BA OUTLINE – FREER

I. Introduction

Always Ask:
1. What is it? (e.g. Corporation, Partnership, LLC)
a. Whether the law sees that business structure as an entity.
i. Affects liability and tax issues.
2. How do you form it?
a. What are the formalities and statutory problems that need to be satisfied? Are there
any formalities? Can it be formed by conduct, or must you jump through hoops?
3. How do you run it?
a. What if there are multiple decision makers? How do you proceed if they disagree?
4. Who’s liable for what?
a. Breach of K? Tort? Do you hold the entity liable or the individuals?
5. How do you fund it?
a. How do you provide for expansion? Borrow (Debt)? Sell and Interest t(Stock --
Equity)?
6. How do you make money?
a. Who gets it?
7. How do you end it?
a. What if someone dies? What if we want to withdraw?

What are the different forms of business?

1. Sole Proprietorship – simplest form.
2. Partnership – 2 or more people operating a business.
3. Corporation
4. Limited Partnership – kind of a combo of partnership and corp.
5. Limited Liability Company (LLC) – hottest ticket today

A. Why does someone own a business?

1. To make money

a. create value and wealth: the defining characteristic of a business is that the
economic activity is organized for the purpose of earning a profit.

2. Milton Friedman – Agency Relationship: The manager is the agent for the owners of
the corporation (principal). Thus, the agent is working for the S/H and the S/H’s only
want money.

a. Friedman believes that Corporate Managers wear 2 hats:

i. corporate - generate money for the corporation; increase wealth

ii. personal – there to assume social responsibility b/c Corp. is a

member of a larger community

 Ex: give time and money to charities

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 iii. Friedman would think that the Board of Directors of Ben & Jerry’s,
which gives a way a large % of its profits to charities, is breaching a
fiduciary duty – b/c the Board is the agent and it is giving away the
principal’s (S/H’s) money. Friedman believes the agent is not there
to be socially responsible or contribute to social causes – that is for
individuals to decide.

3. Warren Buffet. Elephant Bumping. Big shots love to hang out with big shots, so you
go to the other big shots that validate your cause. But the big shots never take out their
wallets; they take out the company wallet.

4. AP Smith v. Barlow (S Ct. NJ)(1953) – Board of Corp. voted to give away donation to
Princeton. The S/H’s sued the Board, claiming the donation was ultra-vires (outside
proper power of the Corp.) The Ct found in favor of the Board, thus finding the act
intra-vires (act that Corp. has a right to do).

a. A body of law has developed comprised of both common law and statutes that
controls the actions of a corporation – which is a separate entity.

b. Ct found that both common law and statute permitted the Corp. to make a
donation.

i. common law – as Corp.’s begin to take up all the wealth in society

(out of the hands of the individuals), they must be allowed to give to
society.

ii. Statute – allows for a reasonable amount of contribution.

c. There are still limitations on Corp’s ability to give away money:

i. amount given – still need to ensure the owners are still making money

ii. needs to benefit some kind of corporate interest – GOODWILL

(public welfare)

 Thus, an anonymous donation is NOT permitted

 Be aware because you are giving away other peoples’ money, but
basically today you don’t have to show corporate benefit.

iii. Corp.’s are usually permitted to give political contributions, but some
state’s put a price ceiling on it.

iv. Cannot make donations indiscriminately or to a pet charity of the

corporate directors in further of personal rather than corporate ends.

d. Rule – A Corp.’s management can do something even though it is opposed by the

owners – S/H’s.

B. How does an owner of a business make money?

1. Distributions out of the business (dividends, partnership draw)

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 2. Selling your interest at a profit.
3. Salary – if you own the business.

C. How does an owner of a business know how much money the business has made and how
much it is worth? – (need to look at the FINANCIAL STATEMENTS)

1. Income Statement – computes the profit [based on revenues and cost] of the business
for the period in question (and factors in tax at the end)

a. factors in straight line depreciation – (the machine gets less valuable each year
b/c we are using part of it up). In equation, take the cost of the machine and
divide it by the years it is expected to last.

b. What you see in the Income Statement is not necessarily how much cash is
available in pocket – b/c we adjust for depreciation.

2. Cash Flow Statement – measures the cash made available to a business from its
operations during a given period.

a. Cash Flow = [Profit after tax + Depreciation] – Investment

b. Cash flow actually shows your income situation, whereas the income statement
does not reflect cash

3. Balance Sheet – snapshot of a point in time. 3 main sections:

a. Assets – “things” that company owns that have value. Assets are the business’
stuff.

b. Liabilities – they are what the company owes

c. Owner’s equity – what is left over after you subtract the liabilities from the
assets.

i. Equity = Assets – Liabilities

ii. Stockholder = equity holder

4. Investments

a. Investors are NOT creditors - they are owners.

i. If the business fails, however, the business owes the investor/owner

nothing.

b. Lenders are NOT investors, they are creditors

i. They do not get profit, merely repayment of loan + interest

ii. they create liabilities for a business

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5. When determining what type of legal structure a business should take, need to look at
the following 3 factors:

a. Who will manage the business?

b. Who will get the profits?

c. What about taxation? (double taxation or single taxation)

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 II. SOLE PROPRIETORSHIP

A. Definition – 1 person owns the business and has a right to the profits and also takes the risk of
loss

1. most common form of business

2. there is NO entity here – thus, owner will get hit with the liability

3. there are NO legal requirements - don’t need a lawyer, don’t need to file or sign any
documents.]

4. Can only be 1 owner – BUT this 1 owner can still have 1000’s of employees

One person owns the enterprise, is responsible for management decisions, receives all profit and bears all
loss. The business is indistinguishable from its proprietor.

B. AGENCY LAW - Once the owner hires an employee[s], agency law principles take over

1. Introduction – it involves Delegation – thus, if P wants to get something done, he

engages A to do it for him.

2. The relationship between the employer and employee is governed by K law; we are not
too worried about these interactions. We are concerned about the relationship between
the employee and the third party.

3. Agencies are created by manifestations - these manifestation s can be conduct, oral or

written. Agency is a result of conduct, not of words used.

RSA §1 4. Agency relationship is created (and is a fiduciary relationship) when:

a. There must be a manifestation of consent by one person (P) to another (A) that
the other (A) shall act on his (P’s) behalf, AND

b. A is subject to P’s control; AND

i. just a general sense that P is in charge

c. A must consent to so act.

5. Once there is an agency relationship, P is bound by the acts of A, so long as A had the
power or authority

6. Once there is an agency relationship there is also a fiduciary relation

a. Fiduciary – relationship of trust (means that A owes P certain duties):

i. duty of loyalty - A can NOT go into competition with the P (if

looking for a house for P, A finds a house that he likes, A can NOT
buy it for himself)
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 ii. duty of care – (be competent and do good work)

iii. good faith - (this may not be a fiduciary duty, rather it is something
else implicit in all of this)

b. If A breaches his fiduciary duties, P can sue A.

7. Agency authority/power – A will bind P to a deal with a third party, if A was

RSA §140 authorized by any of the following: (§140 only applied to the first 3)

a. Actual Authority

b. Apparent Authority

c. Inherent Authority
------------------------------------------------------------------------------------------------

d. Estoppel – A did something and it led a 3rd party to rely to his detriment on it

e. Ratification – A enters deal with a 3rd but A has no authority. P finds out about
it and approves it anyway – thus ratifies it. “Ex post fact approval”

RSA §7 8. RSA §7 Authority: Authority is the power of the agent to affect the legal relations of
the principal by acts done in accordance with the P’s manifestations of consent to him.

9. Actual Authority – some conduct by P to A that leads A to think it is ok to deal with a

RSA §26 3rd party.

a. 2 types of Actual Authority:

i. Actual Express Authority – P tells A what to do. Created by some

sort of expression (words or conduct) from the P to the A.

ii. Express Implied Authority – (fills in the gaps if the authority is not
spelled out in exact detail) A has a right to bind P in doing things that
are incidental to OR necessary to achieving P’s goal. Authority to do
what is reasonably necessary to get the assigned job done, even if
not spelled out in detail.

 Ex: if P tells A to make travel arrangements for him. If A books

a flight for P, P is liable to the airline.

 This extends to what the norm in the industry is

b. Need 3 things for Actual Authority

i. manifestation attributable to the P

ii. this manifestation must reach the A in some way

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 iii. A must have a reasonable belief that the P wants him to do this

c. Manifestation can be written or spoken words or other conduct.

d. ONLY look to the relationship b/w the A and the P, we don’t even look to the
3rd party.

10. Apparent Authority – P communicates something to the 3rd party that leads the 3rd
RSA §27 party to reasonably believe the A is acting for the P.

a. Need 3 things:

i. manifestation attributable to the P

ii. manifestation must reach the 3rd party

iii. cause the 3rd party to reasonably conclude that A is P’s agent (3rd
party does NOT need detrimental reliance)

b. This all depends on the relationship b/w P and the 3rd party, don’t look to the
relationship b/w P and A.

c. Revoking actual authority doesn’t necessarily revoke apparent authority (so if P

told TP that A is his agent, then he has to notify him when he’s not – just firing A
isn’t sufficient)

Both Actual Authority and Apparent Authority are communicated from the principal – actual is to the agent,
apparent is to the third party.

11. Inherent Authority/Power – it binds P for acts of A, even though A does NOT have
RSA §8A actual or apparent authority

a. has to do with status and comes from the office you hold

i. ex: if hiring partner offers you a job

ii. ex: if you are the cook you might have inherent authority to do the
things cooks do, but you do not have authority to place advertisements.

12. When is A is liable on CONTRACTS with a 3rd party (when A has authority):

RSA §4, a. Rule – A is only liable on K’s when P is undisclosed or only partially disclosed
320, 321, (A tells company that he is buying for a P, but won’t tell the company who P is)
322,
i. if A does not have authority then he is still liable but P is off the hook

b. If A is working for a disclosed P, then A is NOT liable and is not a party to the
contract.

i. However, P can sue A for breach of a fiduciary duty if A went against

P’s instructions

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 To test if P is liable for acts of A, as:
Is there actual authority?
Is there apparent authority?
Is there inherent authority?

13. What if A commits a TORT?

a. A is always liable for the physical tort, but the injured want to go after the P b/c of
his deeper pockets

b. For P to incur vicarious liability, must have a master-servant relationship –

respondeat superior.

c. All master-servant relationships are agent relationships BUT not all agency
relationships are master-servant relationships. (Master-servant relationship is a
subset of agency relationship)

d. Master/servant is antiquated and today is usually though of as

“employer/employee.”

e. Difference b/w master-servant and agency relationship is that master-servant

involves physical conduct:

RSA §2 i. Master = someone who has the control or the right to control the
physical conduct of the servant.

RSA §220 ii. Independent contractor = person who contracts with P, but is not
(3) controlled by P (thus, he can NOT be a servant)

 Ex: if I hire someone to build a deck but give him no

instructions about what materials to buy then he an independent
contractor and agent but not a servant

 If independent contractor commits a tort, P is NOT liable

 Independent contractor may or may not be considered an agent

RSA §219 f. For vicarious liability (only in torts), need both:

i. master-servant relationship §220 (see above); AND

RSA §220 (2)  In order to determine if someone has crossed the line from agent
to servant we must focus on the facts.

ii. must be within the scope of employment (this could be very

debatable)

RSA §228  Conduct of a servant is within the scope of employment if, but
only if:
 It is of the kind he is employed to perform
 Within authorized time and space
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  Actuated by a purpose to serve the master
 If force is intentionally used, the use of force is not
unexpectable by the master. (ex. a bouncer at a party,
punching a party-goer is possibly an expected act and the P
might be vicariously liable.)

 need to distinguish b/w a frolic and a detour (very fact specific)

 Frolic = servant is doing his own thing. He is not animated

in doing this for his job. If this is the case, P is NOT liable.
Ex: if guy is on delivery and decides to go to a ballgame
and gets into an accident

 Detour – actuated by the desire to serve the master. If this

is the case, P is LIABLE. Ex: if on delivery servant goes to
lunch and gets into an accident

g. P could potentially get screwed for the intentional torts of his servants b/c
INSURANCE usually does not cover intentional torts

14. Hayes v. Nat’l Service Industries, Inc. (11th Circuit)(1999) – dispute regarding
whether the client’s lawyer had authority (actual or apparent) to bind the client in a
settlement

a. Court ruled that the client (P) was bound by the actions of her lawyer (A) b/c there
was apparent authority –

i. Freer says that’s bullshit b/c the client never said anything or gave any
manifestation (conduct) to the third party

 Yet, it is a possible to argue (however weak) that there was apparent

authority b/c when A stood up and said he was P’s (client) lawyer and
P did nothing to refute that, maybe that was enough of a manifestation
by P to the third party that A was P’s lawyer

ii. Freer argues that it was really inherent authority:

 Incidental to being a lawyer, you have power to settle a case for the
client; the authority may be considered plenary unless it is limited by
the client and that limitation is communicated to opposing parties
(thus, by hiring him and making him the lawyer – she gave him
inherent authority).

b. Rule: if you hire a lawyer he can settle the case whatever way he wants

C. FRANCHISES

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1. Courts will take principles of master-servant relationships (even though they really
don’t apply) and apply them into the area of franchise law. Thus, Court makes agency
law fit when it really does NOT

2. Miller v. McDonald’s Corporation (Oregon Ct. of Appeals)(1997) – Plaintiff finds a

sapphire in her Big Mac and sues the owner (3K) of the franchise as well as McD’s b/c
of the deep pockets. The only way P can sue McD’s is through vicarious liability. But
to get vicarious liability, must have a master-servant relationship.

a. However, there really is NO master-servant relationship here but the Court

treats it as if there is one, so that it could adopt agency principles.

b. Court says there are 2 theories for relief:

i. Actual Authority

ii. Apparent Agency

c. Actual Authority – all boils down to the amount of control McD’s had over the
physical conduct of 3k. This Court concludes that McD’s exercised lots of control
over the details of 3K’s operation and therefore it is liable. (Ex: 3K had to follow
so many rules; control over details; manual to follow; told how to prepare food; . .
.)

i. Court applied the Billops test – if the Franchise Agreement goes

beyond the stage of setting standards, rather, it allocates to the
franchiser the right to exercise control over the daily operations of
the franchise, then an agency relationship exists.

 Thus, for Franchiser’s sake, just want to give general guidelines

d. APPARENT AGENCY – creates an agency relationship that does NOT

otherwise exist

i. Apparent agency is created when both:

 Franchiser holds Franchisee out to 3rd party as its agent; (in

this case, McD’s did “hold out” 3K as its agent)

AND

 The 3rd party RELIES on it

ii. In this case, the Court found that McD’s did “hold out” 3K as an agent
b/c of its centrally imposed uniformity; AND the customer relied on
it

iii. Thus, in order to not be liable, McD’s should give NOTICE by

requiring a HUGE sign on the front door of all of its franchises

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 notifying the customers that McD’s is NOT running it – thus getting
rid of plausible reliance.

iv. Court says that all you need to show justifiable reliance is the
reasonable belief that one entity owned and operated all the
McDonalds.

e. How to advise client not to be liable?

i. Write into k that it is not an agency relationship – but these are

ubiquitous and cts ignore this

ii. Write an indemnification clause into the k that franchisee will pay for
problems

f. Difference b/w Apparent Authority and Apparent Agency is RELIANCE and that
apparent authority applies to K law and apparent agency applies to tort law.

i. Remember also that apparent agency relies on the public’s image –

therefore a smaller franchise w/o the huge McD’s image might make it
easier to show that there was no apparent agency.

D. How do we make a Sole proprietorship grow?

1. Generate money – from

a. sole proprietor himself

b. money from somebody else

i. Debt – loan that business must repay, but lender is not an owner and
thus sole proprietorship stays in tacked.

 Guaranteed to be paid back, less risk but less upside.

ii. Equity – is not a creditor but an owner, which gets rid of the sole
proprietorship

 No guarantee they will get their money back, but the reward may
be higher.

2. Cash Flow View

a. Debt essentially cuts off the top part of your cash flow. i.e. the first $100 goes to
paying off the debt. Creditors are in line ahead of equity holders.

b. Equity does not have an obligation to pay back, although a corporation may issue
dividends. Equity is the right to the remaining cash flow.

3. At some point, the lender exerts so much control that he is not a lender anymore, but a
partner (downside is that partners must share debt)
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 4. In re Estate of Fenimore (DE Ct. of Chancery)(1999) – sister and Vilabona lend
brother money but he becomes insolvent and can’t repay. Brother then inherits money
and sister tries to get him to pay back his loan to her before Vilabona, b/c if she is a
creditor she has priority over Vilabona. The Court, however, rules that Vilabona must
get paid first b/c sister is not a creditor, but rather, a PARTNER. (the order of
UPA §40
repayment according to UPA §40 goes: outside creditorpartner creditorpartners by
way of contribution)

a. Court found sister to be a partner b/c she shared in the profits,

i. which is prima facie evidence that he is partner, but no such inference

UPA §7 will be drawn if such profits were received in payment (a) as a debt by
installments or otherwise, (b) wages, etc. UPA §7

RUPA §202 ii. or presumed to be a partner in the business, unless the profits were
received in payment. . . RUPA §202.

iii. While presumed is considered stronger language, Freer thinks that we

would come out the same way whether using UPA or RUPA. In the
comment of RUPA §202, it discusses that UPA §7 is largely derived
from UPA §7, and to that extent no substantive change is intended.

b. Court looks to the language of the “loan” she gave brother and it uses the words
“advanced” instead of “lent” and described the “loan” as a “business agreement”
and thus Court finds it is NOT a loan but an investment.

c. Thus, as a lender, must make it extremely clear that it is a debt relationship

d. Martin v. Peyton NY (1927) –Peyton made a loan of $2.5M; Peyton was to

receive a capped amount of profits; Peyton was to be consulted as to important
matters; Peyton could veto any business that she though was highly speculative or
injures. Did this constitute a partnership? The court found that Peyton was not a
partner.

i. The court distinguished between active control and reactive control,

emphasizing that Peyton “may not initiate any transactions as a partner
may do.” Interestingly, the case did not talk much about the repaying
debt – it focused on control.

ii. Starting point is profits (prima facie), however the sharing of profits
will not be a partnership if it is to repay debt.

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 III. PARTNERSHIP

A. Introduction

UPA §6(1); 1. Definition: a partnership is an association of 2 or more persons to carry on as co-

RUPA §101(6) owners of a business for profit. UPA §6(1) and RUPA §101(6)
a. don’t have to know you are forming a partnership – can be formed by accident

2. 2 codes which we looked at are: UPA and RUPA (RUPA has been adopted by 1/2 of
the states)

3. UPA – treats partnerships as an aggregate of the partners most of the time.

a. Exception: the partnership is bound by the wrongful acts [tort] of its partners that
UPA §13 are in the ordinary course of business. In this instance, UPA borrows the entity
theory, b/c the partnership itself is held liable for tort actions of its partners.
b. Exception: with partnership property, UPA and RUPA both treat the partnership
as an entity.

RUPA §201 4. RUPA – treats the partnership as its own entity and thus it can be held liable.

5. In taxation, however, both RUPA and UPA do NOT treat a partnership as an entity –
thus, the partnership does NOT pay taxes, rather only the individual partners.

6. UPA and RUPA include:

a. Inter Se Rules – rules that govern the relationship among the partners and
partners; and the partners and the partnership.

b. Formation of the partnership

c. Relationship b/w partners and 3rd parties – there are mandatory rules and the
P.A. can’t alter or change these rules.

d. Dissolution of the Partnership

B. Partnership agreements

7. All the rules in the UPA and RUPA, excluding those that deal with 3rd parties, are
DEFAULT RULES.
UPA §18,
RUPA§103(b)10 8. PA. can NOT restrict the rights of 3rd parties in any way

9. Partnership agreements are very important:

a. P.A. is a K and is enforceable to the extent of general contracts

b. P.A. can change much of the statutory law that would otherwise govern.

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 10. Increasingly, the big movement has been to let the business people (P.A.) make the
decision instead of the state (UPA/RUPA).

11. Usually there is a PARTNERSHIP AGREEMENT (could be oral or written) that lays
RUPA §103(a) out all of the guidelines that allows partners to contract around UPA/RUPA, and the
P.A. is binding. However, if there is no P.A., the default rules of RUPA or UPA apply.

UPA §18 12. According to UPA and RUPA, all partners have equal rights in the management and
RUPA §202 conduct of the partnership business. Partners also share the profits equally and share
the losses according to the same percentage as they get the profits – unless the P.A.
says otherwise.

a. However, most P.A.’s establish that the managing partner or the managing
committee makes those type of decisions.

13. The Partnership Agreement is NOT a public document, unlike the Articles which are
public for a corporation

C. Starting a Business as a Partnership.

14. A business can NOT be both a partnership and a corporation. Rather, partnership is a
RUPA §202(b) residual category of business – you are a partnership if you don’t fit into anything
else.

15. If two or more persons own a business and they do not take any action to qualify it as a
corporation or some other particular form of business, it will be a partnership.
RUPA §202(a)
a. RUPA §202(a) This is true whether or not the person intended to form a
partnership. Comments: they may inadvertently form a partnership despite their
expressed subjective intention not to do so.
RUPA §202(a)
and §101(10); 16. A corporation can serve as a partner in a partnership – b/c a partnership is 2 or more
UPA §6(1,2) persons and a corporation is considered a “person” under both RUPA and UPA.

17. Partnership law does not even require there be a written partnership agreement. But,
partnership agreements are important (see above).

D. What are the Problems in Operating as a Partnership?

18. Who owns what? Partnerships can and do own property, both under UPA and RUPA.

INTENT OF THE PARTIES IS GIVEN A LOT OF WEIGHT IN DETERMINING IF PROPERTY

BELONGS TO THE PARTNER OR THE PARTNERSHIP. (SEE RUPA COMMENTS)

UPA §8 19. UPA§8:

a. All property brought into the partnership or subsequently acquired by purchase in
the name of the partnership is partnership property.

b. Unless the contrary intention, property acquired with partnership funds is

partnership property.
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 RUPA 20. RUPA §203, 204:
§203, 204 a. §203 Property acquired by a partnership is property of the partnership and not of
the partners individually.

b. §204 Property is partnership property is acquired in the name of the partnership,

or one or more partners with an indication in the instrument transferring title to
the partnership.

c. §204 (c) Property is presumed to be partnership property if purchased with

partnership assets. However this presumption can be rebutted. It is the intent of
the partners that rules

d. §204 (d) Property acquired in the name of one or more of the partners w/o an
indication that it was to be part of the partnership property (and not purchased
with partnership assets) is presumed to be separate property, even if used for
partnership purposes.

21. The individual partners do not own partnership property, but they can have their own
separate property. UPA §24,26; RUPA §502, 502. THIS IS AN AREA WERE
UNDER BOTH UPA AND RUPA THE PARTNERSHIP IS SEEN AS AN
ENTITY.

B. Who makes Partnership decisions?

1. There are three different questions regarding who makes decisions:

a. There are disputes between the partnership and some “outside” third party

i. Here, courts look to the provisions of the relevant partnership statute

and then to the common law agency principles such as actual and
apparent authority.

b. Disputes among the partners

i. Here, courts look to the provisions of the partnership agreement first,

and then to provisions of the relevant partnership statute and then to
common law agency principles.

c. Dispute between partner and partnership.

RUPA §401(j) & 2. If there is no P.A. both UPA and RUPA say that partnership decisions made in the
UPA §18(h) ordinary course of business are made by the majority of the partners. An act outside
the ordinary course or an amendment to the P.A. may be undertaken only with the
consent of all of the partners.

RUPA §401(f); 3. Each partner has equal rights in the management of the partnership. RUPA§401(f),
UPA 18(e) UPA §18(e). Still if it is a larger firm this can be quite cumbersome, so they will make
an individual a managing partner in their partnership agreement (which trumps).

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 4. 3rd Parties - Anytime a partner makes a deal with a 3rd party, UPA and RUPA are
applicable. Thus, even if the P.A. contradicts UPA/RUPA – the P.A. is void with
respect to 3rd parties.
RUPA §301(1);
5. Every partner is an agent for the purpose of its business (ordinary course of business).
UPA §(9)
a. Good example of inherent authority; we know that all partners have equal
management rights, the 3rd party does not know that the partnership agreement
contradicts that in this case. We must protect the 3rd party.

b. Ex: If partner A makes a deal with 3rd party without consent of partners B and C,
the partnership is still liable to the 3rd party as long as 3rd party did not know that
A lacked authority– b/c A is an agent. Thus, 3rd parties could RELY on the fact
that A was a partner and thus the partnership is bound. 3rd party can sue under
RUPA §103(b). [B and C can sue A, however, b/c he breached a fiduciary duty]

c. UPA §9: The partnership is not bound if the partner does not in fact have
authority AND the 3rd party knows this.

d. RUPA §301(1): The partnership is not bound if the partner does not in fact have
authority AND the 3rd party knows this or received a notification that the partner
lacked the authority. (notification may be effective upon delivery, whether or not
it actually comes to the other person’s attention) It is much easier in RUPA to
protect the partnership.

§ RUPA 405(b) e. A partner can assert rights against other partners if there is a breach of the
fiduciary duty. They can dissolve the partnership or disassociate the partner.

C. Fiduciary Duties of Partners

1. Meinhard v. Salmon (NY Ct. of Appeals)(1928) – 2 coadventures (Freer thinks they

are partners b/c they agreed to share the profits and the losses –UPA §7 – prima facie
evidence of partnership; RUPA §202(c)(3) – presumption of partnership) join
together in the ownership of an apartment for a 20-year term. After 19 years, Gerry
offers Salmon a deal to lease all 5 of Gerry’s buildings and make it into 1 big building.
Gerry never offered this to Meinhard. Salmon agrees to make the deal with Gerry
without ever consulting with his co-partner Meinhard or even offering him a piece.
Meinhard sues for a piece of this new deal and Cardozo rules he gets one.

a. Court ruled that Salmon breached a fiduciary duty – THE DUTY TO

DISCLOSE [this is a subset of the duty of loyalty] that he owed to Meinhard –
b/c Meinhard was never given NOTICE and thus never had a chance to compete.

i. This case is all about Salmon’s failure to DISCLOSE.

b. Cardozo issued famous language in this case, arguing that Salmon breached his
fiduciary duty b/c he only cared about his “self.” The standard of behavior is the
“punctilio of honor the most sensitive.”

