Biz Org Outline: Fall 2010 Agency

1. Is there an agency relationship? 2. Does the problem involve a 3rd party trying to hold the principal to an

agreement based on the agent’s conduct or an express agreement? 3. Does it involve a 3rd party trying to hold the principal liable for the

agent’s torts? Agency Rest. Def:

● A fiduciary relationship (within the scope of the agency relationship) ● Arises when, and ONLY when

1. One person (principal) manifests her consent to another (agent) that 2. The agent shall act on the principal’s behalf subject to the principal’s

control 3. And the agent consents to act

● Agency does not require intent to create such a relationship. If you act

like a principal, the law will treat you like one. CONTROL is key ● The person asserting that there was a principal-agent relationship has the

burden of proving that there was one ● Agents owe fiduciary duty to her principal: must avoid self dealing,

conflicts of interest, disloyal acts ● Gratuitous agents peform services without gain; cannot be compelled to

perform duty, principals may be liable for torts by gratuitous agents Ways to create agency relationship:

1. by agreement 2. by ratification: principal accepts the benefits or otherwise affirms the

conduct of someone purporting to act for the principal, even though no agency agreement exists

3. by estoppel: a principal acts in such a way that a 3rd person reasonably believes that someone is the principal’s agent

Gordon v. Doty agency arising from use of a car

● teacher allows fb coach to drive car to game, transporting players ● car accident occurs, player gets hurt, father sues ● court finds agency relationship b/c she loaned her car with a condition

attached to its use (coach must drive); this is evidence of exercise of control over the agent

● more control = more responsibility Cargil creditor exercising control over a debtor

● Elements of agency present (1) principal’s consent to the relationship (2) acting on behalf (3) de facto control

● Creditor was liable for debtor’s contracts with others b/c creditor become a principal through:

○ Course of dealing ○ Creditor assumed control of debtor’s business ○ Reviewed expenses, recommended certain business decisions,

maintained a right of entry onto the premises, etc… CONSEQUENCES OF CREATING AN AGENCY RELATIONSHIP: Contract Authority after proving the existence of the agency relationship, to hold the principal liable, the 3rd party must demonstrate agent’s scope of authority to act for the principal

● Actual Authority agent reasonably believes that principal wants her to act based on principal’s manifestations to agent; its about the relationship between the principal and the agent

○ Express Authority principal tells agent to do x + agent does x = principal is bound

○ Implied Authority authority that the agent reasonably believes he has as a result of the principal’s actions

■ Implied from past conduct ● Mill St. Church in determining whether agents

belief was reasonable, consider prior dealings between principal and agent

■ Multiple sources of authority ● Dweck v. Nasser Agent had actual, implied and

apparent authority to settle based on relationship to principal and statements made by principal

○ Scope of actual authority: agent has authority to ■ take action designated by the principal’s manifestations ■ do other acts necessary to achieve the principal’s

objective ■ agent’s understanding of principal’s

manifestations/objectives must be reasonable ● agent’s understanding of principal’s manifestations

is reasonable if: it reflects meaning known to the agent or as a reasonable person would understand; also must reflect fiduciary duty to the principal

● agent’s understanding of principal’s objectives is reasonable if: accords with principal’s manifestations and inferences that a reasonable person would draw from the circumstances

● Apparent Authority its about the relationship between the agent and the 3rd party; the authority that 3rd party reasonably believes the agent

has (belief traceable to the principal) ○ Apparent authority to accept a K

■ 370 Licensing Corp. salesmen generally have the authority to contract, K enforceable

● Inherent Agency power derived solely from the agency relationship (Friedman doesn’t like this one: poorly defined, not in the 3rd restatement)

○ Acts of agent in ordinary course of business ○ Watteau v. Fenwick no apparent authority b/c no one knew

Humble was not the owner, principal still on the hook Ratification the affirmanation of a prior act done by another, whereby the act is given effect as if done by an agent acting with actual authority A person ratifies an act by manifesting assent, conduct that justifies a reasonable assumption that the person consents R3: If the principal (1) ratifies or affirms an agent’s act expressly or impliedly with (2) intent to ratify and (3) full knowledge of all material circumstances

1. express ratification = “I ratify…” 2. implied ratification = (1)accepting benefits when its possible to

decline them (2)silence or inaction or (3) trying to enforce the K on your own behalf

Must ratify all of K or none of it acceptance of any benefit = ratification Estoppel even if a person has not made a manifestation that she may act as an agent, that person may still be subject to liability to a 3rd party if

1. The 3rd party detrimentally relies on believed authority (justifiable belief)

2. The person intentionally or negligently caused such a belief 3. The person failed to take reasonable steps to notify others

● Estoppel differs from Apparent authority in that apparent authority makes the principal a contracting party with the 3rd party (creates enforcement rights); in contrast, estoppel only compensates 3rd party for losses arising from reliance

Agent’s Liability on the K depends on principal’s status

● Disclosed principal: agent not personally liable ● Undisclosed or partially disclosed principal: agent personally liable when

principal not disclosed ○ Atlantic Salmon v. Curran

Liability of Principal to 3rd Parties in Tort 1. Servant vs. Independent Contractor

● Respondeat Superior: employer is liable for all torts committed by an employee if:

i. tortfeasor is an employee/servant ii. acting within the scope of her employment

