Determine Whether a Partnership Was Formed [2 of 2]

Back 78

• Formation is unclear because RUPA does not answer every hypothetical situation
• ALSO . . . a person may function in both partner and non-partner capacities
• Most conflicts are about partnership status (Were they partners or not?)
o Partners (concerned about their own liability) and creditors (concerned about who they can go after for payment) care

Front 79

EX: T and S have a friend named P, a partner in a brokerage firm that is in trouble. T and S lend P $2.5 million in marketable securities. T and S still collect dividends on securities, but get some rights in P’s firm: 40% profits, inspection rights, right to veto transactions. P continues to manage the firm. T and S also get option of 50% equity interest in the firm. T and S get signed resignations from partners to use at will w/ P’s okay (could throw out all partners).

Back 79

• P squanders the loan in foreign exchange markets
• Creditors of P’s firm sue T and S as partners (which makes them personally liable)
• Are T and S partners of the firm?
o Court held: NOT a partnership / Looked at right of control
• Had negative control such as the right to veto
• No positive control such as the right to initiate
• So...they were more like creditors than partners
o Not only were they not liable, but P’s firm owed them $2.5 million as well
o VERY CLOSE case

Front 80

What is a Partnership? (Aggregate Theory)

Back 80

Partnership is an aggregate of persons acting w/ a common purpose, sharing profits / losses and holding partnership assets in joint ownership
o Partnership is only in existence as long as A, B, and C (exact aggregate of P’s) are the partners
o If a new partner joins / old partner leaves or dies, the partnership dissolves and a new one is created
o Could be messy because the partnership must do something every time a partner changes

Front 81

What is a Partnership? (Entity Theory)

Back 81

Partnership is an entity distinct from its partners
• Partners can change, but the partnership still exists
• RUPA (Sec. 201) calls this the “dominant model”

Front 82

PARTNERSHIP PROPERTY

Back 82

PARTNERSHIP PROPERTY

Front 83

RUPA § 203: Partnership Property

Back 83

Property acquired by the partnership is property of the partnership and not of the partners individually

Front 84

3 ways property can be partnership property

Back 84

1. RUPA § 204(a): Property is partnership property if acquired in the name of:
o The partnership, OR
o 1 or more partners w/ an indication in the instrument of the person’s capacity as a partner / existence of a partnership (name of partnership not required)
2. RUPA § 204(b): Property is acquired in the name of a partnership by a transfer to:
o The partnership in its name, OR
o 1 or more partners in their capacity as partners IF the name of the partnership is indicated on the instrument transferring title
3. RUPA § 204(c): Property is presumed partnership property if purchased w/ partnership assets, even if NOT acquired in the name of the partnership or 1 or more partners w/ indication of partnership on the instrument

Front 85

Meinhard v. Salmon

Back 85

• Salmon and Meinhard are partners
o Meinhard = contributed the capital ($100,000)
o Salmon = contributed $100,000 and manages the property
o Agree to split the profits (60/40 at first, then 50/50)
• Salmon gets a 20-year lease on Hotel Bristol and wants to renovate it for $200,000
• The pair begin making money
• 20 years later, new owner (lessor) wants to create a larger project
o Lessor approaches Salmon about the new project
o Salmon (through new corporation he owns) takes the new lease and doesn’t tell Meinhard about the new deal
• Meinhard sues for being cut out of the deal
o Felt that Salmon had violated a fiduciary duty to him
• Issue: Whether Salmon had a duty to disclose the new project to Meinhard so that Meinhard could
compete for the project himself?
• Meinhard won
o Court said that Salmon breached a fiduciary duty of loyalty to Meinhard (co-adventurer)
o Salmon should have shared the business opportunity w/ Meinhard since it arose from their initial venture
• Meinhard should have had the same opportunity to compete since he was involved in the venture
o Salmon only got the opportunity as a result of his agency / Salmon appeared to be the owner because he was the contact person
• Dissent (Andrews)
o No general partnership, but a joint venture for a fixed period of time w/ no renewal
o Salmon did all he had to when he distributed profits to Meinhard up until the end of the venture

Front 86

POINT of the case (Meinhard v. Salmon)

Back 86

Duties that accompany the business relationship are really strict
• A firm’s success depends on intelligent planning!!
• Salmon and Meinhard had nothing in place re: what would happen if more opportunities came along / what would happen when the venture came to an end

Front 87

RUPA 404(a): General standards of a partner’s conduct

Back 87

The only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care
• 404(d): Obligation of good faith and fair dealing
• 404(e): Just because something furthers a partner’s own interest does not necessarily mean it is a violation

Front 88

Duty of loyalty [404(b)]

Back 88

• Account to partnership / Hold as trustee for it any property, profit, benefit derived by the partner in:
o Conduct and winding up of partnership
o Use of partnership property by the partner, including appropriation of a partnership opportunity
→ Would resolve Meinhard v. Salmon today
• Refrain from dealing w/ the partnership as / on behalf of an adverse party
• Refrain from competing w/ the partnership in the conduct of the partnership business before dissolution of the partnership

Front 89

Duty of care [404(c)]

Back 89

Refrain from gross negligence, reckless conduct, intentional misconduct, and knowing violation of the law

Front 90

Partnership Opportunity (not defined in RUPA)

Back 90

• If a transaction is NOT a partnership opportunity, no liability attaches to its taking
• If a transaction IS a partnership opportunity
o Disclosure alone is insufficient
o Other partner’s consent is required for its taking

Front 91

PARTNERSHIP LIABILITY

Back 91

PARTNERSHIP LIABILITY

Front 92

PARTNERSHIP LIABILITY

Back 92

• A lot is about risk / who bears the risk / who will get in trouble
• Partnership is liable for partners’ actions
• All partners are jointly and severally liable for all partnership obligations

Front 93

RUPA § 305: Partnership liable for partner’s actionable conduct

Back 93

• Partnership is liable for loss / injury to another or penalty incurred as a result of wrongful act / omission or other actionable conduct of a partner
o Acting in the ordinary course of business of the partnership, OR
• Ordinary course of business = Similar to “scope of employment” in agency
EX: A partner making disparaging remarks at a cocktail party is NOT in the ordinary course of business
o With the authority of the partnership

Front 94

RUPA § 306: Partner liability

Back 94

All partners are jointly and severally liable for ALL obligations of the partnership UNLESS otherwise agreed or provided by law
o “Unless otherwise agreed” is very common in business / Default rules which can be altered

Front 95

PARTNERSHIP OPERATIONS

Back 95

PARTNERSHIP OPERATIONS

Front 96

Organization of Money [401(a)]

Back 96

• Each partner contributes something and has his own account
o ADD contributions / share of profits
o SUBTRACT money distributed out to him / losses
• Profits / losses are proportional to how the partnership is set up

Front 97

Managing the Partnership [401(f)]

Back 97

• Each partner has a right to manage
• Ordinary decisions require a majority vote
• Some decisions MUST be unanimous (e.g., adding a new member; amending partnership agreement)

Front 98

Partnership Dissolution

Back 98

• What happens when things go wrong
• Often happens when partners disagree or there is not enough $$ to go around

Front 99

Dissociation

Back 99

Shedding a partner (e.g., A leaves partnership between A, B, and C)
• UPA (aggregate theory): A change means dissolving the partnership
• RUPA (entity theory [majority]): Can shed a partner w/o starting over
o RUPA substitutes dissociation for some of the situations that would result in dissolution under UPA
o RUPA entity theory reduces number of situations in which you have to dissolve the partnership

Front 100

Dissolution

Back 100

Partnership goes away completely

Front 101

EX: A, B, and C are partners and B dies. Should the partnership be dissolved?

Back 101

o UPA: Dissolution / Partnership is gone and remaining partners must re-form
o RUPA (majority): Dissociation / B’s estate is entitled to be paid for his interest (a kind of buyout right), but the partnership does not go away

Front 102

RUPA § 601: Events causing a partner’s dissociation

Back 102

• Express will to withdraw
• Event agreed to in the partnership agreement
• Partner’s expulsion by unanimous vote of the other partners [4 reasons]
• Other partners get a judicial determination [3 reasons]
• Partner bankruptcy
• Individual partner death / incapacity

• RUPA: Dissociation of a partner does not necessarily mean dissolution and winding up of partnership
• Dissociated partner remains a partner for some purposes / still has some residual rights, duties, powers, liabilities
o Finish out contracts, etc., but no longer a partner for decision making

Front 103

RUPA § 603: Effect of dissociation

Back 103

• If it results in dissolution, use § 801
o RUPA § 801: Events causing dissolution / winding up of partnership
• At will partnership: Partner expresses will to withdraw
• Partnership for a definite term / particular undertaking:
o Will of the partners (1/2 or all), OR
o Expiration of the term
• Event agreed to in partnership agreement
• Partnership business becomes unlawful
• On partner application, judicial determination that:
o Economic purpose of partnership is likely to be frustrated
o Another partner has engaged in bad conduct related to partnership business which makes it not reasonably practicable to carry on w/ that partner
o It is not reasonably practicable to carry on partnership business in conformity w/ the partnership agreement
• Upon application by transferee of partner’s interest, judicial determination that winding up is equitable
*** Makes sense to dissolve a partnership when it cannot do what it is supposed to do ***
• If NOT, use § 701 (purchase of dissociated partner’s interest)

Front 104

Owen v. Cohen

Back 104

• Two guys enter into an oral agreement to own a bowling alley
• No express term for partnership
• Owen = $7,000 to buy other half of bowling alley which Cohen already owned
o Owen agreed he would be repaid from profits
• Make $$ for 3 ½ months, but Cohen is a super huge jerk
• Partners fight and profits decline
• Owen files for dissolution of partnership and for sale of partnership assets in connection w/ settlement of affairs
o Cohen objected because he did not want to give back Owen’s $7,000
• Court dissolves the partnership based on Cohen’s bad behavior
• Implied term of partnership – time it takes to repay the $7,000 was repaid
o Judge set that aside
o Sell bowling alley and Owen gets his $7,000 from that
• RUPA § 801(5) covers this situation
o Partner application and judicial determination that purpose is reasonably frustrated, not practical to carry on partnership

Front 105

What happens after dissolution?

