Business Associations Fall 2010 Fendler Outline

JR C /Fall 2010/Fendler/B usiness A ssoc .
B USINESS A SSOCIATIONS
Fall 2010/Prof. Fendler/Joshua R. Collums
Business Associations (7th Ed.) by Klein, Ramseyer & Bainbridge
C H A PTER O N E : A G EN CY
I. W ho is an Agent?
A. Restatement (Third) of Agency § 1.01 Agency Defined
Agency is the fiduciary relationship that arises when one person (a “principal”) manifest’s assent to another
person (an “agent”) that the agent shall act on the principal’s behalf and subject to the principal’s control, and
the agent manifests assent or otherwise consents so to act.
B. Restatement (Third) of Agency § 1.02 Parties’ Labeling and Popular Usage Not
Controlling
An agency relationship arises only when the elements stated in § 1.01 are present. W hether a relationship is
characterized as agency in an agreement between parties or in the context or industry or popular usage is not
controlling.
C. Restatement (Third) of Agency § 1.03 Manifestation
A person manifests assent or intention through written or spoken words or other conduct.
D. Gorton v. Doty (Idaho 1937)
1. Issue. W as the coach, Garst, the agent of appellant while and in driving her car from Soda
Springs to Paris, and in returning to the point where the accident occurred?
2. Broadly speaking, “agency” indicates the relation which exists where one person acts for
another. It has these three principal forms:
a. The relation of the principal and agent.
b. The relation of master and servant; and
c. The relation of employer or proprietor and independent contract.
3. Agency. The relationship which results from the manifestation of consent by one person to
another that the other shall act on his behalf and subject to his control, and consent by the
other so to act.
a. Manifestation of consent by P that A will act:
(1) On P’s behalf
(2) Subject to P’s Control
b. A’s consent so to act.
4. This court has not held that the relationship of principal and agent must necessarily involve
some matter of business, but only that where one undertakes to transact some business or
manage some affair for another by authority and on account of the latter, the relationship
of principal and agent arises.
5. Appellant could have driven car herself. Instead, she designated the driver (Garst) and, in
doing so, made it a condition precedent that the person she designated should drive her
car.
a. Appellant consented that Garst should act for her and in her behalf, in driving her
car to and from the game from her act in volunteering the use of her car upon the
express condition that he should drive it.
b. Garst consented to so act for the appellant by driving the car.
6. It is not essential to the existence of authority that there be a contract between principal
and agent or that the agent promise to act as such, nor is it essential to the relationship or
principal and agent that they, or either, receive compensation.
a. There must be an agreement but it does not necessarily have to rise to the level of
a legal contract.
7. The fact of ownership alone, regardless of the presence or absence of the owner in the car
at the time of the accident, establishes a prima facie case against the owner for the reason
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that the presumption arises that the driver is the agent of the owner. 1
8. Dissenting Opinion.
a. An agent is one who acts for another by authority from him, one who undertakes
to transact business or manage some affair for another by authority and on
account of the latter. Agency means more than mere passive permission. It
involves a request, instruction or command.
E. A. Gay Jenson Farms Co. v. Cargill, Inc. (Minn. 1981) (Lender Liability)
1. Plaintiffs Argument. Plaintiffs alleged that Cargill was jointly liable for W arren’s indebtedness
as it had acted as principal for the grain elevator.
2. Issue. W hether Cargill, by its course of dealing with W arren, became liable as principal on
contracts made by W arren with plaintiffs.
3. Rule. Agency is the fiduciary relationship that results from the manifestation of consent by
one person to another that the other shall act on his behalf and subject to his control, and
consent by the other so to act.
a. In order to create an agency, there must be an agreement, but not necessarily a
contract between the parties.
(1) An agreement may result in the creation of an agency relationship
although the parties did not call it an agency and did not intend the legal
consequences of the relation to follow.
b. The existence of the agency may be proved by circumstantial evidence which
shows a course of dealing between the two parties.
(1) W hen an agency relationship is to be proven by circumstantial evidence,
the principal must be shown to have consented to the agency since one
cannot be the agent of another except by consent of the latter.
4. Creditor/Debtor. A creditor who assumes control of his debtor’s business may become
liable as principal for the acts of the debtor in connection with the business. 2
a. Security holder’s mere veto power v. Becoming a principal. 3
5. Buyer/Supplier v. Principal/Agent
a. 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.
(1) Factors indicating that one is a supplier, rather than an agent, are 4:
(a) That he is to receive a fixed price for the property irrespective
of price paid to him. This is the most important.
(b) That he acts in his own name and receives title to the property
which he thereafter is to transfer.
1
W illi v. Schaefer Hitchcock Co. (Idaho 1933).
2
A creditor who assumed control of his debtor’s business for the mutual benefit of himself and his debtor
may become a principal, with liability for the acts and transactions of the debtor in connection with the business.
Restatement (Second) of Agency § 14 O.
3
“A security holder who merely exercises a veto power over the business acts of his debtor by
preventing purchases or sales above specified amounts does not thereby become a principal. However, if he takes
over the management of the debtor’s business either in person or through an agent, and directs what contracts may or
may not be made, he becomes a principal, liable as a principal for 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 his debtor, whatever the terms of the formal
contract with his debtor may be. Id., cmt. a.
4
Id., § 14 K, cmt. a.
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(c) That he has an independent business in buying and selling

similar property.
II. Liability of Principal to Third Parties in Contracts
A. The Agent’s Authority
1. 2 Broad Classifications of Power 5
a. Actual (Real) – arises from the manifestation of consent from the principal to the
agent (not to a third person) that the agent should act for the principal.
(1) Express Authority – actual authority contained within the “four corners”
of the agency agreement between the principal and the agent, i.e.,
authority expressly granted by the principal to the agent.
(2) Implied Authority – An agent’s authority includes not only the authority
expressly granted by the principal to the agent, but also any authority
implied by the agent from the words or conduct between the principal
and the agent.
b. Apparent (Ostensible) – a principal will be bound by his agent’s unauthorized acts
if the principal has manifested to a third party, through words or conduct, that the
agent has authority, and the third party reasonably believes on this manifestation.
(1) An agent cannot create apparent authority by his own manifestations.
The manifestations must be from the principal to the third party.
(Conduct and silence can be a manifestation from the principal).
(a) Exception. If the principal gives the agent express authority to
tell third parties that he has authority.
2. Mill Street Church of Christ v. Hogan (Ky. 1990) (Implied Authority)
a. Implied v. Apparent Authority. Implied authority is actual authority circumstantially
proven which the principal actually intended the agent to possess and includes
such powers as are practically necessary to carry out the duties actually delegated.
Apparent authority on the other hand is not actual authority but is the authority
the agent is held out by the principal as possessing. It is a matter of appearance on
which third parties come to rely.
(1) Implied Authority Rule. In examining whether implied authority exists, it
is important to focus upon the agent’s understanding of his authority. It
must be determined whether the agent reasonably believes because of
present or past conduct of the principal that the principal wishes him to
act in a certain way or to have certain authority.
(a) Nature of task/job. The nature of the task or job may be
another factor to consider. Implied authority may be necessary
to implement the express authority.
(b) Prior similar practices. The existence of prior similar practices is
one of the most important factors. Specific conduct by the
principal in the past permitting the agent to exercise similar
powers is crucial.
b. Burden/Standard of Proof. The person alleging agency and resulting authority has
the burden of proving that it exists. Agency cannot be proven by a mere
statement, but it can be established by circumstantial evidence including the acts
and conduct of the parties such as the continuous course of conduct of the parties
covering a number of successive transactions.
c. Subagent. One agent appoints someone else who will also be an agent of the
principal.
(1) W hen a principal engages an agent to perform a task, the principal has in
effect delegated the task to the agent. If the agent, acting with authority,
in turn delegates part of all of that task to an agent of its own, then the
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The power to bind is equal. The principal is equally bound whether based on actual or apparent authority.
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second agent becomes a subagent of the original principal.

3. Power of Position. Sometimes the principal’s sole manifestation to the third party may be to
put an agent in a particular role. In light of local custom and standard business practices,
that role may by itself cause a third party to believe reasonably that the agent has certain
authority.
4. Highland Capital Management, LP v. Schneider (2d Cir. 2010).
a. An agent must have authority, whether apparent, actual or implied, to bind his
principal.
b. Actual Authority
(1) Under New York law, an agent has actual authority if the principal has
granted the agent the power to enter into contracts on the principal’s
behalf, subject to whatever limitations the principal places on this power,
either explicitly or implicitly. 6
c. Apparent Authority
(1) W here an agent lacks actual authority, he may nonetheless bind his
principal to a contract if the principal has created the appearance of
authority, leading the other contracting party to reasonably believe that
actual authority exists.
(2) Apparent authority exists when a principal, either intentionally or by
lack of ordinary care, induces a third party to believe that an individual
has been authorized to act on its behalf.
(3) Essential to the creation of apparent authority are words or conduct of
the principal, communicated to a third party, that give rise to the
appearance and belief that the agent possesses authority to enter into a
transaction.
(4) However, the mere creation of an agency does not automatically invest
the agent with ‘apparent authority’ to bind the principal without
limitation. A party cannot claim that an agent acted with apparent
authority when it knew, or should have known that the agent was
exceeding the scope of its authority.
5. W atteau v. Fenwick (Q.B. 1892) (Inherent Agency Power).
a. Once it is established that the defendant was the real principal, the ordinary
doctrine as to principal and agent applies that the principle is liable for all the acts
of the agent which are within the authority usually confided to an agent of that
character, notwithstanding limitation.
(1) It is said that it is only so where there has been a holding out of
authority–which cannot be said of a case where the person supplying the
goods knew nothing of the existence of a principal. But I do not think
so. Otherwise, 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 defeat the action of the person
dealing with the agent and then discovering that he was an agent and
had a principal.
6. Inherent Agency Power. In some situations, an agent has neither actual nor apparent
authority, and estoppel does not apply. Yet the agent’s position creates the potential for
mischief with third parties. To deal with such situations (and others as well), the R.2d and
some courts use the doctrine of inherent agency power. The doctrine imposes enterprise
liability; that is, it places the loss on the enterprise that stands to benefit from the agency
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Actual authority is created by direct manifestations from the principal to the agent, and the extent of
the agent’s actual authority is interpreted in light of all circumstances attending those manifestations, including the
customs of business, the subject matter, any formal agreement between the parties, and the facts of which both parties
are aware.
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relationship.
7. Restatement (Second) of Agency § 8A. Inherent Agency Power.
Inherent agency power is a term used in the restatement of this subject to indicate the power of an
agent which is not derived from authority, apparent authority or estoppel, but solely from the agency
relation and exists for the protection of persons harmed by or dealing with a servant or other agent.
8. Restatement (Second) of Agency § 194 states that an undisclosed principal is liable for acts
of an agent “done on his account, if usual or necessary in such transactions, although
forbidden by the principal.”
9. Under the Restatement (Second) of Agency § 195, “An undisclosed principal who entrusts
an agent with the management of his business is subject to liability to third persons with
whom the agent enters into transactions usual in such business and on the principal’s
account, although contrary to the directions of the principal.”
10. The Restatement (Third) of Agency rejected the concept of inherent agency power in
favor of a rule directly targeted at cases like W atteau:
a. Restatement (Third) of Agency § 2.06. Liability of Undisclosed
Principal.
(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 agent’s conduct and that it
might induce others to change their positions, did not take reasonable steps to notify them of
the facts.
(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.
B. Ratification
1. Ratification. Occurs when a principal affirms a previously unauthorized act. Ratification
validates the original unauthorized act and produces the same legal consequences as if the
original act had been authorized.
a. Ratification can take place in the following ways:
(1) Expressly
(2) Implied > Accept benefits
(3) Implied > Silence/Inaction
(4) Lawsuit to enforce the contract
b. Ratification is an “all or nothing” principle.
2. Restatement (Third) of Agency § 4.01. Ratification Defined.
(1) 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.
(2) A person ratifies an act by
(a) manifesting assent that the act shall affect the person's legal relations, or
(b) conduct that justifies a reasonable assumption that the person so consents.
(3) Ratification does not occur unless
(a) the act is ratifiable as stated in § 4.03,
(b) the person ratifying has capacity as stated in § 4.04,
(c) the ratification is timely as stated in § 4.05, and
(d) the ratification encompasses the act in its entirety as stated in § 4.07.
3. Botticello v. Stefanovicz (Conn. 1979).
a. Agency is defined as “the fiduciary relationship which results from manifestation
of consent by one person to another that the other shall act on his behalf and
subject to his control, and consent by the other so to act....” Restatement
(Second) of Agency § 1.
(1) Three elements required to show the existence of an agency
relationship:
(a) a manifestation by the principal that the agent will act for him;
(b) acceptance by the agent of the undertaking; and
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(c) an understanding between the parties that the principal will be

in control of the undertaking.
b. The existence of an agency relationship is a question of fact.
(1) Marriage =/= Agency. Marital status cannot in and of itself prove the
agency relationship. The fact that one spouse tends more to business
matters than the other does not, absent other evidence of agreement or
authorization, constitute delegation of power as to an agent.
c. Ratification is defined as “the affirmance by a person of a prior act which did not
bind him but which was done or professedly done on his account. Restatement
(Second) § 82.
(1) Ratification requires “acceptance of the results of the act with an intent
to ratify, and with full knowledge of all the material circumstances.”
(2) Before the receipt of benefits may constitute ratification, the other
requisites for ratification must first be present. Thus, if the original
transaction was not purported to be done on account of the principal,
the fact that the principal receives its proceeds does not make him a
party to it. Restatement (Second) of Agency § 98, comment f.
(a) W alter at no time purported to be acting on his wife’s behalf, as
is essential to effective subsequent ratification, and Mary is not
bound by the terms of the agreement, and specific performance
cannot be ordered as to her.
4. Ratification is a means by which the principal can say, “my agent didn’t have the right to
enter into this contract, but I’m glad she did so. Accordingly, I’ll affirm the transaction
and agree to be bound by the contract.”
C. Estoppel
1. Hoddeson v. Koos Bros. (N.J. 1957).
a. The liability of a principal to third parties for the acts of an agent may be shown
by proof disclosing:
(1) express or real authority which been definitely granted.
(2) implied authority, that is, to do all that is proper, customarily incidental
and reasonably appropriate to the exercise of the authority granted; and
(3) apparent authority, such as where the principal by words, conduct, or
other indicative manifestations has “held out” the person to be his agent.
(a) General rule that the apparency and appearance of authority
must be shown to have been created by the manifestations of
the alleged principal, and not alone and solely by proof of those
of the supposed agent.
(b) Assuredly the law cannot permit apparent authority to be
established by the mere proof that a mountebank in fact
exercised it.
b. Broadly stated, the duty of the proprietor also encircles the exercise of reasonable
care and vigilance to protect the customer from loss occasioned by the deceptions
of an apparent salesman.
(1) The rule that those who bargain without inquiry with an apparent agent
do so at the risk and peril of an absence of the agent’s authority has a
patently impracticable application to the customers who patronize our
modern department stores.
(2) Our concept of modern law is that where a proprietor of a place of
business by his dereliction of duty enables one who is not his agent
conspicuously to act as such and ostensibly to transact the proprietor’s
business with a patron in the establishment, the appearances being of
such a character as to lead a person of ordinary prudence and circumspection to
believe that the impostor was in truth the proprietor’s agent, in such
circumstances the law will not permit the proprietor defensively to avail
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himself of the impostor’s lack of authority and thus escape liability for
the consequential loss thereby sustained by the customer.
2. Restatement (Third) of Agency § 2.05. Estoppel to Deny Existence of Agency
Relationship.
A person who has not made a manifestation that an actor has authority as an agent and who is not
otherwise liable as a party to a transaction purportedly done by the actor on that person's account is
subject to liability to a third party who justifiably is induced to make a detrimental change in position
because the transaction is believed to be on the person's account, if
(1) the person intentionally or carelessly caused such belief, or
(2) having notice of such belief and that it might induce others to change their positions, the
person did not take reasonable steps to notify them of the facts.
D. Agent’s Liability on the Contract
1. Restatement (Third) of Agency § 6.01. Agent for Disclosed Principal.
W hen an agent acting with actual or apparent authority makes a contract on behalf of a disclosed
principal,
(1) the principal and the third party are parties to the contract; and
(2) the agent is not a party to the contract unless the agent and third party agree otherwise.
2. Restatement (Third) of Agency § 6.02. Agent for Unidentified Principal.
W hen an agent acting with actual or apparent authority makes a contract on behalf of an unidentified
principal,
(1) the principal and the third party are parties to the contract; and
(2) the agent is a party to the contract unless the agent and the third party agree otherwise.
3. Restatement (Third) of Agency § 6.03. Agent for Undisclosed Principal.
W hen an agent acting with actual authority makes a contract on behalf of an undisclosed principal,
(1) unless excluded by the contract, the principal is a party to the contract;
(2) the agent and the third party are parties to the contract; and
(3) the principal, if a party to the contract, and the third party have the same rights,
liabilities, and defenses against each other as if the principal made the contract personally,
subject to §§ 6.05–6.09.
4. Restatement (Third) of Agency § 6.10. Agent’s Implied W arranty of Authority.
A person who purports to make a contract, representation, or conveyance to or with a third party on
behalf of another person, lacking power to bind that person, gives an implied warranty of authority to
the third party and is subject to liability to the third party for damages for loss caused by breach of that
warranty, including loss of the benefit expected from performance by the principal, unless
(1) the principal or purported principal ratifies the act as stated in § 4.01; or
(2) the person who purports to make the contract, representation, or conveyance gives notice
to the third party that no warranty of authority is given; or
(3) the third party knows that the person who purports to make the contract, representation,
or conveyance acts without actual authority.
5. W hen is an agent liable on a contract?7 It depends on the type of principal.
a. Disclosed – Agent is not personally liable.
(1) Exceptions. (1) If the parties intend the agent to be personally liable on
the contract he will be personally liable. However, a parole evidence
rule issue may arise, therefore, it is best to expressly set out in the
contract the agent’s liability. (2) The agent had no authority to enter
into the contract and the principal did not ratify. This would be a
breach of the agent’s implied warranty of authority.
7
The rules on contract liability are default rules. They can be overridden by express or implied agreement
between the agent and third party.
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b. Partially Disclosed (Unidentified) – Agent is personally liable 8

c. Undisclosed – Agent is personally liable.
6. Atlantic
Salmon A.S. v. Curran (Mass. App. 1992)
a. If the other party [to a transaction] has notice that the agent is or may be acting
for a principal but has no notice of the principal’s identity, the principal for
whom the agent is acting is a partially disclosed principal. Restatement (Second)
of Agency § 4(2).
b. Unless otherwise agreed, a person purporting to make a contract with another for
a partially disclosed principal is a party to the contract.
c. It is the duty of the agent, if he would avoid personal liability on a contract
entered into by him on behalf of his principal, to disclose not only that he is
acting in a representative capacity, but also the identity of his principal.
(1) It was not the plaintiffs’ duty to seek out the identity of the defendant’s
principal; it was the defendant’s obligation fully to reveal it.
(a) “The duty rests upon the agent, if he would avoid personal
liability, to disclose his agency, and not upon others to discover
it. It is not, therefore, enough that the other party has the
means of ascertaining the name of the principal; the agent must
either bring to him actual knowledge or, what is the same
thing, that which to a reasonable man is equivalent to
knowledge or the agent will be bound. There is no hardship to
the agent in this, as he always has it in his power to relieve
himself from personal liability by fully disclosing his principal
and contracting only in the latter’s name. If he does not do
this, it may well be presumed that he intended to make himself
personally responsible.
d. Administratively Dissolved. If the corporation has been administratively dissolved it
is because it has failed to pay its franchise taxes.
(1) Those who act on behalf of an administratively dissolved corporation are
personally liable.
(2) Paying fees to reinstate will not backdate any actions.
7. Arkansas. In Arkansas there is a great deal of emphasis on how the contract is signed, i.e.,
whether the contract is signed in a representative capacity or in a personal capacity.
a. Examples:
1. By: John Doe
Agent (or President, Manager, etc.)
2. By: John Doe

John Doe, Agent
3. By: John Doe
John Doe is personally liable under #39 but is not personally liable
under #1 & #2.
8. General Agent/Special Agent.
a. General Agent. If a principal authorizes an agent “to conduct a series of
transactions involving a continuity of service,” the law calls the agent a general
8
The rationale is one of expectations. W ithout knowing the identity of the principal, the third party is
presumably relying on the trustworthiness, creditworthiness, and bona fides of the agent.
9
Arkansas courts would invoke the parole evidence rule and exclude external testimony about the parties’
intent.
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agent.
b. Special Agent. If a principal authorizes the agent only to conduct a single
transaction, or to conduct a series of transactions that do not involve “continuity
of service,” then the law calls the agent a special agent.
III. Liability of Principal to Third Parties in Tort
A. Servant Versus Independent Contractor
1. Restatement (Second) of Agency § 1. Agency; Principal; Agent.
(1) Agency is the fiduciary relation which results from the manifestation of consent by one person to
another that the other shall act on his behalf and subject to his control, and consent by the other so to
act.
(2) The one for whom action is to be taken is the principal.
(3) The one who is to act is the agent.
2. Restatement (Second) of Agency § 2. Master; Servant; Independent
Contractor.
(1) A master is a principal who employs an agent to perform service in his affairs and who controls or
has the right to control the physical conduct of the other in the performance of the service.
(2) A servant is an agent employed by a master to perform service in his affairs whose physical conduct
in the performance of the service is controlled or is subject to the right to control by the master.
(3) An independent contractor is a person who contracts with another to do something for him but who
is not controlled by the other nor subject to the other’s right to control with respect to his physical
conduct in the performance of the undertaking. He may or may not be an agent.
3. Restatement (Second) of Agency § 219. W hen Master is Liable for Torts of His
Servants.
(1) A master is subject to liability for the torts of his servants
committed while acting in the scope of their employment.
(2) A master is not subject to liability for the torts of his servants acting outside the scope of their
employment, unless:
(a) The master intended the conduct or the consequences, or
(b) The master was negligent or reckless, or
(c) The conduct violated a non-delegable duty of the master, or
(d) The servant purported to act or to speak on behalf of the principal and there was reliance
upon apparent authority, or he was aided in accomplishing the tort by the existence of the
agency relation.
4. Restatement (Second) of Agency § 220. Definition of Servant.
(1) A servant is a person employed to perform services in the affairs of another and who with respect to
the physical conduct in the performance of the services is subject to the other’s control or right to
control.
(2) In determining whether one acting for another is a servant or an independent contractor, the
following matters of fact, among others, are considered:
(a) the extent of control which, by the agreement, the master may exercise over the details of
the work;
(b) whether or not the one employed is engaged in a distinct occupation or business;
(c) 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;
(d) the skill required in the particular occupation;
(e) whether the employer or the workman supplies the instrumentalities, tools, and the place
of work for the person doing the work;
(f) the length of time for which the person is employed;
(g) the method of payment, whether by the time or by the job;
(h) whether or not the work is part of the regular business of the employer;
(i) whether or not the parties believe they are creating the relation of master and servant;
and
(j) whether the principal is or is not in business.
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5. Restatement (Third) of Agency § 2.04. Respondeat Superior.

An employer is subject to liability for torts committed by employees while acting within the scope of
their employment.
Comment (a). Terminology and cross-references. This Restatement does not use the
terminology of “master” and “servant.” Section 7.07(3) defines “employee” for purposes
of this doctrine. Section 7.07(2) states the circumstances under which an employee has acted
within the scope of employment. Section 7.08 states the circumstances under which a
principal is subject to vicarious liability for a tort committed by an agent, whether or not an
employee, when actions taken with apparent authority constituted the tort or enabled the
agent to conceal its commission.
6. Restatement (Third) of Agency § 7.01. Agent’s Liability to Third Party.
An agent is subject to liability to a third party harmed by the agent's tortious conduct. Unless an
applicable statute provides otherwise, an actor remains subject to liability although the actor acts as an
agent or an employee, with actual or apparent authority, or within the scope of employment.
7. Respondeat Superior. A venerable doctrine which imposes strict, vicarious liability on a
principal when: 10
a. An agent’s tort has caused physical injury to a person or property
b. The tortfeasor agent meet the criteria to be considered a “servant” (or under the
R.3d, “employee”) of the principal, and
c. The tortious conduct occurred within the servant/employee’s “scope of
employment.”
8. Rationales. The doctrine of respondeat superior rests on three rationales: enterprise
liability, risk avoidance, and risk spreading.
a. Enterprise Liability. Links risk and benefits and hold accountable for risk-creating
activities the enterprise that stands to benefit from those activities.
b. Risk Spreading. The master can: (i) anticipate the risk inherent in its enterprise;
(ii) spread the risk through insurance; (iii) take into account the cost of insurance
in setting the price for its goods or services; and (iv) thereby spread the risk
among those who benefit from the goods or services.
c. Risk Avoidance. Creates a strong incentive for the employer/master to use its
position of control to achieve “risk avoidance.”
9. Under the doctrine of respondeat superior, “master” (employer) is liable for the torts of its
servants (employees).
a. A master-servant relationship exists where the servant has agreed:
(1) to work on behalf of the master and
(2) be subject to the master’s control or right to control the “physical
conduct” of the servant (that is, the manner in which the job is
performed, as opposed to the result alone).
10. Scope of Employment
a. Even if the tortfeasor is en employee, vicarious liability results only if the tort
occurred within the scope of employment.
11. Independent Contractors Are of Two Types: Agent and Non-Agent.
a. Agent-Type. One who has agreed to act on behalf on another, the principal, but
not subject to the principal’s control over how the result is accomplished (that is,
over the “physical conduct” of the task).
b. Non-Agent. One who operates independently and simply enters into arm’s length
transactions with others.
12. Humble Oil & Refining Co. v. Martin (Tex. 1949). (Master/Servant Relationship [Liable])
a. Even if the contract between Humble and Schneider were the only evidence on
10
The injured party may also assert claims of direct responsibility against the principal. In any event, the
tortfeasor agent will be directly liable. Being an agent does not immunize a person from tort liability. A tortfeasor is
personally liable, regardless of whether the tort was committed on the instruction from or to the benefit of a principal.
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the question, the instrument as a whole indicates a master-servant relationship

quite as much as, if not more than, it suggests an arrangement between
independent contractors.
(1) For example, paragraph 1 includes a provision requiring Schneider “to
make reports and perform other duties in connection with the operation of said
station that may be required of him from time to time by Company.
b. Obviously, the main object of the enterprise was the retail marketing of Humble’s
products with title remaining in Humble until delivery to the consumer. 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 of a more or less
laborer status.
c. This case differs from The Texas Company v. W heat. That case clearly showed a
“dealer” type of relationship in which the lessee in charge of the filling station
purchased from his landlord, The Texas Company, and sold as his own, and was
free to sell at his own price and on his own credit terms, the company products
purchased, as well as the products of other oil companies. The contracts contained
no provision requiring the lessee to perform any duty The Texas Company might
see fit to impose upon him, nor did the company pay any part of the lessee’s
operating expenses, nor control the working hours of the station.
13. Hoover v. Sun Oil Company (Del. 1965). (No Master/Servant Relationship [Not Liable])
a. W hile Petersen (Sun’s representative) did offer advice to Barone on all phases of
his operation, it was usually done on request and Barone was under no obligation
to follow the advice. Barone’s contacts and dealings with Sun were many and
their relationship intricate, but he made no written reports to Sun and he alone
assumed the overall risk of profit or loss in his business operation. Baron
independently determined his own hours of operation and the identity, pay sale
and working conditions of his employees, and it was his name that was posted as
proprietor.
b. The legal relationships arising from the distribution systems of major oil-
producing companies are in certain respects unique. As stated in an annotation
collecting many of the cases dealing with this relationship:
(1) “This distribution system has grown up primarily as the result of
economic factors and with little relationship to traditional legal concepts
in the field of master and servant, so that it is perhaps not surprising that
attempts by the court to discuss the relationship in the standard terms
have led to some difficulties and confusion.”
c. In some situations traditional definitions of principal and agent and of employer
and independent contractor may be difficult to apply to service station operators,
but the undisputed facts of the case at bar make it clear that Barone was an
independent contractor.
d. Test. The test be applied is that of whether the oil 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 views as insufficient.
14. Murphy v. Holiday Inns, Inc. (Va. 1975). (Franchise Relationship)
a. W hen an agreement, considered as a whole, establishes an agency relationship,
the parties cannot effectively disclaim it by formal “consent.” The relationship of
the parties does not depend upon what the parties themselves call it, but rather in
law what it actually is.
b. In determining whether a contract establishes an agency relationship, the critical
test is the nature and extent of the control agreed upon.
c. The plaintiff pointed to several provision and rules of the agreement which he
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claimed satisfied the control test to establish the principal-agent relationship. 11

d. Franchising. Franchising is a system for the selective distribution of goods and/or
services under a brand name through outlets owned by independent businessmen,
called “franchisees.” Although the franchisor supplies the franchisee with know-
how and brand identification on a continuing basis, the franchisee enjoys the right
to profit and runs the risk of loss. The franchisor controls the distribution of his
goods and/or services through a contract which regulates the activities of the
franchisee, in order to achieve standardization.
(1) The fact that an agreement is a franchise contract does not insulate the
contracting parties from an agency relationship. If a franchise contract so
regulates the activities of the franchisee as to vest the franchisor with
control within the definition of agency, the agency relationship arises
even though the parties expressly deny it.
e. Having carefully considered all of the regulatory provisions in the agreement, we
are of the opinion that they gave defendant no “control or right to control the
methods or details of doing the work, and, therefore, agree with the trial court
that no principal-agent or master-servant relationship was created.
(1) The purpose of the provisions was to achieve system-wide uniformity of
commercial service, and optimum public good will, all for the benefit of
both contracting parties.
15. Restatement § 1 indicates, as stated by the Holiday Inns court, that control is an essential
element of the definition of agency relationship, whether one is dealing with a servant or
an independent contractor. A key distinction between the servant and independent
contractor types of agents, however, is the differing natures and degrees of control
exercised by the principal. See Restatement § 220.
16. Restatement (Third) of Agency § 1.02. Parties’ Labeling and Popular Usage
Not Controlling.
An agency relationship arises only when the elements stated in § 1.01 are present. W hether a
relationship is characterized as agency in an agreement between parties or in the context of industry or
popular usage is not controlling.
17. Vandemark v. McDonald’s Corp. (N.H. 2006).
a. The weight of authority construes franchiser liability narrowly, finding that absent
a showing of control over security measures employed by the franchisee, the
franchiser cannot be vicariously liable for the security breach.
(1) W endy Hong W u v. Dunkin’ Donuts, Inc. (E.D.N.Y. 2000).
(a) The court specifically examined whether Dunkin’ Donuts had
control over the alleged “instrumentality” that cause the harm.
b. “The evidence demonstrates that although the defendant maintained authority to
insure the uniformity and standardization of products and services offered by the
[franchise] restaurant, such authority did not extend to control of security
operations. Thus, there was no genuine issue of material fact as to whether the
11
That licensee construct its motel according to plans, specifications, feasibility studies, and locations
approved by licensor; That licensee employ the trade name, signs, and other symbols of the ‘system’ designated by
licensor; That licensee pay a continuing fee for use of the license and a fee for national advertising of the ‘system’;
That licensee solicit applications for credit cards for the benefit of other licensees; That licensee protect and promote
the trade name and not engage in any competitive motel business or associate itself with any trade association designed
to establish standards for motels; That licensee not raise funds by sale of corporate stock or dispose of a controlling
interest in its motel without licensor's approval; That training for licensee's manager, housekeeper, and restaurant
manager be provided by licensor at licensee's expense; That licensee not employ a person contemporaneously engaged
in a competitive motel or hotel business; and That licensee conduct its business under the ‘system’, observe the rules
of operation, make quarterly reports to licensor concerning operations, and submit to periodic inspections of facilities
and procedures conducted by licensor's representatives.
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defendant exercised control over the relevant security policies at the [franchisee’s]
restaurant through adopting the QSC Play Book.”
B. Tort Liability and Apparent Agency
1. Miller v. McDonald’s Corp. (Ore. App. 1997).
a. Actual Agency. The kind of actual agency relationship that would make defendant
vicariously liable for 3K’s negligence requires that defendant have the right to
control the method by which 3K performed its obligations under the
Agreement. 12
(1) A number of courts have applied the right to control test to a franchise
relationship.
(a) “If in practical effect, 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
franchise, an agency relationship exists.”
(2) W e believe that a jury could find that defendant retained sufficient
control over 3K’s daily operations that an actual agency relationship
existed. The Agreement did not simply set standards that 3K had to
meet. Rather, it required 3K to use the precise methods that defendant
established. Defendant enforced the use of those methods by regularly
sending inspectors and by its retained power to cancel the Agreement.
b. Apparent Agency 13
(1) Restatement (Second) of Agency § 267.
(a) “One who represents that another is his servant or other agent
and thereby causes a third person justifiably to rely upon the
care or skill of such apparent agent is subject to liability to the
third person for harm caused by the lack of care or skill of the
one appearing to be a servant or other agent as if her were
such.”
(2) W e have not applied § 267 to a franchisor/franchisee situation, but
courts in a number of other jurisdictions have done so in ways that we
find instructive. In most case the courts have found that there was a jury
issue of apparent agency. The crucial issues are whether the putative
principal held the third party out as an agent and whether the plaintiff
relied on that holding out.
2. Restatement (Third) of Agency § 7.08. Agent Acts W ith Apparent Authority.
A principal is subject to vicarious liability for a tort committed by an agent in dealing or
communicating with a third party on or purportedly on behalf of the principal when actions taken by
the agent with apparent authority constitute the tort or enable the agent to conceal its commission.
C. Scope of Employment
1. Restatement (Second) of Agency § 228. General Statement.
(1) Conduct of a servant is within the scope of employment if, but only if:
(a) it is of the kind he is employed to perform;
(b) it occurs substantially within the authorized time and space limits;
(c) it is actuated, at least in part, by a purpose to serve the master, and
(d) if force is intentionally used by the servant against another, the use of force is not
12
Under the right to control test it does not matter whether the putative principal actually exercises control;
what is important is that it has the right to do so.
13
Apparent agency is a distinct concept from apparent authority. Apparent agency creates an agency
relationship that does not otherwise exist, while apparent authority expands the authority of an actual agent. In this
case, the precise issue is whether 3K was defendant’s apparent agent, not whether 3K had apparent authority.
-13-
unexpectable by the master.

(2) Conduct of a servant is not within the scope of employment if it is different in kind from that
authorized, far beyond the authorized time or space limits, or too little actuated by a purpose to serve
the master.
2. Restatement (Second) of Agency § 229. Kind of Conduct W ithin Scope of
Employment.
(1) To be within the scope of the employment, conduct must be of the same general nature as that
authorized, or incidental to the conduct authorized.
(2) In determining whether or not the conduct, although not authorized, is nevertheless so similar to
or incidental to the conduct authorized as to be within the scope of employment, the following matters
of fact are to be considered:
(a) whether or not the act is one commonly done by such servants;
(b) the time, place and purpose of the act;
(c) the previous relations between the master and the servant;
(d) the extent to which the business of the master is apportioned between different servants;
(e) whether or not the act is outside the enterprise of the master or, if within the enterprise,
has not been entrusted to any servant;
(f) whether or not the master has reason to expect that such an act will be done.
(g) the similarity in quality of the act done to the act authorized;
(h) whether or not the instrumentality by which the harm is done has been furnished by the
master to the servant;
(i) the extent of departure from the normal method of accomplishing an authorized result;
and
(j) whether or not the act is seriously criminal.
3. Restatement (Third) of Agency § 7.07. Employee Acting W ithin Scope of
Employment. 14
(1) An employer is subject to vicarious liability for a tort committed by its employee acting within the
scope of employment.
(2) An employee acts within the scope of employment when performing work assigned by the employer
or engaging in a course of conduct subject to the employer's control. An employee's act is not within
the scope of employment when it occurs within an independent course of conduct not intended by the
employee to serve any purpose of the employer.
(3) For purposes of this section,
(a) an employee is an agent whose principal controls or has the right to control the manner
and means of the agent's performance of work, and
(b) the fact that work is performed gratuitously does not relieve a principal of liability.
4. Unauthorized Conduct. Unauthorized conduct can be within the scope of employment.
a. Restatement (Second) of Agency § 230. Forbidden Acts.
An act, although forbidden, or done in a forbidden manner, may be within the scope of
employment.
5. Travel. Comment 3 to R.3d § 7.07 explains that “In general, travel required to perform
work, such a travel from an employer’s office to a job site or from one job site to another,
is within the scope an employee’s employment, while traveling to and from work is not.”
6. Frolic and Detour. Agency law has a pair of labels to distinguish small-scale deviations from
substantial ones.
a. Detour. The employee remains within the scope of employment (and
consequently respondeat superior still applies).
b. Frolic. A substantial deviation puts the employee outside the scope of
14
The R.3d is less formulaic. Note that R.3d has revised the R.2d’s third condition–substituting “an
independent course of conduct not intended by the employee to serve any purpose of the employer” for “actuated, at
least in part, by a purpose to serve the master.” The R.3d also rejects the R.2d’s condition–“substantially within the
authorized time and space limits”–as antiquated.
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employment.
7. Ira S. Bushey & Sons, Inc. v. United States (2d Cir. 1968).
a. The Government relies on Restatement of Agency 2d § 228(1) which says that
“conduct of a servant is within the scope of employment if, but only if: (c) it is
actuated, at least in part, by a purpose to serve the master.”
(1) In Nelson v. American-W est African Line (2d Cir. 1936), Judge Learned
Hand concluded that a drunken boatswain who routed the plaintiff out
of his bunk with a blow, saying “Get up, you big son of a bitch, and
turn to,” and the continued to fight, might have thought he was acting
in the interest of the ship.
(2) It would be going too far to find such a purpose here; while Lane’s
return to the Tamaroa was to serve his employer, no one has suggested
how he could have though turning the wheels to be, even if–which is
by no means clear–he was unaware of the consequences.
b. Motive Test No Longer Viable. In light of the highly artificial way in which the
motive test has been applied, the district judge believed himself obliged to test the
doctrine’s continuing vitality by referring to the larger purposes respondeat
superior is supposed to serve.
(1) A policy analysis, however, is not sufficient to justify this proposed
expansion of vicarious liability.
(a) W hatever may have been the case in the past, a doctrine that
would create such drastically different consequences for the
actions of the drunken boatswain in Nelson and those the
drunken seaman here reflects a wholly unrealistic attitude
towards the risks characteristically attendant upon the operation
of a ship.
(b) Not Negligence Standard of Foreseeability. Put another way,
Lane’s conduct was not so “unforeseeable” as to make it unfair
to charge the Government with responsibility. W e agree with
a leading treatise that “what is reasonably foreseeable in this
context (of respondeat superior) is quite a different thing from
the foreseeably unreasonable risk of harm that spells negligence.
c. Test. The proper test here bears far more resemblance to that which limits
liability for workmen’s compensation than to the test for negligence. The
employer should be held to expect risks, to the public also, which arise out of and in the
course of his employment of labor.
d. Factors of Importance to J. Friendly:
(1) Foreseeability – W ell known that sailors on shore leave drink like
Irishmen.
(2) Economics – Judge Friendly says that the trial court’s economic analysis
may be valid but it is unknown what effect allocation would have.
(3) Justice – Justice requires this. The employer ought not to get a benefit
and be able to simultaneously disclaim the risk.
(4) Proximity – Geographically, seems to be a concern of Judge Friendly
(5) Risks associated with enterprise v. Risk attendant on the activities of the
community in general
(6) Because of the employment, unusual circumstances are encountered,
e.g., the job is inherently stressful.
8. Clover v. Snowbird Ski Resort (Utah 1991). (Frolic & Detour)
a. Ski resort restaurant chef/supervisor, while skiing between resort restaurant
locations, severely injured another skier after ignoring warning signs and
launching off a jump. The trial court granted summary judgment to the resort on
the theory that the employee was not acting within the scope of his employment.
b. The Supreme Court concluded that summary judgment should not have been
-15-
granted in favor of the ski resort and remanded for trial.