● Extent of master’s control over servant’s actions how to distinguish masters from independent contractors

i. Servants: actions subject to master’s control ii. Independent contractors: principal retains no control as to

how the work is performed, merely designated the objective/goal

1. Rights to profits/risk of loss 2. Day to day operations 3. Hours of operation

● Test from R2, 220: Servant v. Independent Contractor i. Extent of control master may exercise over the details of

the work ii.Whether employed party is engaged in a distinct occupation

or business iii.Typical amount of direction from employer iv. Skill required v.Which party supplies the instrumentalities/tools vi. Length of time of employment vii. Method of payment (hourly or by the job) viii. Whether or not the work is part of the regular business

of the employer ix.Whether or not the parties believe they are creating a

master servant relationship x. Whether the principal is or is not in business

2. Tort Liability and Apparent Agency (Franchises) a principal who represents one to be his agent, thereby causing a 3rd party to justifiably rely on said agent’s care/skill, is liable to the 3rd party for harm caused by agent’s lack of skill or care

● Control Test if a franchise agreement goes beyond just setting standards and allocates to the franchisor control over daily operations, an agency relationship exists; more control more liability

i. Holiday Inn off the hook, b/c they really just provided right to use the name and the image; no specific mandates of procedures/practices

● Instrumentality Test (the emerging test) in the Burger case: does not matter whether the principal actually exercised control, only whether it had the right to control over a specific instrumentality

i. McDonalds on the hook for the Sapphire in the Big Mac b/c they specifically controlled food prep practices

3. Scope of Employment

● R2, 228 Conduct by a servant is within the scope of employment if

i. If it is of the kind she is employed to perform ii. occurs substantially within the authorized time and space

limits iii.Actuated, at least in part, by a purpose to serve the master iv. If force used, use of force is not unexpectable by the

master ● The Drunken Sailor Case: 3 part test for Foreseability

i. Conduct must relate to employment sailors required to return to the ship at night

ii.The implicit risks must relate specifically to that type of employment: risk related to persons in the profession (not an individual personal problem) sailors get drunk

iii.The precise risk need not be foreseeable, so long as a general field of risk was foreseeable

● Intentional Acts Principal liable if P can show that employee’s assault was in response to the P’s conduct which was presently interfering with employee’s ability to perform his duties successfully

i. Recall Skuzz and his 80 mph baseball

4. Liability for Torts of Independent Contractors ● Prinicipals generally not liable for torts of ICs ● 3 exceptions

i. principal retains control of the means and manner of work ii. engages an incompetent contractor iii.work constitutes an inherently dangerous activity

1. can only be carried out safely by exercising special skill and care

2. involves grave risk of danger to persons or property if negligently done

Agents as Fiduciaries an agent is a fiduciary with respect to matters within the scope of her agency R3. 8.01 Fiduciary has a duty to act loyally for the principal’s benefit in all

matters connected with the agency relationship R3. 8.02 duty not to accept bribes or kickbacks; cannot accept material benefits in connection with actions taken on behalf of the principal or other use of agent’s position R3. 8.03 duty not to act as or on behalf of an adverse party to the principal R3. 8.04 duty not to compete with principal or assist principal’s competitors during the course of agency relationship; ok to prepare for competition when relationship ends Reading v. Regan if servant has unjustly enriched himself solely by virtue of his employment , without his master’s sanction, he can’t keep the money and it must be given to his master

● if employment is the cause of profits they belong to the principal (British soldier takes bribes in Egypt)

● if merely the catalyst agent can keep them (Pilot “Sully” lands plane in Hudson)

● Secret profits an agent can’t derive ‘secret profits’ (benefits other than those promised by the principal unless the agent discloses said benefits and the principal consents (smart mechanic case)

● Duties after termination ○ Fiduciary duty to keep trade secrets survives the severed agency

relationship Partnerships UPA= Uniform Partnership Act

● Adopted by most states ● Makes law governing partnerships state statutory law, not CL

UPA 6 A partnership is an association of 2 or more persons to carry on as co-owners a business for profit RUPA 202 PARTNERSHIP FORMATION

● Using the term “partnership” does not by itself establish a partnership ● Joint ownership of property, does not by itself establish a partnership ● Sharing of gross returns does not by itself establish a partnership ● A person who receives a share of the profits of a business is presumed

to be a partner in the business, unless profits were received in payment of debt, for services or for rent

● Two factors (turning the dials) that indicate existence of a partnership ○ Profit Sharing ○ Amount of Control

● Fenwick no partnership where: no sharing of losses, no rights upon dissolution, owner retained all control, contributed all capital (owner

wanted secretary to be considered a partner for tax purposes) court will look at parties’ intent

● Martin v. Peyton profit sharing alone, is not always a partnership; b/c there was a limited amount of profit sharing and only passive, indirect control; just a debtor-creditor relationship

● Southex Exhibitions v. Rhode Island Builders totality of the circumstances test; there is no partnership where

○ Agreement not labeled as a partnership ○ Agreement was for a fixed term, not an indefinite duration ○ No agreement to share operating costs, builders company agreed

to advance all monies and absorb all loss ○ Profit sharing looked more like payment

● Partnership by estoppel: proof of reliance on the truth of the representation

○ One who holds herself out to be a partner or who expressly or impliedly consents to representations that she is such a partner is liable to any third person who extends credit in good faith reliance on such representations

○ P must prove reliance on the truth of the representation ○ D must have given consent to the arrangement

