Professional Documents
Culture Documents
Scribd Outline Business Associations
Scribd Outline Business Associations
I. TYPES OF ASSOCIATIONS
a. AGENCY: indicates the relationship that exists where one person acts for another
i. Legal Definition: Restatement of Agency (Second) §1: An agency relationship exists
where:
- One person (the principal) manifests assent to another (the agent) that the agent
shall act on the principal’s behalf subject to the principal’s control, and the
agent consents so to act.
ii. Source of Law: common law; restatement (effort to summarize common law)
iii. Why create an agency relationship?
- You can’t do everything yourself and need someone to act on your behalf.
- Exists when sole proprietor takes on employees to work for him
Page 2 of 115
c. Agency law governs the relations between agents and principals, and
creates legal consequences with third parties
iii. Gorton v. Doty: Doty, a teacher, approached the high school football coach, Garst, and
asked if they had enough cars to transport the team to their away game. Garst told Doty
they needed one more car. Doty volunteered her car on the condition that Garst drove it.
Doty was not promised compensation, and she testified that at no time did she direct
Coach’s work or his services, or what he was doing. Garst then was involved in an
accident where a football player Gorton was injured. Gorton claimed Doty was liable,
so the court had to determine whether a principal agency relationship was formed
between Doty and Garst once Doty let Garst borrow the car.
- Holding: The court found that a principal agency relationship did exist. Doty
had done enough to show she manifested assent for the coach to drive her car on
her behalf and he was subject to her control from the fact that she placed a
condition that he was the only one allowed to drive. Garst manifested assent to
act on Doty’s behalf by driving the car (implied agency). Court inferred Doty
had manifested assent that Garst act on her behalf from the fact that instead of
driving her car herself, she volunteered use of her car subject to the requirement
that Garst be the driver; she wasn’t compensated for use of her nor did she
personally benefit from this.
- Dissent: Is it important??
Gorton v. Doty
III. In every case in principal agency law, you have a triangle: a principal, an agency and a 3 rd party:
i. How do you figure out if someone is in a principal agency relationship?
Teacher Doty We look at restatement 2 § 1:
a) Agency is the fiduciary relation which results from the
manifestation of consent by one person (the principal) to
another (the agent) that the other shall act on his behalf and
subject to his control, and consent by the others so to act.
(1) Prong 1: ask the question, did the principal say that
they want them to be the agent. Did they even want
this to happen?
(2) Prong 2: Its not just that the principal wants him, he
Coach Garst Richard Gorton needs to say I want you as my agent AND that you’re
under my control.
(3) Prong 3: The agent must consent
IV. Issue: was Garth the agent of Doty?
a. Prong 1: Teacher Doty: “Garth, I want you to be my driver.”
b. Prong 2: Teacher Doty: “Only Garth can drive”
c. Prong 3: Coach Garth: “I will be your driver”
i. YES, he was an agent since all three prongs were met
a) “Manifestation”: some kind of action. Doesn’t have to be
spoken, doesn’t have to be I want you to be my agent, it can be
just waiving hands or I ask you to help me and you give me a
thumbs up.
Lessons from Gorton v. Doty:
1. Contract consideration is not required to create a principal/ agency relationship
2. Intent to form a principal/ agency relationship is not required to create such a relationship.
Page 3 of 115
a. Saying HEY HEY I need your help here, then youre good.
3. Potential for principal/agency relationships in many circumstances
ii. Carve outs in formation of agency – CREDITORS and SUPPLIERS (these are like
exceptions to
- Supplier and Agent
a. When someone is your agent, that created liability because its someone
else doing the work for you
b. The form of compensation often described the type of relationship
i. Someone who receives a fixed price is more likely to be a
supplier
ii. If fixed fee for services, this makes it look more like an agency
relationship
- Restatement (Second) of Agency of § 14(k): Suppliers
a. One who contracts to acquire property from a third person and conveys it
to another is the agent of the other ONLY IF it is agreed that he is to act
primarily for the benefit of the other and not for himself.
b. Factors indicting that one is a supplier rather than an agent:
i. That he (middleman) is to receive a fixed price for the property
irrespective of the price he (middleman) pays (I guess this would
as opposed to the middleman’s payment being contingent on the
price he pays for the goods)
- Restatement (Second) of Agency § 14(o): When does a creditor become a
principal?
a. Creditor becomes a principal at the point at which he (creditor) assumed
de factor control over the conduct of the debtor
i. If a creditor takes over management of debtor’s business and
directs what contracts may or may not be made, he becomes
liable as principal
ii. It does not matter what the contract says – the point in time that
the creditor assumes control triggers the principal agency
relationship
iii. Bankers Protection Clause: if someone starts working on your
behalf, they’re your agent and you’re liable UNLESS you’re
lending money
iii. A. Gay Jenson Farms v. Cargill (this case demonstrated the element of control)
- Facts: Farms sued companies Cargill and Warren for damages sustained when
Warren defaulted on contracts made with Farmers. See Quimbee brief for more
facts
- Holding: Cargill is liable for Warren as their principal because of Cargill’s
CONTROL over Warren. Cargill consented to be a principal once Warren
agreed to implement changes and policies Cargill suggested. Cargill’s
subsequent interference in Warren’ internal operations further established
principal agency relationship. Courts have tended to find agency relationship in
debtor-creditor relationship because of amount of control – here, the creditor-
debtor relationship turned into a principal-agency relationship because of the
level of control exercised by Cargill over Warren.
- Restatement 2nd § 1:
Page 4 of 115
a. Agency is the fiduciary relation which results from the manifestation of
consent by one person (the principal) to another (the agent) that the other shall
act on his behalf and subject to his control, and consent by the others so to
act.
i. Prong 1: Cargill: Warren is a supplier “Warren, I want you to buy grain
from farmers for me.”
ii. Prong 2: Cargill: Cargill as a lender “I’ ll tell you how to run your
grain business”
iii. Prong 3: Warren: “I will be your agent.”
Page 5 of 115
the obligations incurred thereafter in the normal course of business by
the debtor who has now become his general agent. The point at which
the creditor becomes a principal is that at which he assumes DE FACTO
control over the conduct of hid debtor, whatever the terms of the formal
contract with his debtor may be
c. Lenders have to act carefully when deciding what to do when a borrower
shows signs of distress. The concern we are talking about here has to do
with lender liability. Lender liability claims have been asserted . . .
i. By borrowers using various theories to attempt to prevent or
recover damages from the lenders exercise of contractual rights,
and
ii. By third parties attempting to hold the lender liable for the debts
of the borrower using an agency theory based on control (as in
Cargill; however, the Cargill case is one of only a handful)
- Cargill also argued that the relationship was one of buyer-supplier. The Court
disagreed because under the Restatement approach, it must be shown that the
supplier has an independent business before it can be concluded that he is not an
agent (this is not the case here because Warren sold 90% of its grain to Cargill,
thus, it doesn’t seem like Warren was an independent business)
- What advice would you give Cargill next time?
a. Draft documents so they do not suggest de facto control
b. Never make loans to operators you are purchasing grain from – Court
said credit agreement is control (Guttentag disagrees – just standard
terms of a loan agreement)
c. Take more control over the operators you lend money to – if you are
going to have liability, you might as well make sure they don’t do
anything wrong
d. Take less control over operators you lend money too, so that you don’t
become a principal to begin with
e. Pay closer attention to the amounts actually being disbursed
- How would you defend Cargill in this case?
a. Its not control, just typical relationship between borrower and lender
b. This would chill loan making by calling lender money an agency
relationship
Restatement 2nd §14k:
o One who contracts to acquire property from a third person and convey it to another is the agent of the
other only if it is agreed that he is to act primarily for the benefit of the other and not for himself.
o This means that warren would be his agent if he was primarily benefitting Cargill
o When youre supplying something to someone else, its unclear if its an agent
o There is a financial test to see when a supplier becomes the agent of someone else
Financial Test:
o Factors indicating that one is a supplier, rather than an agent, are:
1. That he is to receive a fixed price for the property irrespective of price paid by him
Even if Jennifer sells all her coffer to a prosecutor, if they agree to buy the coffee for 5$ a cup,
she’s more likely to be their supplier because it’s a fixed price. If there is a mark-up then its an
agent
Page 6 of 115
o The restatement says that sometimes you’re working for yourself and other times your working for another.
If youre working with a fixed price, then youre workihgn for yourself. If liana pays $3more than what I
would pay, then its an agent
o Supplier: I tell dalia, I will give you 15$ for you to buy me a water bottle. Dalia goes and finds the cheapest
prices so that she can get a bigger profit
o Agent: I tell dalia to buy me a water bottle and no matter the price that she buys it at I will give her $3 in
addition to how much it costs you.
o Back to Cargill: he will argue that cargill lent the money to warren and warren went to make the profit for
himself. (here, cargil gives warren 15$ to buy the bottle)
Page 7 of 115
-Restatement (Second) of Agency § 144 : a principal is subject to liability upon
contracts made by an agent while acting with his authority if made in proper
from and with the understanding that the principal is a party.
- Restatement (Third) of Agency § 6.01 – 6.03: agent with authority can bind a
principal to a contract
- NOTE*** There are 3 types of principals – Restatement (Second) of Agency § 4
& Restatement (Third) of Agency § 1.04
a. Disclosed Principal
i. When we know who the principal is at the time of the transaction
b. Partially disclosed Principal (Second)/Unidentified (Third)
c. Undisclosed Principal
i. We don’t know that agent is operating on behalf of a principal
vi. ACTUAL AUTHORITY
- Source of AUTHORITY which creates liability #1: ACTUAL EXPRESS
AUTHORITY (“AEA”)
a. Restatement (Third) of Agency § 2.01: An agent with actual authority
when the agent reasonably believes that the principal wishes the agent
so to act
b. Look at Agents reasonable belief based on Principals express
manifestation
c. Scope:
i. Rst 2nd § 35: Unless otherwise agreed, authority to conduct a
transaction includes authority to do acts which are incidental to it,
usually accompany it, or are reasonably necessary to accomplish it
a) Were going to look at things from the agents perspective
ii. Rst 3rd § 2.02 (1) An agent has actual authority to take action
designated or implied in the principles manifestations to the agent and
acts necessary or incidental to achieving the principles objectives so
Page 9 of 115
vii. Source of AUTHORITY which creates liability #3: APPARENT AUTHORITY
(“AA”)
- AA deal with the relationship between the principal and the third party
- Here, look at the 3rd parties reasonable interpretation of Principal’s intent,
traceable to the principal’s manifestation
a. The belief of the third party is crucial
- The principal must be disclosed or partially disclosed
- Differences between Restatement (Second) and Restatement (Third)
a. Restatement (Second) of Agency § 8: Apparent Authority is the power
arising from the principal’s manifestation to such third person
(Principal must communication directly with third party)
i. We start by looking at what the 3rd person received from the prinicpal.
b. Restatement (Second) of Agency § 27: Apparent Authority is created
Restatement (Second) by written or spoken words or other conduct of the principal, which
of Agency reasonably interpreted, cause the third person to believe the principal
consents to have the act done on his behalf (act being, entering into a
contract)
c. Restatement (Second) of Agency § 159: a disclosed or partially
disclosed principal is subject to liability upon contracts made by an
agent within his apparent authority
Restatement (Third) i. Aka, if its apparent, the principal is liable
of Agency d. Restatement (Third) of Agency § 2.03: Apparent Authority is the
power held by an agent to affect a principal’s legal relations with third
parties when a third party reasonably believed the actor has
authority to act on behalf of the principal and that belief is traceable
to the principal’s manifestation
i. Restatement (Third) explains the rule much better (it is the
current law):
a) Restatement (Second) focuses on the principal’s
manifestations DIRECTLY to a third party
b) Restatement (Third) adds “TRACEABLE” which makes
it broader
(1) Example: Burns tells Smithers to wear the
company hat, and then Smithers tells Lisa he is
Burns’ agent (even though Principal didn’t talk
directly to Third Party, there is a reasonable belief
on the part of the Third Party, traceable to a
manifestation of the principal).
i. Need the "cloaking" and for the third party to
see the "cloaking" for there to be
liability/apparent authority!
(2) If Smithers stole the hat and lied to Lisa, Smithers
would not have authority under either Restatement
(Second) or Restatement (Third) – any reasonable
belief that Lisa would have that Smithers is the
agent of Burns would not be traceable to
something the principal, Burns, actually did for
Restatement (Third) to apply, and there was no
Page 10 of 115
direct communication with the third party, Lisa,
by the Principal, Burns, for Restatement (Second)
to apply
- Actual Authority v. Apparent Authority
a. Actual Authority looks at the agents reasonable belief and it creates a
right to bind the principal
b. Apparent Authority looks to the third party’s reasonable belief that’s
traceable to the principal’s manifestation, and if that is there, the agent
will have the authority to bind the principal to the transaction (contract)
i. With apparent authority, you are going to always look at how the
third party learned of the agents alleged authority, and ask
whether the principal can reasonably be said to have been the
source of that knowledge so is the third party’s reasonable
belief (does he have a reasonable belief) traceable to a
manifestation by the principal (something the principal did to
give the third part a reasonable belief that the agent had authority
to bind the principal)
ii. Created in Several Ways
a) Direct communication by the principal to the third party
b) Inaction by the people
c) By custom – customary for person (agent) in that position
to enter into certain types of agreement
- Apparent authority for an agent to bind a principal exists when the principal acts
in a way that would lead a reasonable person to believe the agent has the
authority to bind the principal, particularly when the agent does things that are
usual and proper to the principal’s business
- Opthalmic surgeons, ltd. V. paychex, inc
a. Connor did not have actual authority to pay herself extra $233,159
b. Was connor “cloaked with apparent authority”?
i. Yes, according to the court. She was the person that paychex was told
to work with/contact and was told she was the person to do this
c. What are the indicia of Connors apparent authority?
i. That they assigned her to do this job. They entered into an oral contract
in 89 and in 94 they said that conneer was supposed to be in charge
d. Where these direct or indirect?
i. In 1989, it was direct when they put her in that role they told Paychex
that they were to work w/ Connor.
ii. Indirect was the reports that OS had the opportunity to read or not read.
e. What could Andreoni have done to prevent this outcome
f. Can silence count as a manifestation?
i. Only if you’ve acted in a certain way in the past and then you stop
working in that way, that change is a manifestation
- 370 Leasing Corp. v. Ampex Corp.: 370 Leasing was a company owned by Joyce, whose business was to purchase computer equipment from manufactures and then lease it
to end users. In August of 1972, Kays, a salesman of Ampex, reached-out to Joyce to sell him some computer equipment. A meeting was then arranged between Joyce, Kays,
and Kays’ employer Mueller to sell the equipment to Joyce. In November of 1972, Kays submitted a written document to Joyce at the direction of Mueller, stating the terms of
the agreement; there were two signature blocks, one for Joyce to sign and one for a representative of Ampex to sign. When Joyce received the document, the signature box for
Ampex was not signed; Joyce however executed the document and sent it back to Ampex. This document was never signed by a representative of Ampex. Shortly after Joyce
signed the document, Mueller circulated an intra-office memorandum stating that Ampex had an agreement with Joyce for purchase of the computer agreement and that at
Joyce’s request all communications with Joyce concering the sale be handled through Kays. A few days later, Kays sent a letter to Joyce confirming the delivery dates and
installation instructions for the computer equipment.
i. Does a sales person (Kays, the alleged agent) have authority to bind a company (Ampex) to a sales agreement when the company apparently
holds the salesperson out as its agent?
Page 11 of 115
ii. And if so, was there an enforceable contract in place (this question does not matter for our purposes – but it shows that unless their was
authority on the part of the agent (Kays), there could be no enforceable contract between Joyce (third-party) and Ampex (Principal))
b. Rule the Court applies: “An agent has apparent authority sufficient to bind the principal when the principal acts in such a manner as would lead a reasonably
prudent person to suppose that the agent had the authority he purports to exercise . . . Further, absent knowledge on the part of third parties to the contrary, an
agent has the apparent authority to do those things which are usual and proper to the conduct of the business which he is employed to conduct . . .
c. Holding: When a company gives a salesperson various powers in a sales transaction, it is reasonable for the customer to believe that the salesperson, acting in
that capacity, has the authority to bind the company to a sales contract. Ampex authorized Kays to negotiate with Joyce and act as the sole point of contact with
him. Those facts alone would give Joyce good reason to believe that Kays was acting as Ampex’s agent regarding the sales agreement. Additional reason for
that belief is provided by the letter that Kays sent to Joyce delineating the delivery and installation terms. Ampex’s argument that salespeople do not have
authority to bind the company to a contract is irrelevant to the issue of apparent authority (it is customary that salespeople have this authority), unless the
customer was notified of that fact (which Joyce was not). Joyce was never notified of Kays’ purported lack of authority to sign contracts, and Ampex gave no
other indication to Joyce that Kays was not acting as its agent in the sales transaction. It was manifestly reasonable that Joyce would believe Kays had the
authority as Ampex’s agent to execute the sales agreement.
i. Once the court said there was apparent authority, meaning that Joyce belief that Kays was the agent of Ampex was a reasonable belief traceable
to the manifestation of the Principal, Ampex, the court could then decide whether this contract between Joyce and Ampex, through Kays, was
enforceable, because Kays had the authority to bind Ampex
Page 12 of 115
(1) So, if an agent enters into an ordinary
transaction of that business, the principal is
liable, even if no one knew of his presence
- Liability of an undisclosed principal
a. Restatement (Third) of Agency § 2.06:
i. (1) An undisclosed principal is subject to liability to a third
party who is justifiably induced to make a detrimental change
in position by an agent acting on the principal’s behalf and
without actual authority if the principal having notice . . . [of
the agents conduct and that it might induce others to change their
positions,] . . . did not take reasonable steps to notify them of the
facts
a) NOTE*** This rule is supposed to be based straight out
of Watteau v. Fenwick. However, as the comments on the
Restatement (Third) suggest, the bracketed part above
would probably result in the defendant’s winning because
in the case, the defendants were not aware that Humble
was buying cigars from Watteau and therefore would not
be liable (they didn’t have notice in order to notify
Watteau). That is why I think Guttentag didn’t add that
part into our rule statement; because it shuts out scenarios
like Watteau v. Fenwick.
ii. [(2) An undisclosed principal may not rely on instructions given
an agent that qualify or reduce the agent’s authority to less than
the authority a third party would reasonably believe the agent to
have under the same circumstances if the principal had been
disclosed]
- Watteau v. Fenwick:
Inherent agency power
Principal: Fenwick
Agent: Humble
3rd Party: Watteau
a. Facts: Humble transferred his tavern to some brewers (defendants), but
at their direction, Humble’s stayed on to manage the tavern after the
transfer. Humble’s name remained painted on the tavern and the tavern
license remained under his name. The transfer agreement gave most of
the purchasing authority to the brewers; Humble was only authorized to
purchase ales and mineral water. However, for several years after the
transfer, Humble bough cigars, Bovril, and other supplies on credit to be
sold at the tavern. The supplier, Watteau (plaintiff) sued the brewers
(defendants) to collect for the price of supplies Humble purchased.
Fenwick is an undisclosed principal since you cant tell at all especially
since the name of the bar is “humble”.
b. Procedure: At trial, the brewers argued that since they limited Humble’s
purchasing power and did not hold him out as their agent, and didn’t
know he was selling, Humble lacked authority to purchase the forbidden
supplies; thus, they should not be liable to pay for them.
Page 13 of 115
c. Rule: A principal is liable for the acts of an agent who proceeds within
the scope of authority typically given to an agent with similar duties,
regardless of limitations the principal imposes on that agent
i. The reason I put this rule here is for you to see the “Scope of
authority” part
a) First of all, you need to figure out this scope of authority
thing
b) Second of all, notice that if Humble did something that
would not seem to be in the scope of his authority
typically given to an agent with similar duties (like hiring
a circus to play for the tavern), then brewers would
probably not be liable for him (at least I think . . . you
need to figure out this scope of authority thing in regards
to all agency)
d. Issue: Is a principal bound by an agent’s authorized actions in the course
of duty when the agent does not disclose the identity of the principal to a
third party with whom the agent contracts?
e. NOTE***Humble is an agent who purchased cigars and Bovril after he
was instructed not to do so; thus, there is no actual authority. There is no
apparent authority because third party had no idea the person he was
contracting with, Humble, was an agent, acting on behalf of a principal.
f. Holding: Yes. An undisclosed principal who employs an agent to run a
business is liable to third parties who contract with the agent for
transactions typical in the line of business, even if the agent’s actions
violate an agreement between the agent and principal. While the brewers
are the owners of the tavern, they allowed Humble’s name to remain
painted on the tavern and employed Humble to manage it. Although the
brewers did not hold out Humble as their agent and remained
undisclosed to the suppliers, under these circumstances Humble
appeared to have authority to engage in transactions on behalf of the
business. Humble’s purchase of items normally sold in taverns, cigars
and Bovril, were within the reasonable scope of an agent acting on
behalf of a tavern owner. The supplier had no knowledge of Humble’s
limited purchasing authority, but rather had every reason to believe that
Humble had authority to buy supplies for the tavern.
g. Two quotes from the case:
i. “But in the case of a dormant partner it is clear law that no
limitation of authority as between the dormant and active partner
will avail the dormant partner as to things within the ordinary
authority of a partner”
a) Basically saying that this case is similar to that of a
partnership we hold partners liable for each other even
if a third party doesn’t know about one of the partners (or
even if one of the partners doesn’t know what the other
partner is up to . . .)
ii. Policy “In every case of undisclosed principal, or at least in
every case where the fact of there being a principal was
undisclosed, the secret limitation of authority would prevail and
Page 14 of 115
defeat the action of the person dealing with the agent and then
discovering that he was an agent and had a principal”
a) A third party dealing with an agent, that doesn’t know
there’s an undisclosed principal, would think that this
agent could enter into a contract for cigars . . . So if we
don’t hold the principal liable once the third party realizes
that when dealing with the agent there was actually an
undisclosed principal behind the scenes, then the principal
would get away with no liability after they had made that
secret limitation on agent’s authority
b) Basically, principals would put secret limitations on the
authority of agents, and then remain undisclosed by
hiding behind the curtains. Then agents will go do
whatever they want, and principal would remain liability
free . . . this would not be fair, and thus, for this policy
concern we do not allow undisclosed principals.