16
 c. Rather, when fiduciary duties are at play, fiduciaries have the duty of “self-
abnegation.” [All thought of self must be renounced] – this is VERY STRONG
LANGUAGE

d. Partners owe highest duty of loyalty

e. This “opportunity” came up only b/c Salmon was a partner (in his partnership
capacity) and thus it was a partnership asset and the 2 partners must share it

i. Rule: if “opportunity” comes up during partnership [that is NOT a

totally new deal] then you owe these duties. The new deal was related
to the old deal and therefore belonged to both partners.

f. The criticism of this case is that the deal Gerry offered to Salmon might have
been a totally different deal – thus having nothing to do with the partnership.

g. If Salmon researched the situation and approached Gerry, the situation would
likely have been different. The deal would not have fallen into Salmon’s lap
because of his relation with Meinhart and there would not have been a usurpation
of opportunity.

h. HYPO: Let’s say that Salmon was approached about a RENEWAL of the 20-
year lease, does he have to disclose?

i. Maybe – could argue that he does not have to disclose b/c the
partnership was for a term.

2. Managing partners have a greater duty to the silent partners b/c all the “opportunity”
goes to him.

3. UPA – does not really talk about fiduciary duties and thus in UPA jurisdictions, it is left
UPA §21 to common law

4. RUPA looks at fiduciary duties specifically in §404

a. the only fiduciary duties that partners owe to the partners and the partnership are
RUPA §404(a) the duty of care and duty of loyalty

b. Duty of Loyalty –
RUPA §404(b)
i. to account and hold as trustee any property or benefit derived by the
partner in the conduct of partnership business, as well as the
appropriation of partnership “opportunity.”

ii. Also, partner must refrain from competing with the partners or the
partnership before dissolution of the partnership

c. Duty of Care – partner has a duty NOT to do affirmative harm.

RUPA §404(c)
i. partner must not be reckless or grossly negligent, intentional conduct,
or knowing violation of the law.
17
 ii. Thus, simple negligence is NOT enough to breach the duty of care.

d. Good Faith – In everything the partner does, he must do it in good faith and fair
RUPA §404(d) dealing. However, this is NOT a fiduciary duty, rather it is just a contractual
obligation.

e. Partner does NOT violate a duty if the partner’s conduct furthers the partner’s
RUPA §404(e) own interest.

i. This seems to contradict §404(b) - duty of loyalty.

ii. BUT it really does NOT b/c §103(a) says that the duties discussed in
§404 can be contracted around in the partnership agreement.
However, §103(b) restricts §103(a) b/c it says that the partners may
NOT eliminate the duty of loyalty but they can limit the duty of
loyalty by identifying specific types of conduct that do NOT violate
RUPA §103(a) & (b) the duty of loyalty, but only if these changes are NOT “manifestly
unreasonable.” §103(b)(3)(i). The partners could also ratify a specific
act that otherwise would violate the duty of loyalty. §103(b)(3)(ii).

iii. §103b: The partnership agreement cannot unreasonably restrict access

to books, cannot eliminate duty of loyalty, but can reasonably modify
it.

iv. §103(b)(10) protects third parties. The partnership may not (10)
restrict rights of third parties under this act. (even when modifying
duties inter se.)

v. The P.A. may NOT unreasonably reduce the duty of care. §103(b)(4)
but can alter it somewhat

 this is the victory of contract law over fiduciary common law

D. Can a partner sue the partnership?

1. UPA – allows partner 1 remedy against the partnership – just an “accounting or

UPA § 22,
dissolution”
§13, 14
a. UPA treats the partnership as an entity with regard to tort liability, and holds the
partnership liable for wrongful acts or omissions of any partner acting in the
ordinary course of business or with the authority of his co-partners.- UPA§13, 14

2. RUPA – allows the partner more than 1 remedy against the partnership. A
RUPA §405(b) partner can enforce his rights under the P.A., or to enforce her rights under
RUPA; can sue the partnership b/c it is an entity.

3. Difference b/w joint and several and just joint:

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 a. Joint and Several liability– don’t have to sue all of the partners, rather you can
sue them individually.

b. Joint and NOT several liability – supposed to sue all of the partners together in
a single case (you will probably have jurisdictional problems)

4. Liability of the partners:

a. UPA –

i. contract cases – joint liability

UPA § 15
ii. tort cases – joint and several liability

b. RUPA – §§306, 307

RUPA §§ 306, 307 i. joint and several liability for BOTH contract and tort cases

o Therefore, if A of ACE injures P. P can sue ACE b/c A is

an agent of the partnership. P can sue A b/c he is the
tortfeaser and b/c he is jointly and severally liable. P can
also sue C and E of ACE b/c all partners are jointly and
severally liable.

§305(a) ii. If partner does a tort or breaches a contract in the ordinary course of
business or with the authority of the partnership, the partnership is held
liable.

 Note that under RUPA §305(a), a partnership is liable to a person

(not only a third party). The scope of this section allows a
RUPA§305(a), UPA §13 partner to sue the partnership. Under UPA §13 the partner
cannot sue a partnership for a tort, only if it is for an
accounting or dissolution. Under RUPA §305(a) a partner
can sue the partnership under tort law.
§307(b)
iii. An action may be brought against the partnership and any or all of the
partners in the same action or in separate actions.

RUPA §307(c) iv. If P gets a judgment only against the partnership and not against any of
the partners, he can only enforce the judgment against the property of
the entity and not against the property of the individual partners.

v. Exhaustion principle – first need to sue and exhaust all of the assets
of the partnership before you can sue and obtain any personal assets
RUPA §307(d)(1)
from the non-tortfeasing partners. [Thus, if A is the tortfeasor, can’t
go after C and E without first going after the partnership and
exhausting all of the entity’s assets]

o It is debatable whether P can go after the tortfeasor’s

property without first going after the partnership.

19
 o As a result of the exhaustion principle, Creditor’s will try
and make all the partners personally guarantee all loans
and significant contractual obligations,

vi. If partner incurs liability in the ordinary course of business or for the
RUPA §401(c) preservation of its business or property, the partnership “shall”
indemnify him. [Thus, the tortfeasor and other partners must get
indemnified by the partnership]

E. How does a partnership grow?

1. Partners could invest their own money – contribution of capital.

a. While there is not statutory requirement, is common for the P.A. to contain
provisions requiring initial and additional contributions (capital call). Properly
drafted, such provisions will include:

i. The vote or events that trigger the obligation to contribute

ii. The amount of each partner’s contribution obligation
iii. The time in which to make the additional contribution
iv. The consequences for failure to contribute

b. If someone is supposed to contribute but does not, the extra contribution will
often be considered debt as opposed to equity. Partners can lend money to the
partnership – can wear many hats.

i. §404(f) a partner may lend money to and transact other business with
RUPA §404(f) the partnership, and as to each loan or transaction the rights and
obligations of the partner are the same as those of a person who is not
a partner.

2. Lenders/Creditor’s (incurring debt)

a. Leverage – has to do with your return on equity

i. One leverages by using other people’s money – by borrowing money,

your return on equity is higher.

ii. When your return on equity is higher, you have more leverage

3. Investors – (new partners) – equity interest

RUPA §401(i); a. Adding a new partner – need consent of all existing partners (never applies b/c
UPA §18(g) superceded by the P.A.)

b. A new partner is NOT personally liable for partnership obligations “incurred

RUPA §306(b) before the person’s admission as a partner.”

i. However, there are a few exceptions – majority of courts hold partners

liable for periodic leases and the like that were incurred before the
person became a partner.
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 c. Can only AMEND the P.A. by unanimous vote; §401(j)
RUPA §401(j)
d. If some dispute b/w the partners comes about in the ordinary course of business
then it is decided by majority vote - [ex: distributions]; §401(j)

RUPA §401(f) e. Each partner has equal rights in the management and conduct of the partnership
business

RUPA §401(j) 4. Earnings - from business operations – partners can decide not to take money out of the
partnership. Distribution of earnings is a regular decision in the course of business and
would require just a majority vote under §401(j)

F. How do the owners of a partnership make money?

RUPA §401(h); 1. Salary - under RUPA, a partner is NOT entitled to a salary [although the P.A. can
UPA §18(f) obviously modify that §103(a)]; get the same situation with UPA §18(f).

a. Salary increase: If P.A. allows for X amount of salary and a dispute arises b/w
partners about an increase in salary, in order to do so, probably need to amend the
P.A. b/c it is probably NOT in the ordinary course of business and thus majority
vote is not enough. Under RUPA §401(j) you need unanimity because it would
require an amendment of the partnership agreement.

b. Compelled employment: Can a partner compel the partnership to employ him?

If this is in the ordinary course of business it would need a majority vote. If you
need an amendment to the partnership you need unanimity. §401(j)

RUPA §404(d) c. Salary but not working. . . You would not want to pay a partner a salary that
was not working. This would breach the duty of good faith and fair dealing.

2. Profits – If P.A. says nothing about distribution of profits, RUPA says that all the
partners share the profits equally and the are responsible for losses in the same
proportion in which they share profits.
RUPA §401(b)/ a. RUPA §401(b); UPA§18(a): Each partner is entitled to an equal share of the
UPA§18(a) partnership profits and is chargeable with a share of the partnership losses in
proportion to the partner’s share of the profits.

b. Can you compel a distribution of profit? Distributions are in the ordinary course
of business, so under §401(j) you would need a majority vote to compel
distribution. Remember §401(f) each partner has equal rights in
management, therefore each partner gets one vote (even if capital
contribution is uneven. Unless P.A. says otherwise.

RUPA §807(b) c. Can you get a distribution notwithstanding a bad year? A partnership can
distribute any excess of the creditor’s over the charges in the partners account.
You cannot pay a distribution if you are insolvent. RUPA§807(b)

21
 3. Sale of ownership interest to a 3rd party –

a. The only transferable interest of a partner in the partnership is the partner’s share
RUPA §502; of profits and losses of the partnership and the partner’s right to receive
UPA §26 distributions. The interest is personal property. RUPA §502/UPA§26 Thus, the
buyer is NOT a partner and can NOT make business decisions. Buyer has no
voice in the management of the business.

i. Under RUPA §503(a)(2) – if A sell his partnership interest to B, then

B gets all the “financial stuff” but A still remains a partner

ii. If you buy a partnership interest from the partnership, then you are a
partner and have a right to participate in partnership decisions.

4. Sale of ownership interest back into the partnership

a. Buy-Sell Agreements – the business buys the partner out even when the partner
can’t find a buyer.

i. A buy-sell agreement should answer the following questions:

 Are the other partners or the partnership obligated to buy or do
they instead have the option to buy?
 What events trigger the obligation or option?
 How is the selling partner’s interest to be valued?
 What is the method of funding the payment?

b. Withdrawal of a partner – [UPA]

i. Dissolution(UPA §29) – the dissolution of a partnership sis the change

in the relation of the partners caused by any partner ceasing to be
UPA §29, 30 associated in the carrying on as distinguished from the winding up of
the business.

 §UPA 30: The partnership is still there. It exists only for the
purpose of winding up. Dissolution is a commencement of a
process – must wind up and eventually terminate the partnership

ii. Winding up

iii. Termination

c. Withdrawal of a partner – [RUPA]

i. Dissociation – means leaving or withdrawing. §601 lists all the

RUPA §601 different ways a partner can dissociate (death, the P.A. says so,
unanimous vote of all the partners, by judicial determination . . .)
Death causes dissolution under §601(7)(i).

 Under RUPA, there are only 2 possibilities upon dissociation:

22
 o the partnership does a buy-out; OR
RUPA §701
 Buy-out price is either the liquidation value OR
the going concern value (factors in goodwill of the
business)– whichever one is greater (§701(b))

RUPA §801 o the partnership dissolves/winding up

 Under UPA, when a partner dissociates, the partnership is

automatically dissolved (b/c not an entity, but an aggregate of the
partners)

ii. A partner always has the POWER to dissociate, however, sometimes

RUPA §602 (b) it is WRONGFUL

 Term Partnership– partnership that has a defined term. (it could

be for X amount of years OR up until a specific event occurs) If
partner withdraws from a partnership before the expiration of a
term, then it is WRONGFUL

o Exception: BUT if a partner dissociates within 90 days

after another partner dissociates, then it is not wrongful and
it is kosher

 Partnership at Will – partnership that does NOT have a defined

term. If partnership at will, then partner can dissociate whenever
he wants and it will not be wrongful, but the partner must give
express NOTICE §601(1).

iii. What is the Buyout Price?

 Look at the date of the dissociation, buy-out price is the greater

of:

 Liquidation Value; OR
RUPA §701(b)
 Value of the sale of the entire business as a going concern
w/o him there.

a. Note: UPA §38(2)(c)(II) provides that the good will

of the business not be considered in valuing a
wrongfully dissociating partner’s interest. The
forfeiture of goodwill rule is implicitly rejected by
RUPA §602(c) comment 3.

iv. If it turns out that it was a WRONGFUL dissociation then:

RUPA §602(c)  Liable for Damages - the partner is liable for damages that he caused
to the partnership and the partners; the partner is liable for any other
obligations of the partner to the partnership or other partners; AND
23
  Buy-Out Delay - he is NOT entitled to any portion of the Buy-Out
RUPA §701(h) until the term is over (unless he proves that it is NOT a big deal for the
partnership to pay him earlier)

v. The KEY POINT about RUPA is that when a partner dissociates,

the partnership does NOT automatically dissolve. Under UPA
dissociation causes dissolution of the partnership – aggregate
theory.

vi. As soon as a partner dissociates, he can go into direct competition

with the partnership (no longer has the duty of loyalty)

vii. Liability of a dissociating partner:

 Partner who dissociates is liable for any transaction that the

RUPA §703 partnership enters into for 2 years after he dissociates, assuming
the party entering into the transaction did not have any
reasonable knowledge, nor notice that the partner dissociated. If
you give notice you will not be on the hook. It behooves us to
give notice.

 However, a dissociating partner can file a statement of

RUPA §704 dissociation and thus he will no longer be liable for transactions
90 days after he files this statement.

 BUT dissociating partners are NOT liable on post-dissociation

TORT claims

viii. Dissociated Partner’s Power to Bind and Liability to the

Partnership.

 Partner who dissociates is can bind a partnership for any

RUPA §702 transaction that the partner enters into for 2 years after he
dissociates, assuming the party entering into the transaction did
not have any reasonable knowledge, nor notice that the partner
dissociated. If you give notice you will not be on the hook. It
behooves us to give notice.

 A dissociated partner is liable to the partnership for any damage

caused to the partnership arising from an obligation incurred by
the dissociated partner after dissociation for which the
partnership is liable.

REMEMBER PARTNERSHIP AGREEMENTS WILL NOT CHANGE THE RIGHTS BETWEEN A

PARTNERSHIP AND 3RD PARTY. THEREFORE BECAUSE OF RUPA §103(b)(10) THE LIABILITY OF
THE PARTNERSHIP TO THIRD PARTIES WILL REMAIN UNAFFECTED.

24
 d. Creel v. Lilly (Ct. of Appeals MD)(1999) – Creel, Lilly and Altizer are partners.
One of them dies. Issue: does dissociation by death lead to our having to
dissolve the partnership? MD is moving from UPA to RUPA, so technically
RUPA did not apply in this case.
RUPA §601(7)i
i. Under RUPA §601(7)i a partner’s death his dissociation (not
wrongful though).

ii. Under UPA, dissociation lead to dissolution because a partnership is

the aggregate of its partners – if one walks, we no longer have the
aggregate (However we can contract around this through the
partnership agreement).

iii. Under RUPA, partnership is an entity – a thing. Therefore, we don’s

dissolve when a partner leaves. We just buyout the partner that left
under RUPA §701(a). The amount of the buyout is described in
RUPA §701(b).

iv. In this case the court, under UPA, held that a buyout was available
because they read it into the P.A. Also, the court allowed the buyout to
occur at the book value.

G. Partnership End Game

1. Dissolution

a. Partnership at will – If NOTICE of a partner’s express will to dissociate is

RUPA § 801 (1) given pursuant to §601(1), then the partnership automatically must be dissolved.
Thus, any at will partner has a right to force dissolution and the other partners
cannot do shit about it. Yet, this is limited only to express NOTICE.

i. BUT if a partner dissociates any other way, through §601(2)(10),

then the partners have the option of either forcing dissolution or a
BUY-OUT.

 EX: If partner dies, and therefore he is dissociated under

§601(7)(i), the partnership is NOT automatically dissolved –
the partners can force a BUYOUT

ii. Applies in both partnerships at will and term partnerships. RUPA

§802(b) at any time after dissociation but before winding up, if all of
RUPA § 802 (b) the partners agree (including leaving partner unless wrongful
dissociation) they can waive the right to dissolution if:
 The partnership resumes business as if dissolution had never
occurred, and
 Does not adversely affected third parties.

RUPA § 801 (2) b. Term Partnership – if a partner dissociates, only have to dissolve if half of the
partners express that they want to dissolve w/in 90 days of dissociation.

25
 i. Question arises with regard to whether the dissociating partner’s vote
counts towards the votes needed for dissolution. Freer thinks that if it
is a rightful dissociation then his vote counts (b/c upon dissolution, the
partnership is still not terminated) but if it is a WRONGFUL
dissociation, then his vote does NOT count.

2. Dissolution is a process that may take a while:

a. DissolutionWinding up period (liquidation period, sell assets, pay C’s,

distribute the $ left over)Termination (the end point)

i. Winding up = partnership stays in business not to get more business

but to finish old business and complete old work

 Gather all of the assets and liquidate them

 Pay off all of the C’s

RUPA §807(a) o C’s and partner C’s (partners that make loans to the
partnership, but not just contribution) are treated equally

 Any remainder goes to partners.

 C’s can collect unpaid debts from the partners individually b/c
they are jointly and severally liable

RUPA §401(a) 3. Partnership Account – in every partnership, every partner has an account.

a. Whatever is in the account, is the amount the partnership owes the partner

b. In the account, we put pluses and minuses, and at dissolution, that is what the
partner gets paid:

i. Pluses = contributions and profits

ii. Minuses = losses and distributions (draws)

c. It is important for the partners to have an agreement as to the partnership

accounts so there is an understanding of everyone’s starting value

RUPA §807(b) d. Partners are first paid what they are owed in their respective accounts and then
with whatever money is left over (profit), they divide equally or according to the
P.A.

i. If at dissolution of the partnership the sum of the balances of the

RUPA §807(c) individual partners’ partnership accounts exceeds the partnership
assets remaining after payment of creditors, the partners will have to
contribute additional funds to the partnership so losses from
investments are shared appropriately. §807(c)

26
  EX. Done paying off C’s; partnership has $200K.
o Partnership Accounts:
 C-$100K
 P - $8K
 A -$2K
Remember absent an  First thing we do is pay off the partnership
agreement, losses are accounts
divided in the same  We have $90K left.
proportion as we divide  Each partner will get an additional $30K.
profits. RUPA §401(b)
 EX. Done paying off C’s; partnership has $20K.
o Partnership Accounts:
 C-$100K
 P - $8K
 A -$2K
 First thing we do is pay off the partnership
accounts, but there is not enough, we’re 90K in the
hole.
 Each partner must bare a 30K. loss
 C 100K -30K = 70K distribution
 P 8K – 30K = (22K) must contribute
 A 2K – 30K = (28K) must contribute

4. Kovacik v. Reed (S. Ct. CA)(1957) – 2 guys had a K and L partnership, where 1 guy
puts in the labor and the other guy puts in the capital ($). The partnership took a loss
and k-partner claims they must share the losses equally, b/c no P.A.. BUT the court
found that the k-partner had to bear the entire loss.

a. you would think the court was wrong b/c this went against the default rule - that
all partners must share losses equally.

b. BUT, the court really did find that they shared the losses equally, rather, the loss
here was NOT a monetary loss. Ct said that Reed lost labor and he already paid
that loss by working for the past year and getting nothing out of it. (never got a
salary)

c. This decision is blatantly REJECTED by RUPA comments for §401(a), and

labor is NOT considered a loss

RUPA §601(3-5) 5. Expulsion of a Partner

a. RUPA §601(3) recognizes the possibility that partnership agreements might

provide for expulsion of partners. One is expelled pursuant to the P.A.. Nothing
says that expulsion has to be for cause.

b. RUPA §601(5) Partner may be expelled by judicial rule, i.e. wrongful conduct
material breach.

c. RUPA §601(4) Partner can be expelled by unanimous vote of other partners, if:

27
 i. it is unlawful to carry-on the partnership with that partner;

ii. there has been a transfer of all or substantial all of that’s partner’s
transferable interest in the partnership, other than a transfer for security
purposes, or a court order charging the partner’s interest, which has not
been foreclosed;

iii. (deals with corporate partner)

iv. (deals with partnership partner)

d. expulsion is a type of dissociation – thus, still need to see if you do dissolution

or a buy-out

e. It is best to deal with expulsion in the P.A.

f. Bohatch v. Butler (S. Ct. TX)(1998) – partner thinks in good faith that another
partner is overbilling, so she rats the partner out (had a duty) and eventually, her
draw is reduced to $0 and she is expelled. Nowhere in the firm’s P.A. does it talk
about expulsion. Partner sued in tort for breach of fiduciary duty on behalf of the
partnership. The Court ruled against her, finding that the partnership breached no
fiduciary duty in expelling her. (But did find that the firm breached contract when
they reduced her draw to $0)

i. Ct balanced the fiduciary duties that we owe to the partnership vs. the
trust and confidence that we owe to each others as partners.

 Ct compared a partnership to friends, just like you can’t force

people to be friends, you can’t force people to remain partners.

ii. the fiduciary duty owed to the rat-partner is the duty NOT to expel her
in “bad faith.” – thus, can’t expel for self-gain
 But you can expel if the individual is no longer profitable,
that is self preservation, not self gain.

iii. Rule: Have a right to expel partners so long as it is NOT for self-gain
(b/c the relationship of trust and confidence is the reason why
partnerships work)

iv. Freer said that even if the partner was correct in asserting that a
partner was over-billing, she could still be expelled, simply b/c she
made “waves.”

RUPA §701(b) g. Under RUPA, if a partner gets expelled it does NOT cause dissolution, rather, the
partner gets a buy-out.

h. How do you stop someone from dumping you after the biz gets profitable? Is that
possible – sure. How do you protect yourself? You contract for that in the
partnership agreement, make it for a term (so it would be wrongful) or contract
around the expulsion (only expel unanimously, or cause, etc). Remember though:

28
 Walk from a term partnership, you may be liable for damages. Walk from an at
will partnership, you’re fine.

6. Freeze-Out

a. where powerful people stick it to non-powerful people. (ex: trying to compel the
little guy to leave)

b. Page v. Page – 2 brothers had a partnership together and then start fighting with
each other. The business they ran originally was losing $ and now it started
making $, so the more successful brother wants to get a declaratory judgment that
the partnership is at will, so that he could “rightfully” withdraw at any time and
just dissolve the partnership. Ct concluded that the partnership was at will.

i. even though the partnership is at will and the brother can “rightfully”
withdraw and dissolve the partnership, the brother does NOT have an
absolute right to withdraw

ii. The partner still must act in GOOD FAITH, and NOT freeze out
other partners

iii. Thus, a partner can NOT dissolve a business for personal benefit
unless you buy-out your partner

iv. It is unclear how far this duty not to freeze out reaches – it is fact
sensitive

29
IV. Corporations

A. Introduction

1. A corporation is an artificial being, invisible, intangible, and existing only in

contemplation of law. Being a mere creature of law, it possess only those properties
which the charter of its existence confers upon it” i.e. Corporations ONLY have the
rights which the state gives it.

2. Corporation exist only b/c the state (statute) allows them to

a. Unlike a partnership, you have to try and get a legal corporation, it does NOT
happen automatically

b. To get a de jure corporation (legal Corp), must satisfy the state code

3. Every state’s corporation statute provides that:

a. A corporation is a separate legal entity, and

b. It’s owners usually called shareholders (or stockholders) are generally not
personally liable for the debts of the corporation.

i. A corporation is a separate entity from the people that own it.

ii. Means the most that a S/H risks is the shares of stock – limited
liability.

iii. This legal structure makes it substantially cheaper for investors to

commit their capital to risky ventures. (of course this has a downside
of hapless and careless investment)

4. Most corporations are NOT huge publicly traded crop’s but mom and pop deals (closely
held corporations)

5. 4 sources of corporation law:

a. state statute – some are mandatory but some are just default. Always governs
how you incorporate

i. 1/2 use MBCA; MBCA is more hands off, allowing business people to
set their own rules.

b. corporate documents – Articles of Incorporation OR the by-laws

i. Some state statutes are mandatory, others are just default rules that can
be contracted around.

c. case law – serves two functions:

30
 i. cases interpret and apply the provisions in corporate statutes and in a
corporation’s articles and bylaws.

ii. Fills in the “gaps” in the law – most important of which involves
fiduciary duties of directors, officers, and S/H’s

d. federal law – governs various aspects of corporate life (federal securities law)

MBCA §2.02(a) 6. To form a Corp, must prepare the necessary papers - Articles of Incorporation

a. The following must be put in the Articles:

i. a corporate name for the corporation – must have a signal word from
MBCA §4.01 (can use abbreviations)

ii. the number of shares the Corp is authorized to issue

iii. the street address of the corporations initial office and name of its
initial registered agent at the office.

iv. The name and address of each incorporator

 Incorporator = must sign and file the articles

b. Compare to DEL § 102(a)

i. Name of the corporation, which must contain association, company,

DEL §102(a) corporation. . .(see statute

ii. Address of the registered office, and the registered agent

iii. Nature and business or purpose to be conducted or promoted; General

-- “to make and sell bacon” or “any lawful activity in the state.
 If you get specific and do something else, you’ve now Ultra Vires
Activities (beyond stated purpose). If you go ultra vires, you’re
still bound, but the responsible directors and officers are
personally liable if the corporation loses money in that activity
(some states will say the K is void). MBCA does not require
purpose.

iv. Total number of shares and class structure, very detailed here. Par
value of shares, class structure, etc.

