BA Outline 2009

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I. Overview of Business Associations Factors in choosing business structures: trying to maximize benefit while reducing

risko Who will own businesso Who will manage businesso Who will reap profito Who will bear risk of losso Who will pay income tax on business profit

Two fundamental differences of various structureso Tax treatment of profitso Liability exposure of owners for debts

II. Sole Proprietorships Problems with sole proprietorships

o Employees and Agency principles 2 requirements for agency

Principal must consent—give authority—that agent will act for him

o Actual Authority Actual express – principal specifically gives

agent power to undertake specific act on her behalf

Actual implied – agent has authority to get assigned job done even if principal did not spell it out in detail

o Apparent Authority – indication by principal to third party that

agent has authority no need for detrimental reliance by third party

Agent must agree to that consent Tort liability: master liable for torts of a servant only if committed

within scope of employment Master/servant: master has right to control physical conduct of

servant Intentional tort is not usually within scope of employment Could be if, e.g., bouncer at a party

o Other agency relationships Attorney-Client: Hayes v. National Service Industries

Client didn’t want to be bound by attorney’s settlement Attorney has authority unless it is limited by the client in the

representation agreement Court says apparent authority was created by the fact that agent

said he had authorityo This is wrong use of apparent authority, more accurate

would have been if apparent authority was granted because of the attorney’s position


If settlement was prohibited by client, settlement would still be enforced but client could then bring a breach of contract suit to attorney

Franchises/other Business relationships Franchise: successful business doesn’t own all of its outlets Miller v. McDonald’s Corporation

o 3K owns a McDonalds franchise, woman chokes on a sapphire stone in sandwich

o woman sues McDonalds Does McDonalds have control over 3K?

Franchise agreement has detailed requirements

Strict enforcement of requirements Apparent agency

McD held out 3K as its agent to the public

General public doesn’t know enough about franchising to know 3K owned restaurants

Another possible theory is that McD and 3K were partners because of profit sharing, etc.

o How could McD make sure that franchisees pay McD could write an indemnity clause in

franchise agreement Make franchisee take out indemnity/ liability

insurance How does a sole proprietorship grow

o Funding by ownero Overview of debt and equity

Debt: loan that business is legally obligated to repay Riskier to business If business fails, must be paid in full before anything is given

to owners Return amount is known Fixed cost to business – interest rate

Equity: investment that business is not legally obligated to repay Riskier to investor Higher potential return – based on stock price Variable cost to business

o Investors share in success of companyo Investors have right to some control of business

o Cash flow view of debt and equity Debt is selling portion of future cash flow in exchange for money now Equity is ownership, and thus selling ownership turns sole

proprietorship into partnershipo Borrowing money


Get funds in a way that is least risky to the providers Pledge personal or corporate assets against loan as collateral Can have other people guarantee -- cosigner Promise to pay in a short time Give creditor control over business

o Loan covenantso Participation in business decisions (seat on board of

corporation) Profit sharing may change type of business structure, i.e. make

it a partnershipo Partner is behind lender in getting money backo Partner is liable for torts

o Sharing Profits with a Lender In re Estate of Fenimore

Watt (Serge) and Fenimore make an agreement where Watt gives 12,500 to Fenimore to do business selling cars and share profits

Generally, sharing profits is prima facie evidence of partnership, unless the profits are received in payment:

o As a debt by installmentso As wages of an employee/rent to landlordo Annuity to widow or representative of deceased partnero As interest on a loan (even tho amount payment varies

with business profits)o Consideration for sale of a goodwill of business

Not essential that all partners have right to make decisionso Can use profit sharing, and other conduct to show

partnership exists If a partnership, what is the consequence, i.e. who gets paid

first?o Order when insolvent as to claims against separate

property is: 1 - Money owed to separate creditors 2 - Owed to partnership creditors 3 - Those owing to partners by way of

contributiono Here, Villabona is a separate creditor, and Serge is a

partner, so Villabona takes priority over Serge


III. Partnerships Definition: association of two or more persons to carry on as co-owners a business for

profit (RUPA 202) Creating partnership: no need to formally create, but courts look at 5 factors to

characterize as partnership:o Right to controlo Agreement to share losseso Contribution of property to businesso Payout via profit shareo Called a partner in agreement?

Property ownershipo 201- Partnership is entityo 203 – Property acquired by partnership is property of partnership, not of

individual partnerso 204 – 3 ways property is partnership property

If acquired in name of partnership or one of partners with indication that it is in capacity as partner

If acquired in name of partnership by transfer to Partnership in its name Partners in their capacity as partners in partnership (name of

partnership indicated in instrument) Presumed if purchased with partnership assets (even if not in name of

partnership)o 501 – partner not co-owner in partnership property, and has no interest in ito 502 – only transferable interest of partner is share of profits and losses and

right to receive distributions Decision making

o Meinhard v. Salmon (1928) Salmon (real estate developer) was offered a lease for a building on 5th

avenue, couldn’t really afford it himself, so he found Meinhard to join with him on the lease

Lease was 20 years long Meinhard gave money for renovations Shared proits from building Salmon was sole manager of building

Near end of lease the owner wanted someone to lease all of his 5th ave buildings and improve them with a new large building instead

Owner approached Salmon, and they entered an agreement with each other, unknown to Meinhard

Meinhard found out after lease was executed and sued after not being allowed to be part of the lease

Court found that Salmon, as manager of this coventure should have given Meinhard the opportunity to join or compete

Since the Salmon was manager it was even more important that he tell Meinhard, considering Meinhard wouldn’t have known about the opportunity otherwise


To renew the same lease in his own interest without conferring with Meinhard is wrong, it might have been different if it was for an entirely different place

o 103 - Partnership agreement effect; nonwaivable provisions cant unreasonably restrict right of access to books/records cant eliminate duty of loyalty

can identify activities that don’t violate duty (as long as not manifestly unreasonable)

all partners (or percentage specified in agreement) can ratify act that would have otherwise violated, after the fact

cant unreasonably restrict duty of care cant eliminate good faith/fair dealing, but can prescribe standards by

which to be measured (as long as not manifestly unreasonable) cant vary power to at will dissociation (but can require notice in

writing) cant vary requirement to wind up partnership in 801(4-6) vary applicable law under 106(b) cant restrict rights of third parties

o 401 – Partner’s rights and duties each partner has account

credited with anything contributed: money, value of property, amount of liabilities, and share of partnership profits

charged with distribution by partnership: money, value of property, net amount of liabilities, share of partnership losses

entitled to equal share of partnership profits, chargeable with share of losses

partnership reimburses for advance to partnership beyond capital contributions

counts as a loan with interest each partner has equal rights in management deciding differences

if ordinary course of business: just majority if outside ordinary course or amendment to agreement:

unanimous consento 404 – Standards of Partner’s conduct

Fiduciary duties 404b - Duty of Loyalty – codification of meinhart

o Hold partnership as trusteeo If you get personal benefit, you owe it to partnership

404c – Duty of Careo Just don’t be grossly negligent or reckless or conduct

intentional misconducto Merely being a partner does not absolve someone of

normal liability to third parties


401c, partnership reimburse a partner/indemnify for liabilities incurred in ordinary course of business

encourages partnerships to act normally partner will still contribute his

proportion of partnership 404d - Duty of good faith and fair dealings – arises out of contract law 404e – just because u benefit from it doesn’t mean u violated the duty 404f – specifically says you can lend and transact business with

partnershipo 405 – Actions by Partnership and Partners

Liabilityo 306 – partners are jointly and severally liable for all partnership obligationso 401(c) – partnership reimburse/indemnify partner for payments o made/liabilities incurred by partner in ordinary course of business