Back 105

• The law is worried about 3rd parties (§ 804)
• Notice
• Liability
• Settling accounts (§ 807)

Front 106

RUPA § 802: Partnership continues after dissolution

Back 106

• Partnership continues after dissolution for the purpose of winding up the business
• Partnership is terminated when winding up is complete

Front 107

RUPA § 804: Partner’s power to bind partnership AFTER dissolution

Back 107

• A partnership is bound by a partner’s act after dissolution if the act:
o Is appropriate for winding up the partnership business, OR
o Would have bound the party before dissolution, if the other party to the transaction did not have notice of the dissolution

Front 108

RUPA § 807: Settlement of accounts / contributions among partners

Back 108

• Partnership assets must first be used to pay creditors
• Profits / losses are credited / charged to partners’ accounts
o Surplus: Partnership makes a distribution to the partner any amount in excess of his initial
contribution
o Deficit: Partner contributes to the partnership any amount in excess of his initial
contribution
• If the partnership owes money after dissolution, all of the partners are liable for debts
o If a partner won’t pay the debt, it is taken out of the other partners’ accounts (joint and several liability)
o A partner can go after other partners later after having to pay 3rd parties
o Estate of deceased partner is still liable
• Any surplus is divided among the partners
o Not usually a lot of surplus because dissolution is generally due to financial problems

Front 109

Prentiss v. Sheffel [1 of 2]

Back 109

heffel, Iger, and Prentiss buy a shopping center
o S = 42.5%
o I = 42.5
o P = 15
• No partnership agreement re: how it will be managed and how long it will last (at will partnership)
o Sounds dumb to us, but most people have NO agreement
• S and I do not get along w/ P after awhile and they are mean to him, exclude him from partnership decision-making (2 to 1)
o Known as a “freeze out”
• Shopping center starts losing money
• S and I ask everyone to put in more $$ due to the loss, but make sure it’s too much for P to pay
o P is unable to contribute $6,000 (share of operating deficit)

Front 110

Prentiss v. Sheffel [2 of 2]

Back 110

• S and I sue for dissolution and get it
• Property is sold in an auction and S and I buy it
o P claims he was wrongfully excluded from partnership management
o Also claims that S and I should not be allowed to buy the partnership assets since they forced the sale
• Court disagrees and says that P was excluded because they couldn’t get along, not because of a diabolical plan to get the partnership assets
• P was not injured by the sale to S and I
o In fact, P ended up getting more money than he should have because S and I were the highest bid
• Nothing keeps a partner from bidding at a judicial sale of partnership assets, unless that partner did something wrong

• Reality is that 3 partner structure in which 2 don’t get along with the last is common (freeze out)
• The 2 majority partners are allowed to purchase assets in a subsequent judicial sale so long as exclusion of third partner was not done for a wrongful purpose and where the minority partner failed to demonstrate injury

Front 111

Example: A, B, and C find C uninformed, not helpful, just don’t like him. A and B do not want to discuss anything with C at all and they can just out vote C, so they don’t think it even matters. Can A and B do this?

Back 111

• Not a good idea
• All partners are entitled to participate in decision-making process
• Sec. 401(f): Each partner has equal rights in management / conduct of partnership business
• A better idea: Invite C to the meeting, talk about decision, and then A and B outvote C
• When A and B completely exclude C, they have violated C’s rights and might be liable
o Not clear what damages would be
o C will eventually tire of attending meetings

Front 112

Example: A, B, and C are partners and own a shopping center in a partnership at will. A and B get along, but want to buy C out. A and B are willing to pay $700K for C’s interest, but prefer to pay less. A and B think an outsider would pay almost $1.8 million ($600K each)

Back 112

• Prentiss v. Sheffeld rule: Dissolve partnership and insist on an auction, then bid on property
themselves and use interest in partnership as a partial payment
• Rule B: A and B dissolve partnership and insist on an auction, but do not allow them to bid on the
property
A and B offer C $610K for her interest in the partnership...
• Under Prentiss (allowed to bid on it)?
C should accept $610K offer / Otherwise, A and B will bid the $1.8 million (plus some small increment, such as $3) and C will end up w/ $600,001
• Rule B – Not clear what would happen
o Shopping center sold for $1.8 million
o All get $600K, but A and B wanted the shopping center
• Somewhat of a game of chicken

Front 113

NOTE: Think about what you should have to show to dissolve / what should happen to partnership assets

Back 113

• Might be more efficient to let current partners continue as future owners
• Might assume that the current partners aren’t good partners and someone else should have the opportunity to take advantage of the asset

Front 114

General Partnership: Pros

Back 114

o Fair way to organize a partnership (all have a right to manage / say in conduct of partnership)
o Easy to set up (might even do it by accident)
o Flow through tax treatment
• Not taxed at an entity level (like a corporation and double taxation)
• Only partners are taxed on individual tax returns
• Therefore, it is cheaper to have a partnership because less goes to the gov’t

Front 115

General Partnership: Cons

Back 115

o Joint and several liability (partners are liable for each other)
o Management can be tricky (must get along to make partnership work)
• These concerns are addressed by a limited partnership

Front 116

LIMITED PARTNERSHIP

Back 116

LIMITED PARTNERSHIP

Front 117

Limited partnership [1 of 2]

Back 117

Partnership composed of one or more persons who control the business / are personally liable for the partnership’s debts (general partners) and one or more persons who contribute capital / share profits, but who cannot manage the business and are liable only for the amount of their contribution (limited partners)

Front 118

Limited partnership [2 of 2]

Back 118

• Limited partners only liable for contributions
• Hierarchical structure w/ general partners managing and limited partners more passive
• Enables people to invest in a business w/o taking an active part in management and w/o risking more than they contributed
• Secures cooperation of those who have ability and integrity to manage, but insufficient funds

Front 119

Holzman v. de Escamilla (Hacienda Farms) (Limited partners exercising management control)

Back 119

• LLP w/ de Escamilla as the general partner and Russell and Andrews as limited partners
• Partnership went into bankruptcy
• Holzman (trustee) brings action to declare R and A liable as general partners because they took part in control of the business
o A conferred w/ deE about what crops to plant
o R and A went to farm about twice a week and consulted about crops
o Checks needed 2 partner signatures (deE could not write the checks himself)
o A and R asked deE to resign and they replaced him
• Court held R and A were general partners
o Same outcome under RULPA § 303(a)
o HAVE TO BE PASSIVE as a limited partner
• NOT control to write checks, fire someone

Front 120

RULPA § 303(a): Liability to 3rd parties

Back 120

• Limited partner is not liable for the obligations of a limited partnership unless he is also a general partner, OR he participates in the control of the business
• If a limited partner participates in the control of the business, he is liable only to persons who transact business w/ the limited partnership who reasonably believe that, based on the partner’s conduct, that the limited partner is a general partner

Front 121

RULPA § 303(b): Liability to 3rd parties

Back 121

• Limited partner DOES NOT participate in control of the business SOLELY by doing one or more of the following:
o Being a contractor for / agent-employee of the limited partnership / of a general partner
o Being an officer, director, shareholder of a general partner that is a corporation
o Consulting w/ and advising general partner w/ respect to the business of the limited partnership
o Acting as a surety for the limited partnership OR guaranteeing / assuming one or more specific obligations of the limited partnership
o Bringing a derivative action suit as a right of the limited partnership
o Requesting / attending a meeting of partners
o Proposing / approving / disapproving by voting one or more of the following: (list)

Front 122

ULPA § 303: No liability as limited partner for limited partnership obligations

Back 122

• A limited partner is not personally liable (directly or indirectly) for an obligation of the limited partnership, even if the limited partner participates in the management and control of the limited partnership
• Eliminates the “control rule” altogether
o MAIN REASON states don’t like ULPA
o Status-based liability shield no matter what you do
o Reason for change: Thought control rule was too complicated

Front 123

Note: Control is a constant theme in BA

Back 123

• Cargill: Creditor became liable as a principal because it took control
• A person becomes a partner by sharing profits and control

Front 124

Types of Unincorporated Entities

Back 124

• General partnership
• Limited partnership (LP)
• Limited liability company (LLC)
o Very popular these days
• Limited liability partnership (LLP)
• Limited liability limited partnership (LLLP)
o Not very useful
*** In each type, there is a balance of liability and control
NOTE: Don’t get the benefits of such limited liability if you don’t let third parties know that you are entitled to such limited liability

Front 125

LP is one degree away from LLC

Back 125

Referred to as hybrid forms of Business entities because they have some characteristics of general partnerships and some characteristics of corporations
o At least 1 person has to be unlimitedly liable
o Risk losing limited liability if they participate in management / control

Front 126

LLC

Back 126

Not necessarily true that any partners manage the company (could be an outside manager) OR all could manage

Front 127

LLP

Back 127

o Falling off in use / Usually only law firms
o Partner is not liable for a negligent act committed by another partner / an employee (associate) NOT under that partner’s supervision
o Offers some shield against liability for what one partner does

Front 128

LLLP

Back 128

o Similar to a limited partnership
o EXCEPT general partner(s) also enjoy limited liability for debts / obligations
o New / Not available in most states

Front 129

CORPORATION

Back 129

CORPORATION

Front 130

Definition of a corporation

Back 130

• Legal entity (can enter into contracts, sue, be sued, etc.)
• Team of people (shareholders, directors, officers)
• Web of contracts
o Created w/ a bunch of contracts
o Mandatory and default rules for corporations → Some rules can be customized
o Contracts that cannot be unilaterally amended by the legislature
• Investment vehicle (401Ks, stocks, mutual funds)
o People invest in corporations to get a return
• Drama w/ 3 main characters: shareholders, directors, officers)

Front 131

Corporate Actors: Shareholders

Back 131

o Stockholders / Owners of the company
o Contribute capital in exchange for shares (dividend ownership stake in the corporation)
o Elect directors
o Claim on corporate income, but don’t necessarily get that income
• Directors determine whether dividends will be paid
o Get money from profits, but have very limited rights:
• Vote
• Elect directors
• On fundamental transactions (e.g., corporation plans to sell itself)
• Sue (corporation and directors)
• Sell
• Most shareholders do this when they are unhappy
• Problems w/ selling:
o Cheaper
o Most quality conscious participants will sell first
o Large shareholders may be the only ones who have a voice by selling
o Loyalty – Ma continue holding stock even if the company is not doing well
o Presumes a liquid market
• If you are going to sell, there have to be some buyers (e.g., stock market)
• Generally NOT a liquid market in a small, NOT publicly traded company

Front 132

Corporate Actors: Directors

Back 132

o Board of directors that acts collectively
o Elected by shareholders
o Appoint officers who then hire employees
o Manage / supervise the corporation’s business
o Fiduciary duty to act on behalf of the corporation
o Not employees, but employees can be directors (“inside” vs. “outside” directors)
• CEO or CFO can serve as a director
• Advantages to directors who do not have a hand in the business and advantages to those who know the day to day operations

Front 133

Corporate Actors: Officers

Back 133

o Corporate employees chosen by the directors
o EX: CEO, CFO, Executive VP, Secretary, Treasurer
o Not uncommon to want officers and directors to also be shareholders, so they have a stake in the corporation

Front 134

Corporate Actors: Stakeholders

Back 134

o Not actually part of a corporation, but involved w/ the corporation
o EX: Creditors, employees, customers, community, people, institutions
o Impacted by what the company does, but does not have a say in what the company does

Front 135

Corporate Vocabulary: For Profit

Back 135

Established primarily to generate wealth
o Shareholders expect returns – dividends or value increase