 Authorized stock is the maximum number of shares a corporation

can sell, you cannot go above that – aim high.

v. Name and mailing address of the corporation

vi. If the power of incorporators ends at incorporation, the name and

address of directors.

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MBCA §2.03 c. Become a corporation when the Articles are properly filed

i. file it with the “State” Secretary of State

d. The Articles are viewed as a contract b/w the corporation and its S/H’s and the
corporation and the state

e. Nowhere in the Articles, does the Corp have to say what business they are in or
a statement of purpose - MBCA

i. Mass. is the exception, b/c it requires the Corp to state specifically

what its purpose is

7. The Corp is a separate entity under the law

a. Limited Liability – the shareholders owe no liability if the Corp does something
wrong, rather, the Corp is liable for its actions (torts and debts)

8. By-Laws = creations of the corporation created by the board of directors or the

incorporators

a. It is where we put all the other stuff after the articles . . . responsibility of the
officers . .provisions for managing the business and regulating the affairs of the
corporation.

b. These are NOT filed with the state, rather they are INTERNAL

c. It is a contract b/w the S/H’s and the Corporation

MBCA §2.06(a) d. Under the MBCA §2.06(a), the corporation must have By-laws, but it is very
open-ended what could be in it
DEL §109
e. DE does NOT require by-laws, although it is implied

9. If there is a conflict b/w the Articles and the By-Laws, the Articles win, b/c the
Articles are a more important document

10. Promoter = is someone who acts on behalf of the Corp before it is formed

a. Pre-incorporation contract – contract before a corporation is formed. The

promoter is the one who is party in this contract

b. The promoter is jointly and severally liable on the pre-incorporation contract

MBCA §2.04 unless the contract or the circumstances makes it clear that he is NOT liable if
the Corp never comes into existence.

c. After it comes into existence, the corporation is NOT liable on the contract. The
only way it is liable is the corporation does something to adopt the contract

32
 i. Can adopt the contract either expressly (the Board passes a resolution)
OR implicitly (through the corporations conduct – moves into the
leased premises or . . )

d. Even if the corporation adopts the pre-incorporation contract, the promoter is still
liable (although he probably could get indemnified by the corporation). He is only
not liable if there is novation

i. Novation = a deal where the corporation and the other contracting

party agree to release the promoter from liability.

ii. However, promoter could avoid all of this, if he contracts around this

11. Issuing Stock

a. Issuance – when the corporation sells its own stock

MBCA §6.03 b. The Articles specify the amount of shares that are permitted to be issued
(although, all the shares are NOT required to be issued)

i. Authorized shares – shares that are set up in the AOI; the maximum
number we can issue.

ii. Issued shares – stock actually sold by corporation

iii. Outstanding shares – shares that have been issued and sold by the
Corp (not reacquired)

iv. Treasury stock – stock that has been bought back by the corporation

v. Preferred stock – there is a preference of getting paid first (does

NOT mean that you get more) EX. $100K; 10K shares preferred $2
($20K); Common 20K shares ($80K) will get $4/share

i. dividend rights;

ii. liquidation rights

iii. redemption rights

vi. common stock – residual stock, whatever is left over.

DE §153, c. Par – it is the minimum issuance price of the stock that is written into the
154 Articles. (obviously, the stock can be sold for more then par, but just not for less)

i. par has no relevance beyond issuance

ii. the excess amount that is sold above par goes into a “capital surplus”
fund, and from there the Corp pays it S/H’s dividend distributions.
The amount of the par goes into a “stated capital” funds, and this can
NOT be used to pay dividends, rather, it is there to protect C’s.
33
 iii. most corps take advantage of these par rules and make par = about
1/10 of a penny, so that the capital surplus will be greater

iv. modern trend is to abolish par, b/c it really does NOT protect C’s,
b/c of Corp’s manipulation of the par amount (1/10 of a penny)

v. MBCA does not have par- rather, it is up to the Board to decide if the
sale price is adequate.

vi. DE still uses a par system

MBCA §6.21 d. Under the MBCA, a Corp can issue stock, not just for money, but for any
tangible or intangible property for any benefit of the corporation, as long as it
is approved by the Board

i. this might even include goodwill or release form a claim; basically the
MBCA leaves it up to the business people to decide what form of
consideration is important.

e. DE, however, also says that a Corp could issue stock for any tangible real or
DE §152 personal property, or services rendered (notice past tense), it but does NOT
include intangible property (still must be approved by the Board)

i. Thus, goodwill or release from a claim against the Corp would not be a
kosher issuance in DE.

ii. Some states do NOT allow for the issuance of stock for services
rendered before the actual incorporation. (thus, the
promoters/incorporators may not be able to be given stock for their
services)

iii. DE gives you a specific list and promissory notes, future services are
not there. Promissory notes are O.K. but only for excess amounts over
§154 stated capital.

12. Choosing a State of Incorporation

a. Corp does not have to incorporate in more than 1 state

b. Corp does NOT even have to do business in the state that they incorporate in.

c. BUT the state of incorporation is relevant b/c of the Internal Affairs Doctrine

i. Internal Affairs Doctrine = the internal affairs of the Corp are

governed by the state of incorporation. These internal affairs include
procedures for corporate actions and the rights and duties of directors,
S/Hs, and officers

 Thus, if incorporated in NJ, NJ law will govern even if case is tried

in another state
34
 d. Foreign Corporation – if a Corporation is NOT incorporated in that state, it is
called a foreign Corp.

i. By virtue of being a foreign Corp, every state that you do business in

will charge you fees and the Corp will be required to do specific
filings in that state (and you must prove you are in good standing by
showing the state your Articles)

ii. Many Corp’s do NO business in DE, but still make it their state of
incorporation:

 Positives traditionally their statutes have been more flexible and

the case law is well established – the bench and bar is very
knowledgeable about corporate law.

 Negatives: Extra costs to incorporate in DE; if one incorporates

in one state and files in another it will have to pay fees to both
states and will have to bear the label “foreign corporation” in the
state of actual operation.

13. Close Corporation =

a. small number of shareholders

b. NO ready market for stock

c. majority shareholders run the Corp

B. Who is liable to the Corporation’s C’s?

1. If the Corp. incurs a debt it is the Corp that is liable and NOT the S/H’s

a. MBCA §6.22/DE §162: unless otherwise provided in the AOI, a S/H of a corp. is
not personally liable for the acts or debts of the corporation except that he may
become personally liable by reason of his own conduct.

2. BUT, there are 2 ways a S/H may be held liable and the Corp protection evaporates:

a. Contract – a C in extending credit to the corporation might insist on a guarantee

from a shareholder

b. “Pierce the Corporate Veil (PCV).” There are certain things that a shareholder
might do in running a corporation that will allow a C to pierce through the
corporation and hold that shareholder liable – this is a judicial decision.

3. “Piercing the Corp Veil”

a. It is unpredictable how a court will decide PCV cases

35
 b. the Court just applies a laundry list of unclear factors and reaches its decision
(quite arbitrarily)

c. There has NEVER been a successful PCV case with respect to a publicly traded
corporation

d. Thus, only successful PCV cases are “CLOSE” Corporations

i. There has never been a case with more then 9 s/h’s that has
successfully PCV

e. In all PCV cases, only 1 shareholder is liable – the “active shareholder.”

f. The person attempting to PCV has the burden of proof

g. 3 ways to pierce the Corp Veil:

i. Fraud
ii. Alter-Ego = failure by the shareholder to keep the corporate form
These 2 are intertwined and
iii. Undercapitalization
are probably just factors
4. Dewitt Truck Bothers v. W. Ray Flemming, Inc – contract case. Dewitt is not
getting paid by Flemming, Inc. (after Flemming made an oral agreement to personally
guarantee the Corp.’s debt to Dewitt) so he decides to go after Ray Flemming (the
majority S/H) personally. Dewitt actually succeeds and the court PCV and holds
Flemming personally liable

a. The reason Dewitt went after Ray personally, is b/c he had $ and the Corp no
longer had any

b. In this case there was NO fraud, but you can still PCV even if you don’t show
any fraud

i. BUT, if you do show fraud, this is enough to PCV

ii. BUT Freer thinks you can sue the guy directly in tort law for fraud

c. Instead, the Court lists a TEMPLATE of factors in making its determination, but
it does not tell us how many of these factors you need to PCV:

i. Need to look at the totality of circumstances

ii. whether the Corp is grossly undercapitalized, [at the outset or
expansion of the Corp (when Corp is formed)]

 Corp does NOT have enough money to sustain its losses

iii. Failure to observe Corp formalities

36
 Freer criticizes
these factors for
being irrelevant to
the P bringing the
suit and also vague
iv. Non-payment of dividends (this is counter-intuitive – if you are a
creditor you don’t want them to pay dividends)
v. Insolvency of Corporation at the time of the claim
vi. Siphoning of funds to dominant S/H
vii. Nonfunctioning of other officers
viii. Absence of Corp Records
ix. Corp is merely a façade for the action of dominant S/H

d. ONE of those factors is NOT enough but 2, 3, or 4 may be enough to PCV

e. The way to avoid PCV cases, is to keep the CORPORATE FORM, by making
the corporation look separate from the shareholder by:

i. have S/H and Board meetings

ii. keep records

iii. leave some $ in the Corp

f. If the shareholder does NOT keep the separate corporate form, then it looks like
the Corp is really the S/H’s Alter-Ego, and the court will likely PCV.

g. Undercaptialization: Unfair: one should not be permitted to retain substantial

sums from the operations of a corporation w/o having any real capital in the
undertaking (risking nothing of their own).

h. Freer hates this decision b/c he believes that in contract cases, PCV should never
be allowed, b/c the P had the opportunity to protect himself by making the
Contract v. Tort shareholder personally guarantee the contract

i. However, in tort cases, Freer believes that PCV is more practical, b/c
the tort victim does NOT have the opportunity to get a personal
guarantee

i. It is very difficult to get a reversal for a PCV case because it is so fact specific.

j. The court has no trouble PCV when there is a covenant not to compete; i.e.
individual signs a covenant not to compete and therefore forms a corporation and
the corporation will compete.

5. Enterprise Liability – involves multiple corporation’s in 1 particular industry – theory

is that the businesses should be treated as one legal entity for purposes of liability.

a. Ex. Walkovsky Case: 10 taxi cab Corp’s owned by 1 guy, and run as if it were 1
company. If A is injured by Corp #1, then he may be allowed to sue all 10 Corp’s
as if they were one. Ct. said that this is a possibility – but you must show an
enormous amount of domination, and that all 10 co.’s are operated as 1 entity.

b. This is NOT piercing to get to the S/H, rather, cutting through all the walls of
numerous Corp’s that are really 1 business

37
 C. Who runs a Corporation?

1. S/H’s are the owners and they elect the Board of Directors to manage the Corp, and the
Directors elect Officers, who are the agents of the Corp

a. management (policy setting) is vested in the Board of Directors (not agents)

b. Officers are the agents of the Corp – thus, they bind the corporation if they have
the authority to do so – agency principles (officers implement the policy)

c. Employees – work at the corporation and don’t make decisions.

MBCA §8.01 2. Board of Directors

a. Board is elected by the shareholders

b. Board is the manager of the corporation, and it is NOT an agent

i. BOD would hire/fire/monitor officers, but not an intern

ii. BOD would decide whether to keep the restaurant open on the
Sabbath, but would not be concerned with one store in AL.

iii. BOD would be concerned about decision regarding the diversification

of the corporation, but would not be worried about small or local
acquisitions.

c. Management is “under the control” of the Board, but it is NOT usually done by
them – b/c they delegate control to the officers, and the Board monitors the
officers

d. Under the MBCA, the Board are NOT required to be shareholders but you want
them to be shareholders, b/c you want the Board to have a financial stake in how
the corporation performs

i. Permitted to make this a requirement in the Articles

e. “Inside” v. “Outside” D’s

i. “Inside D’s” – on the Board but also work for the corporation

ii. “Outside D’s” – on the Board but do NOT work at Corp day in and
day out

3. A Corp is required to have a Board of Directors unless it is eliminated by a

Shareholder Agreement (in §7.32)

a. Shareholder Agreements to limit or eliminate the Board only apply in CLOSE

CORP’s

b. MBCA - To eliminate or limit the Board, the Shareholder Agreement must:

38
 MBCA §7.32
i. Be set forth in the Articles or By-laws; and

ii. need unanimous approval by the shareholders

In Delaware, to eliminate or limit the Board:

DE §§ 350, 351
iii. Does NOT have to be in the Articles (but can be)

iv. Needs to be in writing

v. Only need a majority approval

c. In NY, to eliminate or limit the Board:

i. Must be in the Articles (can’t just be in writing)

ii. Need unanimous approval by the S/H’s

4. Officers

a. Officers are AGENTS of the corporation. Apply agency law accordingly.

i. Officers can bind the corporation to contracts, loans, etc.

b. Make-up of the officer positions is controlled by the by-laws of the corporation.

MBCA §8.40, 8.41
DE §142 c. BOD may elect. BOD may appoint if authorized by the bylaws BOD

d. The same individual may simultaneously hold more than one office in the corp.

e. Officers shall perform the duties set forth by the bylaws or (to the extent
consistent with the by-laws) the duties prescribed by the BOD or an officer
authorized by the BOD to prescribe the duties to other officers.

f. Both DE and MBCA require that you have someone who can authenticate
corporate records and keep the books.
i. Some states do spell out that you must have particular officers – older
view – the view was that the President could not be both the President
and the Secretary.

D. Shareholder Voting

1. Shareholders get to vote on 3 things:

a. election of D’s; and

b. removal of D’s; and

c. fundamental corporate changes –

39
 i. major changes in the structure of the corporation – things that change
the organic structure of the corporation

ii. 5 types of Corp changes:

 Amending the Articles of Incorporation

 Dissolution
 Merger
 Share exchange (like merger)
 Sale of all or substantially all of the Corp assets

iii. Ex: if the Corp decides to sell a whole new line of product instead of
what it currently sells, then this is NOT a fundamental Corp change,
rather it is a management decision, left for the D’s. Unless need to
amend articles b/c this is not the stated purpose (Mass/DEL)

iv. The shareholders only get to approve the fundamental Corp change if
the Board already voted and approved it – hence, it is a “reactive
power.”

v. We do not use cumulative voting. Almost always it’s a tough

standard – the majority of the shares entitled to vote. In some states
you need 2/3rds of shares entitled to vote; NY has the 2/3rds
requirement now changed to the majority depending on the date your
corporation was formed.

2. Debt holders are NEVER permitted to vote, only equity holders are permitted

3. Cumulative Voting

a. Do NOT vote seat by seat, rather there is just 1 big election

b. This assures, that minority shareholders will have some voice on the Board
(guarantee of having at leas one person on the BOD) – if they vote intelligently
and cooperatively

c. To figure out how many votes you have you multiply your number of shares times
the number of directors to be elected.

d. Formula for how many votes are needed to vote 1 D:

i. = [S/(D+1)] +1

 S = Total # of shares voting

 D = Number of directors to be elected.

ii. HYPO: Assume there are five directors to be elected to the board and
that the corporation has 100 outstanding shares (all of which will be
voted at the meeting). Under Cumulative voting, how many shares
would you need to elect an individual?
40
  100/5+1 = 16 2/3 + 1 = 17 2/3 (all you need is 17 shares

iii. The smaller the number of directors to be elected, the more shares its
going to take to elect someone to the board. Therefore, a staggered
board has the effect of diluting cumulative voting.

e. “Staggered Board” = elect a couple of directors every year. Allows for greater
continuity, but also dilutes cumulative voting.

f. it is only available when voting to elect or remove D’s (NOT available for
fundamental Corp changes)

g. Which states permit cumulative voting?

i. Majority view – If Articles are silent, there is NOT cumulative voting

– Opt-in

ii. Minority View – If Articles are silent, there IS cumulative voting –

Opt-out

iii. Some states (Mass.) never allow cumulative voting

iv. Other states (Az.) require it.

h. Do cumulative voting at the annual meeting or a special meeting (to remove a

D)

4. Straight Voting

a. elect each D in a separate election (seat by seat)

b. get as many votes as you have shares

c. majority shareholder will always win for every single D

5. Quorum

a. need a majority of the outstanding shares entitled to vote (50% + 1) to show up

at the meeting

b. this includes votes that are proxied

6. Removal of D’s

a. D can be removed before his term is up

b. This is done at the annual meeting or special meeting

DE §141(k) c. DE §141(k) - can do this with or without cause (if you have a staggered board,
then you can remove only for cause.)

41
 i. If have a quorum – need majority of the shares that are entitled to
vote (of all the outstanding shares).
MBCA §8.08 d. MBCA §8.08– can do this with or without cause, unless the Articles say
otherwise

i. If have a quorum, - need majority of the shares that actually vote

ii. If cumulative voting is authorized, a director may not be removed if

the number of votes sufficient to elect him are voted against his
removal.

NY §706 e. NY §706– need to show cause, but Articles can change all that

i. follows MBCA approach. Need the majority of shares that actually

vote.

ii. If cumulative voting is authorized, a director may not be removed if

the number of votes sufficient to elect him are voted against his
removal.

f. HYPO: 3000 shares entitle to vote 2000 show up at the meeting. . . what S/H vote
is required to remove a director from officer before his term expires?

i. DE 1501 votes need to remove director.

ii. NY/MBCA: If 2000 show up and 900 vote, you need 451 votes.

7. Proxy

a. it is an agency deal

b. someone votes for you (ex: you sign something with your vote, and even though
you are not present, someone present at the voting votes for you)

MBCA §7.22; i. can be appointed by signed document or electronic transmission; proxy

DE §212(b) is effective on receipt and is valid for 11 months unless a longer period
is determined. (no longer than 3 years for DE – if you push it, it may
be possible to have a oral proxy in DE)

c. Generally, proxy’s are revocable, even if it says they are irrevocable

d. There are 1 exception, when a proxy is irrevocable:

i. when it says it is irrevocable; AND

ii. it is coupled with an interest

 borrowing money from bank and I pledge my stock as collateral –

the bank now has the power to vote
42
 8. Meetings:
a. Annual Meeting: regular meeting held annually: MBCA §7.01; DE §211(b)

b. Special Meeting: any meeting outside the planned annual meeting: MBCA
§7.02; DE §211

c. Must give notice to S/H’s that we are having a meeting. Every S/H entitled to
vote is entitled to notice. That notice must absolutely be written. Some states
allow email, some allow oral notice.

i. MBCA §7.05 Must give notice no fewer than 10 nor more than 60
days before the meeting date.

9. Record Date = cut-off date

a. If you buy stock past this date, you can NOT vote at the meeting
MBCA §7.07
and DE §213(a) b. The record owner at the record date gets to vote at meetings

c. Record Date:
i. The record date must be no fewer then 10 and no more than 60 days
before the meeting DE§213(a)

ii. The record date may not be more than 70 days before the meeting or
action requiring a determination of shareholders. MBCA §7.07(b)

10. 3 options for combining voting power of shareholders:

a. Shareholder Voting Agreement

b. Voting Trust

c. Proxy – but need to couple it with an interest to make it irrevocable

11. Shareholder Voting Agreements (a.k.a. “pooling agreement”)

a. McQuade v. Stoneham – owners made an agreement with other S/H’s in the

Corp to elect themselves as D’s, and then to maintain themselves as officers.

i. It is very possible, especially in “close Corp’s,” for a person to

simultaneously be a shareholder, director and officer. (wear two hats)

ii. Shareholder Voting Agreements are enforceable.

iii. BUT, Voting Agreements amongst Directors are VOID –

iv. Ct said this is NOT allowed, b/c this is a violation of Public Policy –
b/c Directors owe the Corp their independent judgment

43
 v. NY courts disagree with this decision, and don’t think it should be a
per se rule. Rather, think it should be up to the judge’s discretion if
voting agreements among D’s are valid. Basically if the agreement is
between the only S/H’s of the company, then no one is hurt. If you
have unanimity of the S/H’s you can have this type of K.
DE §218(c) and b. For both DE and MBCA, Shareholder Voting Agreements are permitted, so long
MBCA §731(b) as:

i. They are written and signed

c. Ringling Bros. v. Ringling – 2 of the 3 shareholders (H and E) had a

shareholder voting agreement, whereby they agreed to vote strategically (vote
together), this way they could control the Board (5/7 D’s). If they couldn’t agree
on who to vote for, Mr. Loos broke the tiebreaker by telling them who to vote for.
H breached the contract and voted in contrast to E, to whom he was legally bound.
E wants to get an order of specific performance.

i. The court refuses to give a specific performance remedy (forcing H to

vote a certain way), rather, they only eliminate the way H voted and
only counted E’s votes and 3rd S/H’s votes – thus, end up with a split
up board

 Many think this was a BAD decision and the judge should have
ordered specific performance

 Today, there is a split in the courts as to whether to order specific

performance

 MBCA 7.31 says that Voting Agreements are specifically

enforceable

o Two or more S/H’s may provide for the agreement,

must be signed.

o Often called a pooling agreement

o Every state says these voting agreements are valid as

long as they are for a valid purpose – the problem is
“can you get specific performance” the trend is yes, but
the answer is unclear (DE C/L says no – although §218
(c) says nothing about specific performance)

d. Villar v. Kernan – V and K make an oral agreement not to give salaries. Both
are S/H’s and thus this was a shareholder agreement and K has more control b/c
the 3rd D is on his side, so K gave himself a salary at the Board meeting,
obviously V objects.

i. Ct said that K did nothing wrong, b/c according to the statute, the
shareholder agreement must be in writing and this one was oral –
thus, K was permitted to do what he did.
44
 ii. V might be able to argue that K is breaching a fiduciary duty

iii. This is NOT a D’s Voting Agreement case, rather it is a Shareholder

Agreement that applies to limiting the Board

12. Shareholder Agreements (see also pg. 38)

a. MBCA §7.32 Shareholder Agreements (supp. 649)

a) An agreement among the S/H’s of a corporation that complies with this section is effective
among the S/H’s and the corporation even though it is inconsistent with one or more other
provisions of this Act in that it:
(lists what can be changed only (1) and (3) are included here)

(1) eliminates the BOD or restricts the discretion or powers of the BOD

(3) establishes who shall be directors or officers of the corporation, or their terms of office or
manner of selection or removal

(b) An agreement authorized by this section shall be:

(1) set forth (A) in the AOI or bylaws and approved by all persons who are S/H’s at the time of
the agreement or (B) in a written agreement that is signed by all persons who are S/H at the
time of the agreement and is made known to the corporation;
(2) subject to amendment (3) good for 10 years.

(c) Note the agreement conspicuously on outstanding shares, but the failure to do it does not
affect the validity of the agreement;

(d)this is only for close corporations

(e) if S/H’s take over management, they take over all sorts of liabilities

(f) but the existence of an agreement will not be a ground for imposing personal liability (no
piercing the corporate veil.

b. DE §350 and §351 Agreements Restricting Directors/

§350 Written agreement, holding a majority of the outstanding stock – does not have to be
unanimous here (as opposed to MBCA), relieves directors and imposes liability on s/h’s. Villar
(below) would be decided same in DE.

§351 Can put it in the certificate of incorporation (articles of incorporation); such a provision
may be inserted in the articles by amendment – only if you have unanimity. Provision SHALL
be conspicuous – or the agreement will be void. MBCA is a better drafted provision.

13. Shareholder Agreements(MBCA §7.32/DE§ 350&351) and Shareholder Voting

Agreements(MBCA§731/DE§218(c)) are entirely DIFFERENT

14. Voting Trust

45
MBCA §7.30, a. transfers legal title of shareholders stock to a trustee
DE §218(a)
i. Shareholder owns everything else (equitable title) but legal title to the
shares and the right to vote (S/H’s get dividends)

ii. Tr makes his vote based on what the maj. of S/H vote to do

b. The trust must be:

i. written agreement

ii. must file it with the Corp records

iii. it transfers legal title to a voting trustee

c. Advantage of the voting trust is that you get specific performance, b/c the
trustee has to do what you say. (You create a voting trust when you cannot get
specific performance of a voting agreement – unnecessary in a state where you
can get specific performance.)

J. Inspection Rights [of shareholders and D’s]

15. Kortum v. Webasto Sunroofs, Inc. – (DE) – 2 S/H’s own the Corp 50/50 and they
have a fallout and Kortum makes 2 demands to see the corporate records – one as
director and one as a shareholder. The Corp argues that Kortum only wants to gain
access to go into competition with him.

a. Director – it is easier for a D, as a matter of policy, to have unfettered access to

DE §220(c) the books for a purpose reasonably related to his role as D– b/c he is a
fiduciary and has a duty to run the corporation properly

i. when the D is making this demand, the burden is on the corporation

DE §220(d) to prove it is for an IMPROPER PURPOSE

 In this case, the Corp failed to meet its burden that Kortum wanted
to see books for an improper purpose and thus Kortum, as D, was
permitted to inspect the books

 The D has a broad right to inspect the books and records, it is not
unfettered, but overall directors are expected to get access to
the books.

o Only limitation is that the Ct. will not allow the

information go for a competing venture.

b. Shareholders – in order to access books must:

i. make a written demand under oath (which is under penalty of

DE §220(b) perjury); AND

46
 ii. state a proper purpose (bona fide)

 the purpose must be reasonably related to such persons interest as

a shareholder

 need to make a measured request

 Ex: shareholder thinks the D’s are screwing up

iii. the burden is on the shareholder to prove this, and NOT on the Corp
by preponderance of the evidence

iv. If the Corp stiffs the S/H or does NOT reply to the demand within 5
DE §220(c) days, then shareholder goes to court, and the burden shifts onto the
corporation to prove the shareholders purpose is improper (BUT this
only applies to stupid stuff like lists of stockholders and the stock
ledger)

 BUT, the burden is always on the S/H to prove financial, sexy stuff

DIRECTORS RIGHT TO THE BOOKS IS BROADER THAN THE S/H’S

How does DE §220 differ from MBCA §16.02?