Growtho Existing owners: no requirement, but agreement may require capital

contributiono Lenderso Additional owners

401(i) - Need unanimous consent of existing partners unless agreement says otherwise—(not in ordinary course of business)

306(b) – new partner not personally liable for any obligations incurred before they became partner

o Earnings from business operations How Owners make money

o Salary – 401(h) not entitled to payment for services, but agreement can obviously provide otherwise

o Profits – 401(b) each entitled to equal share of profits and charged with share of losses in proportion

o Sale of Ownership Interest 502 – can sell share of profits/losses and right to receive distributions 503 – transfer of interest

does not automatically cause dissociation or dissolution or winding up

transferor still has rights and duties other than distribution, and profit/loss sharing

Dissociation – partner withdrawing from partnershipo 601 - events causing dissociation

partner gives notice of express will to withdraw event agreed to in partnership agreement partner’s expulsion pursuant to agreement expulsion by unanimous vote of other partners if

unlawful to carry on partnership business


transfer of all or substantially all of partner’s transferable interest in partnership (other than transfer for security or court order charging partner’s interest)

within 90 days after partnership notifies partner it will be expelled because it has filed certificate of dissolution, …

a partnership that is a partner has been dissolved and business wound up???601(4)(iv)

on application by partnership or another partner, partner’s expulsion by judicial determination

wrongful conduct material breach of agreement not reasonably practicable to carry on business with partner

bankruptcy death

o 602b: wrongful dissociation breach of partnership agreement, OR before term or undertaking, if

withdraw by express will unless within 90 days of another partner’s dissociation by death or otherwise under 601(6-10), OR

expelled by judicial determination under 601(5), OR dissociated by becoming debtor in bankruptcy, OR if not individual, trust, business trust….

o 602(c) - Person wrongfully dissociating is liable to partnership and to other partners for damages caused by dissociation

o 603 – Effects of dissociation Lose management No more duty of loyalty (404b3) as far as competing Duty of loyalty 404b1/404b2 are not eliminated if they arise out of

stuff from before dissociation Dissociation without winding up (RUPA 7) buyout price if no dissolution/winding

up:o 701(b) - Price determined by the higher of the following (proportional share)

Liquidation of assets at the time of dissociation Sale of entire business as a going concern at date of dissociation

o 701(c) - Subtract damages for wrongful dissociationo 701(h) – wrongfully dissociated partner wont get money until expiration of

term/undertaking unless partner shows earlier payment wont cause undue hardship

o 702(a) – for two years partnership bound if third party believed dissociated party was partner didn’t have notice of partner’s dissociation not deemed to have had knowledge under 303e/704c

o 704 – statement of dissociation name and that partner is dissociated have notice 90 days after this is filed


o 705 – continued use of partnership name does not by itself make a partner liable for obligations of partnership

703 reasonable belief Dissolution

o 801 - events causing dissolution and forcing winding up of business in partnership at will notice from a partner who dissociates by express

will for partnerships of term or undertaking

within 90 days after partners dissociation by death or going away (i.e. bankruptcy, etc.), or wrongful dissociation, half of remaining partners expressly willing to wind up….

Express will of all partners to wind up business Expiration of term or completion of undertaking

Event agreed to in partnership agreement Event making it unlawful –not a default rule Judicial determination (on application by partner) – not a default rule

(103(b)(8)) Unreasonable frustration of economic purpose Partner’s conduct making it not reasonably practicable to carry

on business Not otherwise reasonably practicable to carry on business

under agreement Judicial determination that it is equitable to wind up business – not a

default rule(103(b)(8))o 802 – how/why partnership continues after dissolution

(a) generally only for purpose of winding up, except under exceptions of b

(b) after dissolution and before winding up, all partners, including non-wrongfully dissociating partner can waive the right to wind up and terminate

partnership carries on as if it never happened cant adversely affect third party rights

o 803 – right to wind up partnership business (a) if not wrongfully dissociated, you can participate in winding up

any partner can ask for judicial supervision with good cause (b) legal rep of last partner can wind up

o 804-806: partner/partnership ability to bind each other after dissolution 804 – partnership bound by partner’s act after dissolution that is

appropriate for winding up or that would have bound partnership (under agency laws), if other party did not have notice of dissolution

805 – c – you have notice 90 days after this statement is filed 806 – partners liability to other partners

o 807 – settlement of accounts etc. (a) first pay the creditors, partners can be creditors, they are treated

same (inside or outside debt) (b) entitled to settlement of all partnership accounts upon winding up


o Partnership Accounts Amount invested + share of profits + other gains - share of liabilities - share of losses – distributions

o Issues come up with labor partners Kovacik v. Reed (1957)

Capital partner invests 10000 Only $1320 left, 8680 in losses Split loss with labor partner? Under RUPA, they would share losses Court though says most of the time this rule of sharing losses is

when both contribute capital including money or land or tangible property

o So capital partner bears risko Not majority rule

RUPA rules are only fair in the “average situation” For capital contribution, look at what interest is of the

contributiono E.g. 10k, 10% = 1k

Labor contribution, look at what he could have made salary wise in a year (more than 1k/year)

In this case, labor partner should ask for more partner


IV. Corporations Defined Requirements for a corporation

o Articles of incorporation MBCA 2.02

a: Must include:o Name for corporation satisfying 4.01

Corporation, incorporated, company, limited, or abbreviations….or similar words

o Number of authorized shareso Address of registered office and agent at this officeo Name and address of each incorporator

b: May include:o Names/addresses of initial directorso Provisions not inconsistent with law regarding

Purpose for corporation Managing business Defining powers of corp/directors/shareholders Par value Imposition of personal liability on shareholders

for debts of the corporationo Provision under this act required or permitted to be set

forth in bylawso Provision limiting/eliminating liability of a director to

corp or shareholders for money damages with 4 exceptions

o Bylaws 2.06 managing business/regulating affairs as long as not inconsistent

with law or articles of incorp.o Promoters

2.04 any people acting as or on behalf of corporation, KNOWING there was no incorporation is jointly and severally liable for all liabilities created while so acting

Promoter/agent should do three things to limit liability: Indicate nonexistence of corporation Indicate representative capacity Provide for novation – not automatic must be agreed to by both

parties Ways to raise money

o Loan from banks, investors (bonds)o Retain earningso Issue Stock – sell ownership in company

Shareholder “control” – management decisions Shareholder financial benefits

Own assets (entitled to value of assets if sold – not property ownership)


Dividends Capital gains

Authorized share – corporation has permitted sale, not necessarily in existence

In articles of incorporation Corporation can only sell up to the number of authorized shares Corp might not sell all authorized shares

o to keep some controlo for economic interest

Outstanding share – a share that is actually issued by the company Common stock – normal stock with normal voting and economic

rights (e.g. no guarantee of dividends) Preferred stock – any stock with different rights than common stock

Can agree that dividends go to preferred before common shareholders

Can guarantee amount of dividends Can get favorable liquidation rights Can get redemption rights

Stock can be issued for tangible or intangible property – board of directors determines what value is of property

6.21(b) Delaware 152

Par value – minimum price for which corporation can issue shares Shareholder not governed by this, only limits corporation NYSE for example is not issuance since it is the resale of

