Business Associations Outline DANOFF
Transcript of Business Associations Outline DANOFF
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 1/124
1
Business Associations Outline
(1) Small firms first question - differences between modern RUPA, UPA and partnerships and LLCs
(probably planning questions about OAs suggest what should be in it) or a litigation question
(badly put together small business you figure out who gets sued)a. Def ault rules: why they should modif y them and which of the small entities we should use
(2) Large firms second question
a. Exam distinguish civil, criminal and derivative actions; get through proxy fights
TERM DEFINITION
AffiliateSomeone who is controlling the company or under
common control of some other company
Agency
An agreement by one person (an agent) to act for
a principal at the principals direction and control
AgentSomeone who is authorized to act on behalf of the
principal
Beneficial title
Own Stock: Buy stock in IBM and get it from
Merrill Lynch you are owner of the beneficial
title, while legal title is still owned by Merrill Lynch
Bona fide purchaserSomeone who gives consideration, acts in good
f aith, and who is not on notice of an adverse claim
C CorporationAny corporation that hasn't elected the status of
an S corporation
Callable Can be redeemed at the option of the issuer
Capital
Productive capacity: tangible assets (equipment
and buildings), intangible assets (intellectual
property and human capital), money
Common stock
Residual interest in a corporation: including the
right to elect directors and receive dividends anddistributions
ConvertibleAffiliate Someone who is controlling the company
or under common control of some other company
Corporation by estoppel Doctrine that prevents personal liability for an
obligation entered into in the name of a non-
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 2/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 3/124
3
Fiduciary duty
A fiduciary duty is a legal or ethical relationship of
confidence or trust between two or more parties,
most commonly a fiduciary and a principal .
Flow-through Tax vehicle all partnerships, LLC, S Corps.
General partnershipA partnership in which all partners are general
partners
Limited liability corporation
A business entity that has the limited liability
benefits of a corporation with the tax benefits of a
partnership
Limited liability partnershipA type of general partnership with some limitation
of liability under state law
Mutual fundsA publicly held open end investment company which will redeem its shares at net asset value at
any time
Preemptive rights
Rights that give existing shareholders the chance
to buy part of a new issue of shares before the
general public can, thus protecting them from
dilution of value and control
Preferred stockShares that have preferential rights to dividends or
distributions over common stock
Principal The person owed a fiduciary duty
Promoter This is a person who brings together labor, capital,
and management to start a business enterprise
Proxy Written permission to have another shareholder
vote on your behalf
Proxy agent A shareholder may send a proxy agent to vote on
his or her behalf pro rata
Quo warranto A proceeding to determine "by what right"
someone holds a corporate office
REIT Real estate investment trust
Officers Partnership PIC Poison pill Registered
form Respondeat superior Revised Model
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 4/124
4
Business Corporation Act Rule 10b-5 Security
title Servant-agent Shareholder derivative action
Shareholders Sole proprietorship State court
receivership Stock transfer books Straight debt
Straight voting Subchapter C Subchapter K
Subchapter S Suretyship Tender offer
Business Associations Lawy Formation: Formation, operation and dissolution of business entities
y Legal Issues: Rights and obligations of the participants;
y Internal v. External: Key is to distinguish internal and external participants
y Topics Covered:
o (1) Agency Law
o (2) Small Business Entities
o (3) Corporations
Coverage of a Firm
Internal: Business Associations External: Other Courses
Investors: Provide capital y Equity (ownership)
y Debt (Loans)
External: Customers Suppliers y Fraud and Consumer Law
Managers: Provide skills
y Top
y Sub-managers
Antitrust and Other Competitors; Regulatory
Authorities like Public Utilities, Banking, Insurance
and Environmental
Employees: Provide labor
y Coverage is limited; Labor and
Employment Law
Consultants: Investment bankers, Accountants,
Lawyers
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 5/124
5
Agencyy Agency Defined: People act on behalf of the business to bind
the business in relationships to 3rd
parties;
o Law: The rights of others against each other
y Formation: Consent of both parties, unless agency is equitably implied by the courts
y Agency v. Debtor/Creditor: Creditors promises to 3rd
parties create apparent authority and
management of debtors business aff airs establishes control over debtors, leading to an agency
relationship.
Agency Law1. Defined: Body of law that defines the
legal rights of those affected by
delegations of power to act
2. Three Basic Parties:
a. (1) Principal
b. (2) Agent: independent contractor
or employee (servant)
c. (3) Affected third party: contracts
with agent or is injured by agent
3. Sources: Common Law and Restatement
of Agency (2nd
and 3rd
)
a. No statutory codes
b. Specific statutory provisions for those agents with checkered past
Creating Authority: Agency1. Two Basic Elements for Creations:
a. (1) Consensual (Contract): Oral or written agreement (manifestation of consent of one
and consent by the other that may be express or implied either ex ante (before act) or ex
post (ratification; af ter the act and relating back)
b. (2) By Matter of Law (Equity): May have apparent authority (constructive) or authority
by estoppels (cannot deny)
2.
Creating Authority: An act
a. (1) written or spoken works or other conduct of the PRINCIPAL which is
b. (2) reasonably seen to CAUSE THE AGENT to believe that the principal wants agent to act
on principals account
3. Creating Apparent Authority: An act created as to a 3rd
person
a. (1) written or spoken words or other conduct on principal
Business
Law => Rights of Each Against Each Other
(P) Investors(owners) Legal
Entity (P)
Managers (A)
Third Parties
Labor
Customers
Suppliers
Consultants
(money)
Capital
return
Hires
Contracts
Benefits
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 6/124
6
b. (2) reasonably seen to CAUSE 3rd
PERSON to believe the principal consents to have the
act done on his behalf by the person purporting to act for him
Agents Power: Source to Subject Principal to Torts1. Consensual Agency Relationship
a. Distinguish gratuitous bailee
b. Distinguish independent contractor
2. Within Scope: Agency must acts with scope of employment to create injury
3. Actual: Ex Ante or Ex Post
a. Can be express OR
b. Implied in f act (Jenson Farms)
4. In Equity: Implied in Law or Constructive Agency Court over looks lack of actual authority
a. Apparent Authority (Nogales Service Center)
b. Agency by Estoppel
c. Hybrid: Inherent Authority (by title)
Gorton v. Doty: agency arising from use of car
1. Facts: G was coach driving team to play in other city and offers car to use to help take plays to
game. G was in accident in s car and players f ather () sues on behalf of sons injuries. Jury
awards $5,000 to .
2. Issue: Was G an agent of while driving her car?
3. Held: Yes. Evidence showed that the relationship of principal and agent existed between and
G. was an independent contractor not a gratuitous baliee.
4. Reasoning: An agency relationship results when one person allows another to act on her behalf
and subject to her control.
a. Control consented to G acting on her behalf because she volunteered the car with express condition that G drive it; didnt say anything about G LOANING the car and did
not say anything about BORROWING it
b. Precedent ownership of a car alone, regardless of presence, establishes a prima f acie
case against the owner because there is presumption that driver is owners agent
c. In order to establish an agency relationship benefit is not specifically required
5. Incentive to Insure: Know your hit by lawsuit for letting someone borrow your car, shif t liability
onto insurance company.
Agency: Analysis of Question
1. Key: Necessary to determine when an agent can bind the principal, when the principal is liablefor the wrongful acts of the agent and what duties obligations of agents are to their principals
and vice versa.
2. Analysis: Determine three types
a. (1) Is the problem between the agency and principal?
b. (2) Does it involve a 3rd
party trying to hold the principal to an agreement based on the
agents conduct or an express agreement?
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 7/124
7
c. (3) Does it involve a third party trying to hold a principal liable for the agents tort?
3. Proving Agency
a. Burden: Person claiming there was principal-agent relationship has burden
b. Intent: Whether an agency relationship has been created is not dependent on intent of
parties involved; can arise even if the parties do not intent to be in relationship and may
not arise even if the parties do intend to be in it if certain conditions arise
c. Formation: Factual elements are key, must be an agreement between parties that the
agent will undertake some act on behalf of the principal, with the understanding that
the principal is to remain in control of the undertaking
4. Fiduciary Relationship: Every agent is a fiduciary and owes a high standard of care to her
principal. Must avoid conf licts of interest, self-dealing, disloyal acts and so on; similar to duty a
trustee owes her trustor and beneficiaries.
5. Gratuitous Agents: Agents who perform their services without gain and cannot be compelled to
perform the duty they have undertaken; the principal still may be liable for the torts of
gratuitous agents
6. Principals Duty to Agent: Under duty to compensate agent, including paying back for
expenses, unless contract out of it also has duty to cooperate with agent and aid in performing
duties assigned
Who is an Agent?
1. Relationship Defined: Fiduciary relationship that results from the manifestation of consent that
one person (agent) shall act on behalf of subject to control of another person (principal)
2. Manifestation of Consent: Objective
a. Does not matter what intentions of principal may be depends on what the agent
believed the principal intended
b. May arise even where the principal subjectively intended no relationship and without
true mutual consent
3. Creation of Relationship: Several different ways
a. (1) By agreement
b. (2) By ratification: occurs where principal accepts benefits or affirms the conduct of
someone purporting to act for the principal, even though no actual agency agreement
exists
c. (3) Agency by estoppels: principal acts in such a way that a 3rd
party reasonably believes
that someone is the principals agent
Gay Jenson Farms v. Cargill: creditor control over debtor 1. Facts: Jenson, , large global grain dealer, has K with Warren in MN (grain elevator, small
business). loans money to W and W appointed grain agent with CCC. has right to 1st
refusal. W gets money and paid back from draf ts drawn on through MN banks. Imprinted
with both s and W names and money went to . W gives yearly reports, keep books. W has
problems says reports were f ake. W f ails and 86 f arming s sue to get $2M in payments for
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 8/124
8
grant from BOTH W and . Jenson was claimed as principal with W as agent and was jointly
liable for Ws debt. Jury finds W was s agent.
2. Issue: Is liable as principal on contracts made by W by virtue of its course of dealing with W?
3. Held: Yes, they were principal with W acting as agent.
a. Control and Inf luence: s control and inf luence over W made them principal with
liability for deals of agent. It is OK to prove relationship with circumstance evidence
showing a course of dealing between two parties.
b. Creditor v. Debtor: Creditor who assumes control of debtors business may become a
liable principal for the acts of debtor in connection with business; whatever the terms of
K are, when creditor takes de f acto control over debtor, he becomes a principal.
c. Control and Continuous interference with internal aff airs: (1) W needed permission to
make capital improvements, declare a dividend or buy stock; (2) continually reviewed
Ws work and expenses; (3) recommendations that certain actions take place; (4) gave
W draf ts and forms with s name on them; (5) held right of entry to W premises with
intent to carry on period checks and audits
d. Consent: Principal must be shown to have consented to the agency relationship
consent occurred by directing W to implement its operational recommendations; W
fulfilled its part by acting on s behalf in obtaining grain.
e. Buyer-Supplier: To show non-agency, must prove that a supplier has an independent
business before it can be concluded that he is not agent. Evidence shows that W entire
operation was financed by and that W sold almost all grain to there was no
independent business.
K ey Issues: Jenson v. Cargill1. Other Potential Causes of Action: Refusal to Fund Line of Cases
a. Breach of implied contract to continue to fund bankruptcy trustee as standing in
shoes of W (getting for f armers as creditors)
b. Misrepresentation: if reps to f armers (we will back W) f armers as s (e.g. held itself
out as guarantor)
2. Effects of Decision: Nullified because there was unique f abric in the relationship and Court says
this case is unique, special and one of a kind
a. (1) Fewer lender control provisions in loan agreements less monitoring of elevator
operators, which means lenders would pull plug f aster on elevator loan def aults
f armers lef t as unpaid creditors and loans would be more risky
b. (2) Cargill owns elevators or stipulates that independent elevators are agents and
controls all prices for grain lower grain prices?
3. Mistakes of Jenson Court: Evidence and finding of effect of Cargill Representations to f armers is
missing what did the f armers reasonably believe? They had to reasonably believe that W was
an agent of Cargill.
a. Control equals responsibility: a f alse premise (corporations have limited liability) and
even so how much day-to-day operational control was in evidence because Cargill
didnt approve W grain purchases from f armers not approve excessive expenses
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 9/124
9
Transactional Lawyer: Lender Liability
1. Goal: Lower the interest charge by giving lenders control without liability
2. Solutions and Instructions for Client:
a. Stipulations: require W to stipulate it is not an agent and to include disclaimers of
agency in all W documents seen or signed by f armers
b. Name: do not let W use Cargill name in deals with f armers
c. Payments: no direct payments from Cargill to f armers
3. Risky Advice: Distinguish Jenson case a limited to grain merchants and not for bank loans; if so,
then case doesnt affect customer financing in supply contracts and bank financing
Distinguish Actual from Apparent Authority1. Actual: Conferred by contract; Apparent: conferred in equity
2. Close Case: Distinguish implied in f act actual authority from apparent authority
a. Both cases principal may be honestly surprised
b. Point of reference is key: distinguish reasonable view of agent (contract) from
reasonable view of third party (equity)
Liability of Principal to Third Parties in Contract
1. Authority: af ter establishing agency, 3rd
part wanting to hold the principal liable must show the
scope of the agents authority to act for the principal
2. Actual Authority (Mill Street v. Hogan): May be expressly conferred OR reasonably implied by
custom, usage or conduct of the principal to the agent
a. Express Authority: actually contained within the agency agreement
b. Implied: Comes from words or conduct between principal and agent; of ten labeled on
how it arose (1) incidental to express; (2) implied from conduct; (3) implied from
custom and usage and (4) implied from emergency.
3. Apparent Authority: Results when principal manifests to a 3rd
party that an agent is authorized
and the 3rd
party reasonably relies on the manifestation
a. Holding Out: must be some holding out by the principal that causes a third party to
reasonably believe the agent has authority and the 3rd
party MUST reasonably rely on
the principals manifestations
4. Inherent Agency Power (Wattau v. Fenwick) : Thought to be similar to doctrine of respondeat
superior in torts
a. Authorized Harm: It is inevitable that in course of performing duties, either by mistake,
negligence or misinterpretation of instructions, an agency may harm a 3rd
party or deal
with one in an unauthorized manner
b. Arises even in absence of actual or apparent authority or by estoppels from
designation by the principal of a kind of agent who usually possesses certain powers
c. Reasonable Foreseeability Test: Test is whether the principal could reasonably foresee
that an agent would take the action she did
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 10/124
10
M ill Street Church of Christ v. Hogan: Implied In Fact Authority from Past Conduct
1. Facts: Elders of Church, , hire BH to paint church. BH done many jobs for church in past and
had hired his brother, the , for them of ten. Painted most portion was high, spoke to elder
and asked for help. says hire G, but said it may be hard and never said MUST hire him. BH
hired brother instead and he worked for a while until fell and hurt arm. BH reported accident
and paid them both for hours worked. says was not an employee and that BH had no
implied or actual authority to hire him.
2. Issue: Did BH have authority to hire as an assistant?
3. Held: Yes, BH reasonably believed that the principal wished him to act in the scope of the way
he had acted.
a. Must determine whether the agent reasonably believed that principle wished him to act
in a certain way or to have certain authority Hogan reasonably believed he had
authority to hire to help him finish even though asked to hire GP but didnt require it
b. Prior dealings between principal and agent and nature of the task are f actors to consider
did it before, church even paid for the short time he had worked before the accident
Dweck v. Nasser: Apparent Authority
1. Facts: N, CEO, fired D, President, and members of board for operating competing businesses out
of their officers. Af ter cannot settle suit D hired Wachtel to help, although N had Heyman on
record, Shib. (another attorney for N for 20 years) executed settle onNs behalf requiring D to
pay 52.5% of profits and another $1.05M to N. N was to pay D for 30% interest in Corp. N says
not bound since Heyman didnt execute it.
2. Issue: Did Shiboleth have authority to bind Nasser into a settlement Agreement?
3. Held: Yes. Court says attorney had actual authority, implied authority and apparent authority.
a. Actual: because of 20 year relationship; N told him to do what he wants with K and both
S and H testified N granted authority to S to settle.
b. Implied: course of dealings over 20 year period of time including S settling many cases
for N before and N allowing S to speak on his behalf and directing to him to settle action
c. Apparent: because N knew S was working with H on settlement and S thought he had
the authority to act on Ns behalf
T hree-Seventy Leasing Corp. v. Ampex Corp.: Apparent Authority to Accept Contract
1. Facts: sues Ampex for breach connecting to sale of computers. J owns and was only
employee. K was salesmen of and fired of J. J meets with K and M, K boss, to talk sale of six
computers from to . M tells J could sell computers if could pass s credit
requirements. Negotiations continue K submits documents outlining sale to J for $100,000each with $150K down and rest in 5-years. Two signature lines, one for and . s line was
blank when J saw it K sent J letter confirming delivery. claimed no contract but only an offer
which required acceptance and.
2. Issue: Did , through conduct of agent K, show acceptance of the contract?
3. Held: Yes, affirmed.
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 11/124
11
a. On f ace, document doesnt show that had intent necessary to form a contract in that
the signature line was blank for s. In order to have valid contract, must find some act
of acceptance on part of , which comes in form of Ks letter for delivery dates.
b. says only supervisors have authority to contract for company non-issue because this
f act was never conveyed to , nor were any other f acts giving any reason to believe
that K did not have the authority to speak for and contract for . K was salesmen.
c. Apparent Authority Scope: An agent has apparent authority to do those things that are
usually and proper in the conduct of the business he is employee to conduct; in this case
it is reasonable for a third party to believe a salesmen has the authority to bind his
employer to sell
W atteau v. Fenwick: Inherent Authority
1. Facts: H owned bar called Victoria Hotel and sells to but still managed bar liquor license was
always in H name and had H name painted on door. Under contract with , H only had authority
to buy bottled ales and water for bar. Over years delivers cigars and other supplies, which H
orders, sues to get payment for these. was liable. 2. Issue: Is an undisclosed principal liable for the acts of an agent taken in the ordinary course of
business even if the principal did not authorize the agent to act, nor held the agent out as his
agent?
3. Held: Yes, even without apparent authority.
a. Generally when person carries out business through manager, he holds out his own
credit and is liable for goods supplied even if manager exceeds authority (need proof of
agency in f act in order to make the principal liable)
b. Distinguished here there was not holding out by the principal and the business was
carried out in agents name and supplied on agents credit
c. Complications of Undisclosed Principal: indicated that he gave credit to H alone andhad never heard of (had only heard of Humble) so actual authority is not workable
4. Rule: Principal is liable for all acts of the agent that are within the authority usually confided to
an agent of that character regardless of limitations put on that authority by the principal.
a. 2nd
Restatement of Agency: undisclosed principal is liable for acts of an agent done on
his account if usual or necessary in such transactions, even if they are forbidden by the
principal. An undisclosed principal who entrusts his agent with management of his
business is liable to 3rd
parties with whom the agent enters into deals in the usual course
of business even if the agents actions are against the principals directives
Practical Issue: Lack of Express Authorityy Attorney of Record Confusion
y Actual/Implied Confusion
y Implied/Apparent Confusion
s Lawyer: Principle is Bound If:
1. General Direction Only: Specific power implied in f act. Actual authority
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 12/124
12
2. Explicit Reservation of Authority Disregarded (No Implied Authority): Must show apparent or
inherent authority
a. Inherent Authority = Undisclosed principal (Watteau)
3. Contractual Formalities Fail (Authorized Agent doesnt sign): Cannot use actual authority
a. Must show apparent or authority of employee (Ampex)
Transaction Lawyer: Recommendations - What should a lawyer tell a client to do to control oral
promises by employees?
1. Develop customer forms for use by employees that contain limits
2. Develop info packets for customers that disclose limits and disclaim oral agreements
3. Develop procedures to monitor employee contracts
Litigators Problem: When do I have the authority to settle? Good Practice:
1. Rarely, if ever, sign or agree, on behalf of client; time pressure or availability?
2. Normally I will present whatever we negotiate to my client for a final approval. Lawyer
represent he has authority to pass on bargaining positions (notif y other side if client is fickle?) 3. Can lawyer promise to recommend it to my client to judge or opposing counsel?
Distinguish Actual from Apparent AuthorityActual Authority Apparent Authority
How Conferred? By Contract In Equity
Point of ReferenceDistinguish reasonable view of
agent
Distinguish Reasonable View of
Third Party
Situations
y Actual or real contract y May be oral or written
y May be express of implied in
f act
y Apparent authority y Estoppel
y Ratification
y Close Call: Distinguish Implied in Fact Actual Authority from Apparent Authority
y Key is Point of Reference: Reasonable view of who?
o Agent: Contract
o Third Party: Equity
Ex Post Authority: Ratification
1. Ratification: Principal affirms and agrees to be bound by past acts of otherwise unauthorized
agent professed to be done on principals behalf .
a. May be express or implied in f act
2. Situations: A person may affirm or ratif y a prior act supposedly done on his behalf by another
that was not authorized at the time it was performed.
3. Effect: Causes the agents act to be treated as if the principal had authorized it at the outset
4. Requirements: Intent and full knowledge
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 13/124
13
5. Examples of Ratification
a. Express: if agent of corporation makes a deal outside scope of employment and
corporation still takes the money from the deal, the corporation has expressly ratified
the agents authority in the deal and are liable
b. Implied in Fact: did the principle impliedly agree to ratif y the deal?
Botticello v. Stefanvicz: Apparent Authority by Ratification
1. Facts: Husband and Wife, s, own f arm as tenants in common and makes $75K offer to buy.
Wife tells should couldnt sell for less than $85K and then and husband agree to $85K for
lease with option to buy. Agreement prepped by husbands lawyer and signed by and
Husband. s attorney didnt perform search on property and was unaware of wifes interest.
Husband never indicated to or attorneys that he was acting as wifes agent. took possession
and improved it. Attempted to use option to buy and s refuse to honor. sues for special
performance. Court finds for .
2. Issues:
a. (1) Do the f acts and law support a finding that husband acted as an agent for his wife?b. (2) Did wife ratif y the contract by her subsequent conduct?
3. Held: (1) No, not an agent. (2) No, judgment reversed no ratification.
4. Rule: Existence of an agency relationship is a question of f act and cannot be proved merely by
marital status, nor by joint ownership. For agency, must be shown that
a. (1) the principal consented to the agent acting for her
b. (2) that the agent accepted the undertaking
c. (3) that the parties understand that the principal would be in control of the undertaking.
5. Agency Applied: s admit to sale, wifes statement of selling for no less than $85K is not the
equivalent of an agreement to sell for that amount. Even if husband handled business matters
for f amily, he never signed any document before as agent for wife because wife had ALSOconsistently signed any deed, mortgage or note in connection with the property they held
jointly.
6. Ratification Applied: Ratification requires acceptance of the results of a prior act with an intent
to ratif y and with full knowledge of ALL the material circumstances.
a. Here f acts do not establish that wife had intent required to ratif y or full knowledge of
terms in contract. Even though wife saw using property and improving it and got
payments from , it is not enough to show she had full knowledge of all the material
terms of the agreement
b. No Ratification by Inaction: Because husband had power to lease undivided ½ interest
in property and nothing to show that wife had any reason to believe was for anything
more than that. may proceed against husband for specific performance damages but
not wife.
Implied in Law Authority: Estoppel1. Distinguished from Apparent Authority by Detrimental Reliance AND
a. (1) Cause OR
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 14/124
14
b. (2) Knowledge and f ailure to correct
c. Apparent authority makes the principal a contracting party with the 3rd
party with the
rights and liability on BOTH sides
d. Estoppel only compensates the 3rd
party for losses arising from the 3rd
parties reliance
and creates NO enforcement rights in the principal against the 3rd
party
2. Elements: A principal is estopped from denying the agents authority, when he
a. (1) negligently or intentionally
b. (2) causation: causes a 3rd
party to think his agent has authority to do an act that is
actually beyond his authority AND
c. (3) detrimental reliance: the 3rd
party detrimentally relies on the principals conduct
Hoddeson v. Koos: Estoppel by storeowners negligent surveillance
1. Facts: shopped at furniture store. Approached by man assumed was salesmen and placed
order for $168 without receipt, the goods were never delivered and when called store they
had no record. Store claims that man was not agent but imposter salesman operating without
knowledge or . 2. Issue: Circumstantially, can be liable for acts of imposter even if the imposter was not s
agent?
3. Held: Yes, wins.
a. Burden: when a party seeks to impose liability on a principal for a contract made with
an alleged agent, the burden is on the to prove the agency relationship.
b. Apparent Authority: imposter obviously didnt have express or implied authority to sell
and couldnt prove that appearance of authority was created by the manifestations of
the alleged principal.
c. Appearance of Authority: created by the manifestations of the imposter salesperson
alone and f ailure to prove this element of agency requires a reversal of the judgment. d. Duty of Care for Store: store has duty of care for safety and security of customer which
extends to reasonable care and vigilance to protect the customer from loss by deception
of imposter operating on premises. Tortious dereliction of duty to an invited customer.
e. Fact-Based Analysis: Sale took 30-40 minutes, through s lack of reasonable
surveillance and supervision, imposter operated as f ake for lengthy time.
Agents Liability on Contract 1. General Rule: An agent is not liable on contract executed on behalf of principal but is ultimately
depends upon the status of his principal
2. Status - Disclosed Principal: An agent who purports to contract for disclosed principal is not
personally liable on the contract.
a. Example agent negotiates the contract in the name of the principal and agent is not a
party to the contract.
b. Intent - Parties intent is that the principal be bound.
3. Status Undisclosed Principal: An agent acting on behalf of an undisclosed principal is
personally liable on the contract.
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 15/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 16/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 17/124
17
3. Controls or Has the Right to Control: Direction vs. Advice is key distinction?
a. Problem: When is advice mandatory when backed by termination power. If so, advice
is always followed.
b. Termination power alone is enough? Right to Control, absence of exercise control not
definitive
Humble Oil Refining v. M artin: Liability is Question of Fact
1. Facts: L lef t car at gas station owned by for service and before anyone there touched car, it
rolled down hill and struck and daughters. sued L for negligence and jury gives damages.
says it was not liable because service station was operated by independent contractor, S.
2. Issue: Do the f acts indicate a relation of master-servant between S and so can be liable for
negligence of S and other service station employees?
3. Held: Yes, S was an employee of not independent contractor f acts show.
4. Question of Fact: Contract between and S, s
exercise of control over operation of station, both show
that S was an employee. a. Contract as Proof : Shows owned station, had
financial control, set hours, provided its own
auto products for sale and set the price of those
products; Also paid 75% stations public utility
bills, gave equipment, ads media and products
and paid a lot of operating costs.
b. Employee Actions: No business discretion
except as to hiring, firing and payment of a small
amount of employees.
Hoover v. Sun Oil: Independent Contractors
1. Facts: was hurt when car caught fire while being filled
with gas at station owned by and operated by B.
Accident was due to negligent of employee, S. sues ,
B and S.
2. Issue: Was B an agent of such that could be liable
for negligent actions of Bs employees?