- Another policy for having the rule of undisclosed principal is that the principal
is in the best position to avoid loss, so we will allow the liability for damages to
fall on them
ix. Source of AUTHORITY which creates liability #5: RATIFICATION (“R”)
- Even though the agent did not have authority to enter into a contract at the time
of formation, at a later point, the principal agrees to bind himself to the contract
a. Example: Smithers doesn’t have any authority whatsoever to enter into this
contract. Later this afternoon, Lisa shows up at burns office and tells him about
the agreement. Burns says “well Smithers was never authorized to give you
those terms but I love that deal so at this subsequent I am approving these terms
and I am ratifying it”
- Restatement (Second) of Agency § 89: if the affirmance of a transaction occurs at a
time when the situation has so materially changes that it would be inequitable to subject
the other party to liability thereon, the other party has an election to avoid liability.
a. Ratification is always allowed unless circumstances have majorly changed
i. if allowed, the prinicipal can hold the third party liable and he can pick
and choose who to hold liable
Page 15 of 115
- Restatement (Third) of Agency § 4.01: Ratification is the affirmance of a prior
act done by another, whereby the act is given effect as if done by an agent acting
with actual authority
a. Ratification created effect of actual authority both the principal and
the third party become bound to the contract, and the agent is discharged
- Restatement (Third) of Agency § 4.03: A person may ratify an act if the actor
acted or purported to act as an agent on the person’s behalf
a. Example of this in my notes
- RATIFCATION is DISTINCT from INHERENT AGENCY POWER because
under ratification, there is a disclosed principal, it’s just that the agent doesn’t
actually have authority (or more clearly, maybe that the thing the agent is doing
is not actually with this scope of his authority…)
- If the affirmance of a transaction occurs at a time when the situation has so
materially changed that it would be inequitable to subject the other party to
liability thereon, the other party has an election to avoid liability
a. Example: an agent purporting to act for a principal, but without power to
bind him, contracts to sell Blackacre with a house to a third party. The
next day, the house burns down. The later affirmance by the principal
cannot bind the third party (unfair for principal to gain)
- At the time of ratification, the purported principal must have knowledge of all
material facts (or not unaware of lack of knowledge – remember Mistake of
Fact?)
a. Also, if the third party has already withdrawn from the transaction, the
purported principal can no longer ratify (third party will not be held
liable for withdrawing because principal isn’t bound either, until he
ratifies, which he didn’t yet)
- There is no such thing as a partial ratification either principal ratifies the
whole contract, or none of it.
x. Source of AUTHORITY which creates liability #6: ESTOPPEL (“E”)
- Estoppel is raised where purported agent didn’t have actual or apparent
authority, but a court may hold principal liable to some fault. The principal is
estopped from raising lack of authority as a defense.
a. Estoppel is a one-way street; only defendant is liable (meaning principal
cannot use estoppel as his legal basis against third party)
- Restatement (Second) of Agency § 8B:
a. (1) A person who’s not otherwise liable as a party to a transaction
purported to be done on his account, is nevertheless subject to liability to
person who have change their positions because of their belief that the
transaction was entered into by or for him, if:
i. (a) he intentionally or carelessly caused such belief, or
ii. (b) knowing of such belief and that others might change their
positions because of it, he did not take reasonable steps to notify
them of the facts
b. (3) Change in position, as the phrase is used in the restatement of this
subject, indicated payment of money, expenditure of labor, suffering a
loss or subjection to legal liability
- So basically, under Restatement (Second) of Agency §8B(1), you need to show
(for the sake of easier English)
Page 16 of 115
a. Acts or omissions by the principal, either intentional or negligent, which
creates an appearance of authority in the purported agent;
b. The third party reasonably and in good faith acts in reliance on such
appearance of authority;
c. The third party changed her position in reliance upon the appearance of
authority;
d. Under CONTRACT LIABILITY, when is a THIRD PARTY bound to the Principal?
i. NOTE*** Principal’s rights to step in and enforce the contract are slightly more limited
than a third party’s rights
ii. The following list will tell us when a Principal can enforce a contract against a third
party
- Actual Express Authority – YES
- Actual Implied Authority – YES
- Apparent Authority – YES
- Inherent Agency Power – YES
- Ratification – YES**
a. The decision is left up to the principal whether they want to accept the
contract or not
b. Principal does not have liability unless the contract is ratified by the
principal
- Estoppel – NO
a. The third party can enforce the contract against the principal, but the
principal cannot enforce the contract against the third party
e. Agents’ CONTRACT LIABILITY
i. Restatement (Second) of Agency § 320: Unless otherwise agreed, a person making or
purporting to make a contract with another agent for a disclosed principal does not
become a party to the contract
- Basically, when a principal is fully disclosed and the agent is acting within the
scope of his authority, the principal is liable to the third party; the agent is not
liable
- Exception: If the agent intends/agrees to be bound to the contract (The rules on
contract liability are default rules that can be overridden by express or implied
agreement between agent and third party)
a. Sample MC:
i. Paul signs a K w/ Annie, hiring Annie to in turn hire a manager for a grocery store. Annie is to be paid $1,000 to perform
this service. As Paul Anticipated, Annie shows the K to several candidates for the manager job, including Thomas.
Thereafter, Paul sends a letter to Annie revoking Annie's authority to hire a manager for the store. The revocation Is not
communicated to Thomas. At this point.
a) As to Thomas, Annie's has actual implied authority to hire a manager for Paul's store – (actual auth. –
which goes to the reasonable beleifs of the agent but she was told that she doesn’t so she cant have actual)
b) As to Thomas, Annie has no authority to hire a manager for Paul's store
c) As to Thomas, Annie has apparent authority to hire a manager for Paul's store.
(1) Paul cloaked annie in authority therefore he manifested behavior that granted her authority
and he never undid that manifestation
d) As to Thomas, Annie has inherent agency power to hire a manager for Paul's store.
e) None of the Above.
ii. Restatement (Second) of Agency § 321: Unless otherwise agreed, a person purporting
to make a contract with another for a partially disclosed principal is a party to the
contract
Page 17 of 115
iii. Restatement (Second) of Agency § 322: An agent purporting to act on his own
account, but in fact making a contract on account of an undisclosed principal is a party
to the contract
- The same exception applies as to Partially disclosed and undisclosed principals
(See Exception under i)
iv. Agent Exceeding the Scope of his Authority
- An agent who enters into a contract on behalf of another impliedly warrant that
he or she has authority to do so (unless agent gives notice that no warranty of
authority is given, or third party knows that agent acts without actual authority)
- If the agent acted without authority or exceeded the scope of authority, and the
principal did not ratify, the agent is liable to the third party for breaching the
implied warranty of authority
- The agent may also be liable for fraud or intentional misrepresentation of his or
her authority
f. Relationships with 3rd Parties & Types of Liability – TORT LIABILITY
i. Overview of Principal’s liability to Third Party for Agent’s Tort:
- These are the circumstances for which the master (principal) is liable for the
actions of the servant (agent) outside the scope of employment (I do not think
you need to prove that the agent is a servant, I think as long as you show the
agent is an agent, these will apply).
- There is Direct Liability when:
a. Agent acts with actual authority to commit tort or principal ratifies agent’s conduct;
i. This means that the principal actually intended the conduct or consequences, and gave the agent actual
authority to perform the tort
b. Principal is negligent in selecting, supervising, or otherwise controlling the agent;
i. This is basically when the master was negligent or reckless
c. Principal delegates performance of a duty to use care to protect persons or property and agent fails to perform duty
(this is known as a non-delegable duty); or
d. Activity contracted for is inherently dangerous (i.e., demolition, blasting – things that would be considered strict
liability torts)
e. The servant purported to act on behalf of the principal and there was reliance upon apparent authority
- Vicarious Liability when:
a. Respondeat Superior: Agent is an employee who commits a tort while acting in the scope of employment
b. Apparent Agency: Agent commits a tort when acting with apparent authority in dealing with third party on or
purportedly on behalf of the agent
Page 18 of 115
Diagram of Principal’s Liability for Torts committed by Agent
Page 19 of 115
Law for tort liability: you have to have both PAR and MSR and MSR exists when the principal
has control over physical conduct of agent. There is also, in most circumstances, the tort has
to be committed in the scope of employment.
Is that a good law?
As a principal, you could just not take control over the physical conduct of your agent in order to not
have tort liability. If you don’t take physical control, you can still have people doing what you want for
you, you just don’t have to tell them exactly how to do it.
o Imagine your business is driving explosives around LA. The explosives go off. What do you do
to avoid liability?
You can have people drive the explosives but have them drive their own cars and you
don’t tell them when to drive. Not taking control over physical conduct.
G says that if youre in business, you should bear economic consequences of your activities
and this rule gives clear way to avoid liability of the torts of your employees on your
behalf. So it’s a bad rule.
There is
another benefit for principal. A bunch of state law has developed that requires you treat employees in
certain way (provide insurance, min wage). So as self interest businessman, you can have people
working on your behalf without being an employee. If you look at list of factors to make someone a
servant, you just don’t make them that. They are no longer employers, they are just principals. Not
only do you have tort liability but you no longer need to meet the state requirements.
The judiciary said that this went too far and the point of allowing firms to avoid employee/employer
relationships has led to abuse. Principals are creating independent contractor relationships to avoid
wage laws.
Until the dynamex case, how in CA would we determine if someone was employee for purposes of
whether they should be owed min. wage?
o The courts went back to Rst to figure out if someone was employee.
o In this dynamex case, they cite the case of borello. In 1989, borello addressed employee or
independent contractor.
Someone can be your agent working on your behalf and an independent contractor.
o The question borello trying to decide: are farmworkers independent contractors or
employees/msr?
Page 20 of 115
o They list a bunch of factors. Those distinct factors that used to be the law in CA are very
similar to the 10 we have that make someone a servant. But people are abusing this.
o CA SC out of thin air said that we will switch to new test… ABC TEST.
ABC TEST
Page 4 of case he posted on brightspace
Presumes that all worker are employees-- if you work on my behalf then presumption in
you are an employee. The only way you can be exempt from that is ABC:
o Worker is free from control of physical conduct (like old test)
o It has to be true that worker has to perform that is outside usual course of hiring entities’
business
This means that if I run delivery business and I have plumbing problem and I call a
plumber and have plumber working on some plumbing issues. That person is
performing work that is outside the usual course in my business. When I summon
someone to provide a service that is not related to my business
o The worker is customarily engaged in an independent established trade, occupation, or
business.
What you are doing is a separate and independent trade.
Dynamex Case:
o Driver are independent but they connected to principal
o If you apply the old test what conclusion do you reach In whether they have crossed over into
being in an MSR and if you apply ABC test
o Old test: §220(2) what makes a servant
For d if someone is in high skilled job, they are less likely to be servant.
For f, Length of time-- longer they are there the more they are servant
For g, If paid for time vs being paid job then more likely to be employee servant.
Common law test may determine they are employees over independent contractors But a lawyer at
dynamex could prove they were not employees. There is ambiguity in old test.
Page 21 of 115
New Test:
Does Dynamex decision mean that the ABC test will be applied to determine if the principal has
tort liability?
Lets say an uber driver commits a tort, does uber have liability
Answer is no. if the question is a tort question, does the principal have liability for agents tort, we dont
look at ab5, we look at old common law test and if there was master servant relationship and if it was
within scope of employment. Ab5 is meant to determine if they are independent contractor, not
employee.
ii. Principal Liability in Tort – is the principal liable for torts committed by the agent?
RESPONDEAT SUPERIOR
- Note that this does not replace the basic tort law – you can always sue the
negligent person, this is just a question of whether you can also sue the principal
who likely has deeper pockets
- Restatement (Second) of Agency § 219: A master is subject to liability for the
tort of his (1) servants committed while acting (2) in the scope of their
employment
Page 22 of 115
- The Master/Servant Relationship (subcategory of agency relationships which
give rise to tort liability)
a. Restatement (Second) of Agency § 2(2): A servant is an agent whose
“physical conduct is controlled or subject to the right of control by the
master”
i. Unlike in forming a regular principal agent relationship, here,
physical control is required (higher level of control)
b. Restatement (Second) of Agency § 2(3): An independent contractor is a
person who contracts with another but is NOT controlled or subject to
control of physical conduct. He may or may not be an agent.
i. Types of independent contractors in Restatement (Second)
a) Independent Contractor (Agent-type)
(1) Subject to limited control by principal with respect
to chosen result
(2) Agent has to power to act on principals behalf
b) Non-Agent Independent Contractor
(1) Perhaps less control on principals part
(2) Agent has NO power to act on principals behalf
- Is an Agent also a Servant? (So I think at this point we have identified that there
is a principal agent relationship, but we want to see if it goes to the next level of
master servant relationship, so that we can hold the master liable under a theory
of Respondeat Superior)
a. Restatement (Second) of Agency § 220: 10 factors to consider in
determining if an agent is also a servant
i. Extent of control, by the agreement, the master may exercise over
the details of the work;
a) The more control, the more likely the agent is a servant
(servant means employee, which means liability will
accrue to the principal/master)
ii. Whether or not the one employed is engaged in a distinct
occupation or business;
a) Is it specialized work? Makes it less likely they’re a
servant because won’t have to tell them what to do as
much think about it, the more specialized the work, the
less likely the “master” has control, and the less likely the
“agent” is doing work even similar to that of the
“masters” because its specialized, so it could be different
work
iii. Whether customarily done with or without supervision in this
locality: The kind of occupation, with reference to whether, in the
locality, the work is usually done under the direction of the
employer or by a specialist without supervision;
a) Trade practice – usually closely supervised = servant
b) Trade practice – usually without supervision = not servant
iv. The skill required in the particular occupation;
a) The more skilled, the less likely they are a servant and the
less likely they would be under your control
Page 23 of 115
v. Who provides the instrumentalities, tools, and the place of work
for the person doing the work;
a) Depending on this. If you are plumber but G has all the
tools for you then more likely that we created a MRS and
you’re an employee. Whereas if you bring in your own
tools then you’re more likely a PAR.
vi. The length of time for which the person is employed;
a) The longer they work for you, the more likely they are
your servant (it just seems more like they are employed
on a full time basis)
vii. The method of payment, whether by the time or by the job;
a) Hourly pay = more likely to be servant
b) Flat pay for the whole job = less likely to be servant
viii. Whether or not the work is a part of the regular business of the
employer;
a) If it is a part of the regular business, it is more likely that
“master” has control because you know how you want it
done (and other reasons you can think of as well here)
ix. Whether or not the parties believe they are creating a master
servant relationship
a) In PAR, we ignore the beliefs, but in MSR, we look at the
beliefs
b) If master or servant think they have a master servant
relationship, it is more likely that they do have a master
servant relationship
c) In looking at a principal agent relationship, belief of the
parties doesn’t matter; you only look at the course of
dealing between them to determine if there is a principal
agent relationship
d) However, here when looking at a master servant
relationship, not only do you look at the course of dealing
between the parties (as indicated by the factors above),
but you also look at the belief of the parties (as to whether
or not they believe they are in a master servant
relationship)
(1) Terms put in the contract, as to whether or not a
master relationship exists, will be relative, but not
determinative, as to whether a master servant
relationship does exist or not
i. For example, if in the contract the “master”
says that they do not have control over the
conduct of the “servant,” this may help the
court determine whether there is a master
servant relationship or not
ii. This is the case, when determining a
master servant relationship, even though
you cannot contract your way out of an
principal agent relationship (notice how
Page 24 of 115
you can put things in the contract that the
court can deem relevant, but not
determinative as to the master agency
relationship, but it will be neither relative
nor determinative as to whether a principal
agent relationship exists)
x. Whether the principal is or is not in the business
a) If it is a part of the normal business, then “master” will
have more control because they are more likely to want
things done in a certain way
b) If I hire a plumber to my house, then its not considered
“in the business
NOTE*** The following two cases focus on the differentiation between a master servant relationship and a non-agent independent contractor (I think this is the only thing Guttentag cares about – but
anyways, an agent independent contractor is just someone who is considered an agent, but does not rise to the level of master servant relationship. On the other hand, a non-agent independent contractor doesn’t
even rise of the level of being an agent.
i. Basically, Humble argues that the gas station was operated by an independent contractor, Schneider, and thus Humble is not responsible for negligence on his
part or the part of his employees.
b. Issue: Is an oil company liable for the negligence of an employee of a gas station manager with whom the oil company contracts to sell their products, when the oil company
has power to over the gas station’s daily business?
i. The legal issue of this and the next case, generally, is whether the operator of the station was an employee—a “servant” in the language of the law—or an
independent operator (independent contractor) or, in more modern language, a franchisor.
c. Holding:
i. Factors pointing against existence of master servant relationship – they are the factors that point against there being control by Humble over gas station
a) Neither Humble, Schneider nor gas station employees considered Humble as an employer or master
b) Employees were paid and directed by Schneider individually as their “boss” – Schneider had autonomy over the employees
c) A provision of the Agreement expressly repudiates any authority of Humble over employees (NOTE this one specifically – just because it
said there was no agency relationship in the contract, does not mean there is not one; it is only a factor to consider, it is not determinative).
ii. The court notes that even the Agreement itself is enough evidence to point towards there being a master-servant relationship
a) For example, paragraph 1 includes a provision requiring Schneider to make reports and perform other duties in connection with the
operation of the gas station that may be required of him from time to time by Humble – this points towards there being control
b) Humble pays 75% of the net public utility bills, which is one of the most important operation expense items
c) While the main objective of the Agreement was to enable Schneider to market Humbles retail products at the gas station, this was done
under a strict system of financial control and supervision by Humble, with little or no business discretion reposed in Schneider except as to
hiring, discharge, payment and supervision of a few station employees.
d) Humble furnished the all important service station and equipment, the advertising media, the products and a substantial part of the
operational costs.
f) The Agreement, which was Schneider’s only title to occupancy of the premise, was terminable at will by Humble.
iii. As this all shows, the agreement basically required Schneider in effect to do anything Humble might tell him to do.
a) The court says: “all in all, aside from the stipulation regarding Schneider’s assistants, there is essentially little difference between his
situation and that of a mere store clerk who happens to be paid a commission instead of a salary.”
iv. The court also distinguished with Texas Company v. Wheat (page 45 last paragraph)
v. The court also mentions that this analysis of whether there is a master servant relationship based on the factors that indicate there is or isn’t control, is
question of fact
b. Issue: Is an oil company liable for negligence of an employee of a serve station manager with whom the oil company is contracted, when the oil company does not have
authority over the gas station’s daily business? (basically, is there a master-servant relationship?)
c. Rule: “The test to be applied is that of whether the oil the company has retained the right to control the details of the day-to-day operation of the service station; control or
influence over results alone being viewed as insufficient”
i. An independent contractor relationship exists when one party works on behalf of another independently, with no control exerted by the other party over the
contractor’s day-to-day operations.
Page 25 of 115
ii. A master servant relationship exists when two parties agree that one party will work on behalf of another party, and be subject to that party’s control of how
the job will be performed.
d. Holding: No, there was no master servant relationship. The gas station, operated and managed by Barone, was considered an independent contractor as Sun did not have control
over the details of Barone’s day-to-day operations.
i. The lease agreement had the following terms, which all point against a master servant relationship – these things do not show control by Sun over Barone
a) The station and all of its equipment, with exception of a few minor things, were owned by Sun Barone was required to keep this
equipment and use it solely for Sun products.
b) The lease was subject to termination by either party upon third day written notice
c) The rental was partially determined by the volume of gasoline purchased but there was also a minimum and a maximum monthly rental
a) Baron was to purchase petroleum products from Sun (points toward control), however, Barone was permitted to sell other products from
Sun’s competitors (points against control). The Sun products that he sold, he was required to sell under Sun brand name and not blend them
with products not sold by Sun.
b) Baron’s station had the usual large signs indication that Sun products were sold there. His advertising in the phonebook was under the Sun
label and his employees whore uniforms with the Sun emblem on them, uniforms owned by Barone.
iii. A big one pointing to the lack of control Peterson, a sun representative, visited the gas station weekly to take orders for Sun products, inspect the
restrooms, and communicate customer problems that Barone might be having. Peterson also offered advice to Barone on all phases of his operation, but it was
usually given on request by Barone, and Barone could decide whether to listen to the advice or not.
iv. Barone made no written reports to Sun and he alone assumed the overall risk of profit or loss in his business operation.
v. Also, Barone independently determined his own hours of operation and the identity, held himself out publicly as the proprietor of the gas station, assumed all
risk of loss and benefits of profit, and had complete authority over his employees.
e. This, the court ultimately concluded that Sun did not have control over details of day-to-day operation, and thus was considered an independent contractor, and thus was not
liable for the negligence of Barone’s employee.
Issues:
1. whether conoco was liable for conduct of employees are store branded store
a. Court said they were not because the K says that conoco branded store is independent business and
its employees are not employees of conoco which is evidence that there is no PAR. The court says
we know they arent in PAR because look at what K says.
i. This is not correct because they are basically saying this isnt PAR because we said so. You
have to look at substance of relationship of whether someone is summoning someone else
to act on behalf of them.
ii. In terms of their analysis of whether there is MSR. One of the factors is the parties intent,
but this is not dispositive, it is just a factor. Doesn’t meant there is no MSR either.
Page 28 of 115
b. Do you think there is a PAR or MSR between branded stores and Conoco? Were Cindy Smith’s
actions within the scope of employment?
i. There is no physical control of conduct
ii. It’s a K, so it’s a market relationship. They set forth standards, but Conoco doesn’t have
the power to come in and oversee the day to day operations. The only power they have is
the power to terminate the agreement. So this is not a K that gives control of operations to
conoco. This solution and way of having independent franchise has been carefully crafted
to avoid common law indicia of control. Court is right here. This K has been designed so
that Conoco can be hands off. The court was right but not for the right analysis. The
evidence of way the conoco has kept its hand off is that they didn’t fire any of the
employees and in first instance corbin got involved, but in other times, they didn’t get
involved in operations. If you called for poor service about branded store, they would say
that they don’t have control over that problem. Advantage is no liability. In terms of firm,
they are separating themselves from the person running the store. No control over them
except to terminate K.