Front 136

Corporate Vocabulary: Non-profit

Back 136

Range of purposes – charities, hospitals, universities, etc.
o Not there to generate wealth for shareholders

Front 137

Corporate Vocabulary: Public corporation

Back 137

o Sell shares easily
o Owned by those w/o relationship to the corporation
o Shareholders NOT involved in management
o Most companies are NOT public companies, but the ones that are public are enormous, so they dwarf the close companies in terms of economics

Front 138

Corporate Vocabulary: Close corporation

Back 138

o No ready market for the securities
o Overlap among participants because there are not as many people involved

Front 139

Typical Corporate Characteristics (default)

Back 139

• Most are NOT required characteristics (except for separate entity!)
1. Separate entity
o Separate from managers and investors
o Really the ONLY mandatory characteristic
2. Perpetual existence
3. Shareholder limited liability (limited to amount paid for shares)
o Corporation owns assets of the business and is liable for business debts
4. Centralized management: Ownership vs. control
o Directors and officers run the corporation and shareholders merely elect directors
o Somewhat of a representative democracy
5. Transferability of ownership assets

Front 140

Articles of Incorporation

Back 140

• A.K.A. Certificate of incorporation / Corporate charter
• Filed by those who form the corporation w/ the Secretary of State, corporate division
• Rules of state incorporation statute tell you what has to be filed:
o Name of corporation
o Agent, address for service of process
o # of authorized shares
• Trump corporate bylaws

Front 141

Bylaws

Back 141

• Rules for how the corporation will operate
o Power of directors and officers
o Procedures for electing directors
o Procedures for shareholder meetings
o Shares that will be issued
• Not filed
• Can amend / adjust so long as you do not violate Articles of Incorporation

Front 142

Sources of Corporate Rules

Back 142

• State statutes (vary from state to state)
o Large amount of corporate law is default rules that can be changed by contract, but some are mandatory
o Most famous state statutes = Delaware
• A lot of judicial opinions on corporate law that other states look to
o State corporate statutes can be amended because of Reservation of Rights (MBCA § 1.02)
• States can always change corporate law
• Judicial decisions → Primarily judge-made law
• Privately created rules
• Some tension between state law and federal law
o Increasing federalization of corporations (e.g., Sarbanes-Oxley Act)

Front 143

Internal affairs doctrine

Back 143

• Choice of law rule
• Use the law of the state of incorporation to govern the internal affairs of the corporation
• Leads to shopping around for a corporation-friendly state (inherently shareholder UN-friendly state)
• A court will use the law of the state in which the corporation is incorporated if it is taken to court

Front 144

CORPORATE SECURITIES

Back 144

CORPORATE SECURITIES

Front 145

Two main categories

Back 145

Debt and Equity

Front 146

Debt

Back 146

• Least risky
• Lowest expected return
• Fixed interest payments over a set term
• Debt holders ordinarily play no part in management of a business the way equity holders might

Front 147

Equity

Back 147

• Common shares
o Most risk
o Greater expected return
o Dividends (at board discretion)
o Voting rights
o Residual financial rights to assets
• Preferred shares
o Between debt and common shares
• Less risk than common, but more risk than debt
o Senior right to dividends
• Get before anyone else, but it is still at board discretion
o Priority over common shares if corporation becomes insolvent
• Left over assets go to creditors, then to preferred, then to common
o Typically do not have a right to vote
*** As risk increases, expected return increases

Front 148

Authorized Shares

Back 148

Number of shares that the Articles of Incorporate authorize the corporation to issue
• Might as well put a large number because a corporation is not required to issue that many

Front 149

Issued

Back 149

Number of shares that have actually been sold to investors

Front 150

Outstanding

Back 150

Number of authorized, issued shares that are actually owned by investors
• Issued shares don’t always stay issued → Corporation might buy them back

Front 151

Treasury

Back 151

Shares the corporation has bought back
• Authorized and issued, but not outstanding

Front 152

EX: If XYZ authorizes 100 common shares, and board approves 80 shares, so 80 shares are sold...

Back 152

• Authorized = 100
• Issued = 80
• Outstanding = 80
• 20 authorized, but un-issued

Front 153

If XYZ repurchases 10 of the 80...

Back 153

o Authorized = 100
o Issued = 80
o Outstanding = 70
o Treasury = 10

Front 154

CORPORATE FIDUCIARY DUTIES

Back 154

• Owed by directors and officers to the corporation
• Duty of care: Managers must be attentive and prudent in making decisions
o Bayer v. Beran definition: Must use the same care and judgment he would give to conducting his own affairs
• Duty of loyalty: Managers must put the corporation’s interest ahead of own interests
o Personal transactions of directors w/ the corporation are viewed w/ the most suspicion

Front 155

Business Judgment Rule

Back 155

• Corporate managers have significant discretion in making decisions
• Courts defer to their judgment
• Court presumes director decisions:
1. Are informed
2. Serve a rational business purpose (not waste)
3. Are disinterested
4. Are made independently
• Enormous protection for corporate managers
• Companies lose money all the time, so shareholders shouldn’t be able to sue managers for it unless the behavior was totally out of line

Front 156

Liability for Breach of Duties

Back 156

• Corporate managers who breach their duties can be held liable for losses that they cause
o But who is going to sue them?
• Company should sue them, but it won’t because the managers run the company
• Derivative suit: Shareholders sue on behalf of the company to make the company sue its own managers

Front 157

Shareholder Duties

Back 157

• Not really any
• Controlling shareholders have fiduciary duties to other (minority) shareholders

Front 158

History of Corporate Law

Back 158

• Historically corporations were state-chartered banks or businesses w/ huge capital needs
• Dartmouth: Objected when state tried to amend its charter because it was a corporation
o Marshall described corporate attributes: Separate entity not a part of the state
• Rapid growth in the 1800s and aggregation of corporate wealth and power led to laws to regulate corporate power
o Shareholder derivative suits
o Interstate Commerce Commission
o Sherman Act to combat trusts

Front 159

Modern Corporate Law

Back 159

o Takeovers (80s and 90s) → Borrow money to buy up public shares
• Hostile, if unsolicited
o Leveraged buyout → Borrow $ to buy company and use assets of company as collateral for
the loan
o Sarbanes-Oxley (2002)
• Response to Enron and other companies’ failures
• Federal standards in areas where state law used to control:
o Audit committees
o Corporate officers have to personally certify financials
o Bans loans to directors and execs
o Applies only to “issuers”

Front 160

Modern Actors

Back 160

o Institutional investors (pension funds, insurance companies, endowments)
o Hedge funds: Group of extremely wealthy people / Securities law does not require them
to abide by the same rules as companies w/ smaller time investors (reason:
big investors know the risk and don’t need as much protection
• Limited / wealthy investors
• Less regulated
• Activist
o Successful in pressuring managers to generate high returns for shareholders
• Originally meant to diversify risk

Front 161

State vs. Federal Corporate Law

Back 161

o Tension between federal and state in corporate law
o Federal statutes (banking law, securities law, etc.) govern a lot of corporate behavior, but there is no federal corporate law
o Trend toward more federalization
o States compete for corporations and Delaware wins
• Have corporation-friendly and shareholder-unfriendly rules
• Well-developed and predictable law in Delaware
• Could be somewhat of a race to the bottom (less concerned w/ shareholder rights)

Front 162

ORGANIZATIONAL CHOICES: PARTNERSHIPS, CORPORATIONS & LLCs

Back 162

ORGANIZATIONAL CHOICES: PARTNERSHIPS, CORPORATIONS & LLCs

Front 163

ORGANIZATIONAL CHOICES: PARTNERSHIPS, CORPORATIONS & LLCs

Back 163

• Must look at each partner’s needs / skills / assets and determine which form of business association would be the most ideal
• Happens a lot that one person has all the cash and one person has all the skills

Front 164

Overview of Basic Business Association Forms: General Partnership & Limited Partnership

Back 164

• General: Association of 2 or more people (equal liability)
o LLP = General partnership, but limited liability
• Limited: One general partner and 2 or more limited partners w/ limited liability
o LLLP: All partners have limited liability (might as well make an LLC)

Front 165

Overview of Basic Business Association Forms: Corporation

Back 165

• Common form of business organization which is chartered by the state and given legal rights as an entity separate from its owners
• Centralized management
• Limited shareholder liability (can only lose what you put in)
• Transferability of shares

Front 166

Overview of Basic Business Association Forms: LLC

Back 166

• Owned by members (not called shareholders)
• Could be member-managed (like a partnership) or manager-managed (hire an outside person to manage)
• Hybrid between corporation and partnership
o Limited liability + taxed like a partnership (no entity level taxation)

Front 167

CHARACTERISTICS OF EACH BA FORM

Back 167

• Formation
• Liability
• Management and Control
• Financial Rights
• Continuity and Withdrawal
• Transferability of Interests
• Mergers and Consolidations

Front 168

Formation: GP, Corporation, LLC

Back 168

General partnership
• Do not have to file w/ the state
• Formed by consent (partnership agreement), but can arise inadvertently
EX: June opens a beauty shop and hires Keith. Keith asks for a raise and they agree in writing
that he will share in profits (call it a partnership).
o NOT really a partnership because June controls the business and the two have an employer-employee relationship
o Cannot make something a partnership just by calling it a partnership
Corporation
• Incorporator files Articles of Incorporation w/ the state
o Name of corporation
o # of authorized shares
o Names / addresses of incorporators
• Existence begins when articles are properly filed
LLC
• Also file w/ the state – Articles of Organization
o Name
o Address of registered agent
• Members enter into an operating agreement that sets out members’ rights and duties (usually written)
o Usually written
o Do not have to file agreement

Front 169

Liability: Corporation, GP

Back 169

Corporation
• Limited liability (shareholder can only lose original investment)
• Separate legal entity responsible for its own debt
General partnership
• Partners jointly and severally liable
• Each partner can bind partnership (and other partners)

Front 170

EX: A provides capital and controls day to day operations of custom auto business. A gets a share of profits. B agrees to build C a car but does not. C sues A and A says I’m a “banker,” not a partner

Back 170

A IS a partner because he helps control the business and gets a share of the profits

Front 171

Liability: LP, LLP

Back 171

Limited partnership
• General partner has unlimited liability
• Limited partners have limited liability
o Limited to amount of investment, UNLESS they participate in management (gray area)
LLP
• Entity is liable for all tort and contract obligations in the ordinary course of business
• General partner only liable for his own wrongful or negligent acts (or ones he supervised)
• Basically law firms

Front 172

EX: L and M form an LLP. M litigates a case, but an associate misses a filing deadline.

Back 172

Only LLP liable when client brings a malpractice action, unless M’s supervision was poor.