(1) The court rejected an alternative argument by the plaintiff, based on
Bushey, that the employer’s liability should depend “not on whether the
employer’s conduct is motivated by serving the employer’s interest, but
on whether the employee’s conduct is foreseeable.” The Utah court
noted simply that this is not the test under Utah case law.
9. The district court’s analysis in Bushey amounted to virtually a rule of strict liability for the
torts of an employee as long as any connection in time and space could be made between
the conduct and the employment.
a. Judge Friendly affirmed the district court’s result but rejected its rationale, noting
that it was not at all clear that the proposed rule would lead to a more efficient
allocation of resources.
10. Manning v. Grimsley (1st Cir. 1981).
a. In Massachusetts where a plaintiff seeks to recover damages from an employer for
injuries resulting from an employee’s assault, what must be shown is that the
employee’s assault was in response to the plaintiff’s conduct which was presently
interfering with the employee’s ability to perform his duties successfully. This interference
may be in the form of an affirmative attempt to prevent an employee from
carrying out his assignments.
(1) Miller’s holding that a critical comment by a customer to an employee
did not in the circumstances constitute conduct interfering with the
employee’s performance of his work is obviously distinguishable from
the case at bar. Miller v. Federated Department Stores, Inc. (Mass. 1973).
(a) Constant heckling by fans at a baseball park would be, within
the meaning of Miller, conduct.
b. This test relates to the motivation of the employee to serve his or her employer.
11. Restatement (Second) of Agency § 231. Criminal or Tortious Acts.
An act may be within the scope of employment although consciously criminal or tortious.
12. Serious Crimes or Torts. Under the traditional view, the master is not liable for the serious
crime or tort of the servant. An irrebuttable presumption was created that the servant was
not motivated by a purpose to serve the master.
a. The R.2d modifies this (See § 228(d)(1)): “if force is intentionally used by the
servant against another, the use of force is not expectable by the master.”
13. Liability of Torts of Independent Contractor. In general, a principal is not vicariously liable for
physical harm caused by the torts of a nonemployee agent (in R.2d terms, an
“independent contract agent”).
a. Exceptions: (1) inherently dangerous activity (requires special skill to prevent grave
injury); (2) ultrahazardous activity (harm cannot be averted no matter how
careful); (3) nondelegable duties (special relationship, e.g., common carriers,
innkeepers/contractual relationships, e.g., landlord-tenant/statutory); and (4) cases
that impose liability with no general rationale (e.g., store security guards and false
imprisonment, store ratified when it did not fire guard, and there is an obligation
to protect customers from unwarranted attack).
14. Torts Not Involving Physical Harm. If an agent’s misconduct consists solely of words and the
third party suffers harm only to its emotions, reputation, or pocketbook, the agency
analysis resembles the approach used for contractual matters. The key rules are those of
actual authority, apparent authority, and inherent agency power. Except for the borderline
areas of malicious prosecution and intentional interference with business relations,
respondeat superior is largely irrelevant.
a. Defamation. Not whether the principal authorized the agent to defame but rather
to make the statement (Ex. Credit bureaus reporting incorrect credit
information.)
-16-
IV. Fiduciary Obligation of Agents.

A. Duties During Agency
1. Restatement (Third) of Agency § 8.01. General Fiduciary Principle.
An agent has a fiduciary duty to act loyally for the principal’s benefit in all matters connected with the
agency relationship.
2. Restatement (Third) of Agency § 8.02. Material Benefit Arising Out of
Position.
An agent has a duty not to acquire a material benefit from a third party in connection with
transactions conducted or other actions taken on behalf of the principal or otherwise through the agent’s
use of the agent’s position.
3. Restatement (Third) of Agency § 8.03. Acting as or on Behalf of an Adverse
Party.
An agent has a duty not to deal with the principal as or on behalf of an adverse party in a transaction
connected with the agency relationship.
4. Restatement (Third) of Agency § 8.04. Competition.
Throughout the duration of an agency relationship, an agent has a duty to refrain from competing
with the principal and from taking action on behalf of or otherwise assisting the principal's competitors.
During that time, an agent may take action, not otherwise wrongful, to prepare for competition
following termination of the agency relationship.
5. Restatement (Third) of Agency § 8.05. Use of Principal’s Property; Use of
Confidential Information.
An agent has a duty
(1) not to use property of the principal for the agent's own purposes or those of a third party;
and
(2) not to use or communicate confidential information of the principal for the agent's own
purposes or those of a third party.
6. Restatement (Third) of Agency § 8.06. Principal’s Consent.
(1) Conduct by an agent that would otherwise constitute a breach of duty as stated in §§ 8.01,
8.02, 8.03, 8.04, and 8.05 does not constitute a breach of duty if the principal consents to the
conduct, provided that
(a) in obtaining the principal's consent, the agent
(i) acts in good faith,
(ii) discloses all material facts that the agent knows, has reason to know, or
should know would reasonably affect the principal's judgment unless the principal
has manifested that such facts are already known by the principal or that the
principal does not wish to know them, and
(iii) otherwise deals fairly with the principal; and
(b) the principal's consent concerns either a specific act or transaction, or acts or transactions
of a specified type that could reasonably be expected to occur in the ordinary course of the
agency relationship.
(2) An agent who acts for more than one principal in a transaction between or among them has a duty
(a) to deal in good faith with each principal,
(b) to disclose to each principal
(i) the fact that the agent acts for the other principal or principals, and
(ii) all other facts that the agent knows, has reason to know, or should know
would reasonably affect the principal's judgment unless the principal has
manifested that such facts are already known by the principal or that the principal
does not wish to know them, and
(c) otherwise to deal fairly with each principal.
7. Restatement (Third) of Agency § 8.07. Duty Created by Contract.
An agent has a duty to act in accordance with the express and implied terms of any contract between
the agent and the principal.
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8. Restatement (Third) of Agency § 8.08. Duties of Care, Competence, and

Diligence.
Subject to any agreement with the principal, an agent has a duty to the principal to act with the care,
competence, and diligence normally exercised by agents in similar circumstances. Special skills or
knowledge possessed by an agent are circumstances to be taken into account in determining whether the
agent acted with due care and diligence. If an agent claims to possess special skills or knowledge, the
agent has a duty to the principal to act with the care, competence, and diligence normally exercised by
agents with such skills or knowledge.
9. Restatement (Third) of Agency § 8.09. Duty to Act Only W ithin Scope of
Actual Authority and to Comply W ith Principal’s Lawful Instructions.
(1) An agent has a duty to take action only within the scope of the agent's actual authority.
(2) An agent has a duty to comply with all lawful instructions received from the principal and persons
designated by the principal concerning the agent's actions on behalf of the principal.
10. Restatement (Third) of Agency § 8.10. Duty of Good Conduct.
An agent has a duty, within the scope of the agency relationship, to act reasonably and to refrain from
conduct that is likely to damage the principal's enterprise.
11. Restatement (Third) of Agency § 8.11. Duty to Provide Information.
An agent has a duty to use reasonable effort to provide the principal with facts that the agent knows,
has reason to know, or should know when
(1) subject to any manifestation by the principal, the agent knows or has reason to know
that the principal would wish to have the facts or the facts are material to the agent's duties
to the principal; and
(2) the facts can be provided to the principal without violating a superior duty owed by the
agent to another person.
12. Duty of Loyalty. All agents owe a fiduciary duty of loyalty. Agency is emphatically not an
arm’s-length relationship.
a. Unapproved Benefits. An agent cannot make “secret profits” from the agency
relationship:
(1) Forbids compensation from someone other than the principal in
connection with the agent’s duty (kickbacks, bribes, gratuities, etc.)
(2) An agent may not become the other party to a transaction with the
principal, unless the agent discloses its role and the principal consent.
(3) Not using the position to gain profits from someone with no connection
to the principal.
b. No Competition. Agent cannot compete with the principal or act on behalf of a
competitor.
c. Agent cannot use principal’s property for his own purposes or the purposes of
someone else.
d. Confidential Information. Agent cannot use or communicate the principal’s
confidential information for the agent’s own purposes or those of someone else.
13. Reading v. Regem (K.B. 1948).
a. In my judgment, it is a principle of law that, if a servant takes advantage of his
service and violates his duty of honesty and good faith to make a profit for
himself, in the sense that the assets of which he has control, the facilities which he
enjoys, or the position which he occupies, are the real cause of his obtaining the
money as distinct from merely affording the opportunity for getting it, that is to
say, if they play the predominant part in his obtaining the money, then he is
accountable for it to his master.
(1) It matters not that the master has not lost any profit nor suffered any
damage, nor does it matter that the master could not have done the act
himself. If the servant unjustly enriched himself by virtue of his service
without his master’s sanction, the law says that he ought not to be
allowed to keep the money, but it shall be taken from him and given to
his master, because he got it solely by reason of the position which he
-18-
occupied as a servant of his master.

b. Distinguish from Service Giving Rise to Opportunity. This case is to be distinguished
from cases where the service merely gives the opportunity of making money. A
servant may, during his master’s time, in breach of his contract, do other things to
make money for himself, such as gambling, but he is entitled to keep that money
himself. The master has a claim for damages for breach of contract, but he has no
claim to the money.
14. General Automotive Manufacturing Co. v. Singer (W is. 1963).
a. Singer had broad powers of management and conducted the business activities of
Automotive. In this capacity he was Automotive’s agent and owed a fiduciary
duty to it. Under his fiduciary duty to Automotive, 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.
b. The title of the activity does not determine the question whether it was
competitive but an examination of the nature of the business must be made.
c. Rather than to resolve the conflict of interest between his side line business and
Automotive’s business in favor of serving and advancing his own personal
interests, 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 from Husco or to fill them if possible or to
sub-job them to other concerns with the consent of Husco if necessary, and the profit, if
any, would belong to Automotive.
15. Other Duties
a. Agent to Principal: (1) duty of care; (2) duty of good conduct; (3) duty to act
within authority; (4) duty to obey instruction; (5) duty to indemnify principal for
agent’s misconduct; (6) duty to account; and (7) duty to provide information.
b. Principal to Agent: (1) duty to dear fairly and in good faith; (2) duty to pay; (3)
duty to indemnify.
B. Duties During and After Termination of Agency: Herein of “Grabbing and Leaving”
1. Town & Country House & Home Service, Inc. v. Newberry (N.Y. 1958).
a. The only trade secret which could be involved in this business is plaintiff’s list of
customers.
(1) Concerning that, even where a solicitor of business does not operate
fraudulently under the banner of his former employer, he still may not
solicit the latter’s customers who are not openly engaged in business in
advertised locations or whose availability as patrons cannot readily be
ascertained but whose trade and patronage have been secured by years of
business effort and advertising, and the expenditure of time and money,
constituting a part of the good will of a business which enterprise and
foresight have built up.
C. Attribution
1. Agency law provides that in some situations, information that an agent knows or has
received is attributed to the principal–treated as if the principal knew or received the
information.
a. Agent Has Actual/Apparent Authority to Receive Notice. The notice has the same
effect as if it had been made directly to the principal.
b. Business Entities. It will have a registered person, a person designated in the
records of the Secretary of State who is authorized to receive legal notices.
c. Agent’s Knowledge. If an agent has actual knowledge of a fact concerning a matter
within the agent’s actual authority, the agent’s knowledge is attributed to the
principal.
(1) Exception. The agent’s knowledge is not imputed to the principal if the
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agent was acting adversely to the principal, and the third party knew or
had reason to know that the agent was acting adversely to the principal.
(2) Business Organizations. The law concerning attribution of knowledge is
important when the principal is an organization, like a corporation or
other business entity, that has multiple agents. If the requirements for
imputation are otherwise met, the knowledge of all of the agents is
imputed to the corporation.
C H A PTER T W O : P AR TN ER SH IPS
I. W hat is a Partnership? And W ho Are the Partners?
A. Partners Compared W ith Employees
1. Revised Uniform Partnership Act § 202. Formation of Partnership.
(a) Except as otherwise provided in subsection (b), the association of two 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.
(b) An association formed under a statute other than this [Act], a predecessor statute, or a comparable
statute of another jurisdiction is not a partnership under this [Act].
(c) In determining whether a partnership is formed, the following rules apply:
(1) Joint tenancy, tenancy in common, tenancy by the entireties, joint property, common
property, or part ownership does not by itself establish a partnership, even if the co-owners
share profits made by the use of the property.
(2) The sharing of gross returns does not by itself establish a partnership, even if the persons
sharing them have a joint or common right or interest in property from which the returns are
derived.
(3) A person who receives a share of the profits of a business is presumed to be a partner in
the business, unless the profits were received in payment:
(i) of a debt by installments or otherwise;
(ii) for services as an independent contractor or of wages or other compensation to
an employee;
(iii) of rent;
(iv) of an annuity or other retirement or health benefit to a beneficiary,
representative, or designee of a deceased or retired partner;
(v) of interest or other charge on a loan, even if the amount of payment varies
with the profits of the business, including a direct or indirect present or future
ownership of the collateral, or rights to income, proceeds, or increase in value
derived from the collateral; or
(vi) for the sale of the goodwill of a business or other property by installments or
otherwise.
2. Fenwick v. Unemployment Compensation Commission (N.J. 1945).
a. There are several elements that the courts have taken into consideration in
determining the existence or nonexistence of the partnership relation:
(1) Intention of the parties.
(a) The agreement between the parties is evidential although not
conclusive.
(2) Right to share in profits.
(a) Sharing of profits will raise a presumption that a partnership
exists. See RUPA § 202(c)(3).
(b) However, not every agreement that gives the right to share in
profits is, for all purposes, a partnership agreement.
(3) Obligation to share in losses.
(4) Ownership and control of the partnership property and business.
(5) Community of power in administration.
(6) Language in the agreement.
(7) Conduct of the parties toward third persons.
(8) Rights of the parties on dissolution.
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b. The Uniform Partnership Act defines a partnership as an association of “two of

more persons to carry on as co-owners a business for profit.”
(1) The Act further provides that sharing of profits is prima facie evidence of
partnership but “no such inference shall be drawn if such profits were
received in payment ... as wages of an employee.”
3. Uniform Partnership Act § 18. Rules Determining Rights and Duties of
Partners.
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:
(a) Each partner shall be repaid his contributions, whether by way of capital or advances to
the partnership property 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 of capital or otherwise, sustained by the partnership according to his share in the
profits.
(b) The partnership must indemnify every partner in respect of payments made and personal
liabilities reasonably incurred by him in the ordinary and proper conduct of its business, or
for the preservation of its business or property.
(c) A partner, who in aid of the partnership makes any payment or advance beyond the
amount of capital which he agreed to contribute, shall be paid interest from the date of the
payment or advance.
(d) A partner shall receive interest on the capital contributed by him only from the date
when repayment should be made.
(e) All partners have equal rights in the management and conduct of the partnership
business.
(f) No partner is entitled to remuneration for acting in the partnership business, except that
a surviving partner is entitled to reasonable compensation for his services in winding up the
partnership affairs.
(g) No person can become a member of a partnership without the consent of all the partners.
(h) Any difference arising as to ordinary matters connected with the partnership business
may be decided by a majority of the partners; but no act in contravention of any agreement
between the partners may be done rightfully without the consent of all the partners.
4. Uniform Partnership Act § 31. Causes of Dissolution.
Dissolution is caused:
(1) W ithout violation of the agreement between the partners,
(a) By the termination of the definite term or particular undertaking specified in the
agreement,
(b) By the express will of any partner when no definite term or particular undertaking is
specified,
(c) By the express will of all the partners who have not assigned their interests or suffered
them to be charged for their separate debts, either before or after the termination of any
specified term or particular undertaking,
(d) By the expulsion of any partner from the business bona fide in accordance with such a
power conferred by the agreement between the partners;
(2) In contravention of the agreement between the partners, where the circumstances do not permit a
dissolution under any other provision of this section, by the express will of any partner at any time;
(3) By any event which makes it unlawful for the business of the partnership to be carried on or for
the members to carry it on in partnership;
(4) By the death of any partner;
(5) By the bankruptcy of any partner or the partnership;
(6) By decree of court under section 32.
B. Partners Compared W ith Lenders
1. Liability of Partners. The question of who is a partner is important because of the rule of
partnership law that makes each partner potentially liable for all of the debts of the partnership.
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2. Martin v. Peyton (N.Y. 1927).

a. The plaintiff was a creditor of the firm Knauth, Nachod & Kuhne, and claimed
that the defendants, who had made investments in the firm, were partners and, as
such, liable for its debts.
b. There is no hint that the transaction is not a loan of securities with a provision for
compensation.
(1) Until the securities were returned, the directing management of the firm
was to be in the hands of John R. Hall, and his life to be insured for
$1,000,000, and the polices were to be assigned as further collateral
security to the trustees.
(a) These requirements are not unnatural. Hall was the one
known and trusted by the defendants. W hat they required
seems but ordinary caution. Nor does it imply an association
in the business.
c. The trustees were to be kept advised as to the conduct of the business and
consulted as to important matters. They could inspect the firm books and were
entitled to any information they thought important. Finally, they could veto any
business decision they though highly speculative or injurious.
(1) This was but a proper precaution to safeguard the loan. The trustees
could not initiate any action as a partner could. They could not bind
the firm by any action of their own.
d. Each member of the K.N. & K. firm was to assign to the trustees their interest in
the firm. No loan by the firm to any member was permitted and the amount
each may draw was fixed. No other distributions of profit were to be made.
There was no obligation that the firm continue business and it could be dissolved
at any time.
(1) There is nothing here not properly adapted to secure the interest of the
respondents as lenders.
e. The “indenture” is substantially a mortgage of the collateral delivered by K.N. &
K. to the trustees to secure the performance of the “agreement.” It certainly does
not strengthen the claim that the respondents were partners.
f. The “option” permits the trustees, of any of them, or their assignees or nominees
to enter the firm at a later date if they desire to do so by buying 50 percent or less
of the interests therein of all or any of the member at a stated price. Or a
corporation may, if the trustees and members agree, be formed in the place of the
firm.
(1) This provision is somewhat unusual, yet it is not enough in itself to
show that on June 4, 1921, a present partnership was created, nor taking
these various papers as a whole do we reach such a result.
3. The risk of liability for Peyton, Perkins, and Freeman would have been avoided if K.N. &
K. had been organized as a corporation.
a. Under that form of organization, the equity investors (the counterparts of
partners) enjoy “limited liability”– that is, they are not personally liable for the
debts of the firm and therefore stand to lose only the amount they have invested
in it.
b. The same would be true if they had formed a limited liability company or limited
liability partnership. These forms of business organization, however, were
unavailable at the time this transaction occurred.
C. Partnership v. Contract
1. Southex Exhibitions, Inc. v. Rhode Island Builders Association, Inc. (1st Cir. 2002).
a. Under Rhode Island law, a “partnership” is “an association of two (2) or more
persons to carry on as co-owners a business for profit...”
b. The record evidence indicating a nonpartner relationship cannot be dismissed as
insubstantial:
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(1) Southex insists that the 1974 Agreement contains ample indicia that a
partnership was formed, including: (1) a 55-45% sharing of profits; (2)
mutual control over designated business operations, such as show dates,
admission prices, choice of exhibitors, and “partnership” bank accounts;
and (3) the respective contributions of valuable property to the
partnership by the partners.
(2) The 1974 Agreement is simply entitled “Agreement,” rather than
“Partnership Agreement.”
(3) Rather than an agreement for an indefinite duration, it prescribed a
fixed (albeit renewable) term.
(4) Rather than undertake to share operating costs with RIBA, SEM not
only agreed to advance all monies required to produce the shows, but to
indemnify RIBA for all show-related losses as well.
(a) State law normally presumes that partners share equally or at
least proportionately in partnership losses.
(5) Southex not only entered into contract but conducted business with
third parties, in its own name, rather than in the name of the putative
partnership. As a matter of fact, their mutual association was never
given a name.
(6) Similarly, the evidence as to whether either SEM or RIBA contributed
any corporate property, with the intent that it become jointly-owned
partnership property is highly speculative, particularly since their mutual
endeavor simply involved a periodic event, i.e., an annual home show,
which neither generated, nor necessitated, ownership interests in
significant tangible properties, aside from cash receipts.
c. “Partnership” is a notoriously imprecise term, whose definition is especially
elusive in practice. Since a partnership can be created absent any written
formalities whatsoever, its existence vel non normally must be assessed under a
“totality-of-the-circumstances” test.
d. Profit Sharing Does Not Have to Compel Finding of Partnership. Similarly, even
though the UPA explicitly identifies profit sharing as a particularly probative
indicium of partnership formation, and some courts have even held the absence of
profit sharing compels a finding that no partnership existed, it does not necessarily
follow that evidence of profit sharing compels a finding of partnership
information.
(1) Even though the UPA specifies five instances in which profit sharing
does not create a presumption of partnership formation, Southex cites
(and we have found) no authority for the proposition that the
evidentiary presumption created by profit sharing can be overcome only
by establishing these five exceptions, rather than by competent evidence
of other pertinent factors indicating the absence of an intent to form a
partnership (e.g., lack of mutual control over business operations, failure
to file partnership tax returns, failure to prescribe loss-sharing).
e. The term “partner” is frequently defined with a view to its context. More
importantly, the labels the parties assign, while probative of partnership
formation, are not necessarily dispositive as a matter of law, particularly in the
presence of countervailing evidence.
D. Partnership by Estoppel
1. Young v. Jones (D.S.C. 1992)
a. Plaintiffs assert that PW-Bahamas and PW-US [the Price W aterhouse partnership
in the United States] operate as a partnership, i.e., constitute an association of
persons to carry on, as owners, business for profit. In the alternative, plaintiffs
contend that if the two associations are not actually operating as partners they are
operating as partners by estoppel.
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b. As a general rule, persons who are not partners as to each other are not partners as
to third persons.
(1) Partnership by Estoppel. However, a person who represents himself, or
permits another to represent him, to anyone as a partner in an existing
partnership or with other not actual partners, is liable to any such person
to whom such a representation is made who has, on the faith of the
representation, given credit to the actual or apparent partnership.
II. The Fiduciary Obligations of Partners
A. Introduction
1. Meinhard v. Salmon (N.Y. 1928). 15
a. Duty of Loyalty. Joint adventurers, like copartners, owe to one another, while the
enterprise continues, the duty of the finest loyalty. Many forms of conduct
permissible in a workaday world for those acting at arm’s length, are forbidden to
those bound by fiduciary ties. A trustee is held to something stricter than the
morals of the market place. Not honesty alone, but the punctilio of an honor the
most sensitive, is then the standard of behavior.
b. Uncompromising rigidity has been the attitude of courts of equity when
petitioned to undermine the rule of undivided loyalty by the “disintegrating
erosion” of particular exceptions.
c. The trouble with Salmon’s conduct is that he excluded his coadventurer from any
chance to compete, from any chance to enjoy the opportunity for benefit that had
come to him alone by virtue of his agency.
(1) All these opportunities were cut away from the plaintiff through
another’s intervention.
(2) The very fact that Salmon was in control with exclusive powers of
discretion charged him the more obviously with the duty of disclosure,
since only through disclosure could opportunity be equalized.
d. A different question would be here if there were lacking any nexus of relation
between the business conducted by the manager and the opportunity brought to
him as an incident of manager.
(1) Here the subject-matter of the new lease was an extension and
enlargement of the subject-matter of the old one. A managing
coadventurer appropriating the benefit of such a lease without warning
to his partner might fairly expect to be reproached with conduct that
was underhand, or lacking, to say the least, in reasonable candor, if the
partner were to surprise him in the act of signing the new instrument.
e. Judge Andrews’ Dissent
(1) It seems to me that the venture . . . had in view a limited object and was
to end at a limited time. There was no intent to expand it into a far
greater undertaking lasting for many years. Doubtless in it Mr.
Meinhard has an equitable interest, but in it alone.
2. Revised Uniform Partnership Act § 404. General Standards of Partner’s
Conduct.
(a) The only fiduciary duties a partner owes to the partnership and the other partners are the duty of
loyalty and the duty of care set forth in subsections (b) and (c).
(b) A partner's duty of loyalty to the partnership and the other partners is limited to the following:
(1) to account to the partnership and hold as trustee for it any property, profit, or benefit
derived by the partner in the conduct and winding up of the partnership business or derived
from a use by the partner of partnership property, including the appropriation of a
partnership opportunity;
15
Although Meinhard v. Salmon involved a joint venture rather than a partnership, Cardozo’s words are
equally applicable to partnerships.
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(2) to refrain from dealing with the partnership in the conduct or winding up of the
partnership business as or on behalf of a party having an interest adverse to the partnership;
and
(3) to refrain from competing with the partnership in the conduct of the partnership business
before the dissolution of the partnership.
(c) A partner's duty of care to the partnership and the other partners in the conduct and winding up of
the partnership business is limited to refraining from engaging in grossly negligent or reckless conduct,
intentional misconduct, or a knowing violation of law.
(d) A partner shall discharge the duties to the partnership and the other partners under this [Act] or
under the partnership agreement and exercise any rights consistently with the obligation of good faith
and fair dealing.
(e) 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.
(f) A partner may lend money to and transact other business with the partnership, and as to each loan
or transaction the rights and obligations of the partner are the same as those of a person who is not a
partner, subject to other applicable law.
(g) This section applies to a person winding up the partnership business as the personal or legal
representative of the last surviving partner as if the person were a partner.
B. Opting Out of Fiduciary Duties
1. Perretta v. Promethus Development Company, Inc. (9th Cir. 2008).
a. Under California law, the general partner of a limited partnership has the same
fiduciary duties as a partner in any other partnership. 16
b. Not all self-interested transactions violate the duty of loyalty. The question is not
whether the interested partner is benefitted, but whether the partnership or the
other partners are harmed.
(1) Partnerships is a fiduciary relationship, and partners may not take
advantages for themselves at the expense of the partnership. Thus, a partner
who seek a business advantage over another partner bears the burden of
showing complete good faith and fairness to the other.
(a) Ratification. One way a self-interested partner may meet this
burden is to have disinterested partners ratify its actions. 17
Upon a showing of proper ratification by the partners, any
claim against the partner for a violation of the duty of loyalty is
extinguished.
c. Under California law, a transaction with an interested partner would be
inconsistent with the interested partner’s duty of loyalty and would require
unanimous approval of the partners–unless the partnership agreement provides
differently.
(1) California law permits a partnership agreement to vary or permit
ratifications of the duty of loyalty only if the provision doing so is not
16
(b) A partner’s duty of loyalty to the partnership and the other partners includes all of the following:
(1) To account to the partnership and hold as trustee for it any property, profit or benefit derived by
the partner in the conduct and winding up of the partnership business or derived from a use by the
partner of partnership property or information, including the appropriation of a partnership
opportunity.
(2) To refrain from dealing with the partnership in the conduct or winding up of the partnership
business as or on behalf of a party having an interest adverse to the partnership...
17
There is no breach of fiduciary duty if there has been a full and complete disclosure, if the partner who
deals with the partnership property first discloses all of the facts surrounding the transaction to the other partners and
secures their approval and consent.
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“manifestly unreasonable.”
(a) A comment to the 2001 Uniform Limited Partnership Act,
explaining the provision allowing ratification upon a specified
vote of the limited partners, notes: “The Act does not require
that the authorization or ratification be by disinterested partners,
although the partnership agreement may so provide.
i) The court disagrees. To the extent ratification
represents an exception to California’s general policy
of “thorough and relentless” scrutiny of self-dealing,
we are confident that a California court would
construe it narrowly, with particular skepticism
toward any aspect that might hint of unfairness.
ii) California statutes in related areas of the law support
the idea that interested partners should not be allowed
to count their votes in a ratification vote.
iii) Allowing an interested partner to participate in a
ratification election subverts the very purpose of
ratification itself.
(b) W e hold that a partnership agreement provision that allows an
interested partner to count its votes in a ratification vote would
be “manifestly unreasonable” within the meaning of the statute.
2. Revised Uniform Partnership Act § 103. Effect of Partnership Agreement;
Nonwaivable Provisions.
(a) Except as otherwise provided in subsection (b), 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, this [Act] governs relations
among the partners and between the partners and the partnership.
(b) The partnership agreement may not:
(1) vary the rights and duties under Section 105 except to eliminate the duty to
provide copies of statements to all of the partners;
(2) unreasonably restrict the right of access to books and records under Section
403(b);
(3) eliminate the duty of loyalty under Section 404(b) or 603(b)(3), but:
(i) the partnership agreement may identify specific types or categories of
activities that do not violate the duty of loyalty, if not manifestly
unreasonable; or
(ii) 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;
(4) unreasonably reduce the duty of care under Section 404(c) or 603(b)(3);
(5) eliminate the obligation of good faith and fair dealing under Section 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;
(6) vary the power to dissociate as a partner under Section 602(a), except to
require the notice under Section 601(1) to be in writing;
(7) vary the right of a court to expel a partner in the events specified in Section
601(5);
(8) vary the requirement to wind up the partnership business in cases specified in
Section 801(4), (5), or (6);
(9) vary the law applicable to a limited liability partnership under Section
106(b); or
(10) restrict rights of third parties under this [Act].
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C. Grabbing and Leaving

1. Meehan v. Shaughnessy (Mass. 1989).
a. It is well settled that partners owe each other a fiduciary duty of the utmost good
faith and loyalty. As a fiduciary, a partner must consider his or her partners’
welfare, and refrain from acting for purely private gain.
b. W e have stated that fiduciaries may plan to compete with the entity to which
they owe allegiance provided that in the course of such arrangements they do not
otherwise act in violation of their fiduciary duties.
c. A partner has an obligation to render on demand true and full information of all
things affecting the partnership to any partner.
d. ABA Committee on Ethics and Professional Responsibility Informal Opinion
1457 sets forth ethical standards for attorneys announcing a change in professional
association.
(1) The ethical standard provides any notice explain to a client that he or
she has the right to decide who will continue the representation.
III. Partnership Property
A. Putnam v. Shoaf (Ct. App. Tenn. 1981).
1. Under the Uniform Partnership Act, ... her partnership property rights consisted of her (1)
rights in specific partnership property, (2) interest in the partnership and (3) right to
participate in management.
a. The right in “specific partnership property” is the partnership tenancy possessory
right of equal use or possession by partners for partnership purposes. This
possessory right is incident to the partnership and the possessory right does not
exist absent the partnership.
b. The real interest of a partner, as opposed to that incidental possessory right before
discussed, is the partner’s interest in the partnership which is defined as “his share
of the profits and surplus and the same is personal property.” Therefore, a co-
partner owns no personal specific interest in any specific property or asset of the
partnership. The partnership owns the property or the asset. The partner’s
interest is an undivided interest, as a co-tenant in all partnership property. That
interest is the partner’s pro rata share of the net value or deficit of the partnership.
(1) For this reason a conveyance of partnership property held in the name of
the partnership is made in the name of the partnership and not as a
conveyance of the individual interests of the partners.
B. Revised Uniform Partnership Act § 201. Partnership as Entity.
(a) A partnership is an entity distinct from its partners.
(b) A limited liability partnership continues to be the same entity that existed before the filing of a statement of
qualification under Section 1001.
C. Revised Uniform Partnership Act § 203. Partnership Property.
Property acquired by a partnership is property of the partnership and not of the partners individually.
D. Revised Uniform Partnership Act § 204. W hen Property is Partnership Property.
(a) Property is partnership property if acquired in the name of:
(1) the partnership; or
(2) one or more partners with an indication in the instrument transferring title to the property of the
person's capacity as a partner or of the existence of a partnership but without an indication of the
name of the partnership.
(b) Property is acquired in the name of the partnership by a transfer to:
(1) the partnership in its name; or
(2) one or more partners in their capacity as partners in the partnership, if the name of the partnership
is indicated in the instrument transferring title to the property.
(c) Property is presumed to be partnership property if purchased with partnership assets, even if not acquired in
the name of the partnership or of one or more partners with an indication in the instrument transferring title to
the property of the person's capacity as a partner or of the existence of a partnership.
(d) Property acquired in the name of one or more of the partners, without an indication in the instrument
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transferring title to the property of the person's capacity as a partner or of the existence of a partnership and
without use of partnership assets, is presumed to be separate property, even if used for partnership purposes.
E. Revised Uniform Partnership Act § 501. Partner Not Co-Owner of Partnership
Property.
A partner is not a co-owner of partnership property and has no interest in partnership property which can be
transferred, either voluntarily or involuntarily.
F. Revised Uniform Partnership Act § 502. Partner’s Transferable Interest in Partnership.
The only transferable interest of a partner in the partnership is the partner's share of the profits and losses of the
partnership and the partner's right to receive distributions. The interest is personal property.
G. Revised Uniform Partnership Act § 503. Transfer of Partner’s Transferable Interest.
(a) A transfer, in whole or in part, of a partner's transferable interest in the partnership:
(1) is permissible;
(2) does not by itself cause the partner's dissociation or a dissolution and winding up of the partnership
business; and
(3) does not, as against the other partners or the partnership, entitle the transferee, during the
continuance of the partnership, to participate in the management or conduct of the partnership
business, to require access to information concerning partnership transactions, or to inspect or copy the
partnership books or records.
(b) A transferee of a partner's transferable interest in the partnership has a right:
(1) to receive, in accordance with the transfer, distributions to which the transferor would otherwise be
entitled;
(2) to receive upon the dissolution and winding up of the partnership business, in accordance with the
transfer, the net amount otherwise distributable to the transferor; and
(3) to seek under Section 801(6) a judicial determination that it is equitable to wind up the
partnership business.
(c) In a dissolution and winding up, a transferee is entitled to an account of partnership transactions only from
the date of the latest account agreed to by all of the partners.
(d) Upon transfer, the transferor retains the rights and duties of a partner other than the interest in distributions
transferred.
(e) A partnership need not give effect to a transferee's rights under this section until it has notice of the transfer.
(f) A transfer of a partner's transferable interest in the partnership in violation of a restriction on transfer
contained in the partnership agreement is ineffective as to a person having notice of the restriction at the time of
transfer.
IV. Raising Additional Capital*
V. The Rights of Partners in Management
A. Revised Uniform Partnership Act § 401. Partner’s Rights and Duties.
(a) Each partner is deemed to have an account that is:
(1) credited with an amount equal to the money plus the value of any other property, net of the
amount of any liabilities, the partner contributes to the partnership and the partner's share of the
partnership profits; and
(2) charged with an amount equal to the money plus the value of any other property, net of the
amount of any liabilities, distributed by the partnership to the partner and the partner's share of the
partnership losses.
(b) 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 partner's share of the profits.
(c) A partnership shall reimburse a partner for payments made and indemnify a partner for liabilities incurred by
the partner in the ordinary course of the business of the partnership or for the preservation of its business or
property.
(d) A partnership shall reimburse a partner for an advance to the partnership beyond the amount of capital the
partner agreed to contribute.
(e) A payment or advance made by a partner which gives rise to a partnership obligation under subsection (c) or
(d) constitutes a loan to the partnership which accrues interest from the date of the payment or advance.
(f) Each partner has equal rights in the management and conduct of the partnership business.
(g) A partner may use or possess partnership property only on behalf of the partnership.
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(h) A partner is not entitled to remuneration for services performed for the partnership, except for reasonable
compensation for services rendered in winding up the business of the partnership.
(i) A person may become a partner only with the consent of all of the partners.
(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.
(k) This section does not affect the obligations of a partnership to other persons under Section 301.
B. UPA § 18(e) states that “all partners have equal rights in the management and conduct of the
partnership business,” and § 18(h) provides that “any difference arising as to ordinary matters
connected with the partnership business may be decided by a majority of the partners.” 18
1. Thus, if there are three partners and they disagree as to an “ordinary” matter, the decision
of the majority controls. The majority can deprive the minority partner.
2. 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.
C. National Biscuit Company v. Stroud (N.C. 1959).
1. In Johnson v. Bernheim, this Court said: A and B are general partners to do some given
business; the partnership is, by operation of law, a power to each to bind the partnership in
any manner legitimate to the business. If one partner goes to a third person to buy an
article on time for the partnership, the other partner cannot prevent it by writing to the
third person not to sell to him on time. And what is true in regard to buying is true in
regard to selling. W hat either partner does with a third person is binding on the partnership.
a. It is otherwise where the partnership is not general, but is upon special terms, as
that purchases and sales must be with and for cash. There the power to each is
special, in regard to all dealings with third persons at least who have notice of the
terms.
2. G.S. § 59.39(1). Partner Agent of Partnership as to Partnership Business
a. “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.”
3. G.S. § 59.45 provides that “all partners are jointly and severally liable for the acts and
obligations of the partnership.”
4. G.S. § 59.48. Rules Determining Rights and Duties of Partners.
a. (e) All partners have equal rights in the management and conduct of the
partnership business.”
b. (h) Any difference arising as to ordinary business matters connected with the
partnership business may be decided by a majority of the partners; but no act in
contravention of any agreement between the partners may be done rightfully
without the consent of all the partners.
5. 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 Uniform Partnership Act “equal rights in the management and conduct of
the partnership business.” Stroud, his co-partner, could not restrict the power and
authority of Freeman to buy bread for the partnership as a going concern, for such a
purchase was an “ordinary matter connected with the partnership business,” 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 of the partners.
6. In Crane on Partnership it is said: “In cases of an even division of the partners as to whether
18
To the same effect is RUPA §§ 103, 401(f) and (j).
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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
power to act. The partnership being a going concern, activities within the scope of the
business should not be limited, save by the expressed will of the majority deciding a
disputed question; half of the members are not a majority.”
D. Summers v. Dooley (Idaho 1971).
1. UPA § 18(h) provides: “Any difference arising as to ordinary matters connected with the
partnership business may be decided by a majority of the partners.”
2. UPA § 18(e) provides: “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 . . .
All partners have equal rights in the management and conduct of the business.”
a. This section bestows equal rights in the management and conduct of the
partnership business upon all of the partners. The concept of equality between
partners with respect to management of business affairs is a central theme and
recurs throughout the Uniform Partnership law.
(1) Thus, the only reasonable interpretation of § 18(h) is that business
difference must be decided by a majority of the partners provided no
other agreement between the partners speaks to the issues.
3. In the case at bar one of the partners continually voiced objection to the hiring of the third
man. He did not sit idly by and acquiesce in the actions of his partner. Under these
circumstances it is manifestly unjust to permit recovery of an expense which was incurred
individually and not for the benefit of the partnership but rather for the benefit of one
partner.
E. Day v. Sidley & Austin (D.D.C. 1975).
1. Fraud.
a. The misrepresentation regarding plaintiff’s status cannot support a cause of action
for fraud, however, because plaintiff was not deprived of any legal right as a result
of his reliance on this statement.
b. Plaintiff’s allegations of an unwritten understanding cannot now be heard to
contravene the provisions of the Partnership Agreement which seemingly
embodied the complete intentions of the parties as to the manner in which the
firm was to be operated and managed.
c. Nor can plaintiff have reasonably believed that no changes would be made in the
W ashington office since the S & A Agreement gave complete authority to the
executive committee to decide questions of firm policy, which would clearly
include establishment of committees and the appointment of members and
chairpersons.
2. Breach of Fiduciary Duty
a. An examination of the case law on a partner’s fiduciary duties reveal that courts
have been primarily concerned with partners who make secret profits at the
expense of the partnership.
(1) Partners have a duty to make a full and fair disclosure to other partners
of all information which may be of value to the partnership.
(2) The essence of a breach of fiduciary duty is that one partner has
advantaged himself at the expense of the firm.
(3) The basic fiduciary duties are:
(a) a partner must account for any profit acquired in a manner
injurious to the interests of the partnership, such as
commissions or purchases on the sale of partnership property.
(b) a partner cannot without the consent of the other partners,
acquire for himself a partnership asset, nor may he divert to his
own use a partnership opportunity.
(c) he must not compete with the partnership within the scope of
business.
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b. W hat plaintiff is alleging in the instant case, however, concerns failure to reveal
information regarding changes in the internal structure of the firm. No court has
recognized a fiduciary duty to disclose this type of information, the concealment
of which does not produce any profit for the offending partners nor any financial
loss for the partnership as a whole.
(1) Note. Day would have been in better shape under the Revised Uniform
Partnership Act § 403(c)(1) which provides: “Each partner and the
partnership shall furnish to a partner, and to the legal representative of a deceased
partner or partner under legal disability: (1) without demand, any information
concerning the partnership's business and affairs reasonably required for the proper
exercise of the partner's rights and duties under the partnership agreement or this
[Act].”
F. Technically, under the UPA §§ 29 and 31, the old partnership is dissolved by the retirement of any
partner and when the remaining partners continue their practice a new partnership is formed.
1. “Continuation” agreement: an agreement obligating the remaining partners to continue to
associate with one another as partners under the existing agreement (or, perhaps, some
variation of it).
G. Under RUPA § 601, if a partner retires pursuant to an appropriate provision in the partnership
agreement (and in various other situations), there is a “dissociation” rather than a “dissolution.”
1. The partnership continues as to the remaining partners and the dissociated partner is
entitled, in the absence of an agreement to the contrary, to be paid an amount determined
as if “on the date of dissociation, the assets of the partnership were 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 without the dissociated partner,” plus the interest from the date of
dissociation. § 701(a) and (b).
VI. Partnership Dissolution
A. The Right to Dissolve
1. Uniform Partnership Act § 31. Causes of Dissolution.
Dissolution is caused:
(1) W ithout violation of the agreement between the partners,
(a) By the termination of the definite term or particular undertaking specified in the
agreement,
(b) By the express will of any partner when no definite term or particular undertaking is
specified,
(c) By the express will of all the partners who have not assigned their interests or suffered
them to be charged for their separate debts, either before or after the termination of any
specified term or particular undertaking,
(d) By the expulsion of any partner from the business bona fide in accordance with such a
power conferred by the agreement between the partners;
(2) In contravention of the agreement between the partners, where the circumstances do not permit a
dissolution under any other provision of this section, by the express will of any partner at any time;
(3) By any event which makes it unlawful for the business of the partnership to be carried on or for
the members to carry it on in partnership;
(4) By the death of any partner;
(5) By the bankruptcy of any partner or the partnership;
(6) By decree of court under section 32.
2. Uniform Partnership Act § 32. Dissolution by Decree of Court.
(1) On application by or for a partner the court shall decree a dissolution whenever:
(a) A partner has been declared a lunatic in any judicial proceeding or is shown to be of
unsound mind,
(b) A partner becomes in any other way incapable of performing his part of the partnership
contract,
(c) A partner has been guilty of such conduct as tends to affect prejudicially the carrying on
of the business,
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(d) A partner wilfully or persistently commits a breach of the partnership agreement, or

otherwise 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,
(e) The business of the partnership can only be carried on at a loss,
(f) Other circumstances render a dissolution equitable.
(2) On the application of the purchaser of a partner's interest under sections 28 or 29[in original;
probably should read “section 27 or 28.”]:
(a) After the termination of the specified term or particular undertaking,
(b) At any time if the partnership was a partnership at will when the interest was assigned
or when the charging order was issued.
3. Revised Uniform Partnership Act § 601. Events Causing Partner’s Dissociation.
A partner is dissociated from a partnership upon the occurrence of any of the following events:
(1) the partnership's having notice of the partner's express will to withdraw as a partner or on a later
date specified by the partner;
(2) an event agreed to in the partnership agreement as causing the partner's dissociation;
(3) the partner's expulsion pursuant to the partnership agreement;
(4) the partner's expulsion by the unanimous vote of the other partners if:
(i) it is unlawful to carry on the partnership business with that partner;
(ii) there has been a transfer of all or substantially all of that partner's transferable interest
in the partnership, other than a transfer for security purposes, or a court order charging the
partner's interest, which has not been foreclosed;
(iii) within 90 days after the partnership notifies a corporate partner that it will be expelled
because it has 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;
(5) on application by the partnership or another partner, the partner's expulsion by judicial
determination because:
(i) the partner engaged in wrongful conduct that adversely and materially affected the
partnership business;
(ii) the partner willfully or persistently committed a material breach of the partnership
agreement or of a duty owed to the partnership or the other partners under Section 404; or
(iii) the partner engaged in conduct relating to the partnership business which makes it not
reasonably practicable to carry on the business in partnership with the partner;
(6) the partner's:
(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 partner's 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 partner's property obtained without the partner's consent or acquiescence, or failing
within 90 days after the expiration of a stay to have the appointment vacated;
(7) in the case of a partner who is an individual:
(i) the partner's 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 partner's duties under the partnership agreement;
(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 trust's entire transferable interest in the partnership, but not merely by reason
of the substitution of a successor trustee;
(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 estate's entire transferable interest in the partnership, but
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not merely by reason of the substitution of a successor personal representative; or

