Business Associations Outline I. Entity Forms 1. S P O O

Business Associations Outline I. Entity Forms 1.
SOLE PROPRIETORSHIPS OLDEST AND SIMPLEST BUSINESS FORM
ONLY ONE OWNER BUSINESS MAY HAVE UNLIMITED NUMBER OF EMPLOYEES,

HOWEVER
a. Agency Principles Apply in Employer-Employee Relationship i. Fiduciary Relationship Agent owes fiduciary duty to principal in discharging the act. ii. Manifestation of Consent Principal must consent to agent acting on principals behalf while being subject to principals control. 1. Control = telling the agent what the job is while making it clear that the principal is in charge of the act (principal does not control the means & methods used by the agent) 2. Agency relationship results from conduct, not words used conduct manifests that one will do something for another who is in control a writing is not generally required to form an agency relationship iii. Threshold question in Contractual Context Did the agent have the legal authority to bind the principal?
o o
The acts of the agent can bind 3rd parties to the principal & the principal to the 3rd party. Where the principal is disclosed to the 3rd party, the agent is not a party to the contract.
1. Actual Express Authority Principal expressly gives the agent power to undertake an act on his behalf. 2. Actual Implied Authority Agent has the authority to do what is reasonably necessary to get the assigned job done even if the principal did not spell out, in detail, the manner of accomplishing the task the task is still expressly assigned 3. Apparent Authority Created as to a 3rd person by written or spoken words or other conduct by the principal which, reasonably interpreted, causes the 3rd person to believe that the principal consents to have the act done on his behalf by the person purporting to act for the principal authority is born out of manifestations to the 3rd party An act of an agent within the scope of his apparent authority binds the principal Agents authority may be considered plenary (all-encompassing) unless the principal limits that authority and communicates the limitation to 3rd parties. v. Principal can also be liable for tortious acts of the agent under the doctrine of respondeat superior (vicarious liability) 1. Generally only applies in employer/employee (master/servant) context 2. Employer must have the right to control the basic details (day-to-day performance) of the employees job Control is main ingredient for finding liability o An employee is different than an independent contractor (who is hired but not told how to do the job)
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Independent contractor may/may not be an agent (fact-specific inquiry principal not generally liable for independent contractors tortious conduct) 3. Employer is only liable for torts committed within the scope of the employees employment o Intentional torts may or may not be within the scope of the employees employment o Fact-specific Inquiry -- If the employee leaves the job on personal business (a frolic), torts committed while on the frolic are not a basis for vicarious liability Court could find that the alleged frolic was merely a detour (employee was slightly side-tracked or temporarily paused while completing the employers task) in which case, the employer would be liable b. Other Applications of Agency Principles i. Attorney-Client Relationships Hayes v. Natl Serv. Industries 1. Attorneys authority to act for client is often an example of apparent authority 2. Attorneys authority is determined by the representation agreement between the attorney and the client
or by specific instructions given by the client.
ii. Franchisor-Franchisee Relationships Miller v. McDonalds Corp. 1. Court will look to the franchise agreement to determine the existence of an agency relationship 2. Disclaimer within the agreement could be prima facie evidence of the type of relationship that exists 3. Courts inquiry is into the substance of the relationship. 4. Actual Agency If the franchise agreement goes beyond the stage of setting standards and allocates
to the franchisor the right to exercise control over the daily operations of the franchisee, an agency relationship exists. o If the franchise agreement merely provides standards for the franchisee to meet, no agency relationship exists. Apparent Agency An agency relationship exists if one represents that another is his agent and thereby causes a 3rd person justifiably to rely upon the care or skill of the apparent agent. The party making the representation will be liable to the 3rd person for harm caused by the lack of care/skill of the one appearing to be an agent. o Centrally-imposed uniformity is a fundamental basis for determining whether apparent agency exists. o If the franchisor hold the franchisee out as its agent in a way that would lead a member of the public to believe that the franchisees store was just another store in the chain, apparent agency may exist.
5.
NO LEGAL SEPARATION BETWEEN THE OWNER AND THE BUSINESS OWNER RECEIVES ALL PROFITS AND BEARS ALL LOSSES
a. Growth of the Sole Proprietorship 2 Funding Alternatives: i. Debt 1. Fixed payment obligation business must generate sufficient earnings/cash flow o Debt represents risk to business because it must be repaid with funds the business might need. o Must be repaid before anything can be paid to equity holder if business fails. 2. Interest Expense is tax-deductible o Represents fixed rate of return for the lender o Interest cost is fixed for the business
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3. Loan covenants can control how the business operates Can be a
negative
4. Collateral may be required 5. Personal guarantees are sometimes required ii. Equity 1. Bringing in investors dilutes ownership business ceases to be sole proprietorship o Original owner gives up profit that would have been solely his. o Original owner gives up some degree of control. 2. No set payment obligations to ownership o Owners in risky position if business fails because there is no guarantee of any distribution of remaining assets. o No fixed rate of return rate of return is potentially unlimited 3. Additional owners reduce per share profits 4. Dividends are not tax-deductible
EARNINGS ARE TAXED WHETHER OR NOT THEY ARE DISTRIBUTED (NO VEHICLE FOR SHELTERING THE BUSINESS EARNINGS FROM TAX) ALL ASSETS OF THE OWNER ARE AVAILABLE FOR SETTLEMENT OF LIABILITIES NO LEGAL FORMALITIES IN FORMING THE BUSINESS
2. GENERAL PARTNERSHIP
AN ASSOCIATION OF TWO OR MORE PERSONS TO CARRY ON AS CO-OWNERS A BUSINESS
FOR PROFIT
RUPA 101(6) a. Agreement to share profits is prima facie evidence of a partnership i. RUPA 202(a) Except as otherwise provided in 202(b), the association of 2 or more persons to
carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership. 1. Persons includes corporations RUPA 101(10) Person means an individual, corporation, business trust, estate, trust, partnership, association, joint venture, government, governmental subdivision, agency, or instrumentality, or any other legal or commercial entity.
ii. At least one of the following must be present, along with intent to share profits: right to make decisions for the business, and/or duty to share liabilities on dissolution. iii. Key Principle When money changes hands, terms and conditions for the exchange need to be
clearly defined (i.e. Is this a loan?, Is this an advance?, I this an additional contribution of capital?)
iv. RUPA 401(b) (In the absence of a contrary provision in the partnership agreement) each partner is
entitled to an equal share of the partnership profits and is chargeable with a share of the partnership losses in proportion to the partners share of the profits. 1. Non-RUPA Jurisdiction (Caselaw) In the absence of an agreement to the contrary, the law presumes that the partners intended to participate equally in the profits and losses of the partnership, irrespective of any inequality in the amounts each contributed to the capital employed in the venture, with losses being shared by them in proportion to the way they share profit. o Where one partner contributes the money capital and the other labor or skill, neither party is liable to the other for contribution for any loss sustained.
v. Caselaw 1. Bohatch v. Butler & Binion