Front 173

Liability: LLC

Back 173

• All members and managers have limited liability
o Similar to an LP, but better
• Members can participate fully in management, but it does not change their liability
• Like Limited partnership, but better because of unlimited control

Front 174

EX: LLC hired someone to build a restaurant, but business card given to builder had personal information on it and did not identify them as an LLC. They fail to pay builder and are individually liable because they did not make it known they were an LLC

Back 174

The law thinks that people make choices based on the liability of your company (not necessarily true)

Front 175

Management & Control: Corporation and GP

Back 175

Corporation
• Centralized management function
• Board of directors
o Elected by shareholders
o Manages / oversees management of day to day operations
o Appoints managers and corporate officers
o Bad decisions protected by Business Judgment Rule

General partnership
• All partners manage
• Equal voices regardless of capital contributions
o Possible to change it to be proportional to capital contributions

Front 176

Management & Control: LP and LLC

Back 176

Limited partnership
• Limited partners cannot participate w/o forfeiting limited liability

Limited liability company
• Member-managed
o Members have the authority to make management decisions and act as agents of the LLC
• Manager-managed
o Members make only major decisions
o Members are NOT agents
o Managers make decisions and act as agents
• Whoever is the manager is the agent of the LLC
o Managers do not have to be members, but can be

Front 177

EX: GP disagree about property rent increase. 1 P sues the other P for profits lost and tie is resolved by _________.

Back 177

Dissolution

Front 178

Financial Rights: Corporation and GP

Back 178

Corporation
• According to # of shares you own
• Right to dividend IF the board authorizes it
General partnership
• Right to share equally in profits
• Obligated to share business losses in proportion to profit share
EX: A and B form a logging general partnership. A contributes capital and B contributes equipment. When the business loses money, B has to share in (contribute toward) losses.

Front 179

Financial Rights: LP and LLC

Back 179

Limited partnership
• Financial sharing is NOT equal
• Share if profits / distributions according to capital contributions of limited and general partners
• Only GPs have to share in losses, according to capital contribution

Limited liability company
• Vary / Basically do what you want
o Can share profits according to contributions or equally
• Distributions usually have to be approved by all members

Front 180

Continuity & Withdrawal: Corporation, General Partnership, LP, LLC

Back 180

Corporation
• Perpetual existence
• Voluntary dissolution on board recommendation and majority shareholder approval (voting)

General partnership
• Definite term
• At will → Dissolved upon withdrawal of a partner
• EX: A and B are general partners. A wants to end the partnership, sell the assets, and split the
proceeds.
o A has a right to end an at-will general partnership and liquidate the assets, so long as creditors are paid from proceeds

Limited partnership
• Continues after withdrawal of a limited partner
• Only dissolves if general partner withdraws
• Should pick a dissolution date

Limited liability company
• Perpetual

Front 181

Transferability of Interests

Back 181

Corporation
• Freely transferable, but there must be someone to purchase your interest
o Might be more difficult w/ a close corporation → Could be no buyers available /
restrictions on transferability
General partnership
• All partners must consent to the transfer because it is basically the admission of a new partner
• Possible to separate financial interest from governance interest (NOT available in most states)
o Can pledge shares as collateral (financial interest)
o Transferee has no voice in management, but shares in profits
Limited partnership
• Limited partners can transfer financial interest
• Usually need limited / general partner consent for a transferee to assume governance rights
Limited liability company
• Can transfer financial interest, but not governance interest
• Varied

Front 182

Mergers & Consolidations: Corporation, Partnership Combination, LLC

Back 182

Corporation: Merger
• Both corporations’ boards of directors and shareholders must approve it
• File Articles of Merger

Partnership combination
• Merge assets together
• Can break up a partnership and transfer assets to another partnership
EX: A, B, and C are partners in Beachfront Properties w/ two identical condos. Can form AB partnership and Beachfront transfers condo #1 to it. Can then form BC partnership and Beachfront transfers condo #2 to it. Beachfront Properties is then dissolved.

Limited liability company
• Plan of merger adopted by each LLC and filed

• The organizational choice will depend upon what the parties want to accomplish
o Lots of different types of business entities will work
o Sometimes an entity is not even necessary (e.g., loan, ER/EE relationship)
• Should know the difference between general partnership, limited partnership, and LLC
• LLPs / LLLPs are almost never used (just in law firms)
o Will NOT be on the midterm / final

Front 183

Hypotheticals (from worksheet)
Charles does not have time, but has $$
• Some experience in business
B has all the time but no $$
A has some experience and some $$ (middle of the road)

1. C will hire A and B to work for him (B, D, E)

Back 183

• Corporation could work
o C could be a shareholder
o Does not want the equality of a partnership / more centralized management
• Proprietorship (ER/EE)
o Do not always have to create an entity
o Could be cheaper / more appropriate to NOT do it that way
• LLC
o Could elect manager-management

Front 184

2. B owns the business and borrows capital from A and C (B, D, F)

Back 184

• Corporation
• LLC (very flexible)
• Proprietorship (Debtor / Creditor)

Front 185

3. C, B, A will share profits and operate the business together (A, B, D)

Back 185

• Partnership
• Corporation
• LLC
• They need an entity because they plan to share profits
• Don’t want to form a partnership inadvertently and be jointly and severally liable for all business obligations

Front 186

4. C will provide capital / B and A will manage the business. All share profits (A, B, C, D)

Back 186

• Partnership
o Probably the least good choice
o Not equal partners since C is providing all of the capital
• Corporation
• Limited partnership
• LLC

Front 187

5. C will provide all capital, and will manage w/ A and B. C gets ½ of profits (A, B, D)

Back 187

• Partnership
• Corporation
• LLC
o All allow them to distribute the capital and participate in management
o LLC would be member-managed (C is providing capital and managing)

Front 188

6. C, B, and A will provide capital and share in profits, but management goes to C, Jr.
(A, B, D)

Back 188

• Partnership
• Corporation
• LLC (manager-managed)

Front 189

FORMING A CORPORATION

Back 189

• Two sets of rules:
o Model Business Corporations Act (MBCA)
o Delaware General Corporate Law (KS follows Delaware)

• Formation is quite mechanical
o Must file forms, most of which are available online

• People need an attorney to determine:
o Type of entity
o State of incorporation
o Internal structure and rules
o How to handle conflicting interests of the parties

Front 190

MBCA Incorporation: Locally

Back 190

• If operating locally, probably want to incorporate in state in which you operate
o Reduces filing, reporting, tax burdens
o Avoid cost of incorporating in one state and qualifying to do business as a foreign corporation in another state

Front 191

MBCA Incorporation: Nationally

Back 191

• If operating nationally, probably want to incorporate in some place like Delaware
o Expensive filing fees and franchise taxes
o Need Delaware counsel

Front 192

§ 2.01: Incorporation is formally accomplished by an incorporator

Back 192

o Not always someone who is going to be very involved in the business (sometimes it is the attorney)
o Signs / files Articles of Incorporation
o Can have more than one

Front 193

ARTICLES OF INCORPORATION: § 202(a) – Articles MUST include

Back 193

• Name of corporation
o § 4.01(a)(1): Name must include corp., inc., etc.
o § 401(b): Must be a unique name
• # of shares authorized to issue
• Name / address of each incorporator
• Name / address of corporation’s registered office
o § 5.01(1): Must continuously maintain a registered office in the state / Does not have to be
the same as PPOB
• Name / address of corporation’s registered agent
o § 5.01(2): Registered agent may be –
• Individual (business office identical to registered office)
• Domestic corporation (business office identical to registered office)
• Foreign corporation (business office identical to registered office)

Front 194

§ 202(b) – Articles MAY include [1 of 3]

Back 194

• Names of directors, officers, shareholders
• Purpose of corporation
o § 3.01: Every corporation has the purpose of engaging in any lawful business, unless a
more limited purpose is set forth in the Articles
o Some believe the best thing you can do is give the Secretary of State as little information as possible (very minimalist)
o Some believe you should say exactly what the company does because it is available for the public to see (should not be suspicious)

Front 195

§ 202(b) – Articles MAY include [2 of 3]

Back 195

• Management of business / Regulation of affairs
• Powers of corporation, board of directors, shareholders
o § 3.02: General powers
• Unless Articles provide otherwise, every corporation is perpetual in duration
• Corporation has the same rights as an individual to carry out business: Sue / be sued, have a corporate seal, make / amend bylaws, purchase / receive / lease / sell real property, acquire interest in other entities, make contracts, borrow $, issue notes and bonds, lend $, be a promoter / partner of any other entity, elect directors and appoint officers, employees (define duties, fix compensation, lend them $), pay pensions, make donations, transaction lawful business that will aid gov’t policy, do any other lawful act that furthers the business

Front 196

§ 202(b) – Articles MAY include [3 of 3]

Back 196

• Par value for authorized shares
o How much the shares sell for the first time / Minimum price at which shares can trade
o Most corporations just put a really low value or no value
o Don’t see this a lot anymore, but it is still in statutes

• Imposition of personal liability on shareholders in particular circumstances
• Anything you put in the bylaws
• Exculpation clause: Limits personal liability of directors to the corporation or its shareholders
• Indemnification provisions: Obligation the corporation to reimburse directors for personal liability to 3rd parties connected w/ their board service

Front 197

Did not include:
Kansas Statutes – Chapter 17, Article 60: CORPORATIONS
Kansas Statutes – Chapter 17, Article 76: LLC’s

Back 197

Skipped

Front 198

ROLE & PURPOSE OF THE CORPORATION
• Who should the corporation serve? Shareholders? Society?

Back 198

• Who should the corporation serve? Shareholders? Society?
o Classic answer (Dodge): Corporation as a set of contractual / property interests
o Modern answer (social service): Corporation as a social institution w/ responsibilities to
many constituencies

Front 199

Dodge v. Ford Motor Co., 1919 [1 of 2]

Back 199

• Henry Ford owns 58% of stock in Ford and Dodge brothers own 10% (minority shareholders)
• Ford regularly pays quarterly dividends and occasionally pay “special” dividends
• Ford is making A LOT of money at this time
o Regular return on investment = 60%
• Ford decided NOT to pay the special dividend because he had another idea
o Accumulate surplus for expansion
o Vertical integration
o Reduce price of cars
o Semi-eleemosynary: Kind of charitable
• Ford wants to make cars available to more people and employ more people at his plant so that more can have jobs
• Ford thought it was time to share profits w/ the public because shareholders had made enough money
• Can he do this or is he only allowed to think about shareholder profits??

Front 200

Dodge v. Ford Motor Co., 1919 [1 of 2]

Back 200

• Dodges sue Ford for failing to pay special dividend
o Dodges want to make their own car company and they need money to do it (money coming from special dividends)
o Dodges claim that they expected the money and that Ford has to pay it
• Court decided:
o Dividend policy
• Michigan Supreme Court said: Business organization is carried on primarily for
the profit of the stockholders
o Shareholder wealth maximization theory / Shareholder primacy doctrine
o Vertical integration
• “Judges are not business experts”
• Business judgment rule
• Leaves expansion plans to Ford’s discretion

• Modern view is somewhat different (social institution theory)
• Corporations belong to shareholders and they rely on the profits of that corporation
o Turning a corporation into something charitable is not fair to the shareholders!
• Ford’s plan would have actually maximized shareholder wealth
o Dodge brothers were just messing w/ Ford because they wanted to start their own company and had the court do their dirty work
o If you allow the company to do altruistic things, it will make the company more money

Front 201

BINDING THE CORPORATION

Back 201

BINDING THE CORPORATION

Front 202

Who acts for the corporation?