Page 29 of 115
iii. Lawyers have figured out that they can keep economic power without crossing threshold of
control.
c. Think back to advice we gave teacher doty
i. A solution was to throw the keys at coach garst and say that I wont control what you do
and if you want my car, heres my car but I don’t care what you do with it.
d. The existence of these branded stores is now a possibility without liability and keeping firms
separate
2. When is someone working within the scope of employment. In the cononco owned stores we clearly have
MSR. Now the question is, what counts as scope of employment.
iii. NOTE*** Straight from Pullman Outline (because I believe this is what (e) straight
above refers to: Vicarious Liability – Apparent Agency (not exactly sure if we
learned this)
- Restatement (Third) of Agency § 7.08: A principal is subject to vicarious
liability for a tort committed by an agent in dealing or communication with a
third party on or purportedly on behalf of the principal when actions taken by
the agent with apparent authority to constitute the tort or enable the agent to
conceal its commission
a. Comment a. to Restatement: The torts to which this section applies are
those in which an agent appears to deal or communicate on behalf of a
Page 30 of 115
principal and agent’s appearance of authority enables agent to commit a
tort or conceal its commission. Such torts include fraudulent and
negligent misrepresentations, defamation, tortious institution of legal
proceedings, and conversion of property obtained by an agent
purportedly at principals direction.
b. Comment b. to Restatement: Apparent-authority doctrine focuses on
reasonable expectations of third parties with whom an agent deals. This
focus is inapposite to many instances of tort liability. However, apparent-
authority doctrine is operative in explaining a principal's vicarious
liability when a third party's reasonable belief in an agent's authority to
speak or deal on behalf of a principal stems from a manifestation made
by principal and it is through statements or dealings that agent acts
tortuously.
c. Apparent agency is rooted in the doctrine of equitable estoppel and is
based on idea that if a principal creates appearance that someone is his or
her agent, the principal should not then be permitted to deny the agency
if an innocent third party reasonably relies on the apparent agency and is
harmed as a result.
d. Example: Butler v. McDonald’s Corp.: P pushed against McDonald’s
store door and it shattered, and injured his right hand.
i. Holding: Reasonable for person to conclude that when they go to
McDonald’s, they’re dealing with McDonald’s corporation, and
not just individual franchise, so apparent agency issue should be
submitted to a jury.
iv. Summary – Principals Liability for Agents Tort (follow steps in order below):
- Is there a principal agent relationship between Principal and Agent?
- Is there any ground for direct liability (i.e., inherently dangerous activity or non-
delegable duty)?
- If no, is there Vicarious Liability?
a. Respondeat Superior
i. Is the agent considered an employee of the principal so that we
have a master servant relationship?
a) Go through the 10 factors
ii. If he is considered an employee/servant, was there a tort
committed within the scope of employment?
a) First, look if it fits within the general definition of scope
of employment under Restatement (Second) of Agency §
228
b) If not, check if it is a kind of conduct that will be
considered within the scope of employment even if it is
unauthorized (Restatement (Second) of Agency § 229)
b. Apparent Agency (not sure if Guttantag taught this):
i. Did the agent commit a tort when acting with apparent agency in
dealing with the third party on or purportedly on behalf of the
principal?
ii. The Third party must have detrimentally relied on a
manifestation by the apparent principal and it must have been
reliance which exposed the third party to harm
Page 31 of 115
v. Agents Liability in Tort
- Restatement (Second) of Agency § 343: An agent who does an act otherwise a
tort is not relieved from liability by the fact that he acted at the command of the
principal or on account of the principle
a. Basically, the agent who committed a tort can still be liable for his own
tort (master or third party can come after him if they want)
- Restatement (Third) of Agency § 7.01: An agent is subject to liability to a
third party harmed by the agents tortious conduct.
a. Same thing as above.
g. Roles and Duties of Agency Relationship
i. Roles: Principal and Agent
- Principal sets out what he wants and asks the agent to do so
- Agent either accepts or denies the requests
- The principal is the boss, you're working on behalf of him
ii. Duties: Principal and Agent
- Agency is the fiduciary relation which results from the manifestation of consent
by one person (the principal) to another (the agent) that the other shall act on his
behalf and be subject to his control and consent by the other so to act
a. The fiduciary duty arises regardless of whether there is a contract
iii. Principals Obligations to the Agent (not sure if Guttentag taught us this)
- The plaintiff has a duty to indemnify/reimburse the agent for:
a. The terms of any contract between them;
b. When the agent makes a payment within the scope of actual authority or
that is beneficial to the principal unless the agent acts officiously in
making the payment;
c. When the agent suffers a loss that fairly should be borne by the principal
in light of their relationship
- The principal has a duty to deal with the agent fairly and in good faith
a. Example: If the principal requests certain services from an agent and the
agreement is silent as to compensation, the agent is generally understood
to be entitled to reasonable compensation
iv. AGENT’S FIDUCIARY DUTY TO PRINCIPAL.
- These are not merely obligation, but fiduciary duties an agent has towards his
principal. A fiduciary is someone who stands in a special position of trust,
confidence, and responsibility in certain obligations to others. The fiduciary
relationship requires one party to put the other party’s interests ahead of its own.
- Principal’s Consent: Conduct by the Agent that would otherwise breach below-
listed duties does not constitute a breach if the Principal consents, provided that
the Agent acts in good faith and discloses all material facts in obtaining the
consent.
- Restatement (Second) of Agency § 376: General Rule – The existence and
extent of the duties of the agent to the principal are determined by the terms of
the agreement between the parties
- Restatement (Second) of Agency § 379: Duty of Care and Skill – Unless
otherwise agreed, an . . . agent is subject to a duty to the principal to act with
standard care and with the skill that is standard . . .
Page 32 of 115
a. If an agent claims to have special knowledge or skill, then the agent has
a duty to act with the care normally exercised by agents with such skill
and knowledge. Otherwise, the standard is simply the ordinary care that
an agent would use in similar circumstances, if the agent is paid, or gross
negligence for unpaid agents. The standard of care is also subject to
agreement between principal and agent (exculpatory agreements)
- Restatement (Second) of Agency § 381: Duty to Give Information – Unless
otherwise agreed, an agent is subject to a duty to . . . give his principal
information which is relevant to the affairs entrusted to him
a. This is an affirmative duty to speak and give information to the principal,
even if the agent is not asked. If it is relevant, he must give over the
information; he has an affirmative duty
b. Agent has a duty to provide information to the principal that the agent
knows or has reason to know that the principal would wish to have or the
facts that are material to the agents duties to the principal
c. This duty, unlike the others, remains in force even after agency
relationship has been terminated.
- Restatement (Second) of Agency § 387: Duty of Loyalty
a. Unless otherwise agreed, an agent is subject to a duty to his principal to
act solely for the benefit of the principal . . .
i. This means that the agent should act in the best interests of the
principal when he is acting within the agency relationship
ii. i.e., the agent should not act adversely to the principal, compete
with the principal, take a business opportunity that belongs to the
principal, etc.
b. Also includes the duties to:
i. Duty to Account for any profits arising out of employment
ii. Duty to not act adversely to the principal, and if he does, he must
tell the principal about the deal and treat the principal fairly
iii. Duty to not compete with the principal in the subject matter of
agency, during the time of the agency relationship
iv. Duty to not act with conflicting interests The agent cannot act
for person’s whose interest conflict with the Principal’s interest
in a matter for which Agency is employed
v. Not to misuse or disclose confidential information
Page 33 of 115
v. Accounting Terminology
- Revenue: the amount of money that results from selling products or services to
customers. Also known as Sales or more colloquially, Gross
- Profit: Revenues less expenses (where expenses include taxes) Also known as
Net Income or, more colloquially, Net. The “bottom line” of the income
statement
- Income Statement: Financial statement that indicates results of operations over
a specified period. Also, known as the profit and loss (P&L) statement
- Profit Margin: the percentage of every dollar of sales that makes it to the
bottom line. Profit margin is net income divided by sales. Also known as the
Return on Sales (ROS)
vi. General Automotive v. Singer
- Facts: Singer (defendant) was employed at General Automotive Manufacturing
(Automotive)(plaintiff), holding the title of general manager of operations.
Singer had worked in the machine shop field for over thirty years. He is adept at
machine work and had many other things. He has a great reputation amongst
machine shop circles and no other employee could handle the machines as well
as him. Singer is also very adept at estimating costs. When he was hired, Singer
executed an employment contract with Automotive which provided for a base
salary plus 3% commission of Automotive’s gross sales. The contract prohibited
Singer from engaging in other employment and/or disclosing company
information that would personally benefit Singer or harm Automotive’s
business, and the contract said that he had to devote his entire time, skill, labor
and attention to the employment, and not engage in any other business or
vocation of a permanent nature. During his term of employment, Singer
attracted a substantial number of orders that could have been offered to
Automotive, however, Singer decided that Automotive lacked the necessary
facilities and equipment to fill those orders at a competitive price. Singer then
Page 34 of 115
secretly took orders himself, contracted with a rive machine shop to do the
work, and kept the difference between the price he quoted and the amount the
paid the machine shop. Singer later set up his manufacturer’s consulting
business, brokering orders for the same types of products Automotive
manufactured. Singer remained an employee of Automotive while running his
enterprise, without telling Automotive anything about his side business (he did
not disclose). Automotive eventually found out about Singer’s venture and sued
him for breach of contract and violation of the fiduciary duty he owed to
Automotive. “Under his fiduciary duty to Automotive (as Singer was an agent),
Singer was bound to the exercise of the utmost good faith and loyalty so that he
did not act adversely to the interests of Automotive by serving or acquiring any
private interest of his own . . . He was also bound to act for the furtherance and
advancement of the interest of Automotive.”
- Issue: Whether an employee who operates a business that competes with his or
her employer, without disclosing that business to the employer, has committed a
breach of the fiduciary duty?
- Rule: An employee that violates his or her fiduciary duty to an employee by
secretly running a competitive business is liable to the employer for the profit
made by that enterprise.
- Holding 1:
a. First, Singer argues that in his “side business” he was a manufacturers
agent or consultant, whereas automotive was a small manufacturer of
automotive parts.
i. Sub-Rule: The title of an activity does not determine the question
whether it was competitive but an examination of the nature of
the business must be made.
a) Basically, just because someone calls what they are doing
something else, does not mean it is not competitive
you need to examine the nature of the businesses, not the
names you put on them
b. Singer directly competed with his employer Automotive by secretly
filling orders meant for automotive and then surreptitiously forming his
own venture that conducted the same type of business in which
Automotive engaged.
i. Singer argues that when Automotive had the shop capacity to fill
an order he would award Automotive the job, but he contends
that it was in the exercise of his duty as general manager of
Automotive to refuse orders which in his opinion Automotive
could not or should not fill and in that case he was free to treat
the order as his own property.
ii. A clear conflict of interest is present Singer had the duty to
exercise good faith by disclosing to Automotive all the facts
regarding this matter . . . Upon disclosure to Automotive it was in
the latter’s discretion to refuse to accept the orders or to fill them
if possible or to sub-job them to other companies, and keep the
profit themselves. Automotive would then be able also to decide
whether to expand its operation, install suitable equipment, or to
make further arrangements with Singer. By failing to disclose all
Page 35 of 115
the facts relating to the orders, and by receiving secret profits
from these orders, Singer violated his fiduciary duty to act solely
for the benefit of Automotive.
- Holding 2:
a. Rule: When an agent violates their fiduciary duty, they are liable to the
principal for the amount of profits he earned in his side business
disgorgement of profits
b. What was the gross amount of the sale to Husco (the company putting in
orders that Singered brokered)
i. We know Singer’s profits were $10,183 based on his 3%
commission
ii. $10,183/.03 = $340,000
iii. Gross sales to Husco = $340,000
c. What is Singer’s profit margin on the Husco sale?
i. We know Singer’s profit on the Husco sale = $64,088
ii. 64,088/340,000 = 19% profit margin
- Questions for class:
a. Singer’s contract specified in Section 8A that he must “devote his entire
time to the business” and “not engage in other business of a permanent
nature.” Is it possible for him to breach the contract and not breach his
duty of loyalty?
i. Only if the contract waived the duty of loyalty
ii. These two provisions seem contradictory – in those situations, the
court gets to decide who is more sympathetic
b. Why didn’t General Automotive just sue under breach of contract?
i. It would have been harder to calculate damages
ii. Under breach of fiduciary duty however, General Automotive
remedy would have been disgorgement of profits
a) they would get the entire $64,088 profits made by Singer
rather than just their lost profits
iii. Also, the contract was unclear so the court may have ended up
finding no breach – fiduciary duty was safer since secret profits
always cause breach of duty of loyalty
c. How could Singer have disclosed the information when he was really the
only manager at the shop?
i. The court was trying to prove a point more on the fact that there
was a principal/agent relationship and subsequent duty to disclose
rather than looking at business reality.
d. Would it be possible to conclude Singer breached contract but not duty
of loyalty? Or vice versa?
i. He breached based on the clause of devoting his entire time to the
company
ii. But he didn’t because they contradict eachother in nature
iii. Similar to Watteau, it’s a breach but its not related. His side
business did not created a fiduciary problem
iv. You can modify the fiduciary obligations because they are an
umbrella that is broad and uncertain. So we can say theres no FD
outside of this contract.
Page 36 of 115
e. Why didn’t they just sue on a contract theory?
i. Because contract damages are loss profits but GA probably didn’t
loose much profits. But what is the remedy in Fiduciary law?
What do you get if you find it to be a fiduciary breach?
a) Disgorgement of profits. The damages reward is better
under the fiduciary law
f. What advice might you give singer?
i. Go to your employer ang get consent or try to end the contract
h. Termination of Agency
i. Agreement of Parties: The contract between principal and agent, if there is a contract,
can state when the principal agent relationship will end or if it will end upon a
happening of a specified event
ii. By Lapse of Time: At the end of a specified time, or if no specified time, then the
agency relationship will terminate within a reasonable time period
iii. By change of circumstances that should cause the agent to realize the principal would
want to terminate authority
- Example: destruction of subject matter of the authority, drastic change in
business conditions, change in relevant laws etc.
iv. Fulfillment of the Purpose of the Agency Relationship, i.e., completion of the task, will
terminate the agency relationship
v. By operation of law: Termination occurs automatically
- e.g., upon death or loss of capacity of either agent or principal, such as
dissolution of a corporation or insanity of a person.
vi. Termination At-Will: Agency law says that either party can terminate the relationship at
will
vii. Restatement (Second) of Agency § 118: Revocation and Renunciation – Authority
terminates if the principal (by revocation) OR the agent (by renunciation) manifests to
the other dissent to its continuation
- It has to be manifested directly to the other party (so notice must be given)
- Manifestations can be actions rather than statements (but it must be somekind of
activity)
- NOTE*** This power exists even though the party exercising the power may be
in breach of the agency contract, if there is a contract
viii. Restatement (Second) of Agency § 124(A): Effect of Termination of Authority upon
Apparent Authority – The termination of authority does not terminate apparent
authority
- Termination of actual authority does not end any apparent authority held by the
agent
- Apparent authority ends when it is no longer reasonable for the third party to
believe that the agent continues to act with actual authority (see Restatement
below)
ix. Restatement (Second) of Agency § 136: Notification Terminating Apparent Authority
- Apparent authority terminates when the third party has notice; or
- The third party’s reasonable belief that the other person is working as the
principals agent must be taken away The test is whether the third party knows
or reasonably should have known of the termination of agent’s authority.
a. HYPO: Supermarket tells one of its cashiers that she’s fired
i. Is actual authority terminated? Yes
Page 37 of 115
ii. How can it terminate the cashier’s apparent authority? Principal
can take away the uniform, business cards, etc.
b. HYPO: Supermarket fires the manager responsible for purchase of fish
i. If manager now orders another shipment of fish on supermarket’s
behalf, must the supermarket pay? Yes
ii. How can it terminate the manager’s apparent authority? Taking
away uniform, alerting clients (remember in cases like this the
principal has to give notice)
x. Restatement (Second) of Agency § 396: Agents Fiduciary Duties to Principal After
Termination
- Using confidential information after termination of agency
a. Unless otherwise agreed, after termination of the agency, the agent
i. Has no duty to not compete;
ii. Has a duty not to use or disclose trade secrets . . . the agent is
entitled to use general information . . . and the names of
customers retained in his memory . . .
V. PARTNERSHIPS
a. Sources of Law (its all from statutes)
i. Uniform Partnership Act (“UPA”) (1914)
ii. Uniform Partnership Act (“RUPA”) (1997)
iii. Difference between UPA and RUPA
- Mandatory v. Default fiduciary duties
a. A mandatory provision means that it cannot be altered by agreement
b. A default provision means that the rule applies, HOWEVER, the partners
can alter it by agreement (if no alteration, then default rules will
automatically apply)
- Financial consequences of wrongful termination – UPA more punitive
b. Formation.
i. A partnership is a default business association and you have to affirmatively state that
you are not creating a partnership to opt out and rebut the presumption
ii. A general partnership can be formed without any filing with the state
iii. Once such an association occurs, general partnership law determines the parties’
relative rights and duties
iv. UPA (1914) § 6(1):
- GENERAL RULE: A partnership is an association of two or more persons to
carry on as co-owners of a business for profit.
a. Basically, that is the general rule, unless those persons follow the steps
necessary to have it become a limited partnership, LLC, LLP, LLLP, or
corporation
- “Carry on as co-owners”—But what does this mean UPA (1914) § 7: In
determining whether a partnership exists
a. (3) The sharing of gross returns DOES NOT establish a partnership
(revenues/commissions) (its relevant, but not determinative).
i. NOTE*** Revenue: The amount of money that results from
selling products or services to customers. Also known as Sales or,
more colloquially, Gross.
ii. YOU ARE THE CHICKEN, YOU GET TO LIVE ANOTHER
DAY
Page 38 of 115
b. (4) The receipt by a person of a share of the profits is PRIMA FACIE
evidence that he is a partner . . . but no such inference shall be drawn if
such profits were received in payment
i. (b) as wages of an employee
ii. NOTE*** Profit: Revenue less expenses – this is basically your
accounting “bottom line”
iii. YOURE THE BACON, YOURE ALL IN!
c. HYPO: Alex and Beverly are both wedding planners. Suppose Alex and
Beverly agreed to pool their gross receipts in a joint account, pay all
expenses out of the join account, and then split the profits. In the absence
of evidence to the contrary, is that a partnership? YES
d. HYPO: Suppose two accountants share office space. Do they become
partners of an accounting firm by jointly owning or leasing the office
space? NO
e. HYPO: Suppose two accountants purchased the office space, which has
three offices. The rent out the third office to X, sharing the rent proceeds
equally. Is a partnership formed between the accountants? That by itself
does not establish a partnership; you need to see if there is more facts
that indicate they are co-owners of a real estate business sharing profits
v. How do you if a partnership has been formed?
- First, look at the definition of a partnership – “Enter into an association of two
or more persons to carry on as co-owners a business for profit”
- Second, consider whether UPA §§ 7(3) and 7(4) are relevant
- Lastly, look at the list of factors from Fenwick v. Unemployment Commission
a. The intention of the parties
b. The right to share in profits (not alone conclusive)
c. Obligation to share in losses (i.e., risk)
d. Ownership and control of partnership property (control)
e. Contribution of capital
f. Right to capital on dissolution
g. Control of Management
h. Conduct toward third parties, and
i. Right on dissolution
- Fenwick v. Unemployment Compensation Commission
a. Facts: Fenwick (plaintiff) employed Chesire as a cashier and receptionist
at his beauty shop. Chesire initially worked for $15 per week, but after
several weeks she demanded a raise. Not want to lose Chesire, Fenwick
agreed to increase her compensation if the beauty parlor made more
money. Fenwick and Chesire executed an agreement (which was written
by a lawyer) which described their association going forward as a
“partnership,” and each of them “partners.” The agreement provided that
Chesire would continue her current duties and be paid her existing salary
plus 20% of the profits “if the business warrants it.” The agreement
further provided: (4) That no capital investment shall be made by
Chesire; (5) That the control and management of the business shall be
vested in Fenwick; (7) That as between the partners Fenwick alone is to
be liable for debts of the partnership; (8) That both parties shall devote
all their time to the shop; (9) That the books are open to both for
Page 39 of 115
inspection; (10) That the salary of Fenwick is to be $50 per week and at
the end of the year he is to receive 80% of the profits; (11) That the
partnership shall continue until either party gives ten days’ notice of
termination. After three years, Chesire terminated the partnership to stay
home with her children. A case was brought before the New Jersey
Unemployment Compensation Commission (Commission) (defendant)
to determine whether Chesire was Fenwick’s partner or employee. If
Chesire was Fenwick’s employee, Fenwick would be responsible for
paying into the state unemployment compensation fund. The
Commission found that Chesire was Fenwick’s employee, holding that
the agreement was simply an instrument used by the parties to set the
level of Chesire’s salary.
b. Procedure: The New Jersey Supreme Court reversed, relying heavily on
the fact that the parties entered into an agreement, called themselves
partners, had designated the relationship one of partnership, and held that
the surrounding circumstances, the conduct of the parties, etc., were not
enough to overcome the force and effect of the agreement.
c. Issue: Is a partnership established by an agreement stating that two
parties ae partners, if one party retains sole ownership of the business
and the parties conduct themselves as employer or employee (Quimbee)?
i. Basically, the issue boils down to whether Chesire was a partner
or employee of Fenwick.
d. Rule: The General Rule: A partnership is exists when two or more
persons act as co-owners of a business for profit.
e. Holding: The evidence in this case shows that Fenwick and Cheshire
were not partners in the beauty shop. The court looks at many
elements/factors in deciding this:
i. Intention of the Parties Under this factor, the court looks to the
fact that there is a partnership agreement, however the court notes
that a partnership agreement is relevant, but not determinative. In
analyzing the agreement, the court notes that although the
agreement listed Fenwick and Chesire as “partners,” the intent of
the parties in entering into the agreement was to give Chesire the
possibility of a salary increase at her current job while at the
same time protecting Fenwick from having to pay it if his
business did not improve. After the alleged partnership
agreement was executed, the operation of business continued as
before; Chesire continued to serve in precisely the same capacity
as before and Fenwick continued to have complete control of the
management of the business. Hence, the agreement was intended
simply to memorialize the agree-upon financial relationship
between an employer and employee, and Chesire was excluded
from most of the rights of a partner.
ii. Right to share in profits The right clearly existed in this case
to share profits (remember, these are all factors, so they are
relevant, not determinative) she gets a share of the profits so its
Prima Facie evidence that shes a partner—but there’s a caveat->
there’s some situations where you want to do profit sharing but if
Page 40 of 115
youre doing PSb with your employee does not mean that theres a
prima facie evidence that theyre partners
iii. Obligation to share in losses This factor is entirely absent
because as per the agreement Chesire is not to share in any of the
losses
iv. Ownership and Control of the Partnership Property Fenwick
has all ownership rights and control
v. Contribution of Capital & Right of Capital upon dissolution
Fenwick contributed all the capital and Chesire had no right to
share in capital upon dissolution of the partnership. Fenwick also
reserved himself the control.
vi. Control of Management Basically, Fenwick has all control
over management
vii. Conduct of Parties toward Third Persons They did file
partnership income tax returns and held themselves out as
partners to the commission, and Fenwick in his New York state
income tax return reported his income as from a partnership.