“used” stock Benefits of par value

o Protects shareholders (makes negative dilution less likely)

o Must keep par value of stock - protects creditors Only certain states require this, and in these few states, par

value is usually set nominally low Optional to have par value in some states Reasoning behind change from required par value

o Might be reason for shareholders to want sales lower than par value

Stated capital = (number of shares) x (par value) Capital surplus = (price sold) x (number of shares) – (stated capital)

Only allowed to distribute capital surplus Par = 1/share; sold for 10/share, 100 shares sold

Stated capital = 100 Capital surplus = 900

o State of incorporation Any state you want Laws of that state become default rules governing “internal affairs” of

corp


Internal affairs = procedures for corporate actions and rights and duties of directors, shareholders and officers

Cant avoid application of certain states’ tort law by incorporating in a different state—would restrict third party rights


V. Operation of a Corporation Liability to Creditors

o Generally, corporation as an entity can be held liable to third partieso Shareholder is generally protected from personal responsibility (MBCA 6.22b

and Delaware 162)o Exceptions to rule that shareholders are not personally liable

Contractual – third parties can refuse to extend credit without agreement by shareholders to guarantee payment

Judicially created exceptions – piercing corporate veil Dewitt Truck Brokers (1975): factors to pierce corporate veil:

o Undercapitalization – owners have only put limited amount into corporation—this is usually the key one

o Fraudo All stock owned by 1 persono Corporate formalities – meetings, voting, etc.o No dividendso Excess salary to main Shareholdero No functioning board or officerso No corporate recordso Commingling of fundso SH treats assets as his owno Holding out SH as personally liable

Make sure to refer to corp. as “inc.”o Directors and officers are same people

Get multiple directors Enterprise liability: all corporations in an industry are

enterprise and treated as single entity for liability purposeso Walkovsky – enterprise liability

corp owned by same person who also owned 9 other corporations with 2 cabs as assets –

basically operated as if one single business. Argument that profits were drained out of

companies (i.e. undercapitalization). Enterprise liability would allow him to recover

from combined assets of all companies. Decision Making in a corporation

o Board of Directors and Officers Generally (where corporation has more than a few shareholders) board

of directors makes decisions regarding business operations MBCA 8.01

(a) requires BOD unless specified in shareholder agreement (under 7.32)

(b) Powers exercised by or under authority, business/affairs managed by or under direction of BOD other than limitations set in agreement


BOD is not usually agent of corporation or shareholders ALI Corp. Governance 3.02 – publicly held corporations – p. 1307 MBCA 8.40/41: officers

corp can designate its own offices and BOD can elect officers duties are set forth in bylaws, by BOD, or by direction of

authorized officer authorized by BOD. McQuade v. Stoneham

BOD make agreement to keep M treasurer, Then voted against him, later dropped as a director Dropped because of a falling out Contract is illegal and void if it precludes BOD from

changing officers, salaries, or policies or retaining individuals in office, except by consent of the parties

o Don’t want to allow agreements to abrogate judgmento Want them to be able to act in best interest of businesso Company here isn’t worse off in any way by allowing

them to kick out M Pretty much overturned by new statutes

o Shareholder decisions instead of director decisions Villar v. Kernan

Two founders agreed orally that they wouldn’t get salaries Had a falling out and then one made an agreement with

shareholders that he would get a salary Couldn’t enforce the first because it was not in writing and it

dealt with corporation (since it limited ability to hire the founder as an employee)

o Shareholders’ Decisions about Directors and Cumulative Voting In small, closely held corporations several shareholders can have

power to elect/remove directors May depend on state corporate code or articles of incorporation

Cumulative voting v. straight voting Straight voting

o separate election for each seato each shareholder gets to cast his number of shares in

any way for each election Cumulative voting

o One selection, shareholders cast votes and top vote-getters (depending on how many directors are elected) are elected to board

o Multiply number of shares by number of directors to get number of votes

o Number of shares required to elect [S/(D+1)]+1 S = total number of shares voting D = number of directors to be elected

Some states require cumulative voting, others give choice


Removal of directors Delaware – 141k – majority can remove with or without cause

with some exceptions:o If cert. of incorporation ORo If cumulative voting, certain requirement regarding

number votes NY Bus. Corp – 706 –

o any or all directors can be removed for cause by vote of shareholders

o without cause if certificate of incorporation allowso some exceptions to both above

MBCA 8.08 – with or without cause unless articles of incorp say otherwise

o If elected by voting group, only shareholders in that group can remove

o If Cumulative voting, cant be removed if number enough to elect under cumulative vote are voted against his removal

o Shareholders’ Voting on Directors’ decisions on Fundamental Corporate Changes

Generally, things that are not routine business decisions, such as Amendment of articles of incorporation Dissolution Merger with another corporation Sale of all or substantially all of the assets of corporation

Approval or disapproval of BOD decision is a shareholder reaction, as opposed to action (i.e. decision of election/removal)

No cumulative voting, may be supermajority approval requiremento Where Shareholders Vote, and Who Votes

Annual meeting Special meeting – any other meeting other than annual meeting Record owner – person with legal right to vote at meeting of

shareholders Record date – owners as of that date can get notice of and vote at the

meeting – 7.07a limits on record date Street name Proxy – person entitled to vote authorizes another person, i.e. the

proxyo Who Votes and Proxies?

person entitled to vote can authorize another person, i.e. the proxy proxy can be revoked (even if no provision)

proxy holder is agent of stock owner irrevocable if

o the proxy says it is irrevocable ANDo coupled with some interest in the stock


example of irrevocable is bank that has interest in stock and gets shareholder to execute irrevocable proxy

o Shareholders’ Inspection Rights Kortum v. WSI (2000) Delaware provision

For shareholders: Must prove (1)compliance with requirements for demand in statute and (2) that inspection is for a proper purpose

Must also then show that scope of inspection is proper (i.e. that it matches purpose above

Valuing ones shares is proper reason for inspection, even if they plan on selling the shares

Pending litigation does not prevent inspection MBCA 16.02 – burden of proof is on shareholder to show they are

entitled to access—certain docs are automatically (i.e. corp bears burden)

Corporation has burden to show purposeo Shareholders’ Voting Agreements

Ringling Bros. Barnum & Bailey v. Ringling (1947) Voting agreement by shareholders was not against public

policy Court didn’t grant specific performance, but the mere

acknowledgment that it was valid was groundbreaking MBCA 7.31 and Delaware 218(c) would now command specific

performance Responsibilities of Decision-makers

o Legal Responsibilities - Duty of care Breach by board action

Shlensky (Wrigley Field case - 1968): court didn’t think Cubs’ management’s decision not to install lights for night games was a dumb or negligent decision

o court also didn’t care whether it was a dumb or negligent decision:

o Shlensky could’ve sold his shares or pushed for new directors.

o Is there any different rule for privately held corporations where no sale or assignment or shares allowed? No.

o Big problem if he is a minority shareholder in a closed corporation

o We think this is a just result anyway because we assume he got a discount when he purchased them because market should have recognized corporation was being run by a director who didn’t like lights in the ballpark.

Presumption that board of directors’ judgment was in good faith and designed to promote best interests of corporation


Q: would courts be more lenient in looking at negligence of directors if shares not assignable and there is no public market?

o MBCA 8.30 – duty of directors is to run the company in the best interests of the corporation

Joy v. North (1982) – BJ rule and its limitso BJ rule: wont hold directors/officers liable for bad

judgment Shareholders can select which corps to invest in Hindsight is 20-20, cant analyze effectively the

circumstances around a decision Want to encourage businesses to make some

risky decisions (otherwise too cautious and less potential for profit)

Insurance expensiveo Limits exist in cases where this rationale is not

supported, i.e. if: No business purpose Conflict of interest exists No-win situation (not recognized by DE) Failure of oversight Other examples

o Here, there is likely a finding that potential gain was no more than interest on a loan, i.e. no-win situation

MBCA – 8.31(a)(2)(ii)(A): reasonable believe to be in best interests of corp.