Back 202

• Board of directors
o Act collectively
o Delegate day-to-day responsibilities to corporation’s officers and employees
• Corporate officials then operate under delegated authority
• NOT the shareholders, no matter how many shares they own
o CANNOT bind corporation
o Elect board of directors and approve really important (fundamental) transactions
• Somewhat of a “little republic” – Blackstone
• Power and legitimacy flows from the shareholders to the board of directors to the officers / employers
• Corporation is only bound to third parties through corporation’s agents
o As a 3rd party, need to be sure that a corporation really is bound

Front 203

Allocation of corporate power

Back 203

• Shareholders
o Elect / remove directors
o Approve fundamental transactions
o Amend bylaws / pass resolutions

• Board of directors
o Exercise corporate powers
o Manage business and affairs

• Officers
o Described in bylaws
o Appointed by the board of directors
o Authority is in bylaws or prescribed by board

Front 204

MBCA § 8.01: Requirements for and function of board of directors

Back 204

• All corporate powers should be exercised by or under the authority of the board of directors
• Board of directors exercises all corporate powers and manages business affairs
Note: Delaware and Kansas have similar rules
• Limiting who can act protects 3rd parties and protects the corporation from bad officers and agents

Front 205

5 categories of agency

Back 205

Actual Express: BOD can expressly approves actions of corporate agent (express instructions)
• Must do so at a properly held meeting AND
• Has to be board approval (usually a majority)

Actual Implied: BOD giving express authority to an agent and the agent has to do things incidental to the objective

Apparent: President or CEO has apparent authority to bind the corporation
• VPs in a department have apparent authority at least in that subset of the corporation

EX: VP of sales has apparent authority to sell stuff
Ratification: After the fact approval
Inherent agency power (Liability of undisclosed principal): Generally the real principal is hiding and the agent seems to be the principal

Front 206

POINT: Corporate authority can arise from any of the types of agency theories

Back 206

• Type of authority an officer has can vary
• Authority is usually expressed in the bylaws (Google bylaws in textbook)
• Officer can have actual express authority from being appointed to their office by BOD
• Officer can have apparent authority because of position
• Officer can have actual implied authority to do things that go along w/ express responsibilities

Front 207

Lee v. Jenkin Bros, 2d Cir.

Back 207

• President of a company only has the authority to bind the company by acts arising in the usual and regular course of business
• BUT no authority for acts that are “extraordinary” in nature
o How do you tell if something is ordinary or extraordinary?
• If there is a conflict of interest, it is extraordinary
• Look at 3rd party expectations

Front 208

Menard v. Dage (Modern approach to corporate authority): Facts

Back 208

• Dage = closely held Indiana company that manufactures electronic video products
o Owns 30 acres of land
• Sterling = Dage president (30 years w/ little board oversight)
o Member of board of directors
• Kerrigan = New Dage investor and new member of the board
• Menard = Trying to buy the 30 acres of property
• Menard made an offer → Sterling took it to the board and they rejected it
• What kind of authority does Sterling have?
o No actual authority because they rejected the offer
o Maybe no apparent authority because he told Menard that the board rejected the offer
• Menard had to realize that the board has to make the decision
• Menard makes another offer for all of the land
• Sterling calls Kerrigan, meets w/ Kerrigan’s lawyer and a financial consultant
• Sterling is given the authorization to solicit for offers but cannot negotiate terms of the sale
• Sterling negotiates and sells land to Menard and states in the contract that he is authorized to sell the land
• Three months later, Dage says they want out of the contract

Front 209

Menard v. Dage (Modern approach to corporate authority): Issue, Analysis, and Rule

Back 209

• Lower courts let Dage out of the contract because Sterling did not have actual or apparent authority
o Court says that it was an extraordinary transaction
• What was Sterling’s authority?
o Not actual or apparent
o Court turns to: Inherent agency power
• Power of agent derived solely from agency relationship
• Transaction is usually incidental to transactions agent is authorized to conduct
• Other party believes the agent is authorized OR has no notice that the agent is NOT authorized
• Someone should have to bear the cost of Sterling’s lie
o Dage must do it because they are the most at fault
o They are in a better position to control Sterling’s actions
o Requiring Dage to honor the contract will make them more careful in the future
• Dage could have notified Menard that Sterling lacked authority, controlled Sterling better, or objected sooner than 3 months to contract

Front 210

Investigating Authority Hypothetical
Home Supplies and Construx are going to form a contract, but HS is worried about Construx’s finances, and so wants a guarantee. Construx says that its supplier, Big Machines, can provide a guarantee.
• How do you know if Big Machines is actually providing the guarantee??
• Can Construx obligate Big Machines?
• Why would Big Machines as a supplier even want to do this?
• What do you do if Construx’s word is not enough?

Back 210

o Determine if Big Machines exists and what they do
o Ask someone at BM if they are providing a guarantee for Construx
o Ask to see a copy of the guarantee / Ask who did it
o Figure out why they did it
o Can the person who signed the guarantee make the guarantee? (VP / treasurer)
• Ask to see bylaws
• Look at consent given by the board of directors
• Look at minutes of meeting at which the board consented to such an action
o Authority must be given at a properly held meeting
o Are you comfortable w/ the meeting that was held? (Skype connection is usually sufficient for attendance as long as members can hear and be heard)
o Problems: No authorization to guarantee on behalf of the corporation (personal liability)

Front 211

Ascertaining Corporate Authority

Back 211

• Need to be sure a corporation is bound by a transaction
• Need evidence that individuals acting for a corporation have authority
o Provision of statutory law
o Articles of incorporation
o Bylaws
o Board of Directors resolution
o Evidence the officer has done the same thing before and the corporation approved or ratified those actions
• Copies of minutes at which board adopted the resolution granting that authority
• How can you be sure documents are genuine?
o Secretary’s certificate that certifies minutes and resolution
o Certificate of incumbency certifies title and signature of officers signing the document

Front 212

FORMALITIES OF BOARD ACTION

Back 212

• Board operates collectively
• Has no authority unless they are assembled in a board meeting

Front 213

Meeting Rule

Back 213

o Can only take formal action by a vote at a meeting
o 1 director, one vote
o No proxies (someone voting for you)
o Could be technology such as Skype (must be able to hear others and be heard)
o Exceptions to the rule:
• Closed corporations
• Protecting innocent 3rd parties even though rule was not obeyed
• Court justifications
o Unanimous director approval
o Emergency
o Unanimous shareholder approval
o Majority shareholder-director approval

Front 214

MBCA § 8.21: Action w/o a meeting

Back 214

Board can take action w/o a meeting if each director gives signed, written consent

Front 215

§ 8.20(b): Meetings

Back 215

o Directors can participate in meetings using any means of communication
o Director is present at a meeting if all of the other directors can hear him / be heard by him

Front 216

8.22: Notice: For regular meetings and for special meetings

Back 216

o For regular meetings: Can be held w/o notice of date, time, place, purpose
• You should know
o For special meetings: Must give at least 2 days notice
• Include date, time, and place but purpose is NOT required
• Action taken at a board meeting held w/o required notice is INVALID
• A director can waive notice
• Cannot complain about lack of notice if you show up and participate in the meeting, UNLESS the only reason you show up is to complain about lack of notice
• Board action requires a quorum (majority)
o Ensures that a minority of directors do not take action
o Action taken in the absence of a quorum is invalid
• Board can delegate some authority to different committees (e.g., executive, audit, finance, nomination, compensation)

Front 217

LEGAL OPINIONS

Back 217

LEGAL OPINIONS

Front 218

What is a legal opinion?

Back 218

• Lawyer’s analysis of a situation re: corporation and agency
• Part of transaction where lawyer for each side assures the other side that their client is actually bound
• Example of how to bind a company / how you decide if a company is bound
o Resolves issue of whether the board can do something / whether the director has authority

• Have a formula, so they are pretty easy to write
o Model constructed by BAR committees
o Words / order is the same

• Could be somewhat constraining
o Just have to think about the variables
o What is the other side going to want (broad addressees, not a lot of qualifications) vs. what you are willing to give (narrow addressees, as many qualifications as necessary)
• NOTE: A lawyer who reviews your opinion will not usually ask for something he would not want to give because what goes around comes around
o Probably want to narrow it as much as possible

Front 219

Reasons for legal opinions

Back 219

• Usually have to have them in transactions or cannot close (condition to closing)
• Provide comfort to the parties involved
• Opportunity for each side to do their due diligence to make sure everything is in line
• Some people think of them as a kind of insurance (the attorney does not think of them this way)
o Can go after the attorney for a remedy if things go sour

Front 220

Types of Opinions (3)

Back 220

• Unqualified (“clean”)
o Company is duly constituted, this transaction binds my client, everyone’s consent / approval has been obtained, etc.
• Qualified
o Something is strange, unusual, not quite right
o e.g., noticed that some property has an environmental issue in Wyoming, but setting aside that issue, it appears to be a good transaction
o Means someone is going to have to do further research
• Reasoned (bad news)
o Law is not clear
o Really don’t know what’s going to happen, maybe because the transaction or product is unique
o There is some kind of uncertainty, usually because of new-ness
o Result is usually a long memo about what could possibly happen
o Usually people ask what they can change in order to get a better opinion

Front 221

Skipped Opinion Letter Structure

Back 221

Skipped Opinion Letter Structure

Front 222

CAPITAL STRUCTURE

Back 222

CAPITAL STRUCTURE

Front 223

Capital structure = How a corporation gets money to get started / operate

Back 223

• Matters because of leverage (how much $$ a company gets from debt / how much $$ a company gets from equity)
o If A LOT of debt, creditors can really restrict a company’s actions
o The more you borrow, the more nervous lenders are
• Lenders all want to be the ONLY lender
o More equity means equity owners “go down w/ the ship”
• Creditors / lenders like this because they get paid before equity owners
• Miller-Modigliani “pizza” assumption says that it does not matter how the company’s capital structure is “sliced”
o Not useful in reality because it is based on efficient markets (perfect info, no taxes, bankruptcy-free)
o In reality, debt to equity ratio is extremely important to companies

Front 224

Equity

Back 224

• Seen as a permanent commitment of capital
o You give the company $$ and there is nothing set up in advance for you to get it back

• Maximum number authorized in Articles of Incorporation
o If you want to sell more shares than are authorized, must amend Articles of Incorporation
• Not impossible, but kind of a pain
• Could keep control w/ the shareholders (probably not the case in a publicly traded company)
• Every corporation must have at least one class of equity securities w/ voting rights
o Someone has to elect the board of directors