(10) termination of a partner who is not an individual, partnership, corporation, trust, or estate.
4. Revised Uniform Partnership Act § 602. Partner’s Power to Dissociate;
W rongful Dissociation.
(a) A partner has the power to dissociate at any time, rightfully or wrongfully, by express will
pursuant to Section 601(1).
(b) A partner's 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:
(i) the partner withdraws by express will, unless the withdrawal follows within
90 days after another partner's dissociation by death or otherwise under Section
601(6) through (10) or wrongful dissociation under this subsection;
(ii) the partner is expelled by judicial determination under Section 601(5);
(iii) the partner is dissociated by becoming a debtor in bankruptcy; or
(iv) 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.
(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.
5. Owen v. Cohen (Cal. 1941).
a. 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.
b. However, courts of equity may order the dissolution of a partnership where there
are quarrels and disagreements of such a nature and to such extent that all
confidence and cooperation between the parties has been destroyed or where one
of the parties by his misbehavior hinders a proper conduct of the partnership
business.
(1) It is not only large affairs which produce trouble. The continuation 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.
c. UPA § 32.
(1) “(1) On application by or for a partner the court shall decree a
dissolution whenever...(d) ... it is not reasonably practicable to carry on the
business in partnership with [the other partner].”
6. Buyout of Dissociated Partner. If a partner’s dissociation does not result in dissolution,
RUPA § 7.01 provides as a default rule that the dissociated partner is entitled to be bought
out: “the partnership shall cause the dissociated partner’s interest in the partnership to be
purchased.” Unless otherwise provided in the partnership agreement, “[t]he buyout is
mandatory. The ‘cause to be purchased language is intended to accommodate a purchase
by the partnership, one or more of the remaining partners, or a third party.”
7. Revised Uniform Partnership Act § 801. Events Causing Dissolution and
W inding Up of Partnership Business.
A partnership is dissolved, and its business must be wound up, only upon the occurrence of any of the
following events:
(1) in a partnership at will, the partnership's having notice from a partner, other than a partner who is
dissociated under Section 601(2) through (10), of that partner's express will to withdraw as a partner,
or on a later date specified by the partner;
(2) in a partnership for a definite term or particular undertaking:
(i) within 90 days after a partner's dissociation by death or otherwise under Section 601(6)
through (10) or wrongful dissociation under Section 602(b), the express will of at least half
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of the remaining partners to wind up the partnership business, for which purpose a partner's
rightful dissociation pursuant to Section 602(b)(2)(i) constitutes the expression of that
partner's will to wind up the partnership business;
(ii) the express will of all of the partners to wind up the partnership business; or
(iii) the expiration of the term or the completion of the undertaking;
(3) an event agreed to in the partnership agreement resulting in the winding up of the partnership
business;
(4) an event that makes it unlawful for all or substantially all of the business of the partnership to be
continued, but a cure of illegality within 90 days after notice to the partnership of the event is effective
retroactively to the date of the event for purposes of this section;
(5) on application by a partner, a judicial determination that:
(i) the economic purpose of the partnership is likely to be unreasonably frustrated;
(ii) another partner has engaged in conduct relating to the partnership business which makes
it not reasonably practicable to carry on the business in partnership with that partner; or
(iii) it is not otherwise reasonably practicable to carry on the partnership business in
conformity with the partnership agreement; or
(6) on application by a transferee of a partner's transferable interest, a judicial determination that it is
equitable to wind up the partnership business:
(i) after the expiration of the term or completion of the undertaking, if the partnership was
for a definite term or particular undertaking at the time of the transfer or entry of the
charging order that gave rise to the transfer; or
(ii) at any time, if the partnership was a partnership at will at the time of the transfer or
entry of the charging order that gave rise to the transfer.
8. Revised Uniform Partnership Act § 802. Partnership Continues After
Dissolution.
(a) Subject to subsection (b), a partnership continues after dissolution only for the purpose of winding
up its business. The partnership is terminated when the winding up of its business is completed.
(b) At any time after the dissolution of a partnership and before the winding up of its business is
completed, all of the partners, including any dissociating partner other than a wrongfully dissociating
partner, may waive the right to have the partnership's business wound up and the partnership
terminated.
In that event:
(1) the partnership resumes carrying on its business as if dissolution had never occurred, and
any liability incurred by the partnership or a partner after the dissolution and before the
waiver is determined as if dissolution had never occurred; and
(2) the rights of a third party accruing under Section 804(1) or arising out of conduct in
reliance on the dissolution before the third party knew or received a notification of the waiver
may not be adversely affected.
9. Collins v. Lewis (Tex. 1955).
a. Power to Dissolve But Not a Right. W e agree with the appellants that there is no
such thing as an indissoluble partnership only in the sense that there always exists
the power, as opposed to the right, of dissolution. But legal right to dissolution
rests in equity, as does the right to relief from the provisions of any legal contract.
10. Page v. Page (Cal. 1961).
a. The Uniform Partnership Act provides that a partnership may be dissolved “By
the express will of any partner when no definite term or particular undertaking is
specified.”
b. In Owen v. Cohen, the court 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 pay the loan.
(1) It is true that these cases hold that partners may impliedly agree to
continue in business until a certain sum of money is earned, or one or
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more partners recoup their investments, or until certain debts are paid,
or until certain property could be disposed of on favorable terms.
(a) In each of these cases, however, the implied agreement found
support in the evidence.
(b) In the instant case, however, defendants failed to prove any
facts from which an agreement to continue the partnership for a
term may be implied.
c. Power to Dissolve Must Be Exercised in Good Faith. Even though the Uniform
Partnership Act provides that a partnership at will may be dissolved by the express
will of any partner, this power, like any other power held by a fiduciary, must be
exercised in good faith.
(1) 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 prospective business
opportunity.
B. The Consequences of Dissolution
1. Prentiss v. Sheffel (Ariz. 1973).
a. Facts. Plaintiffs owned a 42 ½ % interest each in the partnership (a shopping,
while the defendant owned a 15 % interest. The plaintiffs alleged that the
defendant derelict in his duties, in particular that he had failed to contribute his
share of the losses. The plaintiffs sought to dissolve the partnership. The trial
court held that a partnership-at-will existed and that it was terminated when the
plaintiff froze-out the defendant. The court ordered a sale and the plaintiffs were
the high bidders.
b. Issue. W hether 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.
c. W rongful Purpose Necessary. W hile the trial court did find that the defendant was
excluded from the management of the partnership, there was no indication that
such exclusion was done for the wrongful purpose of obtaining the partnership assets in
bad faith rather than merely being the result of the inability of the partners to
harmoniously function in a partnership relation.
d. Not Injured by Partners’ Participation in Sale. Moreover, the defendant has failed to
demonstrate how he was injured by the participation of the plaintiffs in the
judicial sale.
(1) Because of the plaintiffs’ bidding in the judicial sale, it appears that the
defendant’s 15% interest in the partnership was considerably enhanced by
the plaintiff’s participation.
e. The defendant has cited no cases, nor has this court found any, which have
prohibited a partner from bidding at a judicial sale of the partnership assets.
(1) Not an Attack on the Order to Sell. It should be emphasized that on this
appeal the defendant does not attack the fact that the trial court ordered
a sale of the assets. The only area of attack is that plaintiffs have been
allowed to participate and bid in that sale.
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2. Uniform Partnership Act § 38. Rights of Partners to Application of Partnership

Property. 19
(1) W hen dissolution is caused in any way, except in contravention of the partnership agreement,
each partner, as against his co-partners and all persons claiming through them in respect of their
interests in the partnership, unless otherwise agreed, may have the partnership property applied to
discharge its liabilities, and the surplus applied to pay in cash the net amount owing to the respective
partners. But if dissolution is caused by expulsion of a partner, bona fide under the partnership
agreement and if the expelled partner is discharged from all partnership liabilities, either by payment
or agreement under section 36(2), he shall receive in cash only the net amount due him from the
partnership.
(2) W hen dissolution is caused in contravention of the partnership agreement the rights of the partners
shall be as follows:
(a) Each partner who has not caused dissolution wrongfully shall have,
I. All the rights specified in paragraph (1) of this section, and
II. The right, as against each partner who has caused the dissolution wrongfully,
to damages for breach of the agreement.
(b) The partners who have not caused the dissolution wrongfully, if they all desire to
continue the business in the same name, either by themselves or jointly with others, may do
so, during the agreed term for the partnership and for that purpose may possess the
partnership property, provided they secure the payment by bond approved by the court, or
pay to any partner who has caused the dissolution wrongfully, the value of his interest in
the partnership at the dissolution, less any damages recoverable under clause (2a II) of this
section, and in like manner indemnify him against all present or future partnership
liabilities.
(c) A partner who has caused the dissolution wrongfully shall have:
I. If the business is not continued under the provisions of paragraph (2b) all the
rights of a partner under paragraph (1), subject to clause (2a II), of this section,
II. If the business is continued under paragraph (2b) of this section the right as
against his co-partners and all claiming through them in respect of their interests
in the partnership, to have the value of his interest in the partnership, less any
damages caused to his co-partners by the dissolution, ascertained and paid to him
in cash, or the payment secured by bond approved by the court, and to be released
from all existing liabilities of the partnership; but in ascertaining the value of the
partner's interest the value of the good-will of the business shall not be considered.
3. Pav-Saver Corporation v. Vasso Corporation (Ill. 1986).
a. Facts. PSC owned the trademark and patents for concrete paving machines.
Dale, the inventor of a machine and majority shareholder of PSC and Meersman,
owner and shareholder of Vasso, formed Pav-Saver Manufacturing. Dale
contributed services, PSC contributed the patents and trademarks, and Meersman
obtained financing. The partnership agreement contained language granting Pav-
Saver the exclusive right to use PSC’s trademarks and patents. The agreement
also stated that if either party terminated, the terminating party would pay
liquidated damages. In 1976, the agreement was replaced with an identical one,
but eliminating the individual partners. PSC terminated the partnership in 1983.
The trial court ruled that Vasso was entitled to continue the business and possess
the partnership assets, including the trademark and patents.
b. Uniform Partnership Act § 38 provides:
(2) W hen dissolution is caused in contravention of the partnership agreement the
rights of the partners shall be as follows:
(a) Each partner who has not cause dissolution wrongfully shall have,
19
RUPA is essentially the same as UPA. However, a wrongfully dissociate partner is entitled to have
goodwill included in the calculation.
-36-
***
II. The right, as against each partner who has cause dissolution
wrongfully, to damages for breach of the agreement.
(b) The partners who have not cause the dissolution wrongfully, I they
all desire to continue the business in the same name, either themselves or
jointly with others, may do so, during the agreed term for the
partnership and for that purpose may possess the partnership property,
provided they secure the payment by bond approved by the court, or
pay to any partner who has caused the dissolution wrongfully, the value
of his interest in the partnership at dissolution, less any damages
recoverable under clause (2a II) of this section, and in like manner
indemnify him against all present or future partnership liabilities.
(c) A partner who has caused the dissolution wrongfully shall have:
***
(II) If the business is continue under paragraph (2b) of this section the
right as against his co-partners and all claiming through them in respect
of their interest in the partnership, to have the value of his interest in the
partnership, less any damages caused to his co-partners by the
dissolution, ascertained and paid to him in cash, or the payment secured
by bond approved by the court and to be released from all existing
liabilities of the partnership; but in ascertaining the value of the partner’s
interest the value of the good will of the business shall not be
considered.
c. Despite the parties’ contractual direction that PSC’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 a wrongful termination
must be derived from and is controlled by the statute.
d. Dissent/Concurrence
(1) The partnership agreement is a contract, and event though a partner may
have the power to dissolve, he does no necessarily have the right to do
so. Therefore, if the dissolution he causes is a violation of the
agreement, he is liable for any damages sustained by the innocent
partners as a result.
(a) The innocent partner also has the option to continue the
business in the firm name provided they pay the partner cause
the dissolution the value of the interest of his partnership.
(2) W hile the rights and duties of the partners in relation to the partnership
are governed by the Uniform Partnership Act, the uniform act also
provides that such rules are subject to any agreement between the parties
(a) The partnership agreement entered into by PSC and Vasso in
pertinent part provides:
i) “the property [patents, etc.] shall be returned to PSC at the
expiration of this partnership.”
ii) The majority holds this provision is unenforceable
because its enforcement would affect defendant’s
option to continue the business. No authority is cited
for such a rule.
(3) I think it clear the parties agreed the partnership only be allowed the use
of the patents during the term of the agreement. The agreement having
been terminated, the right to use the patents is terminated.
C. The Sharing of Losses*
D. Buyout Agreements
1. A buy-out, or buy-sell, agreement is an agreement that allows a partner to end her or his
relationship with other partners and receive a cash payment, or series of payment, or some
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assets of the firm, in return for her or his interest in the firm.
2. Issues
a. Trigger Events: (1) Death; (2) Disability; (3) W ill of any partner
b. Obligation to Buy v. Option: (1) Firm; (2) Other Investors; (3) Consequences of
Refusal to Buy [If there is an obligation]/[If there is no obligation].
c. Price: (1) Book value; (2) Appraisal; (3) Formula (e.g., five times earnings); (4) Set
price each year; (5) Relation to duration (e.g., lower price in first five years)
d. Method of Payment: (1) Cash; (2) Installments (with interest?)
e. Protection Against Debts of Partnership
f. Procedure for Offering Either to Buy or Sell: (1) First mover sets price to buy or sell;
(2) First mover forces others to set price
3. G & S Investments v. Belman (Ariz. 1984).
a. Facts. Century Park was a limited partnership formed to receive ownership of an
apartment complex. Nordale had a 25.5% interest. Nordale became a cokehead
and a hermit. He had coke rage all the time and threatened the other partners.
He totally hit on jailbait and refused to pay rent on the apartment the partnership
let him use after his divorce. Nordale starting make irrational demands. The
other partners finally sought a dissolution of the partnership which would allow
them to carry on the business and buy out Nordale’s interest. Nordale died after
the filing of the complaint. The complaint was amended to invoke their right to
continue the partnership and acquire Nordale’s interest under article 19 of the
partnership’s Articles of Limited Partnership.
b. Uniform Partnership Act § 32 authorizes the court to dissolve a partnership
when:
***
(2) A partner becomes in any other way incapable of performing his part of the
partnership contract.
(3) A partner has been guilty of such conduct as tends to affect prejudicially the
carrying on of the business.
(4) A partner willfully or persistently commits a breach of the partnership
agreement, or otherwise 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.
c. Mere Filing of Complaint Does Not Dissolve. In Cooper v. Isaacs, the court was met
with the same contention made here, to-wit, that the mere filing of the complaint
acted as a dissolution. The court rejected this contention. Dissolution would
occur only when decreed by the court or when brought about by other acts.
d. Gibson and Smith testified that the parties actually intended and understood
“capital account” to mean exactly what it literally says, the account which shows
a partner’s capital contribution to the partnership plus profit minus losses.
(1) The capital amount is also reduced by the amount of any distributions.
(2) The words “capital account” are not ambiguous and clearly mean the
partner’s capital account as it appears on the books of the partnership.
e. Partnership buy-out agreements are valid and binding although the purchase price
agreed upon is less or more than the actual value of the interest at the time of
death.
(1) Modern business practice mandates that the parties be bound by the
contract they enter into, absent fraud or duress. It is not the province of
this court to act as a post-transaction guardian of either party.
E. Partnership Capital Accounts 20
1. Capital Account. As part of the settling-up process, partners are paid the amounts owed “in
20
See Partnership Capital Accounts Handout.
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respect of capital.” The bookkeeping devices that track the amount the partnership owes
each partner “in respect of capital” are called capital accounts.
2. Contribution/Distribution. Property contributed to the partnership increases the
contributing partner’s capital account by an amount equal to the fair market value of the
asset as of the time of contribution, as do profits allocated to partners from ongoing
activities. Distributions made to partners decreased their respective capital account, as do
losses allocated to partners from ongoing activities.
3. Appreciation/Depreciation. Post-contribution appreciation of depreciation of a contributed
asset does not affect the contributing partner’s capital account. The contribution severs the
contributor’s direct connection to the asset; subsequent vicissitudes in the asset’s value are
“for the partnership’s account.”
VII. Limited Partnership
A. Holzman v. De Escamilla.(Cal. App. 1948).
1. Facts. Russell and Andrews were limited partners in Hacienda Farms with Escamilla, the
general partner. Holzman, the trustee in bankruptcy, brought an action to determine that
Russell and Andrews were liable as general partners to the creditors of the partnership.
The evidence showed that Escamilla consulted Russell and Andrews as to which crops to
grow and was even overruled as to some of those decisions. In addition, Andrews and
Russell asked Escamilla to resign as manager and appointed his replacement. Furthermore,
checks drawn on Hacienda’s accounts had to be signed by two of the three partners,
therefore, Escamilla had no power to withdraw funds without the signature of at least one
of the other partners.
2. Section 2483 of the Civil Code provides as follows: “A limited partner shall not become
liable as a general partner, unless, in addition to the exercise of his rights and powers as a
limited partner, he takes part in the control of the business.”
3. The foregoing illustrations sufficiently show that Russell and Andrews both took “part in
the control of the business.”
a. The manner of withdrawing money from the bank accounts is particularly
illuminating. The two men had absolute power to withdraw all the partnership
funds in the banks without the knowledge or consent of the general partner.
b. They required him to resign as manager and selected his successor. They were
active in dictating the crops to be planted, some of them against the wish of the
general partner.
B. Revised Uniform Limited Partnership Act § 303(a) now provides that:
1. “a limited partner is not liable for the obligations of a limited partnership unless the limited
partner is also a general partner or, in addition to the exercise of his rights and powers as a
limited partner, he takes part in the control of the business. However, if the limited
partner takes part in the control of the business and is not also a general partner, the limited
partner is liable only to person who transact business with the limited partnership and who
reasonably believe, based upon the limited partner’s conduct, that the limited partner is a
general partner.
C. Revised Uniform Limited Partnership Act § 303(b) also provides that a limited partner does not
participate in control “solely by . . . (2) consulting with and advising a general partner with respect
to the business of the limited partnership.”
C H A PTER T H R EE : T H E N A TU R E O F TH E C O R PO R A TIO N
I. Promoters and the Corporate Entity
A. Promoter. A “promoter” is a term of art referring to a person who identifies a business opportunity
and puts together a deal, forming a corporation as the vehicle for investment by other people.
1. Preincorporation. Promoters may enter into contracts on behalf of the venture being
promoted either before or after articles of incorporation have been filed.
a. Corporation Bound? A corporation is not bound by a contract made on its behalf
before it was incorporated unless the corporation agrees to be bound. The
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21
corporation must “adopt” the contract.
(1) Express or Implied. It may do so expressly, e.g., where its board of
directors passes a resolution expressly adopting the contract. Or it may
do so impliedly, by knowingly accepting the benefits of the contract.
(2) Quasi-Contract/Unjust Enrichment. The other party to the contract may
be able to assert quasi-contract or estoppel claims against the
corporation.
2. Promoter’s Liability. W hether a promoter is personally liable on the contract he makes for
the corporation that has not been formed depends on the parties’ (the third party and
promoter’s) intent.
a. Corporation Never Comes Into Existence:
(1) Presumption Promoter Liable. The presumption is that the parties intend
the promoter to be personally liable, so that if the corporation is never
formed, the third party can hold the promoter liable for breach of the
contract.
(a) Different Intent. The parties may intend that the promoter is
not liable on the contract, but instead the corporation will be
bound to the contract after it is formed and adopts the contract.
But this is unlikely, because it would mean that there really
wasn’t a contract at all.
(2) Breach of a Separate Promise. The promoter may have expressly or
impliedly promised the third party that she (the promoter) would use
her best efforts to cause the corporation to be formed and to adopt the
contract. If the corporation is never formed and the third party can
prove that this was because the promoter failed to use her best efforts,
the third party can hold the promoter liable.
b. Promoter’s Liability After the Corporation is Formed:
(1) Novation. The presumption that the parties intend the promoter to be
liable on the pre-incorporation contract continues even after the
corporation is formed and even if the corporation adopts the contract.
However, the parties may have a different intent: they may intend that
once the corporation is formed and adopts the contract, the promoter
will be released from liability. This is called a novation: the creditor
agrees to accept a new debtor in place of the old.
(a) Still Must Prove Intent. The intent to enter into a novation must
be proved. If it is not, the presumption of the promoter’s
liability will stand.
c. Defective Incorporation:
(1) If the corporation has not been properly formed, logically then, the
business must be operating as a sole proprietorship or a general
partnership–neither of which afford its owners (shareholders) limited
liability. This would give the third party–who made the contract in the
belief that he was dealing with a corporation, not an individual–an
undeserved windfall.
(2) The common law came up with two theories to deal with cases like this:
(a) De Facto Corporation. W here there has been a defect in the
incorporation process that prevents the business from being
treated as a de jure corporation, but (1) the
promoter/shareholder made a good faith effort to incorporate
the business, and (2) carried on the business as though it were a
21
Some courts describe this action as “ratification,” but technically a corporation cannot ratify acts that
occurred before its existence.
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corporation, some courts treat the firm as a de facto corporation.

i) The State can contest the corporate existence of a de
facto corporation but no one else can.
(b) Corporation By Estoppel. Someone who deals with the firm as
though it were a corporation is estopped to deny the
corporation’s existence even though there has been no
colorable attempt to incorporate.
d. Statutory Efforts
(1) MBCA § 2.04. Liability for Preincorporation Transactions.
All persons purporting to act as or on behalf of a corporation, knowing there was
not incorporation under this Act, are jointly and severally liable for all liabilities
created while so acting.
(2) On its face, this statute creates promoter liability in all cases in which the
promoter knew, at the time she made the contract, that the corporation
was not in existence. The promoter would not be liable if she
mistakenly believed the corporation was in existence at the time she
made the contract.
(3) The promoter is protected in defective incorporation cases, even if there
was no good-faith attempt to form the business (e.g., an attorney was
hired to incorporate the business and never attempted to do so).
(4) Comments to the MBCA indicate that the principles of estoppel can
change the result that the statute would otherwise indicate (e.g., where
the third party urged that the contract be made in the name of the
nonexistent corporation, the third party may be estopped to impose
personal liability on the shareholder/promoter, even though the
shareholder/promoter knew that the corporation did not yet exist at the
time of contracting).
3. Fiduciary Duties. Promoters of a venture own fiduciary duties to each other and to the
corporation. The duty is essentially the same as the duties owed by a partner to a
partnership or partners. A duty of full disclosure is owed to subsequent investors.
a. To Corporation. After the corporation is formed it may obtain from the promoter
any benefits or rights the promoter obtained on its behalf.
b. To Fellow Promoters. Promoters are essentially partners in the promotion of the
venture, and any benefits or rights one promoter obtains must be shared with co-
promoters.
c. To Subsequent Investors. (Based on Old Dominion Copper Mining & Smelting Co. v.
Bigelow (Mass. 1909) & Old Dominion Copper Mining & Smelting Co. v. Lewisohn
(U.S. 1908)).
(1) Under the Massachusetts rule, a corporation may attack an earlier
transaction if the subsequent sale to public investors was contemplated at
the time of the earlier transaction.
(a) More widely followed
(b) Arguably, the real issue in these cases is whether there was full
disclosure of the transaction at the time the public investors
decided to make their investments.
(2) Under the federal rule, the corporation may not attack an earlier
transaction because all the stockholders at the time consented to the
transaction.
d. To Creditors. Fiduciary concepts may also protect creditors against unfair or
fraudulent transactions by promoters. Most of theses transactions also may be
attacked on the ground they constitute fraud on creditors.
B. Southern-Gulf Marine Co. No. 9, Inc. v. Camcraft, Inc.
1. W e believe the defendant, having given its promise to construct the vessel, should not be
permitted to escape performance by raising an issue as to the character of the organization
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to which it is obligated, unless its substantial rights might thereby be affected.

a. Estoppel. It is settled, by an overwhelming array of indisputable precedents that,
as a rule, one who contracts with what he acknowledges to be and treats as a
corporation, incurring obligations in its favor, is estopped from denying its
corporate existence, particularly when the obligations are sought to be enforced. 22
II. The Corporate Entity and Limited Liability
A. Piercing the Corporate Veil
1. Closely Held Corporations. Piercing is exclusively a doctrine applicable to closely held
corporations. But piercing may be applied to subsidiary corporations owned by a publicly
held parent corporation. But in these cases, the separate existence of the subsidiary and not
the parent is ignored. 23
2. Legal Tests 24:
a. Alter Ego and Instrumentality
(1) Requires (a) such unity of ownership and interest between corporation
and stockholder that the corporation has ceased to have separate
existence, and (b) recognition of the separate existence of the
corporation sanctions fraud or leads to an inequitable result.
b. Others: (1) Misrepresentation and Fraud; (2) Personal Guaranty; (3)
Undercapitalization; (4) Operation on the Edge of Insolvency; (5) Commingling
and Confusion; (6) Artificial Division of Business Entity; (7) Mere Continuation;
and (8) Failure to Follow Corporate Formalities
B. W hy Allow Incorporation to Escape Personal Liability
1. Less money available to invest if limited liability was not available
2. Maximizes the amount to be invested. Encourages investment. (Portfolio Theory).
3. Management can take more risk in operating the business.
4. Costs:
a. Creditors can incur a cost.
b. Externalities.
C. Bartle v. Home Owners Cooperative, Inc. (N.Y. 1955).
1. Facts. Defendant (Home Owners) was a co-operative corporation composed of veterans
for the purpose of providing low-cost housing to its members. Defendant was unable to
secure a contractor for construction so it organized W esterlea for that purpose. W esterlea
found itself in financial difficulties and four years later went bankrupt. The plaintiff
22
In Casey v. Galli, 94 U.S. 673 (1877), the rule was stated as follows:
“W here a party has contracted with a corporation, and is sued upon the contract, neither is
permitted to deny the existence, or the legal validity of such corporation. To hold
otherwise would be contrary to the plainest principles of reason and good faith, and
involve a mockery of justice.”
23
No reported case of piercing has ever involved the shareholders of a public traded corporation.
24
Courts have articulated different tests for piercing the corporate veil, such as the “instrumentality”
doctrine of the “alter ego” test. These test focus on the use of control or ownership to “commit a fraud or perpetuate
a dishonest act” or to “defeat justice and equity.” But these tests provide little guidance, and results in particular cases
do not seem to turn on which test a court employs.
Rather, particular piercing factors seem more relevant even though no one fact emerges as determinative.
It is generally believed that courts are more likely to pierce in the following situations: (1) the business is a closely held
corporation; (2) the plaintiff is an involuntary (tort) creditor; (3) the defendant is a corporate shareholder (as opposed
to an individual); (4) insiders failed to follow corporate formalities; (5) insiders commingled business assets/affairs with
individual assets/affair; (6) insiders did not adequately capitalize the business; (7) the defendant actively participated in
the business; and (8) insiders deceived creditors.
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contended that the corporate veil should be pierced.

2. The law permits the incorporation of a business for the very purpose of escaping personal
liability.
3. Generally speaking, the doctrine of “piercing the corporate veil” is invoked to prevent
fraud or to achieve equity.
a. In the instant case there has been neither fraud, misrepresentation, nor illegality.
Defendant’s purpose in placing its construction operation into a separate
corporation was clearly within the limits of our public policy.
4. Dissent. Not only was W esterlea allowed no opportunity to make money, but it was
placed in a position such that if its business were successful and times remained good, it
would break even, otherwise it would inevitably become insolvent.
D. W alkovszky v. Carlton (N.Y. 1966).
1. Facts. Plaintiff was injured when he was run down by a taxi owned by Seon Cab
Corporation. Carlton, the individual defendant, was claimed to be a stockholder of 10
corporations, including Seon, each of which had two taxis registered in its name and the
minimum insurance required by law on each taxi. The corporations were alleged to be
operated as a single entity, unit and enterprise.
2. The law permits the incorporation of a business for the very purpose of enabling its
proprietors to escape personal liability but, manifestly the privilege is not without its limits.
a. Piercing the Corporate Veil. Broadly speaking, the courts will disregard the
corporate form, or, to use accepted terminology, “pierce the corporate veil”,
whenever necessary to prevent fraud or to achieve equity.
(1) In determining whether liability should be extended to reach assets
beyond those belonging to the corporation, we are guided, as Judge
Cardozo noted, by general rules of agency. In other words, whenever
anyone uses control of the corporation to further his own rather than the
corporation’s business, his will be liable for the corporation’s act upon
the principle of respondeat superior applicable even where the agent is a
natural person.
(a) It is one thing to assert that a corporation is a fragment of a
larger corporate combine which actually conducts the business.
It is quite another to claim that the corporation is a “dummy”
for its individual stockholders who are in reality carrying on the
business in their personal capacities for purely personal rather
than corporate ends.
i) Either circumstance would justify treating the
corporation as an agent and piercing the corporate veil
to reach the principal but a different result would
follow in each case.
a) In the first, only a larger corporate entity
would be held financially responsible while,
in the other the stockholder would be
personally liable. Either the stockholder is
conducting the business in his individual
capacity or he is not. If he is, he will be
liable; if he is not, then it does not
matter–insofar as his personal liability is
concerned–that the enterprise is actually
being carried on by a larger “enterprise
entity.”
b. The individual defendant is charged with having “organized, managed,
dominated and controlled” a fragmented corporate entity but there are no
allegations that he was conducting business in his individual capacity.
(1) Had the taxicab fleet been owned by a single corporation, it would be
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readily apparent that plaintiff would face formidable barriers in

attempting to establish personal liability on the part of the corporation’s
stockholders. The fact that the fleet ownership has been deliberately
split up among many corporations does not ease the plaintiff’s burden in
that respect.
(2) The corporate form may not be disregarded merely because the assets of
the corporation, together with the mandatory insurance coverage of the
vehicle which struck the plaintiff, are insufficient to assure him the
recovery sought.
(3) In point of fact, the principle relied upon in the complaint to sustain the
imposition of personal liability is not agency but fraud. Such a cause of
action cannot withstand analysis. If it is not fraudulent for the owner-
operator of a single cab operation to take out only the minimum
required liability insurance , the enterprise does not become either illicit
or fraudulent merely because it consists of many such corporations.
(a) Plaintiff Erroneously Relied on Fraud Allegation Instead of Agency.
W hatever right he may be able to assert against the parties
other than the registered owner of the vehicle come into being
not because he has been defrauded but because, under the
principle of respondeat superior, he is entitled to hold the who
enterprise responsible for the acts of its agents.
c. Dissent. The issue presented by this action is whether the policy of this State,
which affords those desiring to engage in a business enterprise the privilege of
limited liability through the use of the corporate device, is so strong that it will
permit that privilege to continue no matter how much it is abused, no matter
how irresponsibly the corporation is operated, no matter what the cost to the
public. I do not believe that it is.
(1) The Legislature [in enacting the minimum liability law] certainly could
not have intended to shield those individuals who organized
corporations, with the specific intent of avoiding responsibility to the
public, where the operation of the corporate enterprise yielded profits
sufficient to purchase additional insurance.
(2) W hat I would merely hold is that a shareholder of a corporation vested
with a public interest, organized with capital insufficient to meet
liabilities which are certain to arise in the ordinary course of the
corporation’s business, may be held personally responsible for such
liabilities.
E. There are three legal doctrine that the plaintiff might invoke in a case like W alkovszky: (a) enterprise
liability; (b) respondeat superior (agency); and (c) disregard of the corporate entity (“piercing the
corporate veil”).
F. Sea-Land Services, Inc. v. Pepper Source (7th Cir. 1991).
1. Facts. Sea-Land shipped peppers on behalf of The Pepper Source. PS then skipped out on
the freight bill which was substantial. The district court entered a default judgment against
PS for $86,767.70. PS, however, had dissolved in mid 1987 for failure to pay its annual
state franchise tax. In addition, PS had no assets. Therefore, Sea-Land brought an action
against Marchese and five business entities he owned: PS, Caribe Crown, Jamar Corp., and
Salescaster Distributors. Sea-Land sought to pierce the corporate veil and hold Marchese
personally liable and then reverse pierce and hold Marchese’s other corporations liable.
These corporations, Sea-Land alleged, were alter egos of each other and of Marchese and
used to defraud creditors. Sea-Land amended its complaint to add Tie-Net, of which
Marchese owned only half the stock along with Andre. The district court granted Sea-
Land’s motion for summary judgment.
2. A corporate entity will be disregarded and the veil of limited liability pierced when two
requirements are met: First, there must be such unity of interest and ownership that the
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separate personalities of the corporation and the individual [or other corporation] no
longer exist; and second, circumstances must be such that adherence to the fiction of
separate corporate existence would sanction a fraud or promote justice.
a. As for determining whether a corporation is so controlled by another to justify
disregarding their separate identities, the Illinois cases focus on four factors:
(1) The failure to maintain adequate corporate records or to comply with
corporate formalities;
(2) The commingling of funds or assets;
(3) Undercapitalization; and
(4) One corporation treating the assets of another corporation as its own.
3. Marchese’s Playthings. These corporate defendants are, indeed, little but Marchese’s
playthings. Marchese is the sole shareholder of PS, Caribe Crown, Jamar and Salescaster.
He is one of two shareholders of Tie-Net. Except for Tie-Net, none of the corporations
ever held a single corporate meeting. During his deposition, Marchese did not remember
any of these corporations ever passing articles of incorporation, bylaws, or other
agreements. Marchese runs all of the corporations out of the same, single office, with the
same phone line, the same expense accounts, and the like. Marchese “borrows” money
from these corporations, and they borrow money from each other. Marchese used the
bank accounts of the corporations to pay multiple personal expenses.
4. First Prong. In sum, we agree with the district court that there can be no doubt that the
“shared control/unity of interest and ownership” part of the test is met in this case:
a. Corporate records and formalities have not been maintained; funds and assets
have been commingled with abandon; PS, the offending corporation, and perhaps
others have been undercapitalized; and corporate assets have been moved and
tapped and “borrowed” without regard to their source.
5. Second Prong. “Unity of interest and ownership” is not enough; Sea-Land must also show
that honoring the separate corporate existences of the defendants “would sanction a fraud
or promote injustice.”
a. Although an intent to defraud creditors would surely play a part if established, the
Illinois test does not require proof of such intent. Once the first element of the
test is established, either the sanctioning of a fraud (intentional wrongdoing) or the
promotion of injustice, will satisfy the second element.
(1) Promoting Injustice. The prospect of an unsatisfied judgment looms in
every veil-piercing action; why else would a plaintiff bring such an
action? Thus, if an unsatisfied judgment is enough for the “promote
injustice” feature of the test, then every plaintiff will pass on that score,
and the test collapses into a one-step “unity of interest and ownership”
test.
(a) In Pederson v. Paragon, the court offered the following
summary: “Some element of unfairness, something akin to
fraud or deception or the existence of a compelling public
interest must be present in order to disregard the corporate
fiction.”
(b) Generalizing from other Illinois cases, we see that courts that
have properly pierced corporate veils to avoid “promoting
injustice” have found that, unless it did so, some “wrong”
beyond a creditor’s liability to collect would result: the
common sense rules of adverse possession would be
undermined; former partners would be permitted to skirt the
legal rules concerning monetary obligation; a party would be
unjustly enriched; a parent corporation that caused a sub’s
liabilities and its inability to pay for them would escape those
liabilities; or an intentional scheme to squirrel assets into a
liability-free corporation while heaping liabilities upon an asset-
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free corporation would be successful.