D§220 must be a written demand under oath

MBCA§16.02 -- written notice of the demand at least five business days before the date on which he wishes
to inspect and copy. Can be done during regular business hours at the corporation’s principal office. (agent
can also request the information)

§16.01 (e) list of various things you have access to if you give written notice at least 5 business days prior.
Don’t have to say why you need this information. But if you want other stuff,

§16.02(b) is a listing of more sensitive information – minutes of the directors meetings; minutes of s/h
meetings; accounting records. Can only get to this stuff if you fulfill

§16.02(c) – good faith/proper purpose/reasonable particularity of his purpose/records must be directly

connected with his purpose.

HYPO: s/h wants records to fire an officer – that is not a real reason – s/h’s cannot fire an officer.

47
 K. Business Responsibilities

16. Its management’s job to create value for the owners.

a. Private companies shares are usually held by senior management. If outside

managers are running the business, the real owners of the company know
intimately what is going on in the business, and are usually responsible for
making and executing the important decisions that influence the success or failure
of the enterprise.

b. Public companies differ:

i. Their financial results are public

ii. Lots of people own the stock and are therefore “owners” affected by
the company’s performance and price of the stock.

iii. SEC require public companies to announce and explain any material
actions or issues as they occur.

iv. Entire industry is devoted to analyzing and opining on the

attractiveness of the stock.

L. Legal Responsibilities -- Fiduciary Duties - Introduction

17. The management of corporation owe fiduciary duties

a. the highest fiduciary duty is from a trustee to the beneficiary

b. it is unclear whether directors or partners have as high of a fiduciary duty as

trustee have

18. Fiduciary duties come from common law

MBCA §8.30 19. MBCA tries to codify what has come out of common law

§8.30(a) a. Duty of Loyalty – (1) act in good faith; and (2) in a manner the Director
reasonably believes is in the best interests of the corporation

b. Duty of Care – Director’s must discharge their duties with the care that a
§8.30(b) reasonable person would reasonably believe appropriate in like circumstances.

c. D’s can delegate a Committee to perform some of its functions as D’s and D’s
§8.30(c) are permitted to rely in good faith on information from that Committee

d. Safe Harbor - D’s can rely in good faith on what various people [listed in §8.30
§8.30(d) (e)] tell them. (does NOT have to be written reports)

i. Ex’s = public accountants, employees, lawyers

48
 e. §8.30(a) comment 1(supp683): Basic standards of conduct for all directors. Lists
the different duties – duty of care, the duty to become informed, the duty of
inquiry, the duty of informed judgment, the duty of attention, the duty of loyalty,
the duty of fair dealing and the broad concept of fiduciary duty that the courts
often use as a frame of reference when evaluating a director’s conduct.

f. §830 applies to Directors, but it could also apply to shareholders in a “close”

Corp

§8.42 i. Also, if Officers of a publicly traded Corp acts in a managerial

capacity, then officers are bound by the same fiduciary duties

 The bigger the Corp, the more managerial responsibilities the

officers have

20. Delaware has a similar provision as MBCA §8.30(d) – DE allows the other Board
DE §141(e) members to rely in good faith on opinions, reports and statements made by other Board
members.

M. Duty of Care

21. Shlensky v. Wrigley – D made a thought-out decision that the Cubs will only play day
DE law games. Shlensky (minority S/H) brought a derivative suit b/c he believes the D
breached the duty of care to the corporation (by making bad arbitrary decisions and
acting out of his own personal beliefs) b/c thinks the Corp can increase profits if they
installed lights and played night games. Wrigley counters by saying that night baseball
will ruin the community – looking toward the LT property value. Ct ruled in favor of
the D, by relying on the BJR.

a. BUSINESS JUDGMENT RULE (“BJR”) (CB267)– A court will never second

guess a Board of D’s business decisions as long as the directors are acting with
disinterest, good faith and due diligence or unless there is a showing of:

i. Fraud; OR

ii. Illegality; OR

iii. Conflict of interest

b. Presumption that the business people will exercise valid business judgment.
Courts do not second guess business people. No jurisdiction or right to do so.

c. BJR always has to do with the duty of care and will never protect the D’s breach
of duty of loyalty b/c that will always be a conflict of interest

d. Ct says it is NOT equipped to handle these business decisions and thus takes a
laissez faire attitude

e. The BJR gives enormous protection to D’s and almost always the D will win

49
 f. BJR will protect D’s from merely being negligent – BUT NOT GROSS
NEGLIGENCE!!!

22. Joy v. North – This cases is one of the rare cases where the P was able to overcome
the BJR. BOD pursued the Katz venture – a series of loans for real estate
development. The deal never went anywhere – so Katz keeps coming back for more
money, and more money. . . The BOD backed the wrong horse.

a. The ct ruled the BJR did NOT apply b/c the D put the Corp in a NO-WIN
situation (kept giving out significant loans that were extremely risky)

b. Rationale behind the BJR:

i. Relationship b/w shareholders and D’s is voluntary – it is the

shareholders choice as to whether to hold stock.

ii. Post facto litigation to determine if the decision made sense is a

terrible thing to do – “hindsight is 20/20.”

iii. BJR makes the corporate mangers BOLDER – want the D’s to think
outside the box and grab their balls
 It is very much in the interest of the S/H that the law not
create incentives for overly cautious corporate decision.

c. “Outside D’s” and “inside D’s” basically have the same duty of care – both need
to look out for RED FLAGS
i. Inside D’s -- usually are officers, work for the corporation. They are
charged with knowing a little bit more about what is going on.

ii. Outside D’s -- is not an officer or employee. Outside directors were

shocked by this opinion -- they can be held liable here because it
depends on whether they had the knowledge of this situation. But
lack of knowledge is not necessarily a defense, if it is the result of an
abdication of directional responsibility. Directors who willingly allow
others to make major decisions affecting the future of the corporation
wholly without supervision or oversight may not defend on their lack
of knowledge, for that ignorance itself is a breach of fiduciary duty.
Even outside directors have a duty. BJR does not always protect you.

d. §8.31 MBCA and other corporate codes give some guidance as to its application
in dealing with directory liability claims:

i. Director will not be liable to corporation or S/H unless the party

asserting liability establishes that:

 AOI or other MBCA section does not preclude liability.

 The challenged conducted consisted or was the result of:

 Action not in good faith; or

 A decision
50
 a. Which the director did not reasonably believe to be
in the best interests of the corporation.

b. As to which the director was not informed to an

extend the director reasonably believed appropriate
in the circumstances.

 Conflict of interest

 Outside directors failure to remain interested.

 Lining the D’s pockets with $$$.

23. Smith v. Van Gorkom – (DE) – The Board new nothing about a merger and then the
big kahuna told them about it at a meeting and only 2 hours later after reviewing some
material, the D’s voted to get bought out by another Corp and on what the share price
should be. (they had no investment banker advising them and no paperwork

a. To approve the fundamental corporate change, you need: Board approval and S/H
approval. Deal here was approved by both BOD and S/H, but Smith steps up and
tries to undue it. Says $55/share was not enough. Class action

b. Ct in this case said the BJR does NOT apply and the D’s breached their duty of
care by failing to give the corporation a fair assessment of what the true value
of the stock was.
i. BOD comes in and knows very little.
ii. Officers know very little
iii. Nothing in writing . . . no accounting details.
iv. Done in 2 hours.

c. If a D is negligent, he has NOT breached the duty of care, but if the D was grossly
negligent, then the D has breached the duty of care and he will NOT be protected
by the BJR.

d. If a D makes an UNINFORMED DECISION he is considered to be grossly

negligent and will NOT be protected by the BJR
i. Actually in this case, Van Gorkum was damned either way. The court
is trying to stop backroom dealing. One of the attorney’s says that if
you turn down the deal, its off the table. TOO MUCH PRESSURE.

e. BOD was not acting in good faith by doing enough homework.

f. In order to make the decision look INFORMED and avoid being grossly
negligent, D’s must look busy in making their decision by:

i. Having an agenda before the meeting, writing and not oral, allow time
for deliberation, and hire an outside consultant. MORE $$$.

g. The BOD ended up getting screwed and had to shell out millions of $’s b/c they
were held personally liable.

51
 h. As a result of this decision, almost every state enacted statutes to provide for more
protections of the D’s.

i. If DE §102(b)(7) were in effect at the time of the decision, the D’s probably
would NOT have been liable b/c although they were grossly negligent, they
probably acted in good faith

j. Freer: as a director you are liable for whatever the board did if you did not
abstain or dissent in writing. What if you weren’t there? In some states you will
still be liable, but generally you will not be held liable.

24. BJR will NOT protect D’s, if: (Summary)

a. the corporate decision lacks a business purpose

b. tainted by a conflict of interest – thus, if D breaches the duty of loyalty, he will

never be protected by the BJR

c. so egregious that it amounts to a NO-WIN situation

d. obvious and prolonged failure to exercise oversight or supervision (RED

FLAGS)

e. When the D’s are grossly negligent – and make an UNINFORMED decision

f. Oppression in Close Corp’s – only in those jurisdictions that adopt Doanhue

g. Fraud

h. Illegality

25. Protections that Delaware and MBCA grant D’s after the Van Gorkum decision:

DE §102(b)(7) a. In Delaware, a corporation is permitted in its Articles of Incorporation, to limit or

eliminate the personal liability of D’s for breach of their fiduciary duties. BUT,
the Corp can NOT eliminate, and thus the D’s are still personally liable for:

i. breaches of the duty of loyalty

ii. for acts or omissions NOT in good faith or which involve intentional
misconduct or knowing violations of the law

iii. §174 – unlawful dividend payout

iv. situations where D received an improper personal benefit

b. In DE, if corporation chooses to, the D could virtually always be protected from
personal liability in duty of care cases

52
 c. MBCA basically has the same provision as Delaware, except it excludes DE’s
MBCA §202(b)(4) “good faith” clause. Thus, under the MBCA, even if the D acted in bad faith, he
will still be exculpated from personal liability.

i. Thus, MBCA is a broader protection

ii. This protects not only D’s, but also Officers acting in the managerial
capacity

d. Both DE and MBCA involve MONEY DAMAGES by the D and NOT equitable
relief

26. Breach of the duty of care by INACTION:

a. Barnes v. Andrews – case is about inaction by a D. The small corporation was

really making retarded decisions and losing lots of $, b/c of delays in production.
If D would have been INFORMED, he would have realized something was wrong
and attempted to fix it – b/c it was obvious something was wrong. The Ct found
that the D breached the duty of care by failing to INFORM himself. BUT, the
court did NOT find D liable b/c there was NO Causation

i. Thus, D’s have an active duty to INFORM themselves (need some

general knowledge) as to what is going on in the Corp. – grossly
negligent.

ii. D is NOT simply permitted to act as a figurehead, they need to pay

some attention to what is going on.

iii. Members of the BOD are expected to ask questions and push when
there are red flags. Director shall discharge their duties with the care
that a person in a like position would reasonably believe appropriate
under similar circumstances. §8.30(b)

iv. D definitely breached the duty of care BUT he is still NOT liable b/c
there was no way to determine that had Andrews acted properly, the
corporation would have avoided its situation.

 Thus, in both ACTION and INACTION cases, CAUSATION

must be shown [it is just not obvious in omission cases as it is in
action cases]

v. Causation:
 MBCA §8.31(b)(1): P has the burden of showing
CAUSATION (harm to the Corp) on the part of the D whether by
action or inaction

 DE rule seems to be once the plaintiff shows there was a breach

of duty of care, then the burden shifts to defendant to show what
he did was fair.

53
 vi. Francis v. United Jersey Bank: Plaintiff wins on a theory of director
inattention and shows causation. Causation because the theft of money
was so obvious that anyone who paid any attention at all would have
seen the kids were robbing her blind. The widow failed to take any
steps.

b. Alliss-Chalmers Co case – large public Corp., where midlevel employees were

screwing up and the Corp loses money as a result. P goes after the D’s claiming
that they breached the duty of care by failing to monitor the midlevel employees
who are screwing up.

i. Causation in this case is NO problem, b/c obviously had they been

monitoring, the screw up would NOT have happened

ii. Ct says that b/c this is a huge Corp with over 30,000 employees, the
D’s can NOT be expected to monitor all of the employees.

iii. BUT, the D’s are responsible for coming up with some sort of
MONITORING system that “could” catch these problems – BUT
only if there is some sort of RED FLAG

 If D’s fail to set up this monitoring system when there is a RED

FLAG, then they are liable for breaching the duty of care (very
forgiving decision for the BOD.)

c. In re Caremark Int’l case (DE) LIABILITY FOR FAILURE TO MONITOR.

– altered the Aliss-Chalmers holding. Health-care Corp got fined millions of
dollars for actions of its mid-level employees. Eventually the case got settled.

i. The Court holds that a Corp always has to have “some type” of
MONITORING system in place and if there is, the D’s will never be
liable for actions of its midlevel employees.

ii. If there is an appropriate system in place, the P will never be able to

argue that there is a sustained and systematic failure of the Board to
exercise oversight.

 Thus, as long as some type of system is in place, the D’s will be

excused from liability

iii. BUT, it is unclear as to what exactly is a proper MONITORING

system:

 Question of Business judgment – the BOD must exercise a good

faith judgment that the corporations’ information and reporting
system is in concept and design to assure the board that appropriate
information will come to its attention in a timely manner as a
matter of ordinary operations, so that it may satisfy its
responsibility.

54
  D’s have to monitor the broad “big ticket” stuff.

 Thus, put in training sessions, hand out flyers, law compliance

programs, some system regarding federal criminal laws
(medicare or antitrust)

 Only liable if there is a sustained or systematic failure of the

board to exercise oversight.

d. McCall v. Scott – (DE) this is another failure to monitor case. [mid-level

employees committed health care fraud which cause the Corp to lose lots of
money.] This case is a little different, however, b/c the corporation had limited
the liability of the D’s in its Articles pursuant to DE §102(b)(7).

i. The D’s are excused from liability only if the acts or omissions were in
good faith.

ii. The question in this case is whether the failure to monitor the mid-
level employees was an omission that was NOT in good faith –
thereby making the D’s liable.

iii. The court concluded that b/c a red flag was raised and the D’s didn’t
do shit about it, the D’s were reckless, and as a result, the court said
the D’s did NOT act in good faith – and thus are liable

iv. This is very fact sensitive, b/c upon a showing of recklessness, you
could argue both ways – NO good faith and YES good faith.

v. The D’s would have been protected in MBCA2.02(b)4 jurisdiction,

b/c there is no such good faith clause in the waiver of liability

vi.
Lack of good faith is short of intentional, but more than gross
negligence – and not covered by the exculpatory clause. There is a
niche of liability. This means: 1. The D’s are liable, and 2. the
exculpatory clause does not rescue them.
SPECTRUM: MORE THAN GROSS NEG. LESS THAN INTENT.

GROSS NEGLIGENCE INTENTIONAL

NEGLIGENCE LACK OF GOOD FAITH

N. Duty of Loyalty

55
27. it always concerns a potential conflict of interest – thus, BJR never applies

a. Ex’s = D looting from the Corp;

28. There are 3 fact patterns where questions of D’s duty of loyalty usually arise:

a. Competing with the Corp

b. D takes for himself a Corporate opportunity

c. Interested D Transactions (“self-dealing”)

29. Competing with the Corp:

a. Regenstein v. J. Regenstein Co. –MINORITY VIEW -- Corp owns a store A

and 3 of the D’s on the Board for the Corp own a separate competing store (store
B), that is unaffiliated with the Corp. The Corp sues those 3 D’s, claiming that
they breached their duty of loyalty by competing with the Corp by selling the same
type of merchandise, and funneling the more profitable merchandise into store B
as opposed to the Corp’s store.
i. The Ct dismisses this case, stating that the Court failed to ever state a
claim

 Ct reasoned that the Corp did NOT offer enough evidence or detail
in its pleadings to warrant a claim

ii. This Ct said that the D’s are permitted to compete as long as they
don’t violate any legal or moral duty to the Corp or S/H’s

 “When acting in good faith a director may not wrongfully use the
corporation’s resources therein, nor may he enter into an
opposition business of such a nature as to cripple or injure the
corporation”

o Cannot wrongfully use assets of Co.

o Can go into competition, but you cannot be any good at it

(can’t injure or cripple the original corporation)

 Freer hates this decision b/c he says it is too BROAD

 This is inconsistent with Meinhard v. Salmon

iii. Most courts, would have reached the opposite conclusion and held
that competing directly with the Corp is a breach of the duty of loyalty

 b/c D is taking away money from the Corp that he owes a duty to

iv. Other Courts allow D’s to compete, so long as it is NOT UNFAIR

COMPETITION –

56
  can NOT take supplier/seller lists while on the Board

v. Remember officers owe the same fidicuary duty as directors. And ini a
close corporation, managing S/H’s would have the same duty.

 Officers are also agents, so there may be an agency duty of

liability here too.

 Restatement (Second) of Agency §393 Unless otherwise

agreed, an agent is subject to a duty not to compete with the
principal concerning the subject matter of his agency

vi. We are not sure what the plaintiff’s would have had to establish to win
 Show which store was established first.
 Show how the new store hurt profitability.
 If the majority of the BOD have an interest.
 All of the above might have helped.

ALI §5.06 b. A.L.I. view

i. D’s are NOT permitted to compete with the Corp, unless:

 Reasonably foreseeable harm is outweighed by the benefit; AND

 Competition is disclosed and authorized in advance by the Corp

ii. this is a very strict view against competing with the Corp

iii. Modern trend is to follow this view

30. Usurpation of Corporate Opportunity

a. Corporate Opportunity = if D or O becomes aware of an opportunity, either:

ALI i. in his Corp capacity and NOT in his personal capacity; OR

approach
ii. through use of Corp information or property that he used as D; OR

iii. a business activity that you find out (even in your personal capacity)
and you know it is closely related to a business in which the Corp is
engaged or expects to engage in. (applies only to senior executives
not directors)

 this is just like the line-of-business test

ALI
b. Under the ALI, if it is a Corp Opportunity, the D can still take advantage of it,
approach
but only if:
§5.05
i. they disclose it to the Board; and

57
 ii. wait until the Board rejects it;

iii. the rejection is fair OR opportunity is rejected in advance (by

either disinterested director or superior or S/H)

iv. The DISCLOSURE requirement only applies when there is a Corp

Opportunity (thus if hear about opportunity in private capacity, don’t
have to disclose shit unless the business sis closely related)

c. Burden of Proof: burden is on the director or officer if the opportunity is

rejected in advance by disinterested directors or S/H. Otherwise the person taking
the corporate opportunity has the burden.

d. Good faith defective disclosure: can be ratified subsequently by the BOD, S/H or
corporate decision maker.

e. Delayed Offering – can not get sued if the failure was in good faith. The
corporate opportunity is offered to the corporation subsequent to the bringing of
suit.

f. Northeast Harbor Golf Club, Inc v. Harris – Harris is the D and Officer of the
Corp (golf club). There were certain parcels of land that came to her attention
merely b/c she was Prez of the Corp, thus in her Corp capacity and NOT in her
personal capacity. Harris bought this property and only told the Board about it
informally. She also bought another piece of property that she learned about in
her personal capacity. Harris then started developing both the properties together
and the Corp sued her for the breach of loyalty.

i. The Ct rejected DE’s Line-of-Business Test (LBT):

ii. LBT as applied by Trial Ct.

 Land was not in the club’s line of business
 Club didn’t have money for it.
 Harris acted in good faith

iii. Ct says there are serious deficiencies in the LBT:

 The question whether a particular activity is within a

corporation’s line of business is conceptually difficult to answer.

 Why should the element of the financial ability of the corporation

to take advantage of the opportunity be excluded?

 Gives the director an incentive not to act in the best interest

of the corporation – if you can point to the financial
inability of the corporation, it excuses you.

iv. Instead, the court adopted the A.L.I. test– (see above)this test is very
big on DISCLOSING the potential opportunity to the Board

58
 v. Thus, Ct rules against Harris b/c she failed to make a disclosure and
wait for a rejection by the Corp

g. Broz v. Cellular Info System (DE) – Broz is D of CIS and is also personally
owns a separate Corp (RFBC) which was in the same business. An outside Corp
is selling a license and approaches Broz in his personal capacity to see if he wants
to buy the license for his personal company. Broz buys the license. CIS now sues
Broz, claiming that he breached the duty of loyalty.

i. Ct applied the LINE-OF-BUSINESS TEST – [DE Test]

ii. In accordance with this test, the D is NOT permitted to take a

corporate opportunity if all 4 of the following are satisfied:

 Corp is financially able to exploit the opportunity

o If you’re a director and you get sued you have a defense by
showing the corporation was not able to do this anyway.
o Burden is on the individual getting sued.

 Opportunity is within the Corp’s line of business

o Wouldn’t you think this would be the definition of a
business opportunity?

 Corp has an interest or expectancy in the opportunity

o Interest and expectancy seem to be melded with this line of
business test. What is an interest or expectancy – is this
something the company would have been interest in?

 By taking the opportunity, the D will be in a position contrary

to his duties to the Corp
o Conflict of interest – by taking this for yourself you are
essentially competing head to head with the corporation
you owe fiduciary duties.

It is unclear how iii. BUT, D can take the opportunity if:

many of these 4
factors are needed to
take advantage of
the Corp opportunity
 It is in his personal capacity and not his Corp capacity
 Opportunity is NOT essential to the Corp
o Tough – a corporation is interested in a lot of things that are
not essential.
 Corp holds no interest or expectancy in the opportunity
 D has NOT wrongfully employed the resources of the Corp in
pursuing or exploiting the opportunity

iv. Criticism of the Line-of-Business test – by allowing the D to take

advantage of the opportunity only if the Corp can NOT afford it,
rids the D’s of the incentive of fixing the Corp’s financial situation

v. In this case, although Broz was involved in the same line of business
as CIS, Broz found out in his individual capacity and CIS could not

59
 have been able to financially afford the license, b/c they were broke,
and also, CIS did NOT have an interest or expectancy in the
opportunity. Thus, the ct concluded that Broz did NOT breach his
duty of loyalty

vi. Unlike the duty of care, the Burden of Proof is on the D to show he
has NOT breached the duty of loyalty

vii. DE says you don’t have to present the opportunity to the

corporation first, but you should – it’s a safe harbor.

viii. Under ALI: Broz would have had to inform the directors if it was a
corporate opportunity – but since Broz was approached in his civilian
capacity it might not be a corporate opportunity. But we think it is a
corporate opportunity: look B(2) senior executive becomes aware and
knows is closely related to a business in which the corporation is
engaged or expects to engage.

31. Interested D Transactions – “self-dealing”

a. One side of the deal you have the Corp and on the other side of the deal you have
a Corp D or O.

b. We are skeptical of these types of deals b/c were are worried that the D is NOT
negotiating for the best interest of the Corp, but rather for his own self-interest

c. In Delaware, a deal is an interested D transaction, if it is a deal b/w:

DE §144
i. Corp and D

ii. Corp and Officer

iii. Corp and another business where there is a common D or Officer or a

D or O that has a financial interest in this other business

d. In DE, interested D transaction are NOT void if:

i. the conflict and the transaction must be disclosed OR known to the

S/H’s OR D’s(through independent knowledge);

AND

ii. if any one of the following are satisfied:

o (1) approved by the majority of the disinterested D’s on the

Board; OR

 Need a quorum, but the interested D’s count towards

the quorum, even though they can’t vote

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 HMG case changed the DE
statute and says you need
(1) or (2) AND (3). Thus,
the transaction must always
be FAIR for it NOT to be a
conflict of interest
o (2) approved by the S/H’s; OR
 Interested S/H’s can vote their shares – but this
contradicts the requirement that they vote in good faith,
thus open question.

o (3) the transaction is FAIR – “the overall course of dealing” -

 if (1) or (2) are satisfied then Ct does NOT do a

substantive inquiry, but if one of them is NOT satisfied,
ct will do a substantive inquiry

e. HMG/Courtland Properties, Inc. v. Gray (DE)- F and G are both Directors

(D’s) and on both sides of the deal and thus was involved in an interested D
transaction. The Court applied DE §144, but it changed the requirements. It held
that b/c of the word “solely” in the statute, then need (1) OR (2), AND (3) for the
transaction to be kosher. Thus, D must always show that the transaction was
FAIR for there to be NO conflict of interest.

i. ENTIRE FAIRNESS DOCTRINE =

 Fair Dealing – this looks at procedures; AND

 Fair Price - look at the substance of the deal (this is very

intrusive and we normally don’t do this b/c of the BJR)

ii. Ct says that even if you meet (1) OR (2), then the court will still look
VERY IMPORTANT at (3)-FAIRNESS, but it will apply the BJR and will NOT do a
substantive inquiry. (b/c the conflict of interest has been fixed)

iii. In this case, the D did NOT pass (1) or (2) and thus BJR does NOT
apply and court will do a substantive inquiry and look at fairness (3).

 Here the burden is on the director to show that the transaction

was fair as to the corporation.

iv. Interesting even though F disclosed its self interest, G did not disclose.
F knew of G’s interest and did not disclose it. This opinion treats F
just like G.

f. MBCA Approach– has similar requirements with respect to interested D

MBCA §8.60§8.63 transactions:

i. it only applies to D’s and NOT to Officers (although I think it also

applies to officers.)

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 ii. must be a 2-sided “transaction”

iii. Corp v. D; Corp v. direct relative of D; Corp v. business that D or

family member has a financial interest in; Corp v. D or relative is
closely linked to the transaction
What are the iv. Broadly defined -- includes Corp v. relatives of D (but only spouse,
difference in parent or sibling or grandchild or someone sharing the same home as
disclosure the D – NOT cousin)
rules btwn
S/H and v. MBCA is a safe harbor, thus only need to satisfy the statute and do
BOD? NOT need to look at fairness:
 Remember though, you are always subject to your duty of loyalty
under §8.30

vi. The transaction and the conflict be disclosed to the S/H’s and the D’s
before the vote (it can NOT be known like in DE)

 Disclosure is broader than DE; here you have to disclose:

 Existence and nature of the conflicting interest

 All facts known to him respecting the subject matter of the

transaction that an ordinarily prudent person would
reasonably believe to be material.

vii. Only need 1 of the following 3 requirements, and then the deal is
kosher (b/c the word “solely” is NOT in the statute):

 (1) Board Approval; OR

o need majority of all disinterested D’s

o quorum is defined differently = majority of the

disinterested D’s have to show up, but it can be no fewer
than 2.