3. Held: No, f act based.
4. Facts Proving B to be Independent Contractor: B made
no written reports to and alone assumed risk of profit or loss in business operations; he independently set the
stations hours of operation, pay scale and working
conditions of his employees.
a. Typical Relationship: B and had typical company-service station relationship. B
advertised and sold gas and other products with s label. s sales people occasionally
came to station to take orderly, look at restrooms and talk about any problems B had.
Humble Oil v Martin
Humble Oil
Service Station
Public
Products Repair
Schneider
Manis
Martins
Hired
Hired
Tort
Liability??
Schneider paid commissionson products; kept repair fees;
paid some ³rent´
Held: Yes
Hoover v Sun Oil
Service Station
Sun Oil
Barone
Lease
Rent $
Smilyk
Hired
Hoove
Tort
Liability??
Rent payments depended on gas sales inside a
minimum and maximum.
Held: No
Owned
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 18/124
18
b. Suggestions v. Obligations: made suggestions to B to improve sales and marketing BUT
B was under no obligation to follow the advice.
M iller v. M cDonalds: Franchisor Liability (Oregon, 1997)
1. Facts: sues McDonalds () for injuries she got when she bit into stone while eating burger.
That McDonalds was owned and operated by franchisee, 3K. 2. Issue: Was there an agency relationship and 3K that could make liable for s injuries.
3. Held: Yes. Franchise agreement created agency.
a. Agreement Facts: Laid out detailed instructions on how to operate the restaurant.
Periodically sent inspectors to ensure conformity.
b. Jury could find that reasonably retained sufficient control over 2Ks daily operations
such that an actually agency relationship existed
4. Test for Apparent Agency: Whether the putative principal held the 3rd
party out as an agent and
whether the relied on that holding out.
a. Everything about appearance of McDonalds owned by 3K identified it with the and
common image it has created by national advertising, common signage, menus anduniform.
b. said she went to restaurant under belief that it would have same quality of service
and care as other McDonalds around the country
M urphy v. Holiday Inns: Slip and Fall Litigation(VA, 1975)
1. Facts: fell on sidewalk outside of BMH Corp. owned hotel. BMH entered into license with
Holiday Inn to use name subject to terms. provides name, quality assurance, national
advertising and system of operation in return for fees for BMH.
2. Issue: Did exert control over BMH to extent that it would constitute an agency relationship?
3. Held: No, No principal-agent or master-servant relationship exists even with specificrequirement in franchise contract.
4. Reasoning: The franchise agreement was only to standardize the business identity, commercial
service and only for the benefit of both parties. never had control over day-to-day operations,
maintenance, rates, wages, etc. BMH has retained all power that an owner and operator of
business have.
Practical and Policy Questions: Compensation
1. Distinction between Murphy and McDonalds: Person though McDonalds built, owned and
operated as part of business
a. Ignorance of 3rd
Party allows it to sue because they do not know about agency orapparent authority
b. Ignorance sets up apparent authority v. protection of franchisor question if let all
these people sue, franchisors will not come to state
2. DistinguishMurphy/McDonalds v. Humble and Sun Oil: Oil companies owned the stations,
while BMH and 3K owned their business just had contract
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 19/124
19
a. Contract does not control must look to details of control in contract to see if agency
relationship exists
3. Does law discourage company ownership of retail outlets in favor of franchises?
a. Yes, because they already do. If you have control, you lose apparent authority
4. Does this discourage active involvement:
a. Yes, if you are a franchisor and show up and tell franchisee what to do you may be liable
(clean the bathroom liable); cook burgers right are you liable?
b. Business incentives are created by law
5. When is control plus liability less expensive than no control and no liability?
a. Control reduce accident, absorb costs that occur, better marketing, more product sale
b. No control leave accident reduction to operator, avoid liability costs, suffer sloppy
local practices (unclean toilets), fewer product sales
c. Business Decision: What would make me more money?
6. Transactional Lawyer Issues:
a. When is a supplier or franchisor liable for torts of distributor? When controls day-to-
day, maybe, or subjective test.
b. Can a supplier or franchisor limit liability for control agreements at the margin of the
legal test? Make sure documents are in franchisees agreement, make ads mention
franchisees
c. How do we cut off apparent authority? If local customers think McDonalds controls a
local franchisee, are they liable? Use objective test. Real control (sent to clean and they
cleaned) v. Right to Control (had power to inspect but did not)
Scope of Employment Defense1. Defined: For Respondeat Superior to apply, the employee must have committed the tort within
the course and scope of employment.
2. Elements: A reasonably foreseeable act that
a. (1) Must have engaged in work for the employee of a type that he was employed to
perform
b. (2) during work hours
3. Factors: (1) authorization of act by employer; (2) time; (3) place; (4) purpose of act, (5) common
practice; (6) extent to which interest of employer or employee was involved, etc.
4. Intentional Acts: Liability extends to intentional acts if the act is related to carrying on the
employers business
a. Recovery for employees assault may be within scope of employment
b. Serious crimes excluded
c. Miller v. Federated Dept. Stores: interfering with agents duties to principal; agent
responding to interference
d. Issue: Is an employer liable for injuries to a victim of an employees assault.
e. Rule: To relieve himself of liability for injuries from an employees assault, the employer
must show that the assault was in response to the s conduct which was presently
interfering with the employees ability to perform his duties successfully.
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 20/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 21/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 22/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 23/124
23
b. Obey directions and act only as authorized
2. Duty of Loyalty: Restatement Section 387
a. Agent must not compete with his principal anything that an agent obtains as result of
his employment belongs to that principal, barring the retention of secret profits,
advantages and benefits without the principals consent
3. Duty of Candor: Restatement Section 381
a. Duty to give information, keep and render accounts
Reading v. Regem: Secret Profits and Duty of Loyalty
1. Facts: was UK sergeant in Egypt would board truck with unknown contents each week and
escort them through Cairo in uniform. Passes civilian police without inspection and paid large
sums for work. Military finds activities and take money from for crown. Sues to get back.
2. Issue: Is entitled to recover money he made outside the scope of his employment?
3. Held: No, crown justifiably took money.
4. Reasoning: If a servant unjustly enriches himself by virtue of his service without his masters
sanction, the law says he should not be allowed to keep the money and it should be given to his master.
a. Because got the money SOLELY by reason of position he occupied as servant of the
crown uniform and position as servant to Crown were only reasons he was able to
obtain this money which is sufficient to cause him to forfeit it
General Automotive M anufacturing v. Singer: Duty to Disclose Information
1. Facts: was employed by as general manager with contract requiring he not engage in any
other business during his employment and that he not use or disclose any info concerning for
own benefit or to s detriment. Duty as GM was to get work for machine shop he was
successful. Then, took on orders he didnt feel had capacity for and didnt inform that hewould hire another shop to do the work at a lower price than he quoted and would keep the
difference.
2. Issue: Did breach his fiduciary duty to by f ailing to inform of the existence of orders
may not have been able to fill?
3. Held: Yes. Breach.
4. Reasoning: was acting as broker for his own profit in a field where he had contractual duty to
work only for . had fiduciary duty as an agent of to exercise good f aith and loyalty BUT
instead acted in self-interest and adversely to .
a. Failure to Disclose by f ailing to disclose the existence of the secret orders, he was in
violation of fiduciary duty to act solely for benefit of and liable for profits earned
Termination of Agency and Grabbing and Leaving1. General Default Terms:
a. Terminable at will of either party
b. Otherwise end of reasonable term or when specific act is performed
c. OR on violation of duty
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 24/124
24
2. Stipulations: if parties stipulate a set term by time or by task
a. Either can breach principal revokes or agent renounces
b. Remedy limited to damages, no specific enforcement or injunction
3. Grabbing and Leaving: Post-termination competition with a former principal is allowed BUT
former agent cannot disclose trade secrets or other confidential information during his
employment solely because he was agent
T own & Country Home v. Newberry: Soliciting Former Employers Clients
1. Facts: was cleaning business and worked for for three years. Af ter leaving, set up own
cleaning business to directly compete and solicited s clients. brings action for injunction and
damages dismissed.
2. Issue: Can enjoin s from soliciting its clients?
3. Held: Yes, the only trade secret that could be involved in a case like this was s list of
customers.
a. Ex-employees solicitation of employers customers, obtained at considerable cost, was
breach of duty of loyalty b. Conspiracy theory of Apellate Court en masse departure
M icrosoft v. Google: High-T ech Industry
1. Facts: Computer engineer Lee lef t Microsof t to work at Google and Microsof t sued under one
year non-compete clause and confidentiality clause in the Microsof t employment contract.
2. Disposition: Case settled, while dirty laundry was aired.
3. High-Techs generally have employees sign multi-layer confidentiality and non-compete
agreements to stop from giving away trade secrets
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 25/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 26/124
26
i. Tax Example: for tax purposes, income and losses of the partnership are attributed
to the individual partner the partnership itself doesnt pay taxes although it does
file an information return
b. Entity Characteristics: some purposes, partnership is treated as a separate entity apart
from individual partners
i. Capacity to sue or be sued: jurisdictions vary as to whether partnership can be sued
in own name e.g. if federal question is involved then it can in own name in federal
courts
ii. Ownership of property: can own and convey title to real or personal property in its
own name without all partners joining in the conveyance (UPA § 8)
c. RUPA § 201 (Simplification): unlike the UPA, RUPA expressly states that a partnership is
an entity and simplifies many partnership rules like those on property ownership and
litigation
The Decision to Form a Partnership and Split Equity1. Case Example One: You have capital and need labor, skills and management
a. Option 1 pay an employee (sole proprietorship)
b. Option 2 Split equity partnership (moneybags to pay worker bee)
2. Case Two: Have labor but need money
a. Option 1 borrow money (sole proprietorship)
b. Option 2 split equity partnership
3. When to split equity: Lowest contracting cost business decision
Partnership Formation: Default Rules1. Defined: Partnership is a voluntary association and there must be an express OR implied
agreement in order to form one
2. Actual RUPA § 201: Real or by consent
a. Affirmative: co-owners of a business for a profit
b. Negative: not a tenancy in common, employer/employee relationship (sole
proprietorships) or lendor/debtor relationship
c. Factors: sharing of profits, not gross returns proxy for control?
3. By Law RUPA § 308: Implied in Law
a. Equity
b. Partnership by Estoppel (holding out) 4. Formalities: If the partnership is continued beyond one year, Statute of Frauds states that it
must be written
5. Duration: if no term is specified, then the partnership is terminable at the will of any
partnership
6. Capacity: persons must have capacity to contract to be partner some states hold that
corporations cannot be partners
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 27/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 28/124
28
Agreement says no partnership is intended, until loan was repaid, Des were to get 40% of KNK
profits; collateral was given to s in form of speculative securities owned by KNK; all dividends
on securities loaned by s were to be paid to s ; s were to be consulted on all important
matters and had power to inspect and veto assigned interest and had option to join firm at
anytime. Each KNK partner had given letter to resign which could be accepted at anytime by s.
s couldnt initiate any actions or binds firm for their actions.
2. Issue: Has a partnership been formed?
3. Held: No this is a lender-lendee agreement and unpaid creditors cannot collect from s.
4. Reasoning: Sharing of profits is considered an element of a partnership, but not all profit-
sharing arrangements show that a partnership agreement exists.
a. Language saying no partnership is intended is also not conclusive
b. Must look to entire agreement to make the determination and all features of the
agreement are consist with a loan agreement, not a partnership agreement.
c. Return 40% profits capped at $500,000 with minimum of $100K; option to buy up to
50% of firm
d. Protective covenants; collateral; substantial management rights; assignment; right to
control loaned securities
5. OrganizationalNote: If KNK had organized as a Corp., LLC or LLP, the s would have avoided any
risk of liability. Under those forms, as equity investors, s could not have been held personally
liable for the firms debts.
Loan Covenants1. Danger: Martin and Cargill cases show danger of overly aggressive loan covenants
2. Martin result: maybe different if trustees had been aggressive in monitoring KNK under
covenants?
a. Different if the trustees had vetoed investments, fired partnerships, run all distributions
through a controlled bank account?
b. Potentially different because of difference between right to control and exercised
control
Transaction Lawyer: Creditors and Lenders
How could Peyton lawyers have better drafted deal agreements to reduce litigation risk and still
accomplish business goals?
1. Use Limited Liability Vehicle
2. Use more Traditional loan covenants on management rights trust indenturea. Can be very powerful veto rights
a. There are grave dangers to novel deal terms
Debt/Equity Distinction: Introduction1. Tax Effects: interest deduction v. no dividend deduction
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 29/124
29
2. Liability Effects: Assume Insolvent Firm
a. Partnership: in creditor pool claiming share of lef t-over assets v. paying all unpaid
creditors as well as losing investment contribution
b. Limited Liability Entities: Asset distribution priority creditor pool v. residual equity pool
Southex Exhibitions v. Rhode Island Builders: Service Contract or Partnership? 1. Facts: s entered into agreement with SEM, predecessor-in-interest to s regarding future of
s shows in RI arena. Agreement stated that wishes to participate in shows as sponsors and
partners and have 5 year fixed terms, renewable by mutuality. agrees to sponsor and endorse
only SEM, to persuade members to have exhibits at SEM shows and to allow SEM to use name
for promos. SEM agreed to obtain licenses, leases, permits, etc., indemnif y for show related
losses; could accept/reject any potential exhibits, audit show income and advance necessary
capital to finance shows. Mutually determine show dates, prices, bank.
2. Issue: Does a partnership exist between the parties?
3. Held: No. Not a partner, totality of the circumstances test and lack of dissolution rights (renewal
obligation) showed non-partnership. a. Producer absorbed all losses; management rights uneven
b. Also no public self-identification (e.g. no partnership tax return; no partnership
contracts with third parties)
4. Reasoning: Evidence of profit sharing is prima f acie evidence of partnership, and f ailed to
show any enumerated exceptions, BUT without any intent to form a partnership a finding of one
is not compelled.
Lawyers: Renewal Rights
1. Normal Situation: This is a more normal situation than Fenwick
2. Good Litigator: suggests to client af ter-the-f act that a partnership structure is possible and has litigation advantages
a. Client thats good, we were partners, then.
b. Contemporaneous self-declaration is think because no partnership tax returns, no name
or title sharing. Court sees through it.
3. How could Southex better protect renewal rights?
a. Contract language on good f aith
b. Renewal expectations in agreement leave little open to interpretation
Partnership by Estoppel
1. Liability of Alleged Partner: One who holds self out to be partner, or who expressly or impliedly consents to representations that they are partner, is liable to any 3
rdperson who extends credit
in good f aith reliance on such representations (UPA § 16)
a. Example A represents to C that she has wealthy partner in B in order to get credit; B
knows of the representations and does nothing to tell C she is not partner; C makes loan
for purposes of the loan, B will be held to be a partner with A but has no other rights
to participation in As business
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 30/124
30
2. Liability of Partners who Represent Others to be Partners: If in above example A were part of
actual partnership, then she would make B an agent of the partnership by her representation
that B was also a partner in this case, B could bind A as though they were f actually partners
but only those other partners of A who made or consented to As representations would be
bound
Y oung v. Jones: Liability of Affiliated Company (DSC, 1992)
1. Facts: PW-B is Bahamian general partnership and PW-US is NY GP. s invested $550K in SAFIG
based on unqualified audit letter on SAFIG by PW-B. Af ter funds disappeared and s learned
that SAFIG f aked statements s allege that two are partners by estoppel because of
letterheads and signatures and similar names.
2. Issue: Do a US firm and its foreign affiliate operate as partners by estoppel when the foreign
affiliate uses the firm name and trademark, and the US firm makes no distinction in its
advertising between itself and foreign affiliates?
3. Held: No, case dismissed.
4. Reasoning: Two firms are organized separately, there is no partnership in f act. a. UPA § 16 says that a person who represents himself or allows another to represent him
to anyone as partner in an existing partnership or with others who are not actual
partners are liable to anyone whom relies on this representation in good f aith
b. An exception to the rule that persons who are not actual partners as to each other are
not partners as to 3rd
parties
c. This case s do not contend they saw the PW-US brochure or that they relied on it in
investing nor does it say that affiliated entities are liable for each others action. Must
show actual reliance.
Partnerships: Governance, Dissociation, Dissolution andLiquidation
1. Governance and Default Rule UPA § 401(j): Ma jority of partners have power to make all
business decisions within the ordinary course of partnership business
a. Minority dissenting partner cannot opt out, even by informing third party of dissent
b. Third party cannot rely on authority of minority; dissenting partner to bind partnership
c. Problem: apparent authority?
2. Dissociation, Dissolution,Winding Up and Liquidation - Default Rule for At Will Partnerships
(RUPA § 801(1)): Any partner can walk and force liquidation absent other circumstances
(partnership agreement denies option/bad behavior)
a. Duty of Confidentiality
b. Duty to Account Survive
c. Def aults: problem for modern business too easy to leave without no capital lock up;
leaving means that remaining equity owners must reconstitute entire business
3. DissociationWrongful or Not Wrongful?
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 31/124
31
a. Not wrongful: at will partnership RUPA § 601(1) no term or task Death, Bankruptcy,
Court Order
b. Wrongful: breach of partnership agreement (even if partnership is at will) OR short of
agreed term of task
4. Effects of Wrongful or Not Wrongful Distinction: Can remaining partners continue partnership
or may partnership dissolve? RUPA § 801.
a. At Will Partnership Dissociation: Liquidation unless wrongful or plus, kicking out on
proper grounds by unanimous vote or on more general grounds by court order,
bankruptcy of partner, death or incapacity must liquidate
b. Term or Task Partnership: special rules
c. Damages?
M einhard v. Salmon: Duties with Regard to Outside Opportunities
1. Facts: G leased hotel to for 20 years; with agreement, had to spend $2M in improvements
shortly af ter, entered joint venture with to pay1/2 of money needed to alter and manage
property receiving 40% of net profits for 5 years and 50% af ter. had sole power to manage,interest in lease never assigned to . End of deal tried to put deal together to level all property
to put up large building but f ailed and asked to enter new lease for 80 year renewal period.
found out about it and demanded it be held in trust as asset of their joint venture.
2. Issue: Does the new lease come within s fiduciary duty to his joint venture partner as a joint
venture opportunity?
3. Held: Yes. was entitled to ½ interest in the new lease and must assume responsibility for ½ of
obligations.
4. Reasoning: Joint venture partners have highest obligation of loyalty to partners including and
obligation not to usurp opportunities that are incidents of the joint ventures
a. Close Nexus: there was a close nexus between joint venture and opportunity that was brought to manager of JV as it was essentially extension of subject matter
b. controlled gets 51% and should get 49%
5. Punctilio Paragraph: Not honestly alone, but the punctilio of an honor the most sensitive, is
then the standard of behavior.
a. If a court cites this case, the will lose, if the court uses the term punctilio, the will
lose big.
6. Correct Decision:
a. Yes Salmon is greedy and secretive, this is just a renewal when they had the
expectation of sharing.
b. No Would parties have negotiated to the holding ex ante probably not, this is a huge
change in operations and 50/50 split with a passive investor doesnt make sense;
Meinhard had right of first refusal in financing better approximation
7. Rebuttal and Penalty Default: Rules force the party with the information about future
opportunity (Salmon) to disclose that information to the other party (Meinhard) to avoid an
undesirable result. It is not the rule that the parties would have contracted for ex ante.
a. Problem: af ter Salmon disclosure, they do not agree and M sues, who wins?
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 32/124
32
Partners Fiduciary Duties: Defaults1. RUPA § 404: Only (without RUPA § 403) on old Duty of Candor (information) lef t out
a. Duty of Care: Business Judgment Rule (gross negligence rate of agreement, grossly
means that 9 of 10 people would agree)
b. Duty of Loyalty: account, conf lict of interest, non-compete (may be waived in § 103)c. Duty of Good Faith and Fair Dealing: added to RUPA
2. RUPA § 103: Agreement May NOT
a. Unreasonably restrict § 403(b) information
b. Elimination duty of loyalty except for (1) categories of acts if not manifestly
unreasonable or (2) cleansing vote
c. Unreasonably reduce duty of care
d. Eliminate Duty of Good Faith/Fair Dealing but may prescribe standards if not manifestly
unreasonable
Duties after Dissolution of a Law Firm1. Duty of Care: Bane v. Ferguson terminates on end of partnership ex-partners as creditors
BJN introduced - RUPA § 404(c)
2. Duty of Loyalty: Meehan v. Shaughnessy procedure for soliciting firm clients
a. Held: breach on the facts no candor; client notice and other communications not
proper
b. Duty to Account for Fees from partnership clients serviced by Ex-Partnerships (later in
Chapt.)
Lawyer Leaving Firm: What Actions to Take
1. What should do: sit down with the firm and tell them you are leaving jointly negotiate a letter signed by both firm and you; then cut a deal on how the clients will get approached
a. Clients have the choice on who to go to cannot just say that will not give them the file
2. Reality - Firm will kick you out in reality write your letter af ter you already are packed and give
it to them
Perretta v. Prometheus: Opting out of Fiduciary Duties
1. Facts: Prometheus PIP and PDC were partnership to manage two apartment complexes PDC is
100% owned by DNS. Peretta was limited partner in partnership between POP and PDC, PD
notified limited partners that it would merge into PIP Partners-General, which was owned by
DNS and daughter of DNS. Proxy statement sent to LPs with terms and asking to approve it said PIP would vote neutrally. Peretta alleges merger was self-dealing transaction in violation of
PDCs duty of loyalty by setting an unf airly low price
2. Issue: Can we count votes?
3. Held: The partnership agreement controls. Partners werent harmed at expense of partnership;
ratified it properly, so not in breach.
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 33/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 34/124
34
a. was fired to improve our lawyer to partner ratio and f acts showed that was less
productive when an alcoholic and initially concealed problem
b. There was no real issue the firm acted in good f aith to kick him out
Partnership Property1. What is it: Issue is whether property is partnership property of the individual property of a
partner; all property originally brought into the partnership or subsequently acquired, by
purchase or otherwise, for the partnership is partnership property UPA § 81(1)
a. RUPA § 203: partnership holds property as an entity separate from partners
2. Intent: Where there is no clear intention expressed courts consider all f acts related to the
acquisition and ownership of asset
a. Factors: (1) How title is held; (2) partnership funds used in purchase; (3) used to
improve; (4) central to partnerships purpose; (5) frequent and extensive is partnerships
use; (6) accounted for in financial records of partnership
3. Partners Property Rights in RUPA § 501: a. (1) Right to use specific partnership property RUPA § 401(g) tenancy in partnership
b. (2) Owns a partnership interest RUPA § 501, personal property
c. (3) Right to participate in management
Putnam v. Shoaf: Conveyance of Partnership Interest
1. Facts: FJ Gin Co. originally operated as equal partnership between EC, LC, LP, and CP in
agreement, CP succeeded her husband LP af ter death. CP decided to sever relationship and
relief from debt liability owed by gin to Bank. Shoaf s agree to take over position and assume
personal liability for all debts if CP and Cs each paid $21,000. FJ Gin has negative $90K
agreement. All Gin assets and land held in partnerships name and CP conveyed her interest toShoaf by quitclaim deed. In 1977 bookkeeper leaves and find out he embezzled money banks
pay $68,000 into court. ½ sum paid to C and other to dispute to S and CP
2. Issue: When a partner conveys her partnership interest to another, can she later claim an
interest in a recovery resulting from a chose in action unknown to the parties at the time of
conveyance of the interest?
3. Held: No, partner can only convey interest, legal claim of the partnership asset. There was no
existing interest by the exiting partner.
4. Mistake: Right result but wrong reasoning
a. Court treats agreement as partnership assignment under UPA § 27 but assignment
doesnt dissolve partnership itself ; need court decree under UPA § 32(2) and interest can be conveyed, pledged, subject to execution
b. Interest portion of profit and surplus minus cash f low
c. Agreements were in f act a voluntary dissolution under UPA § 31(1)(c) because Putnam
held ½ assets as tenant in common and conveyed all title to S secured release from
ma jor credit and assumption from S; still secondary liable on some debts if creditor
without knowledge of dissolution
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 35/124
35
Problems: Capital Contributions and Free Riders
1. Major Problem: when firm needs more money but some partners dont want to give it or have
enough to give (no requirement to give cash in def ault rules game of chicken)
2. Start Up Capital Equity S1m; Loan $9m
3. New Capital Default Rule: No obligation to contribute, no new partners without unanimous
consent; ma jority of partners can agree to borrow or accept new capital contributions from
existing partners
a. Free Riders: let other take risk of putting in new money and sit on initial capital
contribution
4. Agreements: Pro Rata Agreements: pro rata equity call, penalty dilution, pro rata loans, sale of
shares to new partners, promoter must make loan (def ault rules dont allow without unanimous
vote of all the existing partners)
a. Private Equity Funds: equity calls with caps, refuse, penalties (option in manager to sell
interest or dilute interest)
5. Free Rider Problem: Partners Choice $25K cash paid
a. If make loan to partnership of $12.5K, $37K now at risk
b. If no loan and keep $12.5 cash; $25K at risk and same return if someone else loans an
extra $12.5
c. Answer: Collective action, we all make loan or no one does; game of chicken and who
can bluff better
Partners Management Rights: Defaults1. Equal Rights: in management RUPA § 401(f)
2. Disagreements: ma jority on ordinary matters; unanimity with veto on ma jor changes to
partnership in UPA § 401(j)
3. Effects on Agency Powers RUPA § 301:
a. Power to Bind Partnership in the ordinary course: of the partnership business unless no
actual or apparent authority
b. Power to Bind in Extraordinary Matter: only if authorized by all partners
4. Stalemate Problem: Two partners disagree on deal, can one partner bind the partnership to the
deal?
a. If ordinary: YES, RUPA § 301 controls as def ault; no partnership decision to change
def ault rule is effective
National Biscuit v. Stroud: Cannot Escape Responsibility 1. Facts: and F enter partnership to sell groceries under Strouds name. No restrictions on
management functions of either. told s that he would not be responsible for additional
bread delivered. F still orders $171 more bread from . and F then dissolve partnership and
was responsible for the winding up; refuses to pay.
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 36/124
36
2. Issue: Without restrictions in the PA as to authority, can an equal partner escape responsibility
for obligations by notif ying a creditor that he will not be responsible for partnership debts
incurred with that creditor?
3. Held: No, third party knowledge of disagreement does not affect actual authority to sign bread
delivery contract.
a. Acts of partner within the scope of partnership business bind all partners.
b. A ma jority of partners can make a decision to inform creditors and then will not be
bound but acts of minority in contravention but there is no ma jority here.
4. Dissolution: Had dissolved the partnership and given notification prior to order by F,
would not have been personally liable for the partnership debt to .
5. Why not allow Stroud to opt out by notification? RUPA allows it, but it protects partnership
from hold-up power of minority partners.
6. How can Stroud protect himself?
a. Ex ante partnership agreement
b. Ex post dissolve partnership and notif y 3rd
parties that he is not liable; Fs agency
survives in the winding up period, however
Summer v. Dooley:M ajority Resolutions
1. Facts: and entered into partnership, operating trash business. Both worked, each providing
and paying for sub when couldnt. asked to hire a 3rd
person and refused, hired one
anyway and paid him with own funds. When found out, he objected. sues for
reimbursement.