• Does not really matter how many shares you own, but the percentage of shares you own
• Diluted
o Corporation sold more shares and your percentage ownership went down

EX: Total of 100 shares and you own 25 – you own 1/4 of the company. If they issue 100 more shares, there are 200 and you own 1/8 of company

Front 225

Residual interest in current cash flow of company

Back 225

o Returns depend on corporate profits (how much $$ the company makes)
o IN THEORY: The way a company decides to pay dividends is to look at the payout as a
return on investment
• If a shareholder could make more in the market, the company should pay out a dividend
• If stockholders could make more money by investing that money back into the company, company should retain those earnings and not pay dividends

Front 226

Residual interest in assets on liquidation (less power)

Back 226

o Subordinate to creditors (secured, unsecured senior, unsecured subordinate)
o Then pay equity: Preferred shares, then common shares
• Common stockholders will lose money in almost every case

Front 227

Right to vote (more power) and Double corporate tax

Back 227

Elect board of directors, who make all of the company’s operating decisions

Front 228

Preemptive rights (historical concept)

Back 228

o Prevented dilution
o Shareholders had the right to buy a proportional ownership share of stocks issued
EX: Right to buy 25 of 100 more shares in hypo above
o NOW: Have to opt-in to this

Front 229

Common Stock

Back 229

• Exclusive power to elect board of directors
• Beneficiary of board fiduciary duties
• Residual claim on current income (at board discretion)
• Residual claim on assets (come after creditors and preferred stock)
• Permanent commitment of capital
• Have to exit by selling your shares

Front 230

Preferred Stock

Back 230

• Can customize it to do whatever you want (e.g., like common or like debt)
• Economic rights senior to common stock (get dividends before common stock)
• Contract w/ the company
o Want to be owners w/ special rights, but not common stock
o Get paid dividends before common stock holders
• Cumulative (get caught up before common gets anything) or non-cumulative
• Participating preferred: Get what common stock gets (or more)
• Liquidation preference (senior to common, but subordinate to debt)
o May include a liquidation premium (extra at the end)
• Sometimes it is a permanent commitment of capital, but sometimes it is redeemable
o At option of company or option of stockholder, company buys it back
o Amount usually equal to liquidation preference
• Voting rights possible
o Usually have no voting rights
o Possible to give voting rights / limited voting rights, BUT no voting rights is the price you pay for all the other good stuff
o Voting rights could be limited to BIG things:
• Changes in corporate structure
• No dividends paid ever
• May be convertible to common stock or debt
o Venture capital usually has these convertible preferred
• Similar to debt

Front 231

DEBT

Back 231

• Notes (short-term), debentures, bonds (long-term)
• Can be secured or unsecured
• Can be publicly traded or sold privately
• Can be issued by the board WITHOUT shareholder approval
o More attractive option because you don’t have to ask anyone’s permission

Front 232

Bonds

Back 232

• Long-term debt
• Principal + interest from FUTURE company operations
• Contractual → Have to pay every month
• Sometimes can be secured or backed by a personal guarantee
• Get paid ahead of equity
• Interest may be deductible (good for the company)
• Indenture (inhumanly long document)
o Document that sets up the debt
o Who issues it
o Who is going to buy it
o Principal amount
o Maturity date
o Interest
o Trustee makes sure bondholders are getting what they need
o Includes a lot of events of default
EX: Could have a provision which says that if a company starts to have insolvency
problems, that’s an event of default and debt is accelerated (immediately becomes
due)
• Trying to get money out before bankruptcy
o Covenants: Promises re: What a company can do / cannot do
• Some of most important = Ratios (company issuing bonds must maintain relationship between debt and equity or debt and assets)
o Ratios can serve as an early warning sign
o A good idea to put ratio requirements in a covenant and say that an event of default is violation of a covenant
• Can be redeemable / callable: Company can buy them back at their choice, your choice
• Convertible into common stock
o Similar to convertible preferred
• Downside of debt is that you always have to pay, no matter what
o W/ equity, you can choose to pay a dividend in a good month and not in a bad month

Front 233

Notes

Back 233

• Short-term debt
• Principal + Interest from CURRENT operations

Front 234

Stock Options

Back 234

• Right to buy stock at a specified time and price
• Not an obligation (don’t have to do it)
• Executive compensation / bonuses in the form of options

Front 235

Call Option

Back 235

Right to buy shares

Front 236

Put Option

Back 236

Right to sell shares
o Not as common as call option

Front 237

Strike price (exercise price)

Back 237

Price at which you exercise the option
o Must pick a price you are going to pay for the shares in the future
• Strike price set on the grant date (day you grant the option)
o EX: Hire exec on Feb. 1 when stock is worth $100. Exec should get right to buy stock at
$100 later. However, the exec has the power / HUGE incentive to make the stock
worth more
• Leads to some shady activities
• Incentive to back-date the options and say someone started / received option on a day on which the number was pretty low

Front 238

Maturity date (expiration date)

Back 238

Date on which you buy option

Front 239

Warrants

Back 239

Stock options usually issued to the public
• Derivative instruments because they get their value from some other asset
o Option derives its value from the value of the stock
• If you think stock is going to go up, but don’t want to buy right now, can buy options and wait and see
o Not as much of a gamble
• Options not recorded as an expense if they are “at the money” on the grant date
o Strike price must be the grant date price

Front 240

LAW & POLICY ISSUES

Back 240

LAW & POLICY ISSUES

Front 241

Legal Capital: Money In and Money Out

Back 241

• Money in: “Validly issued, fully paid and non-assessable” from legal opinion
o Share that have actually been bought / Options not included
o Need to know how much money the company really has, not just how much it has the potential to have
• Money out: Legal distributions
o Don’t have money to distribute if you have an I.O.U. even though it is an asset
• Traditionally thought of as the cushion a company has
• Creditors are more confident if you have such a cushion
o Not necessarily a good thing → Banks failed even though they had strict legal capital
requirements
• Historically, legal capital was outstanding shares x par value
EX: If you sell 20 shares at $5, you have $100 somewhere
o Par value doesn’t really mean anything anymore so the equation doesn’t work
o Used to be the idea that you could find the amount that all shares were worth
o Watered stock
• Make a company, issue 20 shares and sell the shares for a lot of $$ until they collected so much money from selling shares that they had more $$ than the company was worth
EX: Building worth $500,000 but you get $1 million from shares
o Want it to have some relationship to actual value, but that is not the case today

Front 242

Legal Capital: Companies now have...

Back 242

• Companies now have no par / low par stock
o Delaware law says you can have shares w/o par value
o Still mentioned, but it doesn’t really mean a lot
• Must give some form of consideration in exchange for share of stock
o If you write a note for the rest of the value of your stock, is there valuable consideration?
o Delaware and most other laws say you can give almost anything of value in exchange for shares
o REALLY low bar

Front 243

Distributions to Shareholders (sending money out)

Back 243

• Debt holders and equity holders are in conflict
o Debt holders want the company to make $$ and repay them / think the company should put extra $$ into an account as a rainy day fund to pay them later (steady, risk free income stream)
o Equity holders want a dividend – otherwise the stock is not worth anything
• Get to vote on the board of directors

Front 244

Cannot make a distribution that would :

Back 244

o Render the corporation unable to pay its debts, OR
o Make it insolvent

Front 245

Revaluation

Back 245

Revalue assets to make it look like you have enough money to make a distribution
EX: Land purchased in 1800 for $4 might still appear as an asset worth $4 on the books, but it is really worth $1.5 million today
o Leaves room for abuse

Front 246

Klang v. Smith Food & Drug (Revaluation of assets)

Back 246

• Smith (SFD) makes a deal w/ Yucaipa to buy one of its subsidiaries and Yucaipa wants as a payment stock in Smith
o Smith’s has to agree to assume some debt and buy back up to 50% of outstanding shares (do so at $36 / share, which is above market price)
o Yucaipa probably wants them to do this so their shares will be worth more
• P claims SFD does not have enough surplus to repurchase stock (impairs capital)
o Would have a negative net worth
• Independent auditor issued a solvency opinion
• Delaware Gen. Corp. law says:
o Cannot purchase shares if it would cause an impairment of capital
o Surplus = Excess of net assets over the amount so determined to be capital (assets – liabilities)
• Smith revalues assets
• The court allows the company to revalue its assets so as to show that the buyback would not impair the capital

Front 247

Dividend Policy in closely held corporations

Back 247

• No market for stocks in a small company, so no one to sell stocks to
• If you can’t sell the stock and you are not getting dividends, the stock is worthless because you are getting nothing
o Most of the time the shareholder works for the company
• Majority will usually vote not to distribute dividends

Front 248

Classic Rule

Back 248

Normally courts say the decision not to distribute stands unless it was made in bad faith (business judgment rule)
o Majority will usually say they needed the money to reinvest in the business

Front 249

Modern Rule

Back 249

Can’t use board’s power to frustrate the reasonable expectations of shareholders
o Can’t use dividend policy to coerce minority to sell their shares cheap

Front 250

Litle v. Waters (closely held corporation)

Back 250

• Company set up w/ a flow through tax status
o Shareholders had to pay taxes, but didn’t necessarily get dividends
• Tax liability w/ no money w/ which to pay it
• Waters puts in capital and owns 2/3 / Litle provides management and owns 1/3
• Two different companies
o Waters fires Litle (no longer receiving a salary), but he is still an owner, so he has to pay taxes
• Litle votes to pay out dividends, but Waters (the majority) outvotes him every time
• Waters is willing to wait it out and buy Litle’s shares for next to nothing
• Standards of review:
o Business judgment rule
o Entire fairness standard
• Classic case of oppression
o Can’t use board’s power to frustrate the reasonable expectations of shareholders
o Cannot use dividend policy to coerce minority into selling cheap
• Court says Waters was serving his own personal financial interest in not declaring dividends
• Waters was still getting money because he was a debt holder as well as an equity holder
• Waters = Interested director
o Basically, he is on both sides of a decision
o Burden on Waters to show that his decision was not made in bad faith
o Does not get the benefit of the business judgment rule

Front 251

Kamin v. AmEx

Back 251

• Company has crappy DLJ stock and has two choices re: what to do w/ it:
o Distribute stock to shareholders (no tax effect on AmEx), OR
o Sell the stock (AmEx takes tax loss)
• AmEx distributes stock to shareholders
• Not a case involving interested directors
o Probably matters a lot
• Court says business judgment rule applies
• Directors can decide what to do even though their decision might not have been the right decision

Front 252

What should a company’s dividend policy be?