Smith v. Van Gorkom (1985)o Informed decision: turns on whether directors have

informed themselves of all material information reasonably available to them, prior to making decision

o Based decision solely on one director’s representations in an oral presentation

No documents or summaries, etco Board did not do researcho Must do research for big decisions

MBCA – 8.31(a)(2)(ii)(B) – not informed to extent reasonably believed appropriate in the circumstances

Delaware 102(b)(7) –can limit personal liability of director but can’t limit liability for (1)breach of duty of loyalty, or (2) acts not in good faith, or (3) improper personal benefit

Breach by board inaction Barnes v. Andrews (1924)

o Director allegedly failed to give enough attention to company affairs.

o Directors have “individual duty to keep themselves informed in some detail”


o P’s burden that performance of duties would have avoided loss

o Must show causation between breach and damages Codified in MBCA - 8.31(a)(2)(iv) Francis v. United Jersey Bank (1981)

o Must exercise diligence, care, skill that ordinary prudent person would use under circumstances

o Plaintiff must prove that the lack of care caused some harm to corporation

In Re Caremark Int’l (1996) – monitoring systems for employees

o Narrows original precedent from Graham which said you need cause for suspicion to impose duty to monitor employees on directors

o Without grounds to suspect deception, directors/officers cant be charged with wrongdoing for simply not monitoring employees

Legal Responsibilities - Duty of Loyalty Competing with the corporation

o Regenstein (1957) Directors of company were involved in

ownership/operation of another store which competed with one store of the company

Corporate officers and directors can engage in a business similar to that carried on by their corporation (as owners or officers or directors), as long as they act in good faith toward their company

Cant wrongfully use corps. resources Cant enter the other business to cripple or injure

corporationo Majority rule – cant compete with corp

Exceptions No negative affect Ratified by corp.

Usurping corporate opportunityo Delaware rule – no distinction between officers and directors -

factors Line of business?

Difficult to determine Key is whether opportunity closely associated

with existing business activities Financial ability

Gives edge to director who has access to finances

Disincentive to execs to solve financing problems


Corporation has interest or expectancy Opportunity puts O or D in confliction/awkward

position Source of information (used in Broz v. CIS)

o ALI corporate opportunity testo Corporate opportunity under ALI model rules, if

For both O’s and D’s, learned of through director or officers position, OR

For both O’s and D’s, learned of from corporation, OR

For officers only, if “closely related” to line of business

o If shown that it is corp opportunity Corp must show that there was no offer to corp.

OR that corp didn’t reject properly (vote of disinterested directors after full disclosure)

D can still can show taking was fair if offeredo NE Harbor Golf Club (1995)

President of corp (owner/operator of golf club) personally purchased land nearby and informed board

Learned of availability of one parcel through position Applies ALI test

o Broz v. CIS (1996) – application of Delaware test Broz acquired a license from a company doing similar

cellular business, CIS was almost bankrupt, being acquired by another company

CIS did not have financial ability Was in line of business Not clear that CIS had interest or expectancy in license

– CIS was trying to divest cellular licenses, and had no plans to acquire licenses

Don’t need to present opportunity to a company in the process of acquiring your corp, if your corp doesn’t have the interest/expectancy or financial ability

Interested director transactions – being on both sides of a deal with a corporation

o HMG v. Gray (1999) No disclosure, and didn’t show fair dealing or price Liquid market – can make sale for going rate

Cant be liquid if its unique land Burden on the interested parties to show fairness

Dealing – timing, initiation, structure, negotiation, disclosure and general procedure

Price – economic and financial considerations, assets, market value, earnings, future prospects, etc.


o General rule – Delaware 144(a) disclose and then have a vote by disinterested directors

OR disclose and then have a vote by majority of

disinterested shareholders OR (ALI) show transaction was fair procedure and pricewise

Shareholder Derivative Suitso Overview

Shareholder sues to vindicate corporation’s claim Not derivative suit if some shareholders benefit from defendant’s

conduct Might not be a derivative suit even if all shareholders are harmed

e.g. Company didn’t give dividends Eisenberg v. Flying Tiger Line

Eisenberg challenged reorganization of corporation because it didn’t allow him any control

This is direct suit because he is not asserting a claim on behalf of the corporation, but rather on his restricted right.

So, no security was needed since it was a direct suit Hypo: 5.8, CEO is bouncer at restaurant, and hits a shareholder

o Compared to class action Class action vindicates a lot of individual claims Both are controversial because there is room for abuse

So they put in procedural requirements as discussed belowo Procedural Requirements of Derivative Suit

Joinder Corporation is necessary party and must be joined

o Recovery goes to corp, so they must be in court to be affected by judgment

o Ensures judgment will bind interest of corp (i.e. res judicata effect)

Corporation is nominal defendant, even though sh are suing on behalf of corporation

Stock ownership/standing reqs. MBCA 7.41

o Must be a shareholder of corporation at time of act/omission complained of (or became sh through transfer by a person who was at that time) AND

Interpreted that need to be at time of act/omission AND time of suit

o Must fairly and adequately represent the interests of the corporation in enforcing the right of the corporation

NY 626(b)o Plaintiff is holder at time of bringing suit and was

during transaction he complains of, or his shares devolved on him by operation of law


Security for expenses Some states require, some do not

Right to Jury Trial Arises in cases of law, not equity. Derivative suit can be product of equity or law

o Seventh amendment doesn’t apply to states Court approval of settlement – cant just be agreement between lawyers Demand on directors[graphic on derivative suit process]

MBCAo 7.42 – (1) must make demand

(2) once made, must wait 90 days unless company rejects demand, OR waiting 90 days would cause irreparable

injury to corporationo 7.44 – dismissal

(a) determined in good faith after reasonable inquiry, that not in best interests of corp. by one of three groups:

majority vote of independent directors majority vote of committee made up of

independent directors (with or without quorum)

(f) court appointed panel of independent persons upon motion by corp: P must show that it is not in interest of corp.

(c) certain things wont by themselves cause a director to be considered not independent

slc – 7.44(f) (e) burden shifting based on number of

independent directors – structural bias


Derivative Suit Process

Make Demand

Corp takescontrol

Dismissed under BJR

No Demand

Dismissed if not excused

NY: demand futile when:1 - Majority of directors interested in transaction, OR2 - Directors failed to inform themselves to a degree reasonably necessary about the transaction, OR3 - Directors failed to exercise business judgment in approving the transaction – no win

Del: demand futile when:1 - majority of directors are interested or not independent, OR2 - Underlying transaction not exercise of sound business judgment

MBCA: MUST make demand

Litigation

SLC

NY: SLC decision OK?1 - SLC members independent?2 - Procedures sound?

a - Meeting regularlyb - Reviewing factsc – lawyer opinion

Doesn’t look at substance of SLC decision

Del: SLC decision OK?1 – SLC members independent?2 – Court applies BJ to determine whether motion should be grantedLooks at substance


Who actually pays, 3 ways directors escape liabilityo Corp. eliminates liability

Van Gorkom case allowed corp to eliminate for violations of duty of care at least