o o o Partnerships exist by the agreement of the partners. Partners have no duty to remain partners. A partner can be expelled without a breach of any common law duty over disagreements about firm policy or to resolve some fundamental schism. A partner can also be expelled for accusing another partner of wrongdoing without subjecting the partnership to tort damages.
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b. Hierarchy of laws governing the partnership i. Partnership agreement Relations among the partners and between the partners and the partnership are governed by the partnership agreement. To the extent the partnership agreement does not otherwise provide, the partnership statute governs relations among the partners and between the partners and the partnership. (RUPA 103(a)) 1. Partnership agreement may be written, oral, or implied RUPA 101(7) 2. Non-waivable provisions (RUPA 103(b)) Partnership agreement may not:
o o o Vary the rights & duties under 105 except to eliminate the duty to provide copies of statements to all partners Unreasonably restrict the right of access to books and records under 403(b) Eliminate the duty of loyalty under 404(b) or 603(b)(3), but partnership agreement may identify specific types or categories or activities that do no violate the duty of loyalty, if not manifestly unreasonable; or all of the partners or a number or percentage specified in the partnership agreement may authorize or ratify, after full disclosure of all material facts, a specific act or transaction that otherwise would violate the duty of loyalty Unreasonably reduce the duty of care under 404(c) or 603(b)(3) Eliminate the obligation of good faith and fair dealing under 404(d), but the partnership agreement may prescribe the standards by which the performance of the obligation is to be measured, if the standards are not manifestly unreasonable. Vary the power to dissociate a partner under 602(a), except to require the notice under 601(1) to be in writing. Vary the right of a court to expel a partner in the events specified in 601(5). Vary the requirement to wind up the partnership business in cases specified in 801(4)-(6). Vary the law applicable to a limited liability partnership under 106(b). Restrict the rights of third parties under the statute.
o o o o o o o
ii. Partnership Statutes provide the default rule in the event the partnership agreement is silent, or there is no partnership agreement iii. Case Law remains an important part of partnership law 1. Unless displaced by particular provisions of the Statute, the principles of law and equity supplement this Act RUPA 104(a) c. Partnership Ownership of Property i. RUPA 201(a) A partnership is an entity distinct from its partners; therefore, ii. RUPA 203 Property acquired by the partnership is property of the partnership and not of the
partners individually.
iii. RUPA 204 (a)(1)-(2) Property acquired in the name of the partnership, or by one or more partners with reference to their capacity as partners, is partnership property; (b) property transferred to the
partnership in its name, or to one or more partners in their capacity as partners in the partnership if the name of the partnership is indicated in the transferring instrument 1. RUPA 204(c) Property is presumed to be partnership property if purchased with partnership assets 2. RUPA 204(d) Property acquired in the name of one or more of the partners, without an indication in the instrument transferring title to the property of the persons capacity as partner is presumed to be separate property, even if used for the partnership.
d. Growing the Partnership i. Existing Owners 1. No statutory requirement that partners make initial or additional capital contributions. 2. Required capital contributions are set forth in the partnership agreement. o Agreement specifies by whom contributed, how much to contribute, and when to contribute o Agreement should specify what to do in the event one partner fails to pay in an additional assessment.
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ii. Outside Lenders 1. Fixed payment obligation business must generate sufficient earnings/cash flow o Debt represents risk to business because it must be repaid with funds the business might need. o Must be repaid before anything can be paid to equity holder if business fails. 2. Interest Expense is tax-deductible o Represents fixed rate of return for the lender o Interest cost is fixed for the business 3. Loan covenants can control how the business operates Can be a
negative
4. Collateral may be required 5. Personal guarantees are sometimes required iii. Additional Owners 1. No fixed payment obligation to new partner. 2. Additional owners do, however, decrease the share available to the other partners. 3. Legal Issues With Bringing in a New Partner o RUPA 401(i) A person may become a partner only with the consent of all of the partners
o (subject to the partnership agreement). RUPA 306(b) A person admitted as a partner into an existing partnership is not personally liable for any partnership obligation incurred before the persons admission as a partner (subject to the partnership agreement).
iv. Earnings from Business Operations 1. Funding for partnership can be obtained by investing partnership earnings back into the partnership. 2. Partnership agreement governs how profits will be split, used, etc. 3. See section on Decision-making within the partnership for how disputes regarding the use of partnership profits will be resolved. e. When a Partner Decides to Leave Dissociation i. Partner can dissociate at any time, but withdrawal under certain circumstances may be wrongful and could affect any payment the partner may receive from the partnership. ii. Events Causing Dissociation (RUPA 601) Occurs upon the happening of any of the following: 1. 601(1) Partnership having notice of partners express will to withdraw as a partner or on a later
date specified by the partner.
2. 601(2) An event agreed to in the partnership agreement as causing the partners dissociation. 3. 601(3) The partners expulsion pursuant to the partnership agreement. 4. 601(4) The partners expulsion by the unanimous vote of the partners if (i) it is lawful to carry on the partnership business with that partner; (ii) there has been a transfer of all or substantially all of that partners transferable interest of the partnership (with certain exceptions); (iii) within 90 days after
the partnership notifies a corporate partner that it will be expelled because it filed a certificate of dissolution or the equivalent, its charter has been revoked, or its right to conduct business has been suspended by the jurisdiction of its incorporation, there is no revocation of the certificate of dissolution or no reinstatement of its charter or its right to conduct business; or (iv) a partnership that is a partner has been dissolved and its business is being wound up. 601(5) On application by the partnership or another partner, the partners expulsion by judicial
5.
(i) the partner engaged in wrongful conduct that adversely and materially (ii) the partner willfully or persistently committed a material breach of the partnership business or of a duty owed to the partnership or the other partners under 404; or (iii)
determination because: affected the partnership business;
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6.
the partner engaged in conduct relating to the partnership business which makes it not reasonably practical to carry on the business in partnership with the partner. 601(6) The partners: (i) becoming a debtor in bankruptcy; (ii) executing an assignment for the benefit of creditors; (iii) seeking, consenting to, or acquiescing in the appointment of a trustee, receiver, or liquidator of that partner or of all or substantially all of that partners property; or (iv) failing, within 90 days after the appointment, to have vacated or stayed the appointment of a trustee, receiver, or liquidator of the partner or of all or substantially all of the partners property obtained without the partners consent or acquiescence, or failing within 90 days after the expiration of a stay to have the appointment vacated. 601(7) In the case of a partner who is an individual: (i) the partners death; (ii) the appointment of a guardian or general conservator for the partner; or (iii) a judicial determination that the partner has otherwise become incapable of performing the partners duties under the partnership agreement. 601(8) In the case of a partner that is a trust or is acting as a partner by virtue of being a trustee of a trust, distribution of the trusts entire transferable interest in the partnership, but not merely by reason of the substitution of a successor trustee. 601(9) In the case of a partner that is an estate or is acting as a partner by virtue of being a personal representative of an estate, distribution of the estates entire transferable interest in the partnership, but not merely by reason of the substitution of a successor personal representative. 601(10) Termination of a partner who is not an individual, partnership, corporation, trust, or estate.
7. 8. 9. 10.
iii. Wrongful Dissociation (RUPA 602(b)) A partners dissociation is wrongful only if: 1. It is in breach of an express provision of the partnership agreement or 2. In the case of a partnership for a definite term or particular undertaking, before the expiration of the term
or the completion of the undertaking: o the partner withdraws by express will, unless the withdrawal follows within 90 days another partners dissociation by death or otherwise under 601(6)-(10) or wrongful dissociation under this subsection; o the partner is expelled by judicial determination under 601(5); o the partner is dissociated by becoming a debtor in bankruptcy; or o in the case of a partner who is not an individual, trust other than a business trust, or estate, the partner is expelled or otherwise dissociated because it willfully dissolved or terminated Partners liability for willful dissociation (RUPA 602(c)) A partner who wrongfully dissociates is liable to the partnership and to the other partners for damages caused by the dissociation. The liability is in addition to any other obligation of the partner to the partnership or to the other partners.
iv.
v. Effect of Partners Dissociation (RUPA 603) 1. If dissociation results in dissolution and winding up of partnerships business, Article 8 applies. o RUPA 801 A partnership is dissolved and its business must be wound up upon the occurrence of any of the following:
Partners express will to withdraw Partnership has a definite term for existence Event specified in the partnership agreement that results in winding up the partnerships business Event that makes it unlawful for all or substantially all of the business of the partnership to be continued. Judicial determination that the economic purpose of the partnership is likely to be unreasonably frustrated, another partner has engaged in conduct making it not reasonably practical to carry on the business of the partnership RUPA 802 (a) Partnership continues after dissolution only for the purpose of winding up, unless (b) partners waive the right to wind up the business of the partnership and terminate the partnership, in which case, the partnership continues as though nothing had happened. RUPA 803 Deals with the Right to Wind Up the Partnerships Business
o o
RUPA 804 Partner can bind the partnership after dissolution if appropriate for dissolution
or the act would have bound the partnership before dissolution (if the other party did not have notice of the dissolution)
RUPA 807 Order of Distributions at Dissolution of Partnership Discharge debts owed to third party creditors Discharge debts owed to partners who are creditors
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Any surplus funds are distributed to the partners Partners must contribute according to their shares to cover any deficit upon dissolution. 2. Otherwise, Article 7 applies (if the partnership agreement does not otherwise control)
o Partnership continues and dissociating partners interest is purchased at the greater of the liquidation value of the assets or the value of the business as a going concern (RUPA
701(a)-(b)).
o The buy-out is offset by any damages caused by the dissociation, if wrongful
(RUPA
701(c)). 3. Upon dissociation: o Partners right to participate in management and conduct of partnerships business terminates, except as provided in 803 o Partners duty of loyalty under 404(b)(3) terminates; and o Partners duty of loyalty under 404(b)(1) and (2) and duty of care under 404(c) continues only with regard to matters arising and events occurring before the partners dissociation, unless the partner participates in winding up the partnerships business pursuant to 803. vi. Case Law 1. Creel v. Lilly
o o o In the absence of a contrary provision in the partnership agreement, the partnership does not automatically dissolve due to a change in its membership. The existing partnership may be continued if the remaining partners elect to buy out the dissociating partner The buy-out option does not have to be expressly included in a written partnership agreement in order to be exercised, but the surviving partners must actively choose to exercise the option since continuation is not automatic as with a corporation. A deceased partners estate does not have to consent to the continuation of the business in order for the business to be continued, nor does the estate have the right to compel liquidation.
UNLIMITED JOINT AND SEVERAL LIABILITY FOR THE OBLIGATIONS OF THE PARTNERSHIP
a. Creditor Status determines the priority order of parties who will receive funds upon the dissolution of the partnership i. 3rd Party Creditors ii. Partnership Creditors partners who loaned money to the partnership iii. Remaining Capital Balance for each partner
PASS-THROUGH ENTITY PARTNERS ARE TAXED INDIVIDUALLY FOR THEIR SHARE OF THE
PARTNERSHIPS INCOME
NO WRITTEN PARTNERSHIP AGREEMENT REQUIRED
a. Conduct of the parties determines the existence of the partnership. b. No formal legal steps required for formation of partnership. i. Partnership is a residual business structure When 2 or more persons operate a business and do not take any action to qualify it as some particular entity, it defaults to partnership. ii. No requirement that any paperwork be filed in public records. iii. A written partnership agreement is not required but is strongly recommended because: 1. The agreement is a contract and is enforceable to the same extent as contracts generally. 2. Partnership agreements can change much of the statutory law that otherwise would govern since the statute is the default in the event that there is no partnership agreement.
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3. The agreement can be tailored to the partners wants and desires, subject to the non-waivable provisions. iv. If there is a written partnership agreement, clarity of the wording in the agreement is key avoid ambiguity.
ANY PARTNER CAN BIND THE PARTNERSHIP ALL PARTNERS ARE AGENTS OF THE
PARTNERSHIP
a. Decision-making within the partnership Questions regarding decision-making authority for the partnership arise in: i. Disputes between the partners and outside 3rd parties Courts will look to the partnership statute & then to common law agency principles 1. RUPA 301 (1) Each partner is an agent of the partnership for the purpose of its business. An
act of a partnerfor apparently carrying on in the ordinary course of the partnership businessbinds the partnership unless the partner had no authority to act for the partnership in the particular matter and the person with whom the partner was dealing knew or had received a notification that the partner lacked authority; (2) An act of a partner which is not apparently for carrying on in the ordinary course the partnership business binds the partnership only if the act was authorized by the other partners. RUPA 103(b)(10) The partnership agreement may not restrict the rights of third parties under this Act.
2.
ii. Disputes among partners Courts will look to the provisions of the
partnership agreement first, then to provisions of the partnership statute, and finally to common law agency principles. 1. RUPA 401(f) Each partner has equal rights in the management and conduct of the
partnership business (subject to the partnership agreement)
2. RUPA 401(j) A difference arising as to a matter in the ordinary course of business of a