Back 252

• Something that companies argue about all the time
• Theory re: shareholder’s investment benefit
o Should only pay dividend if the shareholders can do a better job w/ it in the market
o EX: Project that will make 4% for money, but shareholders could get 5% in the market = Pay out the dividend
• NOTE: Can’t ever tell what the numbers are going to be

Front 253

PIERCING THE CORPORATE VEIL

Back 253

PIERCING THE CORPORATE VEIL

Front 254

PIERCING THE CORPORATE VEIL

Back 254

• Taking away limited liability
• Holding SH’s liable
• Shifting costs back to SH’s

Front 255

Look at corporate externalities and how this interacts with capital structure

Back 255

• Look at corporate externalities
o How the corporation interacts w/ its environment
o How the corporation shifts costs to persons outside of the corporation
• How this interacts w/ capital structure
o Need to determine if the company has enough legal capital if something bad happens and the company is liable for the remedy

Front 256

PCV = Way for outside creditors to get beyond the entity to the investors

Back 256

o Odd because people make a corp. or LLC to prevent this very thing!
o Historically, the trend is to increase the number of BA’s that have limited liability
o Might not want to buy shares if you think you could be held unlimitedly liable
• A lot harder for business organizations to raise capital w/o being able to offer limited liability

Front 257

When does PCV happen?

Back 257

• Happens when corporation does not have enough money to satisfy Ps’ claims
• Court sometimes allow creditors to disregard corporate entity so that Ps recover directly from shareholders
o Equitable doctrine created by the courts to prevent fraud / achieve justice
• No single rule – Very fact dependent
• Idea that limited liability is a “gift” that can be lost if abused

Front 258

A lot of policy-based discussions re: whether limited liability should have exceptions. Pros and cons?

Back 258

o Pros of limited liability:
• Encourage investment
• Foster diversification
• Encourage management risk-taking
• Facilitate stock markets
o Cons of limited liability:
• Discourage extension of credit
• Insider opportunism
• Externalization of risks
• SH responsibility

Front 259

Limited Liability

Back 259

• Creates tension between shareholders and creditors
o If the corporation has to pay, SH’s can lose their investments, but no more than that
o Creditors are out of luck once the company is broke
• Shareholders generally only liable for what they contribute
o If not enough money in the company, creditors bear any losses after that
• Concept of corporation as a “sealed box”

Front 260

When Courts Pierce the Corporate Veil: Who really knows?

Back 260

Fairly unpredictable as a remedy

Front 261

Robert Thompson's List of Factors:

Back 261

o Closely held corporation
o Insiders deceived creditors
o Failure to observe corporate formalities
o Commingling of assets
o Not adequate capitalization
o D actively participated in the business

Front 262

Closely held corporation

Back 262

• Probably only 1 or 2 people that both manage the corp. / own the corp. / are officers of the corp. (have everything to do w/ it)
• 1 individual may dominate
• Shouldn’t get protection as shareholders when they are the irresponsible officers / managers of the corp.

Front 263

Insiders deceived creditors

Back 263

• Protects 3rd parties
• Courts are generally happy to pierce the corporate veil in this situation

Front 264

Failure to observe corporate formalities

Back 264

• e.g., Not properly held board meetings
• Must respect the form, or lose the benefits of it
• Indifference about obligations to 3rd parties

Front 265

Commingling of assets

Back 265

• Similar to fraud
• Goes along w/ respecting the corporate form

Front 266

Not adequate capitalization

Back 266

• Controversial / Not clear what adequate capitalization is
• Don’t give the corp. enough money or take profits out as soon as they come in
• Also look at insurance

Front 267

D actively participated in the business

Back 267

• e.g., Shareholder who acted like a manager
• More control means you should be held responsible / Only fair

Front 268

Availability of PCV

Back 268

• Small businesses / closely held corporations more likely to be dominated by an individual SH
o Thus, more likely to be pierced
o BUT the whole reason for limited liability is to encourage small business and entrepreneurship

• Issue of individual SH vs. corporate SH
o Enterprise liability: Liability of the whole firm for something done by a constituent business
• Enterprise w/ a bunch of companies held by a parent company and all act together

Front 269

Alternatives to PCV: Fraudulent Conveyance

Back 269

o Bankruptcy
o Set aside transfers by an insolvent (or nearly insolvent) corporation to its SH’s if the transfer undermines creditor claims
o Something has been done to defraud creditors

Front 270

Alternatives to PCV: Equitable Subordination

Back 270

o Bankruptcy
o Subordinates some creditors’ claims (especially insiders’ claims) when they have behaved badly

Front 271

Walkovsky v. Carlton (Undercapitalized cab companies): Facts

Back 271

• PCV in a tort context
• Walkovsky hit by a negligently operated cab owned by Seon Cab Corp.
• Carlton (SH) owns a bunch of individual cab companies, Seon being one of them
o Each cab company owns 2 cabs and minimum insurance
• Means that if the cab runs you down, its only assets are 2 cabs
o Medallion = Right to operate a cab
• Judgment proof under state law
o All of the income from operations are taken out of the corporation right away by Carlton

Front 272

Walkovsky v. Carlton: Procedural History, Holding, and Dissent

Back 272

• Walkovsky recovers for his injuries, but wants to sue more than the cab company, maybe the whole enterprise
o Even if he recovered from all of the cab companies (enterprise liability), it wouldn’t matter because they are all basically broke
o Especially wants to sue Carlton for recovery because he is the guy orchestrating this
• Has to pierce the corporate veil
o Not able to show that Carlton did not respect the corporate form
o Carlton is not doing business in his individual capacity
o Carlton completely respects the corporate form because it is what protects him from liability
o Can’t just show that an individual dominated the company
• Must show that the corporate form was completely disregarded
• Court says that the problem is the law, which allows a cab company to have minimum insurance on its cabs
o NY state legislature should take care of this
o Even though min. insurance was not enough, Carlton complied w/ the law
• Strong dissent says that Carlton intentionally undercapitalized the business
• On remand, Walkovsky sues again, alleging that Carlton conducted business in his individual capacity
o Carlton ends up settling

Front 273

PCV in Contract Cases

Back 273

• Piercing is more frequent here than in tort cases
• Odd since plaintiffs had the opportunity to negotiate in advance and get, e.g., personal guaranties from SH’s
• Also odd since tort victims tend to be more sympathetic plaintiffs

Front 274

CORPORATE CRIMINALITY

Back 274

• Generally need intent to be criminally liable, so must determine whether the corporation is a person
• Corporation can do lots of things a human being can do:
o DGCL §122: Specific Corporate Powers
(4) Purchase / own property
(8) Conduct its business
(12) Transact any lawful business
(13) Make contracts
(14) Lend money
• Contract / tort creditor can go after the corporate entity and maybe investors / managers (if PCV)
• Government agencies can probably go after the entity for violation of regulations and maybe investors / managers (if PCV)
• Criminal prosecutor could probably go after management, but there is a question whether they can go after the entity

Front 275

Why Corporate Criminality?

Back 275

• Delaware was one of the first states to allow it (seems odd)
• Managers might want corporate criminality because they want the corporation to be prosecuted and not them individually
o Manager-friendly policy
• Fairly controversial concept
o Isn’t making the corporation pay just making the shareholders pay?
o Does criminal liability accomplish something civil liability does not?

Front 276

State v. Christy Pontiac (Car rebate fraud)

Back 276

• Forgery and fraud re: car rebates and dealership keeps the money instead of giving it to customers
• Company is held criminally liable even though individuals were not held criminally liable
• Three steps:
o Can corporation be held criminally liable for a specific intent crime?
• YES – Not specifically excluded by statute
o What evidence is needed?
• Cannot just be the actions of a rogue employee
• Must reflect corporate policy so that it is fair to say that the activity is that of the corporation
• ELEMENTS:
o Acts of individual must constitute acts of the corporation
o Corporation may be guilty of specific intent crime committed by its agent if:
• Agent acting within the scope of employment w/ authority to act for the corporation w/ respect to the business that was conducted criminally
• A was acting at least in part in furtherance of the corporation’s business interests
• Criminal acts were authorized, tolerated, or ratified by corporation’s management
• Different burden of proof than civil torts
• Corporation may have a policy against the criminal activity or a compliance program
• Sometimes corporation may know what’s going on and ignore it
• Christy Pontiac was as guilty as they could be
• Forger had authority handle the business and management tolerated / ratified it

Front 277

What works to deter criminal activity?

Back 277

• Heavy corporate fines?
o Could wipe the company out (corporate death penalty)
• Send CEOs to jail?

Front 278

Citizens United v. Federal Election Commission

Back 278

• Issue about whether a corporation could expend money on political activities
• Related to viewing the corporation as person
• Means that corporations are more powerful in the political arena

Front 279

SHAREHOLDER RIGHTS

Back 279

SHAREHOLDER RIGHTS

Front 280

SHAREHOLDER VOTING: Vote

Back 280

• One of the three rights SH’s have – Vote, Sue, Sell
1. Vote
o Approve fundamental transactions / changes (usually after Board initiation)
• Mergers
• Sales of assets
• Amendments to Articles of Incorporation
• Dissolution
• Tender offer
o Someone wants to buy company A, so they approach the board and see if they will sell the company
o Can also go into the market and look for A’s shareholders / Offer them more for their stock (bypass the board)
o Elect directors (annually or at special meetings)
• Major role!
o Remove directors / Fill vacancies
o Initiate action and approve bylaw changes
• SH recommendations
• Question whether SH’s can advise the board or only get to elect them (See Auer v. Dressel below)
• Current issue: “Say on pay” = SH’s get to have a say in executive compensation
• Amending bylaws
o Binding on the board
o Tricky because it is a power shared by the board and SH’s
o For a long time, there was the theory that SH’s gave that power to the board, but Auer v. Dressel makes it clear that that is not true
o Adopt resolutions

Front 281

SHAREHOLDER VOTING: Sue and Sell

Back 281

Sue
o To enforce fiduciary duties
o To protect rights (disclosure, voting, appraisal, inspection)
Sell
o Liquidity (except insider trading)
o Takeovers (tender offer)

Front 282

SH Voting & Types of meetings: Annual and Special

Back 282

• Annual meeting
o Usually elect directors
o If none within 13 – 15 months, any SH can call one
• Special meeting
o Particular purpose for the meeting
o Can be called by:
• Board
• Person specified in bylaws
• 10% SH (sometimes)
o SH’s must get written notice within 10 days of meeting that describes the purpose of the meeting
• If SH shows up for any reason other than to say he didn’t get written notice, he waives notice requirement

Front 283

SH Voting & Types of meetings: Action by Consent

Back 283

o Written consent means you don’t have to have a meeting
o Usually must be unanimous
o Limited to closely held corporations

Front 284

Voting Process

Back 284

• One share = one vote
• Quorum
o Harder to get than you think
o Usually the majority of shares entitled to vote
o Must be at least 1/3 of the shares entitled to vote
o Protects against a minority faction taking action w/o the majority
• SH can vote in person or use a proxy (appointment of agent)
o Signed appointment in writing of an agent to appear and vote in place of the SH
o Can be revocable or irrevocable (stays in place for about 11 months)
o Can give instructions and tell them how to vote, or tell them to vote at their discretion

Front 285

Absolute vs. simple majority

Back 285

o Must approve some fundamental transactions by majority vote
o Absolute = Majority of the outstanding stock get to vote
EX: If there are 100 shares outstanding and 60 represented at the meeting, 51 is an absolute majority
• A lot harder to do!
o Simple = Yes votes exceed No votes
EX: If there are 100 shares outstanding and 60 represented at the meeting, 31 is a simple majority
• Supervision of voting

Front 286

Who can vote?