Partnership Governance RUPA 401 Partners Rights and Duties

● Each partner owns what they contributed less liabilities ● Each partner is entitled to an equal share of the profits and if

chargeable with a share in the losses proportional to her share in the profits

● Each partner has equal rights in the management and conduct of the partnership business

● For matters in the ordinary course of business majority rules ● For matters outside the ordinary course of business requires

consent of all partners Nabisco Every partner is an agent of the partnership; joint and several liability; partnership on the hook b/c they were already working with Nabisco

● The Deadlock Problem ○ Case law suggests that the party proposing a change loses b/c you

need a majority for matters in the ordinary course of business see RUPA 401(j)

○ To avoid this problem: after the fact, all you can do is dissociate and give notice; before the fact, you can put in veto power,

require unanimity, get that magic 51%

● RUPA 703 Dissociated Member’s Power to Bind Limited Liability Company for up to 2 years after a member dissociates, the surviving company is bound by an act of the dissociated member if

○ Reasonable belief that member was not dissociated ○ No notice of member’s dissociation

● RUPA 804 Member’s or Manager’s Power and Liability as Agent After Dissolution

○ An LLC is bound by manager’s acts (1) appropriate to wind up business (2) would have bound company before dissolution and the other party did not have notice of dissolution

All partners are agents of the partnership with the power to bind the partnership AND all partners have equal rights to participate in the management of the partnership Day v. Sidley a partnership has broad discretion to consolidate its decision making authority (create efficiency); UPA and RUPA are the default rules, but we can contract around them

Partnership Property and Capital Putnam v. Shoaf transferring partnership is a finality; you take the chance that you may lose out

● The only rights that may be transferred are the rights to profits and losses and rights to receive distributions

● You may NOT transfer control in the partnership (default rule, can be contracted around)

Property Rights of a Partner:

1. Rights in specific partnership property 2. His interest in the partnership 3. his right to participate in the management

Partners are co-owners of property Partner’s interest in the partnership is share of the profits and surplus Raising Capital see the problem on p.136 Fiduciary Duties in Partnership Law duties of partners to other partners include duty of care and loyalty

404(b)(1)Duty of loyalty (much stonger than that owed by agents) “the duty of finest loyalty”

● To account to the partnership any benefit derived by the partner from partnership business or derived from use of partnership property; includes appropriation of a business opportunity

● To refrain from dealing with the partnership on behalf of an adverse party

● To refrain from competing with the partnership before the dissolution of partnership business (Mehan no grabbing and leaving)

404 (c) Duty of care must refrain from engaging in grossly negligent or reckless conduct , intentional misconduct or a knowing violation of the law Meinhard v. Salmon partners have a fiduciary duty to inform each other of business opportunities Meahan no grabbing and leaving; partners left firm and took clients You can contract around some partnership duties, but the limit is that it cannot be manifestly unreasonable

● For example, you could add a 2/3rds vote guillotine ○ Pro: eliminate the weak links ○ Con: potential to get blind sided ○ Mitigate contention with a warning system and a payout

Partnership Dissolution Upon dissolution, partnership is not terminated until all affairs wound up Causes of dissolution:

● Expiration of the partnership term ● At will (if there is no specified term/undertaking) ● Assignment assignee or creditor can get a dissolution decree upon

expiration of partnership term or at any time with a partnership at will ● Death of a partner ● Withdrawal or admission of a partner (most contract around this) ● Illegality ● Death or bankruptcy ● Dissolution by ct. decree

Dissolution is rightful (by agreement) when:

● Expiration of the partnership term/completion of the undertaking ● In an at will partnership, by the express will of a partner ● In term partnership, only by unanimous agreement

● Expulsion of any partner in accordance with the agreement ● Unless specified otherwise in the agreement ● A term can be defined by a period to pay back a loan to the partnership,

which then becomes at will Dissolution is wrongful by:

● Violation of the partnership agreement ● Dissolver acted in bad faith ● Violated fiduciary duty ● Source of the problem

Owens v. Cohen bowling alley asshole, court issues decree of dissolution b/c of significant disagreements between partners Always include a buy sell agreement! Provides a mechanism for exit Dissolution by Judicial decree occurs when: On application by or for any partner…

● Partner has been declared a lunatic ● Parter becomes incapable of performing her part of the K ● Partner guilty of some conduct as tends to affect prejudicially carrying on

the business ● Partner willfully or persistently breaches partnership agreement ● Business of the partnership can only be carried on at a loss ● Other circumstances that make dissolution equitable

On application of the purchaser of a partner’s interest ● After termination of specified term ● At any time if an at will partnership

RUPA 801 Events Causing Dissolution A partnership is dissolved and its business must be wound up only upon the occurrence of: 1. In a partnership at will, upon Partner’s will to withdraw as a partner and notice to the partnership Prentis: partners can dissolve and demand an auction 2. In a partnership for a definite term:

● Express will of all partners OR ● Expiration of the term

3. an event agreed to in the partnership agreement resulting in the winding up of the partnership business 4. illegality 5. on application by a partner or judicial determination that

● Economic purpose unreasonably frustrated ● Not reasonably practicable to carry on the relationship

6. on application by a transferee of partner’s transferable interest, a Judicial

determination that it is practicable to wind up the partnership business ● After expiration of the term OR ● At any time if at will partnership

UPA 33 Except to wind up affairs, dissolution terminates all authority of any partner to act for the partnership UPA 34 If dissolution was caused by act, bankruptcy or death of a partner, each partner is liable to her co-partners for her share of any liability created by any partner acting for the partnership unless:

● Partner incurring the liability had knowledge of the dissolution/bankruptcy or notice of the death

UPA 35 Power of a Partner to bind the partnership after dissolution

● After dissolution partner can bind the partnership ○ to wind up partnership affairs or ○ any action which would have bound the partnership before the

dissolution if ■ The other party knew of the partnership before dissolution

and ■ had no notice of dissolution

● partner’s liability is limited to partnership assets alone if that partner was unknown to the person who contracted with the partnership

● Partnership is not bound when: it is dissolved b/c it is unlawful to carry on the business; partner is bankrupt; partner has no authority to wind up the business

UPA 36 Effect of Dissolution on Partner’s Existing Liability dissolution of partnership does not, by itself, discharge partner from existing liability UPA 37 Right to wind up partners who have not wrongfully dissolved, who are not bankrupt and who are alive, have the right to wind up partnership affairs Right to continue UPA 38 if the dissolution is rightful, innocent parties may continue the business by buying the offending partner’s interest; if dissolution is wrongful, then the offending partner cannot continue the business by buying the partnership at judicial sale UPA 38 When dissolution is caused in contravention of the partnership agreement, the rights of the partners shall be as follows

● Partners who did not wrongfully caused dissolution ○ Have rights to damages against wrongfully dissolving partners ○ Have the right to continue the partnership after paying out the

interest of wrongfully dissolving partner less damages owed

Distribution of Assets: Payback Priority (loans, then capital payback, then profit and loss distrbution)

1. Outside creditors (not partners) 2. Partner creditors 3. Capital Payback to partners who contributed money (capital

contributions + accumulated earnings –accumulated costs) 4. Profits and losses among the partners partners receive their agreed

share 5. Distributions in kind: if there are no debts, or debts have been paid

with the cash account, assets may be distributed to the partners (but may not be sold)

Loss sharing absent an agreement, partners share losses in proportion to their interest in the partnership (equal share in profits and losses)

● Profits and losses are equally shared even when partners do not contribute any capital

UPA 38 specifically states that the value of goodwill of the business shall not be considered; absent an agreement otherwise, there is no compensation for partner work in a partnership Rights of Partners

● If the dissolution does not violate the agreement, then there is no COA against any partner

● If the dissolution violates the agreement: ○ Innocent partners have a right to damages ○ Innocent partners have a right to continue the business by buying

the offending partner’s interest Effects of dissolution

● Partners are liable until debts discharged ● New partnership remains liable for old debts ● Retiring partner’s liability for debt incurred by partners continuing the

business Consequences of Dissolution RUPA 807 determined by whether the dissolution was rightful or wrongful; if wrongful the wronged partner has right to damages for breach and may have a right to continue the business Buyout agreements an agreement that allows a partner to end her relationship with the other partners and receive a cash payment, or series of payments, or some assets of the firm, in return for her interest in the firm

● Trigger events: death, disability, will of any partner ● Obligation to buy vs. option to buy

○ Firm ○ Other investors ○ Consequences of refusal to buy

● Price Market value is the goal, difficult to achieve ● Method of payment ● Protection against debts of partnership ● Procedure for offering to buy or sell

Jewel v. Boxer absent an agreement to the contrary, any income generated though the winding up of unfinished business is allocated to the former partners according to their respective interests in the partnership

● Lawyers run a partnership without a buy-out agreement ● Issue of fee allocation after partnership dissolution

CORPORATION LAW

Corporation Formation Shareholders (control the corporation…at least in theory) Directors (oversee and supervise management) Officers (corporation management) Promoters and the Corporate Entity

● Promoter = a person who identifies a business opportunity and puts together a deal, forming a corporation as a vehicle for investment by other people

● After formation (filing), the promoter is no longer individually liable for debts incurred by the corporation

Organization of Corporation

● After incorporation: ○ Initially appointed directors hold an organizational meeting to

appoint officers, adopt bylaws, etc… ○ If no directors yet appointed, the incorporator holds the

organizational meeting ● Required actions may be taken without a meeting if there is written

consent Southern Gulf Marine Co. v. Camcraft one who contracts for what he acknowledges to be and treats as a corporation, incurring obligations in its favor, is estopped from denying its corporate existence, particularly when the obligations are sought to be enforced

2.04 Liability for Pre-incorporation Transactions all persons purporting to act as or on behalf of a corporation, knowing there was no incorporation under this act, are jointly and severally liable for all liabilities created while so acting Partnership vs. Corporation Partnership Corporation Formation Informal; UPA Formailties required

-articles of incorporation -Bylaws -Board of directors -Officers -Minutes -Elections, filing

Limited Liability No, but can bargain for it, buy insurance, LLP

Yes

Free transferability No, but can agree to allow

Yes, but can agree to restrict

Continuity At will, unless agreed otherwise

Indefinite, but can limit, need exit agreement

Centralized management No each partner is an agent, but you can appoint an executive committee and limit authority by agreement and notice

Yes

Cost Zero, but you should Need lawyer, filing fees etc…

Default rules extensive More extensive

Limited Liability 6.22 Liability of Shareholders a shareholder of a corporation is not personally liable for the debts of the corporation except by reason of her own acts Piercing the Corporate Veil:

● Individual shareholders need to avoid unity of interest ● You don’t want shareholder and corporation to look like the same entity,

otherwise you no longer get protection from liability Sea Land Test, the spicy case!