G. Roman Catholic Archbishop of San Francisco v. Sheffield (Cal. App. 1971).
1. Facts. Sheffield entered into an agreement to buy a St. Bernard dog from Fr. Cretton of
the Canons Regular of St. Augustine in Switzerland. The price was $175 to be paid in
$20 installments with the dog being shipped upon payment of the first installment. In
addition, Sheffield agreed to pay the $125 freight charge for the dog to be shipped from
Geneva to Los Angeles. Sheffield paid a total of $60 but did not receive the dog. The
monastery told Sheffield that the dog would not be shipped until Sheffield paid the entire
amount plus additional “fees.” Sheffield was also told that his $60 would not be refunded
because of the costs of keeping his account on the books. Sheffield filed suit against the
Archbishop of S.F., the Pope, the Vatican, the Canons, and Fr. Cretton under an “alter
ego” theory.
2. Alter Ego/Piercing the Veil. The terminology “alter ego” or “piercing the corporate veil”
refers to situations where there has been an abuse of corporate privilege, because of which
the equitable owner of a corporation will be held liable for the actions of the corporation.
The requirements for applying the “alter ego” principle are thus stated:
a. Requirements for Alter Ego Claim. It must be made to appear that the corporation
is not only influenced and governed by that person [or other entity], but that there is
such a unity of interest and ownership that the individuality, or separateness, of such
person and corporation has ceased, and the facts are such that an adherence to the
fiction of the separate existence of the corporation would, under the particular
circumstances, sanction a fraud or promote injustice.
(1) Factors to Consider. Among the factors to be considered in applying the
doctrine are the commingling of funds and other assets of the two
entities, the holding out by one entity that it is liable for the debts of the
other, identical equitable ownership in the two entities, use of the same
offices and employees, and use of one as a mere shell or conduit for the
same affairs of the other.
3. Alter Ego Does Not Make Subsidiaries Liable to Other Subsidiaries. The “alter ego” theory
makes a “parent” liable for the actions of a “subsidiary” which it controls, but it does not
mean that where a “parent” controls several subsidiaries each subsidiary then becomes
liable for the actions of all other subsidiaries. There is no respondeat superior between the
subagents.
4. Unsatisfied Creditor Not Enough to Lead to Inequitable Result (2 nd Prong). In almost every
instance where a plaintiff has attempted to invoke the doctrine he is an unsatisfied creditor.
The purpose of the doctrine is not to protect every unsatisfied creditor, but rather to afford
him protection, where some conduct amounting to bad faith makes it inequitable... for the
equitable owner of a corporation to hide behind its corporate veil.
H. Parent Corporation/Subsidiary Corporation v. Single Corporation with Divisions
1. Generally, the parent, like any other shareholder, is not liable for the debts of the
subsidiary, so the parent can undertake an activity without putting at risk its own assets,
beyond those it decides to commit to the subsidiary. Like an individual shareholder,
however, a corporate shareholder must be aware of the danger that if not careful, the
creditors of the subsidiary may be able to pierce the corporate veil of the subsidiary. The
parent must also be careful not to become directly liable by virtue of its participation in the
activities of the subsidiary.
I. In re Silicone Gel Breast Implants Products Liability Litigation (N.D. Ala. 1995).
1. Facts. MEC became, in 1982, a Delaware corporation, wholly owned by Bristol. In 1988
Bristol bought two other breast-implant manufacturers, Natural Y and Aesthetech. The
purchase price was paid from a Bristol account though charged to MEC. MEC had a
board of directors, consisting of Bristol’s Health Care Group President. He could not be
outvoted by the other two MEC board members. Former MEC presidents could not
recall MEC having a board. MEC board resolutions were prepared by Bristol officials.
Bristol was involved in much of MEC’s operations including: budgeting, employment
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policies and wages, executive hiring, scientific research, testing, legal counsel, public
relations, marketing (with Bristol’s name and logo), and consolidated federal tax returns.
2. Corporate Control
a. The evaluation of corporate control claims cannot, however, disregard the fact
that, no different from other stockholders, a parent corporation is
expected–indeed required–to exert some control over its subsidiary. Limited
liability is the rule, not the exception.
(1) However, when a corporation is so controlled as to be the alter ego or
mere instrumentality of its stockholder, the corporate form may be
disregarded in the interests of justice.
(2) Veil-Piercing on Summary Judgment. Ordinarily, the fact-intensive nature
of the issue will require that it be resolved only through a trial.
Summary judgment, however, can be proper if the evidence presented
could lead to but one result.
(3) The totality of the circumstances must be evaluated in determining
whether a subsidiary may be found to be the alter ego or mere
instrumentality of the parent corporation. Although the standards are
not identical in each states, all jurisdictions require a showing of
substantial domination.25
(4) Fraud or Like Misconduct (Injustice Requirement). Delaware courts do not
necessarily require a showing of fraud if a subsidiary is found to be the
mere instrumentality or alter ago of its stockholder.
(a) No Showing Required in Tort Cases. In addition, many
jurisdictions that require a showing of fraud, injustice, or
inequity in a contract case do not in a tort situation.
i) A rational distinction can be drawn between tort and
contract cases. In actions based on contract, the
creditor has willingly transacted business with the
subsidiary although it could have insisted on
assurances that would make the parent also
responsible. In a tort situation, however, the injured
party had no such choice; the limitations on corporate
liability were, from its standpoint, fortuitous and non-
consensual.
b. Direct Liability Claims
(1) Restatement (Second) of Torts § 324A: One who undertakes,
gratuitously or for consideration, to render services to another which he
should recognize as necessary for the protection of a third person or his
things, is subject to liability to the third person for physical harm
resulting from his failure to exercise reasonable care to perform his
undertakings, if
25
Among the factors to be considered are whether: (a) the parent and the subsidiary have common directors
or officers; (b) the parent and the subsidiary have common business departments; (c) the parent and the subsidiary file
consolidate financial statements and tax returns; (d) the parent finances the subsidiary; (e) the parent caused the
incorporation of the subsidiary; (f) the subsidiary operates with grossly inadequate capital*; (g) the parent pays the
salaries and other expenses of the subsidiary*; (h) the subsidiary receives no business except that given to it by the
parent; (i) the parent uses the subsidiary’s property as its own*; (j) the daily operation of the two corporations are not
kept separate; (k) the subsidiary does no observe the basic corporate formalities, such as keeping separate books and
records and holding shareholder and board meetings*.
* Indicates those factors which Fendler considers relevant. The court does not explain why the other
factors are relevant to its determination. Most of the remaining factors are present in every parent/subsidiary
relationship.
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(a) his failure to exercise reasonable care increases the risk of

harm, or
(b) he has undertaken to perform a duty owed by the other to
the third person, or
(c) the harm is suffered because of a reliance of the other or the
third person upon the undertaking.
(a) Under this theory, frequently applied in connection with safety
inspectors by insurers or with third-party repairs to equipment
or premises, a duty that would not otherwise have existed can
arise when an individual or company nevertheless undertakes to
perform some action.
(b) Doctrinally, a cause of action under § 324A does not involve
an assertion of derivative liability but one of direct liability,
since it is based on the actions of the defendant itself. The
existence of a parent-subsidiary relationship, while not
required, is obviously no defense to such a claim.
J. Frigidaire Sales Corp. v. Union Properties, Inc. (W ash. 1977)
1. Facts. Frigidaire entered into a contract with Commercial Investors. Mannon and Baxter
were limited partners of Commercial. They were also officers, directors, and shareholders
of Union Properties, Inc., the only general partner of Commercial. Mannon and Baxter
controlled Union and through that control, they controlled Commercial. Commercial
breached the contract and Frigidaire brought suit against Mannon, Baxter, and Union.
2. Petitioner does not contend that respondent acted improperly by setting up the limited
partnership with a corporation as the sole general partner. Limited partnerships are a
statutory form of business organization, and parties creating a limited partnership must
follow the statutory requirements.
a. In W ashington, parties may form a limited partnership with a corporation as the
sole general partner.
3. The concern with minimal capitalization is not peculiar to limited partnerships with
corporate general partners, but may arise anytime a creditor deals with a corporation.
a. Because out limited partnership statutes permit parties to form a limited
partnership with a corporation as the sole general partner, this concern about
minimal capitalization, standing by itself, does not justify a finding that the limited
partners incur general liability for their control of the corporate general partner.
b. If a corporate general partner is inadequately capitalized, the rights of a creditor
are adequately protected under the “piercing the corporate veil” doctrine of
corporation law.
4. Respondents scrupulously separated their actions on behalf of the corporation from their
personal actions, therefore, petitioner never mistakenly assumed that respondents were
general partners with general liability.
K. In re USACafes, L.P. Litigation, (Del. 1991).
1. W hile I find no corporation law precedents directly addressing the question whether
directors of a corporate general partner owe fiduciary duties to the partnership and its
limited partners, the answer to it seems to be clearly indicated by general principles and by
analogy to trust law.
a. W hile the parties cite no case treating the specific question whether directors of a
corporate general partner are fiduciaries for the limited partnership, a large
number of trust cases do stand for a principle that would extend a fiduciary duty
to such persons in certain circumstances
(1) The problem comes up in trust law because modernly corporations may
serve as trustees of express trusts.
(a) “The directors and officers of [a corporate trustee] are certainly
under a duty to the beneficiaries not to convert to their own
use property of the trust administered by the corporation...
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Furthermore, the directors and officers are under a duty to the

beneficiaries of trusts administered by the corporation not to
cause the corporation to misappropriate the property... The
breach of trust need not, however, be a misappropriation...
Any officer who knowingly causes the corporation to commit a
breach of trust causing loss...is personally liable to the
beneficiary of the trust...”
(b) The theory underlying fiduciary duties is consistent with
recognition that a director of a corporate general partner bears
such a duty towards the limited partnership.
i) That duty, of course, extends only to dealings with
the partnership’s property or affecting its business, but,
so limited, its existence seems apparent on a number
of circumstances..
III. Shareholder Derivative Actions
A. Introduction
1. The derivative suit is a nineteenth-century equity jurisdiction’s ingenious solution the
dilemma created by two inconsistent tenets of corporate law: (1) corporate fiduciaries owe
their duties to the corporation as a whole, not individual shareholders, and (2) the board of
directors manages the corporation’s business, which includes authorizing lawsuits in the
corporate name.
2. Derivative Suit v. Direct Claim. Unlike a derivative suit, a direct action is not brought on
behalf of the corporation. In a direct action, the loss is to the shareholder directly, while in
a derivative suit, the loss to the shareholder is the result of a loss to the corporation.
3. Cohen v. Beneficial Industrial Loan Corp. (U.S. 1949). (Shareholder Derivative Suits’ Origin)
a. Facts. Plaintiff, shareholder, brought suit against corporation and its directors for
waste amounting to over $100,000,000. New Jersey had enacted a statute whose
general effect was to make a plaintiff having so small an interest (The plaintiff held
an approximated 0.0125% of the outstanding stock) liable for the reasonable
expenses and attorney’s fees of the defense if he fails to make good his complaint
and to entitle the corporation to indemnity before the case can be prosecuted.
b. Equity came to the relief of the stockholder, who had no standing to bring civil
action at law against faithless directors and managers. Equity, however, allowed
him to step into the corporation’s shoes and to seek in its right the restitution he
could not demand on his own.
(1) It required him first to demand that the corporation vindicate its own
rights, but when, as was usual, those who perpetrated the wrongs were
also able to obstruct any remedy, equity would hear and adjudge the
corporation’s cause through its stockholder with the corporation as a
defendant, albeit a rather nominal one.
c. Unfortunately, the remedy itself provided opportunity for abuse, which was not
neglected. Suits sometimes were brought not to redress real wrongs, but to
realize upon their nuisance.
d. A stockholder who brings suit on a cause of action derived from the corporation
assumes a position, not technically as a trustee perhaps, but one of a fiduciary
character. He sues, not for himself alone, but as representative of a class
comprising all who are similarly situated.
(1) The Federal Constitution does not oblige the state to place its litigating
and adjudicating processes at the disposal of such a representative, at least
without imposing standards of responsibility, liability and accountability
which it considers will protect the interests he elects himself to represent.
W e conclude that the state has plenary power over this type of litigation.
e. Due Process. A state may set the terms on which it will permit litigations in its
courts. No type of litigation is more susceptible of regulation than that of a
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fiduciary nature. And it cannot seriously be said that a state make such
unreasonable use of its power as to violate the Constitution when it provides
liability and security for payment of reasonable expenses if a litigation of this
character is adjudged unsustainable.
f. Equal Protection. W e do not think the state is forbidden to use the amount of
one’s financial interest, which measure his individual injury from the misconduct
to be redressed, as some measure of the good faith and responsibility of one who
seeks at his own election to act as custodian of the interests of all stockholders,
and as an indication that he volunteers for the large burdens of the litigation from
a real sense of grievance and is not putting forward a claim to capitalize personally
on it harassment value.
g. Erie Doctrine: Substantive or Procedural? Even if we were to agree that the New
Jersey statute is procedural, it would not determine that it is not applicable.
(1) This statute is not merely a regulation of procedure. W ith it or without
it the main action takes the same course. However, it creates a new
liability where none existed before, for it makes a stockholder who
institutes a derivative action liable for the expense to which he puts the
corporation and other defendants, if he does not make good his claims.
Such liability is not usual and it goes beyond payment of what we know
as “costs.” W e do not think a statute which so conditions the stockholder’s
actions can be disregarded by the federal court as a mere procedural device.
4. Eisenberg v. Flying Tiger Line, Inc. (2d Cir. 1971) 26
a. Cohen v. Beneficial Industrial Loan Corp. instructs that a federal court with diversity
jurisdiction must apply a state statute providing security for costs if the state court
would require the security in similar circumstances.
b. Derivative v. Individual. If the gravamen of the complaint is injury to the
corporation the suit is derivative, but “if the injury is one to the plaintiff as a
stockholder and to him individually and not to the corporation,” the suit is
individual in nature and may take the form of a representative class action.
Fletcher, Private Corporation § 5911.
c. Gordon v. Elliman Test. The test formulated by the majority in that case was
“whether the object of the lawsuit is to recover upon a chose in action belonging
directly to the stockholders, or whether it is to compel the performance of
corporate acts which good faith requires the directors to take in order to perform
a duty which they own to the corporation, and through it, to its stockholders.”
(1) Flying Tiger argues that if the directors had a duty not to merge the
corporation, that duty was owed to the corporation and only
derivatively to its stockholders.
(2) This test was condemned by commentators. It had the effect of
sweeping away the distinction between a representative and a derivative
action–in effect classifying all stockholder class actions as derivative. The
case has been limited to its facts by lower New York courts.
d. Lazare v. Knolls Cooperative Section No. 2, Inc. The court stated that security for
costs could not be required where a plaintiff “does not challenge acts of the
management on behalf of the corporation. He challenges the right of the present
management to exclude him and other stockholders from proper participation in
the affairs of the corporation. He claims that the defendants are interfering with
the plaintiff’s rights and privileges as stockholders.”
e. New York legislature, in its recodification of corporate statutes, added three
26
W hen a shareholder sues in his own capacity, as well as on behalf of other shareholders similarly situated,
the suit is not a derivative action but a class action. In effect, all of the members of the class have banded together
through a representative to bring their individual direct actions in one large direct action.
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words to the definition of derivative suits contained in § 626. Suits are now
derivative only if brought in the right of a corporation to procure a judgment “in
its favor.”
f. In routine merger circumstances the stockholders retain a voice in the operation
of the company, albeit a corporation other than their original choice.
(1) Here, however, the reorganization deprived him and other minority
stockholders of any voice in the affairs of their previously existing
operating company.
(2) Is it thus clear that Gordon is factually distinguishable from the instant
case. Moreover, a close analysis of other New York cases, the
amendment to § 626 and the other major treatises, lead us to conclude
that Gordon has lost its viability as stating a broad principle of law.
5. Special Injury Test. In Delaware, many courts long used the so-called “special injury test to
determine whether a suit was direct or derivative. A special injury was defined as a wrong
that “is separate and distinct from that suffered by other shareholders, ... or a wrong
involving a contractual right of a shareholder, such as the right to vote, or to assert
majority control, which exists independently of any right of the corporation.” Moran v.
Household Int’l, Inc. (Del. Ch. 1985).
a. Rejection of Special Injury Test. The Delaware Supreme Court rejected the special
injury test in favor of a two-pronged standard 27: (1) who suffered the alleged
harm, the corporation or the suing stockholders, individually; and (2) who would
receive the benefit of any recovery or other remedy, the corporation or the
stockholders, individually.
6. Settlement and Attorneys Fees
a. Settled Before Judgment. The corporation can pay the legal fees of the plaintiff and
of the defendants.
b. Judgment for Money Damages Imposed on Defendants. Except to the extent covered
by insurance, the defendants will be required to pay those damages and to bear
the cost of their defense as well.
(1) The corporation may pay the defendants’ expense only if the court
determines that “despite the adjudication of liability but in view of all
the circumstances of the case, [the defendant] is fairly entitled to
indemnity.”
7. Individual Recovery in a Derivative Action
a. Sometimes a court awards an individual recovery in a derivative action. In Lynch
v. Patterson (W yo. 1985), the trial court award the plaintiff damages as a individual
in the amount of 30 percent of $266,000, or $79,8000. The W yoming Supreme
Court upheld this judgment noting that “corporate recovery would simply return
the funds to the control of the wrongdoers.”
B. The Requirement of Demand on the Directors
1. Grimes v. Donald (Del. Sup. Ct. 1996).
a. Distinction Between Direct and Derivative Claims. Although the tests have been
articulated many times, it is often difficult to distinguish between a derivative and
an individual action. The distinction depends upon the nature of the wrong
alleged and the relief, if any, which could result if plaintiff were to prevail. 28
27
Tooley v. Donaldson, Lufkin & Jenrette (Del. 2004).
28
In Tooley v. Donaldson, Lufkin, & Jenrette, Inc. (Del. 2004), the Delaware Supreme Court clarified the
standard, holding that in determining whether a stockholder’s claim is derivative or direct, the issue must turn solely
on the following questions: (1) who suffered the alleged harm, the corporation or the suing stockholders, individually;
and (2) who would receive the benefit of any recovery or other remedy, the corporation of the stockholders,
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b. Abdication. Directors may not delegate duties which lie “at the heart of the
management of the corporation.” A court cannot give legal sanction to
agreements which have the effect of removing from directors in a very substantial
way their duty to use their own best judgment on management affairs.
(1) W ith certain exceptions, an informed decision to delegate a task is as
much an exercise in business judgment as any other. Likewise, business
decisions are not an abdication of directorial authority merely because
they limit a board’s freedom of future action. A board which has
decided to manufacture bricks has less freedom to decide to make
bottles. In a world of scarcity, a decision to do one thing will commit a
board to a certain course of action and make it costly and difficult
(indeed, sometimes impossible) to change course and do another. This
is an inevitable fact of life and is not an abdication of directorial duty.
(2) If an independent and informed board, acting in good faith, determines
that the services of a particular individual warrant large amounts of
money, whether in the form of current salary or severance provisions,
the board has made a business judgment decision.
(a) That judgment normally will receive the protection of the
business judgment rule unless the fact show that such amounts,
compared with the services to be received in exchange,
constitute waste or could not otherwise be the product of a
valid exercise of business judgment.
c. Demand Requirement. If a claim belongs to the corporation, it is the corporation,
acting through its board of directors, which must make the decision whether or
not to assert the claim. The derivative action impinges on the managerial
freedom of directors. The demand requirement is a recognition of the fundamental
precept that directors manage the business and affairs of the corporation.
(1) A stockholder filing a derivative suit must allege either that the board
rejected his pre-suit demand that the board assert the corporation’s claim
or allege with particularity why the stockholder was justified in not
having made the effort to obtain board action.
(a) Grounds for alleging with particularity that demand would be
futile:
i) Reasonable Doubt. “Reasonable doubt” 29 exists that
the board is capable of making an independent
decision to assert the claim if demand were made.
The basis for claiming excusal would normally be that:
a) A majority of the board has a material
financial or familial interest.;
b) A majority of the board is incapable of acting
independently for some other reason such as
domination of control; or
c) The underlying transaction is not the product
of a valid exercise of business judgment.
individually.
29
Some courts and commentators have questioned why a concept normally present in criminal prosecution
would find its way into derivative litigation. Yet the term is apt and achieves proper balance. Reasonable doubt can
be said to mean that there is reason to doubt. This concept is sufficiently flexible and workable to provide the
stockholder with “the keys to the courthouse” in an appropriate case where the claim is not based on mere suspicions
or state solely in conclusory terms.
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(2) Purposes of the Demand Requirement

(a) By requiring exhaustion of intracorporate remedies, the
demand requirement invokes a species of alternative dispute
resolution procedure which might avoid litigation altogether.
(b) If litigation is beneficial, the corporation can control the
proceedings.
(c) If demand is excused or wrongfully refused, the stockholder
will normally control the proceedings.
(3) W rongful Refusal Distinguished from Excusal. A stockholder who makes a
demand is entitled to know promptly what action the board has taken in
response to the demand. A stockholder who makes a serious demand
and receives only a peremptory refusal has the right to use the “tools at
hand” to obtain the relevant corporate records, such as reports or
minutes, reflecting the corporate action and related information in order
to determine whether or not there is a basis to assert that demand
wrongfully refused.
(a) The stockholder does not, by making demand, waive the right
to claim that demand has been wrongfully refused.
(b) Demand W aives Demand Excusal Argument. A stockholder who
makes a demand can no longer argue that demand is excused.
Permitting a stockholder to demand action involving only one
theory or remedy and to argue later that demand is excused as
to other legal theories or remedies arising out of the same set of
circumstances as set forth in the demand letter would create an
undue risk of harassment.
2. Marx v. Akers (N.Y. 1996).
a. New York Business Corporation Law § 626(c) provides that in any shareholders’
derivative action, “the complaint shall set forth with particularity the efforts of the
plaintiff to secure the initiation of such action by the board or the reasons for not
making such an effort.”
(1) Codified a rule of equity developed in early shareholder derivative
action requiring plaintiffs to demand that the corporation initiate an
action, unless such demand was futile, before commencing an action on
the corporation’s behalf.
(2) Purposes of the Demand Requirement. (1) relieve courts from deciding
matters of internal corporate governance by providing corporate
directors with opportunities to correct alleged abuses, (2) provide
corporate boards with reasonable protection from harassment by
litigation on matters clearly within the discretion of directors, and (3)
discourage “strike suits” commenced by shareholders for personal gain
rather than for the benefit of the corporation.
b. Various Approaches to the Demand Futility Exception:
(1) The Delaware Approach:
(a) The two branches of the Delaware test are disjunctive. Once
director interest has been established, the business judgment
rule becomes inapplicable and the demand excused without
further inquiry. Whether a board has validly exercise its
business judgment must be evaluated by determining whether
the directors exercised procedural (informed decisions) and
substantive (terms of the transactions) due care.
(2) Universal Demand
(a) W ould dispense with the necessity of making case-specific
determinations and impose an easily applied bright-line rule.
(3) New York’s Approach to Demand Futility
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(a) A demand would be futile if a complaint alleges with

particularity that:
i) A majority of the directors are interested in the
transaction, or
a) Director interest may either be self-interest in
the transaction at issue, or a loss of
independence because a director with no
direct interest in a transaction is “controlled”
by a self-interested director.
ii) The directors failed to inform themselves to a degree
reasonably necessary about the transactions, or
iii) The directors failed to exercise their business
judgment in approving the transaction.
c. A complaint challenging the excessiveness of director compensation must–to
survive a dismissal motion–allege compensation rates excessive on their face or
other facts which call into question whether the compensation was fair to the
corporation when approved, the good faith of the directors setting those rates, or
that a decision to set the compensation could not have been the product of valid
business judgment.
C. The Role of Special Committees 30
1. Auerbach v. Bennett (N.Y. 1979).
a. The business judgment rule does not foreclose inquiry by the courts into the
disinterested independence of those members of the board chosen by it to make
the corporate decision on its behalf–here the members of the special litigation
committee. Indeed the rule shields the deliberations and conclusions of the
chosen representatives of the board only if they possess a disinterest independence
and do not stand in a dual relation which prevents an unprejudicial exercise of
judgment.
b. Courts have consistently held that the business judgment rule applies where some
directors are charged with wrongdoing, so long as the remaining directors making
the decision are disinterested and independent.
c. The action of the special litigation committee comprised two components:
(1) First, there was the selection of procedures appropriate to the pursuit of
its charge.
(a) As to the methodologies and procedures best suited to the
conduct of an investigation of facts and the determination of
legal liability, the courts are well equipped by long and
continuing experience and practice to make determinations.
(b) W hile the court may properly inquire as to the adequacy and
appropriateness of the committee’s investigative procedures and
methodologies, it may not under the guise of consideration of
such factors trespass in the domain of business judgment.
i) At the same time those responsible for the procedures
by which the business judgment is reached may
responsibly be required to show that they have
pursued their chosen investigative methods in good
faith.
a) W hat evidentiary proof may be required to
this end will, of course, depend on the nature
of the particular investigation, and the proper
reach of disclosure at the instance of the
30
See also Handout/Chart
-54-
shareholders will relate inversely to the

showing made by the corporate
representatives themselves.
ii) Proof, however, that the investigation has been so
restricted in scope, so shallow in execution, or
otherwise so pro forma or halfhearted as to constitute a
pretext or sham, consistent with the principles
underlying the application of the business judgment
doctrine, would raise questions of good faith or
conceivably fraud which would never be shielded by
that doctrine.
(2) Second, there was the ultimate substantive decision, predicated on the
procedures chosen and the date produced thereby, not to pursue the
claims advanced in the shareholders’ derivative actions.
(a) The substantive decision falls squarely within the embrace of
the business judgment doctrine, involving as it did the
weighing and balancing of legal, ethical, commercial,
promotional, public relations, fiscal and other factors familiar to
the resolution of many if not most corporate problems.
2. Zapata Corp. v. Maldonado (Del. 1981).
a. Directors of Delaware corporations derive their managerial decision making
power, which encompasses decisions whether to initiate, or refrain from entering,
litigation from 8 Del.C. § 141(a).
(1) The business judgment rule, however, is a judicial creation that
presumes propriety, under certain circumstances, in a board’s decision.
Viewed defensively, it does not create authority. In this sense the
“business judgment” rule is not relevant in corporate decision making
until after a decision is made. It is generally used as a defense to an
attack on the decision’s soundness.
(2) The two, § 141(a) and the business judgment rule, are related because
the rule evolved to give recognition to the directors’ business expertise
when exercising their managerial power under § 141(a).
b. Right of a Plaintiff Stockholder in a Derivative Action. W e find that the Chancery
Court’s determination that a stockholder, once demand is made and refused,
possesses an independent, individual right to continue a derivative suit for
breaches of fiduciary duty over objection by the corporation, as an absolute rule,
is erroneous.
(1) The language in Sohland v. Baker relied on by the Vice Chancellor
negates the contention that the case stands for the broad rule of
stockholder right which evolved below. The Court therein stated that
“a stockholder may sue in his own name for the purpose of enforcing
corporate rights in a proper case if the corporation on the demand of the
stockholder refuses to bring suit.” Thus, the precise language only
supports the stockholder’s right to initiate the lawsuit. It does not
support an absolute right to continue to control it.
(2) In McKee v. Rogers, it was stated as a “general rule” that “a stockholder
cannot be permitted to invade the discretionary field committed to the
judgment of the directors and sue in the corporation’s behalf when the
managing body refuses. This rule is a well settled one.
(a) Should not be read so broadly that the board’s refusal will be
determinative in every case. Board members, owing a well-
established fiduciary duty to the corporation, will not be
allowed to cause a derivative suit to be dismissed when it
would be a breach of their fiduciary duty.
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(3) W rongful Board Refusal. A board decision to cause a derivative suit to be

dismissed as detrimental to the company, after demand has been made
and refused, will be respected unless it was wrongful. Absent a wrongful
refusal, the stockholder in such a situation simply lacks managerial
power.
(4) Demand Futility. A stockholder may sue in equity in his derivative right
to assert a cause of action in behalf of the corporation, without prior
demand upon the directors to sue, when it is apparent that a demand
would be futile, that the officers are under an influence that sterilizes
discretion and could not be proper persons to conduct the litigation.
c. W e see no inherent reason why the “two phases” of a derivative suit, the
stockholder's suit to compel the corporation to sue and the corporation's suit
should automatically result in the placement in the hands of the litigating
stockholder sole control of the corporate right throughout the litigation. To the
contrary, it seems to us that such an inflexible rule would recognize the interest of
one person or group to the exclusion of all others within the corporate entity.
(1) W hen should an authorized board committee be permitted to cause
litigation, properly initiated by a derivative stockholder in his own right,
to be dismissed? Even when demand is excusable, circumstances may
arise when continuation of the litigation would not be in the
corporation's best interests. Our inquiry is whether, under such
circumstances, there is a permissible procedure under s 141(a) by which
a corporation can rid itself of detrimental litigation. If there is not, a
single stockholder in an extreme case might control the destiny of the
entire corporation.
d. Delegation of Authority to Independent Committee. Section 141(c) allows a board to
delegate all of its authority to a committee. Accordingly, a committee with
properly delegate authority would have the power to move for dismissal or
summary judgment if the entire board did.
(1) Under an express provision of the statute, § 141(c), a committee can
exercise all of the authority of the board to the extent provided in the
resolution of the board. Moreover, at least by analogy to our statutory
section on interested directors, 8 Del.C. § 144, it seems clear that the
Delaware statute is designed to permit disinterested directors to act for
the board.
(a) Interested Board Majority/Independent Committee. W e do not
think that the interest taint of the board majority is per se a
legal bar to the delegation of the board's power to an
independent committee composed of disinterested board
members. The committee can properly act for the corporation
to move to dismiss derivative litigation that is believed to be
detrimental to the corporation's best interest.
e. Power of Derivative Suit to Continue In Face of Independent Committee’s Dismissal. It
appears desirable to us to find a balancing point where bona fide stockholder
power to bring corporate causes of action cannot be unfairly trampled on by the
board of directors, but the corporation can rid itself of detrimental litigation.
(1) The question has been treated by other courts as one of the “business
judgment” of the board committee. If a “committee, composed of
independent and disinterested directors, conducted a proper review of
the matters before it, considered a variety of factors and reached, in good
faith, a business judgment that the action was not in the best interest of
the corporation”, the action must be dismissed.
(a) W e are not satisfied, however, that acceptance of the “business
judgment” rationale at this stage of derivative litigation is a
-56-
proper balancing point

(2) W e thus steer a middle course between those cases which yield to the
independent business judgment of a board committee and this case as
determined below which would yield to unbridled plaintiff stockholder
control. In pursuit of the course, we recognize that “the final substantive
judgment whether a particular lawsuit should be maintained requires a
balance of many factors ethical, commercial, promotional, public
relations, employee relations, fiscal as well as legal.”
(a) Pre-trial motion by the independent committee to dismiss.
This will require a two-step inquiry by the court:
i) The independence and good faith of the committee
and the bases supporting its conclusion.
a) The corporation should have the burden fo
proving independence, good faith, and
reasonableness.
ii) Determine, applying its own independent business
judgment, whether the motion should be granted.
a) Intended to thwart instances where corporate
actions meet the criteria of step one, but the
result does not appear to satisfy its spirit, or
where corporate actions would simply
prematurely terminate a stockholder
grievance deserving of further consideration
in the corporation’s interest.
3. In re Oracle Corp. Derivative Litigation (Del. Ch. 2003).
a. Structural Bias. The Delaware court fully adopts the structural bias argument–the
criticism that the use of a committee of “independent” directors is that such
directors are not really “independent,” in a psychological sense.
b. The independent inquiry should not “ignore the social nature of humans.”
Corporate directors are “generally the sort of people deeply enmeshed in social
institutions,” and such directors should not be assumed to be “persons of unusual
social bravery, who operate heedless to the inhibitions that social norms generate
for ordinary folk.”
IV. The Role and Purposes of Corporations
A. A.P. Smith Mfg. Co. v. Barlow (N.J. 1953).
1. Facts. Stockholders objected the giving of $1,500 to Princeton University. The
corporation instituted a declaratory judgment action. The stockholders took the position
that (1) the plaintiff’s certificate of incorporation does not expressly authorize the
contribution and under common-law principles the company does not possess any implied
or incidental power to make it, and (2) the New Jersey statutes which expressly authorize
the contribution may not constitutionally be applied to the plaintiff, a corporation created
long before their enacted.
2. The common-law rule developed that those who managed the corporation could not
disburse any corporate funds for philanthropic or other worthy public cause unless the
expenditure would benefit the corporation.
a. In many instances such contributions have been sustained by the courts within the
common-law doctrine upon liberal findings that the donations tended reasonably
to promote the corporate objectives.
3. It seems to us that just as the conditions prevailing when corporations were originally
created required that they serve public as well as private interests, modern conditions
require that corporations acknowledge and discharge social as well as private
responsibilities as members of the community within which they operate.
4. New Jersey doctrine that although the reserved power permits alterations in the public
interest of the contract between the state and the corporation, it has no effect on the
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contractual rights between the corporation and its stockholder and between stockholders
inter se.
a. Although later cases have not disavowed the doctrine, it is noteworthy that they
have repeatedly recognized that where justified by the advancement of the public
interest the reserved power may be invoked to sustain later charter alterations
even though they affect contractual rights between the corporation and its
stockholders and between stockholder inter se.
b. State legislation adopted in the public interest and applied to preexisting
corporations under the reserved power has repeatedly been sustained by the
United States Supreme Court above the contention that it impairs the rights of
stockholders and violates constitutional guarantees under the Federal
Constitution.
B. Business Judgment Rule. The courts have been extremely tolerant in accepting the business judgment
of the officers and directors of corporation, including their business judgment about whether a
charitable donation will be good for the corporation in the long run.
C. Internal Affairs Rule. The basic rule of corporate choice of law in all states is that the law of the state
of incorporation controls on issues relating to a corporation’s “internal affairs,” which includes
responsibilities of directors to shareholders.
D. Dodge v. Ford Motor Co. (Mich. 1919).
1. Power of Court to Interfere in Declaring Dividend. It is a well-recognized principle of law that
the directors of a corporation, and they alone, have the power to declare a dividend of the
earnings of the corporation, and to determine its amount. Courts of equity will not
interfere in the management of the directors unless it is clearly made to appear that they are
guilty of fraud or misappropriation of the corporate funds, or refuse to declare a dividend
when the corporation has a surplus of net profits which it can, without detriment to its
business, divide among its stockholders, and when a refusal to do so would amount to such
an abuse of discretion as would constitute a fraud, or breach of that good faith which they
are bound to exercise towards the stockholders.
2. Purpose of Business Organization. A business corporation is organized and carried on
primarily for the profit of the stockholders. The powers of the directors are to be
employed for that end. The discretion of directors is to be exercised in the choice of
means to attain that end, and does not extend to a change in the end itself, to the
reduction of profits, or to the nondistribution of profits among stockholders in order to
devote them to other purposes.
3. W ithin Business Judgement. W e are not, however, persuaded that we should interfere with
the proposed expansion of the business of the Ford Motor Co. In the view of the fact that
the selling price of products may be increased at any time, the ultimate results of the larger
business cannot be certainly estimated. The judges are not business experts. It is
recognized that plans must often be made for a long future, for expected competition, for a
continuing as well as an immediately profitable venture. The experience of the Ford
Motor Co. is evidence of capable management of its affairs.
E. Shlensky v. W rigley (Ill. 1968).
1. It appears to us that the effect on the surrounding neighborhood might well be considered
by a director who was considering the patrons who would or would not attend the games
if the park were in a poor neighborhood.
2. The response which courts make to such applications is that it is not their function to
resolve for corporations questions of policy and business management. The directors are
chose to pass upon such questions and their judgment unless shown to be tainted with fraud is
accepted as final. The judgment of the directors of corporations enjoys the benefit of a
presumption that it was formed in good faith and was designed to promote the best
interests of the corporation.
C H A PTER F O U R : T H E L IM ITED L IABILITY C O M PA N Y
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I. Formation
A. History and Law of Limited Liability Companies
1. Recently Created Form of Bus. Org. Before 1988,31 the world of unincorporated business
organizations had two main players: ordinary general partnership and ordinary limited
partnerships.
a. Limited Liability Company. The first LLC statute was enacted in Wyoming. The
limited liability company is an alternative form of business organization that
combines certain features of the corporate form with others more closely
resembling general partnerships.
2. The Players. In an LLC the investors are called "members." Like the traditional
corporation, the LCC provides a liability shield for its members. It allows somewhat more
flexibility than the corporation in developing rules for management and control.
a. Member-Managed/Manager-Managed. Most LLC statutes dichotomize governance
between “member-managed” LLCs and “manager-managed” LLCs.
(1) Governance in a member-managed LLC resembles governance in a
general partnership. Governance in a manager-managed LLC resembles
governance in a limited partnership.32
b. Single-Member LLC. LLCs can be single-member LLCs (as can a corporation;
partnerships, by definition, cannot).
3. Formalities
a. Articles of Organization. The public filing of which will create the limited liability
company as a legal person.
(1) Most LLC statutes require the articles to state whether the LCC is
member-managed or manager-managed, a characterization that has
important power-to-bind implications. 33
(2) Arkansas’ default rule is that an LLC is member-managed.
b. Operating Agreement. Like a partnership agreement in a general or limited
partnership, an LLC’s operating agreement serves as the foundational contract
among the entity’s owners.
4. Tax Treatment
a. Corporations. Corporate stockholders face “double taxation” on any dividends
they receive.
(1) First, the corporation pays income tax on any profits it earns. Dividends
to shareholders are therefore made in “after-tax” dollars. Second,
dividends are then taxed as they are received by the shareholders.
b. Other Entities. Partnerships, LLCs, Subchapter S Corporations 34 are subject to
31
In 1988, the IRS issued Revenue Procedure 88-76 which classified a W yoming LLC as a partnership, and
caused legislatures around the country to consider seriously the LLC phenomenon.
32
The resemblance is not complete. For example, managers in a manager-managed LLC are not required
by statute to be members, although they usually are. In contrast, the managers of a limited partnership–i.e., the
general partners–are necessarily partners.
33
In a member-managed LLC, all members have the power to bind absent contrary agreement. In a
manager-managed LLC, managers have the power to bind while the members do not.
34
The following requirements must be for a corporation to elect to be taxed as a partnership: (1) for most
practical purposes, all shareholders must be either U.S. citizens or resident aliens; (2) the corporation cannot be a
certain business type or structure, including foreign corporations, a bank or savings and loan association, or an
insurance company; (4) there can only be one class of stock; and (5) there can be no more than 100 individual
shareholders, though certain tax-exempt entities such as employee stock ownership plans, pension plans, and charities
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“pass through” taxation–the business’ profits (whether distributed or not)

allocated and taxable directly to the members.
5. Limited Liability. Because a limited liability company is “an entity distinct from its
member,” its assets and obligations pertain legally to it and not to its members. As a result,
absent extraordinary circumstances, an LLC’s members are not answerable qua members
for the debts and other obligations of the LLC.
6. Permissible Purposes. At one time, most if not all LLC statutes required an LLC have a
business purpose35 , but the modern trend is to permit an LLC to have any lawful purpose.
“Any lawful purpose” language also permits an LLC to be organized for nonprofit
purposes.
7. Various LLC Acts
a. ABA Model Prototype LLC Act, adopted by Arkansas has many gaps and
ambiguities. The ABA has since promulgated a New Prototype Act.
b. Uniform Limited Liability Company Act (“ULLCA”), was only adopted by eight
states.
c. Revised Uniform Limited Liability Company Act (“RULLCA”) was approved in
2006.
(1) Arkansas Adoption? RULLCA was recently recommended by the
Arkansas Bar Associations’ Committee on Uniform State Laws to be
included in the legislative bar packet. The Board of Governors denied
this request. It is likely that in the future it will be adopted.
B. W ater, W aste & Land, Inc. d/b/a W estec v. Lanham (Colo. 1998).
1. Facts. Clark and Lanham were managers and members of the limited liability company
P.I.I. Clark contacted W estec about hiring it for eng. work for a dev. project known as
Taco Cabana. Clark gave his business card, which included Lanham’s address that was also
listed as the principal office and place of business in its art. of org., to representatives of
W estec. The letters P.I.I. appeared on the card but there was no indication as to what the
acronym meant or that it was an LLC. An oral agreement was reached on the project and
Clark asked W estec to send a written proposal, which W estec did. W estec never received
the contract but received verbal authorization from Clark to begin work. W estec
completed the work and billed Lanham. No payments were made.
2. The LLC has become a popular form of business organization because it offers member the
limited liability protection of a corporation, together with the single-tier tax treatment of a
partnership along with considerable flexibility in management and financing.
a. LLC Avoids Double Taxation. The ability to avoid two-levels of income taxation
[that is, a tax collected from a corporation on its income plus a tax collected from
the shareholders on dividend distributions by the corporation from the remaining
income] is an especially attractive feature of organization as a limited liability
company.
3. The district court’s analysis assumed that the LLC Act displaced certain common law
agency doctrines, at least insofar otherwise would be applicable to suits by third parties
seeking to hold the agents of a limited liability company liable for their personal actions as
agents.
a. W e hold, however, that the statutory notice provision applies only where a third
party seeks to impose liability on an LLC’s members or managers simply due to
their status as members or managers of the LLC. W here a third party sues a
manager or member of an LLC under an agency theory, the principles of agency
can be shareholders.
35
Partnerships, by definition, are formed for a business purpose (“association of two or more person to carry
on as co-owners a business for profit).
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law apply notwithstanding the LCC Act’s statutory notice rules.