2.02(b)4, with exceptions: can’t eliminate liability for duty of loyalty: amount of unentitled benefit received by director intentionally infliction of harm on corp/shareholders violation of 8.33 – unlawful distributions intentional violation of criminal law

o Indemnity 2.02(b)5, can put indemnification clause in articles of incorp. for

director for anything but violations of duty of loyalty 8.51(a) permissive indemnification of directors: 2 categories

8.51(a)(1)o has good faith ANDo reasonable belief

if official capacity: conduct in best interests of corp.

if other capacity: conduct at least not opposed to best interests of corp

o AND no reasonable cause to believe conduct was unlawful

8.51(a)(2): anything that was permissible under 2.02(b)5 8.51(d) where indemnification is impermissive:

proceeding by/in right of corporation resulting in settlement or judgment against director

o but you can get reasonable expenses (NOT JUDGMENT) if you meet the conduct of 8.51(a) (duty of loyalty)

proceeding resulting in judgment that director received improper financial benefit as a result of his conduct

8.52 – mandatory indemnification must indemnify a director who was

o wholly successful on merits/or otherwiseo when director was party because he was director

for reasonable expenses incurred by him in connection with proceeding

8.51(c) judgment/settlement/etc. against director doesn’t automatically mean he didn’t meet conduct of 8.51(a)

o D&O Insurance MBCA 8.57 authorizes corp to buy liability insurance Director can choose lawyer if suit is for more than insurance amount Relevant timing is when claim is made (to determine who is insurer) Questions are

Whether to buy it and what kind (business decision)


Scope of policy and decision-making for settling claims (contract law)


VI. Growth of Corporation: 3 ways for corporation to earn money Debt – borrow money

o Who will make the loan?o Covenants required by lender?o How will corp repay loan?o What happens upon default?

Equity – issuing stocko Existing shareholders: Preemptive rights

Right to purchase the number of shares required to maintain current percentage of ownership

Byelick v. Vivadelli - Fiduciary duty not to issue stock in order to determine control of company as opposed to issuing it to raise capital

Delaware doesn’t have this duty So contract around this, or pay a good price for stock in the

first place MBCA 6.30 – not automatic, must be in articles (and if so, 6.30 will

guide)o Venture capitalists

Substantial equity investment in a non-public enterprise not necessarily involving active control in firm

Usually unstable companies seek venture capital – only 1/3 that use it succeed

VC demand high returns because no reduction of risk through diversification illiquidity of equity

VC protect investments by contracting for “special rights” Liquidation preference Right to acquire stock at predetermined price Voting/veto rights Exit opportunities

They do wait sometimes until IPO, no restrictiono Public offerings

IPO – 3rd round of investing causes a 20% increase in value price often artificially high, so not a good long term investment pricing – need to know current investment return climate underwriting activities

o firm commitment – underwriter bears risko best efforts – corp bears risk

most underwriting is done under this nowo Potential scams by underwriters – both types

Best efforts – Firm commitment – low price, excess demand

give to friends Retained Earnings


VII. How Corporation Owners make money Salaries from Corp.

o Decisions on which shareholders get salaries Hollis v. Hill

For closely held corporations, fiduciary duty between shareholders is greater than normal

In closely held corp, when majority shareholders try to take away salaries from a minority shareholder/employee, there has to be injury as a shareholder

to determine if there is injury as a shareholder you can consider factors:

o Whether corp distributes profits in salary formo Whether shareholder/employee owns a significant

percentage of shareso Whether sh/emp is a founder of businesso Whether shares received as compensation for serviceso Whether sh/emp expects value of shares to increaseo Whether sh/emp has made sig. capital contributiono Whether sh/emp has demonstrated reasonable

expectation that returns from investment will be obtained through continued employment

o Whether stock ownership is requirement of employment

Mass you cant get forced out for nonlegitimate business, so shares there will be worth less than Delaware

MBCA 14.30(2) – dissolution by court liquidation, sometimes just used as a bargaining to get settlement –

Coase Theorem – you will get an efficient outcome if you bargain, no matter what rule is.

o Legal limitations on salaries Exacto Spring Corp (1999)

CEO/cofounder/principal owner got salaries of 1.3 million and 1.0 million

IRS said reasonable would have been 381k and 400k Tax Court said about halfway between these two based on 7

factorso Type/extent of serviceso Scarcity of qualified employeeso Qualifications/earning capacity of employeeo Contrib. of employee to ventureo Net earnings of employero Prevailing compensation paid to employees with

comparable jobso Peculiar characteristics of business

Second Circuit said these factors are retarded


o Vague and nondirectiveo Unrelated to purpose of limitations

Keep dividends (which are not deductible from corporate income) from being disguised as salary (which is deductible)

o Court shouldn’t be a personnel departmento Factors lead to arbitrary decisions

Indirect Market testo Higher the rate of return that manager can generate,

more salary he should geto If investors get higher rate of return than expected,

salary of CEO is presumptively reasonable Presumptive because there are cases in which

return is not due to CEO’s work Examples of things rebutting presumption

Company run by someone else Rate of return was gotten by mere

chance not work of CEOo Even if reasonable by this test, can still limit salary if it

is shown that company was concealing dividend in salary, i.e. bad faith showing

Natural control – built-in safeguard that shareholders will complain if something is wrong

Giannotti v. Hamway (1990) Here minority shareholders sued officers to dissolve and

liquidate the corporation because they claimed that they were being “oppressive” and that the “corporate assets were being misapplied/wasted”

Normally, where there is disinterested approval of salaries, Business Judgement Rule would apply, but here, the defendants were the ones that authorized their own salaries

When P shows director had interest in transaction, burden is on director to show that it was a fair and reasonable transaction

Essentially 5 directors were doing the work of one person, and they were closer to part-time employees with other interests

Business would have been more profitable except for excessive compensation extracted by D’s

Dividends from Corp.o Definition – payment out of current or retained earnings made to shareholder

in proportion to the number of shares they owno Reasoning for dividendso Rules on dividends

MBCA uses term distribution (1.40) – includes dividend 6.40(c) spells out when dividends cant be declared


if after giving it, corp would not be able to pay its debts as they become due in usual course of business

if after giving it, corp’s total assets would be less than sum of its total liabilities plus the amount needed (if corp were to be dissolved at time of distrib), to satisfy preferential rights of shareholders whose preferential rights are superior to those receiving distribution

o this is unless articles of incorporation permit otherwise. Land assets wont help insolvency

Violations of (c) result in liability imposed by 8.33 A) director who votes/approves to excess distribution (as

defined above) is personally liable to corp for amount of distribution that exceeds what could have been distributed without violating 6.40, but only if the other party shows he was not in good faith or didn’t act reasonably in interest of corporation.