1. Unity of interest between individual and corporation that separate entities no longer exist

● Disregard of form Failure to maintain corporate records ● Commingling of assets ● Undercapitalization ● Siphoning ● Respondeat Superior

2. Adherence to the corporate fiction would promote fraud or injustice Catholtic St. Bernard alter ego theory it must be made to appear that the corporation is not only influenced and governed by that person, but that there is such a unity of interest and ownership that the individuality, or separateness, of such person has ceased, and the facts are such that an adherence to the fiction of the separate existence of the corporation would, under the circumstances sanction a fraud or promote injustice

● Catholic Church in San Fran. Is off the hook for the puppy deal gone bad

Limited Partnership and the LLC Limited Partnership RULPA Revised Uniform Limited Partnership Act: entities created by modern statutes to facilitate commercial investments by those who want a financial interest in a partnership, but don’t want the responsibilities and liabilities of partners; def a partnership formed by 2 or more having both general and limited partners

● Being a limited partner protects you from liability, unless you act like a general partner by trying to assert control over business management decisions

General Partner: assumes management responsibilities + full personal liability for debts of the partnership Limited Partner: contributes cash/property/services to the partnership and obtains an interest in the partnership in return: no management rights and limited liability for partnership debts

● No liability for partnership debts ● Max. loss is investment in the partnership

Rights of Limited Partners

● Same as those of regular partner, but no right to control management ● Right to access the books, to an accounting and to a dissolution by court

decree ● Limited Partner can assign rights to: income/dist. of assets but, assignee

is not entitled to inspect the books, obtain an accounting etc…

Holzman v. Escamilla purported limited partners who take control of the finances of the partnership business and control the actions of the general partner are liable as general partners Corporate Partners Frigidaire � parties can form limited partnerships with corporations as the sole general partner, even when limited partners are that corporation’s officers; as long as limited partners respect the form of of the limited partnership, they will be insulated from liability

● This is one of Friedman’s favorites! ● The Corporation is the sole General Partner ● The Corporation’s officers, directors, shareholders are the Limited

Partners ● This creates a limited partnership in which the General Partner is

protected from liability through the corporate veil ● In effect, the Limited Partners control the partnership through their role

within the Corporate partner (best of both worlds) ● The only trick is that actions as limited partners must be kept separate

from personal actions within the corporation LLC hybrid of partnerships and corporations; interest holders are called members, more flexibility in management structure, avoids double taxation, requires formal filing LLC Formation = Filing + Notice: Westec �Members must give notice that there is an LLC to be protected from liability; filing is not sufficient notice; putting the letters LLC on your card would be sufficient notice

● Agent is liable when he fails to disclose that he is an agent LLC Operating Agreement

● Members of an LLC can agree to an operating agreement with provisions different than the default rules (LLC statutes)

● The limit to freedom to contract is when it unreasonably reduces the duty of care ex a clause completely releasing members from all liability

● Duty of care = refraining from grossly negligent/reckless conduct, intentional misconduct or knowing violation of the law

Piercing the LLC Veil Kaycee v. Flahive Oil if the members fail to treat the LLC as a separate entity, they forfeit immunity from individual liability for the LLC’s acts that cause harm to 3rd persons (this issue is still up for debate) Look for fraud, injustice, assets being misused Fiduciary Obligation the operating agreement of an LLC can limit or define the

scope of fiduciary duties imposed on its members McConnell v. Hunt Sports a group of investors tries to attract financiers for hockey stadium, members disagree, one member makes a separate deal with financier on his own; court finds no breach of fiduciary duty b/c the operating agreement allowed competition Dissolution of the LLC dispose of known claims by filing articles of dissolution and providing written notice to creditors; cannot pay members first, or else you will be personally liable Haack gas card case

Duty of Care and the Business Judgment Rule: Operational Decisions Purpose of the corporation = create shareholder value THE BUSINESS JUDGMENT RULE. There is a rebutable presumption that the courts will not overturn the business decisions of a corporation. Unless there is a breach of…

● Duty of Care if breached, burden shifts to directors to prove that the decision produced a fair result and therefore no damages should be awarded

● Duty of Loyalty Dodge v. Ford Motor co.

● Controversy over dividend payment vs. factory expansion + price reduction

Shlensky v. Wrigley Duty of Care and the BJR ● Minority shareholder wants lights at Wrigley field, but Wrigley says

“Baseball is a daytime sport!”; claims the team would suffer from negative reaction to the lights by the neighbors

● Court defers to Wrigley’s judgment b/c there is no proof of a breach of duty of care or duty of loyalty

Duty of Care

● Directors must act on an informed basis ● They don’t need to know the daily workings of the business, but they

should at least 1. Consider all reasonably available information 2. Acquire a rudimentary understanding of the industry 3. Have a basic knowledge of how the business is working

● Gross negligence is the standard for determining if business judgment was informed VanGorkom: Board and CEO only had a 20 min meeting and failed to properly inform themselves about stock price during major merger

The Business Judgment Rule and the Requirement of an Informed Decision Kamin v. American Express: informed business judgment in declaring a dividend

● Rule: In the absence of a claim of fraud, self dealing, bad faith or oppressive conduct, there is no breach of fiduciary duty

● Imprudence is insufficient grounds for equity interference with a corporate management decision

● Objections by the plaintiffs were considered and rejected Smith v. VanGorkom: mergers, LBO