4. Under the common law of agency, an agent is liable on a contract entered on behalf of a
principal if the principal is not fully disclosed. In other words, an agent who negotiates a
contract with a third party can be sued, for any breach of the contract unless the agent
discloses both the fact that he or she is acting on behalf of a principal and the identity of
the principal. 36
a. This somewhat counterintuitive proposition–that an agent is liable even when the
third party knows that the agent is acting on behalf of an unidentified
principal–has been recognized as sound by the courts of this state, and it is well
established rule under the common law.
b. W hether a principal is partially or completely disclosed is a question of fact.
c. W e conclude, however, that the LLC Act’s notice provision was not intended to alter the
partially disclosed principal doctrine.
(1) Section 7-80-208 states: “The fact that the articles of organization are on
file in the office of the secretary of state is notice that the limited liability
company is a limited liability company and is notice of all other facts set
forth therein which are required to be set forth in the articles of
organization.”
(a) In order to relieve Lanham of liability, this provision would
have to be read to establish a conclusive presumption that a
third party who deals with the agent of a limited liability
company always has constructive notice of the existence of the
agent’s principal. W e are not persuaded that the statute can
bear such an interpretation.37
i) Exaggerates Plain Meaning. The statute could be read
to state that third parties who deal with a limited
liability company are always on constructive notice of
the company’s limited liability status, without regard
to whether any part of the company’s name or even
the fact of its existence has been disclosed. However,
an equally plausible interpretation of the words used
in the statute is that once the limited liability
company’s name is known to the third party,
constructive notice of the company’s limited liability
has been given, as well as the fact that managers and
members will not be liable simply due to their status as
managers or members.
ii) Invitation to Fraud. It would leave the agent of a
limited liability company free to mislead third parties
into the belief that the agent would bear personal
financial responsibility under any contract.
36
“If both the existence and identity of the agent’s principal are fully disclosed to the other party, the agent
does not become a party to any contract which he negotiates. But where the principal is partially disclosed (i.e., the
existence of a principal is known but his identity is not), it is usually inferred that the agent is a party to the contract.”
Reuchlein and Gregory, The Law of Agency and Partnership § 118 (2d ed. 1990).
37
Other LLC Act provisions reinforce the conclusion that the legislature did not intend the notice language
of § 7-80-208 to relieve the agent of a limited liability company of the duty to disclose its identity in order to avoid
personal liability. For example, § 7-80-201(1) requires limited liability companies to use the words “Limited Liability
Company” or the initials “LLC” as part of their names, implying that the legislature intended to compel any entity
seeking to claim the benefits of the LLC Act to identify itself clearly as a limited liability company.
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iii) Derogation of the Common Law. Statutes in derogation

of the common law are to be strictly construed.
5. The “missing link” between the limited disclosure made by Clark and the protection of
the notice statute was the failure to state that “P.I.I.,” the Company, stood for “Preferred
Income Investors, LLC.”
II. The Operating Agreement
A. Elf Atochem North America, Inc. v. Jaffari (Del. 1999).
1. Facts. Elf manufactured solvent-based maskants to the aerospace and aviation industries.
Jaffari was the president of Malek, Inc., which developed environmentally-friendly
solvent-based maskants. The EPA soon classified solvent-base maskants as hazardous
chemicals and Elf began looking for alternatives. They found Malek. Elf approached
Malek and Jaffari, finding the offer attractive, caused Malek LLC to be formed in
Delaware.38 The parties then entered into a series of agreements, of which Malek LLC
was not a signatory of, which included an Exclusive Distributorship Agreement, that Jaffari
would manage Malek, and that Jaffari would be the CEO of Malek. Elf contributed $1
million for a 30 percent interest, while Malek, Inc. contributed its rights to the maskant for
a 70 percent interest. The Agreement also contained an arbitration clause and forum
selection clause. In 1998, Elf sued Jaffari and Malek LLC, individually and derivatively
alleging breach of fiduciary duties, breach of contract, tortious interference with
prospective business relations, and fraud. The Del. Court of Chancery dismissed citing
lack of subject matter jurisdiction because of the Agreement’s arbitration clause.
2. The Limited Liability Company and Flexibility. The Delaware LCC Act was adopted in
October 1992. The LCC is an attractive form of business entity because it combines
corporate-type limited liability with partnership-type flexibility and tax advantages. The
Act can be characterized as a “flexible statute” because it generally permits members to
engage in private ordering with substantial freedom of contract to govern their
relationship, provided they do not contravene any mandatory provisions of the Act.
a. LLC Act Modeled on LP Act. The Delaware Act has been modeled on the popular
Delaware LP Act. In fact, its architecture and much of its wording is almost
identical to that of the Delaware LP Act. Under the Act, a member of an LLC is
treated much like a limited partner under the LP Act. The police of freedom of
contract underlies both the Act an the LP Act.
3. Basic Approach. The basic approach of the Delaware Act is to provide members with broad
discretion in drafting the Agreement and to furnish default provisions when the members’
agreement is silent. The Act is replete with fundamental provisions made subject to
modification in the Agreement (e.g., “unless otherwise provided in a limited liability
company agreement . . .”).
4. Section 18-1101(b) of the Act, like the essentially identical Section 17-1101(c) of the LP
Act, provides that “[i]t is the policy of [the Act] to give the maximum effect to the
principle of freedom of contract and to the enforceability of limited liability company
agreements.”
a. In General, Only Mandatory Provisions Trump Agreement. In general, the
commentators observe that only where the agreement is inconsistent with
mandatory statutory provisions will the members’ agreement be invalidated.
Such statutory provisions are likely to be those intended to protect third parties,
not necessarily the contracting members.
5. Malek LLC Not a Signatory to Agreement? Section 18-101(7) defines the limited liability
company as “any agreement, written or oral, of the member or members as to the affairs of
38
The certificate of formation is a relatively brief and formal document that is the first statutory step in
creating the LLC as a separate legal entity. The certificate does no contain a comprehensive agreement among the
parties, and the statute contemplates that the certificate of formation is to be complemented by the terms of the
Agreement.
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a limited liability company and the conduct of its business.”

a. The Act is a statute designed to permit members maximum flexibility in entering
into an agreement to govern their relationship. It is the members who are the
real parties in interest. The LLC is simply their joint business vehicle. This is the
contemplation of the statute in prescribing the outlines of a limited liability
company agreement.
6. Derivative Nature of Suit Irrelevant. Although Elf correctly points out that Delaware law
allows for derivative suits against management of an LLC, Elf contracted away its right to
bring such an action in Delaware an agreed instead to dispute resolution in California. 39
a. The Agreement does not distinguish between direct and derivative claims. They
simply state that the members may not initiate any claims outside of California.
7. Court of Chancery “Special Jurisdiction” Notwithstanding Agreement? Elf is correct that
Delaware statutes vest jurisdiction with the Court of Chancery in actions involving
removal of managers and interpreting, applying or enforcing LLC agreements respectively.
Such a grant of jurisdiction may have been constitutionally necessary if the claims do not
fall within the traditional equity jurisdiction.
a. Merely a Default Provision Modifiable By Agreement. Nevertheless, for the purpose
of designating a more convenient forum, we find no reason why the members
cannot alter the default jurisdictional provisions of the statute and contract away
their right to file suit in Delaware.
b. Conclusion is bolstered by the fact that Delaware recognizes a strong public
policy in favor of arbitration. Normally, doubts on the issue of whether a
particular issue is arbitrable will be resolved in favor of arbitration.
III. Piercing the “LLC” Veil
A. Kaycee Land and Livestock v. Flahive (W yo. 2002).
1. Facts. Flahive Oil & Gas was a W yoming LLC, of which Roger Flahive was the manager,
and possessed no assets at the time of litigation. Kaycee had entered into a contract with
Flahive to use the surface of its real property. However, Kaycee alleged that the property
had been contaminated by Flahive and sought to pierce the veil of the LLC and hold
Roger Flahive personally liable for the contamination.
2. Piercing is an Equitable Doctrine. We have long recognized that piercing is an equitable
doctrine. The concept developed through common law and is absent from the statutes
governing corporate organization.
3. Corporation Act’s Language v. LLC Act’s Language. Section 17-16-622(b)–a provision from
the Model Business Corporation Act–reads: “Unless otherwise provided in the articles of
incorporation, a shareholder of 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.”
a. The LCC statute reads “Neither the members of a limited liability company nor
the managers of a limited liability company managed by a manager are liable
under a judgment, decree or order of a court, or in any other manner, for a debt,
obligation or liability of the limited liability company.” § 17-15-113.
(1) However, we agree with the commentary that; “It is difficult to read
statutory § 17-15-113 as intended to preclude courts from deciding to
disregard the veil of an improperly used LLC.” Gelb, Liabilities of
Members and Managers of W yoming Limited Liability Companies, 31 Land &
W ater L. Rev. 133 (1996).
(2) W yoming’s statute is very short and establishes only minimal
requirements for creating and operating LLCS. It seems highly unlikely
39
Section 13.8 of the Agreement specifically provided that the parties (i.e., Elf) agreed to institute, “[n]o
action at law or in equity based upon any claim arising out of or related to this Agreement” except as action to
compel arbitration or to enforce an arbitration award.
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that the W yoming legislature gave any consideration to whether the

common-law doctrine of piercing the veil should apply to the liability
limitation granted by that fledgling statute.
(a) It is true that some other states have adopted specific legislation
extending the doctrine to LLCs while Wyoming has not.
However, that situation seems more attributable to the fact that
W yoming was a pioneer in the LLC arena and states which
adopted LLC statutes much later had the benefit of years of
practical experience during which this issue was likely raised.
(3) It stands to reason that, because it is an equitable doctrine, “[t]he paucity
of statutory authority for LLC piercing should not be considered a
barrier to its application.” Lack of explicit statutory language should not
be considered an indication of the legislature’s desire to make LLC
members impermeable.
b. W e can discern no reason, in either law or policy, to treat LLCs differently than
we treat corporations. If the members and officers of an LLC fail to treat it as a
separate entity as contemplated by statute, they should not enjoy immunity from
individual liability for the LLC’s acts that cause damage to third parties.
IV. Fiduciary Obligation
A. McConnell v. Hunt Sports Enterprises (Oh. 1999).
1. Facts. Columbus Hockey Limited LLC (CHL), of which McConnell and Hunt were
investors, was formed to seek an NHL team in Columbus, OH. In order to secure a
franchise, CHL sought public financing for an arena but taxpayers rejected a sales tax
increase. Nationwide Insurance then expressed a desire to build an arena and lease it. A
lease proposal was extended but reject by Hunt. McConnell, however, stated that if Hunt
would not agree, he would. Relying on this backup offer, the NHL expansion committee
recommended Columbus be awarded a team. Hunt and his allies still found the lease
unacceptable while McConnell and his allies accepted the lease and signed an agreement in
their own names. McConnell’s group filed suit asking for a declaratory judgment to
establish its right to the franchise without the inclusion of Hunt or CHL. A directed
verdict was granted to McConnell.
2. The term “fiduciary relationship” has been defined as a relationship in which special
confidence and trust is reposed in the integrity and fidelity of another, and there is a
resulting position of superiority and influence acquired by virtue of this special trust.
a. In the case at bar, a limited liability company is involved which, like a
partnership, involves a fiduciary relationship. Normally, the presence of such a
relationship would preclude direct competition between members of the
company. However, we have an operating agreement that by its very terms allows
members to compete with the business of the company.
3. Issue. W hether an Operating Agreement of an LLC May Limit or Define Scope of
Fiduciary Duty?
a. In becoming members of CHL, appellant and appellees agreed to abide by the
terms of the operating agreement, and such agreement specifically allowed
competition with the company by its members. As such, the duties created
pursuant to such undertaking did not include a duty not to compete. Therefore,
there was no duty on the part of appellees to refrain from subjecting appellant to
the injury complained of herein.
b. In so concluding, we are not stating that no act related to such obtaining could be
considered a breach of fiduciary duty. In general terms, members of limited
liability companies owe one another the duty of utmost trust and loyalty.
However, such general duty in this case must be considered in the context of
members’ ability, pursuant to operating agreement, to compete with the
company.
4. Tortious Interference with a Business Relationship. Tortious interference with a business
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relationship occurs when a person, without a privilege to do so, induces or otherwise

purposely causes a third person not to enter into or continue a business relationship with
another.
a. The evidence does not show that appellees induced or otherwise purposely
caused Nationwide and the NHL not to enter into or continue a business
relationship with appellant. Indeed, the evidence shows McConnell stated he
would lease the arena and obtain the franchise only if appellant did not. It was
only after appellant rejected the lease proposal on several occasions that
McConnell stepped in.
5. Breach of Contract Claim Against Hunt for Unilateral Rejection/Failure to Negotiate in Good
Faith. There was no evidence at trial that appellant was the operating member of CHL.
The operating agreement, which sets forth the entire agreement between the members of
CHL, does not name any person or entity the operating or managing member of CHL.
a. Section 4.1(b) of the operating agreement requires at least a majority approval
prior to taking any action on behalf of CHL. Further, the approval of the
members as to any action on behalf of CHL must have been evidenced by
minutes of a meeting properly notice and held or by an action in writing signed
by the requisite number of members.
b. Section 4.4's provision, relating to liability only for wilful misconduct, are in the
context of member carrying out their duties under the operating agreement.
There was no duty on appellant’s part to unilaterally file the actions at issue.
B. K.C. Properties v. Lowell (Ark. 2008)
1. Simplified Facts. A and B set up a Limited Liability Company (LLC) called ABLLC to
construct and operate a water park. They sign an operating agreement. ABLLC is a
manager-managed LLC, and B is the manager. A owns a 49% membership interest in the
LLC, and B owns a 51% interest. B also owns Blackacre, the land that the parties intend to
acquire for the LLC, on which the water park is to be built. Although ABLLC has no
written contract to purchase Blackacre, the parties' intentions are undisputed. B, as
manager, acting on behalf of ABLLC, even makes a contract with a contractor owned by
A to construct the water park on Blackacre. At the same time that these negotiations and
transactions between A and B are taking place, B is secretly negotiating to sell Blackacre to
a third party for a higher price. And that is what she does, without informing A in advance
of her decision to do so. A responds by suing B for damages for breach of fiduciary duty.
2. § 4-32-402. Liability to Company; Duties
Unless otherwise provided in an operating agreement:
(1) A member or manager shall not be liable, responsible, or accountable in damages or
otherwise to the limited liability company or to the members of the limited liability company
for any action taken or failure to act on behalf of the limited liability company unless the act
or omission constitutes gross negligence or willful misconduct; [and]
(2) Every member and manager must account to the limited liability company and hold as
trustee for it any profit or benefit derived by that person without the consent of more than
one-half (1/2) by number of the disinterested managers or members, or other persons
participating in the management of the business or affairs of the limited liability company,
from any transaction connected with the conduct or winding up of the limited liability
company or any use by the member or manager of its property, including, but not limited
to, confidential or proprietary information of the limited liability company or other matters
entrusted to the person as a result of his or her status as manager or member...
3. The court relied on subsection (1) of the statute to hold that K.C. Properties could not sue
anyone except Ozark's other member, LIP, and Ozark's manager, PMS. The court then
observed that neither LIP nor PMS sold the 34 acres to another party, and therefore
“neither PMS nor LIP committed any act or failure to act constituting gross negligence or
willful misconduct for which they could be held liable under § 4-32-402(1).
4. Court Pinned Decision on Duty of Care. W hat is remarkable is that the court pinned its
rejection of the breach of fiduciary duty claim solely on subsection (1) of Arkansas Code
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Annotated section 4-32-402. Subsection (1) of the statute addresses only the fiduciary duty
of care.
a. Court Should Have Looked to the Duty of Loyalty. As is evident from the fact that
they were on both the buy side and the sell side of the planned transaction in this
case, the individual defendants were engaged in self-interested behavior.
Therefore, it is the other principal fiduciary duty— the duty of loyalty— that was
at issue. The duty of loyalty is addressed by subsection (2) of Arkansas Code
Annotated section 4-32-402, set out above. Again, quoting from the drafters of
the Prototype Act, “Subsection [(2)], which is based on UPA § 21, sets forth the
duty of loyalty of LLC managers and managing members— that is, the duty to act
without being subject to an obvious conflict of interest . . . .”
b. Analogous to Limited Partnership Law. In In re USACafes, a Delaware court held
that the directors of the corporate general partner owed some degree of fiduciary
duty directly to the limited partners. W hile the court did not define the limits of
the directors' obligation, it concluded that “it surely entails the duty not to use
control over the partnership's property to advantage the corporate director at the
expense of the partnership.”
V. Dissolution
A. New Horizons Supply Cooperative v. Haack (W is. App. 1999)
1. Facts. Kickapoo Valley Freight, LLC was the “Patron” under a Cardtrol Agreement issued
by New Horizon’s predecessor. Kickapoo agreed to be responsible for all fuel purchased
with the card. The agreement was signed by Haack with no indication of whether she was
signing individually or in a representative capacity. The account soon was in arrears and
when contacted about payment, Haack said she would pay $100 per month but no
payment was ever received. Haack was contacted again but Haack inform New Horizons
that Kickapoo had dissolved and that she was a partner and that Robert, her brother, had
moved out of state and that she would begin payments. No payment was ever received
and subsequent attempts to collect payment proved fruitless. Horizons instituted an action
to recover against Haack.
2. Members of LLCs Not Personally Liable. W is. Stat. § 183.0304 provides that “a member of
manager of a limited liability company is not personally liable for any debt, obligation or
liability of the limited liability company.”
a. May Borrow From Common Law Corporation Principles. W is. Stat. § 183.0304(2)
provides: “Notwithstanding sub. (1) [which sets forth the limitation on member
liability], nothing in this chapter shall preclude a court from ignoring the limited
liability company entity under principles of common law of this state that are
similar to those applicable to business corporations and shareholders in this state
and under circumstances that are not inconsistent with the purposes of this
chapter.”
3. The court disagrees with the trial court’s comments that implied that it erroneously
deemed Kickapoo Valley’s treatment as a partnership for tax purposes to be conclusive.
There is little in the record, moreover, to support a conclusion that Haack “organized,
controlled and conducted” company affairs to the extent that it had “no separate existence
which she “used to evade an obligation, to gain an unjust advantage or to commit an
injustice.”
a. Defendant Failed to Shield Herself After Dissolution. Rather we conclude that entry
of judgment against Haack on the claim was proper because she failed to establish
that she took appropriate steps to shield herself from liability for the company’s
debts following its dissolution and the distribution of its assets.
(1) The record is devoid of any evidence showing that appropriate steps
were taken upon the dissolution of the company to shield its members
from liability for the entity’s obligations.
(a) A dissolved limited liability company may “dispose of known
claims against it” by filing articles of dissolution, and then
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providing written notice to its known creditors containing

information regarding the filing of claims. W is. Stat. §
183.0907.
(b) W is. Stat. § 183.0909 provides that a claim not barred under §
183.0907 or 183.0908 may be enforced under this section
against any of the following:
i) “If the dissolved limited liability company’s assets have
been distributed in liquidation, a member of the
limited liability company to the extent of the
member’s proportionate share of the claim or to the
extent of the assets of the limited liability company
distributed to the member in liquidation, whichever is
less, but a member’s total liability for all claims under
this section may not exceed the total value of assets
distributed to the member in liquidation.”
C H A PTER F IVE : T H E D U TIES O F O FFIC ERS , D IR EC TO R S , A N D O TH ER I N SIDER S
I. The Obligations of Control: Duty of Care
A. Kamin v. American Express Company (N.Y. 1976).
1. Facts. The shareholders’ derivative action complaint alleges that in 1972, AmEx acquired
nearly 2 million shares of DLJ for $30 million. It was alleged that the market value of
those shares was only $4 million. In 1974, AmEx declared a special dividend to distribute
shares of DLJ in kind. A sale of the DLJ shares on the market would sustain a capital loss
of $25 million which would be an offset against taxable capital gains on other investments.
The plaintiffs demanded that the directors rescind the distribution and take steps to
preserve the capital loss. This was rejected by the Board of Directors.
2. Grounds for a Claim for Actionable W rongdoing. In actions by stockholders, which assail the
acts of their directors or trustees, courts will not interfere unless the powers have been
illegally or unconscientiously executed; or unless it be made to appear that the acts were
fraudulent or collusive, and destructive of the rights of the stockholders. Mere errors of
judgment are not sufficient as grounds for equity interference, for the powers of those
entrusted with corporate managements are largely discretionary.
3. Business Judgment for Declaring Dividend. Courts will not interfere with such discretion
unless it be first made to appear that the directors have acted or are about to act in bad
faith and for a dishonest purpose. It is for directors to say, acting in good faith of course,
when and to what extent dividends shall be declared. The statute confers upon the
directors this power, and the minority stockholders are not in a position to question this
right, so long a the directors are acting in good faith.
4. Merely Alleging Better Course of Action Insufficient. A complaint must be dismissed if all that
is presented is a decision to pay dividends rather than pursuing some other course of
conduct. A complaint which alleges merely that some course of action other than that
pursued by the Board of Directors would have been more advantageous gives rise to no
cognizable cause of action.
a. The directors’ room rather than the courtroom is the appropriate forum for
thrashing out purely business questions which will have an impact on profits,
market prices, competitive situations, or tax advantages.
5. The statute permits an action against directors for “the neglect of, or failure to perform, or
other violation of his duties in the management and disposition of corporate assets
committed to his charge.”
a. Improper Decision Insufficient for Neglect. This does not mean that a director is
chargeable with ordinary negligence for having made an improper decision, or
having acted imprudently. The “neglect” referred to in the statute is neglect of
duties (i.e., malfeasance or nonfeasance) and not misjudgment. To allege that a
director “negligently permitted the declaration and payment of a divided without
alleging fraud, dishonesty or nonfeasance, is to state merely that a decision was
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take with which on disagrees.

b. Courts will not interfere unless a clear case is made out of fraud, oppression,
arbitrary action, or breach of trust.
(1) If the business judgment rule is overcome then the court will determine
if the decision was fair to the corporation.
B. Smith v. Van Gorkom (Del. 1985).
1. The court recited a litany of errors by a board composed of five management directors and
five eminently qualified outside directors. According to the court, the directors had failed
to inquire into Van Gorkom’s role in setting the merger’s terms; failed to review the
merger documents; had not inquired into the fairness of the $55 price and the value of the
company’s significant, but unused, investment tax credits; accepted without inquiry the
view of the company’s chief financial officer (Romans) that the $55 price was within a fair
range; had not sought an outside opinion from an investment bank on the fairness of the
$55 price; and acted at a two-hour meeting without prior notice and without there being
an emergency.
2. Under Delaware law, the business judgment rule is the offspring of the fundamental
principle that the business and affairs of a Delaware corporation are managed by or under
its board of directors.
a. The rule itself is a presumption that in making a business decision, the directors of
a corporation acted on an informed basis, in good faith and in the honest belief
that the action taken was in the best interest of the company.
(1) Thus, the party attacking a board decision as uninformed must rebut the
presumption that its business judgment was an informed one.
b. The determination of whether a business judgment is an informed one turns on
whether the directors have informed themselves prior to making a business
decision, of all material information reasonably available to them.
(1) In the specified context of a proposed merger of domestic corporations,
a director has a duty, along with his fellow directors, to act in an
informed and deliberate manner in determining whether to approve an
agreement of merger before submitting the proposal to the stockholders.
Certainly in the merger context, a director may not abdicate that duty
by leaving to the shareholders alone the decision to approve or
disapprove the agreement.
C. Legislative Response to the Decision. Del. Gen. Corp. Law § 102(b)(7) was adopted after the Van
Gorkom decision and the so-called D&O liability insurance crisis. This new law allowed a provision
in a corporation’s articles of incorporation that limited directors’ liability 40:
A provision eliminating or limiting the personal liability of a director to the corporation to its
stockholders for monetary damages for breach of fiduciary duty as a director, provided that such
provision shall not eliminate or limit the liability of a director: (i) For any breach of the director’s duty
of loyalty to the corporation or its stockholders; (ii) For acts or omissions not in good faith or which
involve intentional misconduct or a knowing violation of law; (iii) Under § 174 of this title [relating
to payment of dividends]; or (iv) for any transaction from which the director derived an improper
personal benefit
D. Francis v. United Jersey Bank
1. Directors Generally Afforded Immunity. Individual liability of a corporate director for acts of
the corporation is a prickly problem. Generally, directors are accorded broad immunity
and are not insurers of corporate activities. The problem is particular nettlesome when a
third party asserts that a director, because of nonfeasance, is liable for losses caused by acts
of insiders, who in this case were officers, directors, and shareholders,
40
Del. Gen. Corp. Law 102(b)(7) does not permit the reduction of liability for any breach of the duty of
loyalty or for any acts or omissions not in good faith or which involve intentional misconduct or knowing violations
of the law.
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2. Duty, Breach, and Causation. Determination of the liability of Pritchard requires findings
that she had a duty to the clients of Pritchard & Baird, that she breached that duty and that
her breach was a proximate cause of their losses.
3. New Jersey Business Corporation Act makes it incumbent upon directors to “discharge
their duties in good faith and with that degree of diligence, care and skill which ordinarily
prudent men would exercise under similar circumstances in like positions.”
a. Degree of Care Dependent on Business Type. Courts have espoused the principle
that directors owed that degree of care that a business of ordinary prudence
would exercise in the management of his own affairs. In addition to requiring
that directors act honestly and in good faith, the New York courts recognized
that the nature and extent of reasonable care depended upon the type of
corporation, it size and its financial resources.
4. Director Must Be Knowledgeable. As a general rule, a director should acquire at least a
rudimentary understanding of the business of the corporation. Accordingly, a director
should become familiar with the fundamentals of the business in which the corporation is
engaged.
a. Because directors are bound to exercise ordinary care, they cannot set up as a
defense lack of the knowledge needed to exercise the requisite degree of care.
b. Directors are under a continuing obligation to keep informed about the activities
of the corporation.
(1) May not shut their eyes to corporate misconduct and then claim that
because they did not see the misconduct, they did not have a duty to
look.
c. Directorial management does not require a detailed inspection of day-to-day
activities, but rather a general monitoring of corporate affairs and policies.
(1) Should maintain familiarity with the financial status of the corporation
by a regular review of financial statements.
5. Immunity from Reliance in Good Faith. Generally, directors are immune from liability if, in
good faith:
a. “They rely upon the opinion of counsel for the corporation or upon written
reports setting forth financial data concerning the corporation and prepared by an
independent public accountant or certified public accountant or firm of such
accountants or reports of the corporation represented to them to be correct by the
president, the officer of the corporation having charge of its books of account, or
the person presiding at a meeting of the board.:”
6. Duty to Object & Resign. Upon discovery of an illegal course of action, a director has a
duty to object and, if the corporation does not correct the conduct, to resign.
a. Sometimes more may be required, such as seeking advice of counsel or
preventing illegal conduct by co-directors. This may include threat of suit.
7. Fiduciary Relationship. In general, the relationship of a corporate director to the
corporation and its stockholders is that of a fiduciary.
a. W hile directors may own a fiduciary duty to creditors also, that obligation
generally has not been recognized in the absence of insolvency.
8. Causation. Usually, a director can absolve himself from liability by informing the other
directors of the impropriety and voting for a proper course of action. Conversely, a
director who votes for or concurs in certain actions may be liable to the corporation for
the benefit of its creditors or shareholders, to the extent of any injuries suffered by such
persons, as a result of any such action.
a. A director who is present at a board meeting is presumed to concur in corporate
action taken at a meeting unless his dissent is entered in the minutes of the
meeting or filed promptly after adjournment.
II. Duty of Loyalty
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A. Directors and Managers

1. Bayer v. Beran (N.Y. 1944).
a. Facts. In 1942, Celanese began a radio advertising campaign costing about $1
million a year. It was claimed that the advertising was really merely a vehicle to
launch the career of Miss Jean Tennyson, in real life Mrs. Camille Dreyfus, wife
of the president of the company. Before ‘42 the company had never advertised
on radio. However, in 1937, the FTC promulgated new regulations requiring
celanese products to be designated and labeled rayon. Thus, the directors became
concerned with how to distinguish their product on the market.
b. Business Judgment Rule. “Question of policy and management, expediency of
contracts or action, adequacy of consideration, lawful appropriation of corporate
funds to advance corporate interests, are left solely to their honest and unselfish
decision, for their power therein are without limitation and free from restraint,
and the exercise of them for the common and general interests of the corporation
may not be questioned, although the results show that what they did was unwise
and inexpedient.”
(1) It is only in a most unusual and extraordinary case that directors are held
liable for negligence in the absence of fraud, or improper motive, or
personal interest.
c. Business Judgment Rule Subject to Duty of Loyalty. The business judgment rule,
however, yields to the rule of undivided loyalty. This great rule of law is
designed to avoid the possibility of fraud and to avoid the temptation of self-
interest. It is designed to obliterate all divided loyalties which may creep into a
fiduciary relation.
(1) Such personal transactions of directors with their corporation, such
transactions as may tend to produce a conflict between self-interest and
fiduciary obligation, are, when challenged, examined with the most
scrupulous care, and if there is any evidence of improvidence or
oppression, any indication of unfairness or undue advantage, the
transactions will be voided.
(2) Their dealings with the corporation are subjected to rigorous scrutiny
and where any of their contracts or engagements are challenged the
burden is on the director not only to prove the good faith of the
transaction but also to show its inherent fairness from the viewpoint of
the corporation and those interested therein.
d. Not Improper to Appoint Relative But Action Closely Scrutinized. Of course it is not
improper to appoint relative of officers or directors to responsible positions in a
company. But where a close relative of the chief executive officer of a
corporation, and one of its dominant directors, takes a position closely associated
with a new and expensive field of activity, the motives of the director are likely
to be questioned.
(1) The board would be placed in a position where selfish, personal interests
might be in conflict with the duty owed to the corporation. That being
so, the entire transaction, if challenged in the courts, must be subjected
to the most rigorous scrutiny to determine whether the action of the
directors was intended or calculated to subserve some outside purpose,
regardless of the consequences to the company, and in a manner
inconsistent with its interests.
(a) The evidence fails to show that the program was designed to
foster or subsidize the career of Miss Tennyson as an artist or to
furnish a vehicle for her talents. That her participation in the
program may have enhanced her prestige as a singer is no
ground for subjecting the directors to liability, as long as the
advertising served a legitimate purpose and a useful corporate
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purpose and the company received the full benefit thereof.

e. Directors Acting Separately Cannot Bind Corp. The general rule is that the directors
acting separately and not collectively as a board cannot bind the corporation.
There are two reasons for this: First, that collective procedure is necessary in
order that action may be deliberately taken after an opportunity for discussion and
an interchange of views. Second, that directors are agents of the stockholders and
are given by law no power to act except as a board.
(1) Liability may not, however, be imposed on directors because they failed
to approve the radio program by resolution at a board meeting.
(a) Failure to Meet Formalities Not Fatal. The failure to observe the
formal requirements is by no means fatal. The directorate of
this company is composed largely of its executive officers. It is
a close, working directorate. Its members are in daily
association with one another and their full time is devoted to
the business of the company with which they have been
connected for many years. This same informal practice
followed in this transaction had been the customary procedure
of the directors in acting on corporate projects of equal or
greater magnitude. W hile a greater degree of formality should
undoubtedly be exercised in the future, it is only just and proper to
point out that these directors, with all their loose procedure, have done
very well for the corporation.
2. Benihana of Tokyo, Inc. v. Benihana, Inc. (Del. 2006).
a. Facts. The Benihana Protective Trust (BOT) owned 50.9% of Common stock 41
(1 vote per share/75% of directors) and 2% of Class A stock (1/10 vote per
share/25% of directors). In 2003, Aoki, founder of Benihana, married Keiko.
Conflicts arose between Aoki and his children because of a change in his will that
gave his new wife control upon his death. Benihana’s president discussed the
situation with another director. Benihana was also undertaking a Construction
and Renovation Plan however capital was insufficient. A plan was formed to
issue convertible preferred stock 42 to provide funds and put the company in a
better negotiating position. One of the directors, Abdo, was also a director of
BFC. Three other offers were obtained but were deemed inferior to BFC’s.
BFC executed a Stock Purchase Agreement with Benihana.
b. Safe Harbor for Disclosed Relationships/Interests. Section 144 of the Delaware
General Corporation Law provides a safe harbor for interested transactions, like
this one, if “[t]he material facts as to the director’s relationship or interest and as
to the contract or transaction are disclosed or are known to the board of directors
and the board in good faith authorizes the contract or transaction by the
affirmative votes of a majority of the disinterested directors.”
(1) Board Knew of Abdo’s Interested Status. Thus, although no one ever said,
“Abdo negotiated this deal for BFC,” the directors understood that he
was BFC’s representative in the Transaction.
41
Common Stock: The default rule is that each share receives one (1) vote per share. Common stock receives
dividends, shares are treated identically and are entitled to the residual ownership interest (liquidation rights are in the
following order: secured creditors, creditors, preferred stock, and finally common stock). Common stock can be
issued in multiple classes.
42
Preferred Stock: Some preference over common stock with regards to dividends and liquidation rights.
Preferred stock can have conversion rights that give preferred shareholders the option to convert their preferred into
other stock of the corporation, usually common stock.
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c. Breach of Fiduciary Duty Trigger Entire Fairness Standard?

(1) Director with conflict of interest cannot use confidential information for
himself or for others.
(a) The record does not support BOT’s contention that Abdo used
any confidential information against Benihana. Abdo did not
set the terms of the deal; he did not deceive the board; and he
did not dominate or control the other directors’ approval in the
Transaction. In short, the record does not support the claim
that Abdo breached his duty of loyalty.
d. No Entrenchment43 . It is settled law that, “corporate action may not be taken for
the sole or primary purpose of entrenchment.”
(1) Here, however, the trial court found that the primary purpose of the
Transaction was to provide what the directors subjectively believed to
be the best financing vehicle available for securing the necessary funds
for the agreed upon Construction and Renovation Plan for the
Benihana restaurants.
B. Corporate Opportunities
1. Broz v. Cellular Information Systems, Inc. (Del. 1996).
a. Facts. Broz was the president and sole stockholder of RFBC and also a director
of CIS. RFBC owned and operated FCC license area Michigan-4. In 1994,
Mackinac sought to divest itself of Michigan-2. The license was offered to
RFBC but not CIS because it had just emerged from a lengthy and contentious
insolvency reorganization. Also, from 1992 on, CIS had divested itself of fifteen
separate cellular licenses, leaving it with only five, all outside the Midwest. Broz
contacted several CIS directors about his interest in Michigan-2 but all stated that
CIS would not be interested. CIS then entered agreement with PriCellular to
sell CIS. PriCellular obtained an option to purchased Michigan-2 but Broz met
the a term of the option agreement and ultimately purchased the license. Nine
days after the sale, PriCellular closed its tender offer for CIS.
b. Guth v. Loft Corporate Opportunity Test. The doctrine of corporate opportunity
represents but one species of the broad fiduciary duties assumed by a corporate
director or officer. A corporate fiduciary agrees to place the interests of the
corporation before his or her own in appropriate circumstances.
(1) “if there is presented to a corporate officer of director a business
opportunity which the corporation is (1) financially able to undertake, is,
from its nature, (2) in the line of the corporation’s business (fundamental
knowledge) and is of practical advantage to it, is (3) one in which the
corporation has an interest or a reasonable expectancy , and, (4) by
embracing the opportunity, the self-interest of the officer or director will
be brought into conflict with that of the corporation, the law will not
permit him to seize the opportunity himself.”
c. Mackinac did not offer the property to CIS. Broz became aware of the
opportunity in his individual rather than his corporate capacity. This factual
posture does not present many of the fundamental concerns undergirding the law
of corporate opportunity (e.g., misappropriation of the corporation’s proprietary
information). However, while this lessens to some extent the burden imposed
upon Broz to show adherence to his fiduciary duties, it is not dispositive.
d. Factors. (1) CIS was not financially capable of exploiting the license opportunity;
43
A manager who uses the corporate governance machinery to protect his incumbency effectively diverts
control from the shareholders to himself. Besides preventing shareholders from exercising their control
rights–whether by voting or selling to a new owner–management entrenchment undermines the disciplining effect on
management of a robust market in corporate control.
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(2) CIS was in the business of divesting itself of its cellular license holdings
therefore it is not clear that CIS had a cognizable interest or expectancy in the
license; (3) Finally, the corporate opportunity doctrine is implicated only in cases where the
fiduciary’s seizure of an opportunity results in a conflict between the fiduciary’s duties to the
corporation and the self-interest of the director is actualized by the exploitation of the
opportunity.
e. Presentation to the Board Unnecessary. A director or officer must analyze the
situation ex ante to determine whether the opportunity is one rightfully
belonging to the corporation. If the director or officer believes, based on one of
the factors articulated above, that the corporation is not entitled to the
opportunity, then he may take it for himself. Of course, presenting the opportunity
to the board creates a kind of “safe harbor” for the director, which removes the specter of a
post hoc judicial determination the director or officer has improperly usurped a corporate
opportunity. It is not the law of Delaware that presentation to the board is a
necessary element to a finding that a corporate opportunity has not been usurped.
f. The right of a director or officers to engage in business affairs outside of his or her
fiduciary capacity would be illusory if these individuals were required to consider
every potential, future occurrence in determining whether a particular business
strategy would implicate fiduciary duty concerns.
2. In re eBay, Inc. Shareholders Litigation (Del. Ch. 2004).
a. Facts. Omidyar and Skoll founded eBay in 1995. In 1998, Goldman Sachs was
the lead underwriter on an IPO of common stock. Shares of eBay stock became
valuable and the price rose considerably. In 1999, a secondary offering was made
with Goldman Sachs again as the underwriter. Goldman Sachs “rewarded” the
defendants by allocating to them thousands of IPO shares at the initial offering
price. The plaintiffs alleged that Goldman Sachs provided these allocations to the
individual defendants to show appreciation for eBay’s business and to enhance
Goldman Sachs’ chances of obtaining future eBay business.
b. Distinguishing Broz. First, no one disputes that eBay was financially able to exploit
the opportunities in question. Second, eBay was in the business of investing in
securities. Thus, investing was a “line of business” of eBay. Third, the fact
alleged in the complaint suggest that investing was integral to eBay’s cash
management strategies and a significant part of its business. Finally, it is no
answer to say, as do defendants, that IPOs are risky investments. It is undisputed
that eBay was never given an opportunity to turn down the IPO allocations as
too risky.
c. Not Simply a Case of Broker’s Investment Recommendations. This was not an instance
where a broker offered advice to a director about an investment in a marketable
security. The conduct challenged here involved a large investment bank that
regularly did business with a company steering highly lucrative IPO allocations to
select insider directors and officers at that company, allegedly both to reward
them for past business and to induce them to direct future business to that
investment bank. This is a far cry from the defendant’s characterization of the
conduct in question as merely “a broker’s investment recommendations” to a
wealthy client.
d. Conflict of Interest. One can realistically characterize these IPO allocation as a form
of commercial discount or rebate for past or future investment banking services.
Viewed pragmatically, it is easy to understand how steering such commercial
rebates to certain insider directors places those directors in an obvious conflict
between their self-interest and the corporation’s interest.
e. Agent’s Duty to Account for Profits. An agent is under a duty to account for profits
personally obtained in connection with transactions related to his or her
company. Even if this conduct does not run afoul of the corporate opportunity
doctrine, it may still constitute a breach of the fiduciary duty of loyalty.
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(1) Thus, even if one does no consider Goldman Sachs’ IPO allocations to
these corporate insiders–allocations that generated millions of dollars in
profit–to be a corporate opportunity, the defendant directors were
nevertheless not free to accept this consideration from a company,
Goldman Sachs, that was doing significant business with eBay and that
arguably intended the consideration as an inducement to maintaining the
business relationship in the future.
3. Northeast Harbor Golf Club, Inc. v. Harris (Me. 1995).
a. Guth v. Loft Line of Business Test.
(1) If there is presented to a corporate officer or director a business
opportunity which the corporation is financially able to undertake, is,
from its nature, in the line of the corporation’s business and is of
practical advantage to it, is one in which the corporation has an interest
or a reasonable expectancy, and, by embracing the opportunity, the self-
interest of the officer or director will be brought into conflict with that
of his corporation, the law will not permit him to seize the opportunity
for himself.
(2) W eaknesses. (1) The question whether a particular activity is within a
corporation’s line of business is conceptually difficult to answer (See In re
eBay, Inc. Shareholders’ Litigation); and (2) the Guth test includes as an
element the financial ability of the corporation to take advantage of the
opportunity. Often, the injection of financial ability into the equation
will unduly favor the inside director or executive who has command of
the facts relating to the finances of the corporation.
b. Fairness Test.
(1) The basis of the doctrine rests on the unfairness in the particular
circumstances of a director, whose relation to the corporation is
fiduciary, taking advantage of an opportunity for her personal profit
when the interest of the corporation justly calls for protection. This calls
for application of ethical standards of what is fair and equitable ... in
particular sets of facts.
(2) W eaknesses. Provides little or no practical guidance to the corporate
office or director seeking to measure her obligations.
c. Line of Business/Fairness Hybrid Test.
(1) Two step analysis: (1) Determining whether a particular opportunity is
within the corporation’s line of business; and (2) Scrutinizing the
equitable consideration existing prior to, at the time of, and following
the officer’s acquisition.
(2) W eaknesses. Merely piles the uncertainty and vagueness of the fairness
test on top of the weaknesses in the line of business test.
d. ALI Approach.
(1) The ALI Principles take a disclosure-oriented approach that mandates
informed corporate rejection before a manager can take a “corporate
opportunity.” Under this approach, (1) the manager must have offered
the opportunity to the corporation and disclosed his conflicting interest,
and (2) the board or shareholder must have rejected it. ALI § 505(a).
(2) ALI § 505(b). Definition of a Corporate Opportunity. For purposes of
this Section, a corporate opportunity is:
(1) Any opportunity to engage in a business activity of which a director or senior
executive becomes aware, either:
(A) In connection with the performance of functions as a director or senior
executive, or under circumstances that should reasonably lead the director or senior
executive to believe that the person offering the opportunity expects it to be offered
to the corporation; or
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(B) Through the use of corporate information or property, if the resulting

opportunity is one that the director or senior executive should reasonably be
expected to believe would be of interest to the corporation; or
(2) Any opportunity to engage in a business activity of which a senior executive
becomes aware and knows is closely related to a business in which the corporation
is engaged or expects to engage.
C. Dominant Shareholders
1. Sinclair Oil Corp. v. Levien (Del. 1971).
a. Facts. Sinclair was in the business of exploring for oil and of producing and
marketing crude oil and oil products. It owned about 97% of Sinven’s stock. The
plaintiff owned about 3,000 of 120,000 publicly held shares of Sinven. Sinclair
nominated all of Sinven’s board of directors. These directors were, almost
without exception, officers, directors, or employees in the Sinclair complex. The
plaintiff alleged that from 1960 through 1966, Sinven paid out excessive dividend
and that Sinven was therefore prevented from industrial development. These
dividends exceed earnings.
b. The chancellor held that because of Sinclair’s fiduciary duty and its control over
Sinven, its relationship with Sinven must meet the test of intrinsic fairness.
(1) Intrinsic fairness. The standard of intrinsic fairness involves both a high
degree of fairness and a shift in the burden of proof. Under this standard
the burden is on Sinclair to prove, subject to careful judicial scrutiny,
that its transactions with Sinven were objectively fair.
c. Sinclair argues that the transactions between it and Sinven should be tested, not
by the test of intrinsic fairness with the accompanying shift of the burden of
proof, but by the business judgment rule.
(1) Sinclair’s argument is misconceived.
(a) Intrinsic Fairness not Business Judgment Rule. When the situation
involves a parent and a subsidiary, with the parent controlling
the transaction and fixing terms, the test of intrinsic fairness
with its resulting shifting of the burden of proof, is applied.
i) The basic situation for the application of the rule is
one in which the parent has received a benefit to the
exclusion and at the expense of the subsidiary.
(b) Intrinsic Fairness Not Always Applied in Parent/Subsidiary. A
parent does indeed owe a fiduciary duty to its subsidiary when
there are parent-subsidiary dealings. However, this alone will
not evoke the intrinsic fairness standard. This standard will be
applied when the fiduciary duty is accompanied by self-dealing–the
situation when a parent is on both sides of the transaction with
its subsidiary.
i) Self-dealing occurs when the parent, by virtue of its
domination of the subsidiary, cause the subsidiary to
act in such a way that the parent receives something
from the subsidiary to the exclusion of, and detriment
to, the minority stockholders of the subsidiary.
d. W e do not accept the argument that the intrinsic fairness test can never be applied
to a dividend declaration by a dominated board, although a dividend declaration
by a dominated board will not inevitably demand the application of the intrinsic
fairness standard.
(1) Business Judgment Rule Should Have Been Applied to Dividends. The
dividends resulted in great sums of money being transferred from Sinven
to Sinclair. However, a proportionate share of this money was received
by the minority shareholders of Sinven (fails exclusion requirement).
Sinclair received nothing from Sinven to the exclusion of its minority
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stockholders. As such, these dividends were not self-dealing. Therefore,