2. Issue: In a two-person partnership, can one partner, over the objection of the other partner,
take action that will bind the partnership?
3. Held: No, no actually authority to hire employee. Either not ordinary or not reimbursable
between partners under UPA § 18(b) distinguish third-party cases. a. When one of two partners refuse to consent to hiring a third person and objects upon
finding out hiring there is no sitting idly by and acquiescence in the actions and it
would be unjust to allow to recover
Partnership Tort Liability1. Rule: partnership liable for partners wrongful act in ordinary course of business or with
authority of co-partners RUPA § 305
2. Indemnification: There is no indemnification against partner causing injury (def ault)
M oren ex Rel v. JAX: Indemnification1. Facts: M, partner in JAX, one day M brings in son, , to restaurant while she worked; sat and
rolled dough while pressed hand in roller.
2. Issue: Does have indemnity right against Nicole Moren?
3. Held: No, there is no right to indemnification against partners.
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 37/124
37
a. Distinguished from Agency: partnerships are distinct entities from their partners and
must indemnif y a partner for injuries occurring in the ordinary course of the partnership
business
b. No corresponding right for indemnity for the partnership against the partner
4. Conduct Serving Interests of Partnership: Conduct was in ordinary course of business
a. Liability for Ms negligence rests with the partnership, even if her conduct partly served
her personal interests, she was acting for the benefit of the partnership at the time of
the injury even though she was also acting in her role as mother
Day v. Sidley Austin: Law Firm M anagement
1. Facts: Day was partner at SA with long history in DC office entitled to % of firms profits.
Wants sole control of DC office, sued firm for breach and fraud.
2. Issue: Was s resignation precipitated by any illegality?
3. Held: Firm wins, no.
4. Keys: Rare to get a public glimpse of large firm PAs, practice of ten deviated from agreement
a. New partners dont see agreement b. No votes of partners
c. Power of the Executive Committee: Limited ratification by ma jority of voting
percentages; voting percentages depend on participation units (older and more senior
have more); and members of Exec. Comm. Are technically selected by ma jority vote but
just f açade (heaviest draw rights are EC)
5. Need for continuing amendment contract right adding new or dropping old partners dissolves
the partnerships without one
a. RUPA allows for you to add new partner or drop partner with vote without dissolving
and reforming the partnership
Partnership Termination: Procedure1. Major Changes from RUPA to UPA: RUPA allows for non-dissolution
2. Any change in identity of partners is:
a. UPA: defined as a dissolution
b. RUPA: may be dissolution but isnt necessarily one in § 601
3. Problems:
a. (1) Technically very tough, doctrinally tough
b. (2) All in case book are still under the UPA close but not same as RUPA and we should
look to RUPA now
UPA Partnership Dissolution1. Basic Form: Dissolution any change in identity of partners § 29
a. Winding Up: Turning assets into cash § 30, 33, 35, 37
b. Liquidation: distribution of cash § 38 and 40
c. Termination
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 38/124
38
2. Alternative Form: Dissolution, Buy-Out; Termination; New Partnership Formed among
continuing partners
a. Requires Agreement: Ex ante buy out provision in Day or Ex post with consent of exiting
partner § 41(3) gap filling rules
b. OR Wrongful Withdrawal § 38(2)
3. TriggersWithdrawal Per Agreement
a. Ex ante buy/sell agreement
b. Ex post settlement af ter disagreement with full or partial consent of withdrawing
partner; partial let the court decide price; full price agreed
4. Triggers Unilateral Actions: Withdrawal
a. Involuntary: Death or Bankruptcy
§ 31(4) and (5);
b. Voluntary: at will § 31(1)(b) or
Breach § 31(2)
Rightful Withdrawal Under UPA1. Rights of Any Partner if No Buy-Out
Agreement
2. Demand Liquidation: Yes, but SPLIT -
compare Dreifuerst in Wisconsin to Distoll
v. Stiltner in Arkansas
a. If so winding up: partner can
keep business going by selling to
former partners in the liquidation might need unanimity?
b. Safe harbor: judicial supervision of sale and winding up § 37 (Prentiss)
c. If final then distribution Kovacik v. Reed: Each partner is entitled to an equal share of
the partnership profits and is chargeable with a share of the partnership losses in
proportion to the partners share of the profits;
d. RUPA § 401(b) expressly cites and rejects Kovacik and states that losses are shared
even when one or more partners do not contribute any capital
3. Withdrawing Partner Consents to Continuation of Business:
a. No full settlement: value determined by court § 42 and RUPA § 701
b. Full settlement: agreement determines buyout price
Breach or Expulsion under UPA1. Breach: Wrongful withdrawal withdraw in violation of partnership agreement for a term or
task (Owen can breach implied term)
2. Procedure: Remaining partners can choose between winding-up (liquidation) or continuing
business § 37 and 38(2)
a. Liquidation: exiting partner pays damages
b. If business continued: exiting partner receives value of interest minus damages and
excluding good will
UPA D ol t o Tr gg r Co ¶t
Unilateral Action: Expulsion
� Proper: Per Procedure in Agreement. UPA § 31(1)(d)
Application for Judicial Dissolution. UPA § 32
(lunatic, incapable, guilty of wrongful
conduct, breach of agreement, not
reasonably practicable to carry on business)
� Wrongful: Freeze-Out, Page
Business Failure: UPA § 32
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 39/124
39
c. RUPA: does not exclude good will
RUPA: Dissociation1. Dissociation: change in partners identity or legal status § 601
2. Numerous types: (1) Withdrawal; (2) death or incapacity; (6) insolvency; (3)(4)(5) Expulsion,
(4)(8)(9)(10) Partner is legal entity other than individual and entity is terminated
a. Some type require (2)(3) agreement (3) unanimous vote of other partners and (5)
court order
3. Critical Issue Schism in Agreements:
a. Some enable leaving partner to force winding up and liquidation: partnership dissolves
b. Others only require a buyout and partnership continues on without dissociating partner
4. Wrongful?
a. If YES, dissociating partner pays damages (netted with buy-out or liquidation
distribution)
b. If YES, cannot force liquidation
c. Most happen in partnerships for a term or task: can delay paying you until term or task
is over and when you walk out before term if over or task is done screwed hard
5. Buy-Outs: Partnership buys dissociated partners interest at share of firm value on dissociation
a. Equal to: higher of sales assets in liquidation or sale as ongoing business (without
dissociated partner) MINUS damages AND
b. Must tender cash within 120 days if no agreement dissociating partner can accept or
sue in 120 days
c. Prices Capital account, plus 3 years of average annual profit; other methods
appraiser, multiplier (cash f low times multiplier); game theory; lawyers error is of ten to
use book value
6. Winding Up on Dissolution: partnership continues only to wind up
a. Wind-Up: sell assets of partnership, pay creditors, distribute surplus to partners
b. Af ter distribution of all payments terminated and liquidated
7. Dissociating Partner Returns to Court: Asks court to (1) Determine buyout price § 701(i) OR (2)
Supervise wind-up on application for cause § 803
a. Holds an auction for entire business and approves private sale to old partners (distress
price?)
b. Parties now bargain over true price in shadow of court decision
RUPA: Examples of Dissociations1. Partner: Im leaving. Sell everything and pay me my share.
a. Voluntary exist from at will partnership; no express agreement can force liquidation if
exit not wrongful (can force close of business as long as not wrongful)
2. Spouse: Partners dead. Pay me her share.
a. No express agreement: can force buyout not a liquidation (can force the buyout of your
share cash from partnership)
3. Other Partners: You idiot, get out.
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 40/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 41/124
41
3. Assignment: Not an automatic dissolution, nor is the levy of a creditors charging order against a
persons interest but an assignee or the credit can get a decree to dissolve on the expiration of
the partnership term or at any time in a partnership at will
4. Withdrawal or admission of a partner: Most Pas provide that losing a partner or getting one will
not result in dissolution
a. New Partners: may become parties to preexisting PA by signing it at the time of
admission to the partnership § 13(7)
b. Old Leaving: usually provisions for continuing partnership and buying out the partner
who is leaving
5. Dissolution by Court Decree: A court may use discretion in certain situation to dissolve a
partnership
a. Examples insanity of partner, incapacity, improper conduct, inevitable loss and or
whatever is equitable § 32
Consequences of Dissolution and the UPA
1. Distribution of Assets: Partnership[ debts must first be paida. Capital Account: Amount are applied to pay the partners their capital account (capital
contributions plus accumulated earnings MINUS accumulated losses)
b. Current Earnings: If there is anything lef tover, receive their agreed share of current
partnership earnings § 40
c. Distributions in Kind: Where there are no debts, or where debts can be handled from
cash account, assets may not be sold but they may be distributed in kind to the partners
d. Losses: where liabilities exceed assets, partners must contribute their agreed shares to
make up the difference § 18(a)
2. Rights of Partners: Violation v. No Violation
a. No Violation of PA: assets are distributed as set forth above and no partner has any
cause of action against another
b. Violation of PA: innocent partners have a right in addition to those listed
i. Right to damages: innocent partners have right to lost profits due to
dissolution, etc. against the offender § 38(2)
ii. Right to continue business: right to not sell off and distribute assets, etc. by
buying the offenders interest in the partnership § 38(2)(b) posting bond and
begin court proceedings Alternatively, innocents may simply dissolve and wind
up, paying the offender her share, MINUS damages
3. Effects of Dissolution: Parties are liable until debts are discharged
a. New partnership remains liable for old debts when there has been death, withdrawal
or admission or new partner and business is continued, new partnership remains liable
for old debts incurred by old partnership (§ 41)
b. Retiring partners liability for debts incurred by partners continuing the business ends
power of a partner to bind the partnership except to the extent necessary to wind up his
aff airs § 33; if 3rd
parties do not know of the dissolution, contracts entered into with
partner bind the partnership thus, retiring partner must make sure that prescribed
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 42/124
42
procedures are following to terminate any chance of liability for partnership obligations
UPA provides notice of withdrawal or dissolution may be in newspaper or generally
circulated
Judicial Help in Dissolution: Decrees of Breachy Significant disagreements
y Incompetence
y Implied terms
Owen v. Chen: Significant Disagreements
1. Facts: and had oral agreement to become partners in bowling alley didnt state duration.
advances $7K to partnership to buy equipment knowing he was taking out loan repaid out of
profits of partnership. Disputes cause negative profits.
2. Issue: Was a decree of dissolution warranted? Proper for s loan to be paid from proceeds of
the sale of assets when the PA provided the loan would be repaid through profits?
3. Held: Yes to both, in CA the Court may order dissolution if disagreements between partners make it so they cannot act in confidence and harmony, or if one partner, by his misdeeds,
materially hinders carrying on the business.
a. Although a party to a contract may limit his right to receive payments to a specific
sources - Where the other partys conduct rendered it impossible for the partners to
carry on the business from which the payments would be made, it would be inequitable
to enforce that part of the agreement
Collins v. Lewis: Breach of Agreement
1. Facts: and have PA where puts up money to build and equip big café and would
supervise and manage it. Lease. would be paid back from net income and then they wouldprofit share. Estimate $300K and eventually costs $600K with delays. Agreement provided that
would repay $30K of s investment 1st year and $60K each year af ter. indicated that there
were costs that were being paid out of the operating revenue rather than by as promised.
2. Issue: Does have the right to dissolve the partnership?
3. Held: No, the money partner f ailed to contribute the final $60K.
a. had the right to dissolve the partnership but not the right to do so without damages
since his conduct is the course of the partnership problems and amounts to a breach of
the PA
b. can either continue to the partnership and perform on the agreement OR dissolve and
subject himself to possible damages for breaching agreement 4. Collins Declares Dissolution: Breach Agreement and becomes Wrongful Withdrawer
a. Victim (Lewis) has Options: Can continue business for term by paying Collins (value
excluding good will minus damages or posting bond to pay at end of term § 38(2) OR
can liquidate (cannot afford bond); Collins pays substantial damages (f ailure of business)
out of his share and continues to put in funds per agreement
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 43/124
43
b. RUPA does not deduct good will and no payout or bond until end of term unless
undue hardship
Page v. Page: At W ill Partnership
1. Facts: and partners in linen supply. supplies essentials and PTS owes him $47K
also was managing partner each
contributed $43K in capital; no written
agreement; 8 year losing money then starts
to make profit sues to dissolve for
implied term partnership saying would end
when money was paid back.
2. Issue: Was the partnership for a term
rather than at will?
3. Held: No term, but fiduciary duty to not appropriate new prosperity
a. said there were no
understandings about continuation
for a term or until money was paid back some cases do hold that PTS shall continue for
necessary term to repay debut but only if there is evidence showing this intention
b. No evidence of intention here instead it reveals at will partnership; had power to
dissolve the partnership upon express notice to
c. If dissolves in bad f aith he may be violating fiduciary duty as partner and would have
to pay damages in a separate action but a partner is not bound at will to remain in a
partnership just because it is profitable
Prentiss v. Sheffel: W inding-Up Problem of Bidding for Assets
1. Facts: s and s were three partners to buy Center s filed suit to dissolve saying was
derelict in duties and f ailed to pay balance of his share of operating losses. Seek permission to
continue business and request value be placed on s interest. counterclaims seeking winding
up as well as appointment of receiver and said he was wrongfully excluded from PTS in violation
of rights. Court appointed a receiver to protect the partnership property until it could be sold, a
partition made and assets distributed. At auction, s buy assets from court.
2. Issue: Should two ma jority partners in 3-man PTS, who have excluded the 3rd
from management
and aff airs, be allowed to buy the PTS assets at a judicially supervised dissolution sale?3. Held: Yes, his exclusion was not done for the wrongful purpose of buying the PTS asset in bad
f aith but rather was result of f ailure to relate in harmony for benefit of
Pav-Saver v. Vasso: W ind-Up Problems and PA
1. Facts: owned PST and patents. Ma jority SH, Dale, invests SLP. M owner and sole SH of .
Dale and formed PSMC for sale of PSM. Sale agreed to contribute his service to venture
patents and trademarks are contributed and M agrees to financing. Draf ts PA approved by s
Page v. Page
Can plaint i
d i¡ ¡ ¢
lv£
partnership?
Held: Yes, at will; could be liable for breach of f iduciary duhowever. Effect? ³Implied´ term, long enough time torecover capital investment; or ³Generous´
¤ uy Out Price
Plaintiff Defendant
Leven Supply Ptn.
$43,000
$47,000Credit
$43,000
1948-1957: Lost $62,0001958-1959: Made $6,000
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 44/124
44
president. Dissolved and replaced with identical one between and eliminating individual
partners.
2. Issue: What is the effect of the wrongful dissolution?
3. Held: The business can survive, the innocent may keep his patents and receive the agree upon
penalty in the PA that was poorly draf ted.
Kovacik v. Reed: Sharing of Losses in the UPA
1. Facts: asks to be his superintendent and estimator for kitchen job in SF. said would invest
$50k and share profits on 50-50 if would do it. Never talked about loss obtained jobs and
was super with giving all financing. told venture lost $ and that had to pay portion.
refused sought account and recovery.
2. Issue: Is a party who has contributed only his services and not capital to a joint venture liable
for a portion of the ventures losses?
3. Held: No, generally it is presumed that partners and joint venturers intended to share equally
in profits and losses BUT
a. Capital v. Work: Exception is that when one partner contributes the capital when theother contributes skill and labor neither is liable to the other for losses
b. Rationale: where one party gives money and other services, in event of loss each party
loses the value of his own capital or contribution
Distribution Problems: Default Rules (RUPA)1. Marshall Cash: pay cash in order, UPA § 807 to (1) creditors; (2) partners and loans and (3)
partners for capital contributions
2. RUPA § 401(b): Partners equally split for profits; expressly rejects Kovacik and states that losses
are shared even when one or more partners do not contribute any capital 3. Deficiency in 1, 2 or 3? UPA § 401, 807 (c) and (d) each partner pays suffers losses in same
proportion as split of profits (def ault equal payments)
4. Surprises: Capital Contribution Gross Up
a. Capital contribution proportion not ref lected in def ault split rule (50/50)
b. E.g. A gives $1,000 and B gives $5,000 split on profits and losses 50-50; absent an
agreement otherwise
c. E.g. MB contributes $1,000 in capital; worker contributes labor; 50-50 on profits; If
business insolvent must worker give MB $500; NO in Kovacik and YES in others.
Law Firm Dissolutions1. What is the effect on fees collected after dissolution from old clients?
2. UPA § 21 Default: New fees, net of expenses, allocated under old agreement as partner assets.
a. Duty to Account
b. Deduction for reasonable overhead expenses
c. No partner salaries
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 45/124
45
3. WrongfulWithdrawal: New fees received by leaving partners subject to off set for damages in
breach of duty case
a. If clients would have lef t with proper conduct pay f air charge
b. Pay fees net of overhead and f air charged (double charge)
c. Note that breaching partners lost claim on new fees obtained by continuing firm from
old clients who stayed with the firm
Jewel v. Boxer: Law Partnership Dissolutions without Agreement
1. Facts: s and s dissolved law firm 2 and 2 split. No written agreement as to fees from active
cases allocate. Former went to new firms and hired 3 associated who had been employed by
older firm. s had many cases and s handled most of rest. Sent letter to each af ter
dissolution. Clients executed and return the forms and new firms represented the clients under
fee agreements of old firm. filed complaint for accounting of fees.
2. Issue: Upon dissolution of a law partnership, are attorneys fees received on open cases upon
dissolution to be shared according to the former partners rights under the former partnership
agreement regardless of which former partner provides the legal services?3. Held: Yes. UPA says dissolved partnership continued until unfinished PTS business is wound up.
Without agreement to contract, those are def ault
a. Unfinished business is allocated among partners according to their respected interests
in the former PTS.
b. Unless partner is the surviving partner, UPA expressly stops receipt of extra
compensation and no partner can get more than value of interest regardless of level of
participation in winding up.
M eehan v. Shaugnessy: Enforcement of Agreement
1. Facts: Same f acts as above. 2. Issue: Do a partnership agreements provisions regarding dissolution supersede the applicable
UPA provisions?
3. Held: Yes. s partnership agreement provided specific means for handling dissolution of firm
when partners lef t and they overrule UPA def aults.
a. Burden of proof on s to show that the clients who lef t would have consented to leave
even if there had not been a breach of fiduciary duty; if cannot reach burden must
account to the firm for any profits received from these cases plus must pay firm the f air
charge called for by agreement
b. Damages allowed are only those CAUSED by s actions share of current income and
return of their capital contributions
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 46/124
46
Limited Partnerships1. Modern Limited Partnership: Entities created by modern statutes to protect from liability
a. Used: Private equity funds like hedge funds, venture capital funds
2. Purpose: developed to f acilitate commercial investments by those who want a financial interest
in a business but not all the responsibility and liabilities of partners a. May carry on any business that a partnership could carry on (ULPA § 3)
3. Limited Partnerships before 1976: most states had adopted the ULPA and in 1976 was revised
to make it applicable to large PTSs and to ref lect new business practices; most states now have
adopted the RULPA in 1985
a. New revision of ULPA was draf ted in 2001 and adopted by a few states
4. Liability: LP has no personal liability for PTS debts and max loss is amount of her investment in
the LP; ULPA § 1
a. EXCEPT: when a LP takes part of the management and control of the business, she
becomes liable as a GP RUPA § 303(b)
5. New Act: RULPA (ULPA 2001) overlays RUPA (UPA 1997) and sometimes explicit in the statute,otherwise by duplicative language on duties;
a. RUPA applies unless a RULPA provisions changes the rule
Limited Partnerships: Generally1. Defined: an LP is partnership formed by two or more people and have as its members or more
general partners and one or more limited partners
2. General Partner: the GP assumes management responsibilities and full liability for the debts of
the PTShip
3. Limited Partner: makes contribution of cash, property or services rendered to the PTFship and
gets an interest in the PTS in return, but is not active in management and has limited liability for
PTS debts RUPA § 303(b)
a. Rights of LPs: substantially same as those of a partner in ordinary PTS, except no
substantive right with regard to management; rights to access books of PTS, to an
accounting as to business and to dissolution and winding up by decree ULPA § 10; may
also lend money to, or do business with, the PTS (ULPA § 13)
b. Assignment Interest: unless provided otherwise vests in the assignee all rights to
income and distribution of assets of the PTS but unless and until cert. of LP is amended
with consent of ALL other parties, assignee is not entitled to inspect books, accounting,
etc (RULPA § 702)
4. Person as Both: possible, in such a case the partner has, with respect to her contribution as a
LP, all the rights she would have if she were not also a GP
Forming Limited Partnerships1. Formation: Formalities are generally not required; certain things must be met
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 47/124
47
a. (1) must execute a certificate setting forth the name of the PTS, character of business,
location of principal office, name and address of each partner and their capital
contributions, GP or LP designation, and rights and priorities of any partners
b. (2) Copy must be in country of principal place of business ULPA § 2 but may be
amended or canceled by following similar formalities ULPA § 25
2. Certificates: Three issues
a. False Statements: If included, anyone who suffers a loss by reliance upon them can hold
all of the partners liable, both GP and LP (ULPA § 6)
b. Purpose: to give all potential creditors notice of the Limited Liability of the LPs
c. Substantial compliance of good f aith: required, if there has been no substantial
compliance, the purported LP may be held liable as a GP; the purported LP can escape
GP liability if when seeing the mistake promptly renounces her interest in the profits of
the business or other compensation by way of income
Holzman v. de Escamilla: Limited or General Partner?
1. Facts: HF, Ltd. was a business created as LPh with deEscamilla as the GP and R and A as LPs; Later it went
bankrupt and H was trustee appointed. sued
saying R and A were liable as GPs to creditors
because they had taken control of the business.
2. Issue: Are purported LPs who controlled the
finances o the PTS business and controlled the
actions of the GP liable as GPs?
3. Held: Yes, LPs can be recast as GPs if they take part
in the control of the business of the firm. Change
from ULPA § 303 to RULPA § 303
Limit d Part r hips
Gener ¥ l ¦
§
rtner ( C ̈
r© .?) Limited
¦
§
rtner
Li ited ¥ rtner i
C§
/Sli
e ̈
f ¦
M§
nagement/ ee
Sli
e ̈
f ¦ r
̈
fit
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 48/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 49/124
49
Policy Question: Why Have a Double Tax?
Pre-Bush Evil Bush Obama
Corporate Tax 39% Income 35% Rich only tax-cut
repeal then because
only help rich:
Personal Tax: Dividends 39% Income 15% - do not have to
sell the share; still
Personal Tax: Capital Gains 25% Gains 15%
1. Old tax is good tax (corporate income taxes pre-date Personal Income Taxes
2. Corporations are Wealthy: Not f air for janitor to pay income tax and Microsof t escape it
3. Corporate Investors are Wealthy: Just a hidden progressive tax4. Lawyers and Accountants need money: huge amounts spent on tax planning
BUT?
5. Why do most all of the rest of the developed countries of the world (including those with a more
socialized system) reject the double tax?
6. Why are LLCs not morally offensive?
7. Do we need a tax penalty based solely on business legal structure (and not income type)? Not
based on anything else (e.g. taxing the rich high, etc.)
Small Business Rule of Thumb1. Small business (> 35 investors) presumption in f avor of an LLC (with operating agreement
written); if business grows, convert to a C corporation.
o Rebutted by industry specific common practice (VCs as LPs)
o Rebutted if net profits are zero (use a C Corp.)
2. Medium to large businesses (likely to be publicly held): C Corporation
Source of Law on LLCs1. State Statutes: Old and New
a. Old: Designed to satisf y a tax regulations see Konstant b. New: Very open textured (DE); parties can create what they want; minimum of
mandatory rule; def ault rules based on what most parties to an LLC want and expect
and easily modifiable (OH amendments coming because it is a mess)
c. Elect: Local OH Gen. Corp. L. ch 1701; Other DE Gen. Corp. L. tit. 8 (Supp.)
d. Model: ABAs MBCA (Supp.) constant revisions; 30 or so states have various versions
OH is not an MBCA state
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 50/124
50
e. Federal Securities Law: SOX
2. Model Acts: Uniform Limited Liability Act (ULLCA, 1996) and the DE LLC Act
a. Q uestion use contract or general fiduciary duty doctrines of reasonableness
b. DE uses general fiduciary duty doctrines; OH uses contract doctrines DE better
The Corporate Form1. Legal Person: or entity
2. Indefinite life: since shares cann be transferred
3. Limited Liability: of investors
4. Free Transferability: of ownerships (equity, stock
or shares) interests
5. Centralized: specialized management
6. Oversight Board: elected by equity investors
7. Powers: can sue, be sued, contract and own
property like legal entity 8. Limited Liability: belong to corp. itself and
normally incurs debts and obligations in own
name that are not responsibility of the SHs (owners); same time not responsible for debts and
obligations of owners (SHs)
9. Exceptions and Piercing the Veil:
a. (1) Fraud or injustice where maintenance of the corp. results in fraud/injustice to
outside parties;
b. (2) Disregard of corporate requirements where SHs do not maintain the corp. as a
separate entity but use it for personal purposes (records not maintain, meetings
required not held, money commingled between individuals and corp., etc.) then can
pierce
c. (3) Undercapitalization: prime piercing exists where the corp. is undercapitalized given
the liabilities, debts and risk it reasonably could be expected to incur
d. (4) Fairness: may pierce is any other situation where it is only f air that the corporate
form be disregarded
Limited Liability of Investors: Policy
1. Owners (SHs and Passive Investors): have no personal liability for debts or obligations of the
corporations; their risk of loss is limited to excess of the amount they invest
a. Risk on their capital contributions
b. Original owners risk only their capital contributions
c. Subsequent purchases of the stock risk the purchase price on the secondary market
2. Benefits
a. Ease of valuation cannot have secondary market without it and with unlimited liability,
youd ignore law probably during disasters and financial status of co-owners
b. Enables secondary trading markets check on managers from market
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 51/124
51
c. Specializations: firms can tailor risk to segment investor market, investors can diversif y,
high tech firms get funding
d. Increase incentive of debtors (banks) to monitor firm actions
3. Efficiencies and Controversies of the Corporate Form:
a. Operational: Free standing legal entity with power to act; centralized and specialized;
Too powerful - Should not have Constitutional rights, are unaccountable, anti-social
b. Attractive to investors: limited liability and free transferability (liquidity premium);
Opposition enabled avoidance of responsibility for tortuous conduct, share market
gambling, cons and greed
4. Allow Private Arrangement for - economies of scale and technology advances require mass
scale
a. Diffuse ownership: need large pools of investor capital
Creation of a Corporation
1. Articles or Certificate of Incorporation: Incorporator files Articles for (RMBCA; OH) or Certificate(DE)
2. Records: Sec. of State records the filing and it will be effective on filing date (unless specifically
delayed)
3. OrganizationalMeeting: new Corp. holds one to adopts BYLAWS (regulations in OH) that
empower agents
a. DE Meeting: If Board of Directors isnt listed in articles, Incorporators meet, accept stock
subscriptions, issue stock, adopt bylaws, elect initial directors who appoint officers and
then filing (one page application, no one knows who the owners, directors and
promoters are unless publicly owned)
b. New SHs meet, elect next board of directors and of ten ratif y acts of prior board andpromoters
c. Ohio Common Practice: Incorporators meet and elect directors (no initial Board); initial
Board meets and accepts stock subscriptions, issues stock, appoints officers and adopts
regulations (if meeting within 90 days of formation)
d. Ohio Rare Practice: Incorporators accept stock subs and issue stock no initial Board
listed; new SHs meet, elect Board and adopt bylaws; SH elected Board meets and
appoints officers
4. Analogy: Cert. and Bylaws (constitutional documents), board regulation (legislation) and
executive decisions (Presidential or agency order)
Corporate Charter: Articles/Certificate1. Mandatory Provisions:
a. Name
b. Registered Agent
c. Purpose
d. Authorized Amount of common (voting) stock
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 52/124
52
e. DE and OH par value: archaic practice specif y how many shares will issue and the par
value of the share or check no par value (complex)
2. Discretionary Provisions: Customized and Optional
a. Complex capital structure: preferred stock, two-tier voting stock
b. Complex governance provisions: board terms of up to 3 years; staggered; class voting;
bylaw amendments by board or lower ma jority
Promoters1. Defined: Someone who says they will form a business or corporation but not unless they can get
people to throw money in; wants firm commitments (Agency Law Controls Rest.Ag. § 320 and
326)
2. General Rule: If promoter contracts in the name of and solely on behalf of, the corporation, he
cannot be held liable if the corporation is never formed. If contracts in his own name, then may
be held liable.
a. Intent of parties and other f actors will enter into the determination of the letter
b. YES Liable: Contract, unilateral offer to corporation. Q uasi-contractual if corp.
repudiates contract, still liable for value of anything that it makes use of ; adoption by
implication rule is that ratification is retroactive and adoption is not.
c. NOT Liable: Contract with promoter; for good f aith efforts to get corporation adoption;
until corporation affirms then the promoter is released; survives corporation affirmation
promoter bound and has secondary liability
d. BUT Novation: new K with corporation replaces old deal promoter usually released
but novation language in everything
3. Can unincorporated (or defectively incorporated) firm sue on contract:
a. YES De f acto corporation: has complied strictly with all mandatory provisions for
incorporation cannot be attacked by any party (even state) mandatory and directory is
matter of judicial construction of state
b. YES Corporation by Estoppel: when a corporation is not given de jure or de f acto status,
its existence as a corp. may be attacked by any third party BUT there are situations
where courts will hold that the attacking party is estopped to treat the entity as other
than a corp.