Back 286

• Only SH’s entitled to vote on record date
o Corporation picks a date and whoever owns shares on that date can vote at the annual meeting
• Ownership is reflected on corporations books
o Subject to manipulation
o Could buy shares a day before the record date and sell them the day after (activist SH’s)
o No requirement to keep the shares

Front 287

Electing Directors

Back 287

• Plurality voting
o Normal way to elect directors
o Top vote getters for any open directorships are elected
• Majority voting
o Nominee must get a majority (simple or absolute)
• Removal
o SH’s can do it w/ or w/o cause
• Staggered board
o Classified board
o Three years, multiple year terms
o Each year, 1/3 are up for re-election
o Makes it harder for a takeover or a SH insurgency
• Role of corporate funds
o Incumbents can use corporate funds for re-election automatically
o Challengers have to pay out of their own pocket to try to get elected
• Can be reimbursed for their costs if they win
o One of the main areas people are trying to change

Front 288

Auer v. Dressel (Proper subjects for SH meeting): Facts and Issue

Back 288

• Whether SH’s can propose to have something considered using the proxy mechanism
• Company is not excited about SH’s sending in proposals because they have to give people notice of the proposal, etc.
o Try to avoid getting proposals put up for a vote at annual meetings
• P’s are Class A majority SH’s and elected 9/11 board
• P’s want to:
o Endorse former president and demand his reinstatement
o Amend Articles and bylaws so they can appoint board
o Have a vote on removing 4 existing board members for cause
• Issue: New president (who the SH’s don’t like) refuses to call the meeting because those are not proper subjects for a Class A meeting
• Court has to decide if this is true
• Case set the ground rules for SH resolutions

Front 289

Auer v. Dressel (Proper subjects for SH meeting): Holding

Back 289

• Holding:
o Those are fine subjects for a meeting
o If SH’s can elect, they can remove
o Dissent
• Endorsement of new president is an idle gesture
• Letting Class A fill board vacancies is bad for common stock
• Removal of directors = Judicial

Front 290

CA, Inc. v. AFSCME (Proper subject for SH meeting + Possible director violation of fiduciary duty): Facts

Back 290

• Important and recent case!
• CA is going to have its annual meeting
• CA gets a proposal from a group of shareholders (AFSCME) → They want it put in w/ the proxy materials
o Proposal = SH’s should get reimbursed for reasonable expenses in supporting someone
running for a director if they win
o Company resists
o Must tell the SEC they’re not going to include it and get permission not to include it
• Both sides had lawyers saying they were both right, so SEC sends the issue to the Delaware court

Front 291

CA, Inc. v. AFSCME (Proper subject for SH meeting + Possible director violation of fiduciary duty): Issue and Rule

Back 291

• Issues:
o Is the proposal a proper subject?
• YES
• Delaware gives both SH’s and directors power to mess w/ the bylaws
• Electing board members does not mean SH’s give up power to mess w/ bylaws
o Would it cause CA to violate a Delaware law if it was adopted?
• YES, proposal, if adopted, would violate fiduciary duties to corporation by using money for reimbursement
o Could result in someone launching a frivolous proxy contested motivated by personal gain
• Delaware changed its law after to say that companies could have a provision that allowed for payment of SH proxies

Front 292

SHAREHOLDER INFORMATION

Back 292

• SH’s need some information from the corporation in order to exercise the right to vote and the right to initiate some types of reforms
• BUT...corporation does not necessarily want to give SH’s that information
• SH’s have inspection rights: Vote, Voice, Sue, Sell
o Traditionally equitable
o Now in state corporate statutes and the MBCA

Front 293

Shareholder Information: State law, Federal law, Fiduciary Duty

Back 293

State law: SH’s have a right to inspect corporate books and records if they have a “proper purpose”
Federal law: SH’s have a right to a proxy statement before vote is solicited (public company)
Fiduciary duty: Requires communications to SH’s soliciting their votes be honest and complete

Front 294

Who Can Inspect / Who is a Shareholder for Inspection Purposes

Back 294

• Owner of record: Bank or stock broker company
• Beneficial owner: Client of brokerage house
o Hard to figure out who actually holds the shares
o A lot of shares have an owner of record and a beneficial owner
o In some cases, record owners have inspection rights
o In some cases, beneficial owners have inspection rights
• Both usually have inspection rights since their interests are not in conflict
• Used to need a minimum shareholding amount
o Not the case anymore
• Company must decide that the purpose is NOT proper

Front 295

Shareholder Identity & Depository Trust Company

Back 295

• Stockholder identity can be tricky because they are not certificated anymore
o People don’t always hold things directly in their own name
• Corporation keeps track of owners of record
o Street name ownership
• Street name = Not the name of the person who actually owns the shares (beneficial
owner)
• Bank of America / brokerage house / institutional investor is the owner of the stock, and it is allocated among its clients
• Bank has an account at the Depository Trust Corporation (called cede & co)
o DTC holds the stock for brokerage house
o Lists all members under cede & co
• Cede breakdown gives the names of all of the institutional investors
• The only way a human name appears on the stock is if you are a: NON OBJECTING BENEFICIAL OWNER

Front 296

Stock Ledger

Back 296

Record that shows all of the names of who bought and sold stock
o Lists the street name owners, so probably isn’t very helpful
o Company usually employs a transfer agent to take care of this
• Does not keep the ledger at corporate headquarters
• Transfer agent gets information, breaks it down (cede & co. breakdown), and sends it out (proxy materials) / Also pays dividends and other distributions / Also issues and cancels stock certificates

Front 297

If you get inspection rights, you get:

Back 297

o Cede breakdown
o Names of NOBOs

Front 298

State ex rel. Pillsbury v. Honeywell (1 of 2)

Back 298

• Pillsbury wants to make Honeywell stop making bombs for use in Vietnam
• P buys 100 shares and requests the SH list
o Wants to solicit proxies and elect new directors
o Very up front about WHY he bought the shares and what he wants to do
• Honeywell DOES NOT think soliciting proxies because he disagrees w/ management is a proper purpose
o Proper purpose is something like concern w/ investment return
• Court says: Proper purpose is not for curiosity, inspection, or vexation
o May be for adverseness to management or desire to gain control of the corporation

Front 299

State ex rel. Pillsbury v. Honeywell (2 of 2)

Back 299

• Must be careful about letting things qualify as a proper purpose
o Power to inspect = Power to destroy
o Only those w/ a bona fide interest can do so
o Maybe not if SH holds an insignificant amount of stock
o Maybe not if sole motivation is to change company policy
• Court says he had the wrong reason
o Not concerned w/ Honeywell and short- or long-term economic effect of making bombs
o Only concerned w/ social and political agenda
• He could have gotten around it simply by claiming economic concern about being in the bomb business
o Economic vs. social and political
o Re-frame purpose in order to get through “proper purpose” hoop
• Court actually ruled in favor of the shareholder primacy doctrine
o Wanted to limit inspection rights

Front 300

SHAREHOLDER ACTIVISM: Shareholders can elect directors...

Back 300

o BUT it’s kind of a worthless right because incumbents basically control it
o Don’t actually get to select who they elect
o Right to vote is limited by choices you have
o Don’t really get to say that whoever is in charge sucks and you’re going to elect your friend
o Plurality voting
• 5 open slots and 5 board members running
• Top 5 vote getters win
• If those 5 guys voted for themselves, they would still be elected
o Board is made up of “creatures of the chief executive”
o Resolutions from shareholders are usually just advisory (precatory)
o Management nominees elected 99.9% of the time
o BUT...
• Managers know how to make money
• Maybe they should have discretion to do their jobs (make $ for the investors)

Front 301

Voting as a meaningless right could be changing

Back 301

o Institutional investors – Financial intermediaries that invest other people’s money
(e.g., mutual funds, insurance companies, pension funds)
o Hedge funds – Large, activist investors w/ a lot of money that are looking for a high return

Front 302

State Reimbursement Rule

Back 302

• Shareholder insurgent: SH trying to become a board member who is not an incumbent
• Election-related expenses of shareholder insurgents not paid unless approved after they win
• If it costs money to obtain information, mail out stuff (proxies), SH insurgent must pay for it out of his own pocket
o Corporation will not pay for a shareholder insurgent to run
o Only incumbent board gets to use corporate funds to solicit proxies
• If you win, you can probably get the company to repay you
• If you lose, then you’re out all of that money
o Makes people not want to run for board of directors
• Extremely hard for a non-current board member to become a member of the board
o Discourages shareholder activism and entrenches management
o BUT . . . should the board have to pay for this?
• Could have whackos running for board of directors

Front 303

Rosenfeld v. Fairchild Engine

Back 303

• Insurgents win control of Fairchild through a proxy fight (very unusual)
• Question of what the company should pay insurgents who ran for the board of directors
o Incumbents charged the firm $106,000 for their proxy expenses while in office
• Insurgents pay them an additional $26,000 upon taking control
o Insurgents reimburse themselves $127,000 and arrange for shareholders to ratify the reimbursement
• Reimburse old board and new board!
• SH’s bring a derivative suit to challenge payments
• Court says payments are OK as long as they are reasonable
o Have to be able to let the board solicit proxies
o If directors act in good faith and contest is over policy, they can incur reasonable and proper expenses in soliciting proxies

Front 304

Rosenfeld v. Fairchild Engine: Basic Rules

Back 304

• Insurgents win control of Fairchild through a proxy fight (very unusual)
• Question of what the company should pay insurgents who ran for the board of directors
o Incumbents charged the firm $106,000 for their proxy expenses while in office
• Insurgents pay them an additional $26,000 upon taking control
o Insurgents reimburse themselves $127,000 and arrange for shareholders to ratify the reimbursement
• Reimburse old board and new board!
• SH’s bring a derivative suit to challenge payments
• Court says payments are OK as long as they are reasonable
o Have to be able to let the board solicit proxies
o If directors act in good faith and contest is over policy, they can incur reasonable and proper expenses in soliciting proxies

Front 305

Federal Regulation of SH Communications

Back 305

• SEC proxy rules
o Very picky about what a corporation can send to its shareholders
o Don’t want corporation lying to shareholders
• List of rules about what can be in a proxy letter sent to a shareholder
• Ensures informed shareholder voting
• Must get prior SEC approval
• Communication can include:
o Sending a letter to fellow SH’s
o Putting an ad in the newspaper about rising up and voting