● Transunion merger; Pritzker ● Only 20 minutes spent analyzing the deal ● BJR presumes that directors must act on an informed basis, in good faith

and in an honest belief that their actions are for the good for the company plaintiff must rebut this presumption

1. Was the decision grossly negligent? 2. If so, was the outcome sufficient to legally rectify and cure the

derelictions ● 2 conceptions of the business judgment rule

1. substantive content: the BJR comes into play only after it has been determined that the directors satisfied some standard of conduct; the liability bar is gross negligence/recklessness

● directors have a fiduciary duty to act in good faith, and a director acting in good faith is only liable for gross negligence or worse

2. abstention doctrine: the rules presumption of good faith is also a presumption against judicial review of duty of care claims

● the court will abstain from reviewing the substantive merits of the director’s conduct unless the plaintiff can rebut the business judgment rule’s presumption of good faith

Courts favor process (correct business procedures) over substance (a profitable outcome)

The Business Judgment Rule and “Good Faith” Obligation

● recall: a director acting in good faith is only liable for gross negligence or worse

● the law presumes that directors act on an informed basis, in good faith and with the honest belief that the action taken is in the best interests of the company

○ the presumption can be rebutted if P’s show that the directors breached their duty of care or of loyalty or acted in bad faith

Obligation of Good Faith: There are 2 ways to rebut the obligation of good faith

1. Subjective Bad Intent 2. Intentional Dereliction of Duty * does NOT include gross negligence: this only breaches Duty of Care

In re The Walt Disney Co. Derivative Litigation

● Eisner recruits Ovitz, doesn’t work out huge severance pay out ● Issue: did the plaintiffs ● Holdings

○ Ovitz didn’t breach a fiduciary duty to Disney in negotiating the severance b/c he was not yet an officer during negotiations

○ Failure to pierce the BJR veil: no proof of breach of duty of care/loyalty or acting in bad faith

○ The full board does not have to approve compensation decisions if there; can delegate to a committee

● RULE p. 382 ○ BJR presumes that the directors acted

■ on an informed basis, ■ in good faith and ■ with the honest belief that it was in the best interests of

the company ○ these presumptions can be rebutted ○ if breach of fiduciary duty of care/duty of loyalty or bad faith

is shown, then the burden shifts to the D to show that the action was KOSHER (entirely fair to the corporation)

○ 2 types of bad faith can puncture BJR i. Subjective Bad Faith ii. intentional dereliction of duty

How to rebut the BJR:

● Show a breach of fiduciary duties ○ Breach of Duty of Care

■ Gross Negligence ○ Breach of Duty of Loyalty

● Show Bad Faith ○ Actual intent to do harm or intentional dereliction of duty

● Waste ○ Directors must intentionally squander or give away corporate

assets How director’s can protect themselves: take good meeting minutes, use independent consultants (compensation committee) Jones v. Harris The test is whether the fee schedule represents a charge within the range of which have been negotiated at arms length in the light of all surrounding circumstances

● Fiduciary advisor of a mutual fund charges extremely high fees ● Duty of care: hire an expert to get reliable/neutral advice

Stone v. Ritter directors have a responsibility to follow the law; BLR does not shield you from claims of fraud or intentionally breaking the law

● Caremark Claim: sustained or systematic failure of the board to exercise oversight

Derivative Litigation [From the “SHAREHOLDER LITIGATION” Guide] Question 1: Direct or Derivative?

● Direct = Injury to shareholder often suing corporation/board to restore rights

● Derivative = injury to corporation (often, but not always for a lot of money)

Direct Suits

● Pursue the parties for injuring rights as a shareholder ● Minimal procedural hurdles ● Shareholder owns the lawsuit

Derivative suits

● Instigate the corporation to sue to make itself whole ● Significant procedural hurdles ● Corporation owns the potential lawsuit against the agent of harm ● Demand is required ● THE DERIVATIVE SUIT PATHS (note: by making demand, shareholder

concedes that demand is required) 1. Try to get demand excused due to futility

● Shareholder must allege particularized facts establishing a reasonable doubt that the board would make an independent and unbiased decision

● Grimes/Aronson/Delaware Test 1. a majority of the board has a material interest in the

challenged transaction OR 2. a majority of the board is dominated or controlled

by the alleged wrong doer OR 3. the challenged transaction was not the product of

valid business judgment ● If demand gets excused: an Independent SLC evaluates

litigation ● If demand is not excused, must go through the process

below 2. Demand made

● Board pursues the lawsuit (rare but possible) OR ● Board chooses NOT to pursue lawsuit

○ If board chooses not to pursue lawsuit, Plaintiff must pierce the corporate veil (business judgment rule), per board’s decision not to pursue lawsuit

○ Plaintiff must demonstrate that fiduciary duties were violated in consideration of suit to shift burden to board to prove fairness rarely a winner for S/H

Eisenberg v. Flying Tiger Shareholder’s voting rights get diluted, this is a direct lawsuit

The Demand Requirement as a general rule, shareholder plaintiffs in a derivative suit must approach the board first and demand that they pursue an action against the alleged wrongdoers so that the directors have an opportunity to correct

● Futility exception: this permits a shareholder to bring claims on behalf of the corporation without making demand when it is evident that the directors will wrongfully refuse to bring such claims;

● Futility requires that: Shareholder allege particularized facts establishing a reasonable doubt that the board will make an independent unbiased decision as evidenced by:

○ Self interest a majority of the board has a material interest in the challenged transaction