Southern-Gulf M arine v. Camcraft: Conduct of Parties
1. Facts: Pursuant to Letter of Agreement, , company not formed yet became obligated to buy
boat from for $1.3M; given authority to begin buying components to buy boat. Later parties
executed boat building contract and was listed in a preamble as a corp. organized under TX
law with B as Pres. One condition said was US citizen within meaning SA of 1916. B tells BM,
s Pres. That had finally be incorporated a year later but in the Caymans. BM accepts and
agrees. def aults on building boat and sues for breach.
2. Issue: Should a party to a contract be permitted to escape performance by raising an issue as to
the character of the organization to which it is obligated if its substantial rights are not affected?
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 53/124
53
3. Held: No. If party contracts with entity it acknowledges to be and treats as a corp., and incurs
obligations in its f avor, and later sued it is generally estopped from arguing lack of corp.
existence as defense.
a. was De Facto Corporation: Both parties relied on the K; financed and began no
evidence that s substantial rights were affected by the s de f acto status
Fiduciary Duty of Promoters
Y Must: disgorge profits on land resale
unless Y disclosed to X personal profit
and X ratifies it
Y forms C Corp.: takes C stock in
exchange for land, immediately sells
personally-held C stock to X at a profit,
no disclosure? Potential violationDistinction: Y is in same position ex post
in both transactions but procedure
matters sale to X before or sale of land
Corporate Bylaws or in Ohio, Regulations1. Operating Rule for the Corp.: Empowers board to open bank account, buy and sell land, ect.
2. Amendments: Compare with Charter Amendment - Board must recommend and SH must ratif y
them (2/3 in OH); Exceptions: No SHs; OH no prejudice to SHs and name change § 71, etc.
a. Shareholders: ratif y absolute ma jority (2/3 if by written consent)
b. DE Board Alone: if certificate gives Board power to amend OH must be SH except
emergency exceptions e.g. § .11(C)
c. Limits on SH Bylaw Amendments: Current debate no takeover defenses?
V ocabulary and Equity: Corporate Finance and Shares1. Corporate Finance: Rights, duties, terms for people who give money to a corporation
2. Types: preferred/common, classes, controvertible
a. Three types of Corporate Distributions: (1) Dividends; (2) Liquidating Dividends and (3)redemption
b. Class A and B: common for a few selected areas of industry
3. Authorized/Issued/Outstanding: Like treasury shares
4. Primary Secondary market sales
Fi i r t f
Pr t r Y Form
Corp C,
CEO
! C Corp.
" ll
C
tock
to X, # $ t ! " # Y imm " $ iat " ly t ! " r " af t " r " ll p " r o # ally ! " l$ land to C, acc " pting a CEO, atp " r onal profit. Y m% t di gorg " profit on land r " al "
% nl " Y di clo " d to X p" r onal profit (and Xr atifie ??).Y Form
C Corp, take
C tock in exc
! ange f or land,immediately ell per onally- ! eld C tock to X at a profit. No di clo % r e of per onal profit. Violation? (Split: US no; Ma . ye ) Di
&
tinction?? Y i&
in &
ame po&
i tion ex po&
t in bot ' tr an
&
action&
? ( )
t procedur e matter &
. Sale to X bef or e/af ter &
ale of land.
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 54/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 55/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 56/124
56
2. Distinguish Agency Problems of Executives:
a. Executives as agents bind firm on contracts; agents are not personally parties (or
personally liable) unless agreed upon
b. Liable for PERSONAL wrongful acts not liable for wrongful acts of other agents (absent
some form of participation)
Shareholder Personal Exposure and Piercing the V eil1. Equitable Subordination: If SH is an (1) officer and (2) a creditor of firm and misbehaves debts
subordinated to those of all other creditors
a. Disregard the registered legal entity becomes a General Partnership or Sole
Proprietorship
2. Disregard the Entity: SH (1) Dominates firm and (2) Acts unjustly towards creditors
a. Evidence of Domination: commingling of corporate and personal funds, lack of
observance of necessary entity formalities (board and SH meetings) note that OH lack
of meetings is not f actors
b. Courts Vary what is unf air or unjust?
Exceptions to Limited Liability1. Compare by Contract: execute a personal guarantee with
2. Compare by Law: Disregard the entity or pierce the veil forms
a. Vertical SHs liable on firm obligations
b. Horizontal - sister corporations liable on firm obligation (enterprise liability)
c. Reverse piercing corp. liable to personal creditors of SH
3. Contract v. Tort: Ma jor difference between tort and contract cases is that in contract cases, the
had chance in advance to investigate the financial resources of the corporation and had then
chosen to do business with it. THUS, in contract cases, the intention of the parties and
knowledge of the risks assumed in entering into a contract are f actors to be assessed in making
a determination as to whether the corporate veil should be pierced.
W alkovszky v. Carlton: Liability Insurance as Evidence
1. Facts: was hurt in taxi and sues driver, corp. owning
cab and who owned corp. and 9 others, each with
minimum of $10K of liability insurance coverage
required. Complaint said corporations operated as single
entity and constituted on fraud on public.
2. Issue: Does complaint state a cause of action becausethe companies were underinsured and undercapitalized?
3. Held: No. Dismissed. Courts will pierce the veil when
necessary to stop fraud or achieve equity.
a. Nothing wrong with one corp. being part of
larger enterprise (like subsidiary);
Wal vszky v arlt
Marchese
Employee
Seon Cab: 2 cabs(min. required insurance)
Carlton
O0 ner
Walkovszky
9 other Cab
Companies
Tort
Shares
Shares
Jud1 ment?
Jud1 ment
Can Walkovszky br in1 suit a1 ainst Carlton? A1 ainst the nine
other cab companies? Held: Motion to Dismiss Granted
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 57/124
57
4. Question: issue is if business is really carried on in a corp.
form but by and for another entity or person with a
disregard of the corporate formalities?
5. Undercapitalization: state has set minimum insurance
people driving cabs have taken out minimum; insurance is
OK unless state has legislated higher bar.
Parent and Subsidiary1. Is SH control OR domination enough for disregard of
entity/piercing?
a. No, US v. Bestfoods.
2. Distinguish: Disregard of Entity Other Theories of SH
Liability
a. Direct Liability: Direct intervention or participation In re Silicon
b. Indirect Liability: Corporation is agent of SH (respondeat superior)
Sea-Land Services v. Pepper Source: Cannot Differentiate Between Corp. and Individual
1. Facts: was ocean carrier who ships peppers on PS behalf . PS refused to pay freight bill and
sues. couldnt obtain recovery because PS dissolved and then sues PS sole SH and the
other corporations owned.
2. Issue: May the corporate veil be pierced when the court can no longer different between the
corporate and the person and it would be unjust to protect the person?
3. Held: Yes. A corporate veil may be pierced if two requirements are met (1) must be such unity
of interest and ownership that the separate personalities no longer exist and (2) circumstances
show that adherence to the fiction of separate corp. existence would sanction fraud or promote
injusticea. Four Factors: (1) Failure to comply with formalities; (2) commingling of corp. assets; (3)
undercapitalization and (4) one corporations treatment of another corporations assets
as its own
b. Here used same office, phone, expense account to run ma jority of corps. None of
them ever held a meeting. Borrowed funds for personal expenses and corporations
borrowed from each other. Did not even have a personal bank account.
c. Promote Injustice: f ailure to pierce would result in some wrong that lies beyond the f act
that a creditor may not be able to recover e.g. that a party would be unjustly enriched
( has burden to show the wrong)
Roman Catholic Archbishop of San Francisco v. Sheffield: Liability between Subsidiaries
1. Facts: When in SUI, visits church of RC contracts with PC to buy dog for $175 payable. Dog
shipped to LA made two installments but didnt get the dog. told wouldnt be shipped until
all paid and additional fees for trip to deliver dog. told he couldnt refund. sues RC, Pope,
Canons and FC.
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 58/124
58
2. Issue: When a parent corporation controls several subsidiaries, is each subsidiary liable for the
actions of all other subsidiaries?
3. Held: No, not domination, no injustice. No alter ego theory.
4. Rule: must show that not only is inf luenced and governed by the other entity but also that
there is such a unity of interest and ownership that the individuality or separateness of each has
ceased and the f acts are such that an adherence to fiction of separation would promote
injustice and allow fraud.
a. No respondent superior between subagents. Even though RC is an alter ego of the
Church doesnt show that the RC is an alter ego of ; had no dealings with the church.
In re Silicone Gel Breasts: Liability of Parent to Subsidiary
1. Facts: is sole SH of breast implant MEC, had 3 directors
on board. Two were s execs and MEC president
evidence revealed MEC prepped reports for and had
MEC submit 5 year plan MEC submits budgets, kept
monitoring of . MEC was highly involved in personnel,
auditing, review, name and logo were with sale and
communications. s exec VP suspended MEC sales and
MEC stopped ops later that year selling with s
approval and turning proceeds over to . s bring
products liability.
2. Issue: Is the parent corporation liable for product torts of a subsidiary?
3. Held: Yes. They had control, the subsidiary was underfunded and undercapitalized.
a. Control: A parent corp. is expected to exert SOME control over its subsidiary BUT
when a corp. is controlled to such an extent that it is merely the ALTER EGO orINSTRUMENTALITY of its SH, the corporate veil should be pierced in interest of justice
b. DE can pierce without finding fraud or misconduct if a subsidiary is found to be an
alter ego or mere instrumentality; many states that do require fraud do only in contract
cases not torts
c. Vouched: since MEC funds may be insufficient to pay for damages, and may have
induced people to think was vouching through actions in support allow finding
Frigidaire Sales v. Union Properties: No Improper Actions
1. Facts: contracts with CI, an LP. s were LPs of CI, as well
as officers, directors and SHs of CIs only partner, Union. s
controlled U and through control had day-to-day
management and control of CI. CI breaches and sues.
2. Issue: Do LPs incur general liability for the limited
partnerships obligations because they are directors,
officers, or SHs of the corporations general partner?
3. Held: No, LPs are not personally liable as GPs.
4. Rule: In WA, parties may form an LPship with one corp. as
In r e Silicone Gel r ea tImplant
Held: No S.J. for Bristol. Distinguish Bristols situation fromDow Chemicals.
Publ ic S 2 a r ehol de r 3
ME C
4 r i
3
to l
P lain tiff 3
5
iable?
Product Liability
100%
ne Per on: Many ³Hat ´
Commercial Investors, LP
Limited Partne
M 6 7 7 8 7 & 9 6 xt @ General Partner :
U 7 i 8 7 Pr 8 p@ rti @ s, I 7 c.
A B
C
rD B
E
lF D
rs/OfficD rs
/G irD ct E
rs: MC
H H
E
H &
I
C
xt D r
MC
H H
E
H &
I
C
xt D r Li
C
blD
C
sP D H D
rC
l pC
rt H D
rs??Q D
lF :
R
E
.
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 59/124
59
its only GP if that GP is inadequately capitalized, a creditor is protected under the corporation
law doctrine of piercing the corporate veil.
a. Mere undercapitalization is not a reason to open liability to LPs who control the GP
b. was never misled into thinking s were acting outside their corporate capacity kept
the corp. aff airs away from personal aff airs and did not defraud or create injustice upon
parties in dealings separate entity should be respected;
c. No evidence thought they were GPs, knew they were LPs
Likelihood of Courts Piercing the V eil (Best Chance to Worst)1. By Structure
a. Individual/Wholly Owned Close Corporation (Controlling SH/Close Corp.) less likely
with more SH
b. Parent/Wholly Owned Subsidiary less likely with more minority SHs
c. Public Corp. very rare
d. Sister/Brother Corps. very rare
2. By Claim: Contract > Tort
3. By Reason: Unf airness Commingling of funds (confusions of accounts) undercapitalization
and lack of formalities
4. Highly Unlikely to Disregard the Entity Situations:
a. (1) Public Corps.
b. (2) Against Passive SHs
(3) Against Minority SHs
c. (4) All Corporate Formalities are Observed, business is real and not a sham
Lawyer: Observing Formalities
1. Client Doesnt Observe Formalities: e.g. not held director of SH meetings, has not even issued
shares
2. Do NOT back date: a set of formal documents it is MALPRACTICE
3. Forgeries: backdated documents are forgeries and it is not an excuse that they represent what
was true or CLOSE to true according to the memory of an old person
Policy: LLCs and Tort Claims against SHs
1. Advantages of LLCs: investor incentives pro-investment; holding companies specialized
investment; most contract claimants assumed the risk
2. Disadvantages (Involuntary claimants; Tort victims): Incentive to inf lict injuries without
internalizing costs e.g. run a borderline solvent gold mine on the top of a mountain in CO; Yale
no LL for torts, force or require corporations to carry adequate insurance
3. Torts against SHs:
a. Victims cannot rely on the creditworthiness of the firm when acting
b. Victims cannot negotiate with the firm for contractual protections from
undercapitalization may be unaware of firm itself
c. BUT victims can protect themselves with personal insurance
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 60/124
60
4. Can stock trading market survive the Yale position? No.
a. Difficulties of administration stock must be indistinguishable; equities distinguish
pass/active SHs
b. Worth caring? There are alternatives personal protection and governmental
protection
Shareholder Lawsuits1. Distinguish: Derivative Actions/Direct Actions (class
actions) to whom is duty owed?
a. Classic breach of fiduciary duty by board
derivative (Cohen personal enrichment)
b. Direct: Classic violation of Federal Securities
Laws; State law voting rights violation
(Eisenberg problem for s, no cash)
2. Effect: Procedural hurdles FRCP Rule 23/23.1
a. Who collects damages?
3. Direct and Derivative Suits: a SH may sue to enforce
managements duties
a. Derivative: If claim is that managements breach reduced the residual value of the
business (shirking, self-dealing), file in name of corp.
b. Direct: if claim is that breach deprived the SH of some other right (other than her
contingent right to that residual value) e.g. right to inspect SH list, file in own name (may
be brought as class actions)
4. Threat of Derivative Strike Suits: a person with a small stake in the residual value of a business
may be tempted to bring a derivative suit for the primary purpose of bring bought off
a. Reduce temptation by requiring s to make payment to corp. for the complaining SH
b. Attorney is generally real interest obtain fee from the corporation and legitimately
demand some payment in connection with a settlement
5. Limits to Derivative Action: Pretty much all corporations limit the SH who may bring these suits
many states have laws requiring the -SH in a derivative suit to post a bond or other security
to indemnif y the corp. against certain of its litigation expenses in the event the loses the suit
a. When security must be posted: great variety some says if owns less than % of stock;
some discretionary by court and demanded only when reasonable possibility the action
could benefit the corp. b. Entitled to Security: most state only the corp. may demand security and only for
expenses to pay some states allow officers and directors to demand it
c. Covered expenses: usually all expenses, including attorneys fees, are covered maybe
expenses the corp. must pay the directors and officers because it has indemnified them
(may indemnif y them for actions in good f aith and business judgment but not for fraud)
Shareholder Suits
ShareholdersS
ompany &/or T U
Shareholders:on behal
V
oV
company
Third W arty:
T U ecutives or X
th
S
ompany
Y irect;as a class
Y erivative
cash
cash
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 61/124
61
Cohen v. Beneficial Industrial Loan Corp.: Application in Federal Diversity Cases
1. Facts: Cohens decedent, , brings SHs deriviative action in Federal Ct. in NH against and
managers and directors. Alleged that since 1929 s had conspiracy to enrich themselves at
corp. expense. owned about .0125% of the shares. Af ter began, NJ made law requiring 5%
ownership unless those shares have a value over $50,000 to be reasonable for expenses and
attorneys fees of the defense if the suit f ails. Has to post bond of $125,000.
2. Issue: Must a federal court sitting in diversity apply a state of the forum state providing for the
posting of security for the corporation?
3. Held: Yes. A SH who brings derivative action assumes a position of fiduciary nature sues as a
rep of a class that did not elect him as rep as they elected the corp. director/manager state
has power to regulate and promote accountability, responsibility and liability
a. Reasonable Expenses: law that requires liability and security for only reasonable
expenses doesnt violate Due Process or Equal Protection by classification basis on
financial interest only serves to insure some good f aith
b. Federal Courts in Diversity: must apply substantive law of forum state while following
federal rules of procedure
Eisenberg v. Flying T iger: Statute Applicability
1. Facts: , DE corp., organized subsidiary in DE called FTC organized subsidiary, FTL, month
later. Three DE corps then created plan to reorganization, subject to SH approval, where
would merge into FTL approved by 2/3 vote. Merger,
stops operating and FTL takes over ops. s shares
convert into equal FTC shares then FTL changes name
to FTLI, resulting in all business operations being
confined to a wholly owned subsidiary of a holding
company whose SHs are the former SHs. sues to
enjoin the reorganization and merger stating purpose
to dilute his voting rights. removes to NY motion
for order that comply with § 627 of the NYBCL saying
in derivative suit against corp. must post security for
the corp. costs.
2. Issue: Is an action asserting that SHs have been
deprived of any voice in the aff airs of the company derivative for the purposes of the statute?
3. Held: No. Even if DE law, which has no security requirement, control the merits of the case, this
court must look to the NY law regarding the issue of security.
a. § 627 Applies only to derivative actions claims he and his fellow SHs have been
deprived any voice in the operation of their company; not challenging the management
of the company on behalf of the corp.
b. THUS s action is personal and not derivative within the meaning of § 627
Security for Expenses Statutes in Derivative Actions1. NY and NJ: Deposit bond unless 5% SH or shares > $50K (Cohen) Two way expense shif ting
Eisenber ̀ v Flyin ̀ Ti ̀ er a
ine
b
lainti c c ; Shareholder
Flyin d Tid er
Flyind Tid er e
orp
f
ir Frei d hte
orp
mer d e
b
laintic c
g bjects to
h
er d er i
ondp
q
eld:r
o
sub
sub
stock
es chand e
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 62/124
62
2. MBCA: omitted in 1982 shif t expenses to if court finds proceedings without reasonable
cause or for an improper cause
3. OH: No law one way shif ting (firm to on success)
4. Incentive to Sue: SH collective action problem
a. Gain to any one small SH of success not worth cost of prosecuting suit
b. Solution: firm pays s attorneys fees on success (settlement or judgment) 20% or
30%
c. Problems: agency costs - attorneys and s are both agents of SH and can misbehave
d. Applies to both class/derivative actions
5. American Bounty Hunter System: Expense shif ting is an exception to the American Rule each
side bears its own litigation costs
a. E.g. derivative suit against top 3 execs of CA; settlement return $500m in stock to
firm; attorney collected $50m; attorneys out of pocket expenses - $250K
Shareholder Suits in Practice
1. Collusive Settlement Problem:
a. Corrupt managers collude with s lawyers (double agency) to make cosmetic changes
and buy off lawyers
i. Error managers should pay and do not
b. Tamer managers collude to settle nuisance litigation and buy off lawyers
i. Error managers should pay and dont
2. Value of Settlement: determined by surviving summary judgment motions
3. Problem of Supervision by Court:
a. Judge wants settlements no parties in court opposing settlement; love fest.
4. Incentive to Sue: depends on size of recovery size depends on D & O Insurance Coverage
a. Best Rule: induce some suits that decrease firm value and f ail to induce suits that may
increase value
b. Lodestar Formula: hourly fee with multiplier
c. Auction: among attorneys low ball, settle
5. Other Incentive Problems:
a. Interrelated: obvious solution, control fees
b. Procedural fine-tuning: early decisions (1) pleading particularity (Grimes and PSLRA of
1995); (2) named control who is real party interest and intervention by large SHs; (3)
higher burden of proof (clear and convincing)
c. Substantive Law: higher hurdle for s on legal standards distinguish best practice from
legally required
Real Party In Interest: Standing in Derivative Actions1. Federal Rule of Civil Procedure 23.1
2. must have been SH at time of wrong
3. must be SH for duration of action
4. must f airly and adequately represent the other SHs
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 63/124
63
Derivative Action Burden: The Demand Requirement 1. Demand on Board Requirement
2. If Board disinterested must make demand (boards decision control) actual demand waives
claim of excuse (Grimes)
3. If Board interested (conf licted) demand excused because futile
a. Delaware: reasonable doubt would have to allege particularized f acts that would
create a reasonable doubt about the independence or disinterestedness of the board or
whether the challenged transaction
is otherwise the product of a valid
exercise of business judgment
b. NY (three part test) Grimes
compared to Marx: (1) not sufficient
to merely name a ma jority of the
directors as parties with conclusory
allegations of wrongdoing or control
by wrongdoers -
c. Universal Demand in MBCA 15
states around a notice rule, make
demand, if board doesnt sue, SHs
sue
4. Effect: prefer securities class actions over
derivatives
5. Other Options: (1) SH must hold more than 2% or $500,000 Rule 14a- 1% or $1,000; (2) PSLRA
of 1995: for class actions only largest disinterested SH willing to intervene takes over
a. State courts may use the rule who f airly and adequately represents 6. Legal Standards
a. When is demand excused: Aronson (DE), Grimes, Barr (NY), Marx
b. If not excused, board refuses, sue board for refusing; BJR Grimes case (DE), Spiegel
(actual demand waives claim of excuse)
c. If excused, special litigation committee files a motion to dismiss; SCL decision evaluated
under BJR Shaw (NC), rule of deference, Auerbach (NY) or compelling corporate
interest, Zapata (DE)
Grimes v. Donald: Abdication
1. Facts: is SH in DSC claims board f ailed to use due care, commits waste, approved excessive
compensation and unlawfully delegated by entering to agreement with CEO unreasonably
interfered with s management of the company was agreement. Seeks declaration that the
provision of delegation was invalid.
2. Issue: May a SH proceed directly on an abdication claim when he seeks only a declaration that
an agreement between a board and its CEO is invalid?
The Demand Requirement
Sharehol t ers Must Make a Demand on the Board to Sue (Major ity of Board ³Disinterested´)
± Board¶s Choices: It Agrees to Sue, Ref uses to Sue, or Def ers to Shareholder Suit.
± If Ref uses: Shareholder Sui t Dismissed; Sue Board,Wr ongf ul Ref usal? Grimes: BJR unless conf lict or lack of due care
Demand on Board ³Excused´
± Board Creates a Special Litigation Subcommi ttee (SLC):SLC Def ers or Files a Motion to Dismiss
± On Motion to Dismiss, Court Review on NY or Del test(BJR/´compelling interest´)
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 64/124
64
3. Held: Yes, whether a claim may proceed as a direct or derivative suit depends on the nature of
the wrong alleged and the relief sought. Claims seeking injunctive or prospective relief, such as
s, are more likely to qualif y as direct
a. Focus on nature of relief sought consistent with the idea that the function of the SH
derivative claim mechanism is to avoid the problems of f ashioning compensatory relief
that would plague a class action claim
M arx v. Akers: Futility Exception
1. Facts: Without making demand on IBM board, s, Marx files SH derivative suit alleging that
the board wasted assets by awarding excessive compensation to execs and to outside directors.
Complaint alleged that during a 5 year period, s increased compensation rates from $20K plus
$500 per to $55,000 plus 100 share of IMB.
2. Issues: Excessive compensation? Outside directors? Relation?
3. Held: Having a ma jority of a board of outside director, does not excuse from making a demand
in connection with claims of excessive compensation to execs.
a. With ma jority outside directors on board, futility excuse excuses from making a demand in connection with claims of excessive compensation to outsiders.
b. Demand Requirement: (1) Creates a form of alternative dispute resolution to allow corp.
directors with chance to correct abuses; (2) helps insulate directors from harassment by
litigation on matters within discretion; (3) discourages strike suits began by SHs for
personal gain not benefit of corp.
c. Exception: permits SHs to bring claims on behalf of the corp. when it is evident that the
directors will wrongfully refuse to bring the claims
d. Q ualif y for Exception: (1) ma jority of board are interested by self-interest or control by
self-interest director; (2) board didnt fully inform themselves about deal to the extent
reasonably appropriate under the circumstances; OR (3) deal was so bad on its f acecouldnt have been product of sound business judgment of board
Auerbach v. Bennett: Special Litigation Committees
1. Facts: GTE management looks into chance that co. or subsidiaries made improper payments
board determines that $11m had been bribed and that 4 of 15 s had been personally involved.
SH brings derivative suit on behalf of corp. against bribes. Board creates SLC of 3 disinterested
directors who had joined the board af ter bad deal happened. SLC found that it was not in the
best interest of the corp. for the action to proceed.