 9 directors; 5 interested; 4 disinterested. Only 4

disinterested show up. Can you have the
meeting? Yes all you need is 3.

o Vote must be made with care, good faith and in the best
interest of the Corp

 (2) S/H Approval; OR

o Interested D’s can NOT vote in the S/H voting meetings

o Need a majority of disinterested shares to pass.

o Quorum is majority of disinterested shares.

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  50K shares; 10K shares are qualified
(disinterested). 6K are present at meeting. 4K
vote yes to approve the deal. MBCA – have
quorum. But you need 5,001 votes to pass.

 (3) Transaction is Fair

viii. BUT still some states that adopt the MBCA (Iowa) still require the
D to show the deal was FAIR – by doing a substantive inquiry (not
protected by BJR)

g. In EVERY JURISDICTION, if you don’t meet (1) OR (2), then you only look at
FAIRNESS, and it will always be a searching inquiry (the BJR will NOT apply
b/c the conflict of interest has NOT been fixed)

Q. Derivative Suit

32. Direct Suit – suit brought by a S/H on behalf of himself. Thus, the S/H gets to keep the
entire remedy. BUT could be a class action on behalf of lots of S/H’s (representative)

33. Derivative Suit - Equity developed this shareholder derivative suit, b/c it is a
derivative of the corporations right to sue, and gives the shareholders the right to sue on
behalf of the corporation

a. The corporation, the entity, is the Plaintiff, b/c they are the one being hurt by the
D’s actions or omissions

b. This was created b/c bringing a suit is a management decision, and the D’s are the
ones making these decisions, it is NOT likely the D’s will agree to sue themselves
or their friends.

c. Thus, the S/H’s stand in the shoes of the Corp

d. In Derivative suits, we are dealing with a situation where the Corp could have
sued but it chose NOT to.

e. Director is NOT permitted to bring a derivative suit, unless he holds stock

f. Only S/H’s can bring derivative suits

g. If S/H wins, the Corp gets the recovery

34. 2 types of Derivative suits

a. (1) – when it looks to the S/H’s that the Corp should have sued company X, but it
chose not to. The S/H’s will try to bring the suit on behalf of the Corp against
Company X.

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 i. this is very rare – b/c the Corp usually has good reasons for NOT
bringing the suit (ex: b/c o future relations), and thus, the Corp will
usually be protected by BJR

b. (2) – Suits brought by the S/H’s on behalf of the Corp against D’s for breaching
their fiduciary duties

i. we allow this b/c we don’t trust the other D’s to sue their friends on the
Board

35. Derivative v. Direct Suit

a. Eisenberg v. Flying Tiger Line (NY)– Eisenberg was a shareholder in Flying

Tiger, which had a subsidiary and a parent . . . Point is, Eisenberg who had stock
in Flying Tiger (airline Corp) now owns stock in a subsidiary FTL (holding Corp).
Eisenberg brought the suit as a direct suit, and the Corp argues that it is a
derivative suit and therefore, he needs to post a bond.

i. Ct holds the Eisenberg’s claim was a direct suit and thus he did not
have to post bond

ii. In NY, to figure out if the suit is derivative OR direct:

 Look at the winner or who recovers; (if the Corp wins or recovers,
it is derivative )OR

 Look at who has been harmed (if harm to the S/H, the it is direct
and if it is harm to the Corp, then it is derivative)

 Suits are now derivative only if brought in the right of a

corporation to procure a judgment “in its favor”

 Ex: public or private corp failed to honor a S/H’s pre-emptive

rights

iii. The reason court found the suit to be direct was that Eisenberg
focused on the fact that his vote was taken away from him and
therefore he was harmed, rather then just complaining about the
managerial position, which could have been derivative

b. The Courts are split with regard to whether a suit to force the declaration of
dividends is direct or derivative.

i. Most courts hold that it is direct, b/c S/H is after $ personally

ii. NY would hold that it is direct – b/c the Corp is NOT winning or
recovering

c. HYPOs (CB342)

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 i. E sues the directors of Bubba’s because they issued stock without
honoring his preemptive rights? Direct. . . usurped his right to stock.

ii. R sues the directors of Bubba’s because they failed to permit him to
inspect corporate books and records. Direct –corporation is not hurt.

iii. AOI of Bubba’s provide that the corporation will “sell food and
beverages.” E learns that the directors plan to enter into the voting
machine business. He sues to enjoin the corporation for engaging in
this ultra vires activity. Derivative – corporation is being hurt
because management is doing something it should not do. Ultra vires
is something outside the corporation’s given purpose.

iv. R sues the directors of Bubba’s for wasting corporate assets by paying
themselves huge bonuses. Derivative – they are throwing away
corporate assets. This is a breach of duty of loyalty. Can’t rob the
pantry.

v. F sues the directors of Bubba’s for usurping corporate opportunities.

Derivative – breach of duty of loyalty – ultimately the opportunity is
being taken away from the corporation. Remedy here would be an
equitable one – constructive trust. Put the corporation in the place it
should have been had the director not usurped. i.e. director you may
own the land, but you must transfer to the corporation at the director’s
cost.

vi. E sues the directors of Bubba’s for failing to exercise due care in
purchasing supplies at a price much higher than could have been
negotiated. Derivative – breach of duty of care – but the directors
here would most likely be covered under the BJR.

vii. R is the minority S/H of Bubba which is a close corporation. He sues

the controlling S/H, alleging that they have breached fiduciary duties
by oppressing him. Specifically, he alleges that while they have had
the corporation hire them and purchase their stock for cash, they have
refused to allow the corporation to do such things for him. Direct –
harmed him. In a close corporation, they owe duty to the minority
stockholders. Cannot oppress minority S/Hs. See infra Hollis v. Hill
(CB429)

viii. F holds stock in a publicly-traded corporation. He attends a S/H’s

meeting and asks difficult question of the CEO. The CEO slugs him in
the nuts. Whom can F sue and what kind of suit. Direct – sue the
CEO. Sue the corporation – gets into agency stuff, but directors are
generally not agents of the corporation.

36. Procedural Protections have been developed before one can bring a derivative suit b/c
there are so many “strike suits” – frivolous suits initiated by shady lawyers or pain in
the ass S/H’s who are just after some cash: These protections are the following:

65
 a. Security for Expenses – S/H’s bringing a derivative suit need to post a bond to
cover the Corp’s expenses. If the suit turns out to be frivolous, the court will give
the $ to the Corp to cover their expenses

NY §627 i. These expenses include attorney’s fees of the Corp and all of the other
D’s attorneys’ fees that Corp may be liable for – security size is set by
the discretion of the court and is intended to cover reasonable
expenses.

ii. BUT certain people are exempt from posting a bond:

 5% shareholder or greater – are permitted to aggregate holding

of lots of S/H’s to = 5%

 person holding a voting trust certificate

 if stock has a fair value of $50,000 or greater

iii. NOT all states have this requirement – MBCA does NOT

iv. NY has this requirement in an effort to discourage strike suits

b. Corp must be joined in the lawsuit – always need to join the Corp so it could be
bound by res judicata. We could add the Corp as an involuntary defendant.
“nominal defendant”.
i. S/H v. director/officers and the corporation (although passive)

c. Stock Ownership – in order to bring a derivative suit, the person must own stock:

For both NY i. at the time the questionable act/claim arose; OR

and MBCA
ii. received stock via “operation of law” from someone who owned
stock at the time of the questionable act.

 operation of law = received the stock from inheritance OR

divorce
NY §626(b) iii. In NY – must also be a shareholder at the time of the litigation
 Although NY statute does not say so, NY courts have said you
should own it through the end of the case.

MBCA §7.41(1) iv. Under MBCA – must be also be a S/H at the time of the litigation
AND maintain the stock throughout the derivative proceeding

 §7.41(2) – S/H must also fairly and adequately represent the

interests of the Corp – thus, can’t sue for personal advantage

v. For both NY and MBCA, there is NO $ requirement OR share

requirement (thus can own 1 share of stock)

66
 vi. “Continuing Wrong” theory – if D’s continued to do wrong for a
long period of time, then any S/H that held stock in that time span can
bring the suit. Some states adopt this

d. Demand on D’s - See Below

e. Demand on S/H’s - Must go to the S/H’s and demand that the S/H’s take charge
and bring the corporate claim before bringing the derivative suit. MBCA does
NOT require this. The states that do, always have exceptions to this rule.

f. Right to Jury Trial – 7th Amend requires it in law and NOT equity. (Remember
7th amendment only applies to federal law not state courts) BUT SC has
interpreted it by looking at the underlying claim and the remedy sought.

i. If it looks like a law claim (damages), then it gets a jury trial but if it
looks like an equity claim (INJ, specific performance), then NO jury
trial.

g. Court Approval of Settlement or Dismissal – can NOT settle a class action or a

MBCA §7.45 derivative suit without court approval (b/c need to look out for the unnamed P’s in
the representative suit).

i. Court has the discretion to give NOTICE to those affected by the

outcome before it makes its decision

37. Demand on D’s – where S/H makes a written demand on the D’s that they take action
FRCP 23.1 (bring suit)
&NY§626(c)
a. Under the MBCA, the demand is NOT on the Board, but on the Corp. (but that is
really the Board’s decision)

b. Reason for this requirement = b/c the decision of whether to sue is a

management decision, not a S/H decision

c. Advantages of the Demand on D’s requirement:

i. prevents strike suits

ii. it may convince the Board to bring the suit directly, and thereby avoid
any need for a derivative suit.

d. There are certain circumstances, where making the demand is FUTILE.

[pointless]

i. if this is the case, in most states, the shareholders do NOT have to

make the demand

Use common sense in
determining if it is futile
ii. Example of FUTILE = when the majority of the Board is named as
defendants b/c they could be tainted (OR the majority of the board is
controlled by one of the named defendants), it is futile to ask the board
to sue themselves
67
 e.
Questions on page CB350:
Claim to be asserted:
1. All 5 directors breached
their duty of loyalty by
engaging in competing
ventures?
2. 3/5 of the directors
breached their duty of
loyalty?
3. 2/5 directors breached
the duty?
4. 1 director breached the
duty, but that she is the
dominant member of the
board, and that the other
four are under her control?
5. A former director
breached the duty (while
serving as director), but
that she essentially
arranged to have all 5
present directors named to
the board?
f. Marx v. Akers – (NY) 18 member board and the board allegedly awarded
excessive compensation to themselves. 3 of the 18 D’s are “inside D’s” and the
other 15 D’s are “outside D’s”. P wants to excuse the demand requirement on the
FUTILE basis.
i.
ii.
iii.
Very powerful tool
the courts have
iv.
DE §23.1 g. Delaware Approach – Aronson v. Lewis – Two Prong test
Should the Claim be Excused?
DE NY MBCA
Demand would be futile, Demand would be futile, Always Have to Make
therefore it is excused. therefore it is excused. Demand.
Majority of the board is Majority of the board is
tainted – demand would be tainted – demand would be Always Have to Make
futile and is therefore futile and is therefore Demand.
excused. excused.
Less obvious. Here we can Less obvious. Here we can
trust the democracy of the trust the democracy of the Always Have to Make
BOD and should not BOD and should not Demand.
excuse. excuse.
Here we count those under Here we count those under
control of the tainted control of the tainted
Always Have to Make
person as tainted person as tainted
Demand.
themselves. Demand is themselves. Demand is
excused. excused.
Demand is excused (under
Demand is excused (easier
control of interested Always Have to Make
argument – under control
director – we still think it Demand.
of the interested party)
would be excused)
The Court laid out 3 different approaches:
 Delaware Approach
 MBCA Approach
 NY Approach
This Court adopts the NY Approach and says the Demand is excused
with respect to the 15 “outside D’s” but NOT for the “inside D’s”
BUT court still has tremendous discretion in determining if S/H has
stated A CAUSE OF ACTION b/c of the particularity requirement
(at the pleadings)
Ct in this case ruled against the S/H’s and that they must make the
demand requirement b/c it found that they failed to state a cause of
action – b/c it lacked particularity.
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 i. S/H’s do NOT have to make the demand requirement if the S/H’s state
allegations with particularity and create a reasonable doubt that:

The statute says you  D’s are disinterested and independent; OR

need both of these, but
S.C. said only need 1  The challenged transaction was a result of a valid exercise of
Business Judgment

ii. Criticism

 It is too vague and unclear (how many D’s have to be

disinterested)

 By using the reasonable doubt standard, the court is importing a

crim law standard for a judge to apply, merely upon the pleadings

h. NY Approach –
NY §626(c)
i. In order for the S/H’s not to have to make a demand on the D’s, the
S/H’s must state with particularity that either:

 Majority of the D’s are interested; OR

o Director interest may either be self-interest in the

transaction at issue, or a loss of independence because a
director with no direct interest in a transaction is
“controlled” by a self-interested director.

 D’s failed to inform themselves reasonably necessary about the

transaction; OR

o Did not inform themselves of the transaction to the extent

reasonably appropriate under the circumstances.

 D’s failed to exercise their Business Judgment

o So egregious on its face that it could not have been the

product of sound business judgment.

ii. This test is clearer then the DE Approach, but it could be just as
BROAD

MBCA § 7.42 i. MBCA and ALI Approach –

i. Universal Demand Requirement - demand can NEVER be excused

ii. Rationale:

 Gives Board a chance to re-evaluate the situation (do the right

thing)
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  Eliminates the time and expense that is a result of litigation about
whether demand is necessary

iii. S/H is NOT permitted to bring the suit until 90 days after he issues a
written demand to the Corp.


o permitted to file sooner than 90 days if irreparable harm
would be cause to the Corp by waiting

iv. Under MBCA, the S/H’s are always in a losing position, b/c if the
Corp disagrees, and does not want to bring suit, its decision will be
protected by the BJR -

j. If S/H does NOT make demand, P needs to show that is excused (FUTILE) and
also need to state a cause of action (pleadings must be with particularity)

k. If the S/H’s make the demand on the Board, 1 of 2 things could happen:

i. Board Agrees; OR

ii. Board Disagrees

o S/H can walk away, OR

o If the Board disagrees with the demand and does NOT bring the
suit, then the P (S/H’s) can still sue. BUT this is considered a
management decision and will be protected by the BJR (thus,
only way to overcome this, is to show the Board was grossly
negligent [tainted or uninformed) [either the Board or the SLC
makes the decision]

iii. Under DE law, the fact that the S/H made the demand, means that the
P has admitted the Board is disinterested, and thus if board decides
not to bring the suit, you are screwed.

o Thus, in DE, S/H’s will never make the demand

l. If the S/H does NOT make demand on the Board and just brings the suit, 1 of 2
things could happen, either:

i. Corp Agrees (rare); OR

ii. Corp Disagrees – Corp challenges the case on the grounds that the
demand should have been made (extra-litigation). As a result, the
Court will decide whether:

70
 o Demand is Required; if this is the case, the S/H will always lose
and will not even go on with the rest of suit OR

o Demand is Excused – BUT even if the court excuses the demand

(b/c it would be FUTILE), the Corp can still challenge and try to
dismiss the case by arguing either:

 S/H failed to state a claim 12(b)(6) – failed to

plead with particularity;

Special Litigation Committee = OR

 Subset of the Board
 Comprised of untainted
disinterested D’s
 Usually new members of the
Board
 Charged with looking into
the plaintiff’s allegations.
 We don’t want BOD
deciding – want
independent SLC
 SLC always says dismiss
(not really that indep.)
 Set up a Special Litigation Committee - and the
Committee decides if the suit should be go forward
or be dismissed.
 Court is only permitted to review the SLC’s
decision procedurally - look at the
NY procedures and methodologies of the SLC
and that the SLC discharged their duties in
good faith. BUT the court is NOT permitted
to second guess the SLC’s substantive
decision, b/c the SLC is protected by the
BJR

 Court can review the SLC’s decision both

DE procedurally AND substantively. Thus the
SLC is NOT protected by the BJR

m. Auerbach v. Bennett – (NY) – Demand was properly excused and the Corp still
tries to dismiss the case via SJ. The majority of the Board was tainted but there
NY are 3 new members of the Board that became members after the shadiness, and
thus are disinterested and NOT tainted. These 3 members make up the Special
litigation Committee (“SLC”) and they investigate and conclude that the suit is
NOT in the best interest of the Corp.

i. Ct. says the SLC should be making this decision even though it
consists of D’s hired by tainted D’s. It would be rendered powerless if
they could not make this decision. In fact, it would be a breach of
fiduciary duty if they delegated this nondelegable duty. For the Cts
to preside would be an outster of the BOD’s fundamental
responsibility and authority over corporate management.

ii. Ct is NOT permitted to second guess SLC’s substantive decision b/c

they are protected by the BJR, but is it permitted to look at the
following:

 the procedures the SLC used in making its decision (did SLC look
It is unclear as to who at the appropriate stuff?); AND
has the burden of proof
 see if the SLC followed these procedures in good faith
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 iii. Directors seem to have the burden to show that they have pursued their
chosen investigative methods in good faith. CB370 – roadmap what
you ought to do to show your procedures were kosher.

iv. Criticism – the SLC is comprised of disinterested D’s, but these D’s
were all appointed by tainted Board members – [and NY does not care
about this]

v. Conclusion - In NY, the Corp will normally win, whether you do or do

NOT make the demand, b/c they are always protected by the BJR

 NY Ct. can review the SLC’s independence – can look at

whether they undertook procedurally appropriate steps.

 NY Ct. can look at substantive wisdom if there was no

independence/procedurals were inadequate. Burden will be
on the board to show why the case should be dismissed.

n. Zapata Corp v. Maldonado – (DE) - Demand was properly excused but the Corp
DE is still trying to dismiss the case via SJ. The Corp sets up a SLC comprised of 2
guys who are new members of the Board – they are disinterested. The SLC
advised that the case should be dismissed.

i. The Court ruled that the S/H’s have a right to commence a demand
excused suit, but do NOT have a right maintain the suit the whole
time. Rather, the Corp can step in and take over, via SLC, b/c it is a
management decision.

ii. The court said that the SLC has the power to dismiss the case on
behalf of the Corp, however, the court is permitted to second guess it
procedurally AND substantively

 Procedurally – make sure the SLC is NOT tainted and that it had
proper procedures and that it followed those procedures in good
faith. (same a NY)

o Corp has the burden of proof

 Substantively – Ct can apply its own independent judgment as

to whether the SLC made the correct decision. This is a much
more searching inquiry.

o Basically, the SLC is NOT protected by the BJR

o HUGE because it lets the Court SECOND GUESS.

Thought to be incredibly intrusive of the BOD. Many
people think that the DE allows the intrusion because it was
concered about structural bias.

72
Is Demand Made?
BOD Agrees: file suit

BOD Refuses:
Make the demand (remember if
1. S/H can go away;
you make the demand you are
YES
admitting the maj. of the board is
2. S/H can sue. (here corporation is going to move
not tainted.)
to dismiss – appoint an SLC, etc. Here the Ct. will
use BJR and only review procedural issues.)

2. If demand was excused: S/H will sue;

ASK: Should the S/H have made
corporation will again make a motion to dismiss.
the demand?
(SLC appointed). Court will make a very searching
inquiry:
1. Ct. finds demand should have
been made (dismiss the case)
1. is the SLC independent;
NO Remember in MBCA you must
2. what procedures did they take?
always make the demand. (end)
3. Review of the Merits. (more intrusive, but
maybe that’s because it’s a demand excused case
2. Ct finds that demand was
and it is more likely the board is tainted) DE will
excused (Marks v. Akers)
always look at/NY only if fail 1 or 2.

o. MBCA Approach

i. The process:
MBCA §7.44  S/H is always required to make demand

 Corp will likely reject the demand [Board or the SLC]

 Derivative suit is brought by S/H’s

 Corp. makes a motion to dismiss

 MBCA adopts the same approach as NY:

o Thus, Ct is only allowed to second guess the SLC’s

decision procedurally (did they have proper procedures
and did SLC follow those procedures in good faith) and is
NOT permitted to second guess the SLC's substantive
conclusion, b/c protected by the BJR.

 MBCA is basically the same as the NY approach, BUT it

clarifies the burden of proof element – at the pleadings level the
burden is on the P, but at trial, the burden is on the Corp. [the
Corp must prove its decision was procedurally proper and was in
good faith (followed the procedures)]

ii. The dismissal can only be decided by majority of the independent

D’s that are present at the meeting, but only if the independent D’s
constitute a quorum (50% + 1 of the Board)

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  BUT if the disinterested D’s by themselves do NOT constitute a
quorum, then the disinterested D’s set up an SLC; where only need
majority vote of the committee of 2 or more independent D’s

o SLC must be appointed by majority vote of independent

directors present at a meeting of the BOD.

iii. Everyone making up the SLC, the ones who will issue the dismissal,
must be independent. However, the court will decide if the following
individuals are independent even if:

 they are a named Defendant in the suit; or

 even if the new members were appointed by the shady D’s

iv. MBCA says independent b/c it goes beyond disinterested – it means

you are NOT subject to control.

38. Recovery in Derivative Suits

a. If S/H wins, the Corp wins and the S/H gets nothing.

i. BUT, if the Corp wins, the S/H does recover the costs of litigation

ii. In most instances, the Corp will pay for the S/H’s attorneys fees

b. If S/H loses, the S/H has to pay the costs of litigation

i. Some states even require the S/H to pay the att’s fees of the Corp and
the D’s – but only if the court concludes that the S/H sued without
reasonable cause

c. res judicata – once S/H makes a claim, no other S/H can do it again

d. Who pays for the Directors expenses, whether he wins or loses?

i. Remember can limit liability somewhat under MBCA §2.02(b)(4) and

DE §1.02(b)(7)

ii. Insurance – CB387 sometimes Corp’s get what is known as D & O

MBCA§8.57
Insurance. This spares the D’s from personal liability from breaches
of the duty of care. This covers the D when he loses.

 Typically covers loss arising from claims made from negligent

rather than intentional injury.
 Because the triggering point on the insurance is the date of
the claim, not the date of the act, a former member of the BOD
would have an interest in its former company maintaining D&O
insurance.

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 iii. Indemnity – 3 possible scenarios for Corp to indemnify D’s or
MBCA §8.50§8.52
Officers, under the MBCA:

 Mandatory– if the D wins the Corp “shall” indemnify him for his
§8.52 reasonable expenses in any suit to which he was a party b/c he
was a D.

o Reasonable expenses = include attorney’s fees

o Even if the D prevails merely on a technicality the Corp

must indemnify him.

o Under the MBCA, the D must be “wholly successful,”

thus he must win the entire case. Thus, if D gets sued on 5
counts and wins on only 4 of them, the Corp is NOT
required to indemnify him

o Other States, omit the word “wholly,” and instead put in

the words “to the extent” he was successful. Thus, it is
more D friendly and probably would indemnify him in the
previous example

 Permissive – purely discretionary. Corp “can” indemnify the D if

§8.51(a) he acted in good faith and D reasonably believed that his conduct
was in the best interests of the Corp.

o This applies if the D is being sued by a 3rd party

o Basically, if the D is living up to his duty of loyalty, then he

“may” be indemnified

o Criminal proceedings – accused had no reason to think it

was unlawful.

o CATCH ALL RESIDUAL CATEGORY – IF IT

DOESN’ FIT IN MANDATORY OR PROHIBITED,
PUT IT IN PERMISSIVE.

 Prohibited – if the D is being sued by the Corp or on behalf of

§8.51(d)(1)
the Corp (derivative), then the Corp is NOT permitted to
indemnify the D for any judgment against him or settlement.

o BUT Corp “may” be able to pay for the D’s expenses [but
only the D’s expenses and nothing else] if he met §8.51(a) -
he conducted himself in good faith and he reasonably
believed his conduct was in the best interests of the Corp
(can get this even if D losses).

 The Corp is also prohibited from indemnifying the D if he is held

§8.51(d)(2) by a court to receive an improper personal benefit [this applies to
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 not just suits by the Corp but also 3rd parties] Look out for
securities violations fact pattern – S/H received improper personal
benefit.

§8.53 iv. Advances for Expenses - if you are a defendant merely b/c you are a
D, then you might be able to get the Corp to front litigation expenses

v. Settlement – If D is sued for breach of duty, the corporation may pick

up the tab for expenses if you meet §8.51(a), but the Corporation
may NOT pick up settlement amount.

e. Random shit

§8.54 i. Court has the broad power of ordering indemnification

ii. Court can NOT indemnify a D, unless it is approved by the appropriate

§8.55 people

§8.56 iii. Officers get the same deal as D’s regarding indemnification

iv. REMEMBER UNDER §8.51(a) you have the right to ask for
indemnification – you don’t have the right to it necessarily.

a. No right to indemnification unless fall under §8.52.

b. If you settle, you fall under §8.51 and you don’t have the right to
expenses (it is permissible though).

R. Pre-emptive Rights in Stock

39. it is the right to maintain your % as a shareholder – protects the S/H from dilution

i. BUT shareholders still must pay full price for the stock, it is just the
“right of first refusal.”

40. it only applies to issuances – when Corp is selling its own stock

41. pre-emptive rights only apply when the stock in the issuance is sold for money (if
shares are compensation, you do not have preemptive rights)

MBCA §6.30(a) 42. Under the MBCA, shareholders do NOT have pre-emptive rights unless the Articles say
so

i. Thus, it is an Opt-In statute

43. Other states have an Opt-Out statute, where the shareholders have pre-emptive rights
unless the Articles say that they do NOT.

44. Pre-emptive rights make sense in a “close” Corp – b/c want to keep outsiders out, but
do NOT really make sense in public Corp b/c it is impractical – too many S/H’s

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 45. Byelick v. Vivadelli – Opt-out state. dispute b/w minority and majority S/H’s. The
majority S/H amended the Articles to get rid of the pre-emptive rights. After doing so,
he issued another 50,000 shares and the maj. S/H bought them all. The minority S/H
argues that the maj. S/H breached his fiduciary duties and thus brought a direct suit.

a. The reason this is a direct suit is b/c this is a close Corp, and the minority S/H is
getting personally screwed. Thus, in close Corp, owe fiduciary duties directly to
the other S/H’s.

b. Ct relies on Donahue, and says that a close Corp is essentially like a partnership,
and S/H’s thus owe fiduciary duties to each other.

c. Ct holds that the majority S/H had a right to amend the Articles but that in
everything he does he owes fiduciary duties to the minority S/H – thus, court
FREEZE OUT concluded that the majority S/H breached his fiduciary duty by freezing the
minority S/H out. – [this is ultimately a breach of the duty of loyalty [can also be
oppression]]

d. Burden is on the defendant to show:

i. Fairness to the Corporation of the consent of the BOD.
ii. Fairness of the actual sale itself.