○ Domination majority of board is controlled by the wrongdoers ○ Not a Product of Valid Business Judgment challenged transaction

was not the product of sound business judgment (failure to fully inform, for example)

● Demand Made ○ If demand is made, it will most likely be refused ○ Making demand is a concession that demand is required ○ After demand is made board chooses if it wants to pursue

litigation ■ If/when it chooses not to litigate, shareholder is precluded

from further action if it can prove that their result violates the business judgment rule

● Demand Excused (for futility) ○ if demand gets excused, the corp will have an independent

Shareholder Litigation Committee (SLC) evaluate the situation ○ SLC retains control of the lawsuit

○ If SLC decides not to litigate, their decision is binding

Special Litigation Committees

● You need an SLC to apply the BJR when demand is excused ● Courts evaluate SLCs according to their procedure and independence ● The big question is whether courts should defer to the SLC’s judgment:

○ Majority View Auerbach ■ Courts review the procedure used by the SLC in conducting

their investigation, ■ but SLC’s substantive conclusion is protected by the BJR

○ Minority View Zapata (DELAWARE LAW) ■ 2 steps (court only looks at substance if procedure is kosher) 1. look at procedure: must be untainted by self interest,

independence, good faith, reasonable investigation

2. Court uses its own business judgment to evaluate the SLC’s substantive decision

Director Independence and Oracle

● Unlike the futlity exception (where the board is presumed independent and the shareholder bears the burden of proving otherwise), with SLCs the Coporation bears the burden of proving independence

● Courts strongly disfavor SLCs of 1 (no opportunity to deliberate/debate) ● In order to prove independence, inquiry turns on whether director is

incapable of making a decision with only the best interests of the corporation in mind

● Is there impartiality and objectivity? Includes ○ Social considerations ○ Financial motives ○ Structural/institutional bias

● Oracle and Larry Ellison

○ The SLC was composed of Ellison’s Stanford buddies ○ There were SUBSTANTIAL ties casts a reasonable doubt on the

judgment of the SLC ○ Failure to disclose connections in director’s report

DUTY OF LOYALTY requires that directors be able to objectively put the best interests of the corporation first and make unbiased deicisons accordingly, especially in the face of divided loyalty; THOU SHALT NOT STEAL; the duty of

loyalty is the duty not to steal from the company If duties of care and loyalty are met, BJR applies If not, burden of proof shifts to directors Bayer v. Beran boss hires wife to sing in the commercial

● After a self interested transaction is proved, the burden is shifted to the directors to prove the transaction was fair (profitable to the corporation: good faith, inherent fairness)

● Best practice: interested party should excuse herself, have a formal meeting w/ outside advisors, use industry standards

Benihana there is no breach of the duty of loyalty where interested party excused himself from decision making process, material facts/relations were disclosed Fliegler (mining case) interested directors are required to prove the fairness of a transaction even when it was ratified by shareholders; here there was a breach of the duty of loyalty, but the transaction was fair so it didn’t matter anyway CORPORATE OPPORTUNITIES Standard from Guth: if a corporate officer is presented with a business opportunity (that the corporation could financially undertake, in the line of the corporation’s business, and is of practical advantage…etc see COD below), the officer cannot seize the opportunity for himself But if, after being offered, the corporation refuses, the officer can take advantage Corporate Opportunity Doctrine: 1. Financially able 2. in the corporation’s line of business 3. Interest or expectancy in the opportunity 4. By embracing the opportunity, will create a conflict of interest between herself and the company In re Ebay expands the “line of business prong”

● Goldman Sachs wants Ebay’s business, offers execs borderline bribes ● Investment was in Ebay’s line of business

DOMINANT SHAREHOLDERS

● Generally no duty between shareholders, only btwn directors and

shareholders ● Duty btwn shareholders when: you are the largest shareholder, thus the

board will not act as an independent monitoring system (will not watch out for minority shareholders)

● Intrinsic Fairness Standard ○ When the situation involves a parent and a subsidiary, with the

parent controlling the transaction and there is an element of self dealing, a parent owes a fiduciary duty to the subsidiary

○ burden of proof shifts to the parent (controlling party) ○ self dealing occurs when the parent by virtue of its domination of

the subsidiary, causes the subsidiary to act in such a way that the ■ parent receives something ■ from the subsidiary ■ to the exclusion and detriment of the minority stockholders

● [Self dealing] + [a parent-subsidiary] relationship invokes the intrinsic fairness standard shifts the burden of proof to the dominant shareholder

○ controlling shareholder must prove that the transaction was fair to the corporation

● Trigger: If you see a transaction between a corporation and a controlling shareholder, jump straight to fairness

● Options for corporations dealing with minority shareholders ○ Get them to ratify ○ Buy them out ○ Get independent directors

● Zahn v. Transamerica (the unhold alliance between insurance and tobacco) majority shareholders had a fiduciary duty to the minority shareholders b/c they controlled the board of directors

SHAREHOLDER VOTING Stroh v. Blackhawk a stock must be more than a piece of paper; must include voting rights OR economic benefit (at the very least)

● When a company wants to raise capital, but preserve control, it can issue stock without voting rights, but that pays a dividend

Number of votes need not be proportionate to investment size (number of shares) A share = proprietary rights conferred by ownership of the stock; must include at least one of the following

● Right to participate in control of the corporation (voting rights) ● Right to surplus or profits (dividend) ● Right to assets

INSPECTION RIGHTS shareholder has a right to inspect the shareholder list and corporation documents as long as she has a proper purpose Proper purpose = concern with investment return or the continued vitality of the company