2. Issue: Does BJR stop inquiry into the disinterested impendence of SLC? Is SLC allowed to
determine whether suit may go on?3. Held: Courts may inquire into the disinterested independence of the members of the board
who are chosen to pass on whether the derivative suit should be dismissed or not. To require
the people outside the board to investigation would require that board abdicate its fiduciary to
the corp. to manage aff airs. Good f aith inquiry.
a. Decision of SLC: substantive decision may not be looked into by court; only the
composition of the Committee (Substantive is within BJR)
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 65/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 66/124
66
b. Statutory: MI ongoing business relationship may disqualif y OH § 1701.59 clear and
convincing evidence needed that director salary concerns defeat good f aith
c. NYSE: listing requirements similar to MI
d. DE: common law test evolving
In re Oracle Corp. Derivative Litigation:Burden on SLC 1. Facts: SHs of Oracle bring derivative on insider trading by 4 of board Ellison, H, L and B; Forms
SLC to look into and determine best course 2 board Ms G and G were named to SLC joined
af ter events and both were Stanford prof s. Hourly wage paid but agreed to waive compensation
if a court deemed it necessary to maintain impartiality.
2. Issue: Has the SLC met its burden of persuasion and shown there is no material issue of f act
calling into doubt its independence?
3. Held: No. Did not disclose Boskin was also Stanford professor that L had made donations to
Stanford and that one donations was used by G for personal research. Failed to disclose that B
taught G when PHD, two are good friends in Stanford Committees. L is well known Stanford
alum. Third E was Stanford contributor and wanted to make it best. a. Social Inf luences: may also inf luence and be motivating f actors can use them to show
SLC did not meet burden to show absence of material f actual question about
independence
Questions: s Suits against Corporations1. DE Supreme Court: views in Martha Stewart
a. Burden: directors in Oracle had the burden of demonstrating their independence for
purposes of their motion to dismiss the derivative action. In contrast,
b. In Beam ex rel Martha Stewart Living Omnimedia, Inc v Stewart, which was also a
shareholder derivative action, the PTF had the burden of alleging sufficient f acts to raisereasonable doubts about the independence of directors.
2. Distinguish: should we look at structural bias v. social circle bias personally beholden
3. Oracle: personal and f amilial, collegial as well as economic interests count
4. Standard: too substantial and guided by a general sense of human nature
a. Higher than standard for demand excuse: Martha Stewart (implied)
Plaintiff·s Lawyer: Derivative Strike Suits
1. File and Plead with Particularity:
a. First choice: A class (direct) action securities law; vote or dividend related
b. Second Choice: Derivative Action, plead that demand is excused first choice: breach of duty of loyalty, second choice bready of duty of care (hopeless)
2. Under both actions, expect and defeat
a. Motion based on the named s f ailure to adequately represent SHs
b. Motion on f ailure to plead with particularity
3. IF Class Action, Expect and Defeat Summary Motions: Motions to dismiss and a motion for
summary judgment on the merits; if lose, settle for peanuts; if win, settle for millions
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 67/124
67
4. IF Derivative Actions:
a. Expect and beat motion based on f ailure to make a demand; if lose, make demand and
start second suit for wrongful dismissal (hopeless?)
b. Expect and beat a second summary motion filed by an SLC
c. Expect and beat a third summary motion on the merits defense just a duty of care
case then BJR applies
d. If lose, file appeal and settle for peanuts or take risk of appeal
Settle for Millions: take 20-30% of the cash and collude with lawyers and sell the settlement to the
judge; who must approve. If successful buy naming rights to a law school.
Demand Excused: Aronson v. Lewis (DEL) and Barr v. W ackman (N Y )
1. Aronson v. Lewis: Test
a. Specifically plead one of two claims: reasonable doubt or belief that directors are (1)
ma jority interested or dominated by interested party OR (2) otherwise unable to
exercise independent judgment in evaluating SH demand (procedural/substantive tests of due care)
2. Barr v.Wackman (NY): Marx in NY
a. Ma jority of board interested pecuniary interest or controlled by someone who has
pecuniary interest
b. Directors not informed OR
c. Decision egregious on its f act; directors didnt exercise sound business judgment
PrimaryDuties: Board of Directors (and AppointedOfficers)
1. Duty to Whom: To the firm collectively, to maintain firm health not to individual SHs or
individual constituencies
2. Measuring FirmHealth Legally:
a. SH Value maximize residual profits long/short term; stock market price inaccuracies
b. Total firm capital value SHs returns PLUS bondholder returns
c. Total firm value return to investors plus income value to workers
d. Total social value firm is better off in the long run if society is healthy??
3. Corporate Powers: Express Powers
a. Generally: Most states have provisions to allow corporations to sue, be sued, own
property, make gif ts to charity, borrow money, get stock and redeem or purchase stockb. Limitations: most have limits e.g. transfer of substantially all of corporations assets
normally require approval of ma jority of voting power of the SHs
4. Corporate Powers: Implied Powers
a. Reasonably Necessary: most corporations have power to reasonably do what it is
necessary for the purpose of promoting their purposes (firm health) and help express
powers unless they are expressly prohibited by common or statutory law.
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 68/124
68
b. Broad Power: Trend is to construe broadly what is reasonably necessary
When can a Board Favor Non-SH Constituencies:1. Facts Patterns:
a. (1) Gif ts to Charities AP Smith;
b. (2) Distributions of extra cash, higher wages or dividends Dodge;
c. (3) Community, culture and tradition over profits Shlensky v. Wrigley
2. Potential Answers:
a. Never tie all decisions to shareholder welf are do not do it at all (Friedman);
controversial but it has been the legal rule for almost 150 years
b. Y es, a bit but only if amount is small and promotes the Good and Ethical (ALI)
c. Y es, Full Board Discretion to Act Board may discretionary choose to act in a socially
responsible manner [Ohio Statutory Rule § 1701.59(E)) Board of Directors of OH
Company has no duty to follow Shareholder Primacy Rule (unlike DE)
3. Objective of Corporation: What extent may a corporation may act in a way that is not intended
to maximize profits?
a. Social Responsibility: Early days broad power to contribute; now more of a debate
b. Arguments key objective to get best possible returns and not other legal standard is
enforceable; others says they have social responsibility and must balance with SHs
interests and public at large
AP Smith v. Barlow: Social Responsibility and Charitable Donations (1953)
1. Facts: Corp. formed in 1896 gave $1,500 to Princeton and SH challenged. President testified
that it was sound investment and created f avorable environment for the company public had
reasonable expectation of such socially oriented contributions by corps.
2. Issue: Is such a gif t to a university by a corporation a violation of the duty of loyalty?3. Held: No, judges are Princeton grads.
4. Rule: Probably not an impartial judgment
Questions for Non-Profit Motivated Gifts
1. Does the CEO get any personal benefits from such a gift? Elephant Bumping.
2. Would a majority of SHs ratif y the deal?
3. Does the type of gift matter? Tressel bonus v. Green party presidential campaign
4. Should SHs decide on them?
a. Individually give them cash dividends and they can give to charities themselves
b. Collectively Proportional allocation like Warren Buffet system of requests 5. Are executive decisions based on personal whim? Creates Conflict?
a. Gif ts to outside directors of f avorites ties them to managers form of quid pro quo like
in Seton Hall
b. To bind outside directors just give their school money in their name, easiest form of
bribery and elephant bumping
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 69/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 70/124
70
Shlensky v. W rigley:M isconduct not found
1. Facts: minority SH in corp. that owns Cubs brings derivative suit for refusal to light Wrigley
Field and increase revenues. Directors motivation was result of views of Mr. Wrigley and
ma jority SH who wanted to preserve neighborhood surrounding and who thought baseball
was day sport.
2. Issue: May a SH bring a derivative suit for mismanagement where there are no allegations of
fraud, illegality or conf lict of interest for not installing lights?
3. Held: No, the court will not disturb the business judgment of ma jority of directors without
above reasons. No evidence that installing lights and scheduling will increase benefits to and
there appear other valid reasons for refusal to install e.g. detrimental effect on surrounding
neighborhood (which Corp. Property is located in and has interest in).
a. Not obligated to follow direction taken by other, similar corps. Even if these MAY be
better not guaranteed.
Shareholder Primacy Rule1. Board Members Behold only to SHs if ONLY SHs vote: SH will vote for board that maximizes SH
welf are
a. SH welf are without clear SH direction to contrary a DUTY to maximize SH wealth
2. Duty to Others Constituencies: Ideas
a. Others may vote: Germany
b. Room for duty because SH vote is a joke and board is self-perpetuating
c. YES but only with a clear link of other constituencies welf are to SH welf are our system
3. Distinguish Idea: That Corp. should follow green ideals because it will do better over time
(maximize profits in a long-term plan) FROM
a. Following them because the expense of profits over time because society is better off
(it is moral, ethical or right)
b. Substitute for green sin-free like no booze, etc..
Defense of Shareholder Primacy Rule
1. Goal of Corporate Law: Serve interests of society as a whole
2. Achieved: Does this by advancing aggregate wealth good!
3. Surrogate measure of firm health best interest of SHs? SH Primacy Principle
a. 95% of the time if SHs are happy everyone else is happy (litmus test even for
employees); They are served last so all before them get hooked up
b. Auction of board vote SHs pay the price of what they think the stock would be worse
v. what they think it would be worth if they had control or if the directors had control
i. If SHs control the vote then we are happy they control the interest they
are the ones with the RISK and who have something to lose.
4. Who should prevail when SHs and other constituencies are in conflict? E.g. company is on edge
of insolvency
a. Pro-shareholder - reduce wages or dissolve because if not, I am gone
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 71/124
71
b. Pro-labor run company until broke and until all the cash is gone (like NYTIMES, GM
and CHRYSLER)
5. Opponents of Rule: CEOs in OH have duty to all accountable to none; insulated board from
Court Review
a. Asset redistribution social engineers want say over others assets and money for
greater good of society
b. Opportunistic renegotiation contracts agree to terms (labor money) and ask court to
change it because of circumstances (big profits, no profits)
c. Promoters of idea that consensual, inclusive decision making dialogue is a universal
good and will lead to peace and
happiness
6. Bottom Line on Principle: one of the most
significant structural assets
a. Combination: Economic f lexibility and
accountability of those who control
pools of investor money
b. Constant attack from politicians,
academics, journalists, clergy, etc. and
survives because competition among
nations, states and companies; core
respect for individual initiative and
common sense
What st rl i t ay
Republican � r�
paganda: �
�
(I�
ish), t he Republic�
E�
s do not like
y views eit her. They do not wanbe held account able in shareholder law suits; t hey li
dividend ret ention and t he power t o
ake charit ablegifts (and political contributions t o � ixon).
Profits�
ver Environment : � o, t he met hod of prot ecting t he environment is t o pass general legislawit h prohibitions; do not give t he board a fiduciary dt o be green.
Do � ot Invest in (or buy Products from) only Et hical�
ompanies:� o, recognize and accept t he cost. Res
t he limits of legislating et hics.
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 72/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 73/124
73
W ater, W aste and Land v. Lanham: Gap Filling and Constructive Notice
1. Facts: , manager and member of PII, . was LLC under CO LLC Act and contacted WWL, ,
about doing work. During discussions gave business card with PII and address of other
member and president of PII, L, who had same address listed as principle office and place of
business in Sec. State filing. Oral K with and asked to send written work proposal to sign and
return. Never sent but authorized to begin work; when work done sent $9k bill.
2. Issue: Is a member-manager of an LLC personally liable on a K entered into by another member-
manager and a 3rd
party if the 3rd
party lacks knowledge of the business entity and thinks the
member-manager with who dealing with was acting as an agent for the other member-
manager?
3. Held: Yes, even though L was agent of PII, LLC, he f ailed to fully disclose his principal to a 3rd
party with whom his agent dealt and under agency law, f ailure made him liable on the K with
the 3rd
party.
4. Rule: Even though statute calls for filing with the Sec. of State, the member is liable when not
disclosing principal is LLC. (OH has reverse § .07(c))
a. To interpret the notice section of the LLC Act as making filing constructive notice even if
they lack knowledge of the LLC existence would invite fraud and sharp practices;
allowing agent of an LCC to mislead a 3rd
party to think that the agent would make good
on K.
b. Constructive Notice - Better Interpretation: notice of an LLCs name puts a 3rd
party who
deals with someone that he knows is a member of an LLC on constructive notice f the
LLCs limited liability status and that managers and members bear no liability because of
status.
c. Interpret Statutes in derogation of common law narrowly, particularly when broad
interpretation would depart greatly from settled agency rules and create uncertainty
about known rules when L got proposed K from showing thought L was principal
he could have easily corrected s to avoid this.
Elf Atochem v. Jaffari: Operating Agreements and Arbitration
1. Facts: Elf and J agreed to joint venture to market J product and form M, LCC a DE LLC.
says he gave 30% capital in exchange for 30% interest and J gave rights to product for 70%
interest. OA said arbitration clause would govern all disputes coming from OA and forum would
be in CA. files in DE claiming duty of loyalty. Because OA says forum is CA, DE Court
dismissed claim.
2. Issue: May the members of an LLC, through the use of a forum selection clause in their OA, vest
jurisdiction in a particular forum?
3. Held: Yes. DE LLC Act allows broad discretion in draf ting LLC OA and gives def aults only when
OA members agreement is silent.
a. Maximum effect to freedom to contract and to freedom of enforceability of LLC OAs.
Only when inconsistent with mandatory statutory provisions will the Members
agreement be invalid.
b. Omitted in OH
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 74/124
74
Kaycee v. Flahive: Piercing the LCC Veil
1. Facts: KC, , and FOG contracted to use s real property and Roger, , is managing member of
FOG says that during use, FOG fucked up property. FOG has no assets and seeks to pierce
LCC and hold ROGER individually liable for the fucking up.
2. Issue: Without fraud, may a court pierce the LLC veil in the same manner as the court would
pierce a corporate veil?
3. Held: Yes. Every state that has enacted LCC piercing laws hasnt developed a different LLC
standard but has chosen to follow corp. law standards; no reason to treaty LLCs differently than
corps
a. Some f actors justif ying corp. piercing like f ailure of formalities obviously will not apply
b. OH §.48 says no language on formalities
M cConnel v. Hunt Sports: M ember-M anaged LLC with OA
1. Facts: CHL in 1996 was formed; Member managed LLC with an OA; LLC OA allowed members to
compete with LLC; restricted liability of members of willful misconduct; required ma jority to file
suit. Member of LLC formed new LP to take sports franchise in competition with LLC2. Issue: Can an OA of an LLC limit of define the scope of fiduciary duties imposed on its members?
3. Held: Yes, § 3.3 of the OA said that members may compete and shall not in any way be stopped
from engaging or owning any competing interest. Language is clear and unambiguous
o By very clear terms OA allowed competition and voided duty of loyalty for the LLC
members involved; no duty not to compete
o OA obligations only apply to conduct in carrying out their duties of the OA: Breach of LLC
OA was by member for filing an unauthorized suit against LP
4. Waiver of fiduciary duties: in partnerships harder to do this because of common law duty; cannot
be engaging in any other business in joint venture industry (so preserve the right to pursue other
businesses)
o Members may waive: all duty of care claims other than willful acts and some types of
duty of loyalty claims (duty not to compete)
o Court Refusals to Respect Waiver: basic contract theory strict construction of language
mistake, fraud, contract of adhesion, non-waivable fiduciary rights?
o Homer Opinion: in this case, OA doesnt specifically say that cannot TAKE THIS BUSINESS
only says cannot take others (ridiculous)
5. Cannot waive in RUPA § 103: generally any unless manifestly unreasonable
Formalities of LLCs1. Many Without Formalities: Operate with one-page Articles of Associations
a. Many oral implied agreements custom, course of practice evidence
b. Usually member-managed but can be manager-managed in mutual unwritten
understanding that only B runs business, not A.
2. Effect on Integrity of Entity: Court interprets implied agreement and other applies def ault rules
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 75/124
75
Ohio: Summary of ch. 17051. Keys: No constructive notice on filing; no freedom of contract language
2. Default Rules:
a. Create LLC capital contributions create division of profits
b. No automatic capital calls
c. New members on unanimous vote
d. Lock-in: members may not withdraw but may assign interest in membership to others
for consideration (ceases to be a member on death or insolvency); partnerships
withdraw at your own will
e. Withdrawal: § 1705.16 (go from no lock-in in A and B from absolute lock-in in C)
f . Authority depends on member- or manager-managed distinction
g. Duties of managers comes from Corp. Model
3. Lock-In: Member of LLC with no OA and want to unilaterally leave
a. Cannot withdraw
b.
Can sell; purchaser not a new member
c. Sue to dissolve not practicable to carry on business in harmony, etc.
d. Die estate has powers of members, can assign, not membership
e. Lesson: Use an OA and DO NOT use the def ault rules.
Transaction Lawyers: Operating Agreements
1. Why is lock-in important? Automatic lock-in with LLC def aults, which is why they are so popular
2. Why not law firms? Because of the vanity of the word partnership
a. Inherent lock-in, too
3. Minimal info in articles because updating
4. Money
into bu
sine
ssno
tper
son
al
5. Critical membership issues allow what? Deny what?
6. Review to see if change procedures if so, amend
7. Know about tax issues
8. Oesterle:
a. (1) PutMinimal Information In Articles: Updating Obligations Are Easy to Forget and
Remember Annual Fees; also Check Name (Make Sure No-one Else Has It)
b. (2) Take Extra Care on Instructing Client on Proper Use of Business Name: LLC in Title
and on Signs and Instruct Client, in Writing, on How to Sign Documents
c. (3) Take Extra Care on Instructing Client to Keep Separate Business/Personal Accounts
d. (4) Always, Always Use aW
ritten OA (Start with a Good Form; Modif y It)i. Include Critical Client Understandings on: Membership Issues (Admission;
Withdrawal and Expulsion; Assignments) Division of Profits; Capital Calls;
Management Structure (Decision Making and Voting Procedures) and always
Prefer Simplicity
ii. Handy Road Map: Client Can Read and Follow the Directions - Include Tailored
Rules and Def ault Rules into a Single Package of Instructions
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 76/124
76
iii. Review the OA Periodically to Make Sure that Client Has Not Changed
Procedures. If so, Amend OA or Amend Client Procedures. Do not let it go.
a. (5) Know a Few Essential Details About Partnership Tax and A Good, Reliable Tax
Expert for Clients and Yourself .
FiduciaryDuties on the Corporate Side1. Control of judges: in corporate context much more refined
2. Duty of Loyalty of Good Faith: Bound by rules of f airness, loyalty, honesty and good f aith in
their relationships, dealings and managements
3. Duty of Reasonable Care: Exercise reasonable care, prudence and diligence in the management
of the corp.
4. Duty of Candor: growing in corporate context and reduced in partnership and LLC context (duty
to reveal or disclose info)
Duty of Care and Common Factual Issues5. Takeovers: Board sold for too little or refused to make a good offer (Van Gorkom and Cede)
a. Buyer just pays too much, buy a company that isnt worth that much; OR target
company sells for too little by not holding out for more cash
6. SH Dividend Cases: Board should NOT have paid a dividend (AmEx case)
a. Board decides or doesnt decide to pay an extraordinary dividend (dumping cash on
shareholders) should we do this?
7. Duty of Monitor: (1) Inattention (Francis and Allis-Chalmers) and (2) lack of legal compliance
programs (Caremark)
a. New stuff board is just not paying any attention, stuff is happening with the company
and they are just not informed and dont care enough to create legal complianceprograms to structure information sharing
8. Illegal Act Cases: AT&T Case
a. bribe foreign officials, statute act to stop wholesale bribery of foreign officials; campaign
contribution violations
The Business Judgment Rule1. Along with Care and Loyalty, Third Standard: Confusion as to what the standard actually is
thresholds? If good f aith, gross negligence? Affirmative defense? Good f aith as a defense to
negligence?
2. Purpose: Courts are reluctant to hold directors truly responsible for the management of thecorporation and truly liable for its financial errors
3. Defined: When a matter of business judgment is involved, the directors meet their
responsibilities of care if they use honest, good f aith, unbiased judgment.
4. GrossNegligence: When standard is applied only a director acting in good f aith could be held
liable if his actions were grossly negligent or worse
5. Thresholds:
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 77/124
77
a. (1) Financially disinterested (no conflicts of interest)
b. (2) Reasonably Informed
c. (3) Acting in Good Faith in the firms interests
6. True Standard: Regardless of standard of negligence courts say they use,
a. Generally just look at all the f acts and determine whether the total situation is one in
which the directors or officers SHOULD be held liable
b. BECAUSE they knew or should have known of the situation AND they could have done
anything about it.
c. Applied to each individually
Kamin v. American Express: Informed Business Judgment
1. Facts: Minority SH s sue AmEx on derivative and request declaration that certain dividend in
kind that is to be paid is a waste of assets. s that in 1972 bought 2M shares of DLJ at $29M
and current is about $4M. 1975 board has special dividend to which DLJ were given to SHs in
kind. If sell thinks would sustain capital loss of $25 and would be off set against capital gains
of about $8M to . Rejected. 2. Issue: Minus of a showing of bad f aith, fraud, oppression, arbitrary action, or breach of trust,
are the business judgment decisions of corporate directors judicially rescindable for alleged
imprudence or mistaken judgment?
3. Held: No. Once the plaintiff s had conceded that the American Express board considered the tax
advantages of selling the DLJ stock before deciding to distribute that stock as a dividend,NO
questioning of the board's demonstrably foolish decision would be entertained
a. Neutral of tax reduction economists cannot make decision and neither can AmEx but
they say that boards will spin-off and earnings number will be higher
b. Key it was good f aith, they acted without any impropriety.
What to do if buy business for millions and worth millions less now?
1. Could do one-time write down of -$80M; big write-down will come right out of the net profit
line P/E Ratio would go down price to earnings ratio earnings per share (stock price goes
down, etc. not good for shareholders)
2. Sell shares and get the cash, still have $20M in cash now (true ref lection of value of the firm)
but wont write-down as much
a. Advantages tax deductions for capital losses
3. Which AMEX took declare a special stock dividend (not just cash): give out more cash (in-
kind/in-specie dividend); take shares of the sub (SH Apparent Sub) the Apparent then gives
the SHs stock in the sub for freea. Tax status pay more
b. Net profits looks greater but we are paying more taxes to the government in this
situation EVEN THOUGH our Price/Earnings Ratio (SO therefore paying tax to the
government is good for the company) SHs say NO, take the deduction and cash
because this is retarded
c. AMEX won no fraud, no conf lict of interest, no bad f aith, just plain DUMB
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 78/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 79/124
79
e. Investment banker admits he was paid $1M; had to pay 2nd
or 3rd
investment banker to
make deals like this (free money)
4. Effect on legal advice to board?
a. Fairness opinions from investment bankers and scripted recorded board decision-
making procedures (all a show) no short board meetings
b. Makes money for lawyers for associates
c. Must take at least two weeks to have board meetings on sales to sell it
d. Procedure at meetings must be heavily legalized/official
LiabilityWaivers: Delaware1. SHs must sue on behalf of firm:
a. (1) demand requirement in duty of care cases are hard to get excused
b. (2) BJR of the defense motion to dismiss; hard to overcome
2. Waiver Does not Apply:
a. To injunctions only to claims for damages
b. To allegations of bad f aith or personal benefit
3. DOES apply to:
a. Damage claims against disinterested directors
b. UNLESS the Entire Fairness Test applies controlling SH transactions (Emerald Partners)
4. Duty of Care in DCL § 141(a) Statutory Cases: Business and aff airs of this corporation shall be
managed by the board of directors, except otherwise provided in this chapter or cert. of
incorporation
a. Exception § 102(b)(7) amending the cert. of incorporation limiting or eliminating
the personal liability of the director (not the firm or an officer) for monetary damages
(can always for injunctive relief) sue as a director provided that (1) cannot eliminate
duty of loyalty; (2) intentional or knowing violation of the law; (3) improper personal
benefit problem
b. Problem what do we do for recklessness? Can we exempt or not?
c. § 102(a)(7) can put in a provision (voted on) to eliminate the personal liability of the
director in a duty of care case unless there is a reckless or intentional conduct
Ohio: Duty to Care § 1701.59 and 1701.601. § 1701.59 duty of care;§ 1701.60 also has an impact
2. Tries to rip Smith v. Van Gorkom apart general statement is in § 1701.59 BUT then may
adopt BYLAWS in order to change
3. Bylaws in OH like rules of order use in a context where no one else would understand
(regulation are the actual bylaws of a corporation in OH)
4. Codify the Exceptions to the BJR: straight negligence standard (ordinarily prudent person who
would have done in the situation)
a. (b)Negligence Test:
b. (c) Changes everything (c) is usually most important director SHALL not be found to
have violated (b) duties unless proved by clear and convincing evidence (standard of
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 80/124
80
proof like common law fraud in torts or equitable concepts); cannot sue under a duty
care unless they have clear and convincing evidence
i. No good f aith if unwarranted
c. (d) Injunctive relief to damage action
d. (e) for purposes of duty of care director best interests of the corporation shall
consider the SHs interests (touchstone is best interests of corporation) may consider
economy, community and societal considerations, employees, debtors and creditors,
continuing independence (dont sell)
5. Default rule not amended into the cert. of incorp. but must amend out of it
a. Very pro-director with lots of exceptions
b. Lots of protection from the duty of care impossible to win even if get to a jury (duty to
nobody)
6. (e) constituency statute: directors can be beholden to a lot of constituencies
a. Duty of care has been shat on OH is laughingstock for good corporate lawyers
everywhere
7. § 1701.60(c) Redefine Duty of Loyalty
a. Changes (a) conf lict of interest definitions and duty of loyalty
b. A director is not an interest director SOLELY because the subject of the K, action or
transaction MAY involve or affect a change in control of the corp. or his continuation in
office as a director of that corp.
c. Damages § 102(b)(7) reckless disregard; § in D that excludes negligence and gross
negligence for monetary damages must be intentional disregard for corp.
d. Must opt-out if dont like (d)
e. (e) compensation provision
8. Irrespective of any financial or personal interests of any of them shall have the authority to
establish reasonable compensation
a. With conf lict of interest? Goes to duty of care
9. Duty of Care: all compensation decisions irrespective of financial interests and includes all
takeover decisions as well
10. 1701.59(a): general duty of care;
a. (c) negligence definition of duty of care and also reaches out to takeovers no duty of
loyalty problem
b. Adds clear and convincing test in (c) standard of proof in all actions
c. (d) monetary damages: more restrictions outside (c) get 102(b)(7) situation standard
to get cash from a director is intent or recklessness (not gross negligence or negligence)
recklessness is not express in the DE provision
d. Default in OH: (c) and (d) is an opt-out limitation on director liability in OH if you dont
like it, you can opt out (name the provision) with a waiver specific to this section very
specific (can go back to gross negligence)
e. Opt-in in DE: must have an opt-in amendment voted on by SHs
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 81/124
81
OHIO DELAWARE
Def ault Rule: Opt out not opt in
Opt In but as def aults: Will not apply to injunctions
only to claims for damage and To allegations of
bad f aith or personal benefit
DOES apply to: Damage claims against
disinterested directors UNLESS the Entire Fairness
Test applies controlling SH transactions (Emerald
Partners)
Tighter: Clear and convincing standard of proof ;
best interests of Corp. included other
constituencies; no improper personal benefit
exclusion; no Unocal rule; reckless disregard
Culpability doesnt include reckless disregard for
best interests of corporation; only gross negligence
Cons: SHs are duped. Pros of Waivers: why ratif y? They know what they
are doing.