However, they did not hold themselves out as a partnership to
anyone else, and did not inform any suppliers that they were
partners.
viii. Right of Dissolution As far as Mrs. Chesire was concerned,
things were exactly the same as, if she had quit an employment.
She ceased to work, and ceased to recive compensation and
everything reverted back to the condition it was prior to the
agreement being executed except that Fenwick carred on with a
new receptionist. There was no “winding up the partnership” or
any indication the partnership had been dissolved.
f. Conclusion: The court said that a partnership was not formed, and
basically that the element of “co-ownership” is lacking in this case.
Page 41 of 115
b. The act of every partner being carried out in the ordinary course of
business will bind the whole partnership,
c. Unless the partner has no authority to act for the partnership in a
particular manner and the person with whom the partner was dealing
with had knowledge of this fact or received a notification that the partner
lacked authority
i. This is like agency law; as a co-owner, you are authorized to
anything within the ordinary course of business and thus, can
create liability
ii. Exceptions are when you’re not authorized and the third party has
notice
d. HYPO: A, B, and C form a partnership to run a pet hospital. All agree
that A shall have the exclusive authority to order supplies, B shall have
exclusive authority to handle advertising, and C shall have exclusive
authority to hire help. Could the partnership be liable on an advertising
contract that A entered into on behalf of the partnership? A would have
apparent authority to enter into contract because A is a partner, as long as
the third party does not have notice of limited partnership authority.
- UPA (1914) § 13 (in tort): where there is a wrongful act or omission of any
partner acting in the ordinary course of the business of the partnership, the
partnership is liable
a. A partnership is liable for loss or injury caused to a person, or for a
penalty incurred, as a result of a wrongful act or omission, or other
actionable conduct, of a partner acting in the ordinary course of business
of the partnership or with authority of the partnership
b. You do not need to engage in a respondent superior analysis with
partnerships; you just need to ask whether the person was a partner in the
partnership, and then whether his action was in the ordinary course of the
business of the partnership OR of the type broadly authorized of the
partnership.
c. For apparent authority, if it is something regarding the ordinary course of
the partnership business, there is apparent authority that would bind the
partnership to liability on that, UNLESS the partner had no authority to
act for the partnership in a particular manner and the person with whom
the partner was dealing knew that or received notice of that.
Page 42 of 115
d. Fiduciary Duties Among Partners
It is three dimensional and these ^^^ are the three topics
i. NOTE*** There are differences between UPA and RUPA that we need to know in this
section
ii. Fiduciary Duties Among Partners under UPA (1914)
- Default
a. UPA § 9: Every partner is deemed to be an agent of the partnership
b. Duty of Care
i. Restatement (Second) of Agency § 379: Unless otherwise
agreed, agent is subject to a duty to the principal to act with
standard care and with the skill which is standard
c. Duty of Loyalty
i. Restatement (Second) of Agency §§ 387-395 all apply,
however, they can be modified
a) Restatement (Second) of Agency § 387: Unless
otherwise agreed, an agent is subject to a duty to his
principal to act solely for the benefit of the principal
d. Information Duties
i. Restatement (Second) of Agency § 381
e. NOTE*** everything under principal agent relationship is default and
nothing is mandatory, unlike for a partnership
- Mandatory
a. Duty of Care
b. Duty of Loyalty
i. UPA § 21: Must account for profits from any transaction
connected with partnership
c. Information Duties
i. UPA § 20: Obligation to render true and full information on
demand
a) The information requested must be related to the
partnership
Page 43 of 115
ii. UPA § 22: Each partner has a right to a formal accounting
(Information Duty)
iii. FIDUCIARY & INFORMATION Duties under RUPA (1997): can be modified under
RUPA § 103 (see below) NOTE*** These are mandatory
- RUPA § 409(a) – Fiduciary Duties in a Partnership Partners are fiduciary’s
of each other and the partnership
- Duty of Care:
a. RUPA § 409(c): The duty of care of a partner in the conduct or winding
up of the partnership is to refrain from engaging in grossly negligent or
reckless conduct, willful or intentional misconduct, or a knowing
violation of the law – violating any of these is a violation of the duty of
care
i. So basically, under the duty of care, a partner has the obligation
in not being any one of those things stated above when
conducting the business of the partnership
ii. If just ordinary standard of care, we would have partners suing
each other all the time, so the threshold is higher
a) 409(a) You need gross negligence or worse for a violation
if this fiduciary duty. Ordinary standard of care would be
too low of a threshold, and we would have partners suing
each other left and right
- Duty of Loyalty
a. RUPA § 409(b): The fiduciary duty of loyalty of a partner includes (and
I guess is limited too):
i. To account and hold as trustee any property, profit, or benefit
derived by the partner in the conduct of the partnership, including
a partnership opportunity;
a) Basically, a partner cannot take a partnership
opportunity for themselves.
(1) See Meinhard v. Salmon
ii. Refrain from dealing as or on behalf of a party with an interest
adverse to the partnership; and
a) Basically, a partner cannot act adversely to the
partnership
iii. Refrain from competing with the partnership in partnership
business before dissolution
a) Basically, a partner cannot compete with their own
partnership while it is still in existence, before its
dissolution
Page 44 of 115
b. RUPA § 409(e):
i. Self-interest is not dispositive, meaning the duty is not
automatically violated A partner does not violate a duty or
obligation under this Act or under the partnership agreement
merely because the partner’s conduct furthers the partner’s own
interest – when a partner acts in their own interest, that itself is
not dispositive, it may be relevant.
a) NOTE*** Difference between RUPA and UPA § 9
agency, which brings in Restatement (Second) of Agency
§ 387 solely vs. self-interest not dispositive
ii. As compared to agency, the agent must act solely for the benefit
of the principal, HOWEVER, RUPA says that partners can be a
little self-interested and still be loyal to the partnership (they are
allowed to take a salary)
c. RUPA § 409(f):
i. All partners may authorize or ratify, after full disclosure of all
material facts, a specific act or transaction by a partner that would
otherwise violate the duty of loyalty
a) If the opportunity would violate the duty of loyalty, then
upon disclosure, the other partner can still deny approval
ii. NOTE*** a partner can’t get out of the duty of loyalty unless the
other partner(s) let him out, even if the partner discloses
everything
- RUPA § 408 – Information Duties
a. This is NOT a fiduciary duty
b. (a) maintain books and records
c. (b) provide access to books and records
d. (c)(1)Furnish without demand info required to excersixe rights
e. (c)(2)Furnish any other information on demand unless unreasonable or
improper
Page 45 of 115
- Ability to Modify Duties under RUPA § 105
a. RUPA introduces mechanism that allows some but not complete
modification of duties
b. (a) Relations between partners are governed by agreement
c. (b) To the extent the partnership agreement does not provide for a matter
described in subsection (a), RUPA governs the matter (see Pav-Saver v.
Vasso)
d. (c) The partnership agreement may not:
i. (4) Unreasonably restrict the right of access to books and records
under RUPA § 408
ii. (5) Alter or eliminate duty of loyalty or duty of care, except as
otherwise provided in RUPA § 105(d)
a) (I put subsection (d) here) If not manifestly
unreasonable, the partnership agreement may:
(1) (A) Alter or eliminate the aspects of the duty of
loyalty stated in RUPA § 409(b) (look above to
this section; the blow three are abbreviations);
i. No secret profits
ii. No competing
iii. No dealing in conflicting business
(2) (B) Identify specific types of categories of
activates that do not violate the duty of loyalty
i. i.e., can make clear that certain types of
activities or opportunities are not part of
the partnership so that a partner can still
pursue that activity or opportunity without
violating the duty of loyalty
(3) (C) Alter the duty of care, but may not authorize
conduct involving bad faith, willful or intentional
misconduct, or knowing violation of the law.
e. Manifestly Unreasonable – RUPA § 105(e)
Page 46 of 115
i. RUPA § 105(e): The court shall decide as a matter of law
whether a term of a partnership agreement is manifestly
unreasonable. The court:
a) (1) Shall make its determination as of the time the
challenged term became part of the partnership agreement
and by considering only circumstances existing at that
time; and
b) (2) May invalidate the term only if, in light of the
purposes and business of the partnership, it is readily
apparent that:
(1) (A) The objective of the term is unreasonable; or
(2) (B) The term is an unreasonable means to achieve
the term’s objective
iv. Meinhard v. Salmon (I would 100% read this case again in the book when studying for
finals, and read it very in depth)
- Facts: Salmon (defendant) executed a 20-year lease (Bristol Lease) for the
Bristol Hotel which he intended to convert into a retail building. Concurrent
with his execution of the Bristol Lease, Salmon formed a joint venture with
Meinhard, for the necessary funds. The joint venture, which was reduced to a
written agreement, provided that Meinhard would pay Salmon half the amount
required to manage and operate the property, and Salmon would pay Meinhard
40% of the net profits for the first five years, and 50% thereafter. Salmon,
however, was to have sole power to “manage, lease, underlet, and operate” the
building. Both parties agreed to bear nay losses equally. The joint venture lost
money during the early years, but eventually became very profitable. During the
course of the Bristal Lease, another lessor acquired rights to it. The new lessor,
who also owned tracts of nearby property, wanted to lease all of that land to
someone who would raze the existing building and construct new ones. With
only four month left to the Bristol Lease, Salmon executed a 20-year lease
(Midpoint Lease) for all of new lessor’s property through Salmon’s company,
the Midpoint Realty Company, which was owned and controlled by Salmon.
Salmon did not inform Meinhard about the transaction. Approximately one
month after the Midpoint Lease was executed, Meinhard found out about
Salmon’s Midpoint Lease, and demanded that it be held in trust as an asset of
the joint venture. Salmon refused, and Meinhard filed suit.
- Procedure: At the appeals court, the court affirmed judgement of the lower court
and gave Meinhard 50% interest in the Midpoint Lease.
- Issue: Is a co-adventurer required to inform another co-adventurer of a business
opportunity that occurs as a result of participation in a joint venture?
a. Because think about it, the new lessor went to Salmon because he knew
Salmon would likely be a customer of the extra land surrounding the
Bristol land Salmon owned the Bristol Land, so he may as well want
the surrounding land as part of his venture. However, the new lessor did
not know that Salmon had a partner in the Bristol Lease (nothing in the
lease indicated that Meinhard was a part of it)
- Rule: Co-adventurers, like partners, have a fiduciary duty to each other,
including sharing in any benefits that result from the parties’ joint venture.
Page 47 of 115
-Holding: A co-adventurer who manages a joint venture’s enterprise has the
strongest fiduciary duty to other members of the joint venture. The Midpoint
Lease was an extension of the subject matter of the Bristol Lease, in which
Meinhard had a substantial investment. Salmon was given the opportunity to
enter into the Midpoint Lease because he managed the Bristol Hotel property. If
Meinhard was a part of the lease, or the new lessor knew Meinhard was a
partner, the new lessor would forsure have had presented the deal to both
partners. Because Salmon’s opportunity arose as a result of his status as the
managing co-adventurer, he had a duty to tell Meinhard about it. Salmon
breached his fiduciary duty by keeping his transaction from Meinhard, which
prevented Meinhard from enjoying an opportunity that arose out of their joint
venture. Accordingly, the judgment of the appeals court is affirmed, with a
slight modification. This court holds that a trust attaching to the shares of stock
should be granted to Meinhard, with the parties dividing the shares equally, but
with Salmon receiving an additional share. The additional share enables Salmon
to retain control and management of the Midpoint property, which according to
the terms of the joint venture Salmon was to have for the entire length of that
joint venture.
- Dissent:
v. Comparing DUTY OF LOYALTY under UPA and RUPA
- UPA
a. UPA § 21: Must account for profits from any transaction connected with
the partnership
b. Restatement (Second) of Agency § 287: unless otherwise agreed, an
agent is subject to a duty to his principal to act solely for the benefit of
the principal
- RUPA
a. RUPA § 409(b): must account for profits from any transaction
connected with the partnership
b. RUPA § 409(e): self-interest is NOT dispositive
- Seems like UPA is more limited because only it discusses profits, but UPA
relies on the Restatement and that has a broader test and more onerous
obligation that your agents (partners) have to be acting solely for the principal
(partnership). The RUPA softens that obligation.
vi. Comparing DUTY OF CARE under UPA and RUPA
- UPA
a. Restatement (Second) of Agency § 379 – Duty of care and skill:
unless otherwise agreed, an agent is subject to a duty to the principal to
act with standard care and with the skill which is standard
- RUPA
a. RUPA § 409(c) – Duty of care: gross negligence or worse is violation
i. If you breach your duty of care, the partnership has a claim
against you and can sue. But under the new standard in RUPA, it
is harder to prove breach and harder for partners to sue each
other.
a) Wanted to discourage people from using the courts to
regulate partnerships
Page 48 of 115
b) You signed up to be partners and should have agreed to
specific terms
(1) Otherwise, it would be too easy for disgruntled
partners to sue and the partner with more money
would likely win no matter what
ii. In this way, the law is stepping back from the role of managing
the business, but in other ways it has become more intrusive
because partners now have an affirmative obligation to keep
partners informed under the RUPA
vii. Comparing INFORMATION DUTIES under UPA and RUPA
- UPA
a. UPA § 20: Obligation to render true and full information on demand
b. UPA § 22: Each partner has a right to a formal accounting
c. Restatement (Second) of Agency § 381
- RUPA
a. RUPA § 408(a): Maintain books and records
b. RUPA § 408(b): Provide access to books and records
c. RUPA § 408(c): Furnish information unless not required to exercise
rights and unreasonable
viii. Summary comparison of all Fiduciary Duties under UPA and RUPA
ix. Comparing allowable MODIFCATIONS of Fiduciary Duties under UPA and RUPA
- UPA
a. Restatement duties can be changed/modified – remember, they are the
default duties unless there is an agreement around them
b. You cannot modify UPA §§ 21-23
- RUPA
a. RUPA § 105(c)(4): May not unreasonably restrict access to books
b. RUPA § 105(d)(3): May not eliminate duty of loyalty or care, but can
remove specific categories if not manifestly unreasonable
x. Comparing Partners’ MANDATORY Fiduciary Duties under UPA and RUPA
- UPA
a. UPA § 21: Must account for profits from any transaction connected with
the partnership
- RUPA
a. RUPA § 404(a): Limited to duty of care and loyalty as set forth
b. RUPA § 404(b): Loyalty duty exclusively: hold profit in trust, no
adverse dealing, no competing against business
c. RUPA § 404(a): Duty of care limited to gross negligence
d. RUPA § 404(a): Self-interest is okay
Page 49 of 115
e. RUPA § 105: Can be modified
xi. Meehan v. Shaughnessy
- Facts:
- Procedure:
- Issue:
- Rule:
- Holding:
- Conclusion:
e. Partnership Roles and Rights
i. Management Role of a Partner (default roles) – treat all partners as equals and overlook
the business reality of one money partner and one skill partner
- UPA § 9: Every partner is an agent of the partnership
a. UPA § 9(1): “Every partner is an agent of the partnership for the
purpose of its business, and the act of every partner, including the
execution in the partnership name of any instrument, for apparently
carrying on in the usual way the business of the partnership of which he
is a member binds the partnership, unless the partner so acting has in
fact no authority to act for the partnership in the particular matter, and
the person with whom he is dealing has knowledge of the fact that he
has no such authority”
i. A sub-rule to this that you can extrapolate is that “no act of a
partner in contravention of a restriction on authority shall bind
the partnership to persons having knowledge of the restriction”
see, UPA § 9(4), or NABISCO v. Stroud
- UPA § 18(b): Every partner can spend partnership money if “reasonably
incurred” in “ordinary and proper” conduct of business
a. Entitled to carry on partnership business and partnership has liability
ii. The roles and rights of each partner to participate in the operation of the business in
some will be an implicit term of the partnership agreement. At the same time,
disagreements may arise over various business decisions. In the absence of an
agreement to the contrary, the following UPA’s can help solve the problem
- UPA § 18(e): Partners have “equal rights” to management and conduct of the
partnership business
a. Basically, each partner has equal rights in the management and conduct
of the partnership business
i. HYPO: A contributes 70% of the partnership capital, B
contributes 20% of the partnership capital, and C contributes
10%. How would you describe the rights of management of A, B,
and C? Each has equal management rights. (What are their voting
rights? Each would have 1 vote, unless otherwise agreed)
- UPA § 18(h): Any difference arising as to the “ordinary matters” connected
with the partnership business may be decided by a “majority” of the partners.
a. Disagreements are decided by a majority
i. A difference arising as to a matter within the ordinary course of
business may be decided by a majority of partners.
Page 50 of 115
a) This basically means, that if there is a difference that
arises from the ordinary course of business of the
partnership, you need a majority to decide on it
(1) So, for example, if in NABISCO v. Stroud, there
were three partners, and two of the said they don’t
want to purchase bread from NABISCO and gave
NABISCO notification of this, the act of the third
partner purchasing bread would not be binding on
the partnership.
(2) “In cases of an even division of the partners as to
whether or not an act within the scope of the
business should be done, of which disagreement a
third person has knowledge, it seems that logically
no restriction can be placed upon the powers to
act. The partnership being a going concern,
activities within the scope of the business should
not be limited, save by expressed will of the
majority deciding the disputed question; half of
the members are not a majority.” See NABISCO
v. Stroud
ii. An act outside the ordinary course of business of a partnership,
and an amendment to the partnership agreement, may be
undertaken only with the consent of all the partners.
a) NOTE*** If there is no majority decision, then remains
unresolved and default goes back to UPA § 18(b)
b. In a partnership where one person brings in the money and the other
brings management skill, they will probably have very different interests,
and thus, they would want to contract around this default of having equal
rights.
- HYPO: Thus, if there are three partners and they disagree as to an “ordinary”
matter, the decision of the majority controls. For example, if the partnership
operates a grocery store, and two of the partners, for business reasons, want to
stop buying bread from a certain supplier, their decision is binding on the third
partner. The majority can deprive the minority partner of the authority to buy
bread from that supplier. If the supplier is made aware of the limitation, an order
for bread from the minority partner would not bind the partnership or the other
partners. If, however, there are only two partners, there can be no majority vote
that will be effective to deprive either partner of authority to act for the
partnership.
iii. National Biscuit Company (NABISCO) v. Stroud:
- Facts: Facts: Stroud (defendant) and Freeman formed a general partnership to
sell groceries under the firm name of Stroud’s Food Center. The partnership
agreement did not limit either partner’s authority or power to conduct ordinary
business on behalf of the partnership. Several months before the partnership was
dissolved, Stroud told a National Biscuit Company (NABISCO) (plaintiff)
official that he would not be personally liable for any bread sold to the
partnership. Freeman subsequently ordered more bread on behalf of the
partnership, and NABISCO delivered that bread to the partnership. Shortly
Page 51 of 115
thereafter, the partnership was dissolved, and Stroud refused to pay for the bread
delivered at Freeman’s behest. NABISCO sued the partnership and Stroud for
the price of the bread.
- Procedure: The trial court found in favor of NABISCO.
- Issue: Can one general partner restrict another partner from conducting business
on behalf of a two-person partnership?
- Rule: The court mentions UPA §§ 9(1), 9(4), 18(2), & 18(h) as rules
- Holding: Each partner has an equal right in the management and conduct of a
partnership, and differences within a partnership are decided by a majority of the
partners. However, when there are only two partners there can be no majority,
and neither partner can prevent the other from binding the partnership in the
ordinary course of business. Freeman’s purchase of bread was a binding
transaction, done pursuant to the partnership’s business; certainly, the purchase
and sale of bread were ordinary and legitimate business of Stroud’s Food
Center, during its continuance as a going concern. Stroud, as Freeman’s sole co-
partner, had no authority to negate Freeman’s purchase. The partnership sold the
bread that Freeman bought, and consequently Stroud, as well as Freedman,
benefited from that purchase. The judgment of the trial court is affirmed. (Also
note that they ended up dissolving the partnership)
a. “Freeman as a general partner with Stroud, with no restrictions on his
authority to act within the scope of the partnership business so far as the
agreed statement of facts shows, had under the UPA “equal rights in the
management and conduct of the partnership business.” UPA § 18(e).
Stroud, his co-partner, could not restrict the power and authority if
Freeman to buy bread for the partnership as a going concern, for such a
purchase was an “ordinary matters connected with the partnership
business,” UPA § 18(h), for the purpose of its business and within its
scope, because in the very nature of things Stroud was not, and could not
be, a majority partner, UPA § 18(h).