● Proper purpose derivative suit, class action ● Improper purpose labor union issues, employment related claims,

satisfying idle curiosity Crane v. Anconda a shareholder may access a shareholder list for the purpose of informing other shareholders of its exchange offer and soliciting tenders of stock

● Purpose was proper when it was to inform shareholders about a potential takeover (effects investment return); potential substantial effect on its wellbeing or value

Honeywell a shareholder must demonstrate a proper purpose germane to her interest as a shareholder

● Shareholder purchased shares of Honeywell for the purpose of stopping munitions production for use in Vietnam (social/political concerns)

● Proper purpose = concern with investment return ● Not entitled to inspect books and records

UNDER DELAWARE LAW burdens of proof

● Shareholder list: firm must prove that shareholder does not have a proper purpose

● Business records: shareholder must prove she has a proper purpose reasonably related to shareholder interests (value)

After proper purpose, stockholder must have held the stock for at least 6 months and not have been involved with selling shareholder lists for the last 5 years Sadler It was ok for ATT to use an agent to obtain CEDE (names of brokerage firms who have bought stock and NOBO (non-objecting beneficial owners) lists, as long as that agent is qualified (6 mo. And 5 years) CLOSE CORPORATIONS ownership and management overlap; recall Cargill Control in Close Corporations Ringling Bros

● Cumulative voting (multiple votes allocated per share, you can dedicate

all of your votes to one candidate) is ok ● Vote pooling agreements amongst shareholders re: elections are

enforceable ○ BUT agreements about how director will act are not ok b/c

director owe a duty to all shareholders, not just the ones who elected them

Shareholder Agreements McQuade v. Stoneham shareholders can agree to vote in a certain way, but they cannot form an agreement that precludes the board of directors from changing officer’s salaries, changing policies or retaining individuals in office

● “directors may not by agreements entered into as stockholders abrogate their independent judgment”

● “the power to unite is limited to the election of directors and is not extended to contracts whereby limitations are placed on the power of directors to manage the business of the corporation by the selection of agents at defined salaries”

Directors owe a fiduciary duty to all shareholders; cannot agree to bind actions of directors Clark v. Dodge if there are no minority shareholders b/c all shareholders agree, then the McQuade rule (no agreements as to actions as director) does not apply; ok to agree to keep minority shareholder on as a director Galler v. Galler agreement to protect the wife upheld

● the agreement was not completely unanimous, but the court enforces it anyway b/c

1. close corporation 2. no objection by any minority shareholder (and he

sold out anyway 3. the terms were reasonable (only lasts lifetime, only

payable if financially possible, amount was reasonable, not contrary to public policy)

Ramos v. Estrada we allow agreements to elect a certain director, but we don’t allow agreements to act a certain way once elected; BUT, an agreement to vote with the majority is binding on a shareholder (even when that shareholder happens to be a director) Fiduciary Duties� Abuse of Control share holders of a close corporation have a duty of utmost good faith and loyalty Wilkes v. Springside Nursing Homes 1. Is there a legitimate business purpose

2. Can it be achieved in a less harmful way ● shareholders in a close corporation have a duty of utmost good faith and

loyalty; majority shareholders cannot freeze out (strip control) a minority shareholder unless there is a legitimate business purpose

○ for example: a showing of misconduct on the part of the minority shareholder

● If maj. shows a legitimate business purpose, minority may be entitled to damage it can show there was a less burdensome alternative

Ingle v. Glamore an at will employee does not acquire fiduciary-rooted protection against being fired simply b/c he is a minority shareholder in a close corporation

● Employee agreed to sell back the shares upon his termination; at will employment (employment agreement existed)

● Agreement enforced Brodie v. Jordan P not entitled to a forced buy-out

● Majority shareholders in a close corporation violate their duty of good faith and loyalty when they frustrate the reasonable expectations of benefit from ownership of shares

● Minority shareholder is entitled to reasonable expectations of ownership, NOT a buy-out (a buy out is inequitable b/c it creates an artificial market for shares)

Smith v. Atlantic Properties the CONTROLLING shareholder must act in a reasonable manner, even when in the minority

● Corp of 4 formed where each member has abs. veto power (dumb) ● Sometimes minority shareholders can be the controlling shareholders;

Trigger: VETO POWER Jordan v. Duff close corporations have a fiduciary duty to disclose material facts to the shareholder about their investment Dissolution Alaska Plastics: the ex wife-board member problem

● Failure to give ex-wife notice of board meeting, unequal compensation of dividend-like payments

● Ex wife gets benefit of which she was deprived (back pay for director fees, allowed at meetings) restore expected benefits

● Does NOT get a forced buy-out CORPORATION DISSOLUTION 4 ways

1. buy out provision in the bylaws 2. Involuntary Dissolution

● Must be illegal, oppressive, fraudulent ● Also: waste

3. Significant change ● merger/consolidation ● sale of all assets

4. Breach of duty equitable remedy ● stockholders in a close corp (or majority to minority shareholders) owe

each other the same fiduciary duties as partners Haley v. Talcot (Redfin Grill)Request to dissolve an LLC granted if 1. 2 stockholders with 50% interest each 2. engaged in a joint venture 3. unable to agree upon whether to discontinue the business or how to dispose of its assets Freidman says we don’t need to know this standard, but realize that there is a struggle here between freedom to contract and right to an equitable solution