partnership may be decided by a majority of the partners. 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 of the partners.
b. Partners Duty of Loyalty to One Another i. Partners owe one another the duty of finest loyalty Meinhard v. Salmon 1. Partners are held to stricter standards than the morals of the marketplace 2. The punctilio of honor is the standard of behavior ii. Partners rights & duties with respect to one another defined at RUPA 401 406. 1. RUPA 401 Defines partners rights and duties 2. RUPA 402 Defines partners right to distributions in kind 3. RUPA 403 Defines partners rights with respect to information 4. RUPA 404 Defines general standards of partners conduct 5. RUPA 405 Defines when a partnership or partner may sue 6. RUPA 406 Continuation of the partnership beyond a definite term of a particular undertaking.
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3. C CORPORATION
SEPARATE LEGAL ENTITY
a. General Rule A corporation is a separate and distinct entity from its shareholders and its debts are not their debts. b. Corporate Governance The bigger the corporation, the more defined & delineated the roles of the shareholders, officers, and directors will be (converse is true for smaller corporations). i. Shareholders 1. Elect & remove directors (MBCA 8.03(c)) 2. Modify bylaws (MBCA 10.20(a)) 3. Approve fundamental corporate changes o Mergers with other corporations (MBCA 11.04) o Sale of substantially all of the corporations assets (MBCA 12.02) o Voluntary dissolutions Initiated by Board (MBCA 14.02) 4. Amend Articles of Incorporation (MBCA 10.03(b)) ii. Board of Directors o MBCA 8.01 All corporate powers shall be exercised by or under the authority of, and the
business and affairs of the corporation managed by or under the direction of, board of directors, subject to any limitation set forth in the articles of incorporation or in an agreement authorized under 7.32 o
o o o o o o o o
May delegate management authority to Executive committees, subject to certain limitations (see MBCA 8.25), to the Officers of the corporation (see MBCA 8.40) Exercise high-level oversight over the corporation May approve dividends MBCA 6.40 With the Shareholders approval, may amend the Articles MBCA
10.03(b)
Approve policy changes Approve BIG things Can be protected from liability by Exculpatory Provisions Can also insured against liability (except for intentional or willful misconduct) by D&O insurance MBCA 8.57 MBCA 8.24 Governs voting at Board meetings, what constitutes a quorum, and when a director is deemed to have assented to an action.
iii. Officers 1. Duties set forth in MBCA 8.40 - .41.

o o o Responsibility for preparing the minutes of the directors and shareholders meetings Authenticating the records of the corporation required to be kept under 16.01(a) & (e) Perform the duties set forth in the bylaws or assigned by the Board (to the extent consistent with the bylaws)
2. Run the day-to-day operations of the corporation. 3. Supervise the corporations employees iv. Shareholder Agreements (Generally applicable in the closely-held context) 1. Recognition that shareholders may govern the corporation differently in a closely-held corporation since a few people may serve as shareholder, director, and officer all at the same time. 2. A group of shareholders may vote their respective share to obtain advantages of concerted action
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3. 4.
They may lawfully contract with each other to vote in the future as they, or a majority of their group, from time to time determine o The group may make reasonable provisions for cases of failure of the group to reach a determination o When the vote does not go by way of the agreement, the court can disallow the tainted votes MBCA 7.31 Two or more shareholders may provide for the manner in which they will vote their shares by signing an agreement for that purpose, and this agreement is specifically enforceable. MBCA 7.32(a) An agreement among the shareholders of a corporation that complies with this section is effective among the shareholders and the corporation even though it is inconsistent with one or more provisions of this Act in that it: o Eliminates or restricts the discretion/powers of the Board o Governs the authorization or making of distributions whether or not in proportion to ownership of shares o Establishes who shall be officers or directors of the corporation, their terms of office or manner of selection or removal o Governs the exercise or division of voting power by or between the shareholders and directors or by or among any of them, including the use of weighted voting rights or director proxies o Establishes the terms and conditions of any agreement for the transfer/use of property or the provision of services between the corporation and any shareholder, director, officer or employee of the corporation. o Transfers to one or more shareholders or other persons all or part of the authority to exercise the corporate powers or to manage the business and affairs of the corporation o Requires dissolution of the corporation at the request of one or more of the shareholders or upon the occurrence of a specified event or contingency o Otherwise governs the exercise of the corporate powers or the management of the business and affairs of the corporation, or the relationship among the shareholders, the directors and the corporation, and is not contrary to public policy. o Set forth (A) in the Articles or bylaws and approved by all persons who are shareholders at the time of the agreement, or (B) in a written agreement that is signed by all persons who are shareholders at the time of the agreement and is made known to the corporation o Subject to amendment only by persons who are shareholders at the time of the amendment, unless the agreement provides otherwise o Valid for 10 years, unless the agreement provides otherwise. MBCA 7.32(c) The existence of an agreement authorized by this section shall be noted conspicuously on the front or back of each certificate for outstanding shares or on the information statement required by 6.26(b) Old Common Law Rule An agreement among shareholders to divest directors of their power to fire a corporate employee is illegal. Shareholders may not, by agreement among themselves, control the directors in the exercise of the judgment vested in them to elect officers and fix salaries.
5. MBCA 7.32(b) An agreement authorized by this section shall be:
6. 7.
v. Shareholder Meetings 1. Annual Meeting Required by MBCA 7.01 on date specified in bylaws 2. Special Meeting Allowed under MBCA 7.02 when special corporate action is required 3. Record Date Under MBCA 7.07, only shareholders of record may vote as of the record date 4. Record Owners Under MBCA 7.20(a), the shareholders who are entitled to notice of a shareholders meeting. o Street name ownership shares owned by an individual (the beneficial owner) are held in the name of the depository company (brokerage house). Corporate records show the depository company as the record owner Depository company must give meeting notice to the beneficial owner who then instructs the depository company on how to vote. o Election of Directors Generally Directors face election at each annual meeting (MBCA 8.03(c))
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General Method of Election Plurality voting top vote-getters are elected Voting Methods A shareholder may exercise wide liberality of judgment in the matter of voting his motives may be for personal profit, or determined by whims so long as he violates no duty owed to other shareholders Straight Voting Each seat of the Board is separately elected shareholders can vote his/her shares any way he/she desires in each separate election (i.e. shareholder with 400 shares has 400 votes in each election) Most common method of voting Cumulative Voting Directors are not elected on a seat-byseat basis. There is one at-large election in which the shareholders cast their votes MBCA 7.28(a) Opt-in provision for cumulative voting MBCA 7.28(b) Shareholders do not have the right to cumulate their
votes for directors unless the Articles so provide MBCA 7.28(d) Shareholders may not cumulate their votes unless the meeting notice or proxy statement accompanying the notice states conspicuously that cumulative voting is authorized or a shareholder with the right to cumulate his votes gives notices to the corporation not less than 48 hours before the meeting of his intent to cumulate his votes.
Cumulative Voting Formula for # of Shares Needed to Elect One Director (S/(D+1))+1 S = Total # of Shares Voting; D = # of Directors to be Elected Once the # of required shares is known (before Cumulation), divide the individual shareholders uncumulated by this amount to find out the maximum # of directors he can elect. Advantages of Cumulative Voting Democratic Ensures some minority shareholder representation on the Board Disadvantages Increases shareholder partisanship Promotes divisiveness on the Board Can cause confusion Proxies allow shareholders to vote without being present at the meeting (means by which the corporation solicits shareholder votes) Come into play with large publicly-traded corporations means by which they solicit votes so that the required number of votes will be submitted at annual & special meetings Rules governing proxies are found in SEC Reg. 14a Mandatory Disclosures
Corporate Information Background information on nominees for the Board Management compensation All matters being voted on by shareholders Managements recommendations on shareholder proposals
Rule 14a-4 governs the layout of the proxy card