the business judgment standard should have been applied.
(a) The dividend payment complied with the business judgment
standard. The motives for causing the declaration of dividends
are immaterial unless the plaintiff can show that the dividend
payments resulted from improper motives and amounted to
waste.
(2) Intrinsic Fairness Standard Appropriate for Contract Breaches. Clearly,
Sinclair’s act of contracting with its dominated subsidiary was self-
dealing. Under the contract Sinclair received the products produced by
Sinven, and of course the minority shareholders of Sinven were not able
to share in the receipt of these products. If the contract was breached,
then Sinclair received these products to the detriment of Sinven’s
minority shareholders.
(a) Although a parent need not bind itself by a contract with its
dominated subsidiary, Sinclair chose to operate in this manner.
As Sinclair has received the benefits of this contract, so it must
comply with the contractual duties.
(b) Under the intrinsic fairness standard, Sinclair must prove that
its causing Sinven not to enforce the contract was intrinsically
fair to the minority shareholders of Sinven.
2. Zahn v. Transamerica Corp. (3d Cir. 1947).
a. Facts. A corporation had two classes of common shares, class A and class B. The
class B shares held voting control. The class A shares, which were entitled to
twice as much liquidation as class B shares, could be redeemed by the corporation
at any time for $60. The controlling shareholder had the corporation redeem all
of the minority's class A shares and then liquidate the corporation's assets, which
had recently tripled in value. The result was that the controlling shareholder
received the lion's share of the company's liquidation value.
b. The circumstances of the case at bar are sui generis and we can find no Kentucky
decision squarely in point. In our opinion, however, the law of Kentucky
imposes upon the directors of a corporation or upon those who are in charge of
its affairs by virtue of majority stock ownership or otherwise the same fiduciary
relationship in respect to the corporation and to its stockholders as is imposed
generally by the laws of Kentucky’s sister States or which was imposed by federal
law prior to Erie R. Co. v. Tompkins.
(1) The Supreme Court in Southern Pacific Co. v. Bogert said: “The rule of
corporation law and of equity invoked is well settled and has been often
applied. The majority has the right to control; but when it does so, it
occupies a fiduciary relation toward the minority, as much so as the
corporation itself or its officers and directors.”
(2) W e must also emphasize that there is a radical difference when a
stockholder is voting strictly as a stockholder and when voting as a
director; that when voting as a stockholder he may have the legal right
to vote with a view of his own benefits and to represent himself only;
but that when he votes as a director he represents all the stockholders in
the capacity of a trustee for them and cannot use his officer as director
for his personal benefit at the expense of the stockholders.
(3) W e think that it is the settled law of Kentucky that directors may not
declare or withhold the declaration of dividends for the purpose of
personal profit or, by analogy, take any corporate action for such a
purpose.
(a) The act of the board of directors in calling the Class A stock, an
act which could have been legally consummated by a
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disinterested board of directors, was here effected at the

direction of the principal Class B stockholder in order to profit
it.
D. Ratification
1. Fliegler v. Lawrence (Del. 1976).
a. Facts. One of the Defendant directors, acting in his individual capacity,
purchased a lease option for antimony (metal) rights. He offered the rights to
Agau but the directors agreed that Agau’s financial position would not allow the
purchase. The director then transferred the rights to a company formed for the
specific purpose of holding those rights. He then gave Agau a long-term option
to purchase the holding company. A few months later, Agau’s directors voted to
exercise the option. A majority of shareholders voted the same way, but the
directors also comprised a majority of shareholders. Plaintiff argued that
Defendant directors usurped a corporate opportunity for their own individual
benefit, and that the transaction was inherently unfair. Defendants responded that
their voted was ratified by shareholders, thereby shifting the burden of proof to
Plaintiff to prove that the transaction was fair, but they also offered proof that it
was fair.
b. Shareholder ratification of an “interested transaction,” although less than
unanimous, shifts the burden of proof to an objecting shareholder to demonstrate
that the terms are so unequal as to amount to a gift or waste of corporate assets.
(1) “The entire atmosphere is freshened and a new set of rules invoked
where formal approval has been given by a majority of independent,
fully informed [share]holders.”
c. The purported ratification by the Agau shareholders would not affect the burden
of proof in this case because the majority of shares voted in favor of exercising the
option were cast by defendants in their capacity as Agau shareholders. Only
about one-third of the “disinterested” shareholders voted, and we cannot assume
that such non-voting shareholders either approved or disapproved.
(1) Under these circumstances, we cannot say that “the entire atmosphere
has been freshened” and that departure from the objective fairness test is
permissible.
d. Defendants argue that the transaction here in question is protected by 8 Del.C. §
144(a)(2) which, they contend, does not require that ratifying shareholders be
“disinterested” or “independent”; nor, they argue, is there warrant for reading
such a requirement into the statute.
(1) W e do not read the statute as providing the broad immunity for which
the defendants contend. It merely removes an “interested director”
cloud when its terms are met and provides against invalidation of an
agreement “solely” because such a director or officer is involved.
Nothing in the statute sanctions unfairness to Agau or removes the
transaction from judicial scrutiny.
III. The Obligation of Good Faith
» The process of giving content to good faith began with the Delaware Supreme Court’s decision in Cede & Co v.
Technicolor, Inc., (Del. 1993).
“To rebut the rule, shareholder plaintiff assumes the burden of providing evidence that directors, in
reaching their challenged decision, breach any one of the triads of their fiduciary duty–good faith,
loyalty, or due care. If a shareholder plaintiff fails to meet this evidentiary burden, the business
judgment rule attaches to protect corporate officers and directors and the decisions they make, and our
courts will not second-guess these business judgments. If the rule is rebutted, the burden shifts to the
defendant directors, the proponents of the challenged transaction, to prove to the trier of fact the “entire
fairness” of the transaction to the shareholder plaintiff.”
A. Compensation
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1. In re The W alt Disney Co. Derivative Litigation (Del. 2006).

a. Claims Against Ovitz
(1) A de facto officer is one who actually assumes possession of an office
under the claim and color of an election or appointment and who is
actually discharging the duties of that office, but for some legal reason
lack de jure legal title to that office.
b. Due Care and Bad Faith as Separate Grounds
(1) Our law presumed that “in making a business decision the directors of a
corporation acted on an informed basis, in good faith, and in the honest
belief that the action taken was in the best interests of the company.”
(a) Those presumptions can be rebutted if the plaintiff shows that
the directors breached their fiduciary duty of care or of loyalty
or acted in bad faith. If that is shown, the burden then shifts to
the director defendants to demonstrate that the challenged act
or transaction was entirely fair to the corporation and its
shareholders.
c. Full Disney Board W as Not Required to Consider and Approve OEA
(1) The Delaware General Corporation Law expressly empowers a board of
directors to appoint committees and to delegate to them a broad range
of responsibilities, which may include setting executive compensation.
Nothing in the DGCL mandates that the entire board must make those
decisions.
d. The Good Faith Determinations
(1) At least three different categories of fiduciary behavior are candidates for
the “bad faith” pejorative label:
(a) Bad Faith. “Subjective bad faith,” that is, fiduciary conduct
motivated by an actual intent to do harm. That such conduct
constitutes classic, quintessential bad faith is a proposition so
well accepted in the liturgy of fiduciary law that it borders on
axiomatic. W e need not dwell further on this category,
because no such conduct is claimed to have occurred, or did
occur, in this case.
(b) Not Bad Faith/Rather, Breach of Duty of Care. Lack of due
care–that is, fiduciary action taken solely by reason of gross
negligence and without any malevolent intent. Both our
legislative history and our common law jurisprudence
distinguish sharply between the duties to exercise due care and
to act in good faith.
(c) Bad Faith. Intentional dereliction of duty, a conscious disregard
for one’s responsibilities. This falls between the first two
categories of (1) conduct motivated by subjective bad intent
and (2) conduct resulting from gross negligence.
i) Cases have arisen where corporate directors have no
conflicting self-interest in a decision, yet engage in
conduct that is more culpable than simple inattention
or failure to be informed of all facts material to the
decision. To protect the interests of the corporation
and its shareholders, fiduciary conduct of this kind,
which does not involve disloyalty (as traditionally
defined) but it qualitatively more culpable that gross
negligence, should be proscribed. A vehicle is needed to
address such violations doctrinally, and that doctrinal vehicle
is the duty to act in good faith.
ii) A failure to act in good faith may be shown, for
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instance, where the fiduciary intentionally acts with a

purpose other than that of advancing the best interests
of the corporation, where the fiduciary acts with the
intent to violate applicable positive law, or where the
fiduciary intentionally fails to act in the face of a
known duty to act, demonstrating a conscious
disregard for his duties.
e. W as Action By The New Board Required to Terminate Ovitz?
(1) W hen corporate governing instruments are ambiguous, our case law
permits a court to determine their meaning by resorting well-established
legal rules of construction, which include the rules governing the
interpretation of contracts.
(a) One such rule is that where a contract is ambiguous, the court
must look to extrinsic evidence to determine which of the
reasonable readings the parties intended.
(2) Extrinsic evidence clearly supports the conclusion that the board and Eisner
understood that Eisner, as Board Chairman/CEO had concurrent power with
the board to terminate Ovitz as President.
f. The W aste Claim
(1) Doctrine that a plaintiff who fails to rebut the business judgment rule
presumptions is not entitled to any remedy unless the transactions
constituted waste.
(a) To recover on a claim of corporate waste, the plaintiffs must
shoulder the burden of proving that the exchange was “so one
sided that no business person or ordinary, sound judgment
could conclude that the corporation has received adequate
consideration.”
(2) A claim of waste will arise only in the rare, “unconscionable
case where directors irrationally squander or give away
corporate assets.” This onerous standard for waste is a corollary
of the proposition that where business judgment presumptions
are applicable, the board’s decisions will be upheld unless it
cannot be “attributed to any rational business purpose.”
(3) The payment of a contractually obligated amount cannot
constitute waste, unless the contractual obligation is itself
wasteful.
B. Oversight
1. Introduction
a. At the very least, however, a director must have a rudimentary understanding of
the firm’s business and how it works, keep informed about the firm’s activities,
engage in a general monitoring of corporate affairs, attend board meetings
regularly, and routinely review financial statements.
b. Beyond these obligations, however, the question remained as to whether boards
must adopt rules and procedures to ensure that corporate officers and other
employees do not engage in illegal or unlawful conduct, and must make
reasonable efforts to monitor compliance with those rules and procedures.
2. Stone v. Ritter (Del. 2006).
a. In Caremark, the Court of Chancery recognized that: “generally where a claim of
directorial liability for corporate loss is predicated upon ignorance of liability
creating activities within the corporation . . . only a sustained or systemic failure
of the board to exercise oversight–such as an utter failure to attempt to assure a
reasonable information and reporting system exists–will establish the lack of good
faith that is a necessary condition to liability.
b. Demand Futility. To excuse demand, “a court must determine whether or not the
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particularized factual allegations of a derivative stockholder complaint create a

reasonable doubt that, as of the time the complaint is filed, the board of directors
could have properly exercise its independent and disinterested business judgment
in responding to a demand.”
c. Evolution of Oversight Responsibility:
(1) In Graham, the court held that “absent cause for suspicion there is no duty
upon the directors to install and operate a corporate system of espionage
to ferret out wrongdoing which they have no reason to suspect exists.”
(2) Caremark narrowly construed the holding in Graham “as demanding for
the proposition that, absent grounds to suspect deception, neither
corporate boards nor senior officers can be charged with wrongdoing
simply for assuming the integrity of employees and the honesty of their
dealings on the company’s behalf.
(a) “Generally where a claim of directorial liability for corporate
loss is predicted upon ignorance of liability creating activities
within the corporation, as in Graham or in this case, only a
sustained or systematic failure of the board to exercise
oversight–such as an utter failure to attempt to assure a
reasonable information and reporting system exists–will
establish the lack of good faith that is a necessary condition to
liability.”
d. Good Faith. A failure to act in good faith requires conduct that is qualitatively
different from, and more culpable than, the conduct giving rise to a violation of
fiduciary duty of care (i.e., gross negligence).
(1) The failure to act in good faith is not conduct that results, ipso facto, in
the direct imposition of fiduciary liability. The failure to act in good
faith may result in liability because the requirement to act in good faith
“is a subsidiary element,” i.e., a condition, “of the fundamental duty of
loyalty.” It follow that because a showing of bad faith conduct, in the
sense described in Disney and Caremark, is essential to establish director
oversight liability, the fiduciary duty violated by the conduct is the duty
of loyalty.
(a) Although good faith may be describe colloquially as part of a
“triad” of fiduciary duties that includes the duties of care and
loyalty, the obligation to act in good faith does not establish an
independent fiduciary duty that stands on the same footing as
the duties of care and loyalty.44
(b) The fiduciary duty of loyalty is not limited to cases involving a
financial or other cognizable fiduciary conflict of interest. It
also encompasses where the fiduciary fails to act in good faith.
As the Court of Chancery aptly put it in Guttman, “a director
cannot act loyally towards the corporation unless she acts in the
good faith belief that her actions are in the corporation’s best
interests.”
(2) W e hold that Caremark articulates the necessary conditions predicated for
44
The Arkansas Supreme Court has traditionally used language indicating that “good faith” is a standalone
obligation. In practical terms, it probably does not make much difference as a violation of the obligation of good faith
will most likely also breach the duties of loyalty and due care.
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45
director oversight liability:
(a) the directors utterly failed to implement any reporting or
information systems or controls; or
(b) having implemented such a system or controls, consciously
failed to monitor or oversee its operations thus disabling
themselves from being informed of risks or problems requiring
their attention.
IV. Securities Law Overview
A. Introduction
1. Dual Regulation. There is dual regulation at the federal and the state level. Both federal
and state securities laws must be complied with.
a. Federal Law
(1) Securities Act of 1933 (15 U.S.C. §§ 77a et seq.) The 1933 Act governs
the issuance of securities by business to raise capital.
(2) Securities Exchange Act of 1934 (15 U.S.C. §§ 87a et seq.) The 1934 Act
regulates trading in securities and other regulatory matters affecting
publicly-held corporations.
b. State Law
(1) Blue Sky Laws.46 Arkansas, like most states, has its own “blue sky” law,
codified at Ark. Code Ann. §§ 23-42-101 et seq., and the Arkansas
Securities Commissioner has promulgated regulations.
B. W hat is a Security?
1. Broad Definition. The statutory definitions of “security” under the federal acts are very
broad. See generally § 2(a)(1) of the 1933 Act which sets out a laundry list of both specific
instruments and general categories. The determination of whether a particular investment
interest is a security is made on a case-by-case basis.
a. For example, the definition includes “notes,” “stock,” “bond,” “evidence of
indebtedness,” “transferable share,” “fractional undivided interest in oil, gas, or
other mineral rights,” “investment contract,” “certificate of interest or
participation in any profit-sharing agreement,” “or, in general, any interest or
instrument commonly known as a ‘security.”’
2. Traditional Corporate Stock. W hether common or preferred, whether voting or nonvoting,
whether of a publicly held or a closely held corporation -- is certain to be a security under
federal law. Landreth Timber Co. v. Landreth, 471 U.S. 681 (1985).
3. Promissory Notes. A promissory note may or may not be a security. In Reves v. Ernst &
Young, 494 U.S. 56 (1990), the U.S. Supreme Court adopted the so-called "family
resemblance" test used by the Second Circuit. This test seeks to distinguish between notes
that are given by businesses to raise capital for investment (a security) and those that are
given in connection with consumer transactions or given by businesses in exchange for
short-term loans to finance current operations (not a security).
4. Investment Contracts. The federal statutory definition of "security" includes so-called
"investment contracts." This category is, in substance, a catch-all category that brings
within the definition of "security" a variety of investment interests, including partnership
interests; franchise, distributorship, and licensing arrangements; and sales of property, both
personal and real, coupled with management or development agreements.
45
In either case, imposition of liability requires a showing that the directors knew that they were not
discharging their fiduciary obligations. W here directors fail to act in the face of a known duty to act, they breach
their duty of loyalty by failing to discharge their fiduciary obligation in good faith.
46
So named because they were aimed at promoters who “would sell building lots in the blue sky in fee
simple.”
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a. Howey Test. Federal courts apply the "Howey Test" to determine whether a
particular investment interest is an "investment contract" subject to regulation by
the federal securities laws. In SEC v. W .J. Howey Co., 328 U.S. 293, 298-99
(1946), the United States Supreme Court announced:
(1) “An investment contract for purposes of the Securities Act means a
contract, transaction or scheme whereby a person (1) invests his money
(2) in a common enterprise and (3) is led to expect profits (4) solely
from the efforts of the promoter or a third party.”
(2) Applying this test, the Supreme Court held that the offer of small plots
of land in orange groves in Florida to vacationers from New England,
coupled with the offer of a management contract under which an
affiliate of the vendor would cultivate and tend the grove in which the
plot was located, harvest and market the fruit from the entire grove, and
remit a share of the profits to the various owners was the offer of an
"investment contract" under the 1933 Act.
5. Passive Investments. Subsequent cases have established that a passive investment, whatever it
is called, is very likely to be a security.
a. Limited Partnership Interests. For example, most limited partnership interests are
usually held to be securities, because in most limited partnerships the limited
partners have very little management power over the business of the partnership.
b. Race Horse & Property Syndications, Etc. Investments in race horse or property
syndications are likely to be securities. Chinchilla and earthworm raising ventures
have been held to be securities. Businesses using a multi-level distribution model,
where the role of investors is primarily to attract other investors rather than to sell
a product, have been found to be issuers of securities. Ownership interests in
LLCs may be securities, especially in manager-managed LLCs where the
members do not participate in the management of the LLC's business.
6. Under the Arkansas Securities Act. The statutory definition of “security” in the Arkansas Act
is similar to those in the federal Acts. The important difference lies in how the Arkansas
courts have interpreted the Arkansas Act.
a. The Arkansas Supreme Court looks at various factors to determine whether a
given interest - whether it takes the form of corporate stock or some other
interest– is a “security” subject to regulation under the Arkansas Act. It also
looks to the so-called “risk capital” test, a test that some state courts use instead of
the Howey test.
(1) Risk Capital Test. The Arkansas courts have expressed the risk capital
test in terms of five elements: (a) The investment of money or money's
worth; (b) in a venture; (c) the expectation of some benefit to the
investor as a result of the investment; (d) the contribution towards the
risk capital of the venture; and (e) the absence of direct control over the
investment or policy. Carder v. Burrow, 327 Ark. 545, 549, 940 S.W .2d
429, 431 (1997).
(a) Different Results from Federal Law. Applying this test to classify
various investment interests as securities or not securities, the
Arkansas Supreme Court has sometimes reached conclusions
opposite to the conclusions that a federal court would probably
have reached applying federal law. See, e.g., Cook v. W ills, 305
Ark. 442, 447, 808 S.W .2d 758, 761 (1991)(corporate stock
not a security); Casali v. Schultz, 292 Ark. 602, 732 S.W .2d
836 (1987)(general partnership interest a security).
C. Exemption from 1933 Act Registration
1. In General. W hen businesses seek to raise capital by issuing securities, the securities laws
require that the offering be “registered” with the appropriate governmental authority
before the securities are marketed
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a. Exempt Securities/Exempt Transactions. Because of the expense and the restrictions,

businesses often seek an exemption from the registration requirements. There are
two types of exemptions: exempt securities and exempt transactions. Exempt
securities are listed in section 3 of the 1933 Act.
(1) Examples. Probably the most familiar example of an exempt security is
the municipal bond. “Church bonds” are another example. Exempt
securities are exempt from the registration requirements of the 1933 Act,
but they are not exempt from the antifraud laws.
2. Section 4(2) Exemption. The private placement exemption is founded on Section 4(2) of
the 1933 Act, which says that the registration requirements of the Act “shall not apply to .
. . transactions by an issuer not involving any public offering.” The seminal case
interpreting Section 4(2) is SEC v. Ralston Purina Co., 346 U.S. 119 (1953).
a. Fend for Themselves. The Court reasoned that the Section 4(2) private placement
exemption must be interpreted in light of the purposes of the 1933 Act. The
purpose of the registration requirement of the Act is “to protect investors by
promoting full disclosure of information thought necessary to informed
investment decisions.” Therefore, the Section 4(2) exemption should be limited
to transactions in which the offerees do not need the protection of registration --
in other words, those who are “able to fend for themselves” because they already
have access to the kind of information that registration would disclose and the
ability to understand that information and its significance to an investment
decision. By way of illustration, the Court referred to “executive personnel who
because of their position have access to the same kind of information that the act
would make available in the form of a registration statement.”
b. Automatic Exemption. The Section 4(2) exemption is automatic; it does not
require any filing with the SEC.
3. Regulation D. Section 3(b) of the 1933 Act gives the SEC authority to exempt by
regulation offerings of $5 million or less (“limited offerings”). The SEC has promulgated
two important regulations under this authority, Regulation A and Regulation D. \
a. Accredited Investor.47 One of the key concepts in Regulation D is the “accredited
investor.” Generally speaking, an accredited investor is a person (or entity) that
because of wealth or position is conclusively deemed to be able to "fend for
himself."
(1) Under Rule 506, an issuer can sell an unlimited dollar amount of
securities to an unlimited number of accredited investors and to 35 or
fewer non-accredited investors who nonetheless are sophisticated
enough (either alone or with the assistance of a “purchaser
representative") to “fend for themselves.”
4. Intrastate Offering Exemption. The so-called “intrastate offering” exemption is established in
Section 3(a)(11) of the 1933 Act and Rule 147 promulgated thereunder.
a. Single State. To qualify for this exemption, the security must be part of an issue
that is offered and sold only to persons resident within a single state.
b. Issuer Resident/Incorporated In State. In addition, the issuer must be a resident of
(or incorporated in) that state and doing a substantial part of its business in that
state.
c. Nine Months Resale Restriction. Finally, the issuer must take precautions to make
sure that the securities are not resold to non-residents of the state until nine or
more months have passed.
47
Accredited investors include banks, insurance companies, other corporations with total assets in excess of
$5 million, directors or executive officers of the issuer, and individuals who have a net worth over $1 million or who
have an income of $200,000 in the previous two years (or $300,000 jointly with his or her spouse) and who
reasonably expect to reach the same income in the current year.
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5. Resales. Technically speaking, the registration requirements of the 1933 Act potentially
apply to resales of securities as well as to primary offerings by issuers. Exemptions exist
which remove most resales from the reach of the registration provisions, but trouble can
arise if a “control person” of the issuer sells large amounts of securities publicly.
D. Regulation of Reporting Companies by the 1934 Act
1. Companies Required to Register. The companies that have to register under the 1934 Act are
(1) those whose securities are traded on a national securities exchange (e.g., the New York
Stock Exchange), (2) those whose total assets are $10,000,000 or more and who have 500
or more shareholders, and (3) those companies that have issued securities under a 1933 Act
registration statement (although a small company can discontinue 1934 Act registration and
reporting after the first year). Also, a company can voluntarily elect to register under the
1934 Act and thereby become subject to its provisions.
2. Reporting Companies. Companies subject to the 1934 Act are often called “reporting
companies” because they are required to file periodic reports setting forth their financial
and general business condition.
E. Insider Trading
1. Definition. “Insider trading” means buying or selling securities (almost always stock) on the
basis of material, non-public information.
2. SEC’s Advocation for Blanket Rule. The SEC has always advocated for a rule that would
prohibit anyone in possession of inside information from buying or selling stock on the
basis of it.
a. Supreme Court Rejection/Common-Law Rule of Deceit. The Supreme Court has, for
Rule 10b-5 purposes, rejected this view. Instead, the Court has approached the
problem of insider trading as a specific application of the common-law rule of
deceit.
(1) Common-Law. Remember that under the common law, a person is
allowed to buy or sell property on the basis of information that he has
that is unknown to the other party to the transaction. The exception is
where the person has a "duty to disclose" that information to the other
party. One source of a duty to disclose is where there is a fiduciary
relationship or other special relationship of trust and confidence between
the parties. So, for example, an attorney cannot enter into a business
transaction with a client without making full disclosure to the client of
all material information relating to that transaction that the attorney has.
V. Inside Information
A. Goodwin v. Agassiz (Mass. 1933).
1. Facts. Defendants purchased from plaintiff, through brokers, 700 shares of Cliff Mining
Company. Agassiz was president and director and McNaughton was a director and
general manager of the company. They had certain knowledge, material to the value of
the stock, that the plaintiff did not possess. Exploration in 1925 of the property of Cliff
Mining Company proved unsuccessful. However, an experienced geologist formulated a
theory as to the possible existence of copper deposits in 1926. The defendants decided to
test the theory but agreed that if the information became known the price of Cliff
Mining’s stock would soar. The plaintiff learned of the failed exploration through an
article and sold his stock through brokers. The plaintiff didn’t know that the purchase of
his stock was made for the defendants and they did not know his stock was being bought
for them. There was no communication between them
2. The directors of a commercial corporation stand in relation of trust to the corporation and
are bound to exercise the strictest good faith in respect to its property and business.
a. The contention that directors also occupy the position of trustee toward
individual stockholders in the corporation is plainly contrary to repeated decisions
of this court and cannot be supported.
3. W hile the general principle is as stated, circumstances may exist requiring that transactions
between a director and a stockholder as to stock in the corporation be set aside.
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a. The knowledge naturally in the possession of a director as to the condition of a

corporation places upon him a peculiar obligation to observe every requirement
of fair dealing when directly buying or selling its stock.
(1) Mere silence does not usually amount to a breach of duty, but parties
may stand in such relation to each other that an equitable responsibility
arises to communicate facts.
(2) An honest director would be in a difficult position if he could neither
buy nor sell on the stock exchange shares of stock of his corporation
without first seeking out the other actual ultimate party to the
transaction and disclosing to him everything which a court or jury might
later find that he then knew affecting the real or speculative value for
such shares.
(a) Business of that nature is a matter to be governed by practical
rules. Fiduciary obligations of directors ought not to be made
so onerous that men of experience and ability will be deterred
from accepting such office.
(b) On the other hand, directors cannot rightly be allowed to
indulge with impunity in practices which do violence to
prevailing standards of upright business men.
i) Closely Scrutinized. Therefore, where a director
personally seeks a stockholder for the purpose of
buying his shares without making disclosure of
material facts within his peculiar knowledge and not
within reach of the stockholder, the transaction will
be closely scrutinized and relief may be granted in
appropriate instances.
4. The Geologist’s Theory. At the annual stockholders meeting, no reference was made to the
theory. It was then at most a hope, possibly an expectation. W hether the theory was
sound or fallacious, no one knew, and so far as appears has never been demonstrated. The
Cliff Mining Company was not harmed by the nondisclosure. There would have been no
advantage to it, so far as appears, from a disclosure.
5. The Purchase. The identity of the buyers and seller of the stock in question in fact was not
known to the parties and perhaps could not readily have been ascertained. The defendants
caused the shares to be bought through brokers on the stock exchange. They said nothing
to anybody as to the reasons actuating them. The plaintiff was no novice. He was a
member of the Boston Stock Exchange and had kept a record of sales of Cliff Mining
Company stock. He acted upon his own judgment in selling his stock. He made no
inquiries of the defendant or of other officers of the company.
B. Securities and Exchange Commission v. Texas Gulf Sulphur Co. (2d. Cir. 1969).
1. Facts. TGS began exploratory drilling in Canada. Mollison, VP and a mining engineer,
supervised the project. Clayton, an electrical engineer was also on-site. Stephens, TGS
President, ordered the drilling results be kept secret to prevent a rise in land prices. TGS
employees began buying up stock and options. Rumors of a rich strike spread and TGS
released a misleading press release (April 12th) with regards to the size of operations and
results to quell them. Disclosure of the large ore strike was soon made (April 16 th).
Between the time of the two releases, TGS executives and directors ordered more stock.
Various prices of the stock over the relevant period: Pp. 474-75.
2. Rule 10b-5, 17 C.F.R. 240.10b-5, on which this action is predicated, provides:
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
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(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.
a. Purpose of the Rule. Rule 10b-5 is based in policy on the justifiable expectation of
the securities marketplace that all investors trading on impersonal exchanges have
relatively equal access to material information.
b. Essence of the Rule. The essence of the Rule is that anyone who, trading for his
own account in the securities of a corporation, has “access, directly or indirectly,
to information intended to be available only for a corporate purpose and not for
the personal benefit of anyone” may not take “advantage of such information
knowing it is unavailable to those with whom he is dealing.” i.e., the investing
public.
c. Insiders, as directors or management officers are, of course, by this Rule,
precluded from so unfairly dealing, but the Rule is also applicable to one
possessing the information who may not be strictly termed an “insider” within
the meaning of Sec. 16(b) of the Act.
(1) Thus, anyone in possession of material inside information must either
disclose it to the investing public, or, if he is disabled from disclosing it
in order to protect a corporate confidence, or he chooses not to do so,
must abstain from trading in or recommending the securities concerned
while such inside information remains undisclosed.
d. An insider is not, of course, always foreclosed from investing in his own company
merely because he may be more familiar with company operations than are
outside investors.
(1) An insider’s duty to disclose information or his duty to abstain from
dealing in his company’s securities arises only in those situations which
are essentially extraordinary in nature and which are reasonably certain
to have a substantial effect on the market price of the security if the
extraordinary situation is disclosed.
(2) Nor is an insider obligated to confer upon outside investors the benefit
of his superior financial or other expert analysis by disclosing his
educated guesses or predictions.
e. The basic test of materiality is whether a reasonable man would attach importance
in determining his choice of action in the transaction in question. This, of
course, encompasses any fact which in reasonable and objective contemplation
might affect the value of the corporation’s stock or securities.
(1) Such a fact is a material fact and must be effectively disclosed to the
investing public prior to the commencement of insider trading in the
corporation’s securities.
(a) Material facts include not only information disclosing the
earnings and distributions of a company but also those facts
which affect the probable future of the company and those
which may affect the desire of investors to buy, sell, or hold the
company’s securities.
(2) In each case then, whether facts are material within Rule 10b-5 when
the facts relate to a particular event and are undisclosed by those persons
who are knowledgeable thereof will depend at any given time upon a
balancing of both the indicated probability that the event will occur and
the anticipated magnitude of the event in light of the totality of the
company activity.
f. The timing of a disclosure is a matter for the business judgment of the corporate
officers entrusted with the management of the corporation within the affirmative
disclosure requirements promulgated by the exchanges and by the SEC.
(1) W here a corporate purpose is thus served by withholding the news of a
material fact, those persons who are thus quite properly true to their
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corporate trust must not during the period of non-disclosure deal

personally in the corporation’s securities or give to outsiders confidential
information not generally available to all the corporations’ stockholders
and to the public at large.
g. Our decision to expand the limited protection afforded outside investors by the
trial court’s narrow definition of materiality is not at all shaken by fears that the
elimination of insider trading benefits will deplete the ranks of capable corporate
managers by taking away an incentive to accept such employment.
(1) Such benefits, in essence, are forms of secret corporate compensation
derived at the expense of the uninformed investing public and not at the
expense of the corporation which receives the sole benefit from insider
incentive. Moreover, adequate incentives for corporate officers may be
provided by properly administered stock options and employee purchase
plans of which there are many in existence.
h. The core of Rule 10b-5 is the implementation of the Congressional purpose that
all investors should have equal access to the rewards of participation in securities
transactions. It was the intent of Congress that all members of the investing
public should be subject to identical market risks–which markets risks include, of
course, the risk that one’s evaluative capacity or one’s capital available to put at
risk may exceed another’s capacity or capital.
i. It seems clear from the legislative purpose Congress expressed in the Act, and the
legislative history of Section 10(b) that Congress when it used the phrase “in
connection with the purchase or sale of any security” intended only that the
device employed, whatever it might be, be of a sort that would cause reasonable
investors to rely thereon, and, in connection therewith, so relying, cause them to
purchase or sell a corporation’s securities.
(1) There is no indication the Congress intended that the corporations or
persons responsible for the issuance of a misleading statement would not
violate the section unless they engaged in related securities transactions
or otherwise acted with wrongful motives; indeed, the obvious purposes
of the Act to protect to investing public and to secure fair dealing in the
securities markets would be seriously undermined by applying such a
gloss onto the legislative language.
C. Dirks v. Securities & Exchange Commission (S. Ct. 1983).
1. Facts. Dirks was an officer of a N.Y. broker-dealer firm specializing in investment analysis
of insurance company securities. Dirks caught wind of a massive fraud at Equity Funding
of America and investigated. Senior management denied any wrongdoing while other
employee corroborated the allegations. Neither Dirks nor his firm owned any Equity
stock but Dirks discussed his findings with a number of clients and investors who sold their
stock for more than $16 million. Dirks urged the Journal to publish a story about the
fraud, but they declined citing possible liability for libel. California insurance agency soon
investigated and uncovered the fraud. The SEC then filed a complaint against Equity.
Then, the SEC found that Dirks had aided and abetted violations of Rule 10b-5 by
repeating the allegations of fraud to investors who sold their stock.
2. In the seminal case of In re Cady, Roberts & Co., the SEC recognized that the common law
in some jurisdictions imposes on corporate insiders, particularly officers, directors or
controlling stockholder an affirmative duty of disclosure when dealing in securities.
a. The SEC found that no only did breach of this common-law duty establish the
elements of a Rule 10b-5 violation, but that individuals other than corporate
insiders could be obligated either to disclose material nonpublic information
before trading or to abstain from trading altogether.
3. In Chiarella, we accepted the two elements set out in Cady Roberts for establishing a Rule
10b-5 violation:
a. The existence of a relationship affording access to inside information intended to
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be available only for a corporate purpose, and

b. The unfairness of allowing a corporate insider to take advantage of that
information by trading without disclosure.
4. In Chiarella, the Court held that there is no general duty to disclose before trading on
material nonpublic information, and held that a duty to disclose under §10(b) does not
arise from the mere possession of nonpublic market information. Such a duty arises rather
from the existence of a fiduciary relationship.
a. Not all breaches of fiduciary duty in connection with a securities transaction,
however, come within the ambit of Rule 10b-5. There must also be
manipulation or deception. In any inside-trading case this fraud derives from the
inherent fairness involved where one takes advantage of information intended to
be available only for a corporate purpose and not for the personal benefit of
anyone.
(1) Thus, an insider will be liable under Rule 10b-5 for inside trading only
where he fails to disclose material nonpublic information before trading
on it and thus makes secret profits.
5. W e were explicit in Chiarella in saying that there can be no duty to disclose when the
person who traded on inside information was not the corporation’s agent, was not a
fiduciary, or was not a person in whom the sellers of the securities had placed their trust
and confidence.
a. Not to require a fiduciary relationship, the Court recognized, would depart
radically from the established doctrine that duty arises from a specific relationship
between two parties and would amount to recognizing a general duty between all
participants in market transactions to forgo actions based on material, nonpublic
information.
b. This requirement of a specific relationship between the shareholders and the
individual trading on inside information has created analytical difficulties for the
SEC and courts in policing tippees who trade on inside information
(1) Unlike insiders who have independent fiduciary duties to both the
corporation and its shareholders, the typical tippee has no such
relationships.
6. The SEC’s position is that a tippee “inherits” the Cady Roberts obligation to shareholders
whenever he receives inside information from an insider.
a. This view differs little from the view that the Court rejected in Chiarella. In that
case, the Court of Appeals agreed with the SEC and affirmed Chiarella’s
conviction, holding that “anyone–corporate insider or not–who regularly receives
material non-public information may not use that information to trade in
securities without incurring an affirmative duty to disclose.” Here the SEC
maintains that anyone who knowingly receives nonpublic material information
from an insider has a fiduciary duty to disclose before trading.
b. Imposing a duty to disclose or abstain solely because a person knowingly receives
material nonpublic information from an insider and trades on it could have an
inhibiting influence on the role of market analysts, which the SEC itself
recognizes is necessary to the preservation of a healthy market.
7. The conclusion that recipients of inside information do not invariably acquire a duty to
disclose or abstain does not mean that such tippees always are free to trade on that
information. The need for a ban on some tippee trading is clear.
a. Not only are insiders forbidden by their fiduciary relationship from personal using
undisclosed information to their advantage, they also may not give such
information to an outsider for the same improper purpose of exploiting the
information for their personal gain.
b. Similarly, the transactions of those who knowingly participate with the fiduciary
in such a breach are forbidden as transactions on behalf of the trustee himself.
c. Thus, the tippee’s duty to disclose or abstain is derivative from that of the
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insider’s duty. As the Court noted in Chiarella, the tippee’s obligation has been
viewed as arising from his role as a participant after the fact in the insider’s breach
of a fiduciary duty.
d. Thus, some tippees must assume an insider’s duty to the shareholder not because
they receive inside information, but rather because it has been made available to
them improperly.
(1) For Rule 10b-5 purposes, the insider’s disclosure is improper only
where it would violate his Cady Roberts duty. Thus, a tippee assumes a
fiduciary duty to the shareholders of a corporation not to trade on
material nonpublic information only when the insider 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.
(a) In determining whether a tippee is under an obligation to
disclose or abstain, it is thus necessary to determine whether the
insider’s “tip” constituted a breach of the insider’s fiduciary
duty. All disclosures of confidential corporate information are
not inconsistent with the duty insiders owe to shareholders.
i) W hether disclosure is a breach of duty depends in
large part on the purpose of the disclosure. The test is
whether the insider will personally benefit, directly or
indirectly, from his disclosure. Absent some personal
gain, there has been no breach of duty to
stockholders. And absent a breach by the insider,
there is no derivative breach.
D. The SEC & Selective Disclosure. The SEC recently concluded that selective disclosure to analysts
undermined public confidence in the integrity of the stock markets.
1. Regulation FD. In 2000, the SEC adopted Regulation FD to create a non-insider trading-
based mechanism for restricting selective disclosure. If someone acting on behalf of a
public corporation discloses material nonpublic information to securities market
professional or holders of the issuer’s securities who may well trade on the basis of the
information, the issuer must also disclose that information to the public.
a. Intentional Disclosures. Where the disclosure is intentional, the issuer must
simultaneously disclose the information in a manner designed to convey it to the
general public.
b. Non-Intentional Disclosures. W here the disclosure was not intentional, as where a
corporate officer “let something slip,” the issuer must make public disclosure
“promptly” after a senior officer learns of the disclosure.
E. United States v. O’Hagan (S. Ct. 1997).
1. Facts. O’Hagan was a partner in a Minneapolis law firm, Dorsey & W hitney, that was
retained by Grand Met to represent it in a potential tender offer for the common stock of
Pillsbury. On Oct. 4, 1998, Grand Met publicly announced its tender offer for Pillsbury
stock. However, back in Aug. of 1988, O’Hagan began purchasing call options of
Pillsbury stock.48 By the end of September, he owned 2,500 options. W hen Grant Met
announced its tender offer of Pillsbury, the price of Pillsbury stock rose and O’Hagan then
sold his Pillsbury options and common stock, making a $4.3 million profit. The SEC
initiated an investigation that resulted in a 57-count indictment. A jury convicted
O’Hagan on all counts and he was sentenced to 41-months imprisonment. A divided
Court of Appeals reversed, holding that liability under § 10(b) and Rule 10b-5 could not
be grounded on the misappropriation theory of securities fraud on which the prosecution
48
Each option gave him the right to purchase 100 shares of Pillsbury stock by a specified date in September
1988.
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relied and that Rule 14e-3(a)–which prohibits trading while in possession of material,
nonpublic information relating to a tender offer–exceeds the SEC’s § 14(e) rulemaking
authority because the rule contains no breach of fiduciary duty requirement.
2. Under the “traditional” or “classical theory” of insider trading liability, § 10(b) and Rule
10b-5 are violated when a corporate insider trades the securities of his corporation on the
basis of material, nonpublic information. Trading on such information qualifies as a
“deceptive device” under § 10(b), the Court has affirmed, because “a relationship of trust
and confidence exists between the shareholders of a corporation and those insiders who
have obtained confidential information by reason of their position with that corporation.
a. The classical theory applies not only to officers, directors, and other permanent
insiders of a corporation, but also to attorneys, accountants, consultants, and
others who temporarily become fiduciaries of a corporation.
3. The “misappropriation theory” holds that a person commits fraud in connection with a
securities transaction, and thereby violates § 10(b) and Rule 10b-5 when he
misappropriates confidential information for securities trading purposes, in breach of a duty
owed to the source of the information.
a. Under this theory, a fiduciary’s undisclosed, self-serving use of a principal’s
information to purchase or sell securities, in breach of a duty of loyalty and
confidentiality, defrauds the principal of the exclusive use of that information. In
lieu of premising liability on a fiduciary relationship between company insider
and purchaser or seller of the company’s stock, the misappropriation theory
premises liability on a fiduciary-turned-trader’s deception of those who entrusted
him with access to confidential information.
4. The two theories are complementary, each addressing efforts to capitalize on nonpublic
information through the purchase or sale of securities.
a. The classical theory targets a corporate insider’s breach of duty to shareholders
with whom the insider transacts.
b. The misappropriation theory outlaws trading on the basis of nonpublic
information by a corporate “outside” in breach of a duty owed not to a trading
party, but to the source of information.
(1) The misappropriation theory is thus designed to protect the integrity of
the securities markets against abuses by outsiders to a corporation who
have access to confidential information that will affect the corporation’s
security price when revealed, but who owe not fiduciary or other duty
to that corporation’s shareholders.49
5. The Court agrees with the Government that misappropriation, as just defined, satisfies §
10(b)’s requirement that chargeable conduct involve a “deceptive device or contrivance”
use “in connection with” the purchase or sale of securities.
a. Misappropriators deal in deception. A fiduciary who pretends loyalty to the
principal while secretly converting the principal’s information for personal gain
dupes of defrauds the principal.
b. Full disclosure forecloses liability under the misappropriation theory: Because the
deception essential to the misappropriation theory involves feigning fidelity to the
source of information, if the fiduciary discloses to the source that he plans to trade
on the nonpublic information, there is no “deceptive device” and thus no § 10(b)
violation–although the fiduciary-turned-trader may remain liable under state law
for breach of a duty of loyalty.
6. The element that the misappropriator’s deceptive use of information be “in connection
with the purchase or sale of a security is also satisfied because the fiduciary’s fraud is
consummated, not when the fiduciary gains the confidential information, but when,
49
The Government could not have prosecuted O’Hagan under the classical theory, for O’Hagan was no an
“insider” of Pillsbury, the corporation in whose stock he traded.
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without disclosure to his principal, he uses the information to purchase or sell securities.
a. The securities transaction and the breach of duty thus coincide. This is so even
though the person or entity defrauded is not the other party to the trade, but is,
instead, the source of the nonpublic information.
b. A misappropriator who trades on the basis of material, nonpublic information, in
short, gains his advantageous market position through deception; he deceives the
source of the information and simultaneous harms members of the investing
public.
F. Supreme Court’s Previous Consideration of Misappropriation Theory. The Supreme Court in Carpenter v.
United States (1987), affirmed R. Foster W inans’ convictions on all counts, though the securities
fraud count was affirmed only by an evenly divided court (4-4). W inans published the Wall Street
Journal’s “Heard on the Street” column which provided investing advice and information. The
column had a short-lived effect on the price of stocks it covered. Though it was the Journal’s
policy to keep the contents of the column confidential before publication, W inans disclosed the
contents of his columns to several friends who then traded the affected stocks.
G. Rule 10b5-2. Rule 10b5-2 provides “a non-exclusive list of three situations in which a person has a
duty of trust or confidence for purposes of the ‘misappropriation’ theory.”
1. First, such a duty exists whenever someone agrees to maintain information in confidence.
2. Second, such a duty exists between two people who have a pattern or practice of sharing
confidences such that the recipient of the information knows or reasonable should know
that the speaker expects the recipient to maintain the information’s confidentiality.
3. Third, such a duty exists when someone receives or obtains material nonpublic
information from a spouse, parent, child, or sibling.
VI. Short-Swing Profits
A. Reliance Electric Co. v. Emerson Electric Co. (S. Ct. 1972).
1. Section 16(b) of the Securities Act of 1934 provides, among other things, that a
corporation may recover for itself the profits realized by an owner of more than 10% of its
shares from a purchase and sale of its stock within any six-month period, provided that the
owner held more than 10% “both at the time of the purchase and sale.”
2. The history and purpose of § 16(b) have been exhaustively reviewed by federal courts on
several occasions since its enactment in 1934.
a. Those courts have recognized that the only method Congress deemed effective to
curb the evils of insider trading was a flat rule taking the profits out of a class of
transactions in which the possibility of abuse was believed to be intolerably great.
b. Congress did not reach every transaction in which an investor actually relies on
inside information. A person avoids liability is he does not meet the statutory
definition of an “insider,” or if he sells more than six months after purchase.
3. Among the “objective standards” contained in § 16(b) is the requirement that a 10%
owner be such “both at the time of the purchase and sale ... of the security involved.”
a. Read literally, this language clearly contemplates that a statutory insider might sell
enough shares to bring his holdings below 10%, and later–but still within six
months–sell additional shares free from liability under the statute.
(1) Indeed, commentators on the securities law have recommended this
exact procedure for a 10% owner who, like Emerson, wishes to dispose
of his holders within six months of their purchase.
B. Foremost-McKesson, Inc. v. Provident Securities Company (S. Ct. 1976).
1. Issue. W hether a person purchasing securities that put his holdings above the 10% level is a
beneficial owner “at the time of the purchase” so that he must account for profits realized
on a sale of those securities within six months.
2. Section 16(b) provides that a corporation may capture for itself the profits realized on a
purchase and sale, or sale and purchase, of its securities within six months by a director,
officer, or beneficial owner.
3. Section 16(b)’s last sentence, however, provides that it “shall not be construed to cover any
transaction where such beneficial owner was not such both at the time of the purchase and
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sale, or the sale and purchase, of the security involved...”