- Conclusion: Therefore, Freemans purchase of bread from NABISCO for
Stroud’s Food Center as a going concern bound the partnership and his co-
partner Stroud.
iv. Day v. Sidley & Austin:
- Facts: Day (plaintiff) was the senior underwriting partner in the Washington
office of the Sidley & Austin law firm (S&A) (defendant). S&A’s partnership
agreement, which Day signed, provided that all matters of firm policy would be
decided by the executive committee, of which Day was not a member. In early
1972, S&A’s executive committee discussed merging S&A with another law
firm (Lieberman Firm). In July 1972, the merger was approved by a vote of
S&A’s underwriting partners. Day himself voted in favor of the merger. After
several more meetings of the underwriting partners, the terms of the merger
were entered into an amended partnership agreement, which Day signed. Soon
thereafter, the executive committee of the combined firm decided to move
S&A’s office to a new location and appoint a former chairman of the Lieberman
firm as co-chairman of the new firm. Day resigned soon thereafter, stating that
the appointment of the co-chairman and office move made his job “intolerable.”
Day subsequently filed suit against S&A, alleging that S&A violated its
fiduciary duty by commencing merger negotiations without consulting non-
Page 52 of 115
executive committee partners, and by not informing those partners of the
changes that would result from the merger.
Claims:
o Fraud: Said “no one will be worse off:
Dismiss because:
1. “not deprived of any legal right,” and
2. Could not have believed there would be no changes
Is the claim properly dismissed? No, he had a remedy as a partern so there
was some governance to lobby other partenrs and enforce the merger
o Breach of fiduciary duty: secrecy about merger consequences
partners owe each other honesty
suppose you were the judge, what would you say to daves argument here?
It is dismissed because the K says that all questions of firm policy including
determination of salary required balances shall be decided by executive
committee-- implicitly contracted around that FD and that claim was
properly dismissed.
o What was Days right to control before merger? Did it change after merger?
- Procedure:
- Issue:
- Rule:
- Holding:
- Conclusion:
f. Ending a Partnership
i. There are THREE PHASES to the termination of a partnership
- UPA §§ 29, 31, & 32 – Dissolution where the partnership ends
- RUPA §§ 601, 602, 700 & 800 – Winding up period
- Termination
ii. THE POWER & RIGHT TO DISSOLVE
- A partner always has the power to dissolve the partnership, but does not
necessarily always have the right to dissolve the partnership
- Power to dissolve the partnership – UPA § 29
a. Which may lead to Wrongful dissolution of the partnership – UPA §
31(2)
i. If it becomes a wrongful termination, you look too UPA § 38(2)
(b)&(c) for the consequences of dissolution
- Right to dissolve the partnership – UPA §§ 31(1) & (2)
Page 53 of 115
iii. Terminology – Dissolution UPA § 29: The dissolution of the partnership is the change
in the relation of the partners caused by any partner ceasing to be associated in carrying
on
- A partnership is very easy to dissolve because it is not necessary for a partner to
give an affirmative statement that he is leaving/dissolving the partnership; we
just need to look at whether they are carrying on as co-owners, and if they are
not, then the partnership has been dissolved
iv. Causes of Dissolution -- UPA
- UPA § 31 – Dissolution is caused:
a. (1) Without violation (“right”) of the agreement between the partners,
i. (a) Termination of a definite term or particular undertaking
specified in agreement,
ii. (b) express will of a partner when no definite term or particular
undertaking is specified, or
iii. (e) Expulsion of any partner in accordance with powers conferred
by the agreement between the partners
b. (2) In contravention of the agreement, where the circumstances do not
permit dissolution under any provision
i. See UPA § 38(2)(b)&(c) – you have a wrongful termination,
because only power exists under this section, so you turn to that
UPA
- UPA § 32(1) – Dissolution by Decree of the Court
a. On application by or for a partner the court shall decree a dissolution
whenever:
i. (a) a partner has been declared a lunatic in any judicial
proceeding or shown to be of unsound mind;
ii. (b) a partner becomes in any other way incapable of performing
his part of the partnership conduct;
iii. (d) a partner . . . so conducts himself in matters relating to the
partnership business that it is not reasonably practicable to
carry on the business in partnership with him i.e., the partner
hurts the partnership; or
iv. (e) the business of the partnership can only be carried on at a
loss, i.e., Business can only be carried on at loss.
v. Dissolution and Winding Up – UPA (1914) vs. RUPA (1997)
Page 54 of 115
- Dissolution and Winding Up – The three Consequences that can happen under
each the UPA and RUPA
a. UPA Here, disassociation or dissolution will automatically become a
dissolution. Upon a dissolution occurring, three things could happen
i. Winding up, which is selling the assets (this is the default rule, so
if you cannot do any of the other two, you will automatically go
into the winding up stage) – UPA § 30
ii. Continuation per agreement
a) Cannot continue at the moment UNLESS
(1) Original partnership agreement specified that they
would continue under these circumstances, or
(2) Partner left in contravention of the agreement, or
(3) Can also elect to terminate the partnership
iii. Continuation following wrongful dissolution – UPA § 31(2)
which leads to UPA § 38(2)
b. RUPA RUPA just changed the terminology a little; based on the
consequence, it will either be called a dissolution or disassociation
i. Dissolution will always lead to winding up under RUPA § 801
(see below) – RUPA § 801 tells us what will cause a dissolution
under RUPA and that it will lead to winding up (winding up will
be the same as under UPA § 30)
ii. Disassociation (we have a disassociation under RUPA, which
does not lead to dissolution (like it does under UPA); RUPA §
601 tells us when we have a disassociation under the RUPA) –
There are two potential consequences to a disassociation under
RUPA § 701
a) Continuation per agreement
b) Continuation following wrongful termination
- Terminology – Dissolution v. Dissociation
a. Disassociation: Instead of dissolution of the partnership and formation of
a new partnership, the partner simply leaves the partnership (i.e., he
ceases carrying on of the business), but the partnership is not dissolved.
The partner who left is simply disassociated from the firm (note,
partnership is one type of firm) (basically, a partner leaves the firm)
i. Under UPA, disassociation automatically becomes dissolution
and the partnership cannot continue
a) Thus, because it becomes a dissolution, the remaining
partners have to re-form a partnership
ii. Under RUPA, there can be a dissociation, and it may or may not
lead to dissolution and winding up of the partnership
a) A partner is dissociated from the partnership upon RUPA
§ 601
b) Note: Partners always have the power to dissociate, but
not always the right to dissociate (a partner can always
get out of the partnership, but he might be doing it
wrongfully)
(1) Example: if there’s a term in partnership
agreement (i.e. partnership lasts 1 year), and one
Page 55 of 115
partner leave after 6 months, then the partner will
be wrongfully dissociating from partnership.
iii. Either way, the economic consequences are the same
b. UPA § 29: The dissolution of the partnership is the change in the relation
of the partners caused by any partner ceasing to be associated in carrying
on
c. RUPA § 601: A partner is disassociated from a partnership upon the
occurrence of any of the following events:
i. (1) The partnership’s having notice of partner’s express will to
withdraw as a partner or on a later date specified by the
partner;
a) If it’s an at-will partnership (not term partnership), the
partner can dissociate the partnership and force
dissolution of the partnership
ii. (2) An event specified in the partnership agreement as causing
dissociation;
iii. (3) The partners’ expulsion as provided in the partnership
agreement
iv. NOTE*** these do not mean there is an automatic dissolution;
they just, as of now, show that there will be a disassociation
d. RUPA § 801: a partnership is dissolved and its business must be wound
up only upon occurrence of the following events (this is what happens
under dissolution, and under the circumstances that dissociation leads to
dissolution)
i. In a partnership at will, the partner’s express will
a) Remember, in a partnership, the default form of a
partnership is at-will
ii. An event agreed on in the partnership agreement
- Owen v. Cohen:
a. Facts: Owen (plaintiff) and Cohen (defendant) entered into an oral
agreement to become partners in a bowling alley in Burbank, California.
The parties did not expressly fix any definite period of time for the
duration of this undertaking. Owen loaned the partnership $6,986.63 to
buy the necessary equipment, which the parties agreed would be paid
back to Owen from the profits of the business. The business proved
immediately profitable and the partner were able to take a salary of $50 a
week. Eventually, the parties started quarreling over issues such
as management and policies of the enterprise, and their rights and duties
under their partnership agreement, which began to have an effect on
sales, which, though still substantial, were steadily declining. This
constant dissension over money affairs culminated in defendants
appropriation of small sums from the partnership’s fund to his own use
without Owens knowledge, approval or consent. Monetary matters were
a constant issue between the partners. The partners’ constant arguments
resulted in a steady decline of the bowling alley’s monthly receipts.
Realizing that the parties could not resolve their differences, Owen
offered Cohen the choice of either buying out Owen’s interest in the
bowling alley, or selling Cohen’s interest to Owen. Cohen refused to
Page 56 of 115
reasonably entertain either option, insisting that the business be
continued until he was ready to sell at a price he would set himself,
which he indicated would be extremely high. Owen subsequently filed
an action in equity to dissolve the partnership.
b. Procedure: At the time this action was filed much of the partnership
indebtedness, including the loan made by Owen, remained outstanding.
The trial court found that Cohen’s behavior in relation to the business
made it impossible for the partnership to continue, and decreed
dissolution of the partnership the trial court found that the parties
disagreed “on practically all matters essential to the operation of the
partnership business and upon matters of policy in connection
therewith”; that Cohen had committed breaches of the partnership
agreement and had “so conducted himself in affairs relating to the
business” that it was “not reasonably practicable to carry on the
partnership business with him.” The trial court also appointed a receiver
to sell the partnerships’ assets, ordering that Owen receive half the
proceeds, plus $6,986.63 as payment for the loan he made to the
partnership.
c. Issue: Should a partnership be dissolved when one partner engaged in a
series of hostile actions that harm the partnership?
d. Rule & Holding:
i. The court applies UPA § 32(1)(c)&(d)
ii. Sub-Rules:
a) “Whether the disharmony was the result of a difference in
disposition or other causes, the effect is the same. Most of
the acts of which complaint is made are individually
trivial, but from the aggregate the court found, and the
record so indicates, that the breach between the partners
was due in large measure to Cohens persistent endeavors
to become the dominating figure of the enterprise and to
humiliate plaintiff before the employees and customers of
the bowling alley.”
(1) A few small and trivial acts will not be enough,
but they could be, in the aggregate (so if there a
many small and trivial acts and disagreements,
together they could be enough to lead to a court
ordered dissolution)
b) “Defendant urges that the evidence shows only petty
discord between the partners, and he advances, as
applicable here, the general rule that trifling and minor
differences and grievances which involve no permanent
mischief will not authorize a court to decree a dissolution
of a partnership. However, as indicated bv the same
section in Ruling Case Law and pervious sections, courts
of equity may order the dissolution of a partnership where
there are quarrels and disagreement of such a nature and
to such extent that all confidence and cooperation
between parties had been destroyed or where one of the
Page 57 of 115
parties by his misbehavior materially hinders a proper
conduct of the partnership business. It is not only large
affairs that produce troubles. The continuance of
overbearing and vexatious petty treatment of one partner
by another frequently is more serious in its disruptive
character than would be larger differences which would
be discussed and settled. For the purpose of
demonstrating his own preeminence in the business one
partner cannot constantly minimize and deprecate the
importance of the other without undermining the basic
status upon which a successful partnership rests.”
(1) Summed up: A court may order the dissolution of
a partnership when the parties’ quarreling makes it
impossible for them to cooperate, or when one
partner’s act materially hinder the partnership’s
business.
iii. A partner has a duty to act in the best interest of the partnership.
When a partner continually antagonizes the other partner to the
extent that business is adversely affected, the partnership can
rightly be dissolved. Cohen contends that he and Owen’s
arguments were trivial, and that such minor disagreements do not
warrant dissolution of a partnership. While it is true that small
quarrels between partners would not justify breaking up a
partnership, if such quarrels in the aggregate work to the
detriment of the partnership’s business, a court will properly
grant a complaint for dissolution. Cohen’s persistent cajoling and
belittling of Owen, and his insistence on having his own way in
policy matters, severely harmed the partnership’s business. In the
courts opinion, a finding from the evidence was warranted that
there was very bitter, antagonist feeling between the parties; that
under the arrangement made by the parties for handling of the
partnership business, the duties of these parties required
cooperation, coordination and harmony; and that under the
existent conditions the parties were incapable of carrying on the
business to their mutual advantage. This is illustrated by the
monthly reduction in gross receipts that grew worse as the
partners’ business relations deteriorated. The evidence shows that
under these circumstances, it would be impractical for the
partnership to continue.
e. Holding #2: Cohen also argues that Owen should not be paid $6,986.63
out of the proceeds, as the parties agreed that Owen’s loan would be
repaid from the business’s profits. This court disagrees. Cohen’s
behavior made it impossible for the business continue, let alone remain
profitable. Cohen’s acts violated his fiduciary duty to act in the best
interest of the partnership. Accordingly, the trial court was justified in
dissolving the partnership, decreeing the sale of assets, and ordering the
distribution of the proceeds as it did. The decision of the trial court is
affirmed.
Page 58 of 115
f. When does a loan create a Term partnership? In this case, for these facts,
the court said there was an implicit term “when a partner advances a sum
of money to a partnership with the understanding that the amount
contributed was to be a loan to the partnership and was to be repaid as
soon as feasible from the prospective profits of the business, the
partnership is for a term reasonably required to repay the loan” (this is
another sub-rule from this case)
- UPA § 40 – Proper to repay loan before distributing profits?
a. The following order is observed
i. (1) The claims of the firm’s creditors are paid;
ii. (2) Claims of a partner other than those for capital and profits;
iii. (3) Those owing to partners in respect of capital;
iv. (4) Those owing to partners in respect of profits.
- Page v. Page
a. Facts: Page P. (plaintiff ) and Page D. (defendant) entered into an oral
partnership agreement to run a linen supply business in Santa Maria,
California. Each partner contributed approximately $43,000 for the
purchase of land, machinery, and linen needed to begin the partnership.
The partnerships major creditor is a corporation wholly owned by Page
P., that supplies the linen and machinery necessary for the day-to-day
operation of the business. The corporation holds a demand note of
$47,00. Page P. and Page D. did not discuss a specific term for the
partnership, but agreed that the partnership should stay in existence long
enough to make a profit and pay its debts. The partners did not stipulate
how long the partnership would last if it incurred financial losses. The
partnership was unprofitable for eight years, loosing about $62,000, but
it made a profit in the following two years. In spite of the partnership’s
profitability, Page P. sought to dissolve it.
b. Procedure: The trial court found that the parties’ intention was that their
partnership should last only until it was profitable enough to pay all
debts and operational expenses. Hence, the trial court ruled in favor of
Page D., holding that the partnership had a specific term and was not a
partnership-at-will.
c. Issue: Is a partner required to stay in a partnership at will.
d. Rule: A partnership may be dissolved upon notice by any partner when
there is no definite term set for the partnership. See UPA § 31 “By the
express will of any partner when no definite term or particular
undertaking is specified”
i. Sub-rule: This power, like any other power held by a fiduciary,
must be exercised in good faith
ii. Sub-rule: A partner at will is not bound to remain in a
partnership, regardless of whether the business is profitable or
unprofitable. A partner may not, however, by use of adverse
pressure “freeze” out a co-partner and appropriate the business to
his own use. A partner may not dissolve a partnership to gain the
benefits of the business for himself, unless he fully compensates
his co-partner for his share of the perspective business
opportunity
Page 59 of 115
e. Holding: A partnership is “at will” when it is formed without the partners
specifying or implying that it is to last for a set period of time, or to
accomplish a specific task. Any partner can dissolve an at will
partnership upon notice to the other partners.
i. Owen v. Cohen “In that case we held that when a partner
advances a sum of money to a partnership with the understanding
that the amount contributed was to be a loan to the partnership
and was to be repaid as soon as feasible from the prospective
profits of the business, the partnership is for the term reasonably
required to repay the loan. It is true that this case and other cases
hold that partners may impliedly agree to continue in business
until a certain sum of money is earned, or one or more partners
recoup their investments, or until certain debts are paid, or until
certain property could be disposed of on favorable terms. In each
of these cases, however, the implied agreement found support in
the evidence.”
ii. In this instant case, however, defendant failed to prove any facts
from which an agreement to continue the partnership for a term
may be implied. When Page P. and Page D. formed their
partnership, they expressed their desire that it would be profitable
enough to meet expenses and pay them some return on their
investment. That does not mean, as Page D. argues, that he and
Page P. intended that the partnership go out of business as soon
as it became profitable. Rather, the record shows that the parties
merely expressed a hope that their partnership would make
money. That hope does not imply that a “definite term or
particular undertaking” for the partnership was set (“all
partnerships are ordinarily entered into with the hope that they
will be profitable, but that alone does not make them all
partnerships for a term or obligate the other partners to continue
in the partnerships until all of the losses over a period of many
years have been recovered”) There is no evidence to show that
the partnership was formed with the intent that it last for a
specific term. This court finds that the partnership is a partnership
at will. Accordingly, Page P. may dissolve it upon express notice
to Page D. The decision of the trial court is reversed.
iii. (This part has nothing to do with whether the partnership is at
will, but it teaches something else) Page D. Also argued that that
Page P. was acting in bad faith, trying to use his superior
financial position to appropriate the now profitable business of
the partnership. He argues that the fact that Page P.’s corporation
owns the $47,000 demand note will make it difficult to sell the
business as a going concern, and that Page P., will get the
partnership business that is very profitable from under Page D’s
feet and leave Page D. with nothing. Page D. contends that Page
P. was content to share losses but now that the business has
become profitable he wishes to keep all the gains. The court, in
response to this argument by Page D., says that there is no
Page 60 of 115
evidence showing bad faith or that the improved profit situation
of the business was more than temporary, and that Page D.
contentions here are amply protected by the fiduciary duties of
co-partners. The court notes that if it is proved that the plaintiff
acted in bad faith and violated his fiduciary duties by attempting
to appropriate to his own use the new prosperity of the
partnership without adequate compensation to his co-partner, the
dissolution would be wrongful and the plaintiff would be liable as
provided by UPA § (see the wrongful dissolution UPA—rights of
partners upon wrongful dissolution) for violation of the implied
agreement not to exclude defendant wrongfully from the
partnership business opportunity.
f. Comparing Owen and Page
i. Owen v. Cohen An implied term was found When a
partner loans money to the firm, to be repaid from profits, the
partnership may be for a term until the loan is repaid
a) This was considered debt
ii. Page v. Page No implied term When a partner loans
money to the firm, to be repaid from profits, the partnership may
be for a term until the loan is repaid
a) This was considered equity
b) “Viewing this evidence most favorably for [Page], it
proves only that the partners expected to meet current
expenses from current income and to recoup their
investment if the business were successful.”
c) “It is true that Owen v Cohen and other cases hold that
partners may impliedly agree to continue in business until
a certain sum of money is earned…, or one or more
partners recoup their investments or until certain debts are
paid. … In each of these cases, however, the implied
agreement found support in the evidence.”
- Summation of the Cases on right vs. power to dissolve a partnership:
a. Owen v. Cohen Owen sought and received judicial dissolution to
avoid possible dissolution in “contravention of agreement” finding.
b. Collins v. Lewis Collins failed to get judicial dissolution, so cannot
proceed rightfully without Lewis or agreement.
c. Page v. Page Page allowed to terminate partnership, since “for
profit” does not equal term, but still owes fiduciary duties.
- Introduction to Some Finance Terminology
a. Debt:
i. Funds borrowed by the firm
ii. In exchange for claims of a fixed amount against the firm’s assets
and future earnings
iii. Typical terms firm pays interest, and at “maturity” returns the
principal
iv. Owens v. Cohen was debt because expected payment
b. Equity:
i. Funds invested in the firm. Owners of the firm
Page 61 of 115
a) You pay in to become an owner, don’t expect repayment
b) In exchange for residual (left over) value of the firm
c) Right to firm’s earnings and, in liquidation, firm assets
after all other claims are satisfied
d) Page v. Page considered equity because no implication of
a term for repayment
vi. THE CONSEQUENCES OF DISSOLUTION
- This next case, Prentis v. Sheffel, will get into telling us what happens upon the
acquisition of assets/business by some partners
- Prentiss v. Sheffel
a. Facts:
i. Prentiss (defendant) and two other individuals, Sheffel et al.
(plaintiffs), made an oral agreement to enter into a partnership to
buy and operate a shopping center. The trial court made certain
pertinent findings as follows:
a) The plaintiffs each owned 42.5% of the partnership, for a
total of 85%, and the defendant owned 15%
b) That no detailed partnership agreement as to how the
business would be supervised, how management
decisions would be made, or the term of the partnership’s
existence, was ever made or entered into at any time
between the parties, although there were attempts to
arrive at such an agreement
c) The partners engaged in many serious arguments
concerning the title of partnership property and how
management decisions should be made, which resulted in
an irreparable rift between plaintiffs and defendant
(plaintiff notified defendant that any further dealings
between them should be made through their attorney’s)
d) Defendant had never been denied access to the shopping
center and he visited their from time to time
e) That since the acquisition of the shopping center, losses
from operation had been materially reduced, and certain
more advantageous lease provisions were entered into
with tenants
f) That there was a freeze-out or exclusion of the defendant
from partnership management and affairs.
ii. Defendant added to the problems by being unable to pay his
proportionate share of the shopping center’s operating losses,
which was $6,000. As a result of this, Plaintiff’s subsequently
excluded Defendant from all management duties and sought
dissolution of the partnership, alleging that Defendant had been
derelict in his partnership duties. Plaintiffs also sought a court-
supervised dissolution sale whereby they would bid on all the
partnership assets. Defendant filed a counterclaim, seeking to
prevent Plaintiffs from bidding on or purchasing the partnership
assets—he was seeking a winding up of the partnership and the
appointment of a receiver. Defendant contended that he had been
Page 62 of 115
wrongfully frozen out of the partnership, and would unfairly
disadvantaged if Plaintiffs were permitted to buy the partnership
assets at a judicial sale.
b. Procedure: the trial court concluded that partnership-at-will existed
between plaintiffs and the defendant which was dissolved as a result of a
freeze-out or exclusion of the defendant from the management and
affairs of the partnership. A receiver was appointed by the court until the
partnership property could be sold and a partition and distribution of
assets could be made. Plaintiffs were allowed to bid on the assets during
the judicial sale.
i. The receiver and the trial court did actually carry out the sale of
the shopping center, and the plaintiffs were the high bidders.