Brehm v. Eisner: Informed Compensation and Severance
1. Facts: Disney hires O as Pres. In 1995 approved 5 year compensation pack of $1 with bonuses
and stocks with generous compensation package. O lef t without f ault before 5 year term. O
sucked at work and 1996 Eisner allows to terminate. Vote to approve non-f ault termination.
Give package over $140M.
2. Issue: Was there a breach of fiduciary duty of board by f ailing to assess employment agreement
properly or approval of termination for no f ault?3. Held: No. Had expert assess contract didnt look to package doesnt infer that board f ailed to
look at cost of firing him.
a. Standard: doesnt require that boards decision be informed on every f act only
reasonably informed (even without exact cost fully informed about manner in which
such payment would be calculated because of expert)
b. Negotiations for severance was BJR value of contract against value of employee; court
will not apply 20/20 hindsight to 2nd
guess boards opinion UNLESS rare cases when a
deal is so bad on its f ace that the boards approval cannot meet the BJ test.
c. Terms of Agreement limit to gross negligence or malfeasance for at f ault termination
he may not have been here, so boards f ailure wasnt problem. 4. Duty of Care: Directors decisions respected as presumption unless
a. (1) Interested
b. (2) Lack independence relative to the decision
c. (3) do not act in good f aith
d. (4) act without a rational (not reasonable) business purpose
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 82/124
82
e. (5) Use grossly negligent process (includes f ailure to consider all material f acts
reasonably available)
Business Judgment Rule: Implications1. Design: to end cases at Summary Motion pleading matters and should use SH inspection
rights at first
2. Second Guessing: Courts will not 2nd
guess business judgment if they are rational or reasonable;
defer to disinterested and independent directors and rely on experts (this will make judgment
reasonable or rational)
3. Best Practice Standards are not liability standards: Standards evolve; process and procedure
matters (keep good records, no check box drills; objective reasonable test on procedures of
gross negligence)
4. BUT NewWrinkle of Good Faith: different from duties of care and loyalty?
a. Violated by willfulness or recklessness (intentional misconduct or conscious disregard
for duties
b. Even though no recklessness in the record
Eisner v. Disney: Implications of New W rinkle
1. Facts: Board Compensation Committee Rarely Met. Some Members (Sidney Poitier) Attended by
Phone from His Yacht and Did Not Have the Foggiest Idea What Was Going On. They Relied on
Eisners Recommendations
a. Changes in Severance Provisions (For Tax Purposes) At the Last Minute Were Not
Understood Nor Discussed by the Board of its Committees. [The Compensation
Consultant was also surprised.]
b. Eisners Severance Provisions Were Similarly Bad.
2. Issue: Breach of fiduciary duties?3. Because of 102(b)(7) Waiver: Court must hold
a. (1) Board was reckless
b. (2) Board violated good f aith by deliberate disregard
c. (3) Wasted corporate assets
4. LoyaltyNot Available because O not on board and O not f amily or friend of dominant SH or CEO
5. NewWrinkle Effect of BJR Rebuttal of Presumption?
a. DE: shif ts burden of proof to directors standard of entire f airness
b. Others (Allen): s must prove(1) lack of due care (negligence), (2) proximate cause and
(3) damages
c. Difference: Rescission available as damages? Eliminated by Allen ruling that NO
Transaction Lawyers: Waivers
1. ALWAYS: include a 102(b)(7) waiver
2. WithWaiver: board members personally liable, only for (1) willful misconduct, (2) recklessness
or (3) personal pecuniary gain
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 83/124
83
3. ALWAYS: include corporate promise to employment agreement (backed with provisions in
Articles) to maximize indemnification and insurance coverage
4. NOW have new rules to deal with: organizational sentencing guidelines lower fines for firms
a. with compliance problems
b. that turn into bad actors because scapegoats
c. SOX of 2002 for publicly traded firms; they MUST have internal compliance info and
disclosure programs that are audited; federal and criminal/civil penalties; CEO and CFO
certifications
The Duty to Monitor: Corporations1. Argument: directors were ignorant and things happen that should not have because they were
not paying necessary attention
2. Distinguish: a breach by commission FROM one by omission (unwitting express ratification of
fraud; willful blindness?)
3. Distinguish: Excusable ignorance FROM breach 4. Director must:
a. (1) understand business;
b. (2) stay informed in operations;
c. (3) be f amiliar with financial status and
d. (4) inquire on any red f lags
5. Standards: Distinguish between objective and more subjective sophistication of director
6. Statutory Defense: reasonable reliance on experts
7. Key Question: did the board of directors establish an adequate procedural disclosure system to
inform them of problems and keep them up to date on key company issues?
Francis v. United Jersey Bank: Familiarity
1. Facts: Bank was run by idiot sons who embezzled money af ter son died; their mother didnt care
nor pay attention even though was also director.
2. Issue: Was Mother, as director, individually
liable because negligent, and if so, was
negligence proximate cause of losses by s?
3. Held: Yes. Causation was provable because
banks are special and easier to prove causation.
4. Director must: know and understand basic and
required to generally monitor aff airs andpolicies; if illegal conduct, had duty to object and
maybe take reasonable means to prevent such
conduct or resign.
5. Nonfeasance: causation issue requires
determining what reasonable steps a director
could have taken and whether those steps
Ba ne v. And ew ( .D.N.Y. 1924)
Liable f or f ailur e to stay inf ormed?
Held: No, unless evidence that neglect caused losses.
Liberty Starter s(Insolven t)
Receiver
Andr ews (Dir ector and lar gest shar eho lde
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 84/124
84
would have prevented the loss. The f ailure to act must be a substantial f actor in producing the
harm. Here inaction encouraged it and could infer she should have acted to object or seek
counsel.
a. Causation case by case analysis.
In re Caremark Intl.: Duty to Oversee Employees1. Facts: Settling a lawsuit where Caremark employees were engaging in Medicaid fraud
2. Issue: were the directors liable for these employees who were breaking the law and losing lots
of money?
a. Settled the case af ter suit by SHs
b. In the settlement (non-reviewable) directors have a duty to install internal controls
(info and reporting systems)
3. Settlement Creates Law new law could be
installed in settlements, so they try to change
it; now they have internal controls, could have
found as a judge that we established doctrinebased on internal control (judge)
a. If a board doesnt have a procedure to
stop illegal procedure and care for it,
then it is a duty of care breach (by
dicta)
Legal Compliance Programs: General Duty to Investigate?
1. Old Rule: No, unless there was a red f lag. 2. New Rule Caremark: Must have internal legal compliance program because there is a general
duty to establish it.
3. Why? 1991 Sentencing Guidelines on how to sentence Corporations 2002 SOX Requirements
says they will go lenient on corporations with Legal Compliance Programs will not get
sentenced harshly if illegal stuff is going on
a. Sarbanes-Oxley adds to this type of thinking
b. Only if you are publically traded S-O requires legal compliance and audits
4. What is a legal compliance program? Audited? Costs?
a. Legal compliance program must be audited (required by Sarbanes-Oxley)
b. Must hire one of the 4 big accounting firms to audit your firm Congress makes this rule5. Problems: If the accounting firms makes a mistake?
a. (1) they get delicensed SO they are hypercritical to save their own asses because of the
fines and potential loss of business this happened to Arthur Anderson in Enron (out of
business)
b. (2) this is not their specialty they are accountants, not legal compliance officers or
lawyers who should know this type of stuff (no lawyer expertise)
Stone v Ritter (Del. 6)
� The f inal br ick in the wall against an independent good f aith standard. Just a
recklessness standard in disguise.
� Also Aff irms the Caremark duty, a duty to put in internal contr ols. Did the company have money-launder ing contr ols in place?Yes. Case Dismissed.
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 85/124
85
c. (3) Use checklists for CYA; use among all the officers so no problems
6. Sum total incredible added expense to our auditing of companies (antithesis of what we
wanted to do in Sarbanes-Oxley to attack auditors)
Duty to Object 1. Once a director identifies a problem must the director: Object?
a. Form: in a meeting? On the Record?
2. Once outvoted:
a. Resign
b. Attempt to prevent? Francis (unusual)
c. Blow the whistle? Notif y
i. Government the state, the SEC (of Resignation or Of Specific Info), prosecutors
ii. Shareholders (media)
d. Sue offenders? Standing as a director to sue on behalf of the firm may sue the other
directors 3. Compel to whistle blow? Sarbanes-Oxley whistle blow for public financials
a. Rule Now: Want to protect from litigation, all you are obligated to do is resign publicly
and object in the public forum (unless you have done something yourself, in the
conspiracy, then resignation will not be enough)
4. Question: Should we go one step further? Problems?
a. Sarbanes-Oxley: attempts to protect voluntary whistle blower you are owed lots of
cash in litigation (protections voluntary whistleblowers)
b. Creates incentive for voluntary whistle blowing
c. Duty to Rat: creates incentive not to inform others, creates incentive to not rat, not
share information or at least too much (cliques)
Illegal Acts: Exception to the Business Judgment Rule1. Miller v. ATT&T: Allegation of illegal campaign contribution
2. Standard: good f aith? In best interests of the corporation?
3. Duty to Act Lawfully: Officers and directors have a duty to act within law; if they KNOWINGLY
cause their corporations to violate the law, they are in violation. Also have duty to ensure that
the corporation has effective internal controls to prevent employees from engaging in illegal
acts.
The Entire Fairness Test 1. Duty of Loyalty/Conflict of Interest: These are the cases you can win, have settlement value
and are cases that judges actually do understand cannot judge real business decisions
a. Judges are outside capacity in duty of care; here this is traditional stuff serving two
masters, conf licting goals, lying to people (human condition stuff)
b. E.g. Director/Officer on one firm inks a deal with a second firm that is owed by
director/officer (Bayer listen to wife who is an idiot); Lewis (board members own more
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 86/124
86
than lessor); BOT v. Benihanna (board member bought convertible preferred stock); has
independently paid (bribed) the director/officer or CS (Agency)
2. Standard of Review: Entire Fairness Test is current version
a. Test: It makes little difference whether the board is disinterested or not, the issue is
whether the transaction is f air.
b. Requirements: Directors interest must be fully disclosed if the board is not
disinterested, the contract will be given very close scrutiny; many states have this.
c. Burden: On the conf licted board with careful scrutiny met in Bayer and BOT
3. Two Types of Duty of Loyalty
a. (1) Sweetheart deal: CEO who owns both
corporation, one corp. is 2% and other is 100%
- has them deal with each other with 2% share
and sell goods for too little money to the 100%
(Singapore asset stripping); CEOs Mom buys
$100 hat for $10 puts asset value out
b. (2) Bribery: CEO approaches CEO and wants
deal says will bribe CEO for decision-making
in company, outside the deal (a lot of problems
here e.g. takeover artist with one CEO
blocking it pays that guy bribe and he stops
blocking it)
Bayer v. Beran: Relatives
1. Facts: Wife choose advertising campaign even though
she is singer. She chose herself to sing in ads and paid
normal price. SHs sue who was ma jority owner. 2. Breach? No. Burden to show good f aith of deal and
inherent unf airness. No disloyalty. Just because the
participation of wife may have helped her singing
career is not a sole ground for subjected s to liability
for breach because there wasnt excessive pay to her
and directors free to chose campaign.
Lewis v. SL: Fairness Burdens
1. Facts: SR owns SLE and LGT and real property used by LGT owned by SLE. Transfers stock to 6
children in LGT but not SLE, who leases from LGT. Sell stock to LGT at low price and refused tosell saying rental was greater than what lease was for and so was book value.
2. Burden: Overcome by s, made no effort to determine f air rental value at any time. Must show
the deal was f air and reasonable.
Safe Harbor State Statutes1. Sources: DGCL § 144; RMBCA § 8.60-63; OH GCL § 1701.60
Sweet Heart Deal
R m
n o f
o Pm
m
I
.A
o
S
m
n n o I
S z
{
|
}
~
|
{
. A
}
~
~
| z
50%
. A
100
CEO C z
{
z
. A
D| z
~
S o
� �
A
o
f
� m
�
o
�
�
� y �
o
f
� �
BOT v Benihanna
AokiB
r ust
Benihanna, US
50.9
Common 75%Seats2% Class A Common 25% Seats
BF C$20M Conv. Pr ef err ed
oting Stock
1 dedicat ed seat;
oted as × 28% of CommonFor 75% seats
( Abdo,
0%
wner )
( Abdo, Dir ector-Exec.
Comm .)
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 87/124
87
2. Transaction not voidable if:
a. Details fully disclosed AND
b. Ratified by disinterested directors OR disinterested SHs
c. AND Fair
3. § 144 Issues: Ratification and Fairness Tests Same tests (ma jority)?
a. If no, does ratification effect f airness; if no, use weaker test
b. If yes, does ratification end inquiry? No, BJR on ratification decision
c. Full disclosure required by f airness test? Ma jority, Yes.
d. Fair procedure and pair price? Ma jority, yes. (Hayes Oyster, Wash.)
4. § 144 Issue: Relate to suits against directors for damages or unjust enrichment like BOT? Agency
law controls. BOT defines duty:
a. (1) Section 144 of Delaware General Corporation Law provides a safe harbor for
interested transactions if the material f acts as to the directors relationship or interested
and as to the contract or transaction are disclosed or are known to the Board and the
Board, in food f aith, authorizes the contract or transaction by the affirmative votes of a
ma jority of the disinterested directors
b. (2) Corporate action may not be taken for the sole and primary purpose of
entrenchment
5. Distinguish: director deals FROM controlling SH (parent/partially controlled subsidiary) deals
§ 144 Issues with Ratification
1. Are Shareholder Ratification and Fairness Alternative Tests?? (Is or conjunctive or
dis junctive?)
2. Majority With Delaware Style Statute: No. See Fliegler v Lawrence (Del. 76)?? [But in Fliegler
there was not a disinterested ma jority of shareholders.]
a. If no, does valid ratification affect strength of f airness test?
i. No, unless disinterested votes in ma jority. Delaware Court effectively amended
the statute to look more like Ohios.
ii. If disinterested ma jority vote, use weaker test: BJR.
iii. In parent- controlled sub deal, then shif t burden of proof on ma jority of
minority vote but use entire f airness test. In Re Wheelabrator
6. Minority: Yes (Ohio: Statute Requires a Disinterested Shareholder Vote).
a. If yes, does ratification end inquiry?
b. Effectively, yes (hard to second guess informed, disinterested shareholder decision
when protecting disinterested shareholders).
7. Is Full Disclosure Required by the Fairness Test (as well as the Ratification Test)?? Fair
Procedure and Fair Price?? Majority: Yes (H ayes Oyster )
Shareholder Ratification1. Maybe Stronger than Board Ratification
2. BJR Applies: SH Ratification of director/officer related party transactions
a. BUT if wasted assets, unanimity required (Lewis)
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 88/124
88
3. Fairness Test Applies: Transactions between corporation and controlling SH with burden shif ted
(Wheelabrator)
Transaction Lawyer: Special Committee of Independent Directors
1. Composition: independent directors
2. Authority: full powers to decide, delegated by resolution of full board3. Charge: negotiate best price
4. Powers: may hire outside lawyers, banks and accountants
5. Effect on Standard of Review: Only shif ts burden to to show unf airness in controlled SH
transactions
The Duty of Loyalty1. Distinguish from Duty of Care:
a. (1) Sloth, inattention or stupidity
b. (2) Disloyalty, betrayal, personal benefit at firm expense selfishness c. (3) Care: s lose; Loyalty: s win.
2. Alternative Terms: Bad f aith, self-interested, self-dealing, conf licted, interested or related party
transactions; conf licts of interest
Corporate Opportunities1. Prevents: Corporate officers and directors from taking opportunities for themselves that should
belong to the corporation
a. Example of Property: May not use corp. property to develop own personal business
2. Distinguish: FROM related party transactions like In re Ebay (bribes not Cos)
3. Standard: interest or expectancy test; stronger line of business test (Guth)4. Expectancies: May not assume for herself property or interests in which the corp. is interested
or which the corp. could be said to have a tangible expectancy or which are important to corp.
business purposes
a. Corp. leases land cannot buy the land for self
b. If reasonably foreseeable corp. would be interested in property necessary expectancy
and if opportunities relate very closely to the business of the corp. necessary
expectancy
5. Defenses: Must be in good f aith
a. (1) Individual Capacity: s may claim opportunities were presented to them as
individuals and not through role in corp. b. (2) Corp. Unable to Take Advantage: if disclosed to corp. first, and cannot use, then
officer and director may use. Need heavy justification to show no finances.
c. (3) Corp. refuses: May take advantage of
6. Remedies: (1) Damages or (2) constructive trust
7. Competition with Corporation: May not use assets, property, materials, secrets to form
competition BUT
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 89/124
89
a. A fiduciary may leave corporation and form a business in competition occasionally the
conduct of the fiduciary while still with the corp. prior to leaving may be examined
Broz v. Cellular Info Systems: Financially Unable
1. Facts: hears of chance to buy company; wants to sell and tells in personal capacity because
Corp. was not seen as viable to purchase. 2. Issue: did usurp corporate opportunity?
3. Held: No, they were financially incapable of exploiting the chance to buy the land and was; not
clear that had a cognizable interest or expectancy in the license because their business plan
didnt involve any new acquisitions.
a. Emphasis that did not formally present the matter to the board of directors but
these are not required under circumstances where there is no interest, expectancy or
financial ability to pursue the opportunity
b. Came to Broz in capacity as individual not CIS director and CIS had no expectancy or
financial capacity
c. Same line of business; CIS CEO says that expectancy not there f ailure to act oninformal disclosure would be impeaching evidence
In re E B AY : Delaware
1. Facts: 1995 O and S found Ebay as sole proprietorship and in 1998 retained underwriters for
IPO, GS was lead and GS recommends to rewarded clients including directors of Ebay by
allocating 1000s of IPO shares at IPO price for HUGE profits.
2. Issue: Were allocations a corporate opportunity?
3. Held: Yes. Ebay was financially able to exploit the opportunity; was in the business of investing
in securities and had been their cash management strategy
a. Unique, Below Market Price: offered as a direct reward for their dealings with Goldmanb. Agent is under a duty to account for profits obtained personally in connection with
transactions related to the company; reasonable to infer that s accepted a commission
or gratuity from GS that rightfully belonged to eBay
Controlling or Dominant Shareholder Transactions 1. Situations: (1) Parent-Subsidiary and (2) Dominant individual SH founder, raider
2. Can SH favor interested while running firm: Yes, but must be done within NARROW bounds
a. Cannot be unf air to the minority
b. Cannot be due to bribe
3. Example: if a dominant SH deals with the corp. (contract) the deal will be closely scrutinized tosee that minority SHs are treaty f airly
a. Corp. loans a ma jority SH money scrutinize
b. Deals where ma jority had effect to make deal check to see good f aith and NOT to
the specific detriment of minority SHs
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 90/124
90
Sinclair Oil v. Levien: T he Standard
1. Facts: owns 97% of subsidiary stock in Sinven, involved in SA Oil; appoints all board and
officers and drains dividends from Sin to meet cash needs. All met limits by state law but
exceeded current earnings. charged for inability to grow.
2. Issues: (1) Fails to sue on breach; (2) paid excessive dividends and(3) didnt buy fields purchased
by other subsidiaries
3. Tests: Fairness to f ailure to sue, BJR for 2 and 3. Distinguish SELF-DEALING and f ailure to sue
from others even though - All decisions f avored controlling parent.
a. Fairness applies to ma jority SH issue with self-dealing to show that the deal with the sub
was objectively f air; f ailure to sue on contract from payment of healthy dividends and
from allocations of business opportunities
b. With dividend there was no self-dealing since parent didnt get something from the sub
to the exclusion or detriment of the minority they shared pro rata in the dividend
distributions
c. Expansion issue didnt usurp opportunities that would normally have gone to the
sub
Z ahn v. T ransamerica: Liquidation
1. Facts: owned class A stock two other classes B and preferred liquidation and preferred
gets sset and then A gets $2:1 ratio to B class. bought both A and B then converted A into B
and owned almost all of the B stock (A was controvertible). Book value of $6M and worth $20M
FMV. Unknown to SHs and called A shares then liquidated assets and paid itself remained.
claimed that had he been included in liquidation would have got $240 and not $80.
2. Issue: Can MSH use control over board to gain at the expense of the minority SH in a deal
where each step is performed in accordance with state law?
3. Held: Ma jority SH has a fiduciary duty to the corp. and minority the same as directors and
actions must meet good f aith and f airness tests.
a. Disinterested directors could have called the class A stock but here the directors were
controlled by the MSH
b. Directors owe fiduciary duty for the best interests of ALL of the SHs and only acted in
interests of MSH.
Mutual Funds1. Legal Structure of Mutual Funds: trustees fund is a statutory trust, not common law created in
the equity court
2. Trustees: elected by the owners no def ault rule by elections, they can actually appoint
themselves (like in NPOs)
o Investors Give Cash: want return on investment
o How to get cash + return: trustee hires an advisor who tells trustee what to do with the
cash and sends returns back
o Sponsors are also advisors and trustees hire them to give them advice they get money
from fees by advisor groups (Fidelity and Vanguard)
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 91/124
91
3. Index Funds: mimic the movements of the ma jor industries tell us where the markets are and
we decide where they are going
4. Closed-end funds v. open-end funds no redemption value
Jones v. Harris: Advisor Fees for M utual Funds
1. Advisor Fees In Mutual Fees: especially not in index funds the fees can get crazy big andridiculous; consumer advocates say investors get cheated by the fees
2. Investment Company Act of 1940: one of five acts passed to regulate securities af ter the Great
Depression (fees regulated in companies act)
a. Hedge Funds: not under the act because the number of investors is small less than 30
and go to very rich guys in small groups and are not considered investment companies
b. Mutual Funds: public investment funds
c. Structural Protections: 40% of trustees must be independent of the sponsors, that
group must be only group acting on setting fees
3. Advisors Regulated qualified, licensed, conf lict free
4. Supreme Court rules against Trustees by vacating and remandinga. Vacating is odd because District Court at first did exactly what should have been and
could have reinstituted that original opinion without remand
5. Gartenberg Standard: balancing test and just shill for judicial discretion
a. Look to process and amount if process progress
b. Less rigorous look at amount and vice versa
6. Circuit Court SHOULD have considered but threw out one of the KEY f actors the f actor that
the advisor and sponsor were affiliated with other funds and charged different fees for those
other funds they worked together with
a. Other fees were much lower than the ones they charged the s who brought suit
b. Evidence of fees in and out brings suit 7. Easterbrook-Posner argument based on bargaining power, if they didnt like them they could
have gone to another fund because they have to disclose all the fees to the investors and they
are not hidden
a. Easterbrook they can leave, can drive down themselves since there is full disclosure
shouldnt be allowed to sue
b. Posner I used to be market-guy, market now sucks because investors are not
protected; shocking to law-economics community; market is imperfect and these
investors must be protected from these affiliated and non-affiliated fees
8. Supreme Court consider all f actors, dont go down to the nitty gritty of Easterbrook dispute,
dispute from Posner-Easterbrook is one for Congress to decide
a. Punted on central issue to declare an imperfect or perfect market
b. Protection in the market is up to Congress
c. Preserve small procedural area for judicial review still look at a bit but defer to
trustees, almost like BJR (gross negligence standard?); maybe put BJR in but didnt
decide case officially
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 92/124
92
Securities1. Statutory Definition: 33 Act § 2(1); 34 Act § 3(10) Ohio § 1707.01 (title interests)
2. 1993 Act: Defines security very broadly as most passive instruments; if you sell the security to
the public, must go through a full registration process at a federal level involving the SECa. If didnt sell them to public find exemption to federal registration system and had
procedural and merit based exemption issues
b. Criminal and civil penalties criminal if sell a security which is not registered properly,
you can go to jail (if selling big security, not small listen for broadness and schemes to
get around it)
3. Once in broad net: (1) Register or (2) find exemption
4. Look to state laws on top of federal laws
5. Technical side of the side deal securities
Securities:Defined1. 1933 and 1934 Acts: do not agree; a technical difference
2. Ohio title interest only state that adds to federal definition, and doesnt just take it in
whole; title interests, which is real estate titles are added (split up real estate title among small
amount of people may have a security)
a. In Rem Property Interest: generally, outside of OH, is never a security
3. Specific Instruments: stock, notes, bonds
4. Catchalls: Evidence of indebtedness, investment contracts and any instrument commonly
known as a security
a. Trying to catch: passive investors (want peoples manage, who are not going to manage
the company who get investment back and return)
b. Partnerships active investors not securities
c. Surprises: worm f arming, condos, strips of orange grove, oil drilling rights, pyramid sales
schemes and scams
Sources of Corporate Capital1. Retained earnings how much capital of obtained in growth
a. By f ar the biggest way to capitalize a company
b. Tax incentives to retain earnings double tax phenomenon very strong tax incentive
to grow by retained earnings
2. BorrowMoney: cash for promises to repay plus interest
a. Bonds real estate, secured, earnings
b. Debentures unsecured, middle length
c. Notes unsecured, shortest term (security itself is only helpful if there is a def ault you
dont want it, youd rather the IOU)
d. Lines of credit and commercial paper house and business;
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 93/124
93
e. Commercial paper is alternative to line of credit but cheaper (legal notion execute a
document and the document itself has value document itself is transferrable and has
real value like a check)
i. Rules for the endorsement; fraud, etc.; legal rules that stand behind problems
with enforceable commercial paper
3. Stocks and Bonds Transferrability: § 8
a. Difference with check bearer paper (check) but stock and bond has books and
registration with endorsements (corp. is a player); issue bearer bonds then not a
player
b. Problems with Bearer Bonds/Stocks (illegal in US): money laundering since equivalent of
cash
4. Commercial Paper Special IOU issued by a blue-chip, highly rated companies (highly secure)
a. To issue must be qualified; AAA, very secure never been a def ault except for 1 (Penn
Central)
b. Reason so secure very short term (60-90 days must roll, pay original issuer and then
get another), very secure companies issue them
c. Roll: every 60 days interest rates i.e. treasury is higher, then buy a lot, then goes
down, worth much less; treasury notes very secure, no money made, no interest shock
d. Just as good as cash very liquid, very secure, little shock, sell for a lot; issuers of
commercial paper can use it as cash
e. Money market fund: no risk for individual only invests in commercial paper; no risk at
all and make very little compensate for inf lation and interest rates (BUY INDEX FUNDS
diversified)
f . CombineMoney Market Fund/Mutual Funds with Index Funds invest cheaply, go for
growth more in index fund and go for retirement more in index funds
5. 2008 Stock Market Crash: Lehman Brothers declared bankruptcy and had issued commercial
paper
a. Only One Money Market Fund Says: may have to bust the buck and lose money as
money market fund shocking
b. Busting The Buck: created the calamity because money markets were supposed to be
so secure and this wouldnt happen
c. Suggestion prop up money market funds; government does exactly the opposite with
bailouts and stimulus
Hybrid of Capitals1. Convertible option to change so if stock goes way up in value you dont just sit there with
none of gains
2. Convertible preferred can convert to common
a. Both for high tech companies
3. Stock options (warrants) put and call options are 3rd
party bets (original derivative); company
can get in the business as writer warrants with one exception if writing for CEO they are
compensatory options (bonus plans)
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 94/124
94
4. Redeemable bonds/stock options to repurchase
Debt Covenants1. When issue debt and IOUs to protect repayment there are many options
2. Self-help: collateral
3. Financial/Operational Commitments: limits on dividends, senior debt, veto on decisions
a. Can be in indenture that is not even in the IOU itself
4. Repayment terms: periodic payments
5. Guarantees: secondary liability (homes, cars, etc.)
6. Def ault Conditions: broad definition, acceleration of repayment obligation
a. Dont make an interest payment clearly def ault
b. Many others: business goals, def ault on someone elses interest payment (then def ault
on mine too)
c. When def ault get principle back right now, this moment; acceleration clauses hit
insolvency immediately
d. When def ault any one of debtors can put you in bankruptcy but they dont they
want to work out of a deal; bargain over Chapter 11 because no one wants it
Stock 1. Problem of dilution control: effect on existing shareholders
a. Dilute percentage of ownership af ter youve paid the money and you understand that is
the price
b. How do you protect against dilution: pre-emptive rights (whenever they issue new
shares you get a piece of new shares equal to the percentage Issued of what you
hold); Can put in contract rules that prohibit watered stock, stock issued for less than
FMV
2. Private/Public
a. Private: private offerings venture capital, etc.
i. Hardly any regulations
ii. Hedge funds
b. Public: public offerings
i. Meet § 12 of Securities Act - > 300 OR IPO > belong to ma jor market
ii. Heaviest hit by regulations on securities
iii. Mutual Funds
Importance of Defining Securities1. Registration requirements: the definition indicates whether the registration requirement of the
Sec. Acts apply to the transaction
2. s: generally have easier time bringing suit under federal securities laws than under state
common law fraud rules because elements of federal securities are easier to prove
3. 1933 Application: offer or sale of a property interest must constitute the offer or sale of a
security to apply
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 95/124
95
4. Three Categories:
a. (1) Any interest of instrument commonly known as security: stocks, bonds debentures,
warrants, etc.
b. (2) Types mentioned specifically in the Act: preorganization subscriptions and fractional
interests of oil, gas or minerals
c. (3) Investment contracts and certificates of participation: broad and catchall (Howey
Test)
Four Part Howey Test 1. Critical Test: everywhere except in OH (where we have our own test from HI)
2. Facts: orange grove, didnt want to sell securities, so sold strips of the grove and could buy the
strips; problem oranges on those trees were not yours, the profits came from selling juice to
the public; had option to get into the processing deal, which would take slice of the profits
based on % of strips of land owned
3. Held: this is a security you dont have a % of ownership in property, you have a security 4. Ask: An investment contract is any K or scheme whereby a person invests his money in a
common enterprise and expects to make a profit solely on the efforts of the promoter or a third
party responsible for management.
a. (1) is it a profit-making venture?
b. (2) is the investor passive in management?