S. Venture Capitalists

46. model – entrepreneur comes up with an idea and needs money and therefore tries to
borrow money, but it is really difficult to get debt-financing b/c it is usually a start-up
and most Corp’s won’t survive, thus, the only way these entrepreneur’s ever get money
is through Equity Financing, which is a venture capitalist

47. Venture Capitalist –

a. VC invests in this risky start-up in exchange for 40-50% interest and sometimes
the ability to control decisions

48. BUT VC needs to also protect himself, b/c 2/3 of all start-ups fail. He does this by:

a. Downside protection

i. Liquidation preference clause – VC gets paid first

ii. Redemption of Option of investors – VC can force the Corp to buy

him back if Corp goes to shit

b. Upside opportunities

i. Option to buy if the stock goes up

ii. Registration Rights – regarding the IPO, in order to go public there

are lots of filing and disclosing requirements.

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 c. Voting and veto rights

d. Exit opportunities

T. Common Law Fraud and Misrepresentation: Rule 10b-5 Constraints on Any Stock
Issuance
49. Rule 10b-5 – promulgated by SEC in 1948. (CB419) Rules are broadly applied.

Unlawful for any person (entities count) , directly or indirectly, by the use of any means or instrumentality of
interstate commerce, or the mails or of any facility of any national securities exchange (interstate nexus),

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary to
make the statements made, in the light of the circumstances under which they were made, not
misleading, or (duty to disclose – if I say something, I cannot stay quiet to make the statement not
misleading)

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or
deceit upon any person, in connection with the purchase or sale of any security.

CB421 Problems
1. First this is C/L Fraud – someone says something and you rely upon it. CEO is officer of a corporation.
Also, 10b-5 violation (a)(b)(c). No doubt – it is in connection with the purchase or sale of a security.

2. This is not C/L fraud because there is no material misstatement. He didn’t lie. Falls under 10b-5 (b) this
would be an omission of stated material fact that would make what you have said not misleading.

3. No C/L fraud. Not a violation of 10b-5. (b) imposes a duty of disclosure only if what you already said
would be misleading. However, case law does impose liability here (simply a hint of how broadly 10b-5 can
be construed)

4. Common Law Fraud. Epstein can get in trouble here. It is not limited to corporate defendants. The
individual can get slammed. Note that Epstein is not selling the stock – the defrauder is not selling the stock,
but it does not matter. In connection with the purchase or sale of a security.

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 U. How do shareholder’s make money?

50. Shareholders make money, either by:

a. selling their interest - sell stock for more then it is worth; OR

b. ownership interest generates money, either:

i. receive dividends; OR

ii. the right to employment (salaries)

 this is only possible in “close Corp’s”

51. It sucks to be a minority shareholder in a close Corp – b/c of the potential for serious
oppression. [could get dividends denied, could get fired from employment] And the
problem is that no one in their right mind would ever buy stock from a minority S/H,
thus minority S/H’s have begun suing - claiming oppression

52. 2 ways a minority shareholder can sue claiming OPPRESSION:

a. Legislative – some states allow a minority S/H to dissolve a Corp based on

oppression b/c the word “oppression” is in the dissolution statute. However, some
courts will not dissolve, but rather just force the majority S/H to buy-out the
minority shareholder

b. Judicial – some courts recognize a cause of action by a minority shareholder for

oppression.

53. Salaries

a. MBCA really does NOT talk about salaries

i. MBCA §7.32 (a)(5) You can agree in the AOI on establishing the
terms and conditions of any agreement fro the transfer or use of
property or the provision of services between the corporation and any
S/H, director, officer or employee of the corporation or among any of
them.

b. It is a management decision of who gets to work and for what amount –

however, there is room for abuse

When close corp is c. Wilkes case – (Mass) – 4 shareholders and 3 of them fire the 1 minority
permitted to take shareholder and take away his salary. S/H sues for oppression and wins. There
away salary w/o is a fiduciary duty and oppression is a violation of that duty. The ct
being oppressive established this model: [Legitimate Business Purpose Test]

i. Burden is on the P – prove the D’s breached their fiduciary duty

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  it depends on jurisdiction in determining if there even was any
duty breached – if in jurisdiction that follows Donahue for close
corp – then usually a duty

ii. Burden is on the D – D can make a defense that it was a legitimate

business decision

iii. Burden on the P – BUT P can still show that there is a less drastic
alternative for accomplishing the business purpose

d. Hollis v. Hill – 2 S/H’s have an equal interest in the Corp [50/50]. The started
fighting and Hill transferred part of the Corp into a sole proprietorship, stopped
sending Hollis financial reports, decided to cut costs by reducing salaries (Hollis =
$0, Hill = $80k), and closed the Fla office, which is where Hollis worked.

i. Ct applied the Internal Affairs Doctrine – and thus NV law applied

in TX federal court. (note that NV is not bound by this decision)

ii. In NV, there is NO Legislative Oppression statute and there is also

NO Judicial Approach for Oppression, but the ct nonetheless adopts
the Judicial Approach of Donahue and finds that the Hill breached his
fiduciary duty.

iii. Problem with this case, is that Oppression doctrine really should NOT
apply b/c there is NO minority shareholder (50/50) – BUT ct doesn’t
care b/c Hill is the one controlling everything (taken control of the
Corp assets)

iv. If it is a close Corp, and we follow Donahue, then ct can look to see if
there is oppression and will not follow the BJR.

 BUT in a jurisdiction that would NOT adopt Donahue, the

majority S/H’s actions would be protected by the BJR.

v. The ct finds oppression in this case, b/c Hollis had a legitimate

expectation that he would receive a salary for his employment – thus,
his employment was part of the deal. (Breach of the legitimate
business purpose test (supra)).

vi. Remedy - the ct acted as if the word “oppression” was included in the
statute and forced a buy-out of Hollis

 Reminds us of a partnership, we dissociate whenever we

want, the only question is whether it was wrongful.

e. Freer says that there is a difference b/w investors who make money by way of
salary (employment is part of the deal) v. employees who happen to be
investors. Thus, those that have a legitimate expectation for a job (employment is
part of the deal), and their employment is taken away, then they have an action for
oppression b/c the majority S/H has breached his fiduciary duty.

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f. The statutes are silent with regard to what is an appropriate salary, thus the
limitations are imposed by TAX LAW

i. salaries are tax deductible

ii. Corp must pay income tax, but it can deduct salaries as a business
expense

iii. BUT dividends/distributions are NOT tax deductible for the Corp

iv. Thus, Corp try to disguise dividends as salaries and therefore payout
higher salaries, to save $ on taxes

v. BUT some shareholders may prefer dividends b/c they are taxed at a
lower rate (capital gains tax) as opposed to salary which is taxed a
regular rate

vi. Posner says that it is a greater danger in close Corp then it is in

public Corp to disguise the dividends as salary b/c in public the board
is separate from the officers and thus will set the salaries appropriately,
but in a close Corp, the one making the decision is also the one getting
paid (wear 2 hats)

g. Exacto Spring v. IRS – Corp paid the CEO a $1.3 million salary and claimed it
as a tax deduction. The IRS disagreed, claiming it was way too high to be a mere
salary and was a disguised dividend. The Tax Court applied a 7 factor test and
arbitrarily determined what the proper salary should have been.

i. Upon review, Posner expressed dislike for the factor-test, arguing that
it is non-directive and vague, the factors have nothing to do with the
task at hand, it invites the tax court to be in a super-personnel dept,
gives no guidance and gives no certainty.

ii. Posner instead looks at the Indirect Market Test: a corporation can
be conceptualized as a contract in which the owner of assets hires a
person to manage them. The owner pay the manager a salary and in
exchange the manager works to increase the value of the assets that
have been entrusted to his management; that increase can be expressed
as a range of return to the owner’s investment. The higher rate of
return (adjusted for risk) that a manager can generate, the greater a
salary he can command.

iii. Posner reverses and says the CEO is doing a very good job b/c his
Corp is making 7% more profit than the average Corp, and Posner
said this could be attributed to the CEO. Therefore the salary is
presumptively reasonable.

iv. Posner says that the only way the IRS could decrease his salary is if
they show that the increase in profit had to do with something other
than the CEO.
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 v. Also, the government could still prevail by showing that this was in
fact a concealed dividend.

 Here, CEO didn’t set his own salary – no one inside the company
is unhappy with what the CEO is getting paid. There is no bad
faith, no overreaching here, no conflict of interest, no oppression
– therefore BJR should apply.

vi. BUT at some point, excessive salaries might be a waste of corporate

assets, and may be a breach of the duty of loyalty (conflict of interest),
and the BJR will NOT apply.

h. Giannotti v. Hamway – minority S/H v. majority S/H dispute. Close Corp.

When D’s are Nursing home D’s are giving themselves huge salaries and simultaneously have
paying excessive been giving the “outside D’s” no dividends. The minority (outside D’s) S/H’s are
salaries asking for dissolution of the corp., appointment of a receiver and the inside D’s to
repay the money they took out (restitution) on the basis of oppression – of
excessive salaries.

i. Ct found there was oppression – taking advantage of minority S/H’s is

a violation of the standard of fair dealing – it does not require fraud
or illegality. Breach of duty of loyalty.

ii. In determining there was oppression on the grounds of excessive

salaries, the court looked at the following factors:

 Ratio of salaries to profits

 The inside D’s experience in nursing homes
 Most of the D’s are part-timers
 Look at the amount of profit in contrast with other nursing homes

iii. This state has a legislative basis for oppression, but the minority S/H
wants the court to force a buy-out instead of dissolution. BUT Va
law does NOT allow for a buy-out, and only allows for dissolution and
that is what the court ordered.
 Always look very carefully at the dissolution statute

iv. BUT Ct refused to give restitution for the $ the inside D’s already
took.

v. In “close Corp’s” we get rid of the BJR, b/c there is self-dealing b/c the
people making the salaries are the people receiving the salaries – thus,
there is a likely finding of oppression.

54. Dividends

a. Dividend is a subset of distributions. Distributions are payments from the

corporation to the S/H because you are a S/H. Three major kinds:

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 i. Dividend - per share; pro-rata; payable in cash or in property;

ii. Repurchase – corporation buys your stock back from you.

iii. Redemption – set in the AOI; gives the corporation the right to force
you to sell the stock back at a set price.

b. Dividends represent the return to the investor who put his money at risk in the
corporation. Rewarding existing S/H, and to encourage others to buy new issues
of common stock at high prices.

c. common in public Corp’s

i. most common form of distribution

d. how much you can pay out is limited by statute

e. NO statute requires that the Corp pay a dividend, it is left to the discretion of the
Board – protected by the BJR unless it is self-dealing

f. NO such thing that a S/H has a right to a dividend. Thus, P will always lose if
he tries to force the Corp to pay dividends (b/c it is NOT a statutory
requirement) [unless show BAD FAITH]

i. Ziddell v. Ziddell – close Corp. Minority S/H worked for Corp and
received a salary and then voluntarily quit and complains that his
dividend is too small. Therefore, the minority S/H sues for
oppression

 Ct says minority S/H can NOT force the Corp to pay him a higher
dividend b/c the burden is on the P to show bad faith. BUT P
failed to meet the burden, and thus, the majority S/H is protected
by the BJR. [thus, if Corp says that they want to keep it in house to
generate more business the P will lose b/c of the BJR]

 This case would have come out differently if P was fired. This
would have looked a lot like Wilkes (supra). Here, since there was
no finding of bad faith, the BJR applies (in Giannoti, there was a
finding of bad faith and therefore the defendant could not rely on
the BJR)

ii. FREER know of only one case in which a court forced a corporation
to pay more dividends absent a showing of bad faith. Dodge v. Ford
Motor Co. – in this case the Mich. S. Ct. forced Ford to pay the
dividend w/o a showing of bad faith. Our rule of thumb is Zidell
unless you have a fact pattern identical to Ford which it will never be.

g. There are certain situations where the Corp is forbidden from paying out
dividends – when the Corp is INSOLVENT or the distribution will make the
Corp insolvent:

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 h. There are 3 tests used to figure out if the Corp is insolvent:

Modern Approach i. Equity Test = if the Corp “can NOT pay debts as they come due”; OR

MBCA §6.40 (c)(1)(2) ii. Bankruptcy Test = If Liabilities > Assets

 Liabilities includes IOU’s and stock that has a dissolution

preference
TX, DE and NY iii. Traditional View – Corp is permitted to pay distributions out of the
follow this view Capital Surplus OR the Earned Surplus

 Earned Surplus (Retained Earnings) - $ earned from making

money in the real world. Corp “may” make distributions out of
these funds.

o Formula: Earnings – losses – distributions previously

paid.

Every $ that comes in
from the issuance goes
into either the Stated
Capital OR the Capital
Surplus fund.
 Stated Capital - gets the par value from the issuance. [if par =
$2 and the sold 1000 shares = $2000]
o This can NEVER be used for distributions (b/c it is
supposed to be the cushion to protect C’s)
 Capital Surplus – the excess over par goes into this fund [if par =
$2 and Corp sold 1000 shares for $5, then the fund has $3000]

o This can be used for distributions, but in many states you

must tell the S/H’s that you are making the distribution
from this account

i. If Corp is in a state that adopts the Traditional View, but does not have par stock,
then it is up to the board to decide, but if Board says nothing – the default
position is that is STATED CAPITAL

j. The traditional view is rarely used today b/c it gives Corp’s the ability to
manipulate par (make it a very small amount) and then the C’s are NOT protected.

k. Sinclair Oil Corp v. Levien – (DE) - Sinclair is a holding Corp and it owns 97%
of its subsidiary, Sinven. Sinclair has the Sinven Board constantly pay out
dividends but they were legal b/c they came out of the Capital Surplus. P owns
the other 3% of Sinven and he sues arguing that the majority S/H breached its
fiduciary duty to the him,(minority S/H) by paying out too many dividend

i. Ct says that they look at this under 1 of 2 tests, either:

 BJR; OR

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  Intrinsic Fairness Test – This is the same test from HMG
Courtland – looks at both procedural and substantive decision of
the Corp– very searching inquiry.

o BUT this test only applies when there is a conflict of

interest

ii. Ct in this case, applies the BJR b/c it said there really was NO conflict
of interest b/c Sinclair is NOT self-dealing.

 Reason the Corp is NOT self-dealing is b/c the minority S/H is

getting the same dividend as the majority S/H (getting treated
the same way)

 Court says this would be a problem if there were two classes of

stock and Sinven paid dividends on only one class of stock.

55. Classes of Stock

a. All shares within a class must be treated alike

i. BUT the different classes can be treated differently

ii. Different classes of stock must be listed in the Articles

b. Common Stock – this is the residual category. It is whatever is left over after
paying all the other classes – no preference

c. Preferred Stock – means getting paid first, it does NOT mean getting paid more

i. There are 2 types of preferences:

 Dividend preference

 Liquidation (dissolution) preference

ii. The Articles must state what the preference is ($2) how many shares
are preferred (20,000 shares)

iii. Preferred Participating – “pay again.” This means that those with
the preferred stock will initially get paid first and then they also get
added into the pool with the common stock holders and get paid again
with the common stock people.

 Ex: $2 preference for 20,000 shares, and 100,000 common shares

and a $400,000 distribution. Thus, the S/H with the preference get
paid $40k first and then get paid again in the $360,000 distribution
to the common stock holders. Thus, instead of dividing $360,000
by 100,000, we divide it by 120,000.

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 iv. Preferred Cumulative – dividends add up from year to year and if
Board does NOT declare a dividend for a number of years, it just gets
added to the next time they pay out dividends.

 Ex: Same numbers as the previous example but this time the
Board does NOT pay out dividends for 3 years (+this year). Thus,
this year you multiply the $2 preference x 4 years and these 20,000
shares get paid $8 a share. Thus, there is $240,000 left for the
common stock

 It is possible to have Preferred Cumulative Participating

56. Buying and Selling Stock at a Profit

a. if public Corp, this is very easy, just sell stock on the open market

b. if “close” Corp, the it is difficult to sell stock b/c there really is NO market.

i. Thus, the way to figure out how much the Corp’s worth, you can look
at the Corp’s books and then sell your % of stock.

ii. BUT if the information that you have access to is NOT really on-point
(altered in some way), then you can get screwed.

c. Thus, there are certain laws that govern the “purchase and sale of any security”
that protect those parties involved from fraud or misrepresentations

d. Rule 10(b)(5) – this all about fraud and misrepresentations with regard to both the
“purchase and sale of any security.” (investment)

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V. Rule 10(b)(5)

57. Rule = “it shall be unlawful for any person (includes Corp’s),

a. (1) To employ any device, scheme or artifice to defraud

b. (2) To make any untrue statement of a material fact OR omit to state a

material fact necessary to make the statements made, in the light of the
circumstances under which they were made, not misleading, OR

c. (3) To engage in any act, practice, or course of business which operates or would
operate as a fraud or deceit upon any person, in connection with the purchase or
sale of any security

58. In a 10(b)(5) case, need to show all of the following:

a. Materiality – an omitted fact or stated fact is material if there is a substantial

likelihood that a “reasonable person” would consider it important in making his
decision.

i. Most of the time it is very easy to figure out if something is material

ii. BUT in certain situations, we need to apply the Probability-

Magnitude balancing test. See Basic, Inc.

 We only apply this in situations which are very speculative and we

are not sure about the outcome yet [potential mergers]

iii. Defendant is sometimes protected by the “bespeaks caution

doctrine”

b. Reliance – this is really difficult to determine in a public market transaction

i. Thus, it is determined by the “Fraud-on-the-market theory,” but

with regard to publicly traded companies.

ii. When there are face-to-face representations, reliance is much easier

to prove and fraud-on-the-mkt theory does not apply] – it becomes a
jury question

c. Loss Causation – P has the burden of proving that the act (lie) or omission of the
defendant caused the loss [caused the P to buy the stock]

i. This is very closely related to Reliance

d. Scienter – “knowingly” – the statements or omissions must be made in a slimy

manner and NOT by accident

e. Particularity - When alleging fraud in the pleadings, must always do so with

particularity (this is to avoid frivolous and cookie-cutter complaints)
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59. 10(b)(5) is really a criminal proceeding, thus, the SEC has the power to punish and
fine D for violations (prosecuted criminally)

a. BUT Cts have inferred that there is a private right of action for 10(b)(5)
violations as well. (Herman & MacLean v. Huddleston – S.Ct. decision)

60. BUT, to be a Plaintiff under 10(b)(5), the P must be:

a. seeking damages (NOT equitable relief)

b. Birnbaum rule – must be a buyer OR a seller of securities

i. Those folks who sit on the sidelines and do not buy or sell in the face
of a false or misleading statement may not bring a private case for
damages under Rule 10b-5.

61. 10(b)(5) applies to both Public and “Close Corp’s.”

62. 10(b)(5) requires there to be interstate commerce

63. applies NOT just to re-purchases but issuances as well

64. With respect to INSIDERS, 10(b)(5) imposes a duty upon them:

a. they either DISCLOSE the information OR ABSTAIN from buying it for

personal benefit.

65. Basic Inc. v. Levinson – this case is all about misleading statements (NOT LIES).
Corp was asked if they were in negotiations for a merger and they said NO, b/c it was
discussions and NOT negotiations - misleading. Corp also stated that they did not
know why the volume on the stock was increasing rapidly – also misleading. Corp
eventually went through with the merger and the stock soared. P brought a class action
to recover money, claiming that they sold in reliance on these misleading statements,
and had there been disclosure, they would NOT have sold. Ct remanded but it looks like
this was a violation of 10(b)(5) as a result of the misleading statements.

a. In order to determine Materiality, the court used a BALANCING TEST:

i. Probability-Magnitude Test = the probability the event will occur v.

the magnitude of the future event.

 The higher the level of the executives, the more probable the
merger is.

 In determining the magnitude, need to factor in the size of the

Corp

 Problem – the test is hard to predict

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 b. Ct in this case concluded that the magnitude of the event was so big that it (in
merger – the Corp will disappear if it goes through) outweighed the probability
of the event not occurring]and thus found it to be material, b/c a reasonable person
would find this fact to be material

c. In order to determine Reliance, which is difficult in the public setting, the court
applied the “Fraud-on-the-Market theory”

i. Needs to be a public statement

ii. Needs to be a publicly traded company (that has lots of volume)

iii. AND, the market must digest that information so that it was a factor
in determining the price of the stock.

d. The “Fraud-on-the-market theory” allows the P to switch the burden b/c reliance
is now presumed on part of the P, and the D must rebut it by a showing that
severs the link between the alleged misrepresentation and either the price received
(or paid) by the plaintiff or his decision to trade at FMV. (not likely D can ever
rebut it)

i. Must show market makers were privy to the truth, OR

ii. Plaintiff believed that he statements were false, but sold anyway for
unrelated concerns.

66. EP Medsystems, Inc. v. EchoCath, Inc. – this case is about face-to-face

representations. Echo Director lied to EP in order to get EP to invest in Echo’s
company. If this is true, Echo should be liable for a 10(b)(5) violation, BUT Echo
argues that it is protected by the “bespeaks caution doctrine.”

a. “Bespeaks Caution Doctrine” - this permits the defendant CORP to make

misleading statements and those statements are NOT considered to be Material,
only if: [protects the defendant]

The sources of this rule are i. if Corp lies or misrepresents to someone; AND
both common law and a
statutory “safe-harbor” ii. But somewhere else there is cautionary language (everything I say is
speculative); AND

iii. The cautionary statements must be specific to the alleged misleading

(forward looking) statements; AND

iv. The misleading statements must be “forward looking” statements

v. If this is all true, then the statements are NOT material

b. Ct in this case failed to allow the Defendant to protect himself with the “ bespeaks
caution doctrine” b/c the misleading statements were NOT forward-looking,
they were merely about the present. Thus, his misleading statements were
Material.
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 c. Ct in this case did NOT care that the pleadings were NOT alleged with
particularity as required, via Scienter, b/c this was not a frivolous suit, rather, it
was brought by someone out $1.4 million

d. With regard to Reliance, ct said it is a jury question – question of fact. Ct said it

was NOT unreasonable to come to the conclusion that the P relied on D’s
misrepresentations b/c this was a face-to-face representation.

67. Malone v. Brincat – (DE) Corp’s earnings were grossly overstated and S/H’s end up
holding their stock and NOT selling. When the news gets out that the Corp has screwed
up, the stock plummets and the S/H takes a huge loss, and sues.

a. Ct rules that the P’s can NOT sue under 10(b)(5) b/c they did NOT buy and did
NOT sell stock, they just held on to it.

b. Thus, the only claim P can sue on is under DE state law for breach of fiduciary
duty (for their misrepresentation). The P sues the D for breach of the DUTY OF
Not 10b-5 (use DISCLOSURE –
state law)
i. DE basically created this fiduciary duty (combination of the duty of
loyalty and good faith)

c. There are 3 times where the Corp is bound by the DUTY of DISCLOSURE, and
is bound to communicate with the S/H’s:

i. Public statements made to the market

 DE law doesn’t help you because you are covered under the
Federal Regulation

ii. Statements informing S/H’s about the affairs of the Corp without
request for S/H action (not required by law)

 While the Defendants argue since they had no duty to disclose,

they don’t have to worry about the propriety of their statements,
the court says you stil have a fiduciary duty to disclos accurate
information. Tell the truth, not as a duty to disclose, but under
the umbrella of duties that you owe.

iii. Statements to S/H’s in conjunction with request for S/H action.

 Required to give S/H information on topics of fundamental

changes.

 Duty to tell the truth – duty to release accurate info.

d. The Ct takes this one step further and says that anytime the Corp talks to the
S/H’s, (whether it is required to or NOT), the Corp is NOT permitted to LIE.

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68. Dupuy v. Dupuy – 2 brothers have a Corp and 1 buys the other out for a low price.
The brother lied to him by not disclosing info about a partnership in order to depress the
price of the stock.

a. 10(b)(5) applies even in close Corp’s regarding the sale or purchase of stock

b. the brother argues that 10(b)(5) does not apply b/c there is no federal jurisdiction,
b/c no interstate commerce.

c. Thus, 10(b)(5) requires there to be interstate commerce

d. BUT court rules that even the telephone calls he was making intrastate, were
sufficient for interstate commerce.

i. Thus, almost anything is sufficient to be interstate commerce – it is

read very BROADLY (telephone call, letter, check)

ii. The only way there would not be interstate commerce is if it was a
close Corp, and the people met face-to-face and cash exchanged hands
– then 10(b)(5) would NOT apply and would have to argue common
law fraud.

iii. The interstate commerce nexus does not have to be used for the
fraudulent behavior itself.

69. SPECIAL FACTS DOCTRINE – “Insiders” (D’S and O’S) owe an affirmative duty
to disclose special facts – what a reasonable investor would think is important.
[defined like materiality]

a. BUT the “insiders” only owe the affirmative duty to existing shareholders and
thus doctrine does not protect “would be investors.”

b. This is important – b/c it allows S/H’s to sue where they normally would have no
remedy under common law fraud, b/c that only applies to lies and not non-
disclosures

c. This doctrine only applies if this is a private transaction as opposed to one in the
public market.

i. At least one court has held that insider trading on the open stock
market violates a fiduciary duty to the corporation and thus opens the
offending insider to a derivative suit. (even thought the corporation did
not suffer a loss as a result of their actions). The case might be saying
that the insiders misappropriated corporate property (the confidential
information) for their own benefit.

d. only some states accept this

e. only have to rely on the common law special facts doctrine if you can NOT do 10
(b)(5) and you are buying securities

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 f. Goodwin v. Agassiz – Goodwin owns 700 shares of Cliff Mining. Agassiz is
president and director. G sold the stock and A bought it on an exchange. A had
information that there were copper deposits on land just purchased. G sues.

i. Ct. says this is not C/L fraud. Ct. says that the defendants had no duty
to set forth to the S/H’s this information. Here we don’t apply special
fact doctrine because we are not sure that this is a special fact and this
was on a public market.

ii. Ct. here rejects the view that a director who obtains inside information
in his role as a director holds the information in trust for S/H’s

iii. Ct does recognize a situation that when a director personally seeks a

S/H for the purpose of exploiting insider information (and the S/H’s
lack of information), the transaction will be closely scrutinized and
relief may be granted.

g. SEE HYPOs CB 521

70. INSIDER TRADING – trading on information that I have b/c of my position

a. Insiders = D’s or Officers or temporary insiders and (anyone who has a

relationship of trust and confidence)

b. 10(b)(5) – imposes a duty upon INSIDERS:

i. they either DISCLOSE the information OR ABSTAIN from buying

it for personal benefit.