Who is soliciting the proxy (could be the corporation or a dissident shareholder) Must give shareholders the right to abstain Must give shareholders the right to vote for directors as individuals or as a group Proxy card must adequately explain to shareholders what they are voting for
Rule 14a-9 Proxy Fraud
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Proxies may not contain false/misleading statements of material facts or omissions of material facts (applies to management and shareholders) Filing a proxy statement with the SEC does not mean that the SEC has deemed it accurate, complete, not false, or not misleading, or that the SEC has passed on its merits J.I. Case Co. v. Borak Gave shareholders a private right of action for violations of Rule 14a-9
Elements of Rule 14a-9 Cause of Action Misrepresentation or omission within the proxy statement (Would the omission have produced substantial likelihood that a reasonable shareholder would have considered it in deciding how to vote?); and
A conclusory statement can be a basis for a Rule 14a-9 action ( must base the cause of action on more than just the conlusory statement; there must be some objectively verifiable information that the Board is aware of and the shareholder is not; must have more than proof of mere disbelief of the statement The challenged transaction must have caused harm to the shareholder Transaction causation proxy solicitation must be the essential link to the accomplishment of the transaction (votes solicited by the proxy must have been legally required to approve the transaction) causation of damages by a material proxy misstatement can be established by showing that minority proxies necessary and sufficient to authorize the corporate acts have been given in accordance with the tenor of the transaction
Causation

The shareholder is not required to prove intent (scienter) on the part of the proxy issuer or that relied on the false statement Both shareholders & management can solicit proxies Shareholder Proposals
Shareholders recommendation or requirement that company and/or its Board take action which the shareholder intends to present at the annual meeting. Included with the proxy solicitation
Governed by SEC Rule 14a-8

Must be submitted to corporation within 120 days before the scheduled proxy mailing (based on the previous years annual meeting) Proposal must in the form of a resolution Must provide a means for shareholders to specify by boxes a choice between approval, disapproval, or abstention. Eligibility Requirements for submission shareholder must continuously hold at least $2,000 in FMV or 1% of corporate securities entitled to be voted on the proposal for at least one year by the date of the submission Each shareholder may submit one proposal per year per proxy statement Length, including a supporting statement, is limited to 500 words managements response is not so limited Proposals may be excluded if: Improper under State law (Proposals must be phrased in the form of a suggestion instead of a mandate) Violation of law Violation of proxy rules Personal grievance/special interest Relevance Absence of power/authority by company to implement Management functions (related to ordinary business operations) Relates to election of the Board Conflicts with company proposal Already substantially implemented Duplication of proposal already submitted Resubmissions (shareholder can resubmit the proposal up to 3 times as long as the proposal previously received a specified percentage of the vote) Related to the amount of a dividend
c. Growing a Corporation
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i. Borrowing Money Underlying principle of leverage is that the corporation

can raise capital without diluting ownership as long as the business generates sufficient earnings to cover the debt. 1. Who will make the loan? Banks will look for the presence of unencumbered assets as collateral in the event of default. 2. What covenants will be required? Lenders reduce risk by requiring financial and operational commitments from the borrower until the loan is repaid. 3. How will the corporation service the debt? Fixed payment obligation must be satisfied by cash generated by the corporation. 4. Default Lender may require personal guarantees to guard against this. 5. Tax problems IRS has challenged interest payments in thinly capitalized corporations, arguing that the debt in such corporations should be classified as equity and the interest as dividends. Also, failure to make regular payments could cause the IRS to challenge the interest payments and asset that they are really dividends. 6. Bankruptcy problems Bankruptcy court may subordinate shareholder debt to that of outside creditors in thinly capitalized corporations. 7. Highly Leveraged Position If the corporation is too highly leveraged (high debt-to-equity ratio), other potential creditors may be reluctant to extend further credit to the corporation
ii. Issuing More Stock

1. Preemptive Rights protect existing shareholders from dilution when the corporation issues new shares o MBCA 6.30 No preemptive rights unless provided for in the Articles o MBCA 6.30(b) rights do not attach when shares are issued as compensation, when
shares authorized in the Articles are issued within 6 mos. from the date of corporate formation, and when shares are used to acquire property. o
Case Law Elimination of preemptive rights by amendment of the Articles is possible if such amendment is authorized by the law of the jurisdiction of incorporation, no violation of fiduciary duty is involved, and procedures required to effectuate such amendment are allowed.
Even where preemptive rights are not allowed in the Articles, issuance of shares at favorable prices to directors (while excluding other shareholders) or issuing shares on a nonproportional basis for the purpose of affecting control rather than raising capital may violate the directors fiduciary duty.
2. Raising Money Through Venture Capitalists o Venture capital is substantial equity investment in non-public enterprise not involving active control of the firm (usually receive preferred stock; generally the alternative when no others exist) o Venture capitalists demand a high rate of return profit must cover losses from other investments and the high transaction costs they incur in seeking, monitoring and evaluating their investments o Venture capitalists usually obtain a significant voice in control of the firm o Venture capitalists usually demand protective covenants 3. Issuance of Shares to a Person or to the Public o MBCA 6.21 Governs Issuance of Shares Shares may not be issued for less than par value Where that occurs, the shareholder is liable for the difference between the price paid and the par value
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o o
Where shareholder pays less than the amount authorized by the Board, the shareholder is contractually liable for the difference even if the amount paid is more than par value. The Board may issue shares at a price it deems adequate MBCA 6.21(c) ---- MBCA 6.21(b) gives the Board flexibility in determining what is adequate consideration (cash, services, etc.) A private sale of stock is exempt from registration Public Sale of Stock Main reason to go public is to raise money Usually try to raise enough money to meet anticipated needs for 2-3 years Process: Select an underwriter (investment bank who can get the deal done) responsible for the offering memo filed with the SEC; responsible for structuring the offering, pricing the securities, and maintaining a market for the securities after the offering. Firm Commitment Underwriting money raised comes from the underwriter who buys all of the shares and then re-sells them Best Efforts Underwriting Underwriter acts as the corporations agent, using best efforts to sell shares. Initial Public Offering Corporation offers its shares to the public Corporation typically registers its shares with the SEC (costly, but worthwhile, endeavor) gives the corporation access to tons of cash Is corporation a good candidate for going public?
Large enough? considerable costs in going public and staying public regardless of the size of the company Fiscally sound? potential for growth must be evident Requisite Management Expertise? running a public company is much different than a private one because of the scrutiny Public Appeal of the Companys Business Are Market Conditions Right? market timing is key Access to lots of capital Liquidity of Shares Prestige and other intangibles High initial start-up costs Continuing reporting obligations Increased exposure to securities law actions Decreased flexibility corporate formalities must be observed Loss of privacy Takeover exposure Additional liability for directors and officers Strategic planning affected stock price in short-term drives everything.
Advantages
Disadvantages
INTANGIBLE STRUCTURE
a. Corporate Stock i. Represents owners pro-rata share of ownership in the corporation