B) Director liable under A is entitled to o contrib. from other directors who could have been held

liableo AND recoupment from each shareholder of pro-rata

portion of amount of unlawful distribution sh accepted knowing distrib was made in violation of section 6.40

Traditional approach refers to specific accounts according to corporate code (followed by many states, including NY and Delaware)

Traditional approach uses solvency test AND restricts based on what account it is—more restrictive than modern/MBCA approach

Earned surplus – value generated by business, i.e. profits minus losses minus distributions already paid

Capital raised by issuing stocko Stated capital – par value times number of issued stocks

No states allow dividends to be paid from stated capital

Original purpose of stated capital was to make sure corps had enough assets to keep going

o Capital surplus – amount past par value times number of issued stocks

Some states allow dividends to be paid out of capital surplus

o For no par issuance: directors can allocate funds received between stated capital and capital surplus

Zidell v. Zidell (1977) Plaintiff owned 3/8 of outstanding shares of closely held corp Brother and Nephew owned remaining 5/8 All worked for corp until 93 and got salaries P resigned after his salary increase demand was refused


Then sued to compel payment of higher dividends Showed evidence

o Corp had enough earnings to pay greater dividendso That D’s got substantial salaries (not excessive)o And that there was hostility between P and D’s

Trial court said he wasn’t getting reasonable return on investment (no bad faith found), and forced more dividends

State supreme court said P has to show bad faith by Do i.e. Business judgment rule applies to discretion as to

payment of dividendso important that here he resigned and did not get fired (so

they weren’t necessarily trying to get him to sell at unreasonably low price)

Dodge v. Ford Motor Company (1919) Ford had a lot of surplus and was closely held at the time, and

paid large dividends Dodge had stock and used dividends to start its own company Ford got pissed and stopped dividends….ended up paying

higher wages and concentrating on making cheap cars Instead of saying the reason was to increase profits, Ford said

he wanted to make sure people could afford cars and company wasn’t trying to make money as first priority

o courts found this reasoning to be so grossly imprudent that they were not protected by Business Judgment rule

o thus, they concluded directors had duty to distribute large sum of money because of huge surplus, and history of dividends

Sinclair Oil Corp. v. Levien Sinclair owns Sinven and its board dominates the Sinven board Minority shareholder of Sinven is complaining that Sinclair

board gave out too much dividendo Even if the corp statute requirement (i.e. only used

capital surplus) is met, the dividend payment may not be justified

o If dividend is self dealing by parent then tough test of intrinsic fairness is used

o Self dealing parent dominates subsidiary and board of

directors subsidiary has x (owned by parent) and y

(owned by minority) classes of stock subsidiary (under direction from parent) gives

dividend only to class xo Here, no self dealing because minority shareholders got

a lot of money too, so business judgment rule protects the transaction


o Who gets dividends Usually found in articles of incorporation Preferences

Priority of receipt – just get paid first, not moreo Example: 4k total dividend, 2000: $2 priority, 10,000

common stock Only give $2 each to priority = $4k

o Example: 40k total dividend, 2000: $2 priority, 10,000 common stock

First give $2 to priority = $4k Then you split remaining $36k between 10k Priority = $2 each; common = $3.60 each

Preferred participating stock – gets paid first and then again with the leftover

o Example: 40k total dividend, 2000: $2 preferred and participating, 10,000 common stock

First you pay $2 each to 2000 = $4000 total Then you take remaining $36k and divide by all

12k Preferred/participating: 2+3= $5 each; common

= $3 each Only cumulative dividends accrue (carry over year to year)

o Total dividend of $40k, 2k shares of $2 cumulative preferred, 10k of common stock, no dividend declared in last three years

First pay 4X$2 = 8 (3 previous plus current = 4X) to each 2000 = $16k

Then split remaining $24000 between 10k, = 2.40 per share

o Rationale is so that they don’t delay and screw over preferred

Buying and Selling Stock at Profito Valuating shares

Reliability of information – 10b5—protection from fraud Basic inc. v. Levinson

o Basic president denied they were in negotiations for mergers (they had some interest and talks about merger)

o People sold stock before merger and after the denialo Sued saying they relied on material misleading

statementso Standard for materiality = must be substantial

likelihood that reasonable shareholder would consider it important…

Merger discussions speculative nature make this analysis difficult


Weigh indicated probability of occurrence and anticipated magnitude of event

probability – look at indications of interest in transaction at high corp levels

o Board resolutions, instructions to i-bankers, actual negotiations, etc.

Magnitudeo Size of corporate entitieso Size of potential premiums over

market valueo Presumption of reliance by fraud-on-the-market theory

Fraud-on-the-market theory says market price of the stock takes into

consideration all information the public has(including misreps)

so a misrep makes the price lower, and thus the shareholders, by relying on this price relied on this

rebuttable if you can “sever the link between the alleged misrepresentation and either price received by P or decision to trade at fair market price

show actual market determining people knew of truth behind misreps

or if credible reports showed truth or if person knew of truth and still sold

for some other reason EP MedSystems Inc v. Echocath

o Echocath allegedly enticed MS to invest 1.4 million, saying that licensing was imminent

o Echocath said investment is risky and had MS sign saying it did not rely on representations etc.

o No licensing after investment and then stock dropped…so MS sued

o Bespeaks caution doctrine Cautionary language if sufficient can make the

alleged omissions/misreps. immaterial as a matter of law

Cautionary language must be directly related to alleged misreps/omissions

Only applies to forward looking statementso Loss Causation

In addition to but for causation you need to show causal link between the fraud and the harm done


Plaintiff has burden Usually a matter of fact

Malone v. Brincato Company overstated earnings and when it announced

this, stock plummetedo Shareholders who didn’t sell the stock and lost money

after this sued to say the corp breached its fiduciary duty of disclosure

o Court dismissed, and remandedo Directors who knowingly give false information

resulting in corporate injury to individual stockholders violate their fiduciary duty

o Here, they didn’t violate duty to disclose because it was not combined with a request for action, and it was not in connection with purchase or sale

o They could potentially file derivative suit on behalf of corp saying that fiduciary duty was violated.

o Legal Duties for buying/selling stock 10b5 – buying/selling with inside information

Dupuy v. Dupuyo Jurisdictional requirement for 10b5: “use of any means

or instrumentality of interstate commerce”o Intrastate phone calls are enough to satisfy this

Goodwin v. Agassizo State law treatment of insider tradingo President/director of mining company knew of a

geologist’s theory that Michigan was rich in copper, and company was getting land in Michigan

o Only special circumstances will require disclosure by director to stockholder in a transaction of stock

here there was no “fact” it was more of a theory generally no duty when transacting on a stock

exchangeo where director personally seeks stockholder for purpose

of buying shares w/out disclosing material facts it will be closely scrutinized

SEC v. Texas Gulf Sulphuro Directors and management of TGS got word of a core

sample that was high in minerals. They kept it secret and in the meantime bought a lot of stock and told close contacts to do the same

o SEC sued based on 10b5o Court said that “anyone in possession of material non

public information has a duty to disclose that information before trading in the stock”


o Policy behind decision 10b5 is based on expectation that all investors

have relatively equal access to material information

directors/officers have other incentives besides inside info such as dividends and stock options

Chiarella v. US (1980)o Chiarella worked for printing company, whose client

was about to acquire a companyo There were some gaps for security, but he found out

who the target was, and bought stock before acquisition, then sold it right afterwards, making 30k

o Was criminally convicted of violating 10b5, and appeal went up to S.C.

o S.C. reversed, saying that the disclose or abstain rule is limited to persons in fiduciary relationship with one another

Here, jury instruction only said he was guilty if he did not disclose, did not speak to whether he had fiduciary duty, which is new requirement

Dirks v. SEC (1983)o Facts

Dirks worked for broker-dealer firm and got nonpublic info that corps assets were overstated from a former officer of corp.

Dirks investigated further and told clients about it—some of whom sold stock based on this

Tried to get wall street journalist to write article Stock dropped from 26 to 15; Cal investigated,

SEC filed complaint, wall street published storyo How does tippee acquire duty to disclose or abstain?

SEC says they inherit whenever they get inside info from insider –

Tippee then breaches duty when he transmits info to someone who is likely to trade on the info.