 If disclosing, what must you disclose? Material information

(Balancing Probability v. Magnitude)

ii. Purpose of this rule, is to assure equal access to information – based

on fairness

iii. The part of 10(b)(5) that is violated as a result of insider information,

are provisions (1) and (3), which talk about fraud, b/c we just expand
the meaning of fraud.

 We learn from this that 10(b)(5) is much BROADER then

common law fraud, (b/c insider trading is NOT common law
fraud b/c don’t have to disclose and under special facts doctrine
only have to disclose to S/H’s, and therefore it is limited), rather 10
(b)(5) is applying the federal meaning of fraud, which is much
broader then common law fraud.

o The federal meaning of fraud adopts the notion of the

special facts doctrine, but expands it and applies it even to
people who are NOT merely shareholders, but applies it to
anyone that buys or sells securities.

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c. SEC v. Texas Gulf Sulfur – insiders knew there was minerals in an area and
bought up all the land around it and before the press release came out, the insiders
bought a shitload of shares. Ct ruled this was insider trading and therefore a
violation of 10(b)(5) b/c they did NOT disclose or abstain

i. If couldn’t get to federal court, could also argue under the special facts
doctrine. (couldn’t be C/L fraud because there was no untrue
statements)

ii. buying the land from the seller w/o disclosing was NOT a violation of
10(b)(5) b/c it was NOT for the sale of securities – it was land

d. Chiarella case – guy at printing company looks at documents that he should NOT
have that talk about an upcoming merger, but the target company was left blank
on the pages. He did his own research and figured out the target company and
bought stock in that company.

i. SC found him NOT guilty. They said that to find him guilty, he
needed some relationship of trust and confidence with the company
whose stock he was dealing with.

 Traditional View of 10(b)(5) = Anyone that has a relationship of

trust and confidence with the Corp that he is dealing with, owes a
duty to that company and therefore would be guilty of insider
trading. [usually D’s or O’s]

ii. The guy in this case had no relationship of trust and confidence and
thus he owes no duty to the company and is NOT covered by 10(b)(5)

iii. Rule 14(e) – 3 would apply to Chiarella – it is aimed at the fraud

committed in connection with a tender offer.

e. Dirks case – total fraud case. Publicly traded Ins. Co. claimed they were making
money and sent out fake reports. Disgruntled employee ended up telling an
analyst of the scam and the analyst informed all his clients and told them to sell
stock and only after that, did he inform the SEC of the scam. SEC then went after
the analyst for insider trading. The analyst ended up winning.

i. Court adopted the Traditional View, but expanded it to include

“temporary insiders” – anyone who is temporarily taken into trust
and confidence of the Corp and given access to inside info (could
include attorneys) – it makes sense that those persons have the same
duties as insiders

ii. This is a classic “Tipping case”:

 Tipper – one who passes along inside information in breach of

his duty to his corporation [info that if he used himself he would be
screwed for] AND also must receive personal benefit by doing
the tip (like duty of loyalty)

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 o Personal benefit = money, make a gift of this, enhance
reputation

 Tippee – you must trade on the tip AND must know or should
have known the tipper was giving over the tip improperly

iii. court ruled that the disgruntled employee was NOT a tipper b/c he
was NOT doing this for personal benefit, rather he was only trying to
break up a fraud.

iv. Thus, b/c there was NO tipper, there can be NO tippee and the
analyst is off the hook.

f. O’hagen case – big time lawyer in law firm finds out about a huge merger that his
firm was doing, although he was NOT on the deal, and buys stock and ends up
making 4M and gets busted and is prosecuted under 10(b)(5).

i. court adopts the Misappropriation Doctrine as an alternative to the

traditional view. [much easier to get a conviction this way b/c don’t
have to figure out the duty]

 Misappropriation Doctrine – If individual is found stealing

information, then he is guilty of fraud.

ii. In this case, lawyer violated 10(b)(5) by misappropriating information

[STEALING information]. He stole from the law firm’s client, and
was therefore found guilty of fraud.

 Point – the lawyer was NOT a “temporary insider” – thus, would

not have been able to find him in violation of 10(b)(5)

iii. Misappropriation Doctrine is good law when the government is

bringing the suit

iv. BUT in a private action, it is questionable whether the doctrine could

be applied.

Z. Section 16(b)

71. do NOT have to have scienter to violate 16(b)

a. it is Strict Liability – intent is irrelevant

72. In a 16(b) action, the corporation is the plaintiff

73. Corp sues for profits for buying and selling Corp’s “own” stock in a 6 month
period – “Short Swing Trading”

a. If violate 16(b), must pay to the Corp the profit earned – usually a derivative suit

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74. Potential Defendants:

a. Directors

b. Officers

c. Beneficial Owner = more than 10% S/H’s

75. 16(b) ONLY applies to publicly traded Corp’s on national exchange (10b-5 wasn’t
limited to registered corps)

76. To be covered under 16(b), [when not referring to D’s or O’s] need to be more than a
10% shareholder before you buy or sell – you take a snapshot of the holding
immediately before the purchase or sale. (see Reliance Electric v. Emerson
Electric Co. (CB558))

77. It is IMPERATIVE to have both a buy AND a sale within 6 months to be covered
under 16(b)

78. It does not make a difference if the D or O or 10% S/H is really losing money in the
grand scheme (whole year of buying and selling), all 16(b) is concerned with is whether
he is gaining a profit in the 6 month period, and if so, he is liable.

79. To figure out how much is owed, all you need is there to be a buy at a lower price
then a sell (it does not mater what order it is in)

a. To figure out the amount of shares to multiply the amount of profit per share, you
just do it by the largest number of shares that is common to the purchase
AND sale.

b. If there are multiple sales and buys, then you match them up with the highest
buys and the lowest sales (you could pick any 2 and match them up)

80. HYPOs
a. Start at 0 buy 15%. If you have 15% and buy 5% more, then the purchase is
covered. The sale of all 20% you will be hit on the profit of 5%.

CB563
b. Registered; 1M shares outstanding. R buys 200K 1/20.
i. If he sells these shares (assuming R is not D or O) he will not be liable
because the purchase took him from 0 to 20%. (snapshot before
purchase)

c. If R is a director, he is covered under 16b – 10% is irrelevant.

i. (a) 1/20 200K @$10. 5/1 sells 200K @30K. $20/share profit * 200K
shares = $4M he owes corporation.

ii. (b) 1/20, 200K @10K. 5/1 he sells 110K @$30. $20/share profit
*110K shares = $2.2M; 5/ 10 sells 90K @$40K. $30/share profit *
90K = 2.7M profit. Owes $4.9M.
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 d. Freer is officer owns 200K shares; bought the stock two years ago at $70/share.
1/1 – freer sells 100K/shares @$30. March 1 Freer buys 110K/shares @ $20.
Just based on this Freer is liable under §16b. He bought at 20 and sold at 30.
Buying or selling can be in either order. Focus on the sale – he sold at 30,
6mos. before or after, did he buy at less than 30? YES. He bought at 20.
Here Freer would be hit on $10 * $100K/shares. Ouch this sucks.

e. What if Freer sells an additional 110K shares on 4/5 for $10/share? Focus on
the sale. Here there are two sales. Did Freer buy at less than 10? NO, there is no
profit. If her was to sell at more than 20 it would again fall under §16b.

AA.Common Law Duty of Selling S/H’s

81. Debaun v. First Western Bank & Trust Co. – J founded corporation and hired D and
S. J had majority of shares, then died, leaving the shares for the bank to take care of.
Bank sells the shares to M who is a corporate looter. There was plenty of evidence that
said M was shady, and the bank knew this, but still sold him the shares. Mattison
destroys the company and D sues the Bank.

a. Court says that there is a duty to investigate as a prudent person would, and if
you fail to investigate, you are liable for all harm inflicted on the corporation.

i. Duty is owed to both the S/H and the corporation (therefore could have
been either a derivative suit or direct suit.

b. Damages: Bank breached duties in selling to M. Liability of the bank is to put

the corporation in the position it ought to have been in. Elements of the damage:
i. Value of Corporation when the bank sold.
ii. Loss of earning power (PV: 8% profit over 10 years)
iii. Claims of valid creditors against corporation

c. Derivative suit. One of the problems of which is the damages recovered are
partially going to the bad guy – M because he owns 70% of the stock.

82. Perlman v. Feldman – (unique set of facts that will never be replicated). About
controlling and minority S/H’s. Feldman sold his interest to another Corp and his stock
at a really high premium. The reason he got such a premium is b/c NOT only did he
sell them his shares, but he also sold them the right to run the Corp – this is called the
“controlling share premium.” The minority S/H’s sue claiming that this premium is a
Corp asset.

a. In this case, Feldman did NOT own (50+ 1 share percent), rather only 37%, but
the court considered him controlling b/c everyone else in the company owned a
really small amount

i. this is common among the courts today

b. As a general rule, a controlling shareholder IS permitted to sell his stock for a

premium (based on his controlling interest) and it is NOT a Corp asset (it is a perk
of being a controlling S/H)

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 c. BUT if the controlling S/H sells his controlling interest:

i. without doing a reasonable investigation; AND

ii. to someone who hurts the Corp

d. then the controlling S/H could be liable for all the harm that is done to the Corp

i. RULE = controlling S/H has a fiduciary duty to do a reasonable

investigation of the buyer upon selling his shares

e. Court ended up holding Feldman liable even though the Corp’s stock increased.
Freer said the decision was WRONG b/c there was no problem as of yet.

83. Rule = a Controlling S/H can NOT sell a Corp asset without sharing it with the Corp

i. BUT the premium is NOT a Corp asset

84. Rule = Some courts do NOT allow a controlling S/H to sell or include seats on the
Board in the deal.

a. Ex: if controlling S/H sells to X for a premium on the condition that once X takes
over, the controlling S/H will have his buddies on the Board resign – some courts
say this is against public policy

b. BUT, if the controlling S/H is actually the majority S/H, then as part of the deal it
is ok if he has his buddies on the Board resign

i. B/c the new buyer could do it anyway by just firing the board members
at the first meeting

BB.To Whom can a Shareholder Sell his Shares?

85. Equal Access Rule – in “close Corp,” the minority S/H’s must be given the same equal
opportunity as the majority S/H’s are given

a. not universally accepted

b. most states do not accept it in such a broad blanket proposition

c. Ex. Corp buys back 100% of majority S/H’s stock, must also give minority S/H
opportunity to buy back 100% of their stock (done on a pro-rata basis)

d. Distribution = dividends (do really occur in close Corp’s) AND repurchase

(where the Corp buys back stock from a S/H)

e. established by Donahue

f. Donahue v. Rodd Electrotype Company of New England – close Corp and

Corp buys back stock from one of the heavy hitters (repurchase) and a minority

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 S/H wants the Corp to repurchase his stock but the Corp refuses. (normally this
would be protected by the BJR, but not in a close Corp)

i. Close Corporation:
 Small number of S/H’s

 No ready market for the corporate stock

 Substantial majority S/H participation in the management,

direction and operations of the corporation.

ii. Court said that in a “close Corp,” S/H’s owe each other the same
fiduciary duties as partners owe each other

 Partners owe each other the highest and utmost duty of good faith
and loyalty – much higher standard

iii. Court ruled that the D’s have a fiduciary duty in a close Corp, to give
the little guy the same equal opportunity as you give the big kahuna

 Reason – there is a fiduciary obligation in a “close Corp” – b/c

Oppression majority S/H can always oppress the little guy

 AND, unlike in a partnership, a S/H of a Corp can NOT just walk

out, and thus the courts must help out the little guy

iv. Thus, minority S/H should have been given the opportunity for a
repurchase

86. Stock Transfer Restrictions – (a.k.a. Buy-Sell Agreements)

a. simple contract

b. these are very common, particularly in “close Corp’s”

MBCA §6.27 c. MBCA §6.27 – codifies this

i. §6.27(a) – tells you where the restrictions should be put in (Articles,

by-laws, agreement among S/H’s, agreement among S/H’s and the
Corp)

ii. §6.27(b) – tells you how to make it enforceable – needs to be

conspicuously noted on front or back of the certificate
 not all states will enforce it

iii. §6.27(c) - needs a proper purpose – See statute

iv. §6.27(d) – 4 types of restrictions:

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  obligate the S/H to first offer the Corp the opportunity to acquire
the shares

 obligate the Corp to acquire the shares

 require the Corp or a class of shares or another person to approve

the transfer of the shares

 prohibit the transfer of shares to designated persons or classes of

persons

d. Jordan v. Duff & Phelps, Inc. – Corp had a buy-back agreement – where the
S/H’s are all employees and when the employee leaves the Corp, he is forced to
sell his shares to the Corp. Jordan leaves Corp and they buy him out. BUT soon
after they bought him out, the Corp was bought out and the stock almost doubled.
Jordan sues the Corp under 10(b)(5) for the Corp’s failure to disclose those
material facts to him, b/c if the Corp would have disclosed, he would have NOT
sold his shares. The merger ends up falling through and 2 yrs later the Corp
makes another merger.

i. The court ends up ruling that (SJ) a jury could find in Jordan’s favor
b/c there could be a fiduciary duty on the Corp’s part to disclose

ii. Although the Corp never lied and never made any misrepresentations,
thus no common law fraud, Jordan still might win under the special
facts doctrine – but the SFD only applies to shareholders.

 BUT here Jordan was a shareholder at the time of the buy-back and
thus the SFD applies and the Corp is liable for its failure to
disclose.

iii. this could also have been brought under 10(b)(5) b/c it has adopted
the special facts doctrine, but it is even broader be it covers people
who are NOT even shareholders.

 Corp has a duty to disclose this relevant material fact – b/c a

reasonable investor would think it is important

iv. Freer says that you could waive the 10(b)(5) protection – thus, Corp’s
could add a provision in the buy-sell agreement that waives the 10(b)
(5) protection – but only in a private suit b/c -

 it is a crim provision, thus, if SEC wants to go after you they can –

it can NOT be waived

e. Berreman v. West Publishing Company – basically the same facts as the

previous case. Corp buys Berreman’s stock back when he leaves and after he
leaves a merger goes through and the stock soars. Berreman sues alleging that the
D’s breached their duty to disclose to him the merger. (if he would have stayed he
would have received 5 times what he got)
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i. Berreman does NOT sue under 10(b)(5) b/c he brings the suit in
STATE court – thus, he could only win with the special facts
doctrine.

ii. Court originally says that this Corp is NOT a close Corp b/c they have
200+ shareholders but Berreman gets around this by saying that the
Corp is really run by 1 family (3-4S/H’s), which owns 94% of the
stock.

iii. Thus, court treats this as a “close Corp,” and therefore, under Donahue
there must be a duty to disclose all material facts (b/c treats “close
Corp’s” as a partnership)

 BUT this biased state court rules that these facts were NOT
material by applying the magnitude-probability balancing test
(the probability that this would NOT occur outweighed the
magnitude of the event) and therefore said the merger discussion
were merely speculative and thus there was no duty to disclose.

 Freer said this decision was WRONG b/c it is just like Basic, Inc.
and Jordan

iv. This case is an example where the court applied 10(b)(5) jurisprudence
even though this was filed in state court.

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 CC.Endgame for the Corporation

87. It is a Fundamental Corp Change – so organic that the Board never really does it
alone, the S/H’s usually have to approve it (includes things such as amendment of AOI,
dissolution, merger, etc.)

a. First must get Board approval then, S/H approval.

b. There are 3 approaches to S/H approval of all Fundamental Corp Changes:

MBCA §11.04(e) i. MBCA – need a quorum of majority of votes entitled to be cast and
then need majority of the votes actually at the meeting (only those
that vote at the meeting, not majority of the votes present)

 Not many states adopt the MBCA in this area

ii. Most States – need a quorum and then need a majority of the shares
entitled to vote

iii. Traditional Rule (some states adopt this) – need a quorum and then
need 2/3 of the shares entitled to vote

 NEW YORK – if Corp is formed on or before 2/22/98, then need

2/3. BUT if Corp is formed after 2/22/99, then only need
majority

88. Dissolution

a. During Dissolution, must go through the Winding Up phase:

i. gather up all the assets and then liquidate themthen pay C’s
the S/H’s get paid, if anything is left over (this is a dividend [could get
a liquidation preference] then get a certificate of dissolution, and
the Corp is out of business

ii. Corp stays in business and is in an entity until the wind up phase is
over

iii. it is good to do the formal dissolution b/c if the Corp does NOT, it
could be liable in franchise taxes

MBCA §14.02 b. “Voluntary Dissolution”

i. this is a fundamental Corp change

ii. Board needs to recommend dissolution to the S/H’s after it approves it,
and then the S/H’s vote on it

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  There are rare situations where the Board does NOT decide and
only the S/H’s make the decision

iii. S/H must get notice via §14.02(d) – even non-voting shares.

iv. Approval by the S/H’s –








 Depends on what state you are in, either 1 of the 3 approaches

v. HH’s approve

c. “Involuntary Dissolution”

i. Administrative Dissolution – done by the Secretary of State

 When a Corp fails to do something that it is required to do

 Given a 60 day grace period, after that, if still fail to do it, get
involuntarily dissolved

 Ex: annual report, register agent, franchise taxes

MBCA §14.30 ii. Judicial Dissolution – done by the court (Giannotti Case)

 There are 4 ways the case can get into court:

o The Attorney General can go after the Corp

 Act fraudulently or in abuse of its power (act in

ultra vires way)

o Allows a S/H to sue for dissolution

 Can do this if he believes the D’s acted in an illegal,

oppressive and fraudulent way

 Usually in “close Corp’s,” the judge won’t order a

dissolution, but a buy-out instead (read the statute to
determine what remedies are appropriate for each
state)
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 o Creditor can sue

o The Corp itself can sue

89. Merger

a. Generic phase that covers both traditional mergers and consolidations

i. Traditional Merger = A and B form one entity and one survives.

A+B=A

o A = surviving Corp

o B = disappearing Corp

ii. Consolidation = 2 corps get together and form a whole new entity and
the original 2 Corp’s disappear. A + B = C

b. Triangular Merger = When A wants to acquire B and before A does so, A forms
an entire new subsidiary, C, whose stock is solely owned by A. Now C and B
merge together and C becomes the surviving Corp, which is solely owned by A.

i. Reason – B’s liabilities now go to C and they do NOT pass to A –

thus, shielding A from liability. BUT can still PCV.
 While B’s S/H’s would still have a vote, this might be a way to
avoid A’s S/H’s from having a say in the transaction.

ii. This is a forward looking triangular merger

iii. Reverse Triangular Merger = if B and C merged, but B was the

surviving Corp

c. Any merger must be approved by the Board’s of both Corp’s

d. Effect of Merger -
MBCA §11.07
i. the surviving entity succeeds to ALL the “rights” AND “liabilities” of
the disappearing Corp

o Therefore, C’s of the disappearing Corp become C’s of the

surviving Corp

ii. The S/H’s of the disappearing Corp get whatever the merger plan
gives them

o The plan of merger will always spell out what the S/H’s of the
disappearing Corp get – it must be clear

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 o usually just get stock of equal value in the surviving Corp
OR they get a check (cash-out merger)

e. There are 2 or (maybe 3) forms of protection for S/H’s – provided by statute:

i. Maybe S/H’s get to vote on the approval

ii. Dissenting S/H’s right of Appraisal

iii. Might be able to sue D’s for breach of fiduciary duties– this is very
rare

f. S/H’s right to Vote on merger:

i. The disappearing Corp’s shareholders always must vote (3 different

approaches) (b/c it is a fundamental Corp change)

ii. BUT if you are a shareholder of the surviving Corp, and as a result
MBCA § 11.04(g) of the merger your life as a shareholder does not change, then the
shareholder’s do NOT get to vote. (Ex: same # of shares, identical
preferences . . .)

 Must meet all 4 of the requirements in the statute

o Corporation will survive the merger
o AOI will not be changed (except if under 10.05)
o S/H rights do not change, same number, etc.
o Vote is not required.

g. Dissenting S/H’s Right of Appraisal

i. This only applies to close Corp’s or Corp’s with less than 2K S/H’s

 Does not apply to publicly traded Corp’s, the value of the stock is
MBCA §13.02(b)(1);
well established by the market
DE §262(b)(1)
 MBCA says this also does not apply to any Corp with more than
2K S/H’s and the stock is worth at least $20 mill.

ii. this is the S/H’s right to force the Corp to buy him out at “fair value.”

 This is NOT fair market value b/c there is No market

iii. This right applies to Mergers and the Sale of the Assets (it can, but
never really is applied to amendments of the Articles)

iv. This applies to cash-out mergers and stock mergers

v. There are 3 requirements that all must be satisfied for the S/H to get
this right:

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  (1) S/H must make a written demand to the Corp before the deal
goes through stating that you are against the deal and you want to
be bought out if the deal goes through

 (2) The S/H must abstain or vote against the deal

 (3) After the vote, S/H must make a formal written demand against
the Corp, saying that you have warned them and now you are
making the demand.

o This must be made w/in 20 days of the deal

vi. General Rule = can only make the demand if you are permitted to
vote on the deal

 Exception: Short Form Merger – this is 90% owned subsidiary

is being merged into a parent. In this case, the S/H do NOT have
to vote b/c obviously they will lose, yet, they may still have this
right of appraisal
o Strong sense that the below cases don’t apply to the
short form merger. The courts have been less willing to
entertain claims of fiduciary obligations. What this tells
you is, you should keep buying stock and then do a short
form merger.

h. HMO-W, Inc. v. SSM Health Care System – SSM is 20% S/H of HMO-W.
HMO-W is going to merge into United. When they announce the merger they say
HMO-W is worth 17 mill. When the merger goes through, SSM perfects its right
of appraisal b/c when the merger actually went through, HMO-W claims that it is
only worth 7 mill, thus decreasing dramatically the amount each S/H will receive
from the merger. Additionally, HMO-W discounts the minority shares by 30%,
arguing that it is a close Corp and thus should get paid less b/c as minority S/H’s,
they have no controlling rights and b/c there really is no market for the shares.

i. This court rejects the minority share and lack of marketability

discount. Thus, when determining the fair value, it means the % of
the true value of the Corp as a whole, without reducing it for minority
status.

 Court determines fair value

ii. Even though the statues say that the right of appraisal is the S/H’s only
right, Freer says that S/H’s can still sue for the breach of fiduciary
duties

 Ex: if the guys figuring out the appraisal were acting fraudulent

i. Sue D’s for Breach of Fiduciary Duties: Weinberger v. UOP –(DE) Signal
owns 50.5% of UOP and they are the controlling S/H. Signal wants to acquire the
rest of the shares and try to figure out a target price. They decide that it would be
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Both of these tests a good deal anywhere up to $24. So then they agree to merge with UOP and they
apply when there is a agree on $21 a share, w/o ever telling the rest of the UOP Bd about the $24 issue.
shady Merger - the Divided loyalties. Thus, there is a breach of the duty of loyalty b/c Signal wants to
guy actually benefits get the lowest price and UOP wants to get the highest price – and Signal has a
personally duty to both is own S/H’s and the minority S/H’s of UOP. Thus, there are
fiduciaries on both sides of the deal.

i. S/H brings a suit for breach of fiduciary duty even though the merger
was approved by 76%

ii. The D’s obligation not to breach fiduciary duties exists

notwithstanding any statutory right to appraisal (although there should
be no right to appraisal here.)

iii. Ct. says there is no need to show a legitimate corporate purpose here
(for the entire fairness test below) because it is a parent/sub
transaction.

iv. Since there is a conflict of interest here, the BJR goes out the window.
The burden is now on the defendants. The entire fairness test is then
used.

v. The Court said the ENTIRE FAIRNESS doctrine applies and it is the
D’s burden to show both:

 Fair dealing – look at the procedures (did the outside D’s really
Both cases are NOT have enough time to make a good decision, especially if they did
interested D NOT know about the $24 price); AND
transactions,
although they look o Court found that Signal fails the course of dealings test.
like it All of this was Signal’s idea, there was a lack of disclosure
and this was railroaded by Signal.

 “Fair price” - some courts use the DE block method (weighted

average method), which is a method of setting the price for
appraisal proceedings, yet it is also used for breach of fiduciary
duties, but DE courts reject it in favor of any method that is
acceptable in the financial community to figure out fair price –

o Ct. said it was not sure if price was right either.

 There is lots of leeway here

j. Coggins v. NE Patriots (Mass) – AFL was a wonderous and noble thing.