ii. iii.
Shown in the Owners Equity section of the Balance Sheet Types Common & Preferred
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iv.
Dynamics 1. Corporation issues its own shares of stock for capital 2. Articles determine the number of shares the corporation has the legal authority to issue 3. The corporation is not required to issue all authorized shares 4. Issued shares are referred to as outstanding shares 5. The corporation may have more than one class of stock Mandatory provisions within the Articles relating to authorized shares MBCA 6.01(b) 1. Articles must authorize one or more classes or series of shares that together have unlimited voting 2.
rights; and Articles must authorize one or more classes or series of shares that together are entitled to receive the net assets of the corporation upon dissolution.
v.
vi.
Optional provisions within the Articles relating to authorized shares MBCA 6.01(c) 1. Articles may authorize one or more classes of stock with special, conditional, or limited voting rights, or
no right to vote o MBCA 6.02 If the Articles so provide, the Board may classify or reclassify any unissued shares into one or more classes or into one or more series within a class. o MBCA 6.03 Authorizes the corporation to issue the number of shares authorized for each class or series of shares.
2. 3. 4.
Articles may authorize one or more classes of shares that are redeemable or convertible at option of the corporation or the shareholder for cash, indebtedness, securities, or other property and at prices determined in accordance with a formula. Articles may authorize one or more classes of shares that entitle the holders to distributions calculated in any manner (including cumulative, non-cumulative, or partially cumulative dividends) Articles may authorize one or more classes of shares that have preference over any other class or series of shares with respect to distributions (including distributions upon the dissolution of the corporation).
vii.
Common Shares 1. Voting rights 2. Represent basic form of ownership right to net assets upon dissolution 3. Enjoys capital appreciation 4. Generally no legal rights to dividends (granted at Boards discretion) 5. Precise rights are set forth in the Articles Preferred Shares (Typical Features) On Exam, dont forget that rights, preferences, and privileges can be built into other classes of shares 1. Typically purchased at higher price 2. Typically non-voting 3. Typically receive dividends first dividends usually paid at a fixed amount 4. Precise rights set forth in the Articles 5. Can have cumulative dividend rights dividend is owed for each year, whether or not one is paid 6. Can be Participating shareholders get their guaranteed dividend, plus a share of the dividend to be
distributed to the common shareholders.
viii.
7. 8.
ix.
Liquidation preferences May have redemption rights & conversion rights under MBCA 6.01(c)
Par Value minimum price for which corporation can issue its shares 1. If par value is given, it must be put in the Articles 2. Par value is not required in most states; MBCA does not require a par value 3. Stated Capital aggregate par value of all issued shares 4. Capital Surplus amount in excess of par value
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CREATED AND RECOGNIZED BY STATE LAW 1. Corporate law sets out the rights, duties, and obligations of shareholders,
officers, and directors to each other and to the corporation a. Hierarchy of Laws Governing Corporations i. State Statutes
ii. Articles of Incorporation

1. Function as the governing document for the corporation & are on file with the State for public access 2. Preempt any contrary provisions within the bylaws
iii. Corporate Bylaws

1. MBCA 2.06(a) The incorporators or board of directors of a corporation shall adopt initial bylaws for the corporation. 2. Function as an internal operating document. 3. No formal filing requirement for bylaws. 4. Absence of bylaws may allow someone to pierce the corporate veil and sue the shareholders.
iv. Case Law v. Federal Statutes securities regulation applying to publicly-traded

corporations b. Where to incorporate i. Generally, the business incorporates in the state where it will do business
ii. Businesses can incorporate in any state, but the business will be subject to the
laws of that jurisdiction and the state where it operates.
iii. Corporations that will do interstate business generally incorporate in Delaware

c. Incorporation Process i. Incorporator (MBCA 2.01) files the articles of incorporation with the secretary of state
ii. MBCA 2.02(a) Mandatory Provisions within the Articles

1. 2. 3. 4. 1. 2.
Name that satisfies the requirements of 4.01 [WE HAD QUESTIONS ON NAMING] Number of authorized shares of stock Street address of registered office; name of registered agent Name and address of each incorporator
iii. MBCA 2.02(b) Optional provisions within the Articles

Name and addresses of initial directors Provisions regarding the purpose for which the corporation was organized, management of the business and regulation of the affairs of the corporation, defining, limiting or regulating the powers of the corporation or its board of directors or its shareholders, a par value for authorized shares of stock, imposition of personal liability on shareholders for the corporations debts to a specified extent. [Keep in mind MBCA 3.02, which provides that the duration of the corporation is permanent unless the Articles provide otherwise] Any provision that is required or permitted to be set forth in the bylaws.
3.
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4. 5.
A provision eliminating or limiting the liability of a director to the corporation or its shareholders for money damages (except for improper financial benefits, intentional infliction of harm upon the corporation/shareholders, violation of 8.33, or intentional violations of criminal law) A provision permitting or making obligatory indemnification of a director for liability to any person for any action taken or any failure to take any action except as limited in 4 above.
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HAS LEGAL RIGHTS THAT PARALLEL INDIVIDUALS (CORP. CAN SUE, BE SUED, OWN
PROPERTY, PAY TAXES, ETC.)
a. Types of Shareholder Litigation i. Direct Action Shareholder sues on his own behalf to enforce his rights as a shareholder 1. Compel corporation to pay a dividend declared but not paid 2. Enforce shareholder inspection rights 3. Compel corporation to hold shareholder meetings 4. Challenge corporate restrictions on share transferability 5. Rule Where a shareholder sues on behalf of himself and all others similarly situated to enjoin a proposed merger or consolidation, he is not enforcing a derivative right; he is enforcing a right common to the shareholders which runs against the corporation.
ii. Derivative Suits Shareholder sues on the corporations behalf to enforce the
corporations rights. Typically applies in Duty of Care suits and Duty of Loyalty suits 1. Procedure for Filing a Derivative Claim o MBCA 7.41 Shareholder must have standing to bring suit. Must have owned shares at
the time of the action complained of or become a shareholder through transfer from one who was a shareholder at such time and must fairly represent the interests of the corporation. o
MBCA 7.42 (Universal Approach) Shareholder must make written demand on

the corporation and wait 90 days unless shareholder has been notified that the demand has been rejected or doing so would cause irreparable harm to the corporation.
Other Approaches to When Demand is Not Needed New York Approach Demand is futile where alleges with particularity that:
Majority of the directors are interested in the transaction (which may be gauged by selfinterest in the transaction at issue or a loss of independence because a director with no direct interest in the transaction is controlled by the self-interested director); or The directors failed to inform themselves to a degree reasonably necessary about the transaction (A director does not exempt himself from liability by failing to do more than rubber-stamp the decisions of active managers); or The directors failed to exercise their business judgment in approving the transaction (the transaction must be so egregious on its face that it could not have been the product of sound business judgment).
Delaware Approach For demand to be futile, must allege particularized facts which create a reasonable doubt that:
Directors are disinterested and independent; and The challenged transaction was otherwise the product of valid exercise of business judgment
MBCA 7.44 Suit will be dismissed on motion by the corporation if one of the groups in (b)-(f) (basically a majority of disinterested directors) has determined in good faith and after reasonable inquiry that maintenance of the derivative proceedings is not in the best interests of the corporation Special Litigation Committees Board can delegate responsibility for determining whether to proceed with or move for dismissal of a derivative suit (MBCA 7.44(b)(2)) BJR shields the deliberations and conclusions of the chosen representatives of the Board only if they possess a disinterested independence and do not stand in a dual relation which prevents an unprejudicial exercise of judgment Court makes 2-step inquiry to determine if the SLC was shielded by the BJR:
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Procedural Inquiry Are the directors who select the members of the SLC disinterested? Are the members of the SLC also disinterested? Is the process used in reaching the decision appropriate? Substantive Decision Inquiry If the process was appropriate, the court looks at whether the decision was reasonable and made in good faith. The inquiry into the soundness of the substantive decision is outside the courts review because it falls within the BJR. (Where demand was excused, as in Zapata Corp. v.
Maldonado, the court will apply its own independent business judgment in determining whether the motion for dismissal should be dismissed.)
Shareholder can press on if he can demonstrate with particularity that majority of the Board was not disinterested or the decision was not made in good faith after reasonable inquiry ( 7.44(d)).
iii. Class Action A direct suit brought by a shareholder on behalf of similarly