Defendant appeals from that sale.
c. Issue: May partners who legally excluded a third partner from
management duties be permitted to buy partnership assets at a judicially-
supervised dissolution sale?
i. “The question presented by this appeal is whether two majority
partners in a three-man partnership-at-will, who have excluded
the third partner from partnership management and affairs,
should be allowed to purchase the partnership assets at a
judicially supervised dissolution sale.
d. Rule: When a partnership is legally dissolved, any partner acting in good
faith may purchase the assets.
i. Had the partners been acting in bad faith, then the defendant
would have been wrongfully excluded (frozen-out), and then, the
plaintiffs would not be allowed to bid on the assets because it
would be an unfair disadvantage (as there purpose would have
been to use their power to get an advantage over another partner)
e. Holding: Partners may dissolve a partnership-at-will by excluding
another partner from management duties, as long as they act in good
faith. Such partners may also bid on and purchase any assets in a
dissolution sale. The record shows that Plaintiffs excluded Defendant
from management duties and broke up the partnership because the
dissention Defendant caused made it impossible for the partnership to
effectively continue (the partners could not harmoniously function
together anymore). Prentiss did not offer any evidence that Sheffel et al.
acted in bad faith or had any ulterior motive in dissolving the
partnership-at-will. Had Defendant brought in evidence of bad-faith, the
matter would be much different – then, the Plaintiffs would not be able
to bid on the assets; however, here, while the court did find that the
defendant was excluded from the management of the partnership, they
did not find that the exclusion was done for a wrongful purpose (such as
obtaining the partnership) in bad faith, but rather that the partners could
no longer get along, so because the partnership was at-will, an exclusion
of a partner ended the partnership (which is not bad faith over here).
Consequently, there is nothing to prevent them from purchasing the
assets at a dissolution sale. Also, Defendant was not disadvantaged by
Plaintiffs participation in the asset sale. Plaintiff’s bids vis-à-vis the
Page 63 of 115
other participants resulted in a final sales price that was higher than it
would have been had they not bid on the assets (they increased the bid
and purchase price to 2.25 million = that is what plaintiffs purchased it
at). Consequently, Prentiss’s 15% interest in the partnership was
enhanced by Plaintiffs bidding. Remember, Defendant had the same
rights to purchase the assets at the judicial sale (maybe not the same
ability – but the court does not consider the parties respective abilities).
Defendants final argument was that Plaintiff’s were bidding “paper”
dollars because essentially the money they bid, 85% of it will come back
to them; however, court noted that Defendant had all the same rights to
bid, and also could have used “paper” money to purchase the assets up to
his 15% share obviously, and that he was not disadvantaged because the
Plaintiffs bid up the price and actually caused Defendant to make more
money.
- The next case, Pav-Saver v. Vassso, will tell us what happens when a
partnership continues following wrongful dissolution – when we have a
wrongful dissolution, UPA § 38(2) takes over
- UPA § 38 – Rights of Partners to Application of Partnership Property
a. (2) When dissolution is caused in contravention of the partnership
agreement the rights of the partners shall be as follows
i. (a) Each partner who has not caused dissolution wrongfully shall
have
a) II. The right . . . to damages for breach of the agreement
ii. (b) Other partners may continue the business if they choose
iii. (c) A partner who has caused the dissolution wrongfully shall
have
a) I. If the business is not continued, . . . the remaining cash
less damages
b) II. If the business is continued, . . . the value of his
interest in the partnership, less damages, . . . but the value
of the goodwill of the business shall not be considered
(1) Goodwill – value of intangible assets, such as the
businesses’ reputation and brand names, and
patents.
(2) HYPO: Professors Guttantag’s Barber Shop – if
he has a barber shop, the goodwill will be the
difference between the amount Guttantag could
sell the business for (because lets say it has such a
good reputation) and the value of the supplies
(3) Remember, the goodwill exclusion only applies if
the other partner continues the business
- RUPA § 701 – if a partner withdraws from a partnership in contravention of the
partnership agreement, the partnership does not necessarily dissolve. If it does
not, the partnership must buy out the withdrawing (“disassociated”) partner for
an amount equal to his or her share of the value of the assets of the partnership if
“sold at a price equal to the greater of the liquidation value or the value based on
a sale of the entire business as a going concern.” This amount is reduced by any
damages for wrongful withdrawal.
Page 64 of 115
- UPA 38 v. RUPA 701 – Under RUPA, there is no reduction for the value of
goodwill. Under UPA, on the other hand, deducts the value of goodwill, i.e., the
disassociating partner will not be compensated for goodwill under UPA
- Pav-Saver Corporation v. Vasso Corporation
a. Facts: Plantiff, Pav-Saver Corporation is the owner of the Pav-Saver
trademark and certain patents for the design and marketing of concrete
paving machines. Charles Peart is the attorney of Pav-Saver. Moss
Meerson is the owner of Vasso Corporation, the defendant. Pav-Saver
corporation and Vasso Corporation entered into a partnership agreement,
under the business name Pav-Saver Manufacturing Company. Pav-Saver
contributed certain intellectual property to the partnership, that was
important and necessary to the business of the partnership. Pav-saver’s
principal would manage the operation. The partnership agreement
contained two paragraphs which lie at the heart of the appeal and cross-
appeal: the partnership agreement stated that the partnership would be
permanent unless both partners agreed to terminate the partnership; and
the partnership agreement also stated that if one party terminated
unilaterally, Pav-Saver would take back its intellectual property, and that
the party not terminating would receive liquidated damages. The state of
Illinois had adopted the Uniform Partnership Act, which provided that
when a partnership is terminated in violation of the partnership
agreement, the non-terminating partners may continue the enterprise, as
long as they pay the terminating partner the value of their interest, not
counting good will. UPA § 38(2) – (the version of the rule I put here just
sums it up for our purposes). The partnership did very well for a few
years, until a few years later, the economy slumped, sales decreased
dramatically, and the principals could no longer agree on the direction
the partnership should take to survive. Eventually Pav-Saver terminated
the partnership unilaterally. In response, Vasso took over the
partnership’s operations, physically ousted Pav-Saver from the offices,
assumed the position as the day-to-day manager of the business, and
retained control over the intellectual property contributed by Pav-Saver.
b. Procedure: Pav-Saver sued to recover its intellectual property, which it
argued it was entitled to under the partnership agreement. Vasso
countersued for a declaratory judgment that Pav-Saver wrongfully
terminated; that Vasso was entitled to the partnership business, which
included being entitled to the intellectual property contributed by Pav-
Saver; that Pav-Saver interest in the partnership was worth 165,000
based on a 330,000 valuation (up to here, all the countersuits by Vasso
are pursuant to the Illinois UPA § 38); and that Vasso was entitled to
liquidated damages (this, Vasso argued, was pursuant to the partnership
agreement). Illinois UPA . The trial court found that Vasso was entitled
to retain control of the intellectual property and to liquidated damages.
c. Issue: Can the terms of a partnership agreement override statutory law?
d. Rule: The terms of a partnership agreement cannot override the statutory
law governing partnerships in the jurisdiction.
e. Holding/Reasoning: No. The partnership agreement expressly stated that
the partnership is a “permanent” partnership, terminable only if both
Page 65 of 115
partners mutually consented to terminate the partnership. Thus, it is
undisputed that Pav-Saver’s unilateral termination of the partnership was
in contravention of the partnership agreement; because it was in
contravention of the partnership agreement, the termination was a
wrongful termination by Pav-Saver. The wrongful termination invokes
the provision of the UPA, UPA § 38, so far as they concern the rights of
the partners, which, under UPA § 38, gives Vasso the right to continue
the business. Vasso did in fact, pursuant to UPA § 38(2)(b), exercise his
right to continue the business, and to continue the business in possession
of the partnership property. That property includes the intellectual
property contributed by Pav-Saver, which is absolutely essential to the
manufacture and sale of paving machines – and thus necessary for Vasso
to continue the business. While the partnership agreement stated that
Pav-Saver was entitled to return of its property, the right to possess the
partnership property and continue in business upon wrongful termination
must be derived from and is controlled by the statute (my thought over
here – the court says “despite the parties contractual direction that Pav
Saver’s patents would be returned to it upon the mutually approved
expiration of the partnership, the right to possess the partnership property
and continue in business upon wrongful termination must be derived
from and is controlled by the statute.” Then they say that the patents are
necessary in order for Vasso to actually carry out the business. Then the
court says “Thus, to continue in business pursuant to the statutorily-
granted right of the party not causing the wrongful dissolution, it is
essential that paragraph 3 – the return to Pav Saver of its patents – not be
honored.” See the problem is that the partnership agreement doesn’t tell
the partners step by step what happens upon a unilateral termination, so
the UPA has to take over; it doesn’t say that upon unilateral termination,
the patents should go back to Pav-Saver. Thus, the UPA has to step in as
the law we follow, and the UPA provision that applies here, gives power
to Vasso to continue the business if it wants too; in order to continue the
business, Vasso needs the patents. Thus, the UPA has to take supremacy
to paragraph 3 of the partnership agreement). The UPA act requires
Vasso, upon exercise of his right to continue the business, to pay Pav-
Saver for their interest in the partnership, which the trial court deemed to
be 165,000. Pav-Saver argued that this did not include the value of the
intellectual property. However, the court says that the evidence that Pav-
Saver brought to court shows that the value of the intellectual property is
attributed to goodwill. The Partnership Act specifically states that good
will not be considered when determining the value of a terminating
partner’s interest, thus, the trial court properly valued Pav-Savers interest
at 165,000. The decision of the lower court to assign liquidated damages
is affirmed.
f. Dissent: The Uniform Partnership Agreement recognizes that a
partnership is governed by the partnership agreement. In this case, the
partnership agreement directly addressed the status of Pav-Saver’s
intellectual property in the event of termination. The majority was wrong
Page 66 of 115
to allow Vasso to retain control of Pav-Saver’s property in direct
contravention of the terms to which the parties agreed.
vii. SHARING LOSSES
- UPA § 40(b): Subject to contrary agreement, upon dissolution partnership assets
should be distributed as follows:
a. (I) Those owing to creditors other than partners,
b. (II) Those owing to partners other than for capital and profits,
i. This is the rule we saw in Owen v. Cohen – partners lend money
with the expectation of repayment
c. (III) Those owing to partners in respect of capital, and
i. Partnership law tells us to look at how much each partner put in –
e.g., Page v. Page, where each partner put in $40,000, and they
were paid back pro rata proportionally for how much money each
partner put in
d. (IV) Those own to partners in respect of profits.
i. In the absence of agreement, partners split profits 50/50 – default
treats partners equally (remember this from before . . .)
- UPA § 40(d): partners shall contribute, as provided by [UPA§ 18(a)] the
amount necessary to satisfy the liabilities [set forth in UPA § 40(b)]
a. What happens if there is a shortfall?
b. UPA § 18(a) says that “the rights and duties of the partners in relation to
the partnership shall be determined, subject to any agreement between
them, by the following rules:
i. (a) Each partner shall be repaid his contributions, … and share
equally in the profits and surplus remaining after all liabilities,
including those to partners, are satisfied; and must contribute
towards the losses, whether capital or otherwise, sustained by
the partnership according to his share in the profits.”
a) Default is that you contribute equally to losses
b) Otherwise (which means if you made agreements around
the default rules), in proportion to the share in profits as
per agreement
- HYPO: Homer earns a salary of $40 for partnership work and Bill Gates invests
$100. Mo sells beer to the company for $30. Homer and Bill agree to 50/50
share – if they close the business after a year and sell the, how will the proceeds
be split?
a. #1: Lets say Homer and Bill sell the business for $300. UPA § 40(b)
tells us how to distribute the profits and losses
i. (I) Those owing to creditors other than partners,
a) First repay Mo the $30 – he is a creditor, because Homer
and Bill purchased beer from him on credit and have yet
to pay him
ii. (II) Those owing to partners other than for capital and profits,
a) Next, Homer is paid his salary of $40, because he is a
partner and this is not capital or profits, it is salary
iii. (III) Those owing to partners in respect of capital, and
a) Next, Bill is paid back the $100 capital investment he put
into the business. Homer is a partner, but he did not invest
Page 67 of 115
capital into the business, so he doesn’t get anything under
this one.
iv. (IV) Those owing to partners in respect of profits.”
a) Homer and Bill agreed to a 50/50 share. The profit is
$130. They will split this amount amongst them, so each
will get $65.
b. #2: Now lets assume that instead of $300, the company sold for $150.
i. Mo will be paid his $30 as he is a creditor. Next Homer will be
paid as he is a partner, and his $40 is salary, not capital or profits.
At this point there is only $80 remaining. All of this will go to
Bill to recoup him of his capital investment, however, there will
still be a shortfall of $20. This shortfall is then split between
Homer and Bill, which means that Homer must pay Bill $10 (this
last part is pursuant to UPA § 40(d) which leads us into UPA §
18(a)).
- Kovacik v. Reed
a. Facts: Kovacik (plaintiff) and Reed (defendant) entered into a
partnership to remodel kitchens (they both owned 50% of the
partnership). Kovacik would contribute funds to the enterprise in the
amount of $10,000. Reed would contribute labor and skill, acting as an
estimator and superintendent of the projects without compensation. The
partners did not discuss the apportionment of losses. While the two
received some jobs, they lost money. Kovacik asked Reed to contribute
money to cover half of the total losses. Reed refused, and Kovacik filed
this lawsuit. The lower court held that the partners had agreed to share
profits and losses equally, and Reed was thus liable for half the shortfall.
b. Issue: Is a partner who contributed only skill and labor liable for the
monetary losses of the enterprise?
c. Rule:
i. General Rule: “in the absence of an agreement to the contrary,
the law presumes that partners and joint adventurers intended to
participate equally in the profits and losses of the common
enterprise, irrespective of any inequality in the amounts each
contributed to the capital employed in the venture, with the losses
being shared by them in the same proportions as they share in the
profits”
a) Sub-rule: “However, it appear that in the cases in which
the above stated general rule has been applied, each of the
parties had contributed capital consisting of either money
or land or other tangible property, or else was to receive
compensation for services rendered to the common
undertaking which was to be before computation of the
profits or losses.”
(1) Basically, monetary losses will be apportioned
equally between partners who make capital
contributions.
b) Sub-rule: “Where, however, as in the present case, one
partner or joint adventurer contributes the money capital
Page 68 of 115
as against the other’s skill and labor, all the cases cited,
and which our research had discovered, hold that neither
party is liable to the other for contribution for any loss
sustained. Thus, upon loss of the money the party who
contributed it is not entitled to recover any part of it from
the party who contributed only services.”
(1) Rationale: “where one party contributes money
and the other contributes services, then in the
event of a loss, each would lose his own capital—
the one his money and the other his time.
d. Holding: Generally, when there is no explicit agreement as to losses,
losses are to be divided equally between the partners, without regard to
the amount each partner contributed to the venture. That rule, though, is
only applied in cases where each of the partners contributed capital to the
enterprise. In cases where one party contributed only labor and the other
only capital, the rule is not applied because the partner contributing labor
takes a loss in the form of his lost labor. In this case, both partners have
endured losses: Kovacik with the loss of his monetary investment, and
Reed through the time and effort he contributed that went
uncompensated. Reed is not liable for any of Kovacik’s monetary losses.
Accordingly, the decision of the lower court is reversed.
e. RUPA expressly rejects the rule and holding in this case, see Note 1 on
page 172 of the textbook
i. Thus, we have two possible rules
a) Kovacik v. Reed All capital losses were to be boren
by the capital partner alone
b) Statute sharing of capital losses in accordance with
sharing of profits
VI. CORPORATIONS
a. Overview
i. solution to problem in partnership law of when one person brings the money and the
other the labor/ideas, because partnership default rules are not well designed for a
situation with these types of unequal contributions
- Legal personality
a. The corporation is an entity with separate legal existence from its owners
i. Possess (some) constitutional rights
a) Free speech (citizens united)
Page 69 of 115
b) But no personal privacy
b. Separate tax payer
c. Requirement for formal creation
i. Need to be legally created
ii. Permanence, autonomy, ownership of assets
iii. Can stand in the world as a person, partnership depends on the
people involved though
- Limited Liability
a. MBCA §6.22(b)
i. Unless otherwise provided in the articles of incorporation a
shareholder or a corporation is not personally liable for the acts
or debts of the corporation except that he may become personally
liable by reason of his own acts or conduct
b. You can only lose the amount of money you put in
c. Inconsistent with economic theory in tort law – people should be liable
for the harms their activities cause
d. Intended to enable and encourage large business
ix. Enterprise Value: measure of the total value of the firm’s assets
implied by the trading value of the firm’s stock (determined by
adding the market value to the firm’s obligations)
a) Total value of the firm as determined by adding market
capitalization to the firm’s obligation
b) One share of stock x number of outstanding shares +
firm’s debt (and other liabilities) = value of the firm’s
assets (enterprise value)
Page 72 of 115
a) Subtract obligations (liabilities/debts) from the value of
the firm
iv. Step 3: calculate equity value per share
a) Divide the firm’s equity value by the number of shares
outstanding
v. Can also determine the value of the firm’s assets minus the debt
by multiplying the number of outstanding shares by the value of
one share then get total value of assets.
vi. Everyone who invests money, based on how much they invested,
gets a share of stock – value of equity of the corporation is split
equally among those shares
- Liquidity
Page 73 of 115
a. Stock exchange – enables ability to buy and sell shares
b. Called secondary trading markets
i. E.g. NYSE and NASDAQ
c. Why Share Prices Matter: Efficient Capital Market Hypothesis
i. ECMH: the price of stock reflects all available information
ii. says the stock market is always right as to the value of the firm
iii. accountants are only looking at costs of things based on receipts
iv. people buying and selling stocks are looking at everything to
decide what the company is worth
d. Earnings per share for Disney
i. Another way to vie wthe $9 billion is to figure out what that
means for each shareholder
ii. Net Income (2015) = $9 billion divided by 1.6 billion share
holders
a) Each shareholder's share earned $5.63 - earnings per
share (EPS)
iii. Alternative calculation:
a) $92/$5.63 = 16.3x (same calculation but on a per share
basis)
e. Lower PE is better because would mean cheaper stock
i. Stocks with a high P/E - price people are willing to pay compared
with earnings - mean more expensive stock
ii. Would still get the same earnings on stock, but would mean
someone got $5 back on their $25 investment rather than a $92
investment per stock
Page 74 of 115
on the dividends)
Page 75 of 115
a) Could put in money and be involved and not risk liability
beyond the amount you invested
b) AND, the LLC still wasn't a separate tax-paying entity -
has tax structure as partnership
c) Still no formal capital structure, so not easy to buy and
sell but ideal vehicle for small business
v. Varies by state if more like corporation or partnership, but as a
general matter, more like a partnership
a) Default rules you can contract around
b) Complicated part is that there has to be an agreement
(1) Whereas corporation has ready-made corporate
structure you can step into
vi. Flexibility: like partnership, most aspects of management and
sharing dictated by the LLC's operating agreement."
vii. Two types:
a) Member managed - all members are managers
b) Manager managed - some owners not managers with no
right to vote
viii. Limitations on capital structure complexity and share
transferability
ix. Unfavorable state franchise taxes in some states
e. S corporation
i. Creation of tax code (actually a corporation)
ii. Advantage - pass-through taxation and limited liability
iii. Get limited liability protection and pass-through tax treatment of
a partnership
iv. Disadvantages:
a) Constraints on the number of shareholders, source of
corporate income, types of shareholders (one class only),
deductions on pass-through losses
v. Can't go public (only corporations can go public, generally
speaking)
b. Source of Law
c. Formation
i. Pick a State: can pick any state to be incorporated regardless of where you do your
business
ii. Draft Foundational Documents – Articles of Incorporation and By-Laws
- Articles of Incorporation:
a. Must include: name, number of shares, address, incorporators – MCBA
§2.02(a)
b. May include: initial directors, management, limits on rights, liability on
a shareholder – MCBA §2.02(b)
i. Advantage of including the “may” factors is that you have a lot of
flexibility when writing articles of incorporation but to change it
later is really hard, you need votes of the board members – it’s
better to put it all in in the beginning
c. DGCL §102(a) and (b)
iii. File Articles and By-Laws with Secretary of State (MBCA §2.03)
iv. Have Organizational Meeting (MBCA §2.05) – pick directors, appoint officers, and
adopt by-laws
- Final steps
a. Finalize directors (MBCA §2.05)
b. Appoint officers (MBCA §2.05)
c. Adopt by-laws (MBCA §2.06)
i. Firm might have liability (determined through agency law), this is about when liability
spills onto the people in the firm
ii. In partnership, always true that if more liability than firm can handle, has to be absorbed
by individual partners
iii. When do shareholders have liability beyond the amount of money they put in?
iv. Limited Liability
- MBCA §6.22(b):
Page 77 of 115
a. (1) a shareholder of a corporation is not personally liable for the (2)
acts or debts of the corporation (3) EXCEPT that he may become
personally liable by reason of his own acts or conduct
i. Shareholder losses limited to the amount the shareholder has
invested in the firm
ii. It is the corporation that incurs the debt or commits the tort (legal
person)
iii. Primarily “piercing the corporate veil” – PCV doctrine
a) Limited liability protection goes away
b) Often something to plead in a case if shareholders have
the deep pockets
- Piercing the Corporate Veil
a. To protect yourself as a shareholder and avoid piercing the corporate
veil, MUST
i. Respect formalities
ii. Have annual meetings and keep records of those meetings
iii. Set up separate bank accounts so no comingling off funds.
- The downside of limited liability
a. Allows business to avoid some of the cost of their activities
b. People are able to profit and take assets without liability
Rule: A creditor cannot pierce the corporate veil without a showing that there is a substantial unity of
interest between the corporation and its shareholders.