Weird type of Corp b/c the Pats are NOT publicly traded but still have thousands
of owners – thus, somewhere in between a close Corp and a public Corp. Sullivan
owns all of the voting shares and wants to buy out all the non-voting S/H’s of the
Corp in order to give collateral to the bank for his persona loan. Thus, he forms a
new Corp and decides to have a merger with the new and old Pats and the new
Pats will survive with a cash out sale of the existing non-voting stock. Non-

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 voting S/H decides to bring a class action against Sullivan for breach of
fiduciary duty – conflict of interest –

i. It is sketchy that the S/H brought a direct suit b/c normally the D never
owes a duty to the S/H, rather only to the Corp, but in a close Corp,
the D does owe a duty to the S/H and here it is not really a close Corp,
so the S/H should not have been able to really sue the D in a direct suit
and thus should only have been permitted to bring a derivative suit.

ii. Court rules that Sullivan is NOT permitted to do this b/c he lacks a
legitimate BUSINESS PURPOSE – thus, the court won’t even look
at fairness if there is NO legitimate business purpose

iii. Remedy: recissory damages. . . (won’t get recission because it is so

far from the merger) Cashed out at a price if the merger didn’t happen.
Get the difference between the value of his stock today, and what he
was paid.

iv. Court says that the S/H has the right to sue for breach of fiduciary
duty, notwithstanding the S/H’s right to a S/H right of appraisal

 Thus, even if the statute says that the right of appraisal is the
exclusive remedy, the duty of loyalty will always trump

 Here, the S/H’s were allowed to get a right of appraisal, even

though they had non-voting stock

 IN DE: plaintiff must show conflict of interest. At that point the

burden shifted to the defendant. Must meet the entire fairness test:

o Course of dealing;
o Price (Weinberg)

 In Mass. plaintiff must show that there is a conflict (here the

controlling S/H was putting his own interest first.) Now the
burden shifts to the defendant. The defendant must show that the
deal had a legitimate business purpose. (which was rejected by
DE). Notice even if you can show a legitimate business
purpose, the defendant still must show entire fairness. MASS
IS TOUGHER!!!!

k. Cash Out Merger HYPO -- S owns 20% of the stock of T. A owns just under
49%. T and A enter into a cash-out merger. S believes the $30 price is
inadequate. How will the minority s/h proceed?

i. Breach of duty of care like in Van Gorkum. Not enough time in

the meeting.

ii. Have the right to vote against the merger, but you’re going to lose.

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  Some states requires 2/3rds

 Majority states require majority

 MBCA majority of those who do vote assuming we have a

quorum.

iii. Right of appraisal.

 But S wants to stop the merger from happening.

iv. Breach of Fiduciary duty.

 There are shenanigans here where the deal is being done for an
improper purpose

 Must show that this is done for selfish motives.

 Mass. – D must show Leg. Bus. Purpose and entire fairness

 DE – only need to show entire fairness

 MBCA -- §13.02(b) S/H can’t get an injunction that

appraisal right is exclusive unless unlawful or
fraudulent (Some MBCA states basically follows DE or
MA)

90. Sale of Assets

a. this is normally done to avoid liability

b. it looks like a merger

c. Instead of B merging into A, B just sells all its assets to A. Thus, even though B
has sold all its assets, B still exists (it has money instead of assets).

d. Thus, if there is a claim against B, X must sue B and NOT A (b/c A has NO
successor liability) But eventually B will dissolve.

e. When there is a sale of the assets, the Board’s of both corp’s must approve it

f. BUT, the general rule is that need S/H approval only from the SELLING Corp
(B) b/c it is a fundamental corp change

g. MBCA §12.01 – Says that S/H approval is NOT needed (unless Articles say
otherwise) with regard to:

i. selling of assets in the usual course of business

ii. mortgaging assets

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 iii. transferring assets

h. MBCA §12.02 – Process for when need S/H approval:

i. Sell off assets, and its effect leaves the corp w/o a significant
business activity

ii. The Board have to approve and then the S/H’s must come to a special
meeting

iii. Notice must be given, whether or not the S/H’s are entitled to vote

iv. You need approval by majority of the votes cast if there is a quorum

 DE need majority of shares entitled to vote

i. It depends on the statute whether there is a S/H’s right of approval for S/H’s with
non-voting stock – most of the time they do NOT have the right to vote

j. DE §262 says that you do NOT get a S/H Right of Appraisal for the sale of
assets –

i. BUT in most states S/H’s do get this right for the sale of assets

k. What happens if a C’s claim does not arise until after the corp that sold its assets,
dissolves?

i. In most states, there are SOL that say you must bring your claim w/in
some period. Some states will have a fund in reserve for 3 years for
these type of C’s (usually environmental torts)

ii. Franklin v. USX - Franklin dies from asbestos and her husband is
suing the corp responsible. BUT the corp that gave it to her no longer
exists b/c it dissolved, but before it dissolved, it sold all its assets to
USX. P is trying to hold USX liable on the grounds of successor
liability.

 Successor Liability - the thrust of these theories is that the

purchaser of the assets IS liable just like in a merger. There are 4
different theories of successor liability:

o (1) Successor agrees to be liable – this is impractical

o (2) de facto merger – the transaction amount to a

These 2 are very consolidation or merger of the two corporations
similar
o (3) “mere continuation” theory - A has some debts, and to
unload its debts, they sell their assets to B. BUT if B has
the same officers and D’s as A, then it would seem like this

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 is a mere continuation of A. Obviously, the problem is that
A is trying to get rid of its debt and they sell their assets to
B and then buy the assets back for some minimal amount

o (4) fraud – extremely difficult

 With regard to (2) and (3), if there was adequate consideration

given for the sale of the assets, then the courts will not even look at
these theories and successor will NOT be liable. – this is what
happened in this case.

 In order to prevent successor liability, the buying corp is better off

paying cash for the assets, b/c if they pay stock it looks more like a
merger

l. HYPO: Approval by S/H CB667-668

S sells assets to B in exchange for 283K shares of B. B stock will be distributed to S’s S/Hs. S will dissolve. C
owns 140K shares of the 280K shares of B. C is pissed because he is going to a 50% S/H of B to less – control
is being diluted. This is DE.

I. Preemptive rights. Only attach if a cash transaction.

II.
III. If this were a merger, under DE the S/H of both corporations get to vote. It is a fundamental
corporate change for both.

QQ.In DE you need a majority of shares entitled to vote. C can block this transaction.

I. If merger under MBCA, you only get to vote if you are the disappearing target.
II. This is not a merger though, it’s a sale of assets:

RR.In virtually every state this is a fundamental corporate change requiring approval by the BOD of
S and B, but only a S/H vote only for the seller, not for the buyer.

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 I. Limited Partnerships

SS. Introduction

91. How to form a limited partnership:

a. must file with the Secretary of State and then the LP comes into existence
(unlike general partnership which is formed by action) In the filing we need:

i. name
ii. address of office and name and address of agent for service of process
iii. name and business of each general partner
iv. the latest date the limited partnership can dissolve

b. Must file to get limited liability.

c. LP is an entity in the eyes of the law

d. there must be at least 1 general partner (who has the same duties and liabilities
as a partner in a general partnership [jointly and severally liable] – bound by
UPA/RUPA) and at least 1 limited partner

e. The general partner is the one who is supposed to have all the management
responsibilities and thus has all the liability to 3rd parties

f. How does a general partner avoid personal liability? Have a corporation be your
general partner. Limited Liability of the corporation at the general partnership
position.

g. Limited partner –

i. The limited partner is NOT supposed to be liable for debts

ii. Limited partner does have a right to inspect the books

iii. limited partner must invest in the LP

iv. limited partner has the right to bring derivative suits

v. Thus, limited partners look like S/H’s - passive investment

TT.At what point do we treat a limited partner as a general partner?

92. RULPA §303 helps to resolve this:

RULPA §303
a. §303(a) - limited partners are NOT liable for obligations of the LP unless:

i. the limited partner participates in the control of the business; AND

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 ii. the person suing reasonably relied on limited partner’s actions b/c
they believed he was a general partner

b. §303(b) – it acts as a SAFE HARBOR b/c it lists a TON of things that do NOT
constitute control and thus it is extremely difficult for a limited partner to be held
liable b/c of §303(b):

Permitted to do all this i. can be Officers and Directors of the corp that is the GP
and it is still NOT ii. Contractor/agent/employee
considered control iii. Consulting, advising a general partner
iv. Surety
v. Derivative action
vi. Requesting or attending meetings of partners
vii. they can vote to approve and disapprove
viii. can remove a limited partner
ix. Allows you to spell out in the PA, what the LP’s can do, and that is
NOT considered control

93. Normally, a corp is the GP so can only go after them for a certain amount - and no
personal liability on the officers or D’s

94. Zeigler v. Wilf - Zeigler has land and decides to sell it to a corp and in return Zeigler
was supposed to receive a consulting fee for years to come. The corp defaults on its
payments and Zeigler sues. After the Corp bought the land it assigned it to a LP. The
general partner for the LP is another Corp whose VP was Wilf. The limited partners are
Midnov, CPA, and Zeigler. BUT the corp’s stock is owned by CPA and Midnov. Wilf
is also the general partner of CPA. Q arises, about who is really running the LP?

a. Zeigler stops getting paid and decides to go after Wilf b/c he argues that although
Wilf is only a limited partner, he should be held liable as the general partner

b. Court says that the only way Wilf can be held liable as a general partner is if he
exercised enough control over the business and the court concluded he did NOT
(b/c of safe harbor) and thus he was NOT liable (de facto- Wilf is running things;
De jure – Wilf is not the general partner)

c. Zeigler could have gotten a personal guarantee from Wilf once he saw the corp
as the GP

§403 UU.Duties owed to each other and the partnership

95. §403(a) – the GP has the rights and powers (this is stuff he can do) of a partner at a
general partnership unless the PA changes this

96. §403(b) - With respect to 3rd parties, GP is just like a general partner at an ordinary
partnership and is therefore subject to the restrictions of RUPA and UPA.

a. This can NOT be limited by the PA (same as RUPA/UPA)

97. §403(b) - BUT with respect to liability to the other partners and the partnership,
GP is like a general partner at an ordinary partnership unless the PA says otherwise
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 a. Thus, the PA can severely limit the duties the GP owes to the other partners and
the partnership as a whole. [just a matter of contract law]

98. Kahn v. Icahn – API (corp) is the GP of AREP. Kahn is a limited partner of AREP.
Icahn owns and runs API and is also a limited partner. Kahn accuses Icahn of
breaching his fiduciary duty to AREP by usurping a corporate opportunity- everyone
agrees that Icahn did usurp a corp opportunity but Icahn still ended up winning.

a. Icahn ends up winning b/c the Partnership Agreement stated that the D’s of API
(the GP) can compete directly or indirectly with AREP.

i. judge found that Icahn’s conduct fell w/in the language of the PA and
thus Icahn was NOT liable. No one forced Kahn to enter into the
contract

b. The PA says that you can do this, and the DE state statute allows you to state
whatever terms you want in the PA, and the PA is allowed to permit the GP to
compete with the LP. [this is the same as §403(b), which lets the business people
run their show instead of state imposed duties]

c. This is a clear example of how we have moved in the direction of contract law
(let the people decide for themselves) as opposed to state imposed duties

i. the law and economics crowd has one the debate

99. Thus, in an LP, partners (GP) can waive fiduciary duties to each other, but in corp’s you
can NOT

100.In re USA Cafes – GP is a corp and it is run by the Wiley’s who dominate the Board
and the stock of the corp. Another business comes along and purchases all the assets of
the LP for 72 mill. BUT the limited partners complain that that is NOT enough money,
yet they can NOT do anything b/c they have no voice. (if corp, they would get to vote,
but LP’s have no rights unless PA says so) The limited partners claim the GP (people
running the corp – the Wiley’s), are getting kickbacks. The Wiley’s claim that they
only owe fiduciary duties to the corp, and do NOT owe fiduciary duties to the LP.

a. Unlike the previous case, the judge here says that the D’s of the GP (the Wiley’s)
do owe fiduciary duties to the LP. We believe that the officers of the
corporation do owe duties to the limited partnership as well as the general
partnership corporation.

b. Judge makes an analogy to trust law. Where the trustee has to do everything in
his power to look out for the beneficiary (who judge says is analogous to the LP)

i. Trust = a relationship where X transfers his legal title (of something

valuable) to the trustee and the trustee owns the property and then
gives it out to the beneficiaries but the beneficiaries own the equitable
title.

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 ii. Law imposes the highest fiduciary duty on trustees (higher then
Meinhard v. Salmon)

iii. Someone who controls property of another (the D’s of the GP) can
NOT use that property for personal benefit

c. Freer says the only difference b/w these 2 cases, is that here, the PA did NOT
specifically say the GP can do this.

VV.How to make money in an LP?

101.Job – and thus a salary

102.Distribution
a. §504 RULPA – Distributions are done pursuant to agreement, if there is no
agreement, the distribution is done in accordance with the value of your
contributions (§503 says the same thing w/regard to profits and losses).

103.Can sell your interest

a. BUT can only sell all the financial stuff (right to get distributions) but you still
remain a partner and thus do not sell your management abilities – if you have
them – similar to RUPA/UPA

b. §702 RULPA assignment of the partnership interest except as in the P.A. is

allowed. Allows assignee to receive only the distribution to which the assignor
would be entitled. Does not even include the §503 sharing of profits.

c. RULPA §602 withdrawal – general partner may withdraw at any time. If the
withdrawal violates the agreement, the entity may recover damages from the
agreement.

d. RULPA §603 limited partnership may withdraw according to P.A. If not

discussed in P.A., the limited partner may withdraw in not less than 6 mos. notice
writing to the general partner. (fetter the right to the partner’s ability to walk.)

i. Easier for GP to get out. We don’t want the limited P to walk because
it could frustrate the business by taking the capital.
e. RULPA §801 -- dissolution; a limited partnership is dissolved and its affairs
shall be wound up when: it is specified in the certificate; P.A. says so; written
consent of all partners; judicial decree; withdrawal of a general partner
(unless there is at least one other GP and the P.A. allows for the single G.P. to
continue).

i. Limited partnership is not dissolved if within 90 days of withdrawal all

partners in writing agree to the appointment of a new G.P.

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I. Limited Liability Corporation - LLC

104.this is another example of the victory of the contract crowd

a. Code = ULLCA

105.LLC is an entity – also combines features of LP and a corporation in that flow through
taxation, but also limited liability (here there is not general partner)

106.Investors have limited liability just like the S/H’s in a corp; ULLCA §303(a) except in
(c) debts, liabilities, obligations, etc. are solely liabilities of the company, not
individuals.

107.this is founded on contract, the Operating Agreement

a. Put in how to run, who votes, what’s required, what happens if someone leaves,
etc.

108.LLC statutes merely establishes default rules that govern if and only if there is no
contrary provision in the operating agreement.

a. ULLCA §103 except in (b) all members of a LLC may enter into an operating
agreement (it need not be in writing). Regulate affairs of company, govern
relations, etc.

b. BUT ULLCA §103(b) Operating agreement may not:

i. Unreasonalby restrict the right to information

ii. Cannot eliminate eh duty of loyalty under §409(b) (but you may
contract around the duty either ex ante (a provision that restricts by
identifying certain deals that are O.K.) or ex post (we can ratify the
action)

iii. Cannot unreasonably reduce due care §409(c)

iv. Cannot eliminate the obligation of good faith and fair dealing.

109.LLC’s have a choice – they can make it member managed or manager managed

a. Member Managed – the people who own the business run it

i. This is like a close corp or like general partnership

b. Manager Managed – like a corporation

110.How to form

a. File with state and give name that shows its an LLC: §ULLCA 203 requires:
i. An Articles of Organization (DE – certificate of formation) is filed
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 ii. Name of Co. §105ULLCA/DE§18-102 must contain certain letters.
iii. Address of initial designated office
iv. Name and street address of initial agent for service of process
v. Name and address of each organizer of LLC
vi. Term Co.? What is the term?
vii. Must tell if manager managed (names and address)
viii. Whether one or more of the member s of the LLC are liable for its
debts under §303(c) may provide for liabilities to individual
members, but don’t have to.

111.What about liability to third parties?

a. See §303 in ULLC

i. except as provided in (c) – starting point that stockholders and D’s

aren’t liable, the corp entity is

b. Liability if 1) its in the articles AND 2) member so liable consents

c. Starting point: stockholders not liable, but cts can pierce corp in certain
situations

i. But here its not clear if they’ll pierce the corp veil: some courts say
only way liable is if they meet 303(c) while other courts apply the
piercing principles

112.Hypo #2 p. 8

113.What about the fiduciary duties?

a. If LLC is formed by 3 members and they allow for rights of first refusal, it simply
obligates members to offer first to business before going to a 3rd party

b. Notion of a free standing fiduciary obligation is less important here than in other
business structures – here we are always looking to the contract to spell out what
everyone must do

c. If agreement is minimalistic then that’s all there is to it!

d. Contract supercedes all common law stuff regarding duties: Cardozo would be
shocked by this

114.How do members of LLC make $

a. Employment: Terms have to be spelled out in the K!; default provisions are
sparse
b. Distributions: again have to be spelled out in operating agreement;
c. Sell Interest: See Lieberman

115.What can we sell in an LLC –

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 a. Membership: If you sell to a 3rd party you sell your whole interest, not just your
financial interests (unlike partnerships and LPs)

116.LLC’s started in Wyoming

Decision making
Member managed company or manager managed company.

Problems CB791
1. §301 ULLCA It is important whether you are dealing with a member managed or manager managed. It
matters who the agent is. §301(a) subject to (b) and (c) each member is an agent of the LLC for the purpose of
its business. Members’ act binds the company – you are an agent. Unless the member had no authority and the
person with whom the person was dealing knew or had notice. (2) act of a member not for ordinary course of
business does not bind unless approved by other members.

If you are dealing with a member managed co. any member can bind.

(b) subject to (c) in a manager managed company, a member is not an agent. Each manager is an agent.

§301(c) can sign or deliver interest in real property only by member in a member managed co. and managers in
a manager managed company.
In a ULLCA state, it must say in the articles if you are member managed or manager managed.

2. DE §18-402: If there is no operating agreement all the members have management rights in proportion to
their ownership. All have rights in the management. Fall to a vote of the managers.

ULLCA §404 we must decide in articles (a) member managed – each member has equal rights (different from
DE) – must be a majority of the members (not just those that show up) per capita -- §404(d) action may be
taken w/o a meeting ; (b) manager managed – each manager has equal rights in the management and conduct.
May be exclusively decided by manager or majority of the managers. Look at (3) for additional information.

§404(c) need unanimity for these things (but you cannot K around it).

CAN YOU PIERCE THE CORPORATE VEIL?

 Not much law here.
 Hollowell – Ct decides that the LA law would allow piercing of the corporate veil.

Q (CB793)
1. Is Hollowell persuasive anywhere else? -- NO OF COURSE NOT, anyway, this a federal judge guessing.
§303(a) entity is liable
(c)can list ind. That are liable.
(b) NO PIERCING. ULLCA seems clear on that.
 This makes sense. Piercing the veil is very open ended and arbitrary. It may well be that legislatures
just don’t want this mess here too.
 Justified because these co. must file so the world knows that you are not liable.

2.HYPO CB793: E orally employs my client, but does not make clear for whom he was acting. E gives his
business card to C. EFR appear above the address, but there is no indication that it was an LLC. C does the
design work, from whom can C collect.

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§ULLCA 301: (a) if it’s a member managed deal, E is an agent for caring on the business (binds the entity). If
it’s a manager managed, E has no authority to bind.

E can bind EFR, but does he bind EFR? Agency deal – if an agent contracts with a third party for an
undisclosed principal – we know that the agent is on the hook personally. But is the LLC liable? All we have is
a business card for EFR, would EFR be bound? This court determines that this is a matter of fact to be
determined by a jury. (whether the LLC was disclosed is a matter for the jury)

NO REASON TO BE AN L.P. – FREER THINKS IT IS JUST INTERTIA. PEOPLE JUST FEEL

COMFORTABLE BECOMING L.P.’S.

Liability to the Company in an inter se situation.

Lynch Multimedia Case (CB794) federal ct. interpreting state law

CLR Video LLC (entity)

Three members:
Lynch
Rainbow
Carson Trust

Manager managed LLC.

Two key provision in operating agreement on (CB795):
1. right of first refusal.
2. Reminds us with Icahn; any member or manager may engage independently or with others in other business
ventures of every nature and description.

Carson is President of CLR. Carson learned that Cablevision might be for sale. According to the Plaintiff
(Lynch the corporation – not the LLC) at a subsequent meeting they approved the acquisition of Cablevision.
Carson learns that Galaxy might become avail and tells the other partners.

Carson was told to acquire these companies on behalf of the LLC. Carson wears the hat of President of LLC
(acquire the companies); Carson says we can acquire but only if we change the operating agreement (raise my
salary; un-punctillio); Carson then buys the companies himself.

This court says that Carson is O.K. (enters summary judgment). No triable issue of fact. That right of first
refusal only required Carson to tell the gang about the existence of these opportunities. He did that. After that
you can compete anyway that you want. The LLC is about an agreement or a contract. Indeed on the last page
of the opinion, there is no fiduciary claim because the agreement says we can go out and do these things.

Look at ULLCA§409; see whether you think Lynch would have come out the same way under the uniform act.
(fiduciary obligations that can be changed in accordance to §103(b)).

November 19, 2003

CB798: Under this statue applied in Lynch, we know that the Kansas statute has incredible flexibility to waive
stuff.

Q1. We are tempted to say yes Carson does owe a fiduciary duty to CLR Videos, so we are surprised you can
waive this fiduciary duty. Gives primacy to freedom of K.

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Q2. Why is Lynch the Plaintiff instead of CLR videos? Freer thinks CLR should be suing because it is the
entity. They seem to assume that any member can sue as well. It’s a closely held business with very few
players. We are used to the idea that you owe duties to the entity and to each other.

Kansas seems to say you can waive,

under the ULLCA §409(b)(c)(d)

(b) duty of loyalty to a member managed company you duty runs to the entity and to each other
 §409(b)duty of loyalty (review this)
o something that came your way in the conduct of the business or use of the property.
o don’t go into competition and don’t do a deal with divided loyalties.
o Refrain from competiting
 §103(b) operating agreement may not eliminate the duty of loyalty, but you can identify specific types of
stuff that does not violate the duty of loyalty.
o Uniform Act is less K division to this extent.
 §409(c) duty of care to a member managed company and to each other
o grossly negligent or reckless conduct
 §103(b)(3) cannot unreasonably reduce that duty of care.
 §409(d) discharge our duties consistently w/ obligation of good faith and fair dealing.
 §103(b)(4) cannot eliminate, but operating agreement can alter if not manifestly unreasonable.

What about manager managed company?

§409h in a manager managed company a member that is not a manager – you owe no duties to the company just
for being a member

§409(h)(2) manager is held to the same standard as in §409 (b)(c)(d)

CB798 Q3
Member has no duties. But a manager does because this is a manager managed company.

How do we make money?

 Salary
 Distributions -- handle in the operating agreement; or
o §405 ULLCA – distributions must be equal shares and approved by all members
o §DELLCA §18-503/§18-504 DE has us look at the contributions made by each member. You
get the distribution in the same ratio as your contribution into the LLC. Pursuant to the
contributions made by each member
 Sell your interest
o Buyer’s rights are limited (like all business forms except corporations)
o You are not a full fledged member.
o §DELLCA§18-702
 Assignee shall have not right to participate in the management of the business and affairs
of a LLC.
 Can transfer financial interest but that does not make you a member

§502/503 ULLCA -- §502 – can transfer your distributional interest – does not entitle the transferee to become
or exercise the rights of a member (only receives the financial interest)
§501(b) distributional interest
§503(a) transferee may become a member if and to the extent that the transferor gives the transferee the right in
accordance to the operating agreement or if all other members consent.
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  Reflects the idea that these businesses are closely held.

CB800 Seems to Freer that you should be thinking about having the right of first refusal. The company would
have the first shot at buying back the interest. You might even have a set price.

Lieberman v. Wyoming.com LLC (CB801)(2000)

First state having an LLC statute.

Hole in the statute.

Facts: Lieberman goes into the LLC w/ two other individuals. Lieberman contributes capital of $20K; 40%
owner of the business. L was fired as officer. Can’t fire him as member. L provides notice that he no longer
wants to be a member.

L says recently an offer was made for the LLC for $1M; I want my FV of $400K. They think he should get
$20K.

W.com sues for declaratory judgment. L wants dissolution.

Everyone agrees that L gets his $20K back.

Does his withdraw force dissolution? When a member dies or walks he is dissociated (dissolution is a different
deal). Ct. concludes that in this fact pattern dissociation does not demand dissolution. Here the remaining
member agree to keep up the business.

We are not dissolving. . the business will continue. . . what do we do about the distribution? Well the court
says the Wyoming statute does not seem to address this. . .

W.com’s position does not make sense. He’s a 40% equity holder and ought to be able to get 40% of the
business.

CB808 the statute only talks about the return of contributed capital, but what happens to his interest. The court
punts this issue – finds the provision in the operating agreement that says if you’re a member you get a
membership certificate. We can’t find the certificate. . .so we’re going to remand.

Affirmed – L gets his 20K back. No order of dissolution.

But we don’t know about the membership interest – where is the certificate.

Q1 CB812
If L presents the certificate to the LLC would they be legally obligated to pay L the FV of his equity? WE
THINK THE ANSWER IS YES. His interest could not have disappeared. . gotta give him the interest.

Don’t worry about DE.

Q3: what happens under the ULLCA §602/701. ULLCA provides for dissociation and that the LLC will
purchase the dissociating member’s distributional interest at FV unless the operating agreement otherwise
provides.

§601 ULLCA – member is dissociated from an LLC on the occurrence of:

1. you just walk;
2. event agreed upon in the deal;
3. transfer of all of the distributional interest;
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4. expulsion;
5. expulsion by unanimous vote;
8. in the case of a member’s death

§602 unless otherwise provided by operating agreement (a) member has the power to dissociate at any time
although it could be wrongful (same as RUPA)

§603 (a) (1) upon dissociation in an at will company (mot of them are, although you can have term); cause the
distributional interest to be purchased (must buy him out – same idea of RUPA); (2) if it is a term company you
will get bought out but on the date of the expiration of the term.

§603(b)(1) right in management terminates.

§702 says how you put a price on the buy out. In an action to determine the FV – considering among all the
relevant evidence – the going concern value of the company. Any agreement fixing the price or specifiying a
formula. Appraisal. Etc.

§703 (comment)default valuation standard is FV (not FMV) – can determine any way it wants. FMV is too
narrow and often inappropriate because there is not market.

CLOSING POINTS
LLP (invented by TX) – like a limited partnership in which the general partner has limited liability. Set up like
a limited partnership – but general partner has limited liability. Require a public filing as an LLP. Shows the
world that the GP has limited liability (consistent – limited liability you need a public filing).

Sarbanes-Oxley. . . issue of public moment. Aimed primarily at publicly traded organizations – develops
PCAOB (oversight board – over public accounting). Ensures independent auditing; independent analysis;
conflict of interest.

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