situated shareholders b. Director Fiduciary Duty managements job is to create value for shareholders (can lead to a lot of pressure) Director can be sued for breach of this duty i. Duty of Care Addresses the attentiveness and prudence of fiduciaries in performing decision-making supervisory functions ( must show breach of duty and that the breach was the cause of loss to the corporation) 1. MBCA 8.30(a) Each member of the Board, when discharging the duties of a director, shall act in good faith and in a manner the director reasonably believes to be in the best interests of the corporation. o MBCA 8.30(b) The directors shall discharge their duties with the care that a person in a like position would reasonably believe appropriate under similar circumstances. o MBCA 8.30(c) The Board may rely on persons to whom they may have delegated, formally or informally by course of conduct, the authority or duty to perform one or more board functions delegable under applicable law. o MBCA 8.30(d)-(e) The Board may rely on the opinions of officers or employees of the corporation, legal counsel and accountants or other professional (as long as the matter is within his profession/expert competence), or a committee of the Board as long as the director reasonably believes such confidence is warranted. o Duty of Care Facets Good Faith Honesty, no conflict of interest Reasonable Belief Involves the substance of decision-making Reasonable Care Involves the process of decision-making (looks at the time and effort involved in the decision to an extent reasonable under the circumstances) 2. MBCA 8.31 Standards of Liability for Directors o MBCA 8.31(a) Director liable for actions not in good faith or reasonably believed to be in the best interest of the corporation or where director was not informed to the extent he believed reasonably
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appropriate under the circumstances or because of directors lack of independence or a sustained failure of director to devote attention to ongoing oversight of the business of the corporation or where the director receives a financial benefit to which he is not entitled o MBCA 8.31(b) has the burden of establishing that harm to corporation or its shareholders has been suffered and the harm suffered was proximately caused by the directors challenged conduct 3. Business Judgment Rule (Common Law Version) Presumption by courts that officers and directors actions in performing their functions are honest and well-meaning and that their decisions are informed and rationally undertaken. o Unless this presumption is overcome, courts abstain from secondguessing the business decisions of the Board, even if they are bad ones, unless there is a showing of fraud, illegality, or conflict of interest o Whether a Board decision was informed turns on whether the directors have used all material reasonably available to them to reach a decision. Directors duty to inform himself is a fiduciary one Director must execute his duty with the recognition that he acts on behalf of others Obligation to do so does not tolerate faithlessness or selfdealing Fulfillment of the duty requires more than the mere absence of bad faith or fraud Directors have an affirmative duty to protect the interests of the shareholder Directors duty of care is predicated upon concepts of gross negligence o Reasons for the BJR Encourages risk-taking, avoids judicial meddling, and encourages directors to serve o Liability is rarely imposed upon corporate directors or officers simply for bad judgment. Shareholders voluntarily undertake the risk of bad judgment After-the-fact litigation is not an effective device in evaluating corporate business decisions Overzealous judicial review would cause boards to avoid actions which might actually benefit shareholders o BJR does not apply when: Decision lacks a business purpose Decision is tainted with a conflict of interest Decision is so egregious as to amount to a no-win situation Decision results from an obvious and prolonged failure to exercise oversight or supervision Duty of care involves duty of oversight A director must give reasonable attention to the corporations business Directors are not expected to interfere individually in the corporations business this would disturb the authority of the officers Directors have an individual duty to keep themselves informed in some detail (level of detail depends on the size of the corporation)
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Duty to Monitor Liability to the corporation for a loss may arise from an unconsidered failure of the Board to act in circumstances in which due attention would have prevented the loss Where a director exercises a good faith effort to be informed, and to exercise appropriate judgment, he is deemed to satisfy fully the duty of attention. A directors obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system, which the Board concludes is adequate, exists, and a failure to do so under some circumstances may render a director liable for loss caused by non-compliance with applicable legal standards. Where a claim of director liability for a corporate loss is predicated upon ignorance of liability-creating activities within the corporation, only a sustained/systematic failure of the Board to exercise oversight will establish the lack of good faith that is a necessary condition to liability. Unconsidered inaction can be the basis for director liability because ordinary business decisions of officers and employees deeper in the corporation can significantly injure the corporation and make it subject to criminal sanctions. 4. Proximate Cause Aspect (Common law version) Directors are the general advisers of the corporation, and if they faithfully give such ability as they have to the charge, they cannot be liable ( must show that if the director had performed his duties, the corporation would not have suffered loss).
ii. Duty of Loyalty Addresses the fiduciaries conflict of interest and requires
them to put the interests of the corporation ahead of their own 1. Self-dealing Director and the corporation enter into a transaction with terms that are unfavorable to the corporation not prohibited if the transaction is at arms-length o No presumption that the BJR applies in the realm of self-dealing director must prove to the court that the transaction was fair. o MBCA 8.60 - .63 Relevant sections for self-dealing 8.60 Defines Conflicted Interest transactions 8.61 Defines when a conflicted interest transaction may be enjoined 8.62 Deals with required to disclosure to Board that will prevent a transaction from being enjoined 8.63 Specifies what type of shareholders action with regard to a transaction may prevent it from being enjoined. o Common Law Rule Where directors stand on both sides of a transaction, they have the burden of establishing its entire fairness, sufficient to pass the test of careful scrutiny by the courts. They will be found to have acted with entire fairness where they demonstrate their utmost good faith and the most scrupulous inherent fairness of the bargain. Entire fairness has two components: Fair Dealing embraces questions of when the transaction was time, how it was initiated, negotiated, structured, disclosed to directors, and how the approval of directors and shareholders was obtained
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The Court can make a fairness assessment even though the director disclosed the transaction, terms, and conflict to the Board no equivalent requirement under the MBCA if full disclosure has been made Fair Price Relates to economic and financial considerations of the transaction, including all relevant factors: assets, market value, earnings, future prospects, and any other elements that affect the intrinsic/inherent value of the companys stock 2. Usurpation of Corporate Opportunity Director seizes an opportunity that the corporation likely would have taken o Line of Business Test An officer or director breaches his duty of loyalty by seizing for himself a business opportunity which: The corporation is financially able to undertake Is in the corporations line of business (must be so closely associated with existing business opportunities of the corporation that taking advantage of the opportunity puts the officer/director in competition with the corporation) Is of practical advantage to the corporation Is one in which the corporation has an interest or reasonable expectancy Puts the officer/director in conflict with the corporation o Corollary to Line of Business Test An officer or director may take a corporate opportunity if: The opportunity is presented to the director in his individual and not his corporate capacity The opportunity is not essential to the corporation The corporation holds no interest or expectancy in the opportunity The director has not wrongfully employed the resources of the corporation in pursuing or exploiting the opportunity. o ALI Test An officer or director may not take advantage of a corporate opportunity unless: He first offers the opportunity to the corporation and makes disclosure concerning the conflict of interest The corporate opportunity is rejected by the corporation, and either Rejection of the opportunity is fair to the corporation; or The opportunity is rejected in advance, following such disclosure, by disinterested directors in a manner that satisfies the BJR; or Rejection is authorized in advance or ratified following such disclosure by disinterested shareholders and the rejection is not equivalent to a waste of corporate assets. 3. Failed Disclosure to Shareholder Merger disclosure, significant company event, etc. c. MBCA 7.45 Court Approval of Settlement or Dismissal Because derivative and class action suits affect a number of parties, procedural rules put the judge in the position of having to police the terms of the settlement or dismissal to ensure fairness to everyone before the court as well as anyone else who may be affected.
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d. MBCA 7.46 Recovery in Derivative Suits Corporation gets the recovery in a successful derivative suit. s attorney gets fees. Some statutes allow to recover its attorney fees from the shareholder if the court finds that the shareholders sued without reasonable cause. e. Securities Law Violations Rule 10b-5 i. Rule 10b-5 It shall be unlawful for any person, directly or indirectly, by the use of any means or
instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.
ii. Purpose is to make sure that there is no purposeful, fraudulent statement made
in the sale of securities
iii. Basically a gap-filler provision in the event that other rules do not apply to hold
purchasers or sellers liable for fraud in the purchase or sale of a security.
iv. Elements:
1. Material misstatement o General Rule Must be a substantial likelihood that a reasonable investor would consider the statement important in making the decision to invest. o A true but incomplete statement could be a basis for liability o Silence can be actionable when there is an affirmative duty to speak o Materiality depends on the probability that the transaction will consummated and its
significance (magnitude) to the issuer of securities. In determining the probability, the court should look at the indicia of interest in the transaction at the highest corporate levels (Board resolutions, instructions to investment bankers, actual negotiations between the principals) and should assess the magnitude of the transaction to the issuer of the securities (consider the size of the entities involved, consider potential premiums over FMV). Statutory Safe Harbor Issuer is not liable for forward-looking financial statements if they are identified as such and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the statements. Bespeaks Caution Doctrine Cautionary language in forward-looking financial statements, if sufficient, renders alleged omissions/misrepresentations immaterial as a matter of law. Cautionary language must be directly related to the alleged omissions/misrepresentations.
2. With Scienter (Knowledge on the part of the person making the representation at the time it was
made, that the representation was false) o
knew or was reckless in not knowing of the misrepresentation and intended that rely on the information (Mental state embracing intent to deceive,
manipulate or defraud)
Heightened Pleading Requirement must state with particularity facts giving a strong inference that acted with the requisite state of mind
3. Reliance o must show reliance on s misstatement o Tests the link between the information and s buy-sell decision o Reliance element not met where false information had little to do with the buy-sell decision o Context-driven element: Face-to-face showing of actual reliance is required
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Market Transaction Use Fraud-on-the-Market theory theory of liability in