Holding: A plaintiff can pierce the corporate veil and hold a company’s owners liable for the debts of
the company if the company is a dummy corporation, whose interests are not distinguishable from
those of the owner or owners. It is very relevant to the discussion of veil-piercing if a business is
undercapitalized, because this suggests that the business is a fraud intended to rob creditors of the
ability to fulfill their debts. It is also relevant that the formal barriers between companies are not
respected. That said, a business enterprise may divide its assets, liabilities, and labor between multiple
corporate entities, without impinging the limited liability of the shareholders. In this case, Seon Cab
Company was undercapitalized, and carried only the bare minimum amount of insurance required by
law. However, while this is relevant, it is not enough to allow a plaintiff to pierce the veil, otherwise,
owners would be on the hook every time their corporation accrued liabilities outstripping its assets, and
limited liability would be meaningless. Instead, there must be some evidence that the owners
themselves were merely using the company as a shell. While Walkovszky alleged that each of
Carlton’s companies was actually part of a much larger corporate entity, he could offer no proof to that
effect. The mere fact that Walkovszky might not have been fully able to recover his damages was not
enough to justify letting him pierce Seon Cab’s veil.
Page 78 of 115
The court said there was no fraud or deception because everything was of public record. The beauty of
limited liability is that if you set up a corporation and follow the rules you basically get an insurance
policy of what you can lose, which is limited to your investment. You also don’t lose the dividends you
made back.
The court also talks about ideas of agency liability and enterprise liability. Carlton as a shareholder
does not have liability because he respected the formalities. The law treats sister corporations
differently than shareholders. It is not about whether the shareholder co-mingled funds (Carlton) but
whether the assets of the corporations are comingled with the sister companies.
NOTE enterprise liability is distinct from piercing the corporate veil. In order to pierce the corporate
veil, the plaintiff will have to show that Carlton was doing business in an individual capacity, shuttling
personal funds in and out of the corporation. With piercing the corporate veil, you can go after the
shareholders. Enterprise theory means that they can go after the sister companies to get more money.
To do that, plaintiff would have to show that Carlton did not respect the separate identities of the
corporations by co-mingling back accounts, etc.
Rule: When a company’s owner does not take care to observe the formal separation between himself
and his business, the business’s creditors can collect their debts directly from him.
Sea-Land Services, Inc. v. Pepper Source (corporations: limited liability): Gerald Marchese (defendant)
owned six separate business entities (defendants). Marchese ran all of the companies out of a single office.
The companies shared expense accounts in common and lent funds to each other, as well as regularly lending
money to Marchese for his personal expenses. None of these companies had internal governing documents
such as bylaws. One of those businesses, Pepper Source, contracted with a shipping company, Sea-Land
Services, Inc. (plaintiff) for the delivery of some peppers. Pepper Source failed to pay for these services, and
Sea-Land filed a collection suit against Pepper Source. Pepper Source never appeared and had in fact been
dissolved for failure to pay business taxes. Sea-Land then brought suit against Marchese and all of his
companies, seeking to pierce Pepper Source’s veil and collect from Marchese, and then to “reverse pierce”
Marchese’s other companies and collect from them
Holding: Veil piercing requires two things: first, that there be a strong alignment of interest between
the shareholders and the business itself, and second, that observing the corporate form would promote
injustice or fraud. The courts look for a handful of factors that suggest that the interests of a
corporation and those of its shareholders are sufficiently aligned to allow veil-piercing. The following
factors are relevant: (1) if the corporation fails to observe corporate formalities; (2) if the business fails
to keep its assets separate from those of shareholders and each other; and (3) if the business is
undercapitalized. In this case, the first requirement for veil-piercing was met. Marchese shared money
with his companies, and they shared money with each other. Because Marchese often withdrew money
from Pepper Source, it was not sufficiently capitalized to meet its obligation to Sea-Land, and did not
even have enough assets to maintain its own existence. None of the companies had bylaws, articles of
incorporations, or minutes from regular board meetings. However, simply because Sea-Land would not
have been able to collect its debt does not mean that an injustice was being perpetrated. Plaintiffs only
seek to pierce the veil when there are insufficient assets in one company; if this was always an
injustice, the second requirement would be meaningless. Injustice must mean that there is some wrong
beyond the harm to the creditor. Often, this means that some legal obligation or rule would be
undermined, or that some scheme to place liabilities and assets in different companies would be
successful. In this case, there may in fact be such a scheme, but there is not enough evidence to justify
Page 79 of 115
such a holding. Instead, the court reverses the lower court and orders them to hold a new hearing on
whether the scheme will allow an injustice in the absence of veil-piercing.
Rule: A company cannot take actions that harm its shareholders and are motivated solely by
humanitarian concerns, not by business concerns.
Dodge v. Ford Motor Co. (corporations: roles and duties) The Ford Motor Company (defendant) was
incorporated in 1903, and began selling motor vehicles. Over the course of its first decade, despite the fact
that Ford continually lowered the price of its cars, Ford became increasingly profitable. On top of annual
dividends of $120,000, Ford paid $10 million or more in special dividends annually in 1913, 1914, and 1915.
Then, in 1916, Ford’s president and majority shareholder, Henry Ford, announced that there would be no
more special dividends, and that all future profits would be invested in lowering the price of the product
and growing the company. The board quickly ratified his decision. Henry Ford had often made statements
about how he wanted to make sure people were employed, and generally run the company for the benefits of
the overall community. The Dodge brothers (plaintiffs), who owned their own motor company, were minority
shareholders in Ford, and sued to reinstate the special dividends and stop the building of Ford’s proposed
smelting plant in River Rouge.
Holding: A business exists to conduct business on behalf of its shareholders. It is not a charity to be
run for its employees, or neighbors. In this case, Ford was even more profitable in 1916 than it was in
1915, when it paid over $10 million in dividends. However, in 1916, Ford paid only its $120,000
dividend. While a corporation may choose to invest in future ventures, and may choose to maintain
cash on hand to plan for future shortfalls, Ford had done that in prior years and still managed to pay
special dividends. These actions, combined with Henry Ford’s statements about putting profits into the
Page 81 of 115
business to provide for the workers, suggest that the decree against new special dividends was not
motivated by any business concern. By taking an action with no business concerns motivating it,
Henry Ford and the Ford directors who supported his decision were acting arbitrarily, to the direct
detriment of the shareholders in whose interest they were supposed to be acting.
**Shareholder Primacy is the Rule – FMC must issue special dividends but can continue with
the construction plans of the River Rouge plant – too big a business decision for the court to
second guess
***Ford could have gotten away with limiting dividends if he had argued that it was in the best
interest of the shareholders, but he specifically said he didn’t care about the shareholders, so his
own testimony and articulated goal hurt him.
**Courts may not scrutinize decisions about how to maximize profits; but will scrutinize
decisions about whether to do so
CORPORATION’S DUTIES:
iii. Who is bound by fiduciary duties?
- Directors
- Senior officers
- Shareholders in special situations can have fiduciary obligations to other
shareholders (but generally not the case)
iv. Fiduciary Duties
- Protecting Directors from Liability
a. Business Judgment Rule
b. Indemnification
i. MBCA §8.51-8.56
ii. Delaware §145
c. Directors and Officers Insurance
i. MBCA §8.57
ii. Delaware §145(g)
d. Legislative reaction to Smith v. Van Gorkom
i. Delaware §102(b)(7)
ii. MBCA § 2.02(b)(4)
Page 82 of 115
vi. BUSINESS JUDGMENT RULE
- A court will defer to the Board of Director’s business judgment unless their
actions:
a. Are not in the honest belief that action is in the best interests of the
corporation, or
i. Test failed in Dodge v. Ford
ii. Test Passed in Kamin v. AmEx
b. Are not based on an informed investigation
i. Test failed in Smith v. Van Gorkom
ii. Look to process board went through to make that decision
a) Records
b) Time making decision
c) Lawyer
d) Investment banker
c. Or involve a conflict of interest
i. i.e. all kids of board of directors of Disney get free merchandise.
Conflict because supposed to act in the best interest of the
shareholders and not the board of directors and their families
Rule: Courts will not interfere with a business decision made by directors of a business unless there is a
claim of fraud, bad faith, or self-dealing.
Kamin v. American Express (Business Judgment Rule and acting in the best interest of the corporation):
American Express (defendant) authorized dividends to be paid out to stockholders in the form of shares of
Donaldson, Lufkin and Jenrette, Inc. (DLJ). Kamin, et al. (plaintiffs), minority stockholders in American
Express, brought suit against the directors of American Express, alleging that the dividends were a waste of
corporate assets in that the stocks of DLJ could have been sold on the market, saving American Express about
$8 million in taxes. The American Express directors filed a motion to dismiss the case.
Holding: Courts will not interfere with a business decision made by directors of a business unless there
is a claim of fraud, bad faith, or self-dealing. An error of judgment by directors, as long as the business
decision was made in good faith, is not sufficient to maintain a claim against them. In the present case,
the plaintiffs do not allege any bad faith on the part of the directors. The only wrongdoing that the
plaintiffs claim is that the directors should have done something differently with the DLJ stock. This
allegation without more is not sufficient to maintain a claim.
Rule: There is a rebuttable presumption that a business determination made by a corporation’s board
of directors is fully informed and made in good faith and in the best interests of the corporation.
Smith v. Van Gorkom (corporations – informed decisions): Jerome Van Gorkom, the CEO of Trans Union
Corporation (Trans Union), engaged in his own negotiations with a third party for a buyout/merger with Trans
Union. Prior to negotiations, Van Gorkom determined the value of Trans Union to be $55 per share and during
negotiations agreed in principle on a merger. There is no evidence showing how Van Gorkom came up with
this value other than Trans Union’s market price at the time of $38 per share. Subsequently, Van Gorkom
called a meeting of Trans Union’s senior management, followed by a meeting of the board of directors
(defendants). Senior management reacted very negatively to the idea of the buyout. However, the board of
directors approved the buyout at the next meeting, based mostly on an oral presentation by Van Gorkom. The
meeting lasted two hours and the board of directors did not have an opportunity to review the merger
agreement before or during the meeting. The directors had no documents summarizing the merger, nor did
Page 84 of 115
they have justification for the sale price of $55 per share. Smith et al. (plaintiffs) brought a class action suit
against the Trans Union board of directors, alleging that the directors’ decision to approve the merger was
uninformed.
Holding: Under the business judgment rule, a business determination made by a corporation’s board
of directors is presumed to be fully informed and made in good faith and in the best interests of the
corporation. However, this presumption is rebuttable if the plaintiffs can show that the directors were
grossly negligent in that they did not inform themselves of “all material information reasonably
available to them.” The court determines that in this case, the Trans Union board of directors did not
make an informed business judgment in voting to approve the merger. The directors did not adequately
inquire into Van Gorkom’s role and motives behind bringing about the transaction, including where
the price of $55 per share came from; the directors were uninformed of the intrinsic value of Trans
Union; and, lacking this knowledge, the directors only considered the merger at a two-hour meeting,
without taking the time to fully consider the reasons, alternatives, and consequences. The evidence
presented is sufficient to rebut the presumption of an informed decision under the business judgment
rule. The directors’ decision to approve the merger was not fully informed. As a result, the plaintiffs
are entitled to the fair value of their shares that were sold in the merger, which is to be based on the
intrinsic value of Trans Union.
xii. INDEMNIFICATION
- Third type of protection for directors in addition to BJR and Insurance
- Directors are liable to shareholders so may have to pay compensation damages
for the h arms they caused
a. Indemnification lets them look to corporation to reimburse them because
it is a business expense
i. MBCA §8.51-§8.56
ii. DGCL §145
b. Delaware Indemnification – §145
i. (a) a corporation shall have power to indemnify a person who is
or was a director against expenses (including attorney’s fees),
judgments, fines and amounts paid in settlement, if the person
acted in good faith and no reasonable cause to believe conduct
was unlawful. Termination by settlement does not create a
presumption that the conduct was not in good faith or unlawful.
ii. (b) No indemnification if person shall have been adjudged liable
to corporation unless Court of Chancery permits
a) Almost always will settle because the board of directors
are making the management decision to settle and they
will then be assured indemnification
iii. (c) If successful on the merits, such person shall be indemnified
Rule: A director has a duty to know generally the business affairs of the corporation.
Page 87 of 115
Francis v. United Jersey Bank (BJR and inaction): Charles, Jr. and William Pritchard (sons) were directors
of Pritchard & Baird Intermediaries Corp. (Pritchard & Baird), a reinsurance broker that controlled millions of
dollars of client funds in an implied trust. The only other director was their mother, Mrs. Pritchard. The sons
siphoned large sums of money from Pritchard & Baird in the form of “loans.” Eventually, the corporation
went insolvent because of the siphoned funds. During the time the funds were misappropriated, Mrs. Pritchard
did nothing in her role as director. She never went to the corporate office; she never received or read financial
statements; and she knew nothing of the corporation’s business affairs. Her husband, the deceased founder of
Pritchard & Baird, had actually warned her to watch out for the sons before he died. Subsequently, Mrs.
Pritchard died and the trustee in bankruptcy (representing the interests of many creditors) brought suit against
the estate of Mrs. Pritchard (defendant) to recover the siphoned funds.
Holding: A director has a duty to know generally the business affairs of the corporation. This duty
includes a basic understanding of what the company does; being informed on how the company is
performing; monitoring corporate affairs and policies; attending board meetings regularly; and making
inquiries into questionable matters. In the case at bar, Mrs. Pritchard did none of the above. She did not
seem to know what a reinsurance agency does; she never received or read financial statements; and she
generally knew nothing of the corporation’s business affairs. Her failure to keep herself informed
breached not only a duty of care to the corporation, but a fiduciary duty to Pritchard & Baird’s clients.
It would have only taken a brief, non-expert reading of the financial statements to know that something
was wrong and money was being misappropriated. Her failure to do so was the proximate cause of the
misappropriations of the clients’ money not being discovered. The fact that her husband had warned
her about the sons, but she still made no effort to monitor them is even more evidence that she violated
her fiduciary duties.
- Why does the court use a reasonable person standard rather than the
business judgment rule?
a. This is a question of inactivity rather than activity so the business
judgment rule does not apply.
i. Gross negligence does not count as business judgment
b. For a reasonable person standard have to use ordinary care
c. When you’re a director, you don’t get deference in carrying out your
affirmative obligations
i. When it comes to the basic metrics of your job and not actual
business decisions (e.g. showing up, reading statements, etc.),
you have to meet a reasonableness standard rather than BJR
where threshold is just gross negligence
ii. Higher threshold for basic requirements of the job
- Court looks for three requirements for liability under reasonable person
standard:
a. (1) Did Lillian have a duty to the Pritchard and Baird clients?
i. Usually just have a duty to shareholders but this case is an
exception because of the nature of the reinsurance business
a) Duty to customers exists when holding funds in trust
for others
b. (2) Did Lilian breach that duty to those clients?
i. Yes because she had an affirmative duty to show up to meetings
and know about the business
Page 88 of 115
c. (3) was her breach the proximate cause of the clients’ loss
i. Court made a stretch
ii. It said that but for her negligence the brothers wouldn’t have
stolen the money and if she had just come to meetings she would
have noticed they were taking money
- Affirmative duties of a director
a. Obligation of basic knowledge and supervision
b. Read and understand financial statements
c. Object to misconduct, and if necessary, resign
Page 89 of 115
DIRECTOR’S DUTY OF LOYALTY
xv. Director’s Duty of Loyalty
- Note: Business Judgment Rule covers ONLY duty of care and NOT duty of
loyalty
- Duty of loyalty regulates self-dealing transactions, has no BJR shield, and
- mandates that the best interests of the corporation and its stockholders take
precedence over any interest possessed by a director and not shared by the
stockholders generally
Step 2: Has the transaction been properly “cleansed”? (can other members/judge
void the decision?)
- MBCA §8.61-§8.63
a. Qualified directors cleanse by disinterested directors
i. MBCA §8.62 – defines qualified director’s cleanse
b. Independent Shareholders ratify the transaction
Page 90 of 115
i. MBCA §8.63 – defines qualified shareholder ratification,
requiring that they be independent
a) Note: Delaware statute doesn’t say “disinterested” or
“independent” shareholders – so all get to vote, even
those getting a benefit
c. Transaction can be cleansed if adjudged fair
i. MBCA §8.61(b)(3)
a) Any shareholder can go to a judge and ask for the
transaction to be voided
- DGCL §144
a. No contract or transaction between a corporation and one or more of
its directors or officers shall be void or voidable if:
i. Informed, disinterested directors approve; or
ii. Informed shareholders ratify; or
iii. Transaction is substantively fair to the corporation
- NOTE: difference between MBCA and DGCL
a. DGCL gives more latitude, says substantially fair, informed shareholders
instead of independent (means in DE shareholders that are involved in
the transaction can still vote – according to case law)
1. Use the GUTH TEST: (factors not elements from Guth v. Loft)
a. A corporate opportunity exists where:
i. Corporation is financially able to take the opportunity
1. Not dispositive
2. Lessens the D’s burden
ii. Opportunity is in the corporation’s line of business
1. Activity as to which it has fundamental knowledge, practical
experience, and ability to pursue
Page 91 of 115
2. Consonant with its reasonable needs and aspirations for
expansion
a. Like Singer case, because manufacturing side job very
similar to general automotive’s business
3. Line of business test is broader and covers more opportunities
than the interest/expectancy test
iii. A corporation has an interest or expectancy in the opportunity
1. Interest: something to which the firm has a right, legal
entitlement
2. Expectancy: something which, in the ordinary course of
things, would come to the corporation
3. If officer bought land to which the corporation had a
contractual right, the officer took an “interest”
4. If the officer took the renewal rights to a lease the corporation
had, the officer took an “expectancy”
iv. Embracing the opportunity would create a conflict between the
director’s self-interest and that of the corporation
1. Seizing the opportunity creates the conflict
Rule: Under the corporate opportunity doctrine, it is not required that the director in question formally
present the opportunity to his corporation’s board of directors if the corporation does not have an
interest in or the financial ability to undertake the opportunity.
Broz v. PriCellular (Delaware duty of loyalty/corporate opportunity doctrine): Robert Broz (defendant) was a
director of Cellular Information Systems, Inc. (CIS) (plaintiff). He was also the president and sole stockholder
of RFB Cellular (RFBC), a competitor of CIS in the cellular telephone service market. At the time in question,
CIS had recently undergone financial difficulties and had begun divesting its cellular licenses. Mackinac
Cellular Corp. (Mackinac), a third party cellular service provider, was seeking to sell one of its licenses.
Mackinac thought that RFBC would be a potential buyer and contacted Broz about the possibility. The license
was not offered to CIS. Broz spoke informally with other CIS directors, all of whom told him that CIS was not
interested in the license and could not afford the license even if it were interested. At about the same time, a
fourth service provider, PriCellular, had undergone discussions with CIS about PriCellular purchasing CIS.
PriCellular had also been in negotiations with Mackinac about purchasing the license in question. In
September 1994, PriCellular agreed on an option contract with Mackinac about purchasing the license. The
option was to last until December 15, 1994, but if any competitor offered Mackinac a higher price during that
time, Mackinac would be free to sell the license for that higher offer. On November 14, 1994, Broz, on behalf
of RFBC, offered Mackinac a higher price for the license and Mackinac agreed to sell to RFBC. Nine days
later, PriCellular completed its purchase of CIS. CIS then brought suit against Broz, alleging that Broz
breached his fiduciary duties to CIS by purchasing the license for RFBC when the newly formed
PriCellular/CIS corporation had had the option open to make the same purchase.
Holding: There is no requirement that the director take into consideration future interests of an at-that-
time third party corporation, and there is no requirement that the director in question formally present
the opportunity to his corporation’s board of directors if the corporation does not have an interest in or
the financial ability to undertake the opportunity. In the instant case, at the time Broz closed the deal
for the license on behalf of RFBC, PriCelluar had no equitable interest in CIS. He was under no duty to
consider the “the contingent and uncertain plans of PriCellular.” In addition, it was clear that at the
time CIS could not financially afford to purchase the license and that it in fact had no interest in
Page 92 of 115
purchasing the license. This was not only clear given CIS’s financial troubles and divesting of other
licenses, but because directors of CIS told Broz as much during informal discussions. Consequently,
Broz did not violate any fiduciary duty to CIS.
Page 93 of 115
SHAREHOLDER’S DUTIES
Rule: A parent corporation must pass the intrinsic fairness test only when its transactions with its
subsidiary constitute self-dealing.
Sinclair Oil v. Levien: (duty of loyalty for controlling shareholders): Sinclair Oil Corp. (Sinclair) (defendant)
owned about 97 percent of the stock of its subsidiary, Sinclair Venezuelan Oil Company (Sinven) (plaintiff).
From 1960 to 1966, Sinclair caused Sinven to pay out $108 million in dividends, which was more than Sinven
earned during the time period. The dividends were made in compliance with law on their face, but Sinven
contended that Sinclair caused the dividends to be paid out simply because Sinclair was in need of cash at the
time. In addition, in 1961 Sinclair caused Sinven to contract with Sinclair International Oil Company
(International), another Sinclair subsidiary created to coordinate Sinclair’s foreign business. Under the
contract, Sinven agreed to sell its crude oil to International. International, however, consistently made late
payments and did not comply with minimum purchase requirements under the contract. Sinven brought suit
against its parent, Sinclair, for the damages it sustained as a result of the dividends, as well as breach of the
contract with International. The question is whether Sinclair was improperly engaging in self-dealing.
Holding: A parent corporation must pass the intrinsic fairness test only when its transactions with its
subsidiary constitute self-dealing in that the parent is on both sides of the transaction with its
subsidiary and the parent receives a benefit to the exclusion and at the expense of the subsidiary.
Otherwise, the business judgment rule will apply. Starting with the issue of the dividends in the present
case, the Delaware Court of Chancery improperly applied the intrinsic fairness standard. The dividend
payments were not self-dealing by Sinclair. Although they resulted in a lot of money changing hands
from Sinven to Sinclair, a portion of the money was also received by Sinven’s minority shareholders.