4. The legislative record reveals that the drafters focused directly on the fact that the original
draft of the bill that became § 16(b) covered a short-term purchase-sale sequence by a
beneficial owner only if his status existed before the purchase, and no concern was
expressed about the wisdom of this requirement.
a. But the explicit requirement was omitted from the operative language when it
was restructured to cover sale-repurchase sequences.
b. In the same draft, however, the exemptive provision was added to the section.
(1) On this record, we are persuaded that the exemptive provision was
intended to preserve the requirement of beneficial ownership before the
purchase. W e hold that in a purchase-sale sequence, a beneficial owner
must account for profits only if he was a beneficial owner “before the
purchase.”
C H A PTER S IX : P R O BLEM S O F C O N TRO L
I. Proxy Fights*
A. Strategic Use of Proxies*
B. Reimbursement of Costs*
C. Private Actions for Proxy Rule Violations*
D. Shareholder Proposals*
E. Shareholder Inspection Rights*
II. Shareholder Voting Control*
III. Control in Closely Held Corporations
A. Voting
1. Straight Voting. In straight voting, each share may be voted for as many candidates as there
are slots on the board, but no share may be voted more than once for any given candidate.
Directors are elected by a plurality (not necessarily majority) of the votes cast.
2. Cumulative Voting. Cumulative voting entitles a shareholder to cumulate or aggregate his
votes in favor of fewer candidates than there are slots available, including in the extreme
case aggregating all of his votes for just one candidate. The consequences are that a
minority shareholder is far more likely to be able to obtain at least one seat on the board.
a. Mandatory/Permissive Cumulative Voting. Corporations formed after January 1,
1987 are governed by the ‘87 Act while those formed before are governed by the
‘65 Act, under which cumulative voting is required.
(1) A corporation governed under the ‘65 Act can elect to be governed by
the ‘87 Act.
b. Removal of Directors. In most states, shareholders have the right to remove a
director without cause at any time during his term. Consequently, because the
right of cumulative voting would be completely nullified if an election to remove
were done by a straight “yes or no” vote at which the majority of votes cast
determined the result, most states have a special provision to prevent this result.
(1) Under MBCA § 8.08(c), if a corporation has cumulative voting, the
director cannot be removed if the number of votes cast against his
removal would have been enough to elect him.
3. Staggered Board. Only a minority of the board will stand for election in any given year.
The rationale given is that there will be a continuity of experience on the board. It is also
used as a takeover defense mechanism.
B. The Statutory Norm. “The business of a corporation shall be managed by its board of directors.”
Traditionally, powers have been allocated among the shareholders, the directors and the officers of a
corporation in a particular way. Even today, most statutes assume that this allocation of powers will
be followed.
1. Shareholders. The shareholders act principally through two mechanism: (1) electing a
removing directors; and (2) approving or disapproving fundamental or non-ordinary changes (e.g.,
mergers).
2. Directors. The directors “manage” the corporation’s business. That is, they formulate
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policy, and appoint officers to carry out that policy.

3. Officers. The corporation’s officers administer the day-to-day affairs of the corporation,
under the supervision of the board.
4. Inappropriate for Large or Closely-Held Corporations. For very large or very small
corporations, this statutory scheme does not reflect reality.
a. A small corporation generally does not have its affairs managed by the board of
directors–the shareholders usually exercise control directly (they may happen also
to be directors, but they usually do not act as a body of directors, and the
controlling shareholders often disregard any non-shareholder directors).
b. A very large publicly-held company is really run by its officers, and the board of
directors frequently serves as little more than a “rubber-stamp” to approve
decisions made by officers.
C. Shareholder Vote Pooling Agreement. An agreement in which two or more shareholders agree to vote
together as a unit on certain or all matters.
1. Disagreement. W hat if the shareholders disagree? Arbitration? How do you enforce the
decision? Proxies? To make irrevocable, the proxy must say that it is irrevocable and it
must be coupled with an interest.
2. MBCA § 7.32 validates shareholder agreements no matter how far they stray from the
statutory norm (non-public corporations).
a. Can eliminate the board of directors altogether.
b. Shareholder Agreement. The shareholder must agree. Notice to new shareholders
is given on the stock certificate.
D. Ringling Bros.-Barnum & Bailey Combined Shows v. Ringling (Del. Sup. Ct. 1947).
1. Facts. The corporation had 1000 shares outstanding (315 by petitioner Edith, 315 by
defendant Aubrey and 370 by defendant John. Edith alleged that Aubrey was bound to
vote her share for an adjournment of the meeting, or in the alternative, for a certain slate
of directors. The agreement was entered into in 1941. First, the agreement provided that
each party “will consult and confer with the other and the parties will act jointly in
exercising such voting rights in accordance with such agreement as they may reach with
respect to any matter calling for the exercise of such voting rights.” Second, in the event
that the parties disagreed, the disagreement was to be submitted to arbitration to Mr. Loos
o W ashington, D.C. The arbitrator’s decision was to be binding. Finally, the agreement
was to be in effect for a period of ten years unless terminated earlier by mutual agreement.
A disagreement arose before the ‘46 meeting between Mr. Haley (acting on behalf of
Aubrey) and Edith. Edith demanded that Mr. Koos arbitrate the dispute. He concluded
that both parties vote to adjourn for 60 days. Mr. Haley opposed the motion to adjourn.
The chairman concluded that the motion carried but proceeded with the election of the
directors, regardless.
2. Issue. Should the agreement be interpreted as attempting to empower the arbitrator to
carry his directions into effect?
a. Certainly there is no express delegation or grant of power to do so, either by
authorizing him to vote the shares or to compel either party to vote them in
accordance with his directions.
b. The agreement expresses no other function of the arbitrator than that of deciding
question in disagreement which prevent the effectuation of the purpose “to act
jointly.” The power to enforce a decision does not seem a necessary or usual incident of
such a function.
(1) Mr. Loos is not a party to the agreement. It does not contemplate the
transfer of any shares or interest in shares to him, or that he should
undertake any duties which the parties might compel him to perform.
The parties provided that they might designed any other individual to
act instead of Mr. Loos. The agreement doesn’t attempt to make the
arbitrator a trustee of an express trust. W hether the parties accept or
reject his decision is no concern of his, so far as the agreement or
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surrounding circumstances reveal.

(2) W e think the parties sought to bind each other, but to be bound only to
each other, and not to empower the arbitrator to enforce decisions he
might make.
(a) From this conclusion, it follows necessarily that no decision of the
arbitrator could ever be enforced if both parties to the agreement were
unwilling that it be enforced, for the obvious reason that there would be
no one to enforce it.
(3) The language in the agreement with respect to a decision of the
arbitrator other than to provide that it “shall be binding upon the
parties,” when considered in relation to its context and the situations to
which it is applicable, means that each party promised the other to
exercise her own voting rights in accordance with the arbitrator’s
decision.
(a) The agreement is silent about any exercise of the voting rights
of one party by the other. There is nothing to justify implying
a delegation of the power in the absence of some indication
that the parties bargained for that means. W e do not find
enough in the agreement or in the circumstances to justify a
construction that either party was empowered to exercise
voting right of the other.
(4) Separating the Voting Right of Stock From Ownership. The defendants
contend that there is an established doctrine “that there can be no
agreement, or any device whatsoever, by which the voting power of
stock of a Delaware corporation may be irrevocably separated from
ownership of the stock, except by an agreement which complied with
[statute].”
(a) The defendants’ sweeping formulation would impugn well-
recognized means by which a shareholder may effectively
confer his voting rights upon others while retaining various
other rights.
(b) Various forms of such pooling agreements, as they are
sometimes called, have been held valid and have been
distinguished from voting trusts.
(c) Generally speaking, a shareholder may exercise wide liberality
of judgment in the matter of voting, and it is not objectionable
that his motive may be for personal profit, or determined by
whims or caprice, so long as he violates no duty owed to his
fellow shareholders.
(5) Voting Agreements Okay. The ownership of voting stock imposes no
legal duty at all. A group of shareholders, may, without impropriety,
vote their respective shares so as to obtain advantages of concerted
action.
(a) Provisions Regarding Deadlock Okay. Reasonable provisions for
cases of failure of the group to reach a determination because of
an even division in their ranks seem unobjectionable.
c. Right to Reject Votes. The Court of Chancery may, in a review of an election,
reject votes of a registered shareholder where his voting of them is found to be in
violation of right of another person.
(1) W e have concluded that the election should not be declared invalid, but
that effect should be given to a rejection of the votes representing Mrs.
Haley’s shares.
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E. McQuade v. Stoneham (N.Y. 1934).

1. Although it has been held that an agreement among stockholders whereby it is attempted
to divest the directors of their power to discharge an unfaithful employee of the
corporation is illegal as against public policy, it must be equally true that the stockholders
may not, by agreement among themselves, control the directors in the exercise of the
judgment vested in them by virtue of their office and to elect officers and fix salaries.
Their motives may not be questioned so long as their acts are legal. The bad faith or the
improper motives of the parties does not change the rule. Directors may not by
agreements entered into as stockholders abrogate their independent judgment.
2. Agreeing to Combine to Elect Directors. Stockholders may, of course, combine to elect
directors. That rule is well settled.
a. Limitations on Power to Unite. The power to unite is, however, limited to the
election of directors and is not extended to contracts whereby limitations are
placed on the power of directors to manage the business of the corporation by the
selection of agents at defined salaries.
3. Stoneham and McGraw were not trustees for McQuade as an individual.50 Their duty was
to the corporation and its stockholders, to be exercised according to their unrestricted
lawful judgment. They were under no legal obligation to deal righteously with McQuade
if it was against public policy to do so.
4. The court holds that it is restrained by authority to hold that a contract is illegal and void
so far as it precludes the board of directors, at the risk of incurring legal liability, from
changing officers, salaries, or policies or retaining individuals in office, except by consent
of the contracting parties. 51
5. Concurring Opinion. The agreement contemplated no restriction upon the powers of the
board of directors, and no dictation or interference by stockholders except in so far as
concerns the election and remuneration of officers and the adhesion by the corporation to
established policies.
a. It seems difficult to reconcile such a decision with the statements in the opinion
of Manson v. Curtis that “it is not illegal or against public policy for two or more
stockholders owning the majority of the shares of stock to unite upon a course of
corporate policy or action, or upon the officers whom they will elect,” and that
“shareholders have the right to combine their interests and voting powers to
secure such control of the corporation and the adoption of and adhesion by it to a
specific policy and course of business.”
b. The directors have the power and the duty to act in accordance with their own
best judgment so long as they remain directors. The majority stockholders can
compel no action by the directors, but at the expiration of the term of office of
the directors the stockholders have the power to replace them with others whose
actions coincide with the judgment or desires of the holders of a majority of the
stock.
F. Clark v. Dodge (N.Y. 1936).
1. Issue. The only question which need be discussed is whether the contract is illegal as
against public policy within the decision in McQuade v. Stoneham.
2. Statutory Norm. The business of a corporation shall be managed by its board of directors.’
Gen. Corp. Law § 27.
a. That is the statutory norm. Are we committed by the McQuade case to the
50
“A trustee is held to something stricter than the morals of the marketplace.” Meinhard v. Salmon.
51
The court also concludes, in the alternative, that the agreement was invalid because at the time of the
contract, McQuade was also a city magistrate. A New York City criminal statute prohibited from holding other
employment during his government service.
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doctrine that there may be no variation, however slight or innocuous, from that
norm, where salaries or policies or the retention of individuals in office are
concerned?
b. Basis of McQuade Nebulous. Apart from its practical administrative convenience,
the reasons upon which it is said to rest are more or less nebulous. Public policy,
the intention of the Legislature, detriment to the corporation, are phrases which
in this connection mean little. Possible harm to bona fide purchasers of stock or
to creditors or to stockholding minorities have more substance; but such harms
are absent in many instances.
c. No Harm in Agreements. If the enforcement of a particular contract damages
nobody-not even, in any perceptible degree, the public-one sees no reason for
holding it illegal, even though it impinges slightly upon the broad provision of §
27.
3. Directors as Sole Stockholders–Agreement Enforceable. Where the directors are the sole
stockholders, there seems to be no objection to enforcing an agreement among them to
vote for certain people as officers. There is no direct decision to that effect in this court,
yet there are strong indications that such a rule has long been recognized.
4. Agreement Did Not Sterilize the Board. Except for the broad dicta in the McQuade opinion,
we think there can be no doubt that the agreement here in question was legal and that the
complaint states a cause of action. There was no attempt to sterilize the board of directors,
as in the Manson and McQuade cases.
5. McQuade Confined to Its Facts. If there was any invasion of the powers of the directorate
under that agreement, it is so slight as to be negligible; and certainly there is no damage
suffered by or threatened to anybody. The broad statements in the McQuade opinion,
applicable to the facts there, should be confined to those facts.
G. Agreements Requiring Election of Directors. Agreements by which the shareholders simply commit to
electing themselves, or their representatives , as directors, are generally considered unobjectionable,
and are now expressly validated in many jurisdictions. They do not interfere with the obligations of
the director to exercise their sound judgment in managing the affairs of the corporation.
1. Agreements Requiring Appointment of Particular Officers/Employees. The courts have had more
difficulty with shareholder agreements requiring the appointment of particular individuals
as officers or employees of the corporation, since such agreements do deprive the directors
of one of their most important functions.
H. Voting Trust. Another device that can be used for control is the voting trust, a device specifically
authorized by the corporation laws of most states. W ith a voting trust, shareholders who which to
act in concert turn their shares over to a trustee. The trustee then votes all the shares, in accordance
with instructions in the document establishing the trust.
1. The general requirements for creating a voting trust are as follows: (1) a written agreement,
signed by the trustees and the beneficiary; (2) property is conveyed into the trust, i.e., the
shareholders transfer some or all of their shares to the trustee; (3) the books of the
corporation are changed to reflect that the trustees have the right to vote the stock; and (4)
the voting trust issues certificates to the beneficiaries.
a. Early Hostility. Early courts were hostile to voting trusts because they separated
shareholders’ voting power and economic ownership interests. Today, statutes
specifically authorize voting trusts in virtually all jurisdictions.
(1) MBCA § 7.30 sets a maximum term for such a trust at ten years. This is
in contrast with the Delaware corporation law which does not contain a
sunset provision.
b. W hy a Voting Trust? (1) Provides cohesion and certainty to management in large
companies with a large number of shareholders; (2) Regulatory agencies want
assurance that control of the business isn’t transferred without consent; (3)
Closely-held family corporations; (4) Creditors may insist as a condition of
making loan the power along with the power to appoint trustee.
2. Proxy. A written grant of authority that grants the right to vote stock.
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a. Generally Revocable. Generally, a proxy is revocable by the shareholder, even if

the proxy itself recites that it is irrevocable.
b. Exception for Proxy Coupled with Interest. All states, however, recognize one major
exception to this general rule of revocability: a proxy is irrevocable if it meets two
requirements: (1) it states that it is irrevocable; and (2) it is coupled with an
interest.
(1) Coupled with an Interest. The recipient of the proxy must have some
property interest in the shares, or at lease some other direct economic
interest in how the vote is cast. 52
I. Special Statutes for Closely Held Corporations. Provisions vary widely from state to state. Generally,
they allow certain corporations to elect (it’s voluntary) close corporation status (whereupon the
corporation is said to be a statutory close corporation).
1. Ex. In Delaware, close corporation status may be elected by corporations with not more
than 30 shareholders.
a. Del. Gen. Corp. Law § 351 provides, “The certificate of incorporation of a close
corporation may provide that the business of the corporation shall be managed by
the stockholders of the corporation rather than by a board of directors.”
J. Limited Liability Company. W ith an LLC, issues of control are largely left to individual choice,
reflected in a document, drafted by (or for) the investors (the “members”) and called “regulations”
or “operating agreement” or something of the sort.
1. Member Managed (like a partnership) or Manager Managed (like a corporation).
K. Ramos v. Estrada (Cal. App. 1992).
1. Cal. Corp. Code § 178 defines a proxy to be “a written authorization signed ... by a
shareholder ... giving another person power to vote with respect to shares of such
shareholder.”
a. No Proxy Statement Created. No proxies are created by this agreement. The
agreement has the characteristics of a shareholders' voting agreement expressly
authorized by § 706(a) for close corporations. Although the articles of
incorporation do not contain the talismanic statement that “This corporation is a
close corporation,” the arrangements of this corporation, and in particular this
voting agreement, are strikingly similar to ones authorized by the Code for close
corporations.
2. Section 706(a) states, in pertinent part: “an agreement between two or more shareholders
of a close corporation, if in writing and signed by the parties thereto, may provide that in
exercising any voting rights the shares held by them shall be voted as provided by the
agreement, or as the parties may agree or as determined in accordance with a procedure
agreed upon by them....”
3. Even though this corporation does not qualify as a close corporation, this
agreement is valid and binding on the Estradas. §706(d) states: “This section shall
not invalidate any voting or other agreement among shareholders ... which
agreement ... is not otherwise illegal.”
a. The Legislative Committee comment regarding § 706(d) states that
“[t]his subdivision is intended to preserve any agreements which would
be upheld under court decisions even though they do not comply with one or
more of the requirements of this section, including voting agreements of
52
MBCA § 7.22(d) gives a catalog of people who will be deemed to hold a suitable “interest”: (1) a pledgee
(e.g., a holder pledges his share in return for a loan from bank, and gives bank, the pledgee, his proxy); (2) a person
who has purchased or agreed to purchase the shares; (3) a creditor of the corporation (e.g., creditor says he won’t give credit to
corporations unless the controlling shareholder gives creditor a proxy that’s irrevocable while the debt is outstanding;
and a party to a voting agreement (e.g., A, B, and C are the shareholders in a closely-held corporation; they sign a voting
agreement to vote their shares together, which impliedly gives the two shareholders in the majority on any ballot an
irrevocable proxy to vote the shares of the third).
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corporations other than close corporations.”

4. The agreement calls for enforcement by specific performance of its terms because the stock
is not readily marketable. Section 709(c) expressly permits enforcement of shareholder
voting agreements by such equitable remedies. It states, in pertinent part: “The court may
determine the person entitled to the office of director or may order a new election to be
held or appointment to be made, may determine the validity, effectiveness and
construction of voting agreements ... and the right of persons to vote and may direct such
other relief as may be just and proper.”
IV. Abuse of Control
A. Donahue v. Rodd Electrotype (Mass. 1975).
1. Facts. Plaintiff was a minority shareholder in a corporation who had inherited her shares
from her husband, an employee of the corporation. The corporation had previously
bought back shares from its majority stockholder at a high price. It refused to buy a similar
portion of P’s shares back from her at anything close to that price, thus leaving her with a
largely unmarketable interest.
2. Close Corporation. There is no single, generally accepted definition. Some commentators
emphasize an ‘integration of ownership and management’ in which the stockholders
occupy most management positions. Others focus on the number of stockholders and the
nature of the market for the stock. In this view, close corporations have few stockholders;
there is little market for corporate stock. The court accepts aspects of both definitions:
a. The court deems a close corporation to be typified by: (1) a small number of
stockholders; (2) no ready market for the corporate stock; and (3) substantial
majority stockholder participation in management, directors and operations of the
corporation.
3. Close Corporation Similar to Partnership. As thus defined, the close corporation bears a
striking resemblance to a partnership. Commentators and courts have noted that the close
corporation is often little more than an ‘incorporated’ or ‘chartered’ partnership. The
stockholders ‘clothe’ their partnership with the benefits peculiar to a corporation, limited
liability, perpetuity and the like.
a. Relationship of Trust. Just as in a partnership, the relationship among the
stockholders must be one of trust, confidence and absolute loyalty if the enterprise
is to succeed. Disloyalty and self-seeking conduct on the part of any stockholder
will engender bickering, corporate stalemates, and perhaps, efforts to achieve
dissolution.
4. Although the corporate form provides the above-mentioned advantages for the
stockholders (limited liability, perpetuity, and so forth), it also supplies an opportunity for
the majority stockholders to oppress or disadvantage minority stockholders.
a. The minority can, of course, initiate suit against the majority and their directors.
Self-serving conduct by directors is proscribed by the director’s fiduciary
obligation to the corporation. However, in practice, the plaintiff will find
difficulty in challenging dividend or employment policies. Such policies are
considered to be within the judgment of the directors.
(1) Thus, when these types of ‘freeze-outs’ are attempted by the majority
stockholders, the minority stockholders, cut off from all corporation-
related revenues, must either suffer their losses or seek a buyer for their
shares. Many minority stockholders will be unwilling or unable to wait
for an alteration in majority policy.
(a) At this point, the true plight of the minority stockholder in a
close corporation becomes manifest. He cannot easily reclaim
his capital. In a large public corporation, the oppressed or
dissident minority stockholder could sell his stock in order to
extricate some of his invested capital. By definition, this
market is not available for shares in the close corporation.
5. In a partnership, a partner who feels abused by his fellow partners may cause dissolution by
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his ‘express will at any time’ and recover his share of partnership assets and accumulated
profits. By contrast, the stockholder in the close corporation or ‘incorporated partnership’
may achieve dissolution and recovery of his share of the enterprise assets only by
compliance with the rigorous terms of the applicable chapter of the General Laws.
a. The minority stockholders may be trapped in a disadvantageous situation. No
outsider would knowingly assume the position of the disadvantage minority. The
outsider would have the same difficulties. This is the capstone of the majority
plan. Majority ‘freeze-out’ schemes which withhold dividends are designed to
compel the minority to relinquish stock at inadequate prices.
6. Close Corp. Stockholders Owe One Another Fid. Duty. Because of the fundamental
resemblance of the close corporation to the partnership, the trust and confidence which are
essential to this scale and manner of enterprise, and the inherent danger to minority
interests in the close corporation, the court holds that stockholders in the close corporation
owe one another substantially the same fiduciary duty in the operation of the enterprise
that partners owe to one another.
7. Equal Opportunity in a Close Corporation. W e hold that, in any case in which the
controlling stockholders have exercised their power over the corporation to deny the
minority such equal opportunity, the minority shall be entitled to appropriate relief.
a. Remedy. (1) The judgment may require Rodd to remit $36,000 with interest at
the legal rate to Rodd Electrotype in exchange for forty-five shares of Rodd
Electrotype treasury stock or (2) The judgment may require Rodd Electrotype to
purchase all of the plaintiff’s shares for $36,000 without interest.
B. W ilkes v. Springside Nursing Home, Inc. (Mass. 1976).
1. Facts. Four men (W ilkes, Riche, Quinn, and Pipkin) each invested $1,000 and acquired
10 shares of a Mass. corp. called Springdale, which was incorp. for the purpose of running
a nursing home out of an old hospital. It was understood by the four parties, at the time of
incorp., that they would each participate in management of the corp. It was also
understood that they would receive money in equal amounts as long as each assumed his
responsibility. The business became profitable. In ‘59, Pipkin sold his shares to Connor,
president of F.N. Agr. Bank, due to illness. In ‘65, Quinn purchased a portion of the
corp. property. W ilkes apparently helped inflate the price and his and Quinn’s relationship
deterioated. W ilkes was not given a salary when the board exercised its right to establish
them and not reelected as a director or officer at the ‘67 annual meeting. He was informed
his presence was not welcome. The master found that this exclusion was not due to
neglect or misconduct but rather because of bad personal relationships.
2. In Donahue, we held that “stockholders in the corporation owe one another substantially
the same fiduciary duty in the operation of the enterprise that partners own to one
another.”
a. As determined in previous decisions of this court, the standard of duty owed by
partners to one another is one of “utmost good faith and loyalty.”
3. Thus, we concluded in Donahue, with regard to “their actions relative to the operations of
the enterprise and the effects of that operation on the rights and investments of other
stockholders, [s]tockholders in close corporations must discharge their management and
stockholder responsibilities in conformity with this strict good faith standard. They may
not act out of avarice, expediency, or self-interest in derogation of their duty of loyalty to
the other stockholders and to the corporation.”
a. Freeze-Outs. In the Donahue case we recognized that one peculiar aspect of close
corporations was the opportunity afforded to majority stockholders to oppress,
disadvantage or “freeze out” minority stockholders. 53
53
In Donahue itself, for example, the majority refused the minority an equal opportunity to sell a ratable
number of shares to the corporation at the same price available to the minority. The net result of this refusal was that
the minority could be forced to “sell out at less than fair value,” since there is by definition no ready market for
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(1) Deprivation of Corporate Offices & Employment. “Freeze outs” may be

accomplished by the use of other devices. One such device which has
proved to be particularly effective in accomplishing the purpose of the
majority is to deprive minority stockholders of corporate offices and of
employment with the corporation.
(a) Courts Hesitant to Interfere with Corp. Internal Affairs. This
freeze-out technique has been successful because courts fairly
consistently have been disinclined to interfere in those facets of
internal corporate operations, such as the selection and
retention or dismissal of officers, directors, and employees,
which essentially involve management decisions subject to the
principle of majority control.
(b) The denial or employment to the minority at the hands of the
majority is especially pernicious in some instances. A guaranty
of employment with the corporation may have been one of the
“basic reasons why a minority owner has invested capital in the
firm.”
b. The Donahue decision acknowledged, as a “natural outgrowth” of the case law in
this Commonwealth, a strict obligation on the part of majority stockholders in a
close corporation to deal with the minority with the utmost good faith and
loyalty.
(1) Concern of Donahue Standard Tempering Legitimate Action. The court is
concerned that the untempered application of the strict good faith
standard enunciated in the Donahue case to cases such as this one will
result in the imposition of limitations on legitimate action by the
controlling group in a close corporation which will unduly hamper its
effectiveness in managing the corporation in the best interests of all
concerned.
(a) Selfish Ownership. The majority, concededly, have certain
rights to what has been termed selfish ownership in the
corporation which should be balanced against the concept of
their fiduciary duty to the minority.
4. Balancing Test. Therefore, when minority stockholders in a close corporation bring suit
against the majority alleging breach of the strict good faith duty owed to them by the
majority, the court must carefully analyze the action taken by the controlling stockholders
in the individual case.
a. Legitimate Business Purpose. W hether the controlling group can demonstrate a
legitimate business purpose for its action.
(1) In making this determination, the court must acknowledge the fact that
the controlling group in a close corporation must have some room to
maneuver in establishing the business policy of the corporation. It must
have a large measure of discretion, for example, in declaring or
withholding dividends, deciding whether to merge or consolidate,
establishing the salaries of corporate officers, dismissing directors with or
without cause, and hiring and firing corporate employees.
b. Less Harmful Alternative? W hen an asserted business purpose is advanced, it is
open to the minority to demonstrate that the same legitimate objective could
have been achieved through an alternative course of action less harmful to the
minority’s interest.
minority stock in a close corporation.
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C. Ingle v. Glamore Motor Sales, Inc. (N.Y. 1989).

1. Facts. In ‘64, Ingle sought to purchase an equity interest in Glamore but was instead
initially hired as a sales manager. In ‘67, Ingle and Glamore entered into a shareholders’
agreement that provided that Ingle would purchase 22 shares of the 100 shares in the corp.
and that Ingle would have an five-year option to purchase 18 more shares and that
Glamore would nominate and vote Ingle as a director and secretary. The agreement also
gave Glamore the right to purchase back the stock if Ingle ceased to be an employee for any
reason. In ‘82, 60 more shares were issued which were purchased by Glamore and his two
sons. A third agreement was entered into with a repurchase provision stating that if any
stockholder shall cease to be an employee of the Corp. for any reason, Glamore would have an
option to repurchase within 30 days. Ingle was voted out in ‘83 and fired. Glamore
notified Ingle that he was exercising his option.
2. A minority shareholder in a close corporation, by that status alone, who contractually
agrees to the repurchase of his shares upon termination of his employment for any reason,
acquires no right from the corporation or majority shareholders against at-will discharge.
There is nothing in law, in the agreement, or in the relationship of the parties to warrant
such a contradictory and judicial alteration of the employment relationship or the express
agreement.
a. It is necessary to appreciate and keep distinct the duty a corporation owes to a
minority shareholder as a shareholder from any duty it might owe him as an
employee.
(1) Under the established common-law rule–and without any reference to
the shareholders’ agreement–the corporation had the right to discharge
plaintiff at will.
(a) In Murphy v. American Home Products Corp. the court concluded
that there is no implied obligation of good faith and fair dealing
in an employment at will, as that would be incongruous to the
legally recognized jural relationship in that kind of employment
relationship.
b. Divestiture of his status as a shareholder, by operation of the repurchase provision,
is a contractually agreed to consequence flowing directly from the firing, not vice
versa.
c. No duty of loyalty and good faith akin to that between partners, precluding
termination except for cause, arises among those operating a business in the
corporate form who “have only the rights, duties and obligations of stockholders”
and not those of partners.
3. Dissent. The majority is incorrect in treating the case as one of a claimed breach of a
hiring contract by the employer rather than an unfair squeeze-out of a minority
shareholder in a close corporation by the majority.
a. The majority’s decision summarily rejects, without discussion, plaintiff’s
underlying theory which is rooted in his equitable rights as a minority shareholder
and principal in a close corporation and the fiduciary duty of fair dealing owed
him by the majority shareholders–rights and duties which have been widely
recognized in statutory and decisional law in this and other jurisdictions. W ilkes
v. Springside Nursing Home (Mass. 1976).
b. The relationship of a minority shareholder to a close corporation, if fairly viewed,
cannot possibly be equated with an ordinary hiring and, in the absence of a
contract, regarded as nothing more than an employment at will.
D. Brodie v. Jordan (Mass. 2006).
1. Brodie, Barbuto and Jordan each held one-third of the shares of the Malden. After Brodie
ceased participating in the day-to-day operations, disagreements between him and Barbuto
and Jordan arose. His requests to be bought out were denied. In ‘92, W alter was voted
out as president and replaced by Jordan. W alter died in ‘97 and his wife inherited his
share. She attended an annual shareholder’s meeting, through counsel, at which she
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nominated herself for director. Jordan and Barbuto voted against her election. She also
asked for a valuation of the company, which was denied.
2. “Stockholders in a close corporation own one another substantially the same fiduciary duty
in the operation of an enterprise that partners owe one another. That is, a duty of “utmost
good faith and loyalty.” Donahue v. Rodd Electrotype Co. Of New England.
a. Majority shareholders in a close corporation violate this duty when they act to
“freeze-out” the minority.
(1) Freeze Outs. The squeezers [those who employ the freeze-out
techniques] may refuse to declare dividends; they may drain off the
corporation's earnings in the form of exorbitant salaries and bonuses to
the majority shareholder-officers and perhaps to their relatives, or in the
form of high rent by the corporation for property leased from majority
shareholders; they may deprive minority shareholders of corporate
offices and of employment by the company; they may cause the
corporation to sell its assets at an inadequate price to the majority
shareholders.
(a) W hat these examples have in common is that, in each, the
majority frustrates the minority's reasonable expectations of
benefit from their ownership of shares.
b. Shareholder’s Reasonable Expectations. W e have previously analyzed freeze-outs in
terms of shareholders' “reasonable expectations” both explicitly and implicitly. See
Bodio v. Ellis Mass. 1987) (thwarting minority shareholder's “rightful expectation”
as to control of close corporation was breach of fiduciary duty); W ilkes v.
Springside Nursing Home, Inc. (Mass. 1976) (denying minority shareholders
employment in corporation may “effectively frustrate [their] purposes in entering
on the corporate venture”).
(1) A number of other jurisdictions, either by judicial decision or by statute,
also look to shareholders' “reasonable expectations” in determining
whether to grant relief to an aggrieved minority shareholder in a close
corporation.
3. Remedy for Freezed Out Minority Shareholder. The proper remedy for a freeze-out is to
restore the minority shareholder as nearly as possible to the position she would have been
in had there been no wrongdoing.
a. If, for example, a minority shareholder had a reasonable expectation of
employment by the corporation and was terminated wrongfully, the remedy may
be reinstatement, back pay, or both.
b. Similarly, if a minority shareholder has a reasonable expectation of sharing in
company profits and has been denied this opportunity, she may be entitled to
participate in the favorable results of operations to the extent that those results
have been wrongly appropriated by the majority.
E. Smith v. Atlantic Properties, Inc. (Mass. App. 1981).
1. Facts. W olfson purchased property in ‘51 for $350,000 ($50,000 down and a note, payable
in 33 months, for the remainder). He offered a 1/4th interest in the property to Smith,
Zimble, and Burke, who each paid $12,500. Smith, an attorney, organized Atlantic to
operate the property. Each of the four investors received 25 shares. The articles of
incorporation and by-laws included an 80% provision and had the effect of giving any one
of the investors a veto in corporate decisions. Atlantic, after selling some assets, retained
about 28 acres. Atlantic showed a profit during subsequent years and the mortgage was
paid. Disagreements arose between W olfson and the other stockholders as a group.
W olfson desired repairs to structures on the property, the other stockholders desired
dividends. He exercise his veto power in spite of potential IRS penalties–which were
soon assessed in ‘62, ‘63, and ‘64. Further penalties were assessed in ‘65, ‘66, ‘67, and ‘68.
2. Donahue Rule. The court in Donahue relied on the resemblance of a close corporation to a
partnership and held that stockholders in the close corporation owe one another
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substantially the same fiduciary duty in the operation of the enterprise that partners owe to
one another. That standard, the court said, was the utmost duty of good faith and loyalty.
The court went on to say that such stockholders may not act out of avarice, expediency, or
self-interest in derogation of their duty of loyalty to the other stockholders and to the
corporation.
3. Majority Shareholders May Seek Protection. In the Donahue case, the court recognized that
cases may arise in which, in a close corporation, majority stockholders may ask protection
from a minority stockholder.
a. Such an instance arises in the present case because Dr. Wolfson has been able to
exercise a veto concerning corporate action on dividends by the 80% provision
(in Atlantic's articles or organization and by-laws) already quoted. The 80%
provision may have substantially the effect of reversing the usual roles of the
majority and the minority shareholders. The minority, under that provision,
becomes an ad hoc controlling interest.
4. W hatever may have been the reason for Dr. W olfson's refusal to declare dividends (and
even if in any particular year he may have gained slight, if any, tax advantage from
withholding dividends) we think that he recklessly ran serious and unjustified risks of
precisely the penalty taxes eventually assessed, risks which were inconsistent with any
reasonable interpretation of a duty of “utmost good faith and loyalty.
F. Nixon v. Blackwell (Del. 1993). 54
1. The tools of good corporate practice are designed to give a purchasing minority
stockholder the opportunity to bargain for protection before parting with consideration. It
would do violence to normal corporate practice and our corporation law to fashion an ad
hoc ruling which would result in a court-imposed stockholder buy-out for which the
parties had not contracted.
2. It would be inappropriate judicial legislation for this Court to fashion a special
judicially-created rule for minority investors when the entity does not fall within those
statutes, or when there are no negotiated special provisions in the certificate of
incorporation, by-laws, or stockholder agreements.
G. Jordan v. Duff and Phelps, Inc. (7th Cir. 1988).
1. Facts. Jordan began work at Duff in ‘77. By ‘83 he had purchased 188 of 20,100 shares
outstanding. The shares were purchased at book value and he was required to sign an
agreement before purchase. The agreement provided that upon certain events, the
corporation would buy back the stock. A board resolution, however, provided an
exception allowing the stock to be kept for five years after termination. Jordan, seeking a
move because of family strife, inquired about transferring and was denied. Jordan
subsequently took a job in Houston. He finished the year out at Duff, however, to have
his stock valued at the end of the year. A merger between Duff and SP was soon
announced however, after Jordan had received a check for his stock. His stock would
have been valued much higher under the merger. He refused to cash the check and asked
for his stock back. This was denied and he filed suit. The merger, nevertheless, fell
through after the Fed disapproved. Jordan amended his complaint to ask for rescission
rather than damages.
2. Close corporations buying their own stock, like knowledgeable insiders of closely held
firms buying from outsiders, have a fiduciary duty to disclose material facts. The “special
facts” doctrine developed by several courts at the turn of the century is based on the
54
The equal opportunity rule is at odds with the premise that equity investments in the corporation are
permanent and are not subject to easy withdrawal, as in a partnership. That is, parties often choose the corporate form
because it assures the stability of corporate resources. Shareholders can withdraw their investment only by selling to
another investor. Based on this, some recent courts have refused to infer partnership-type duties in close corporations
of the theory that parties could have contracted for them and, absent an agreement, corporate principles apply. Nixon
v. Blackwell is representative of this trend.
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principle that insiders in closely held firms may not buy stock from outsiders in
person-to-person transactions without informing them of new events that substantially
affect the value of the stock.
a. Because the fiduciary duty is a standby or off-the-rack guess about what parties
would agree to if they dickered about the subject explicitly, parties may contract
with greater specificity for other arrangements. It is a violation of duty to steal
from the corporate treasury; it is not a violation to write oneself a check that the
board has approved as a bonus.
(1) No Agreement, Express or Implied, Regarding No Duty to Disclose. The
stock was designed to bind Duff & Phelps's employees loyalty to the
firm. The buy-sell agreement tied ownership to employment. The
Agreement did not ensure that employees disregard the value of the
stock when deciding what to do, and neither did the usual practice at
Duff & Phelps. So the possibility that a firm could negotiate around the
fiduciary duty does not assist Duff & Phelps; it did not obtain such an
agreement, express or implied.
(2) Employment at will is still a contractual relation, one in which a
particular duration (“at will”) is implied in the absence of a contrary
expression. The silence of the parties may make it necessary to imply
other terms-those we are confident the parties would have bargained for
if they had signed a written agreement. One term implied in every
written contract and therefore, we suppose, every unwritten one, is that
neither party will try to take opportunistic advantage of the other. “The
fundamental function of contract law (and recognized as such at least
since Hobbes's day) is to deter people from behaving opportunistically
toward their contracting parties, in order to encourage the optimal
timing of economic activity and to make costly self-protective measures
unnecessary.”
3. Dissent. The mere existence of a fiduciary relationship between a corporation and its
shareholders does not require disclosure of material information to the shareholders. A
further inquiry is necessary, and here must focus on the particulars of Jordan’s relationship
with Duff and Phelps.
a. Jordan’s deal with Duff and Phelps required him to surrender his stock at book
value if he left the company. It didn’t matter whether he quit or was fired,
retired, or died; the agreement is explicit on these matters. The majority
hypothesizes about “implicit parts of the relations between Duff & Phelps and its
employees. But those relations are totally defined by:
(1) The absence of an employment contract, which made Jordan an
employee at will
(2) The shareholder agreement, which has no “implicit parts” that bear on
Duff & Phelps’ duty to Jordan, and explicitly tie his rights as a
shareholder to his status as an employee
(3) A provision in the stock purchase agreement between Jordan and Duff
& Phelps that “nothing herein contained shall confer on the Employee
any right to be continued in the employment of the Corporation.”
V. Control, Duration, and Statutory Dissolution
A. Dissolution
1. Voluntary. In a corporation, a minority shareholder cannot dissolve the corporation. This
requires a board proposal and majority shareholder approval. See MBCA § 14.02. 55
Articles of dissolution are then filed with the Secretary of State.
2. Administrative. The corporation is dissolved for failure to pay its franchise taxes. The
55
Two-thirds is required in some jurisdictions.
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corporation can, however, pay its back taxes and be reinstated (resurrected). See Ark.
Code Ann. § 4-27-1420 et seq.
3. Judicial. Modern corporate statutes provide a minority shareholder another
option–involuntary dissolution. The minority shareholder can ask a court to dissolve a
corporation, and she would receive a final disposition after the corporation’s assets are
liquidated and its affairs are wound up. A court in its discretion56 may order involuntary
dissolution if the shareholder shows one of the statutory grounds:
a. Board Deadlock. The directors cannot agree and the shareholders have been
unable to break the impasse on the board–and the corporation’s business is
suffering as a result (irreparable injury to the corporation threatened or suffered).
b. Misconduct. Those in control have acted in a way that is “illegal, oppressive, or
fraudulent.” See MBCA § 14.30(2)(iv).
(1) Oppressive. Most litigation is over the meaning of oppression.
(a) Unfairness.
c. Shareholder Deadlock. The shareholders are deadlocked–that is, the shareholders
have been unable to elect new directors for a specified period, such as two
consecutive meetings. See MBCA § 14.30(2)(iii)
(a) Arkansas courts have tied oppression to reasonable expectations
of the minority shareholder. Smith v. Leonard, 317 Ark. 182,
876 S.W .2d 266 (1994).57
B. Alaska Plastics, Inc. V. Coppock (Alaska 1980).
1. No Market For Close Corp. Shares. In a corporation with publicly traded stock, dissatisfied
shareholders can sell their stock on the market, recover their assets, and invest elsewhere.
In a close corporation there is not likely to be a ready market for the corporation's shares.
a. The corporation itself, or one of the other individual shareholders of the
corporation, who are likely to provide the only market, may not be interested in
buying out another shareholder. If they are interested, majority shareholders who
control operate policy are in a unique position to “squeeze out” a minority
shareholder at an unreasonably low price.
2. From a dissatisfied shareholder's point of view, the most successful remedy is likely to be a
requirement that the corporation buy his or her shares at their fair value. Ordinarily, there
are four ways in which this can occur:
a. Articles of Incorporation. First, there may be a provision in the articles of
incorporation or by-laws that provide for the purchase of shares by the
corporation, contingent upon the occurrence of some event, such as the death of
a shareholder or transfer of shares.
b. Involuntary Dissolution. Second, the shareholder may petition the court for
56
Therefore, shareholders are not entitled to dissolution even if they prove a ground to do so. Courts are
reluctant to dissolve a corporation: (1) dissolution is the ultimate form of corporate punishment, and (2) courts fear
that corporations, if dissolved, will be sold piecemeal and become worthless.
57
Court considers "oppressive actions to refer to conduct that substantially defeats the 'reasonable
expectations' held by minority shareholders in committing their capital to the particular enterprise. A shareholder
who reasonably expected that ownership would lead him or her to a job, a share of corporate earnings, a place in
corporate management, or some other form of security, would be oppressed in a very real sense when others in the
corporation seek to defeat those expectations and there exists no effective means of salvaging the investment."
A court considering a claim of oppression "must investigate what the majority shareholders knew, or should
have known, to be the petitioner's expectations in entering the particular enterprise. Majority conduct should not be
deemed oppressive simply because the petitioner's subjective hopes and desires in joining the venture are not fulfilled.
Disappointment alone should not necessarily be equated with oppression."
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involuntary dissolution of the corporation.