But this is based on notion that all traders should have equal info, and conflicts with chiarella

Would inhibit the trading market Tippee gets duty from insider, which means that

tippee assume duty only when the inside info is made available to them improperly

o Rule: need to show two things for tippee liability (personal benefit test)

Tipper breached fiduciary duty


Tipper tipped for the purpose of obtaining some sort of personal benefit

Selling information Giving info to enhance

reputation/standing or with expectation of reciprocal benefit

Giving info to someone with whom you have a personal relationship

o Here, no tippee liability Tipper was not employed and had no fiduciary

duty Tipper did not try to get any personal benefit,

merely a whistle blower US v. O’Hagan (1997) – misappropriation theory

o Classical v. misappropriation Classical is fraud on the other party of

transaction Misappropriation is fraud on source of

informationo Misappropriation theory

Person commits fraud violating 10b5 when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information

Defense: if person discloses intention to source, duty is relieved and thus no fraud.

Section 16b and Short-Swing Trading 16b: If there is a purchase and sale within 6 months, and done

by an insider, than any profit (excess of sale and purchase) must be relinquished to corporation

only insider (and thus liable) if you are officer, director or if before purchase and before sale you own more than 10%

only applies to large companies registered under Sec. Exchange Act

Common law duty of selling shareholder Debaun v. First Western Bank & Trust Co. (1975)

o Founder of close corp owned 70% of stock, when he died, bank sold company to someone who then looted corp (turned net worth of 220k to negative 218k)

o Minority shareholders sued bank in derivative capacityo RULE: where control of corp is material, controlling

majority shareholder must exercise good faith and fairness from the viewpoint of the corp and those interested therein

If you have facts to awaken suspicion you must conduct a reasonable and adequate investigation


o Here, there were enough facts to alert the prudent person:

bank knew from report that his financial record was bad

knew only source of funds was corp assets dividends wouldn’t have been enough to cover

cost of shares bank officer knew that he was guilty of fraud THUS, bank had duty to investigate

o Can recover from either the looter or the former controlling shareholder

o Bank had to pay corporation net worth of copr when bought

To allow corp to pay creditors Sometimes it gives to minority shareholders

Perlman v. Feldman (1954)o Controlling sh and CEO sold stock and got 8/share

control premium, minority sued saying he had to share it.

o Court, based on the specific, unique facts in this case (steel market issues), found that he had used his corporate opportunity for personal gain and owed duty to minority shareholders…

o HELD only to its own facts….not many courts have followed this.

o To whom can Shareholder sell her shares? Redemption and equal access rule

Donahue v. Rodd Electrotype Co. of NE (1975)o For Closely Held Corporations: Controlling

shareholders owe duty to minority shareholders to give them equal opp to sell shares to corporation on same terms as controlling shareholder

o Remedy here was to either buy the minority shares at same price as controlling, or rescind agreement to buy controlling shares at that price

o Definition of close corp: Small number of stockholders No ready market for corp stock Substantial majority stockholder participation in

management/direction/operations of corp. Greenmail -

Buy-sell agreements Contract requiring corporation/majority stock holder to

purchase shares in specified situations at a specified priceo Usually upon death, disability, or retirement of owner


Purpose: Guarantee that there is a market for stock in close corporations (since in large, public corps

Funding: two primary ways to fundo Sinking fund: ongoing contributions from ownerso Life insurance covering the owners

Types of buy-sell agreementso One-way: third party acquires the interest

Usually a “key” employee CEO, .e.g. may not have money, so insurance or

set aside moneyo Cross-purchase: surviving owners obligated to purchase

interest from heirs or directly from owner (if disabled/retired)

Usually buy enough to keep proportional ownership

If funded by life insurance, must have multiple policies (if more than two owners)

Each owner gets policy on other owners’ lives

E.g. 4 owners = 12 policieso Stock redemption – corporation buys back stock

Look at ownership outcomes: control can shift Ex. A, B, C have 20% each, D has 40%

A dies (and corp buys back stock) B, C, now have 25% each, D has 50%

Business gets one policy on each owner E.g. 4 owners = 4 policies

o Wait-and-see – give options, corp gets first stab, then other shareholders

Jordan v. Duff & Phelpso Closely held corporation; buy-sell agreement; 10b5o Jordan resigned and then sold shares back to D&F

pursuant to agreement (after end of year to use new year’s valuation)

o D&F then announced merger which made stock rise greatly, and Jordan sued saying corp had duty to disclose merger negotiations

o Issue was whether the info was material (depended on time of actual sale—since that would determine the probability v. magnitude test)

o Would have trouble proving scienter, since they didn’t intend to fraud necessarily…

o Go through 10b5 elements when closely held corps buy back stock through buy-sell agreement

Berreman v. West Publishing Company (2000)o State case


o Berreman retired from West (closely held corp), sold back shares at 2000/share pursuant to agreement; West then merged with Thomson, and Thomson paid 10k per share

o Berreman sued saying that West had duty to disclose info about potential merger

o Issues: whether there was duty: yes, because close

corporation buying shares back if duty, were facts material: no, low probability

of occurrence at time of sale


VIII. Corporation Endgame Dissolution

o Involuntary/judicial: 14.30 By attorney general if fraudulently incorporated, or abuse of legal

authority By shareholder petition: often used as negotiation/blackmail

Deadlock Oppression Corporate waste illegality

By creditor if debts are unsatisfied, and corp. insolvent Administrative, don’t pay taxes, etc. 14.20

o Voluntary: majority vote default (14.02(e)), can be greater Merger

o MBCA - 11.06o Liabilities of disappearing corporation transfer to surviving corporation.o Triangular merger

McDonalds creates a subsidiary MCSUB Puts cash or stock into subsidiary Cause subsidiary to merge with bubba’s burritos McDonalds controls MCSUB which now includes BB

Result: McD limits liability to MCSUB i.e. McD cant be sued for BB (unless corporate veil is pierced)

o Effect of a merger on Creditors/SH of disappearing corp: MBCA – 11.07o Stockholder protection

Sue directors who approved merger for breach of duty of care Van Gorkom

Vote against merger – 11.04e/g DE need a vote if 20% or more are issued

Assert dissenting shareholders’ right of appraisal Hypo

o target corporation worth 1 million; acquirer buys 51% for 600k

o acquirer proposes merger for very low priceo “cash out” merger

HMO-W Inc. v. SSM Health Care System (2000)o Minority discount – might pay more than price per

share for a majority of the shareso Marketability discount – shares are worth less if there is

no public market for themo No minority discount o In appraisal hearings court can entertain assertions of

misconduct that relate to value of dissenter’s share


Short form merger – already hold 90% of target corp: easier to cash out on minority

Public corp, if you own 20% of target corp, you have a right of appraisal

MBCA – once you seek appraisal, you lose right to sue Delaware – appraisal doesn’t bar suit

Sue directors who approved merger for breach of duty of loyalty Weinberger v. UOP, Inc.

o Signal was majority shareholder of UOP, and decided to merge with it

o Decided anything up to $24 would be acceptable and then offered $21 cash out merger price

o Proposal went to board of UOP and signal members did not vote, but it was still approved

o No Business Judgment rule because same people were on both sides of transaction

o Since no business judgment rule, look to fairness Procedurally – rushed through, didn’t reveal

information, etc. Price – should be further evaluated based on

newer techniqueso No business purpose necessary to squeeze out minority

in Delaware.o Ways signal could have avoided this

Better procedure Interested directors shouldn’t have participated

in meetings Valuation techniques

o Coggins v. New England Patriots Football Club (1981)

o Sullivan bought football team, nine others bought 10000 shares for 2.50 each

o Sold some non-voting shares in addition (120k @ 5/share)

o Sullivan bought all voting shares back at 102/shareo Pledged assets of company to do that, so he needed to

get rid of nonvoting shares (otherwise hes usurping corp assets, etc.)