5. Howey Test:
a. (1) Investment of value to get money back
b. (2) In a common enterprise selling orange juice together, pooling requirement
c. (3) With an expectative of profits - return
d. (4) Solely (not largely) from the efforts of others picking, selling, marketing andprofiting from the efforts of the f arm
6. Glynn: is he a passive or active investor?
a. Application (1) Member-managed or manager-managed?
b. Member: Presumption to Member is not a security;
c. Manager: Presumption to Manager it is a security and must overcome on the f acts
d. Glynn: overcomes presumption even though it was manager-managed; it was not a
security
7. Trend Towards Expansion in Decisions: Expansion of the word security now covers situations
where investors do participate in management and the form of benefit derived by the investor
may be something other than cash profits
a. Mentioned: (1) Is the property interest one that is specifically mentioned in the Act?
b. Commonly Thought: (2) Is the type of interest commonly thought to be a security?
c. Profit-Making: (3) Is it an investment contract or a participation in a profit-making
venture? Benefit of substance to investor? Third party management?
d. Need: (4) Is there a need for the protection of the Act? Is there an investment so that
investors need the protection of full disclosure?
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 96/124
96
8. ExamplesHeld as Securities:
a. Interests in Land
b. Pyramid sales plans
Bypass the Howey Test
1. Initially required: purchasers must perform some minor management duties like filing reports but investors dont assume the ma jor duties normally required of a person buying a franchise
2. BUT Substantial Control: even these plans have been held to involve securities and now the test
no longer requires total management passivity but only substantial control
3. Not Only Cash Benefit: may be any economic benefit as property interest
Registration1. Registration: prior to IPO must file.
2. Purpose: to disclose all info possible to decide if sound investment
3. Prospectus: most important info is in shorter document given to a purchaser prior to buyingor at some time delivered
4. MaterialRequired:
a. SEC exercises broad discretion over what is put in the statement
b. Financial info about issuer is a very big part and must be disclosed
Private Placement Exemption to Registration1. 1933 Act Allows: certain exemptions from registration in § 5 (e.g. issues by banks or guaranteed
by the US); certain deals are also exempt (e.g. deals without an IPO private offerings are
exempted from registration under § 4(2)
2. Private offerings under § 4(2) 3. Fact Q uestion: to decide if private or public offering
a. (1) need for protection;
b. (2) Access to investment info sophistication of offerees
i. for private must show that offerees were given or had access to the same kind
of info that would have been contained in a registration statement
ii. Must be allied with or have CLOSE RELATIONSHIP with issuer and management
c. (3) Distribution of Material info: implied that the mere access to material info is not
enough may have to actually distribute to the offerees the same type of material in
registration and may even have to give additional info if requested by private firm
d. (4) Number of offerees: fewer in number generally not ma jor f actor but RULE OFTHUMB is > 25 = IPO but now it is more like > People = > Chance of Public;
e. (5) Dollar amount of offering
f . (6) Marketability of securities smaller denominations greater public
g. (7) Diverse group rule more unrelated to each other, the more chance of public
h. (8) Manner of offering manner in which the offering is made (advertising?)
4. New Regulations: (1) Integration; (2) Info Requirements; (3) Manner; (4) Resale limits
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 97/124
97
Doran v. Petro M anagement: Public or Private?
1. Facts: PMC was LP with oil; Advised by securities broker of chance to become special
participant in drilling and puts in put in $25K of $125K rest down under note by MCS and
sends info periodically; overproduced in violation of allowances. Seal property. Def aults and
loses money.
2. Issue: Private or public?
3. Held: No registration was filed in connection with the offering. Look to f actors. Size was only 8.
BUT relationship between issuer and offerees
a. Information available to the offerees by virtue of special relationship clearly
establishes that and were both sophisticated but had special knowledge it did not
disclose to
b. If the investors do not possess the info required for a registration, they cannot bring
their sophisticated knowledge into play to determine if to invest
c. Availably of info means either disclosure or access to the relevant info relationship
may be most important
The Successful High-Tech Start-Up
1. Resales are NOT Exempt except for 504s and need second exemption to resell Rule 144
(trickle out)
2. Birth: founders, 100% equity personal savings, credit cards (but new bankruptcy laws)
3. Private Placements of Equity (1933 Act Exempt)
a. Seed Money: friends, f amily and angels (founder 70%, equity worth $300,000, firm
value $500,000)
b. Venture Capital: 3 to 5 rounds of financing from VC funds (private equity markets)
founder 40% equity worth $4M, firm value $10M (invest in 20 companies with hopes of
1 making it big means they must take a lot of equity in all of the companies, so when
that one hits it will pay off the losses)
4. Goal: to get out of the equity market and into the debt market by establishing income stream
5. Go Public (IPO): sell 20% or more of the equity to public in a Register PO under 33 Act
a. Dont go public unless worth more than $100M jackpot this market $500M
b. Founders problem: how to retain management control? Turn stock to cash? Trickle out.
Regulation D: Safe Harbors Exemption1. Defined: Ma jor initiative was to help small business grow with 501-506 and new definitions only
apply to issue, the control persons may not use them
2. Purpose: to simply and clarif y existing exemptions, expand availability of exemptions and
uniformity between state and federal exemptions
3. Four Conditions to be Met:
a. (1) Integration: All sales that take place at least 6 months before start of or six months
af ter the end of the Reg. D offering as long as there are no offers and sales of same
securities (aside from pensions) within either 6-month period
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 98/124
98
b. (2) Info Requirements: 505 or 506 then specific disclosure to ALL purchasers is required;
Type of info depends on nature and size of offering. Must also give investors the chance
to ask questions and get any info the issuer can get without unreasonable effort Only
under 504 or sells under credited investor then Reg. D doesnt mandate specific
disclosure.
c. (3) Manner of Offering: Use of general ads or solicitation in connection with Reg. D is
prohibited unless in certain 504 cases see 502(c)
d. (4) Limitations on Resale: With exceptions of certain 504 offerings, have status of
securities acquired in a transaction under 4(2) of the 1933 Act 502(c) issuers must
use reasonable care to assure that buyers of these securities are not UWs and to make
reasonable inquiry as to an investors investment purpose; legend restricting transfer
must be placed on the share
certificates.
4. Form D: Uniform notice of sales
form for use in 4(6) and Reg. D
offerings give info on Form D with
checklist within 15 days af ter first
sale in Reg. D; then every 6 months
af ter first sale and 30 days af ter last
sale.
Exemptions on Lower Priced
Sales1. Rule 504 Sales Less than $1M:
Section 3(b) of 19
33 allows sales >$1M during any 12-month period
(SA 504); not available to investment companies or to 1934 Act reporting companies
commissions or similar remuneration MAY be paid to those selling the offering in a rule 504
offering
a. Rule 504: Does not mandate specific disclosure BUT issuer is subject to antifraud and
civil liability provisions of the fed. Sec. laws and MUST comply with any applicable STATE
requirements
b. If whole offering is in states with registration requirement: and the offering is in
compliance then the general rule of 502(c) (manner) and (d) (restrictions) do not apply
2. Rule 505 Sales Less than $5M: Under 3(b) of 1933 Act allows any number of ACCREDITED investors and to no more than 34 NONACCREDITED investors for sale of $5M or less available
to any issuer that is not an investment company
V enture Capital1. Goal: get income f low to begin selling debt; must have some type of equity to begin selling debt
and stop selling equity then final goal to sell equity into the public market
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 99/124
99
2. Controversial: the 20% that comes out to manager thats where the traders make the money
3. Convertible Preferred Stock: takes first cut and then residual cut from the equity pool
convertible into common and also loads; unusual preferred stock usually preferred stock is not
convertible, just get first cut
4. Downside Protection: voting rights, veto rights, dilution protection if sell equity to someone
else, redeemable in 5 years (get out or death knell so can kill the company if dont work with
them)
5. Upside Protection: Liquidation rights, registration force a portfolio company to go public if
they dont want to sometimes (manager taking 20% - taxed as capital gains now; Obama tax will
tax normal at 39%)
a. Government would be taking cash away from the managers at the margin, make VC
funding more expensive and less prevalent
6. Venture Capital in Ohio: state government in Columbus because most VC are on both coasts
created VC through citizens vote Third Frontier (add to it)
7. Alternative Investment Pools: VC, Hedge funds, etc.
a. Hedge fund: only difference is duration; hedge fund
wants to make money in 2-5 years, while VCs want to
make money in 60 days
Private Placement Exemption1. Graph above 2 private placements: (1) Investors investing in VC fund
and (2) VC fund investing in the company
2. PP Exemption: Dont have to go through the full exemption process with
the SEC, wait, etc. (very important for small business)
3. Statutory 4(2) Exemption: Ralston Purina Test
4. Reg. D: Rules 504, 505 and 506 safe harbors
a. 504 - > $1M
b. 505 - > S5M (35 + accredited investors), no ads
c. 506: 35 sophisticated plus accredited investors, no ads
5. Disadvantage: resales are not exempt (but some 504s) need a 2nd
exemption to resell rule
144 (trickle out rule)
a. If Private Placement: everyone who invests and gives money, the investment contract
cannot be sold unless the reseller itself has another private exemption (such as Rule 144
but only trickle it out as constrained by the rule)
b. Hardest on the founders because equity they got is subject to this rule and until they
do the IPO there is no market and if resell it have to take note to have another
exemption
6. General Practice: Combine 4(2) and Reg. D
a. Private offering memo: record recipients of memo; prefer accredited investors
b. Investor meeting: info with scripting meeting; sign statements by investors
c. Legends on stock certificates
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 100/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 101/124
101
2. File registration statement with SEC: waiting period of limited offers and no sales felony if do it
o Go on the road (road shows)
3. SEC: effective distribution period (offers and sales with delivery of prospectus)
o Declaration declared to be effective
o Everyone who buy stock during primary distribution period must have this prospectus
o When distribution period is over start the secondary trading on the NYSE, etc.
4. Key to process: protect the exclusivity of the prospectus during and until the distribution period
cannot buy and sell without a prospectus
5. Goals to Regulation:
o All buyers in distribution receive prospectus on sale or confirmation of sale
o Distribution over: secondary market trading like NYSE without prospectus delivery
requirement
6. Liability of Participants Offering Firm, UWs and Individuals
o Defective Public Offers § 12, 33 Act no registration, not exempt (invalid private
placement) and
defective offering
process
o Fraud (material
misrepresentatio
ns or omissions):
§ 11, 12 and 17 of
33 Act and Rule
10b-5 of the 34
Act
Securities:Liability
1. Common Law: a
defrauded purchaser
had to prove same thing
to recover for any other
good; now can recover for material misstatements and omissions in an effective prospectus
unless the s can show they had reasonable grounds to believe and actually did believe that the
statements were accurate
2. Materiality: must prove that it was actually material f act
3. Persons Subject to Liability: § 11 says that
a. (1) anyone who signs the registration statement (including people who MUST issuer,
CEOs, CFO, accounting officer and ma jority of board of issuer);
b. (2) Director of the issuer;
c. (3) Named with his consent as about to become director;
& choi pritchard securities regulatio
Section 12(a)(2) MisstatementsC/L \ 10(b) \ 11 \ 12(a)(1) \ 12(a)
Materiality
State of
Mind
Reliance
Causation
Damages
yes
yes
scienter
yes
yes
unlimited
yes
yes
scienter
transactioncausation
loss causation
unlimited
yes
yes
strictliability
tracingr equir ement
(losscausation)
off eringprice
no
no
strictliability
no
no
r escission
yes
yes
(negligen
no
(losscausati
r esciss
Misstat. or
Omission
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 102/124
102
d. (4) Any expert who gives certification that part of the registration statement was
prepped by him (accountants, etc.);
e. (5) Every UW involved
f . (6) Controlled persons people who control any other person listed above SA § 15
4. Key Practical Issue: Law firm should be very interested in what partners are doing because the
law firm itself and board of directors may be liable for it; can get malpractice insurance but
there are of ten rider for securities to not insure you for it
a. Why dont insure it? Cant assess the premium, cannot assess the liability so of ten
exclude environmental and securities liability because cannot predict what judges will
do
Private Securities Litigation
Reform Act 1. 1994 Contract of America Legislation put
in to reign in Clinton2. Key: to try to reign in strike suits
3. How: if you are on the private side and bring 10(b)5 lawsuit,
you must plead scienter (particularity) with particularity, must show
in the pleadings why there was scienter so that means that you can
throw a lot of these out for Rule 12(b)(6)
4. Key Provisions apply to Section 11 but not Rule 10(b)5 on slide
Elements in Section 11 Action
1. Privity of Contract not Required: Anyone buying a security that was subject of a defectiveregistration may sue under § 11 but there is a tracing requirement so that the must be able
to trace the securities bought back to the defective registration statement
2. Reliance: need not prove relied on misstatement or omission in order to recover BUT if the
issuer sends out an earnings statement covering period of 1 year af ter the effective date of the
registration statement then a person buying it af ter that must prove reliance to recover
Section 11: Defenses1. Issue Defenses:
a. (1) Show were true
b. (2) Show immateriality c. (3) Show knew of them and bought the securities anyway
2. Distinctions: Non-issuers can get due diligence excuse but issuers cannot
Non-experts in Section 11
1. Standard of Diligence: Must meet test and (1) actually believe statements were true and that
belief must be reasonable
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 103/124
103
a. With reasonable investigation; look at each based on position, skill, background,
responsibilities, training and access to info to determine if a reasonable investigation
was made
b. Goes Beyond just trusting: and respecting the responses and opinions of the issuers
officers as to material f acts
c. Includes: original written records,
verif ying f acts and statements in the
statement and would probably
examine f acility, ops, material
contracts, minutes and other
documents and items material to
financial status
3. Portions of Registration: Attorneys
a. Nonexperts For attorney-director of
issuer who draf ted registration
statement for the issuer to be
nonexpert as to registration
statement
b. Expert: May be conceivable that
attorney may be requested to examine, certif y, as an expert, some portion of the
registration statement in that case, he would be held to due diligence test of expert
c. Inside Directors and Principal Executive Officers: Must meet standard of due diligence
required by nonexperts
4. Reviewing Statements of Experts: lower standard of care and non-experts are entitled to rely
to a greater extent on the ste statemens made by experts (outsider director relying on
accountants financial statements, e.g.)
a. Nonexpert MUST: (1) did not think they were untrue and had no reasonable ground to
think they were f alse no need for investigation
b. (2) s usually meet burden: BarChris
General Civil Liability under the Act § 121. Fraud: Prohibits fraud generally if sale or offer and anyone who offers or sells a security by
the use of any means of interstate commerce and makes an untrue statement of material f act or
omissions in connection with and who cannot sustain the burden of proof that he didnt know
and in the exercise of reasonable care could not have known of such untruth is liable to the
buyer.
2. Privity Requirement: Must be arms length may only sue the seller from whom she purchased
the security
3. Persons Liable: Only people offering or selling security can be liable
a. Issuers, dealers and maybe control people can be liable but others in registration
process like directors, accountants would not be)
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 104/124
104
4. Liability Standard: is held for intentional of negligent violations has burden to prove non-
negligence
a. (1) Privity with
b. (2) has violated one of the privisions of Section 5 and she can recover
c. (3)No need for reliance, causation and scienter
5. Damages: Consideration paid with interest MINUS the amount of any income received on the
securities OR for damages if the purchaser no longer owns the security
Experts and Section 11
1. Statement Test:
a. (1) Must ACTUALLY believe that they were true
b. (2) Belief must be reasonable
c. (3) Reasonable belief comes from investigations perform at least standards of his
professor (accountants in certifiying that financial statements of the issuer are prepared
according to generally accepted principles of accounting, e.g.)
Rule 10b-b Fraud1. Rule: Unlawful in connection with the purchase or sale of any security for any person, directly or
indirectly by the use of any means to:
a. (1) employ any scheme or device to defraud
b. (2) make any untrue statement of material f act OR to omit a material f act necessary in
order to make the statements made (circumstantially) not misleading
c. (3) engage in any act, practice, or course of business conduct which operates or would
operate as fraud or deceit upon any person
2. Transactions Covered:
a. (1) Purchases and Sales can be either buy or sell
b. (2) Remedies: security must be involved
c. (3) Securities: a security must be involved in some way broad application
d. (4) Jurisdiction: interstate commerce must be involved or MEANS
e. (5) Statute of limitations: not applicable
f . (6) Liable parties: broad to application ANY person CONNECTED WITH a securities
transaction so accountants and lawyers and others involved in some way with a
securities deal may be liable
Elements of 10b-5 Fraud
1. (1) Fraud, Deception, Misrepresentation, etc.: Must be fraudulent act that has ACTUALLYoccurred
a. Insider Concept: Two elements to an insider (1) must have a relationship that grants
them access to info intended to only be for a business purpose and not for personal
benefit of anyone and (2) must be inherently unf air where party takes advantage of
such information knowing it is unavailable to those he is dealing with
2. (2)Materiality: Material f act
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 105/124
105
a. Reasonable person standard: whether a reasonable person would attach importance
to the misrepresented f act in determining his choice of action in the deal in question
b. Probability balanced against magnitude: high probability likely will occur or high
magnitude of occurrence will be clearly material
c. Totality of Facts: under whatever test use all f acts to see if info might reasonably
inf luence conduct
d. Examples: intention of a company management to pay a dividend or a significant drop
in the profit level of the company
3. (3) Reliance: relied on f act to make decision; actual with effect on market; act different if know
f acts; Trend towards abolishment
a. Two Cases: (1) Actually relied OR (2) Effect on market may allege that s statements
affects the market price at which the sold his stock; would need not argue reliance
4. (4) Causation: s action must have caused the s injury. E.g. misrepresentation caused the
drop in the price of the stock; necessity is also trending to disappear
5. (5) Scienter: A material misstatement or material omission of a f act necessary to make revealed
f acts not misleading runs afoul of 10b-5 if defendant intended to defraud, knew he was
defrauding, or was reckless with regard to the possibility that he could be defrauding
a. Mental state embracing the intent to deceive, manipulate or defraud BUT
b. Other courts have held recklessness to apply
c. Supreme Court must be shown in injunctive actions brought by the SEC
d. Private damage and SEC injunctions reckless couduct may also qualif y under 10b-5
e. IF SEC is there is no Scienter
6. Remedies:
a. (1) Rescission: take deal back and restart in place came from
b. (2) Damages provide restitution e.g.
restore what lost (reasonable period
of time?)
c. (3) Unlimited Liability unsettled if
can be held for unlimited amount
d. (4) Punitive none
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 106/124
106
Escott v. Barchris Construction
1. Garden variety financial fraud like Enron
in small case
2. Facts: Barchris sells bowling alleys to
athletes, then take back a note under
Art. 9 if real estate note, its a
mortgage (goods v. real estate); then
Barchris has cash problems and sells the
IOUs from the bowling alleys to Talcott
(f actor) and he gave back cash
3. Misrepresentations:
a. (1) Amount of sales backlog
b. (2) Contingent liability to Factor guarantee to repay
c. (3) Loans repaid
d. (4) Use of proceeds lied about what they would use for bailing out bowling alleys
theyd already sold stuff too
4. Problem: bowling alleys start to def ault on the loans then Barchris needs money from
debenture investors to pay of the notes
a. Def aults owe to people then take over and register sales to self (which you cannot
do) so revenue statement looked acceptable
5. Fraud: selling debentures to the public and were making a public offering of debentures (f airly
unsecured debt instruments on short-term)
6. Young Lawyer: hit by red f lag test and lost reasonable investigation test even though he was a
non-expert in a non-expertise situation; two key problems:
a. (1) two contracts should have been read the f actor contract more closely at the
guarantee that if money was lost had to pay guarantee (cannot pay off guarantees
because he does not take the full risk definition of ownership off-balancing
financing) hiding debt with independent guarantees to f actors
b. (2) Sales same types of guarantees to sell a bunch of stuff ; have trouble paying, we will
pick up payments and buy the bowling alleys from them off-balance sheet financing
their our sales
Securities and Fraud1. Factor someone you sell obligations to
2. Channel stuffing inventory channeled down to buyers you control and setup to look like sales to
outside buyers on balance sheet even though they arent getting money back from it
o Dealing with self and lying about it OR dealing with 3rd
party and lying about risk
Fraud in the Markets1. Common Law (State Law): Shareholder to Shareholder traditional fraud
o Reason why works complexity and misunderstanding; superseded by federal now
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 107/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 108/124
108
o Duty to inform at annual meeting? Ohio § .38 is very broad
o None unless SH vote needed (Malone)
o State Blue Sky Law exemptions
2. Federal Law: Very heavy Mandatory Disclosure Rules Publicly-traded, wherever Incorporated;
o Periodic filings of financials: quarterly earnings reports audited forms of 10-K (cannot
lie)
o Episodic filings Events: 8-K (mergers, lose accounting forms); S-1 (IPO Filing); and 14d-1
(tender offer)
3. Voluntary Disclosures (CEO Statements): Duty to be accurate
Policy Debate
1. Mandatory Disclosure
o Cons: (1) firms would disclosure voluntarily anyway and that stuff would be more tailored
to what market really wants and then (2) enforce anti-fraud rules we have
Incentive to disclosure negative information? Accurate for fraud rules?
o Pros: More info
2. Contours of Private Actions for Disclosure Violations
o Con: Strike suits legal extortion
o Pro: Private attorney-generals can supplement government where no time
Basis Elements of Fraud: Rule 10b-51. Misstatements or omissions of a:
o (1) Material f act with (TSC Industries, Basic)
o (2) Scienter (Intent to Deceive Hochfelder) plead with specificity now
o (3) In connection with the purchase or sale of securities (Blue Chip Stamps) includes stock options like Deutchman (must be
buyer or seller cut out people who would
have bought or would have sold); does it
include derivatives and swaps? Big new
question SEC says YES now. A swap is a
security completely neutral third party
bet on anything (interest rates, life of CEO,
life of company, etc.)
o (4) Upon which relies but see
presumption of reliance in Basic if firms securities publicly-traded)
o (5) Reliance was proximate cause of injury
(lost causation)
Types of Actions1. Criminal DOJ
Rule 0b-5
Face-to-Face Fraud in Secur ities �
ransactions (br other buys sidling¶s stock in a f amily cor poration)
Fraud in the Pr imar y �
rading Mar ket: ± Fir m/Shar eho lder
�
ransaction s (Pr im ar y Mar ke t Sales
(Placemen ts o r �
istr ibution s); Secur ity Repur chases
( � egotiated; Sel f -
�
ender ff e r s)
Fraud in the Secondar y �
rading Mar kets ± Mar ke t Manipu lat ion (i.e .,
o sho rt, start bad r umo r s, close
position ; o long , f alse ly tou t, close position )
± Insi de r �
rad ing/Misappr op r iat ion
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 109/124
109
2. SEC can prosecute can be in Fed. Ct. or in Agency Actions
3. Private Actions by Investors implied under 10b-5 and express in § 16 (34Act)
Elements of Rule 10b-5
1. When is f ailure to disclose actionable must be under a duty to speak: SEC Filings, mandatory duty to disclosure; voluntary statements, duty to be accurate; insider trading
o (1)Materiality
probability X
magnitude test to
determine if material
o (2) Scienter Ernst and
Ernst
o (3) Reliance or
Causation
o (4) Standing 2. Rule 10b-5 Elements Change if SEC is
o No scienter
o No standing problems
o Enhanced remedies
Materiality1. Puffery: vague statements of optimism by company officials are immaterial
2. Bespeaks Caution: read in context
3. Zero Price Change: price of security doesnt drop when truth revealed
4. Trivial: only effect small % of total firm sales/revenues (exceptions for lies of the CEO presumedto effect and not be trivial)
5. Truth in the market: if market already knows truth, then new lie isnt material
Materiality Problems
1. Internal Forecasts: Do I have to tell everyone internal ideas of what business will be like?
2. Sensitive Business Info: like merger dont want to tell the world you are negotiating, what to do.
Scienter1. E rnst & E rnst : intention to deceive
a. Only Private Actions b. Inference from Recklessness??