securities fraud cases in which s material misrepresentation regarding a public security affects the price of the security so that a who suffers a loss after purchasing the security is presumed to have relied on the misrepresentation Rebuttable presumption if can show anything that severs the link between the alleged misrepresentation.
4. Causation must establish but for and loss causation o Transaction Causation But for s statement, would not have bought or sold the security o Loss Causation must show that s conduct was the direct cause of s loss with no other intervening factor 5. Damages s recovery cannot exceed actual damages generally no punitive damages
SHAREHOLDER RISK IS LIMITED TO THE CAPITAL CONTRIBUTED
a. Pre-incorporation Contract Liability i. MBCA 2.04 All person purporting to act as or on behalf of a corporation, knowing there was no incorporation under this Act, are jointly and severally liable for all liabilities created while so acting. 1. Statute makes no allowance for disclosing to creditor that the corporation has not been formed b. Piercing the Corporate Veil i. General Rule - Shareholders are not generally personally liable for the debts of the corporation.
ii. Exception When appropriate and in furtherance of justice, the corporate veil
will be pierced and the corporation and its shareholders will be treated as identical.
iii. The burden for establishing a basis for doing so rests on the party asserting
such a claim.
iv. Every case is to be decided in accordance with its own facts. Under the
Inactivity Test, only the shareholder primarily responsible for the challenged conduct will be liable other shareholders are not. Factors considered include: 1. Fraud (Key Factor) not a necessary element on its own but is one of many factors 2. Substantial stock ownership by one person (Instrumentality Theory) Court will look at the 3.
corporations operation and the individual s relationship to that operation Gross undercapitalization of the corporation funds should be sufficient to meet the obligations of the corporation Failure to observe corporate formalities Non-payment of dividends Purposeful insolvency of the debtor corporation Purposeful siphoning of corporate funds by the dominant shareholder
4. 5. 6. 7. 8. Non-functioning of other officers and directors 9. Absence of corporate records 10. Corporation is a faade for the operations of the dominant shareholder (Alter ego Key factor) 11. Inducement to extend credit to the corporation by the dominant shareholders personal
guarantee
12. Presence of injustice or fundamental unfairness 13. Co-mingling personal and corporate assets and affairs
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o o o o o
Typical scenario where corporate veil is pierced occurs when the corporation fails to honor contractual obligations with a 3rd party creditor or when a 3rd party tort victim is injured as a result of corporate action If the corporation lacks sufficient assets, the victim will probably try to go after the personal assets of the shareholder Almost always occurs in the context of a closely-held corporation Courts are generally hesitant to pierce the corporate veil Veil piercing is done on a case-by-case basis the veil is not pierced for all time once it is pierced in a particular case.
v. Veil piercing in the Parent-Subsidiary Context A parent is expected to

exercise some control over its subsidiary. When a subsidiary is controlled so as to be the alter ego of the parent, the corporate form may be disregarded in the interest of justice. The Totality of Circumstances must be evaluated and a showing of Substantial Domination (Party seeking to pierce corporate veil must show that Parent & Subsidiary acted as a single economic entity) is required. Factors considered include: 1. Parent & Sub. have common officers/directors 2. Parent & Sub. share common business departments 3. Parent & Sub. file a consolidated tax return 4. Parent finances the sub. 5. Parent caused the incorporation of the sub. 6. Parent pays the salaries and expenses of the sub. 7. Sub. is grossly undercapitalized 8. Sub. receives no business except what the Parent gives it. 9. Daily operations of the two corporations are kept separate. 10. Parent uses the Sub.s property as its own 11. Sub. does not observe corporate formalities.
EARNINGS SUBJECT TO DOUBLE TAXATION TAXED AT ENTITY LEVEL WHEN EARNED;
TAXED AGAIN WHEN DIVIDENDS ARE DISTRIBUTED TO INDIVIDUAL SHAREHOLDERS
a. Dividends
i. Distribution to shareholders out of the current or retained earnings of the

corporation in proportion to the shares owned. 1. Represent a return for the investor 2. Encourage potential investors to buy new issues of common shares at high prices.
ii. MBCA 6.40(c) No dividend if the corporation would not be able to pay
debts as they come due in the usual course of business or if the corporations total assets would be less than its liabilities. [Modern Approach]
iii. MBCA 6.23 Allows shares to be issued as a dividend as long as the

Articles do not prohibit it
iv. Traditional Approach Dividends can be paid out of capital surplus or

retained earnings.
v. MBCA 8.33 Imposes liability on directors for unlawful distributions.

b. Salary
i. Tax-deductible business expense for the corporation
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ii. Problematic for the corporation only when the corporation tries to characterize
distributions to a shareholder as compensation when it should be a dividend.
iii. Corporation can deduct salary if it is ordinary and necessary.