o Organized subsidiary (wholly owned), and merges the new company with the old company

Buys nonvoting shares for 15/shareo One person sues to undo merger

No business judgment rule since owner is on both sides

3 part analysis for Massachussets


fair procedure fair price business purpose

advising clients when they want to have a merger to get rid of minority shareholders: have some sort of business purpose

o deadlock, expensive with minority shareholders, Sale of Assets

o Definition – instead of becoming part of original company, you sell all of your assets; i.e. two companies survive after sale of assets

o Effect of sale of assets on the creditors of the selling corporation Buyer of corporation’s assets is not liable for selling corps’ debts Sale of assets does not automatically terminate its legal existence But often it is followed by corps’ dissolution Franklin v. USX Corp (2001)

WPS sells assets to ConCal. ConCal sells assets ConDel General rule is that there is no successor interest in sale of

assets, but there are exceptions. Look to see if the acquisition is a de facto merger

o Main factor is whether adequate consideration was paido As long as it was adequate consideration, no successor

liabilityo Effect of sale of all/substantially all of assets on shareholders of selling corp

and buying corp. Hostile Takeover – who cares


IX. Limited Partnerships Defined

o Limited partnerships practically obsolete, but states have some similar entities, and many still exist.

More likely LLC or similar entity nowo When founders want control, but need money from outside sources they can

form limited partnership E.g. two founders, and two investors who don’t want liability Two founders are the general partners, the investors are the limited

partnerso Rights and responsibilities of general partners are the same as normal

partnership – RULPA 403 Personal liability, management, etc.

Legal Problems with starting Limited Partnershipo Need to file certificate of limited partnership to come into existenceo Can form a limited partnership under a different state’s laws, and will be

governed by those lawso 102: Name of partnership – must contain “limited partnership” – to give

others notice of the entity’s natureo name and address of registered agento name and address of general partners

Setting up LP to avoid ALL personal liabilityo Make a corporation the general partner – thus the only way you get to specific

person is if you pierce the corporate veil (cant sue limited partners)o Shareholders of corporate general partner might also want to be limited

partners Benefit from tax treatment

If only shareholders, they would get taxed twice (corp, then dividends)

If both, they could have control through cheap shares as shareholders, but have their economic ownership through role as limited partners (and not be taxed twice)

Operating Limited Partnershipo Decisions

Unless agreement specifies, limited partners have no say in decisions RULPA 302

o Liability Third parties

RULPA 403b – general partners are personally liable RULPA 303 – limited partners not personally liable

o Unless they are also general partners or o “participate in control of business”o if you find they participate in control of business then

only liable to people who reasonably believe they are general partners


o things that are not considered participating in control of business:303(b)(1-8)

1 - contractor, agent, employee of limited partnership/general partner or officer, director, shareholder of corporate general partner

Zeiger v. Wilf (2000)o Wilf is one of owners of corporate general partner, and

also a limited partner.o Limited partnership agrees to pay plaintiff consulting

fees and then defaults on this payment after strugglingo Note – remember that corporate general partners should

avoid undercapitalization in order to avoid piercing the corporate veil

o Plaintiff sues Wilf personally Wilf has safe harbor under 303(b)1, and retains

his limited liability status Even if no safe harbor, plaintiff knew that

general partner was the corporation, so 303(a) would give same result

Should have argued for piercing corporate veil because Wilf didn’t observe corporate formalities

o Plaintiff should have made Wilf sign guarantee of payment to avoid litigation in the first place

To partnership/partners 403b – general partners have liabilities of normal partnership to

the partnership – i.e. fiduciary duties Kahn v. Icahn (1998)

o Agreement essentially said gp was allowed to usurp corp opportunities (compete directly with business of partnership)

How Owners of Limited Partnership make moneyo Salaries for employeeso Distributions from business earningso Transfer of ownership interest to third party

504 702 – sale of partnership interest only gives right to get distributions,

no right to controlo Transfer of ownership interest to limited partnership

602 – general partner can give written notice and leave whenever 603 – default rule: limited partner must give at least 6 months notice to

leave reason behind tougher standard for limited partner is that they

contribute the money which would stop business, whereas gp can be replaced more easily.


X. Limited Liability Companies Generally: unincorporated business association which provides its members with

limited liability (like corp), pass through taxation(like partnership), and management flexibility (more than with corp or partnership)

LLC statutes vary widely, but are mainly just default rules KEY document is Operating Agreement (part contract-part articles of incorp.) LLC’s almost always closely held BA’s Operating problems

o Decision making: two ways, up to owners Member managed company – owners run it themselves

Operating agreement determines how to determine number of votes by member, and which matters require more than majority vote

Manager managed company – hired like board of directors in corporation

Operating agreement determines how members elect/remove managers, and what issues require member vote

o Liability Members’ To Third Parties

No personal liability of members for company’s debts Open question of whether you can pierce the LLC veil

o Louisiana court says it can be pierced if the LLC is acting as “alter ego” of its members or if members were committing fraud or deceit on third parties through the LLC. Hollowell v. ORH LLC (ED La. 1998)

Members’ and managers’ liability to company Fiduciary duty members owe to member-managed company

and other memberso ULLCA 409(b): duty of loyalty

Account to company and hold as trustee… Don’t deal with company on behalf of adverse

party Don’t compete with company in conduct of

business before dissolutiono ULLCA 409(c): duty of care: refrain from engaging in

grossly negligent/reckless conduct, intentional misconduct, or knowing violation of law

o ULLCA 103(b): what operating agreement cant waive/limit unreasonably:

Cant eliminate duty of loyalty but can essentially limit it to the point of practical elimination

Cant unreasonably reduce duty of care Lynch Multimedia v. Carson Communications

o Member/manager of LLC acquired cable company on his own behalf after telling company about the


opportunity, was sued by other members for violation of fiduciary duty

o Operating agreement basically limited the duty of loyalty to the point of nonexistence, so his mere disclosure of opportunity was enough to relieve him from any liability

How do LLC owners make moneyo Sharing in earnings of business

Operating agreement provides how and when LLC earnings are to be distributed to members

ULLCA 405 creates default rule: distributions before dissolution/winding up must be in equal shares

o Selling ownership interest Usually tough to sell because not a big market for ownership in closely

held entities Even if you can find buyer, there are statutory limits or operating

agreement limits on selling Delaware LLCA 18-702:

o assignee has no right to participate in management, but can if agreement says so and:

Members all approve Comply with procedure in agreement

o Unless otherwise provided in agreement Assignment of LLC interest doesn’t entitle

assignee to become member or get member rights

Assignment of LLC interest entitles assignee to share in profits/losses, to get distributions, receive allocation of income, gain, loss, deduction, credit…etc.

ULLCA 502, 503o 502: transfer doesn’t give transferee rights of member,

just distributions which transferor would have gotteno 503: transferee CAN become member if its in

accordance with operating agreement or if all other members consent

Lieberman v. Wyoming.com LLC (2000)o Entity theory of LLC: if remaining members of LLC

want to continue, they can.o Withdrawing member can get his initial capital

contribution.o Question is what happens to his equity interest?

i.e. he is a 40% owner, does he get this back somehow?

Usually look to operating agreement

BA Outline 2009

Documents

Transcript of BA Outline 2009