There was no benefit to Sinclair that came at the expense of Sinven’s minority shareholders and so the
payments do not constitute self-dealing. Accordingly, the business judgment rule applies to the
payments and under the business judgment rule, the court can find no evidence that the decision to
cause Sinven to pay dividends was fraudulent or made in bad faith. Sinclair, therefore, did not violate
its fiduciary duty to Sinven by causing the dividends to be paid and the Delaware Court of Chancery is
reversed on that issue. On the other hand, in terms of Sinclair inducing the contract between Sinven
and International, Sinclair was engaged in self-dealing, as Sinclair is the parent of both parties to the
contract. Moreover, when the contract was breached by late payment, Sinclair was able to reap the
benefits of the crude oil to the detriment of Sinven’s minority shareholders. As a result, the Delaware
Court of Chancery was correct in applying the intrinsic fairness standard to Sinclair’s involvement in
the contract, and the court determines that the Delaware Court of Chancery was also correct in finding
that Sinclair did not meet its burden of showing objective fairness under that standard. Clearly
Sinclair’s involvement is not objectively fair because International breached the contract and Sinclair
Page 94 of 115
reaped benefits without fully paying for them. Sinclair thus breached its fiduciary duty to Sinven by its
role in the formation and execution of the contract with International.
Page 95 of 115
Rule: Under Delaware law, the business judgment standard applies to a shareholder’s duty of loyalty
claim related to a merger if the merger does not involve an interested and controlling stockholder.
In Re Wheelabrator (duty of loyalty – cleansing): Waste Management, Inc. (Waste) owned 22 percent of the
shares of Wheelabrator Technologies, Inc. (WTI). The two companies negotiated a merger agreement, which
was approved by WTI’s board of directors (defendants) and shareholders. Certain WTI shareholders
(plaintiffs) brought suit, claiming, among other things, that the board of directors breached its duty of loyalty.
Holding: The business judgment standard—not the entire fairness standard—applies to a shareholder’s
duty of loyalty claim regarding a merger, so long as that merger does not involve an interested and
controlling stockholder. The entire fairness standard represents a heightened standard of care for
directors and thus is appropriate when the controlling, interested stockholder is participating in the
merger. This heightened standard is not necessary when a controlling, interested stockholder is not
involved. In the present case, Waste was only a 22 percent shareholder of WTI. There is no evidence
that Waste had de jure or de facto control over WTI. As a result, the merger did not involve a
controlling shareholder, and therefore the business judgment standard applies.
Page 96 of 115
Directors’ Obligation of Good Faith
iv. The obligation of good faith is not a separate fiduciary duty; it is a subset of the duty
of loyalty
v. Now part of the Delaware legal doctrine and has implications for roles and duties of a
director
Rule: Directors will be liable for failure to engage in proper corporate oversight where they fail to
implement any reporting or information system, or having implemented such a system, consciously fail
to monitor or oversee its operations.
Stone v. Ritter (duty to act in good faith): AmSouth Bancorporation (AmSouth) was forced to pay $50
million in fines and penalties on account of government investigations about AmSouth employees’ failure to
file suspicious activity reports that were required by the Bank Secrecy Act (BSA) and anti-money-laundering
(AML) regulations. AmSouth’s directors were not penalized. The Federal Reserve and the Alabama Banking
Department issued orders requiring AmSouth to improve its BSA/AML practices. The orders also required
AmSouth to hire an independent consultant to review AmSouth’s BSA/AML procedures. AmSouth hired
KPMG Forensic Services (KPMG) to conduct the review and KPMG found that the AmSouth directors had
established programs and procedures for BSA/AML compliance, including a BSA officer, a BSA/AML
compliance department, a corporate security department, and a suspicious banking activity oversight
committee. The plaintiffs nonetheless brought suit against AmSouth directors (defendants) for failure to
engage in proper oversight of AmSouth’s BSA/AML policies and procedures.
Holding: Directors will be liable for failure to engage in proper corporate oversight where they fail to
implement any reporting or information system, or having implemented such a system, consciously fail
to monitor or oversee its operations. The standard for such a determination is whether the directors
knew that they were not fulfilling their oversight duties and thus breached their duty of loyalty to the
corporation by failing to act in good faith. This is a forward-looking standard and hindsight may not be
used to determine whether directors exercised their corporate oversight responsibilities in good faith.
In the present case, the KPMG report shows that the AmSouth directors had substantial BSA/AML
policies in place, including a BSA officer, a BSA/AML compliance department, a corporate security
department, and a suspicious banking activity oversight committee. The implementation of this system
discharges the directors’ oversight responsibilities because it is an adequate reporting system and it
delegated monitoring responsibilities to AmSouth employees and departments. Simply because an
AmSouth employee failed to follow the BSA/AML policies and procedures in place does not mean
that the directors did not put the policies and procedures in place in good faith
vi. Court says that duty of good faith is a subsection of duty of loyalty, therefore falls
under DE §102(b)(7) and can’t contract around your liability.
vii. What would an adequate law compliance program include?
a. Policy manual
b. Training of employees
c. Compliance audits
d. Sanctions for violations
e. Provisions for self-reporting of violations to regulators
viii. New rule from In Re Caremark – Now DE law
Page 97 of 115
a. Directors’ obligation includes a duty to assure that a corporate information
and report system exists, and that failure to do so MAY render a director
liable for losses caused by non-compliance with legal standards
Rule: When a board of directors reaches a disinterested decision on corporate governance, the board’s
reasoned business judgment will be given great deference by the courts.
Grimes v. Donald (demand requirement): The board of directors of DSC Communications (DSC) (defendant)
approved a compensation agreement for DSC’s CEO, James Donald (defendant), that promised him
employment until his seventy-fifth birthday, and provided that if he lost his job without cause, he would be
entitled to the same salary he would have earned until the contract would otherwise have expired. The contract
also included further incentive bonuses, lifetime medical coverage for Donald and his family, and other
benefits. Grimes (plaintiff), made a demand to the board that it abrogate the contract with Donald. The board
refused. Grimes filed a derivative suit alleging that the board abdicated its responsibility to oversee the
Page 100 of 115
management of the company. Grimes alleged that by granting Donald a contract that allowed him to collect
compensation even if the board chose to reject the course of action he chooses as CEO, the board had given up
its responsibility to oversee the future of DSC. In his derivative action, Grimes alleged that he never had to
make a demand of the board, because the demand would have been futile in the first place.
Holding: Generally, the courts will grant great deference to the valid exercise of business
judgment of a board of directors. This deference will sometimes mean that board decisions
about executive compensation in a competitive market for executive expertise receive
deference from the courts. The courts’ deference will mean that a board’s decisions about how
to respond to requests from concerned shareholders will be given similar deference.
Additionally, the courts are required to take the demand requirement in a derivative case very
seriously. The demand requirement can only be excused if a plaintiff can show that any demand
would have been futile. In this case, not only did the board of directors have discretion to find a
CEO and induce him to take the job with DSC, it was the board’s responsibility to do so. The
fact is that any contract will require the board to give up some of its future ability to make
decisions about how the company should be run, but the choice to pay Donald to make some
decisions for the board is itself a business judgment. Because the contract was a valid exercise
of business judgment, Grimes’ abdication claim was rightfully dismissed. Grimes argues, with
regard to his derivative claim, that he was excused from making any demand on the board at
all. However, the fact that he did make a formal demand that the board reconsider Donald’s
contract bars him from pleading that his demand would have been futile. As far as the rejection
of the claim Grimes did make, once the board considered his demand, its judgment was entitled
to business judgment deference.
**Takeaway: in DE never make demand, always file suit first and claim futility because
once the board considers it, you lose your underlying suit and can only argue that they
inadequately considered the request
Rule: A corporate board of directors cannot dismiss a derivative lawsuit based solely on the fact that a
committee composed of disinterested members found that the litigation is not in the corporation’s best
interest.
Zapata Corp. v. Maldonado (special litigation committee): William Maldonado (plaintiff) brought a
derivative action on behalf of Zapata Corp. (defendant) against Zapata’s board of directors, alleging breach of
fiduciary duty. Maldonado had not made a prior demand on the board and instead argued that demand was
futile, because all of the board members were alleged to have taken part in the challenged transactions. After
two new outside directors were added to the board, the board as a whole appointed those two members to an
investigation committee charged with investigating Maldonado’s claims. The committee found that it was in
Zapata’s best interest that the derivative suit be dismissed.
Holding: Many states, relying on Delaware law, have held that the business judgment rule
allows a board of directors to terminate a derivative suit based on a vote by a disinterested
committee. However, the business judgment rule requires far more than that, notably a showing
that the decision was well informed and reached through proper procedures. While the powers
of a shareholder to allege a breach of fiduciary duty are not limitless, they certainly cannot be
extinguished by the board without any examination by the courts. However, when the court
examines the facts of a derivative case, it must engage in a balancing act. One the one hand are
the interests of the individual shareholder, for whom the derivative suit is an important tool for
guaranteeing good corporate governance. On the other hand are the interests of the corporation
and its body of shareholders, for whom derivative suits are a hassle and a needless expense. In
this case, there is no serious allegation that the members of the committee were disinterested.
While the board as a whole had an interest, as it was a named defendant in the case, the board
does not transfer its members’ interest in the litigation to the committee when it empowers the
committee to make decisions about the litigation. However, mere disinterest is not enough to
dismiss the suit. The committee must show, in a detailed manner, how it reached its conclusion
that the suit is not in the best interest of the corporation. Further, the committee must give
Maldonado the opportunity to dispute its findings. If the trial court is convinced that the
committee’s findings are both fair and reasonably arrived at, then the trial court, taking the
committee’s findings into account, should decide whether the litigation truly should be
dismissed.
v. Non-binding “say on pay” vote at least every 3 years (per Dodd-Frank Act
(2010/SEC)
Rule: In a proxy contest over policy, corporate directors have the right to make reasonable and proper
expenditures from the corporate treasury for the purpose of persuading the stockholders of the
correctness of their position and soliciting their support for policies which the directors believe are in
the best interests of the corporation.
Rosenfeld v. Fairchild Engine & Airplane Corp. (shareholder voting and proxy rules): In a policy-related
proxy contest (as opposed to a personal contest for power) for a board of directors election in Fairchild Engine
& Airplane Corp. (Fairchild) (defendant), Fairchild’s treasury paid $106,000 in defense of the old board of
director’s position; $28,000 to the old board by the new board after the change to compensate the old board for
their failed campaign; and $127,000 reimbursing expenses that the new board members incurred in their
campaign. That reimbursement was ratified by a majority vote of the stockholders. The policy question behind
the proxy contest was the long-term and very expensive pension contract of a former director, Carlton Ward.
Rosenfeld (plaintiff), brought suit to compel the return of the above payments to the Fairchild treasury
Holding: In a proxy contest over policy, corporate directors have the right to make reasonable and
proper expenditures from the corporate treasury for the purpose of persuading the stockholders of the
correctness of their position and soliciting their support for policies which the directors believe are in
the best interests of the corporation. The stockholders may also reimburse new directors for costs that
the new directors incur in their policy campaign. Because corporations have so many stockholders, if
directors were not able to use corporate funds for solicitation of proxies, it is very possible that
corporate business would be “seriously interfered with.” There are so many stockholders that each
individual stockholder cannot make much of a difference in a vote. Use of proxies is a way to pool
stockholders’ votes, making corporate business conductible. And proxies would likely not be used as
much as they are if the directors had to pay for their solicitation out of their own pockets.
Consequently, directors, if acting in good faith, may incur reasonable expenses in the solicitation of
proxies in a policy-related proxy contest.
**Majority decision called FROESSEL RULE (judges name): payoff structure: incumbent board
proxy costs paid regardless of outcome; insurgent costs may be reimbursed if insurgent wins (omission
of discussion about what happens if insurgent loses - therefore not allowed)
Rule: The meaning of “significantly related” in the SEC rule for omissions in proxy statements is not
limited to economic significance.
Lovenheim v. Iroquois Brands, Ltd. (shareholder proposals): Peter Lovenheim (plaintiff) was a shareholder
in Iroquois Brands, Ltd. (Iroquois) (defendant). Iroquois was preparing to send proxy materials to its
Page 107 of 115
shareholders containing information about a shareholders meeting. Lovenheim sought to include in the proxy
materials a proposed resolution that he planned to offer at the meeting. The resolution pertained to the
allegedly inhumane procedures used to force-feed geese for production of pate de foie gras in France, which
was a type of pate imported by Iroquois. Iroquois refused to include information on Lovenheim’s resolution in
the proxy materials. Iroquois defended its refusal based on the SEC rule that a corporation may omit a
proposal from its proxy statement “if the proposal relates to operations which account for less than 5 percent
of [Iroquois’s] total assets at the end of its most recent fiscal year . . . and is not otherwise significantly related
to [Iroquois’s] business.” Pate accounted for well less than 5 percent of Iroquois’s business. However,
Lovenheim maintained that his proposal could not be excluded because of the second part of the rule in that it
cannot be said that the proposal is not otherwise significantly related to Iroquois’s business. Lovenheim
argued that the proposal had ethical or social significance.
Holding: The meaning of “significantly related” in the SEC rule for omissions in proxy statements is
not limited to economic significance. Therefore, because of the ethical and social significance of
Lovenheim’s proposed resolution, Lovenheim has shown a likelihood of prevailing on the merits in
that his proposal is “otherwise significantly related” to Iroquois business. The proposal therefore may
not be excluded from the proxy statement being distributed.
Rule: Shareholders holding shares worth 10 percent or more of a corporation’s outstanding stock must
pay to the corporation any profits they make from buying and selling the corporation’s stock within a
six-month period.
Reliance Electric Co. v. Emerson Electric Co. (statutory insider trading): In June 1967, Emerson Electric
Co. (Emerson) (plaintiff) bought 13.2 percent of the outstanding stock in Dodge Manufacturing Co. (Dodge)
at $63 per share. Within six months thereafter, Dodge merged with Reliance Electric Co. (Reliance)
(defendant), at which time the stock was priced at $68 per share. Emerson did not want to own shares of the
new merged entity, but also did not want to pay Dodge all of the profits it was going to earn by selling the
stock under Section 16(b) of the Securities Exchange Act of 1934 (Section 16(b)). To get around the
requirement, Emerson sold enough of its shares in the merged entity to bring it below the 10 percent threshold
prescribed in Section 16(b). Emerson paid the profits from that sale to Dodge as required in Section 16(b) and
then sold the remainder of its shares for $69 per share. Emerson did not pay Dodge the profits from its second
sale because at the time of that sale, as a result of the first sale, Emerson owned only 9.96 percent of Dodge’s
shares. Reliance made a demand for the profits from the second sale, and Emerson filed an action seeking a
declaratory judgment that it did not have to pay those profits to the Reliance/Dodge entity.
Holding: Under Section 16(b), shareholders holding shares worth 10 percent or more of a
corporation’s stock must pay to the corporation any profits they make from buying and selling the
stock within a six-month period. However, once the shareholder’s interest in the corporation drops
below the 10 percent threshold, it is no longer liable to the corporation for profit made from sale of
shares. In the present case, although Emerson’s two sales were part of the same “plan,” this is
immaterial to its liabilities on the second sale. The relevant requirement in Section 16(b) is an
objective standard. Once a shareholder drops below 10 percent ownership, it is not liable to the
corporation for profits realized from a subsequent sale. Emerson is thus not liable to Reliance for
profits realized from its second sale of Dodge stock.
Rule: Individuals with knowledge of material inside information must either disclose it to the public, or
abstain from trading in or recommending the securities concerned while such inside information
remains undisclosed.
SEC v. TGS (classical insider trading): Texas Gulf Sulphur Co. (TGS) began drilling on a site in Canada and
found high mineral content. To keep the purchase price of the site low, TGS kept the results of the drilling
quiet. When word of the high mineral content of the site started to get out, TGS released a statement saying
that the reports were exaggerated and that reports of the content of the site were inconclusive. Between that
Page 111 of 115
statement and TGS’s official announcement of the discovered copper ore four days later, the TGS secretary, a
TGS director, and a TGS engineer (defendants) all bought TGS stock. The SEC started an investigation and
eventually brought suit
Holding: Individuals with knowledge of material inside information must either disclose it to the
public, or abstain from trading in the securities concerned while such inside information remains
undisclosed. The materiality of a statement depends on the significance that a reasonable investor
would place on the withheld or misrepresented information. In the present case, the inside information
about the specifics of the drilling site discovery that the defendants withheld from the public was
material because the high mineral content of the site is information a reasonable investor would have
liked to have known and, if known, would certainly have affected the price of the stock. This is
evidenced by the importance placed on the drilling site by those individuals who knew about it,
including the defendants. Because the information was material, the defendants were not entitled to
acquire TGS stock until public disclosure of the high mineral content was made. Their doing so before
public disclosure constitutes insider trading in violation of Rule 10b-5. The trial court is therefore
reversed. In addition, the court determines that the case will be remanded for a determination of
whether the TGS press release saying that reports of the discovery were exaggerated was misleading
and/or deceptive.
Rule: A breach of an insider’s fiduciary duty must occur before a tippee inherits the duty to disclose
inside information.
Dirks v. SEC (tipper/tippee liability): Ronald Secrist, a former officer of Equity Funding of America (Equity
Funding), told Raymond Dirks (defendant) that Equity Funding’s assets were exaggerated due to fraudulent
corporate practices. Secrist told Dirks to verify the fraud and publicly disclose it. Dirks investigated Equity
Funding and over the course of his investigation, he discussed his findings with various investors, including
some investors who had stock in Equity Funding and who sold the stock after they spoke with Dirks. As a
result of the stock sales, Equity Funding’s stock fell abruptly and the SEC opened an investigation. The SEC
found that Dirks aided and abetted insider trading in violation of SEC Rule 10b-5. The court of appeals
affirmed. Dirks appealed.
Holding: A tippee assumes a fiduciary duty to the shareholders of the corporation not to trade on the
material nonpublic information only when the insider giving the tip has breached his fiduciary duty to
the shareholders by disclosing the information to the tippee, and the tippee knows or should know that
there has been a breach. An insider breaches that duty only if he gives the information to the tippee in
order to personally benefit, directly or indirectly, from his disclosure. Where the insider does not
violate any fiduciary duty, the tippee cannot be deemed to violate a fiduciary duty either. In the instant
case, Secrist’s motivation in telling Dirks about the fraud within Equity Funding was for the purpose of
exposing the fraud, not to benefit personally in any way. Therefore, because Secrist in fact did not
benefit either directly or indirectly from telling Dirks, he did not violate a fiduciary duty to the Equity
Funding shareholders. Consequently, Dirks did not violate any resulting fiduciary duty to the Equity
Funding shareholders. Note reality that Secrist was a disgruntled employee and might not have
really been acting for public good so much as personal benefit.
a. CONSTRUCTIVE INSIDER
a. can violate insider trading prohibitions
Page 113 of 115
i. Obtains material nonpublic information from the issuer
ii. With an expectation on the part of the corporation that the outsider
will keep the disclosed information confidential, and
iii. The relationship at least implies such a duty
iv. Classic example: lawyers for the company
b. New way of violating insider trading prohibitions when doesn’t fall under
classical insider trading
iii.
Rule: (1) A person is guilty of securities fraud when he misappropriates confidential information for
securities trading purposes, in breach of a duty to the source of that information. (2) SEC Rule 14e-3 is
a proper use of the SEC’s rulemaking authority and should be given deference.
US v. O’Hagan: (misappropriation): James O’Hagan (defendant) was a partner in the law firm that
represented Grand Metropolitan PLC in its tender offer of Pillsbury Company (Pillsbury) common stock. The
possibility of the tender offer was confidential and not public until the offer was formally made by Grand Met.
However, during the time when the potential tender offer was still confidential and nonpublic, O’Hagan used
the inside information he received through his firm to purchase call options and general stock in Pillsbury.
Subsequently, after the information of the tender offer became public, Pillsbury stock skyrocketed and
O’Hagan sold his shares, making a profit of over $4 million. The Securities and Exchange Commission (SEC)
initiated an investigation into O’Hagan’s transactions and brought charges against O’Hagan for violating §
10(b) and § 14(e) of the Securities Exchange Act. The trial jury convicted O’Hagan, but the United States
Court of Appeals for the Eighth Circuit reversed on the grounds that violation of SEC Rule 10b-5 cannot be
grounded in the misappropriation theory of insider trading. The United States Supreme Court granted
certiorari.
Holding: (1) A person is guilty of securities fraud when he misappropriates confidential information
for securities trading purposes, in breach of a duty to the source of the information. Under the
misappropriation theory of insider trading, an individual misappropriates material nonpublic
information for the purposes of trading, in breach of a fiduciary duty to the source of the information.
This is in contrast to the classical theory of insider trading where a corporate insider misappropriates
material nonpublic information for the purposes of trading, in breach of a fiduciary duty to the
shareholders of the corporation itself. Insider trading under the misappropriation theory satisfies SEC
Rule 10b-5’s requirements of fraudulent practices because individuals who engage in such
misappropriation clearly use deceptive practices in connection with the purchase of securities. Such
individuals “deal in deception” by feigning loyalty to the principal while using confidential
information to purchase stocks—a clear violation of Rule 10b-5. In this case, the misappropriation
theory applies because O’Hagan violated a fiduciary duty to his law firm and Grand Met (i.e. the
sources of the information), not Pillsbury, the trading party in which he bought the stock. This
deceptive misuse of confidential information in order to purchase stocks constitutes a violation of Rule
10b-5. Therefore, O’Hagan breached his duty, and his conviction should be upheld. The judgment of
the court of appeals is reversed.
f. Termination of a Corporation
a. Without action towards termination, corporation goes on in perpetuity
b. Voluntary Dissolution
a. Board submits and shareholders vote on proposal to dissolve – MBCA §14.02(b)
b. Submit articles of dissolution to state
c. Can only carry on to wind up (similar to partnership)
c. Involuntary Dissolution
a. Arises f there is a deadlock: MBCA §14.30
b. Unlike partnership which is fragile (end of carrying on as co-owners ends a
partnership), corporation lasts forever