2. Pleading: Private Securities Litigation Reform Act of 1995. State with particularity f acts giving
rise to a strong inference of scienter.
a. Is pleading motive and opportunity enough??
3. Possession (Trading while in possession of) Versus Use (Trading on the Basis of) See Rule 10b5-1
(possession test with exceptions)
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 110/124
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 111/124
111
b. Example- Widow SH asks director before a board if company would pay dividend and he
showed her financials and said didnt know; he then bought her stock for $1.25 and
declared $1 per share dividend three days later director was liable
4. Special Circumstances Rule: Number of courts took position that a duty of disclosure is owed
only if there are special f acts or circumstances making nondisclosure unf air
a. Example Strong v. Repide director and pres. And 75% SH use strawman to buy
minority interest knowing that government would buy company property had duty
of disclosure
5. State Law No Duty to Disclose unless special f acts in Goodwin v. Agassiz
SEC v. T exas Gulf: M ateriality and Probability
1. Facts: TGS conducted exploratory activities in eastern Canada. These operations resulted in the
detection of a significant amount of commercially mineable ore. Rumors of the ore strike began
circulating throughout Canada. TGS issued a press release denying having struck ore and stating
that the rumors were only speculation. Between the time of the press release (April 12) and the
dissemination of the TGS official announcement (April 16), two of the defendants purchasedTGS stock as the mining industry journal article was published, statement to Ont. Min of Mines
and US Finance Media released. . April 13 press release drilling inconclusive but stock goes to
30 because info was seeping out that they pulled some good stuff out
a. April 16 Release to media they found largest copper mine in all of North America
timeframe from 9:40-10:54 am.
2. Questions:
a. Coates: lef t TGS Presser and buys shares at 10:20 liable? Yes, because market must
have time to disseminate info which was done at 10:54 am when ran on ticket
b. Call Options: if client buys call options who usually doesnt buy them at all, he is doing
insider trading use them for leverage because for $1 in stock but if option on 10,000shares is $1 because for each share I buy I can get leverage on stock price
3. Held: Basic test of materiality is whether a reasonable person would attach importance to the
information in making decisions about the deal.
a. Need not be conservative one in sense of f acts solely by measuring effect knowledge
would have upon prudent and conservative investors (may be risky)
b. Test encompasses any f act that in reasonable and objective contemplation may affect
the value of the securities
Insider Trading: Duty to Disclosure and Questions to Ask
1. What was the injury to the people who sold their shares:
2. Who are the insiders? directors, Sr. employees and in some cases (like man who pulled out
sample of copper) can be an insider ONLY if there was a confidentiality agreement with employer
and anyone these people tells
3. Information is material? Must be was discovery of hole material YES.
4. Trades? Purchased stock and calls on stock.
5. Latent Issue: is possession alone enough or must it motivate the trade possession is enough.
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 112/124
112
Critical Question in TX Gulf Sulphur
1. Assume that af ter find copper TGS had to buy land for mine what do they have to tell the
f armer who owns the land? NOTHING, just cannot misrepresent, however:
2. Why is what TGS has to tell f armer different from what insiders must tell SHs when insiders
purchase shares? He owns the land, could have found it himself .
o Fruits of his labor not the f armers; but why not fraud by omission?
o Essence of capitalist system: the incentive to discover something, do something for
yourself so you can benefit for yourself
o Law: no need to tell f armer but cannot tell f armer there is nothing on your land, dont
worry; if f armer asks why are you buying borderline?
o Difference between SHs and telling f armer? Fiduciary duty to you, if there is not a
fiduciary duty (like f armer) then it is ok
Dirks v. SEC: T ippers and T ippees
1. Facts: was officer in firm to give investments to insurance company securities to investors
info on EF due to fraud were grossly overstated and investigated many regulatory f ail to act
and EF says he is right. No one published the articles, etc. talked with clients about it and
they sold shares. EF plummeted as fraud shows up and is investigated.
2. Issue: Is a tippee always under an obligation to disclose inside info before trading or to refrain
from trading?
3. Held: No, tippees inherent the insiders duty to SHs to disclose material, nonpublic info before
trading to not trade ONLY when the info has been IMPROPERLY disclosed to them by the insider.
a. Cannot impose duty just because someone knows something
b. Test: will the insider receive a direct or indirect personal benefit from the disclosure, if
the insider doesnt stand to personally gain he has not breached his duty to the SH and
there can be no derivative breach by the tippee
Insider Trading: Potential s1. Insiders: Senior Executives, Directors, Controlling SHs
2. Quasi-Insiders: Temporary Insiders Professionals (UWs, Investment bankers), accountants,
lawyers, consultants who get info with an obligation of confidentiality
3. Tippees of Insiders or Quasi-Insiders: or other tippees
Tipper/Tippee Liability (Dirks)
1. Why was Dirks not liable as a Tippee of Secrist (insider officer of equity funding)?
o Dirks liability is derivative of Secrists liability problem with tippor and tippee becausehe gave him information without any motivation for PERSONAL GAIN
o In tippee and tippor relationship must know that Secrist is breaching (1) fiduciary duty
AND (2) doing it for personal gain directly or indirectly with a (3) personal gain
2. Personal Benefit:
o Secrist was just a whistleblower not doing it for personal gain doing it out of good
f aith and that was difference
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 113/124
113
o Must usually be: Pecuniary gain, reputation benefit that will generate future earnings, gif t
to fried or relative
3. From 1934-1967 insider trading was illegal in US Japanese are forced to adopt but does so
without tippor/tippee liability: not universally illegal except with US pressures countries to do it
Aftermath of Chiarella/Dirks1. Chiarella: Employee of printer handling corporate takeover bids who deduced target companies'
identities and dealt in their stock without disclosing knowledge of impending takeovers, held
not to have violated 10(b) of 1934 Securities Act (15
USCS 78j(b)) and SEC Rule 10b-5.
2. Misappropriation Theory: A person commits fraud in
connection with a securities transaction and violates
10(b) and 10b-5, when he misappropriates confidential
info for securities trading purposes, in breach of a duty
owed to the source of the information.
a. Liability: premised on traders deception of
those who entrusted him with access to
confidential information not fiduciary duty;
duty is owed not to other trader BUT to the
source of the information
b. Requirement: Deceptive conduct in
connection with securities transactions
MUST involve deceptive device (f ake identity while secretly getting info from
confidential source for personal gain)
i. If had disclosed to source that he planned to trade on this nonpublic info,
there would be no deceptive device and no violation
3. SEC Rule 143-4 Tender Offers: Prohibits fraud in connection with a tender offer given
authority to prescribe means reasonably designed to prevent, such acts and practices as are
fraud.
a. Rule 10b-5 covers all misappropriation cases
4. No More Selective Disclosure: open to all market professionals
5. Secondary liability: catches professionals in aiding and abetting and conspiracy
a. Answered in Central Bank of Denver (1994) no aiding and abetting in private civil
actions
6. Strike Suits: Hurdles erected in PSLRA of 1995
Duty of trust or Confidence: Rule 10b5-21. Person Agrees Explicitly to Maintain Confidence
2. Recipient Knows or Reasonably Should Know that Confidence is Expected by Tipper
3. Info from spouse, parent, child or sibling, not confidential unless knows or reasonably should
know of expectation of confidentiality
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 114/124
114
4. Questions from OHagan: If Burglar Breaks into Dorsey, steals information and trades, breach
of Rule 10b-5?
a. Deception required; none from burglar; Would breach Rule 14e-3, however.
5. If OHagan tells Dorsey he wants to trade and Dorsey does not object, breach of Rule 10b-5??
a. No, Breaches Rule 14e-3, however. [Odd language from the ACLU Justice.]
6. Whats left for eavesdroppers?
a. Shadow Traders: Can broker shadow trade on Warren Buffetts purchases?
b. Assume he is a client: No.
c. Assume broker is an eavesdropper: No.
d. Assume a janitor, eavesdropper: Yes, if not explicit duty to remain confidential and
information is given in trust.
SEC Safe Harbor: Rule 10b5-1 Plans
1. On the Basis: Not trading on the basis of inside info IF
a. Insider has adopted a written plan before becoming aware of information
b. Written plan should specif y mechanics for period deals
c. No subsequent inf luence
d. Good f aith and not scheme to evade liability
Congr : Enf or nt t t t (34A t § A, A & )
In ider Tr ding S n ti n Act f 1 4 SEC can impo e tr eble damage fine , plu disgor gement (4x).
Insider Tr ading And Securities Fr aud Enf r cement Act f 1
± ounty Hunter Pr visi ns (10%) ± Contempor aneous Tr ading, Private Plaintiff Class (also
covers Rule 14e 3) §20 A
± Contr olling Person Liability ($1 M or tr eble damages)(br oker age fir ms)
Private Securities Litigation Ref or m Act of 1 ± Lead Plaintiff Substitution (lar gest financial inter est)
± Specific Pleading Requir ements
± Settlement Notice & Damage Allocation
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 115/124
115
Shareholder Derivative Suits and Indemnification
1. Derivative Suits: State statutes govern extent to which the corp. may properly indemnif y its
officers for expenses incurred in of suits for conduct in official capacity; apply to both derivative
and direct exclusive basis for indemnification
o Demand on SHs?o Right to jury trial?
2. Court approval of settlement (or voluntary dismissal): Ellison settlement in CA derivative litigation
3. Recovery of attorneys fees: Benefit to Corporation standard
o Non-monetary awards consent decrees with injunctions against future violations and/or
structural relief
Indemnification1. Mandatory v. Options: Discretionary
o
Statutory: mostly discretionary with the board but under some statutes
the corp. must indemnif y the Ds and
Os when he is successful on the
merits in of derivatives.
o Ex Post DE: right is subject to a
judicial finding that his conduct f airly
and equitably merits such indemnity
o Ex Post (optional board of directors
hires attorney and pays advances
that is unsecured)2. Mandatory: Successful defense § 145(c)
3. Contractual Option ex ante becomes
owed in ex post
o optional ex ante firm will indemnif y to the full extent allowed ex post; § 145(f) BUT requires
board to indemnif y if able to
o Good Faith: good f aith finding required to extend
Ex Post Indemnification1. Ex post good faith (DE); as long as the D or O wins on the merits, there is usually no problem;
o DSCC § 145(c) required indemnification expenses in connection with the of any action as towhich the indemnification is successful on the merits or otherwise
o When loses: varying statutes when lose distinguish 3rd
party suits and derivative suits
o Amounts paid DGCL § 145(a) and (b);
o Advances in (e) unsecured promised to repay reasonableness requirement
2. Procedure: Decision By
o independent board (not been sued);
Indemnification and Insurance:
Terms
Indemni ication: Firm ays Jud ments and
ama es evied ainst embers o the
oard
& Insurance: Firm ays remiums to
Insurance ompany; Insurance ompany
ays Jud ments and ama es evied ainst
embers o the oard
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 116/124
116
o independent legal counsel (only area where lawyers may speak for firm)
o OR Shareholders
3. Ohio Distinguish Direct/Derivative Modeled on Del. § 144
o has weird one again and adds Court of Common Pleas Procedure adds Court review to
Decision by board or independent counsel
o Advance for expenses is mandatory and not optional in Ohio (opt out) unless you go to court
and they find under clear and convincing test that the CEO intended to hurt the
corporation
o MUST extend CEO cash to defend themselves with a lawyer
D & O Insurance: Practically
1. Power to insure broader than power indemnif y?
o Yes, insurance companies will limit coverage based on their ability to price and profit
2. Maximize money two clauses
o (1) agree to indemnif y to max and
o (2) insure for what additional protection they can (D & O insurance)
3. Employment Agreement:
o MAX Obligation to advance
o MAX obligation to reimburse
o MAX obligation to buy D & O
Insurance
4. In litigation: claim advance, if
derivative settle and claim
indemnification;
o Otherwise claim insurance
5. New wrinkle Thompson memo
Duty of Care: Summary1. Very hard to win: AND If lose dont
pay damages
o Exception: Francis Total
Dereliction of Duty
2. If Win: Directors Dont Pay Damages:
o Indemnification for settlement amounts
o Insurance for judgments
3. Cases, even if success very embarrassing to the s because Court
o Court moral arbiters; scolding the CEOs
Dutyof Loyalty: s Gold Mine
1. Key Hurdle: Only hurdle is effective ratification (vote of independent board or SHs)
2. Preponderance of evidence, burden on s no deference to business decisions (de novo review
entire f airness test)
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 117/124
117
o Can argue good f aith test cannot be met on indemnification
3. Indemnification is harder best interest of the firm? on settlement; insurance coverage offend
not available
4. Insurance Companies will not insure CEO on OWN duty of care
Basics of SH V oting Proxy1. Combination of State and Federal Law
2. State Law: defines what a proxy is because an area of agency
3. Federal law: defining disclosure obligations for publicly traded company
o Not publicly traded no federal law at all with exception of anti-fraud statute
4. Record owner writer grants proxy to proxy holder to vote shares at a physical meeting
o Guys name on record books of a corporation
o Right to vote when shows up at SH meeting then vote your shares of which you are a
record owner
o If do not go may grant an agency power to someone else (proxy) who shows up at themeeting and votes your shares
o Proxy delegation of agency to vote on your behalf
5. Proxy is an AGENCY created by state law OH § .48 and DE § 212
6. NOT a written or absentee ballot:
o distinguish written consent procedure
7. Terms: revocable at will unless coupled with an interest (e.g. sale of stock af ter record date but
before meeting)
o Coupled problem with SH meetings is that you must close the record 30 days prior to the
meeting; what if buy stock in that period record holder does not change, so there may be a
guy who sold his stock and still has right to vote as record holder; SO when you buy stockfrom a record holder, you get stock PLUS proxy (that would be coupled with an interest) ex-
record stock
o Supplemented by federal law if IPO
Federal Proxy Rules1. Defined: required that you solicit proxies from all your SHs; if have annual meeting, must send out
firm proxy solicitation to all the record SHs and then firm will nominate proxy for SHs who do not
show up and votes all the shares in whichever way the firm wants
2. Why are they needed?
3. What law controls?
o State
o Federal: 34 § 14(a)-(c) AND has rules 14a to 14a- 15 and Schedule 14A
Overview: Regulation 14A1. Mandatory Disclosure Requirements: Full disclosure all material information to the SHs
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 118/124
118
2. SolicitationRegulation can only solicit them in certain way, regulation form no discretionary
voting; general anti-fraud prohibition; must be true(form and process)
3. SH Resolutions (Rule 14a-8): regulates when ordinary SHs can get access to the firm held property
normally board of directors controls what is on the firm
4. Fraud Prohibition (Rule 14a-9)
Proxy V oting: Terms1. Must be publicly traded company
2. Must be a proxy someone authorized to act on someones behalf
3. Solicitation is carefully defined
o Doesnt include: efforts at persuasion as opposed to requests for proxies Rule 14a-2
o 10 Person exception Rule 14a-2(c)
o Cannot just try to convince people to vote one way or another must try to get them to give
proxy votes to you before going in
Basic Requirements1. Proxy statements form 14A, items
2. Proxy Card: format requirements
o Limited discretionary grants
o Slates of directors yes and abstain (no NO or other)
3. Filing requirements: general rule for plain vanilla proxy statement and form file with the SEC on
first use
How is a Ballot Slate Selected?4. Only one candidate per seat decided by the board of directors with ONE choice (YES or abstain)
5. Opponents do not have access to Managements Proxy 6. Voting Oddities: All you need is plurality so when there is no vote it is very hard for anyone to
win
7. Must send out NEW FORM to get someone else on the form in there is a quorum requirement
but SOME do not have it in states that dont require it (usually 25% vote abstentions count
toward it)
8. New Rage: ma jority vote buy-ups, we will not seek a director unless he or she gets a ma jority of
all those voting (which means more yeses than abstentions)
o Stricter: ma jority of outstanding shares to vote YES
o If do not get: seated because you win but you offer letter to resign but Board has decision to
take it or not if there is an empty seat and they accept, Board fills empty seat
Proxy Contest 1. Insurgents: to defeat management slate MUST
o Create own proxy statement and card with an alternate slate
o File with the SEC AND
o Pay to have firm mail the material to all SH or if firm elects, mail material themselves
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 119/124
119
2. Who Pays: Incumbents firm pays all expenses and no SH ratification is necessary
o Insurgents pay own way, firm pays back only on victory if ratified by SH vote and if on policy
dispute
3. If want to contest board must get own group of candidates together
o File own form
o File own statement
o Send to all SHs
4. Costs - $500,000 to $1M and chance to win is very small
o Very rare
5. Even with happen rarely win; only makes sense if you have a huge block of shares or are
coupling the proxy contest with a takeover control of board then buy the stock
6. If win firm pays all the expenses of the incumbents, no SH ratification necessary
o Insurgents firm pays ONLY on victory if ratified by SH vote and if on policy dispute
Options for Thrifty Challenge1. Ask SH to abstain on Managements proxy: Disney in 2004
o CEO running for board had 45% abstention vote stripped of Chairman title and resigned in
2006 because
2. SEC Rule Change now languishing ma jor SHs can nominate a candidate IF nominee gets 35%
abstention vote
3. SH Resolutions on Management Proxy Rule 14a-8: Bylaw Amendment that allows large SHs to
nominate candidate for board AIG case
o Cannot run a contested election through a 14a-8: problem is whether you can force a bylaw
through that allows this type of stuff
4. Who nominates candidates for the firm?
o Nominating committee creates a slate but independent nominating committee usually just
takes advice of the CEO and doesnt give much thought to anything else
Litigation Over Proxy M aterials: Supreme Court
1. J.I. Case v. Borak (1964): first private cause of action for violations of Rule 14a-9 (up to now
private lawyers couldnt bring these types of suits, could bring 16b suits, though)
o Affirmative vote on merger f alse statements in proxy statement
o Af ter this case lid was blown on 14a and 10b-5 for all securities actions to open up to
litigation in lower courts
o Began argument of what materiality is because f alse statements must be material
o Material: maybe same as reliance, show that if new would have been negative vote on
merger (changed vote of merger), if not just leave it alone
2. Mills v. Electric Auto-Lite Co (1970): Causation doesnt require proof that vote would have been
different
o Facts that s controlled 54% needed 66% to control
o Virginia Bankshares 66% control does break causation
o Awards of attorneys fees to proper
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 120/124
120
o Substantial benefit test does not have to be pecuniary
3. TSC Industries v. Northway: Defined materiality
o Materiality: doesnt require proof that the vote would have been different but for f alse
statement
o Defined as Reasonable Investor-TotalMix TestIf a reasonable investor would have found
it to be an important f act in the questioning of the deal
o Define causation, materiality, reliance
4. Take these doctrines and apply them to 10b because these proxy fights were big deal: open
license to sue as private litigants under 10b-5 with the diminished causation, reliance and
materiality requirements
o Borak now limited to its f acts
o Congressional Intent Test Now: if you have an open-ended prohibition in a federal statute
the presumption is NO and rebutted only if you have very strong evidence that Congress
intended to have a private cause of action available; generally not implied by the courts
would write it in
Seinfeld v. Bartz Application
1. Importance: compensation of CEOs and stock options
2. Qualified 16b-3 Plan: must have a plan distributed to your SHs
3. Facts: everyone knew all the details of dates and what not but there was no present valuation
of the options in the statement released;
o CEO would get $2m salary and then $1m in stock options but they didnt say they were
paying the CEOs the salary plus the options because firm didnt value the options correctly
and were under by $320,000
4. Held: No, not material. If you wanted to value the shares, then you do it. We have no obligation
to do it ourselves when you have enough information that was released
o Call Options: Note on p. 555 on options; compensatory call option that give CEOs, can buy
stock from company that is well in the black
o No back dating controversy
Proxy Rights and Shareholder Proposals (14a-8)1. Compare incentives for takeover and proxy fights
2. CompareMethods of Takeovers to Proxy Fights
3. Capitalism (1) private property ownership and (2) are able to aggregate, buy and sell, property
(widows and orphans owning one share of GM permissibility of aggregation creates our largest
corporations)
o Example assume only own 10% (very much) of firm with capital value of $8m (worth
$800,000) and believes that firing CEO will raise value by 20% to another $1.6m
o Question: how do you execute upon that belief when willing to take the risk
4. Option 1 Proxy Fights: win ma jority of the seats and throw him out but cost lots of money
$250,000 and you wouldnt gain enough back to gain costs (odds of f ailing are extremely high, risk
not worth rewards)
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 121/124
121
o Effect of Staggered Board: two 2 successful contests gain control of board elect 1/3 first
year and another 1/3 the next year double expense
o Usually not done proxies unless gains would be monstrous with low risk
5. Option 2 Takeovers: Have 10% and want to buy 40% but key is you want to buy it at the lower
rate get interest rates to cover the difference so it makes up for the losses while also getting
20% - must get another from firing CEO to repay the 20% and carry the interest payment
o Purchase 90% you dont own costs $7.2m and gain $1.6m assume premium is required;
can pay SHs up to 20% (less than $8.2) and still show gain
o Assume premium required and must borrow money can pay SHs up to 20% minus interest
(e.g. 6%) and still show gain
o States and politicians hate on these now stop it at the buying ma jority ownership in OH
Board must accept takeover (meaning there are ZERO takeovers here UNLESS there are
special consulting contracts OR confidential information agreements that are basically
bribery); OH empowers boards to take bribes so they dont have to allow the takeover
o Bad Managers Blocking Takeovers: stay in power effect OR can pay SHs up to 20% minus
interest and minus bribes to managers and still show gain (severance, golden chutes, etc.)
o Worries: companies are liquid in the past you could not raise that type of money so quickly
but now you can easily
So with the OH legislation all the shares are worth 97% less than they are in other
states without this type of legislation
Instead front-end tax incentives like property tax relief (non-contingent on anything
government planning)
New Option Three1. New Rules for Proxy Contests: AIG Case stands
o SH proposes and wins 14a-8 resolution
2. Let 10% SH nominate slates of candidates for the boards and the firm has to pay
o Option one would suddenly make sense
o If force firm to put opposing slates that are real on ballots then there is whole different
issue
o Easiest way to pick opposition slate SH amounts of largest opposition SH gets the right to
select candidate to oppose
3. Problem: more collusion CEO pays much more attention to that SH in opposition and may give
him other perks and information that may dissuade him from putting quality candidate on the
ballot
Rule 14a-8: Shareholder Proposals1. Town Meeting Rule: Q ualif ying SHs may include some kinds of proposals for a SH vote in the
companys proxy solicitation material
o Allows ordinary people to get on the SH Voting proxy list; 500 words or less
o Something for nothing
2. § 14 in SEC Act (a) delegates power to the SEC and regulating proxies
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 122/124
122
o 14a means it was 1934 Act rule, later Acts are larger numbers
3. Policy:
o Pros: Low cost SH access to SH vote process
No SEC filing, no cost of mailing
Even f ailed proposals make the point
o Con: Costly annoyance overwhelming number of proposals f ail; infringed on
management prerogatives
4. Procedure: Submit to request (resolution and supporting statement) to corp. within deadlines of
14a-8
o Firm requests a no-action letter from the SEC on whether firm can exclude
o SEC issues no-action letter (will you sue us? Not at this time, but may sue you later but
not today doesnt bind SEC); only if clear precedent that the SEC will not allow this to
keep out then they will try to get it out of there
o Review of staff latter by 5 SEC Commissioners
o Loser Petitioners Federal Circuit Court to overturn SEC decision or firm excludes it despite
advice and forces SEC to sue in FDC
5. Types of Proposals: 13 Most Improper
o Personal Grievance or Personal interest
o Ordinary business operations (Dole proposal, study on health care, Con Ed proposal on
retirement age)
o Election for a board seat (AIG case)
o Materiality (relevance): less than 5% of
Total assets or net earnings and gross sales
Exception for otherwise significantly related to business (Iroquois Brands proposal on
pate)
o Resubmission in 5 years: any do-gooder that gets 3% vote once, less than 6% twice this
is the definition of victory
6. Shareholder Power?
o Are these Rule 14a-8 Resolutions Binding on the board:
NO Corp. Code State that Board has power to manage because resolution must be
proper under State Corp. Codes (which gives power to the directors)
Possible exception: SH power to amend bylaws
o Solution: make resolutions precatory recommend or request the board act (see Con Ed
proposal)
Board may or may not comply boards of ten f ail to comply;
If they do not? Option is to vote them out.
7. Special Case: Bylaw Amendments
o Not Resolved
o Common Practice: To allow SHs to make bylawys by charter election in MBCA; boards
have exclusive power to amend bylaws (DE and OH) some states can take this right out
in the charter
8/6/2019 Business Associations Outline DANOFF
http://slidepdf.com/reader/full/business-associations-outline-danoff 123/124
123
o But DE § 109(b) and OH § 11(regulations): SHs have inherent right to amend bylaws can
SHs amend bylaws with a Rule 14a-8 resolution, making it binding?
o When do SHs recommend bylaw changes?
In DE issue is scope of SH management power SHs do not have power to manage
board; directors do some argue that this invalidates Poison Pill bylaws
AIG Case: Amending B ylaws
1. Proposal: Amend bylaws to allow ma jor SHs (3%) to nominate candidates for board elections; put
a bylaw amendment on AIG proxy solicitation to allow a ma jor SH to nominate candidates
o Access Bylaw can SH amend proxy machinery that is in place?
2. SEC: Deals with election, may be excluded
3. 2nd Circuit: SEC is not following text of rule AN ELECTION allows bylaws that change election
procedure (all elections)
4. SEC Could rewrite rule: DE could change SH power to amend bylaws (would not stop precatory
resolutions, however)
o SEC has new rule out to change decision of 2nd Circuit ando DE has new rule to blunt effect 2
ndCircuit decision
V oting Results1. Social Responsibility Resolutions Fail (Dole vote, 5.4% in f avor; 83.6% against, 11% abstained
unusually high) goal is to beat resubmission 3% bar; Vietnam victory for proponents (advice to
Nixon declare victory and pull out)
2. Governance resolutions may succeed: these may be ones that matter
o Example drop the staggered board because it makes it too hard
o Drop the poison pill plan
o Sponsored by the institutional investors in your company who are worried about the stopprice
o Resolutions by the big players, on economic issues to maximize the stock price
Corporate Responsibility Proposals
1. Types abortion funding, gay rights, affirmative action, environmental impact rarely succeed
2. C racker Barrel controversy (not in book):
o 1992 SEC allows company to exclude SH proposal to prohibit employment
discrimination based on sexual preference
Ordinary business matter or not material (5% rule)
o 1998 Under political pressure SEC withdraws Cracker Barrel letter says it will rely on a case by case analysis
Governance Resolutions
1. Examples: Repeal stagger boards; repeal poison pill plans; ma jority vote bylaws; SH nomination
bylaws (AIG case)
2. Success? Because institutional investors involved and public pension plans