TWO TYPES (MAINLY BASED ON SIZE):
1. Closely-Held: Few shareholders Shareholders in a closely-held corporation owe each other essentially the same fiduciary duty in the enterprises operation that partners owe to one another. Shares are not publicly-traded Officers, directors, and shareholders are usually the same people Can be a C Corp. or S Corp. a. Disputes in a Closely-held Corporation i. Close corporation typified by a small number of shareholders and an absence of a market for the corporations stock, and substantial shareholder participation in the corporations management
ii.
Shareholders usually expect employment and a meaningful role in management, along with a return on the money they paid for their shares. Shareholders typically look to salary rather than dividends for ROI earnings of close corporations are usually distributed in the form of compensation Minority shareholders can be freezed-out by the majority with no way to dispose of shares on an open market Squeeze-out/Freeze-out techniques Terminate minoritys employment; Withhold dividends; Remove minority from management; Siphon corporate funds through high majority compensation; Exclude minority shareholders from new share issues and redemptions Two avenues of relief 1. MBCA 14.30 Allows for involuntary dissolution as a possible remedy for oppression by the controlling shareholder forces the majority shareholder to buy-out the minority shareholder. Shareholder must show Board deadlock ( 14.30(2)(i)), Shareholder deadlock ( 14.30(2)(iii)), or Misconduct ( 14.30(2)(ii), (iv)). 2. Common law route Enhanced fiduciary duty between close corporation shareholders allows oppressed shareholder to bring a direct cause of action for breach of this duty (Fiduciary Review). Duty Between Shareholders (Common Law Route) 1. The duty existing between the controlling shareholder and the minority shareholder in a close corporation is same as the duty existing between partners. In determining whether this type of duty exists, the court should consider:
o o o Whether the shareholders treated each other as partners Whether actual stock was issued Whether annual shareholder meetings were held
iii.
iv.
v.
vi.
vii.
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o o
Whether officers and directors were actually elected Whether the bylaws were followed in operating the corporation
2. The fiduciary duty between shareholders in a close corporation is not breached if the majority acted pursuant to a legitimate business purpose (BJR applies). When a legitimate purpose exists, the minority shareholder must be given an opportunity to demonstrate that the purpose could have been achieved through means less disruptive to its shareholders interests. 3. Shareholders do not enjoy fiduciary-rooted entitlements to their jobs. Fiduciary duty in a close corporation is viewed as a protection of shareholder investment. The Court must distinguish investors who obtain their ROI through benefits provided to them as employees who happen also to be investors. Courts may consider the following in doing so:
o o o o o o o o Whether the corporation typically distributes profits in the form of salaries Whether the shareholder/employee owns a significant percentage of the firms shares Whether the shareholder/employee is a founder of the business Whether the shares were received as compensation for services Whether the shareholder/employee expects the value of the shares to increase Whether the shareholder/employee has made a significant capital contribution Whether the shareholder/employee has otherwise demonstrated a reasonable expectation that the returns from the investment will be obtained through continued employment Whether stock ownership is a requirement of employment
4. The minority shareholders interest is not injured if the corporation redeems shares at a fair price or a price determined by prior contract, or the shareholder is otherwise able to obtain a fair price. 5. Minority shareholder must demonstrate oppressive conduct on the part of the majority. Oppressive refers to conduct which departs from standards of fair dealing and violates the principles of fair play on which persons who entrust their funds to a corporation rely. o The term contemplates a continuous course of conduct and includes a lack of virtue in corporate affairs to the prejudice of some of its shareholders. 6. When the minority shareholder demonstrates that a director had an interest in the transaction at issue, the burden shifts to the director to prove that the transaction was fair and reasonable to the corporation. o A director of a private corporation cannot directly or indirectly, in any transaction in which he is under a duty to guard the interests of the corporation, acquire any personal advantage, or make any profit for himself, and if he does so, he may be required to account for it to the corporation. 7. Close Corporation Fiduciary Duty of Majority to Minority with Regard to Dividend Payments
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Majoritys duty is discharged with regard to dividend payments if the decision regarding dividends is made in good faith and reflects legitimate business purposes rather than the private interests of those in control. The burden of demonstrating bad faith, fraud, breach of fiduciary duty or abuse of discretion on the part of the directors of a corporation rests on the party seeking judicial mandatory relief respecting the declaration of dividends. Absent any bad faith, fraud, breach of fiduciary duty or abuse of discretion, no wrong cognizable by or correctable in the courts has occurred. has the burden to prove bad faith when the Boards actions apply to all shareholders in proportion to their shares (i.e. payment of a dividend) as opposed to situations where the majority owner takes action to benefit himself or burden /penalize the majority Factors relevant to the issue of bad faith: Intense hostility by the majority to the minority Exclusion of the minority from employment by the corporation High salaries, or bonuses, or corporate loans made to the officers in control majority may be subject to high FIT if substantial dividends are paid Existence of desire by controlling directors to acquire the minority stock interests as cheaply as possible If the above are not motivating causes, they do not constitute bad faith as a matter of law.
b. Fiduciary Duty Toward Minority Shareholders in Parent-Subsidiary Context Threshold Issue is Who has the burden of proof? i. Where there is a parent-subsidiary relationship along with self-dealing on the part of the parent, apply the Intrinsic Fairness Test Parent will have the burden of proving that its transactions were objectively fair (Once shows that Parent controlled the Subsidiary in a way that benefited the Parent to the exclusion of the minority shareholder, the burden shifts to the Parent)
ii. If there was no self-dealing because the transaction applied to all

shareholders, BJR applies, and bears the burden of showing that the Parent breached its fiduciary duty. 2. Publicly-Held: Many shareholders Shares are publicly-traded & freely transferable Officers, directors, and shareholders are usually different people Offers the advantage of pooling of resources Centralized management and expertise Clearly-defined roles and relationships within the corporation Only choice is C Corp. form
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Characteristics Common to all Corporations: Allows investors to pool resources Allows for centralized management & expertise Roles & relationships within the corporation are usually clearly defined Free transferability of ownership Limited liability for shareholders
4. LIMITED PARTNERSHIP
SIMILAR TO PARTNERSHIP FOR TAX PURPOSES SIMILAR TO CORPORATION FOR TREATMENT OF LIABILITIES HAS BOTH GENERAL PARTNERS AND LIMITED PARTNERS
o o
GP assumes management responsibility and unlimited liability for the business LP has no voice in management and is legally liable only for the amount of his capital contribution plus any other debt specifically accepted
5. S CORPORATION
OFFERS TAX STATUS OF A PARTNERSHIP (PASS-THROUGH ENTITY) LIABILITY PROTECTION OF A CORPORATION ONLY ONE CLASS OF STOCK ALLOWED, BUT VOTING RIGHTS MAY BE VARIED MUST BE A DOMESTIC CORPORATION, WHOLLY-OWNED BY U.S. CITIZENS ONLY INDIVIDUALS, ESTATES, AND CERTAIN TRUSTS MAY BE SHAREHOLDERS NO MORE THAN 25% OF REVENUES CAN COME FROM PASSIVE SOURCES MUST HAVE NO MORE THAN 75 (ACTUALLY THE NUMBER IS 100) SHAREHOLDERS
6. LIMITED LIABILITY COMPANY (LLC)

EXISTENCE DEPENDS ON COMPLIANCE WITH STATE LLC LAW ENTITY CHOICE FOR MANY SMALL BUSINESSES NO LIMIT ON THE NUMBER OF MEMBERS NO LIMIT ON HOW REVENUES ARE DERIVED NO DOUBLE TAXATION OF EARNINGS NO LIMIT ON THE TYPES OF ENTITIES THAT CAN OWN SHARES
7. LIMITED LIABILITY PARTNERSHIP (LLP)

PARTNERS HAVE NO PERSONAL LIABILITY BEYOND THE PARTNERSHIP PARTNERS CAN INCUR LIABILITY FOR PERSONAL MISCONDUCT MUST FILE A STATEMENT OF QUALIFICATION WITH THE SECRETARY OF STATE
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Business Associations Outline I. Entity Forms 1. S P O O

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Business Associations Outline I. Entity Forms 1. S P O O

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Business Associations Outline I. Entity Forms 1.

SOLE PROPRIETORSHIPS OLDEST AND SIMPLEST BUSINESS FORM

ONLY ONE OWNER BUSINESS MAY HAVE UNLIMITED NUMBER OF EMPLOYEES,

3. Loan covenants can control how the business operates Can be a

v. Caselaw 1. Bohatch v. Butler & Binion

NO WRITTEN PARTNERSHIP AGREEMENT REQUIRED

2. RUPA 401(j) A difference arising as to a matter in the ordinary course of business of a

iii. Officers 1. Duties set forth in MBCA 8.40 - .41.

5. MBCA 7.32(b) An agreement authorized by this section shall be:

Rule 14a-4 governs the layout of the proxy card

Rule 14a-9 Proxy Fraud

Governed by SEC Rule 14a-8

i. Borrowing Money Underlying principle of leverage is that the corporation

ii. Issuing More Stock

a. Corporate Stock i. Represents owners pro-rata share of ownership in the corporation

ii. Articles of Incorporation

iii. Corporate Bylaws

iv. Case Law v. Federal Statutes securities regulation applying to publicly-traded

iii. Corporations that will do interstate business generally incorporate in Delaware

ii. MBCA 2.02(a) Mandatory Provisions within the Articles

iii. MBCA 2.02(b) Optional provisions within the Articles

MBCA 7.42 (Universal Approach) Shareholder must make written demand on

iii. Class Action A direct suit brought by a shareholder on behalf of similarly

Market Transaction Use Fraud-on-the-Market theory theory of liability in

v. Veil piercing in the Parent-Subsidiary Context A parent is expected to

i. Distribution to shareholders out of the current or retained earnings of the

iii. MBCA 6.23 Allows shares to be issued as a dividend as long as the

iv. Traditional Approach Dividends can be paid out of capital surplus or

v. MBCA 8.33 Imposes liability on directors for unlawful distributions.

i. Tax-deductible business expense for the corporation

iii. Corporation can deduct salary if it is ordinary and necessary.

ii. If there was no self-dealing because the transaction applied to all

6. LIMITED LIABILITY COMPANY (LLC)

7. LIMITED LIABILITY PARTNERSHIP (LLP)

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