c. Statutory Right of Appraisal. Third, upon some significant change in corporate
structure, such as a merger, the shareholder may demand a statutory right of
appraisal.
d. Equitable Remedy for Breach of Fid. Duty. Finally, in some circumstances, a
purchase may be justified as an equitable remedy upon a finding of a breach of a
fiduciary duty between directors and shareholders and the corporation or other
shareholders.
3. Dissolution/Liquidation. As to the second method, Alaska's corporation code provides a
shareholder may bring an action to liquidate the assets of a corporation upon a showing
that “the acts of the directors or those in control of the corporation are illegal, oppressive
or fraudulent....” A shareholder may also seek liquidation when “corporate assets are being
misapplied or wasted.” Upon a liquidation of assets all creditors and the cost of liquidation
must be paid and the remainder distributed among all the shareholders “according to their
respective rights and interests.”
a. Extreme Remedy. Liquidation is an extreme remedy. In a sense, forced
dissolution allows minority shareholder to exercise retaliatory oppression against
the majority. Absent compelling circumstances, courts often are reluctant to order
involuntary dissolution. As a result, courts have recognized alternative remedies
based upon their inherent equitable powers.
(1) Alternative Remedies. Among those alternative remedies:
(a) An order requiring the corporation or a majority of its
stockholders to purchase the stock of the minority shareholders
at a price to be determined according to a specified formula or
at a price determined by the court to be a fair and reasonable
price.
4. Statutory Appraisal. Available under the Alaska Business Corporation Act in two
circumstances where there is some fundamental corporate change: (1) the remedy is
available upon the merger or consolidation with another corporation; or (2) upon a sale of
substantially all of the corporation's assets.
a. De Facto Merger. In some circumstances courts have found that a corporate
transaction so fundamentally changes the nature of the business that there is a “de
facto” merger which triggers the same statutory appraisal remedy.
5. Breach of a Fiduciary Duty Triggers Equitable Remedy. The Massachusetts Supreme Judicial
Court, in Donahue v. Rodd Electrotype Co., concluded that shareholders in closely held
corporations owe one another a fiduciary duty. 58
a. The California Supreme Court concluded that a controlling group of
shareholders owes a similar duty to minority shareholders. In Jones v. H. F.
Ahmanson & Co. (Cal. 1969), the court held that a controlling block of stock
could not be used to give the majority benefits that were not shared with the
minority.
b. W e believe that Donahue and Ahmanson correctly state the law applicable to the
relationship between shareholders in closely held corporations, or between those
holding a controlling block of stock, and minority shareholders. W e do not
believe, though, that the existence and breach of a fiduciary duty among
corporate shareholders supports the appraisal remedy ordered by the trial court in
this case.
58
“Because of the fundamental resemblance of the close corporation to the partnership, the trust and
confidence which are essential to this scale and manner of enterprise, and the inherent danger to minority interests in
the close corporation, we hold that stockholders in the close corporation owe one another substantially the same
fiduciary duty in the operation of the enterprise that partners owe to one another. In our previous decisions, we have
defined the standard of duty owed by partners to one another as the ‘utmost good faith and loyalty.’ ” Donahue.
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6. Trial Court’s Remedy Inappropriate. W e are not aware of any authority which would allow a
court to order specific performance on the basis of an unaccepted offer, particularly on
terms totally different from those offered. Such a rule would place a court in the impossible
position of making and enforcing contracts between unwilling parties.
a. Appropriate Remedy–Equal Opportunity. Donahue and Ahmanson suggest the
appropriate form of a remedy, however. In Donahue the court stated that where a
controlling shareholder took advantage of a special benefit, the fiduciary duty
owed to the other shareholders required that the corporation offer such a benefit
equally: “The rule of equal opportunity in stock purchases by close corporation
provide equal access to these benefits for all stockholders.”
7. Derivative Suit Claim/Business Judgment Rule. Judges are not business experts, a fact which
has become expressed in the so-called “business judgment rule.” The essence of that
doctrine is that courts are reluctant to substitute their judgment for that of the board of
directors unless the board’s decisions are unreasonable.
a. Unfair Distribution of Corp. Funds W ill Trump Bus. Judg. Rule. If a stockholder is
being unjustly deprived of dividends that should be his, a court of equity will not
permit management to cloak itself in the immunity of the business judgment rule.
Thus, there is authority for concluding that an unfair distribution of corporate
funds would be a proper subject for a derivative suit.
C. Meiselman v. Meiselman (N.C. 1983).
1. North Carolina statute allowed a court to order dissolution where such relief was
“reasonably necessary for the protection of the rights and interests of the complaining
shareholder.” As an alternative, the court could order a buy-out of the complaining
shareholder’s shares.
2. Reasonable Expectations. The Supreme Court held that, at least in cases involving close
corporations, the complaining shareholder need not establish oppressive or fraudulent
conduct by the controlling shareholder or shareholders. Instead, “rights and interest,”
under the statute include “reasonable expectations,” which include expectations that the
minority shareholder will participate in the management of the business or be employed by
the company but limited to expectations embodied in understandings, express or implied,
among the participants.
D. Note on Limited Liability Companies
1. Under the Delaware Limited Liability Co. Act § 18-604:
[U]pon resignation any resigning member is entitled to receive any distribution to which such member
is entitled under a limited liability company agreement and, if not otherwise provided in a limited
liability company agreement, such member is entitled to receive, within a reasonable time after
resignation, the fair value of such member's limited liability company interest as of the date of
resignation based upon such member's right to share in distributions from the limited liability
company.
2. Thus, while in a corporation the default rule generally will be one of no right of
dissolution or buyout, under the LLC default rule members are granted that right.
E. Haley v. Talcott (Del. Ch. 2004).
1. Facts. Haley and Talcott were members of Greg Real Estate, LLC, which owned the land
that a second company, Delaware Seafood (a.k.a. Redfin Grill), occupied. Haley and
Talcott chose to create and operate the Redfin Grill as an entity solely owned by Talcott.
However, due to a series of contracts between the two, the relationship was more similar
to a partnership than a typical employer/employee relationship. The business grew into a
profitable one. The two parties exercised an option to purchase the land on which the
business was situated and both signed personal guaranties for the mortgage. A rift evolved
between the two due to Haley’s expectance to receive a share in the Redfin Grill. Letters
were exchange, revolving around Haley’s alleged resignation. A stalemate ensued due to
Haley’s mere 50% interest in the LLC. While the agreement contained a detailed exit
mechanism, it did not express any details about releasing the party from the personal
guaranty or whether the party could resort to judicial dissolution in lieu of the exit
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mechanism. Therefore, Haley sought judicial dissolution of the LLC.

2. Section 18-802 provides in its entirety:
On application by or for a member or manager the Court of Chancery may decree dissolution of a
limited liability company whenever it is not reasonably practicable to carry on the business in
conformity with a limited liability company.
a. Section 18-802 of the Delaware LLC Act plays a role for LLCs similar to the role
that § 273 of the Delaware General Corporation Law plays for joint venture
corporations with only two stockholders. 59
(1) Section 273 essentially sets forth three pre-requisites for a judicial order
of dissolution: 1) the corporation must have two 50% stockholders; 2)
those stockholders must be engaged in a joint venture; and 3) they must
be unable to agree upon whether to discontinue the business or how to
dispose of its assets.
3. The Delaware LLC Act is grounded on principles of freedom of contract. For that reason,
the presence of a reasonable exit mechanism bears on the propriety of ordering dissolution
under § 18-802.
a. W hen the agreement itself provides a fair opportunity for the dissenting member
who disfavors the inertial status quo to exit and receive the fair market value of
her interest, it is at least arguable that the limited liability company may still
proceed to operate practicably under its contractual charter because the charter
itself provides an equitable way to break the impasse.
(1) In In re Delaware Bay Surgical Services, the court declined to dissolve a
corporation under § 273 in part because a mechanism existed for the
repurchase of the complaining members 50% interest. But this matter
differs from Surgical Services:
(a) The court in Surgical Services found that both parties clearly
intended, upon entering the contract, that if the parties ended
their contractual relationship, the respondent would be the one
permitted to keep the company.
(b) By contrast, no such obvious priority of interest exists here.
Haley and Talcott created the LLC together and while the
detailed exit provision provided in the formative LLC
agreement allows either party to leave voluntarily, it provides
no insight on who should retain the LLC if both parties would
prefer to buy the other out, and neither party desires to leave.
(c) In this case, forcing Haley to exercise the contractual exit
mechanism would not permit the LLC to proceed in a
practicable way that accords with the LLC Agreement, but
would instead permit Talcott to penalize Haley without expres
contractual authorization.
59
The relevant portion of § 273(a) reads: If the stockholders of a corporation of this State, having only 2
stockholders each of which own 50% of the stock therein, shall be engaged in the prosecution of a joint venture and if
such stockholders shall be unable to agree upon the desirability of discontinuing such joint venture and disposing of
the assets used in such venture, either stockholder may, unless otherwise provided in the certificate of incorporation of
the corporation or in a written agreement between the stockholders, file with the Court of Chancery a petition stating
that it desires to discontinue such joint venture and to dispose of the assets used in such venture in accordance with a
plan to be agreed upon by both stockholders or that, if no such plan shall be agreed upon by both stockholders, the
corporation be dissolved.
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60
F. Pedro v. Pedro (Minn. App. 1992).
1. Closely Held Corp. Shareholders Analogous to Partners. The relationship among shareholders
in closely held corporations is analogous to that of partners. Shareholders in closely held
corporations owe one another a fiduciary duty. In a fiduciary relationship “the law imposes
upon them highest standards of integrity and good faith in their dealings with each other.”
Owing a fiduciary duty includes dealing “openly, honestly and fairly with other
shareholders.”
2. Inasmuch as appellants’ breaches of fiduciary duty forced the buyout, they cannot benefit
from wrongful treatment of their fellow shareholder and must disgorge any such gain.
a. Breach of Fiduciary Duty. Appellants claim no breach of fiduciary duty can exist
because there has been no diminution in the value of the corporation or the stock
value of respondent's shares. In support of this assertion, appellants cite several
cases where actions by an officer or director did reduce the value of the
corporation, constituting a breach of fiduciary duty.
(1) An action depleting a corporation's value is not the exclusive method of
breaching one's fiduciary duties. Moreover, loss in value of a
shareholder's stock is not the only measure of damages.
3. Damages Calculation. Moreover, the measure of damages for the buyout was proper.
a. If the fair value of the shares is greater than the purchase price for the buyout as
calculated from the formula in the SRA, the difference is the measure of
respondent's damage resulting from having been forced to sell his shares in the
company.
4. Lifetime Employment. Minnesota statute provides, “In determining whether to order
equitable relief, dissolution, or a buy-out, the court shall take into consideration the duty
which all shareholders in a closely held corporation owe one another to act in an honest,
fair and reasonable manner in the operation of the corporation and the reasonable
expectations of the shareholders as they exist at the inception and develop during the
course of the shareholders' relationship with the corporation and with each other.”
a. Employment Part of Reasonable Expectations. This section allows courts to look to
respondent's reasonable expectations when awarding damages. In addition to an
ownership interest, the reasonable expectations of such a shareholder are a job,
salary, a significant place in management, and economic security for his family.
b. Double Recovery? Even appellants concede respondent has two separate interests,
as owner and employee. Thus, allowing recovery for each interest is appropriate
and will not be considered a double recovery.
G. Stuparich v. Harbor Furniture Mfg., Inc. (Cal. App. 2000).
1. Issue. The issue is whether plaintiffs raised a triable issue of material fact as to whether
dissolution is “reasonably necessary” to protect their rights or interests.
2. On this undisputed record, we cannot say that the trial court erred in finding as a matter of
law, that the drastic remedy of liquidation is not reasonably necessary for the protection of
the rights or interests of the complaining shareholder or shareholders.
VI. Transfer of Control
A. Frandsen v. Jensen-Sundquist Agency, Inc. (7th Cir. 1986).
1. Merger Not a Sale. A sale of stock was never contemplated. The transaction originally
contemplated was a merger of Jensen-Sundquist into First W isconsin. In a merger, as the
word implies, the acquired firm disappears as a distinct legal entity. In effect, the
shareholders of the merged firm yield up all of the assets of the firm, receiving either cash
or securities in exchange, and the firm dissolves. In this case, the shareholders would have
60
The result in this case is curious because the court finds a breach of fiduciary duty to make up the
difference between the SRA buyout price and the fair market value of the shares. The Minnesota statute, however,
explicitly states that the court may order a buy-out of the shares of either party at “fair value” is “those in control have
acted fraudulently, illegally, or in a manner unfairly prejudicial toward one or more shareholders.”
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received cash. Their shares would have disappeared but not by sale, for in a merger the
shares of the acquired firm are not bought, they are extinguished.
a. The distinction between a sale or shares and a merger is such a familiar one in the
business world that it is unbelievable that so experienced a businessman as
Frandsen would have overlooked it.
b. A sale of the majority bloc’s shares is not the same thing as a sale of either all or
some of the holding company’s assets. The sale of assets does not result in
substituting a new majority bloc, and that is the possibility at which the protective
provisions are aimed.
B. Zetlin v. Hanson Holdings, Inc. (N.Y. 1979).
1. Premium Price for Majority Shares. Absent looting of corporate assets, conversion of a
corporate opportunity, fraud or other acts of bad faith, a controlling shareholder is free to
sell, and a purchaser is free to buy, that controlling interest at a premium price.
a. Premium Price is for Privilege of Controlling Corp. Certainly, minority shareholders
are entitled to protection against such abused by controlling shareholders. They
are not entitled, however, to inhibit the legitimate interests of the other
stockholders. It is for this reason that control shares usually command a premium
price. The premium is the added amount an investor is willing to pay for the
privilege of directly influencing the corporation’s affairs.
C. Perlman v. Feldmann (2d. Cir. 1955).
1. Facts. Feldmann owned 32% of the shares of Newport Steel and sold his shares for $20 per
share–a two-thirds premium over the then-market price of $12. A minority shareholder
brought a derivative suit claiming Feldmann had sold a corporate asset, namely Newport’s
steel supplies, during the Korean W ar’s steel shortage, when steel prices were controlled
and access to steel commanded a premium. Feldmann had invented a way to skirt the
price controls (known in the industry as the “Feldmann Plan”) by having buyers make
interest-free advances to obtain supply commitments. The buyer (W ilport), a syndicate of
steel end-users, wanted Newport’s steel supplies free of the Feldmann plan. The court
held that Feldmann had breached a fiduciary duty to the corporation because his sale of
control sacrificed the favorable cash flow generated by the Feldmann Plan.
2. Both as director and as dominant stockholder, Feldmann stood in a fiduciary relationship
to the corporation and to the minority stockholders as beneficiaries thereof.
3. It is true that this is not the ordinary case of breach of fiduciary duty. W e have here no
fraud, no misuse of confidential information, no outright looting of a helpless corporation.
a. But on the other hand, we do not find compliance with that high standard which
we have just stated and which we and other courts have come to expect and
demand of corporate fiduciaries. The actions of defendants in siphoning off for
personal gain corporate advantages to be derived from a favorable market
situation do not betoken the necessary undivided loyalty owed by the fiduciary to
his principal.
b. W e do not mean to suggest that a majority stockholder cannot dispose of his
controlling bloc to outsiders without having to account to his corporation for
profits or even never do this with impunity the buyer is an interested customer,
actual or potential, for the corporation’s product. But when the sale necessarily
results in a sacrifice of this element of corporate good will and consequent
unusual profit to the fiduciary who has caused the sacrifice, he should account for
his gains.
c. So in a time of market shortage, where a call on a corporation’s product
commands an unusually large premium, in one form or another, we think it
sound law that a fiduciary may not appropriate to himself the value of this
premium.
4. Dissent. Concededly, a majority or dominant shareholder is ordinarily privileged to sell his
stock at the best price obtainable from the purchaser. In so doing he acts on his own
behalf, not as an agent of the corporation. If he knows or has reason to believe that the
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purchaser intends to exercise to the detriment of the corporation the power of

management acquired by the purchase, such knowledge and reasonable suspicion will
terminate the dominant shareholder’s privilege to sell and will create a duty not to transfer
the power of management to the purchaser.
D. Essex Universal Corp. v. Yates (2d. Cir. 1962).
1. Illegal to Sell Office W ithout Sufficient Stock. It is established beyond question under New
York law that it is illegal to sell corporate officer or management control by itself (that is,
accompanied by no stock or insufficient stock to carry voting control). The same rule
apparently applies in all jurisdictions where the question has arisen.
a. Rationale. The rationale of the rule is indisputable: persons enjoying management
control hold it on behalf of the corporation’s stockholders, and therefore may not
regard it as their own personal property to dispose of as they wish.
2. There is no question of the right of a controlling shareholder under New York law
normally to derive a premium from the sale of a controlling block of stock. In other
words, there was no impropriety per se in the fact that Yates was to receive more per share
than the generally prevailing market price for Republic stock.
3. Issue. W hether it is legal to give and receive payment for the immediate transfer of
management control to one who has achieved majority share control but would not
otherwise be able to convert that share control into operating control for some time.
a. The easy and immediate transfer of corporate control to new interests is ordinarily
beneficial to the economy and it seems inevitable that such transactions would be
discouraged if the purchaser of a majority stock interest were require to wait
some period before his purchase of control could become effective. Conversely,
it would greatly hamper the efforts of any existing majority group to dispose of its
interest if it could not assure the purchaser of immediate control over corporation
operations.
b. If Essex was contracting to acquire what in reality would be equivalent to
ownership of a majority of stock, i.e., if it would as a practical certainty have been
guaranteed of the stock voting power to choose a majority of the directors of
Republic in due course, there is no reason why the contract should not similarly
be legal. W hether Essex was thus to acquire the equivalent of majority stock
control would, if the issue is properly raised by the defendants, be a factual issue
to be determined by the district court on remand.
(1) Because 28.3 percent of the voting stock of a public held corporation is
usually tantamount to majority control, I would place the burden of
proof on this issue on Yates as the party attacking the legality of the
transaction.
4. Concurrence #1 (J. Clark). Prefer to avoid too precise instructions to the district court in
the hope that if the action again comes before us the record will be generally more
instructive on this important issue than it is now (a case-by-case approach).
5. Concurrence #2 (J. Friendly). I have no doubt that many contracts, drawn by competent
counsel and responsible counsel, for the purchase of blocks of stock from interests thought
to “control” a corporation although owning less than a majority, have contained
provisions like paragraph 6 of the contract sub judice.
a. However, developments over the past decades seems to me to show that such a
clause violates basic principle of corporate democracy. To be sure, stockholders
who have allowed a set of directors to be placed in office, whether by their vote
or their failure to vote, must recognize that death, incapacity or other hazard may
prevent a director from serving a full term, and that they will have no voice as to
his immediate successor.
(1) But the stockholders are entitled to expect that, in that event, the
remaining directors will fill the vacancy in the exercise of their fiduciary
responsibility. A mass seriatim resignation directed by a selling
stockholder, and the filling of vacancies by his henchman at the dictation
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of a purchaser and without any consideration of the character of the

latter’s nominees, are beyond what the stockholders contemplated or
should have expected to contemplate.
E. Classified Board. A classified board is one for which different classes of stock elect different sets of
directors. Contrast this with a staggered board, as was the one set out in the facts of Essex.
F. DeBaun v. First W estern Bank and Trust Company (Cal App. 1975).
1. Early Law. Early case law held that a controlling shareholder owed no duty to minority
shareholders or to the controlled corporation in the sale of his stock.
a. Now Controlling Shareholder Must Exercise Good Faith & Fairness. Decisional law
has since recognized the fact of financial life that corporate control by ownership
of a majority of shares may be misused. Thus the applicable proposition now is
that in any transaction where the control of the corporation is material, the
controlling majority shareholder must exercise good faith and fairness from the
viewpoint of the corporation and those interested therein.
2. Duty of Good Faith Encompasses Recognizing Potential Looter. That duty of good faith and
fairness encompasses an obligation of the controlling shareholder in possession of fact such
as to awaken suspicion and put a prudent man on his guard (that a potential buyer of his
shares may loot the corporation of its assets to pay for the shares purchased) to conduct a
reasonable adequate investigation (of the buyer).
C H A PTER S EVEN : M ER G ER S , A CQ U ISITIO N S , A N D T AK EO VER S
I. Mergers and Acquisitions61
A. The DeFacto Merger Doctrine
1. Statutory Merger. A statutory merger is a combination accomplished by using a procedure
described in the state corporation laws (most of which are essentially the same in this
respect). Under a statutory merger the terms of merger are spelled out in a document
called a merger agreement, drafted by the parties, which prescribes, among other things,
the treatment of the shareholders or each corporation. Considerable flexibility is available.
a. Approval Required. If the statutory merger procedure is used, approval by votes of
the boards of directors and shareholders of each of the two corporations is
required.
b. Appraisal Right for Non-Approving Shareholders (Dissenter’s Rights). In addition,
shareholders of each corporation who voted against the merger would have been
entitled to demand that they be paid in cash the fair value of their shares
(determined by agreement or, failing agreement, by a judicial proceeding). This
right to be paid off is called the “appraisal right.”
2. Practical Mergers. These acquisitions do not use the statutory procedure.
a. Short Form Merger. Corp. A would offer its shares to Corp. B shareholders in
return for their shares of Corp. B. Corp. A would seek to acquire enough shares
to gain control of Corp. B (and the offer could be made contingent on that
outcome). No votes of the shareholders and directors of Corp. B would be
required since the transaction would be between Corp. A and the individual
stockholders of Corp. B. Neither would there be any appraisal rights. Once it
gained sufficient control (typically 90%), Corp. A could use a special procedure, a
short form merger, to merge Corp. B into Corp. A.
(1) Corp. A might also acquire the shares of Corp. B for cash. It might also
use a subsidiary to accomplish the acquisition. The common element
would be a sale by the individual Corp. B shareholders for their shares,
for share of Corp. A, or for cash.
b. Assets Acquisition. Corp. A buys all of the assets of Corp. B for stock (or for cash).
Here, Corp. A would deal with Corp. B rather than with its shareholders.
61
See also Handout on Mergers and Acquisitions: Diagrams.
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(1) One advantage of assets acquisition is that the acquiring corporation does
not succeed to unforeseen liabilities of the acquire corporation as it
would under a statutory merger. (Known liabilities will be satisfied by
the seller or assumed by the buyer and taken into account in the
purchase price).
(a) There is authority, however for holding an acquiring
corporation in an assets acquisition liable for product liabilities
of the acquired corporation that did not arise until years after
the asset transfer. See, e.g., Knapp v. North American Rockwell
Corp. (3d. Cir. 1974).
(2) Corp B will be left with nothing but shares of Corp. A. Ordinarily, it
would then liquidate and distribute the share to its shareholders. Corp.
B would cease to exist.
3. Farris v. Glen Alden Corporation (Pa. 1958). 62
a. Facts. Glen Alden acquired the assets of List in a stock-for-assets exchange
approved by both companies’ boards and the List shareholders, but not the Glen
Alden shareholders. The transaction doubles the assets of Glen Alden, increased
its debt sevenfold, and left its shareholders in a minority position. To
b. W hen use of the corporate form of business organization first became widespread,
it was relatively easy for courts to define a “merger” or a “sale of assets” and to
label a particular transaction as one or the other.
(1) But prompted by the desire to avoid the impact of adverse, and to
obtain the benefits of favorable, government regulations, particularly
federal tax laws, new accounting and legal techniques were developed by
lawyers and accountants which interwove the elements characteristic of
each, thereby creating hybrid forms of corporate amalgamation. Thus, it
is no longer helpful to consider an individual transaction in the abstract
and solely by reference to the various elements therein determine
whether it is a “merger” or a “sale.”
(2) Instead, to determine properly the nature of a corporate transaction, we
must refer not only to all the provisions of the agreement, but also to the
consequences of the transaction and to the purposes of the provisions of
corporate law said to be applicable.
c. Appraisal Rights. Section 908(A) of the Penn. Bus. Corp. Law provides: “If any
shareholder of a domestic corporation which becomes a party to a plan or merger
or consolidation shall object to such plan of merger or consolidation, such
shareholder shall be entitled to ... [the fair value of his shares upon surrender of
the share certificate or certificates representing his shares].”
d. Fundamental Change? Does the combination outlined in the present
“reorganization” agreement so fundamentally change the corporate character of
Glen Alden and the interest of the plaintiff as a shareholder therein, that to refuse
him the rights and remedies of a dissenting shareholder would in reality force him
to give up his stock in one corporation and against his will accept shares in
another?
(1) If so, the combination is a merger within the meaning of the corporation
62
Glen Alden was incorporated in Pennsylvania and List in Delaware. Delaware law at the time provided
that a sale of substantially all of the assets of List required the approval of a majority of the List shareholders, but the
List shareholders did not have appraisal rights. Under Pennsylvania law, if Glen Alden had sold it assets to List,
approval by a majority of the Glen Alden shareholders would have been required and dissenting shareholders would
have had appraisal rights. Under present Delaware law, appraisal is not available in a merger if the shares relinquished
are “(i) listed in a national securities exchange or (ii) held of record by more than 2,000 stockholders,” and if the
shares received have similar characteristics (e.g., voting and dividend rights). Del. Gen. Corp. Law § 262(b)(1).
-113-
law.
e. The amendments do not provide that a transaction between two corporations
which has the effect of a merger but which includes a transfer of assets for
consideration is to be exempt from the protective provisions of the statute. They
provide only that the shareholders of a corporation which acquires the property
or purchases the assets of another corporation, without more, are not entitled to the
right to dissent from the transaction.
4. Hariton v. Arco Electronics (Del. 1963). 63
a. Equal Dignities. The sale-of-assets statute and the merger statute are independent
of each other. They are, so to speak, of equal dignity, and the framers of a
reorganization plan may resort to either type of corporate mechanics to achieve
the desired end. This is not an anomalous result in our corporation law.
B. Freeze-Out Mergers
1. Tender Offers. A tender offer is a public offer made by a bidder to a target’s shareholders, in
which the bidder offers a substantial premium above market price for most or all of the
target’s shares.
a. Oversubscribed. More shareholder tender their stock than needed. The wanted
shares have to be purchased pro-rata.
2. Authorized, Issued, & Outstanding. Shares are (1) authorized by the articles of incorporation;
(2) issued, meaning they have at some time been sold by the corporation to an investor; or
(3) outstanding, meaning that the stock is currently owned by someone other than the
corporation.
a. Authorized, Issued But Not Outstanding. “Treasury stock.”
3. W einberger v. UOP, Inc. (Del. Sup. 1983).
a. The plaintiff in a suit challenging a cash-out merger must allege specific acts of
fraud, misrepresentation, or other items of misconduct to demonstrate the
unfairness of the merger terms to the minority.
b. The ultimate burden of proof is on the majority shareholder to show by a
preponderance of the evidence that the transaction is fair. Nevertheless, it is first
the burden of the plaintiff attacking the merger to demonstrate some basis for
invoking the fairness obligation.
(1) However, where corporate action has been approved by an informed
vote of a majority of the minority shareholders, we conclude that the
burden entirely shifts to the plaintiff to show that the transaction was
unfair to the minority.
(2) But in all this, the burden clearly remains on those relying on the vote to
show that they completely disclosed all material facts relevant to the
transaction.
c. In considering the nature of the remedy available under our law to minority
shareholders in a cash-out merger, we believe that it is, and hereafter should be,
an appraisal under 8 Del.C. § 262 as hereinafter construed.
d. Complete Candor. In assessing this situation, the Court of Chancery was required
to: examine what information defendants had and to measure it against what they
gave to the minority stockholders, in a context in which “complete candor” is
required. In other words, the limited function of the Court was to determine
whether defendants had disclosed all information in their possession germane to
the transaction in issue. And by “germane” we mean, for present purposes,
information such as a reasonable shareholder would consider important in decided
whether to sell or retain stock.
63
Most courts have rejected the de facto merger doctrine and have refused to imply merger-type protection
for shareholders when the statute does not provide it. In fact, in many states where courts have used the de facto merger
analysis, the legislature has later abolished the doctrine by statute.
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(1) Completeness, not adequacy, is both the norm and the mandate under
present circumstances.
(2) This is merely stating in another way the long-existing principle of
Delaware law that these Signal designated directors on UOP’s board still
owed UOP and it shareholders and uncompromising duty of loyalty.
e. There is no “safe harbor” for such divided loyalties in Delaware. W hen directors
of a Delaware corporation are on both sides of a transaction, they are required to
demonstrate their utmost good faith and the most scrupulous inherent fairness of
the bargain.
f. The concept of fairness has two basic aspects: fair dealing and fair price. 64
(1) Fair Dealing. The former embraces questions of when the transaction
was time, how it was initiated, structured, negotiated, disclosed to the
directors, and how the approvals of the directors and the stockholders
were obtained.
(a) Part of fair dealing is the obvious duty of candor required by
Lynch I. Moreover, one possessing superior knowledge may
not mislead any stockholder by use of corporate information to
which the latter is not privy.
i) Delaware has long imposed this duty even upon
person who are not corporate officers or directors, but
who nonetheless are privy to matters of interest or
significance to their company.
(2) Fair Price. The latter aspect of fairness relates to the economic and
financial considerations of the proposed merger, including all relevant
factors: assets, market value, earnings, future prospects, and any other
elements that affect the intrinsic or inherent value of a company’s stock.
(a) Delaware Block/W eighted Average Method. Elements of value,
i.e., assets, market price, earnings, etc., were assigned a
particular weight and the resulting amounts added to determine
the value per share. This procedure has been used for decades.
i) However, to the extent that it excludes other
generally accepted techniques used in the financial
community and the court, it is now clearly outmoded.
It is time we recognize this in appraisal and other
stock valuation proceedings and bring out law current
on the subject.
(b) More Liberal Approach. W e believe that a more liberal approach
must include proof of value by any techniques or methods
which are generally considered acceptable in the financial
community and otherwise admissible in court, subject only to
our interpretation of 8 Del.C. § 262(h). 65
i) Fair price obviously requires consideration of all
64
Not Bifurcated. The test for fairness is not a bifurcated on as between fair dealing and price. All aspects of
the issue must be examined as a whole since the question is one of entire fairness. However, in a non-fraudulent
transaction we recognize that price may be the preponderant consideration outweighing other features of the merger.
Here, the court addresses the two basic aspects of fairness separately because it finds error as to both.
65
The Court of Chancery “shall appraise the shares, determining their fair value exclusive of any element of
value arising from the accomplishment or expectation of the merger, together with a fair rate of interest, if any, to be
paid upon the amount determined to be the fair value. In determining such fair value, the Court shall take into
account all relevant factors. (emphasis added).
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relevant factors involving the value of a company.

(c) No Limitation On Other Relief. W hile a plaintiff’s monetary
remedy ordinarily should be confined to the more liberalized
appraisal proceeding herein established, we do not intend any
limitation on the historic powers of the Chancellor to grant
such other relief as the facts of a particular case may dictate.
i) The appraisal remedy we approve may not be
adequate in certain cases, particularly where fraud,
misrepresentation, self-dealing, deliberate waste of
corporate assets, or gross or palpable overreaching are
involved.
g. No Business Purpose. In view of the fairness test which has long been applicable to
parent-subsidiary mergers, the expanded appraisal remedy now available to
shareholders, and the broad discretion of the Chancellor to fashion such relief as
the facts of a given case may dictate, we do not believe that any additional
meaningful protection is afforded minority shareholders by the business purpose
requirement. Accordingly, such requirement shall no longer be of any force or
effect.
4. Coggins v. New England Patriots Football Club, Inc. (Mass. 1986).
a. In Singer v. Magnavox Co. (Del. 1977), the Delaware court established the so-
called “business-purpose” test, holding that controlling stockholders violates their
fiduciary duties when they “cause a merger to be made for the sole purpose of
eliminating a minority on a cash-out basis.”
(1) In 1983, Delaware jettisoned the business-purpose test, satisfied that the
“fairness” test, long applicable to parent-subsidiary mergers, the
expanded appraisal remedy now available to stockholders, and the broad
discretion of the Chancellor to fashion such relief as the facts of a given
case may dictate, provided sufficient protection to the frozen-out
minority. W einberger v. UOP, Inc. (Del. 1983).
(a) Business Purpose Test Still Applicable in Mass. Unlike the
Delaware court, however, we believe that the “business-
purpose” test is an additional useful means under our statutes
and case law for examining a transaction in which a controlling
stockholder eliminates the minority interest in a corporation.
This concept of fair dealing is not limited to close corporations
but applies to judicial review of cash freeze-out mergers.
b. A controlling stockholder who is also a director standing on both sides of the
transaction bears the burden of showing that the transaction does not violate
fiduciary obligations. Judicial inquiry into a freeze-out merger in technical
compliance with the statute may be appropriate, and the dissenting stockholders
are not limited to the statutory remedy of judicial appraisal where violations of
fiduciary duty are found.
(1) Judicial scrutiny should begin with recognition of the basic principle that
the duty of a corporate director must be to further the legitimate goals of
the corporation. The result of a freeze-out merger is the elimination of
public ownership in the corporation. The controlling faction increases
its equity from a majority to 100%, using corporate processes and
corporate assets.
(2) The corporate directors who benefit from this transfer of ownership
must demonstrate how the legitimate goals of the corporation are
furthered. A director of a corporation violates his fiduciary duty when
he uses the corporation for his or his family’s personal benefit in a
manner detrimental to the corporation.
(a) W hile we have recognized the right to “selfish ownership” in a
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corporation, such a right must be balanced against the concept

of the majority stockholder’s fiduciary obligation to the
minority shareholders.
(3) Because the danger of abuse of fiduciary duty is especially great in a
freeze-out merger, the court must be satisfied that the freeze-out was for
the advancement of a legitimate corporate purpose.
(4) If satisfied that elimination of public ownership is in furtherance of a
business purpose, the court should then proceed to determine if the
transaction was fair by examining the totality of the circumstances.
c. The normally appropriate remedy for an impermissible freeze-out merger is
rescission.
(1) Because Massachusetts statutes do not bar a cash freeze-out, however,
numerous third parties relied in good faith on the outcome of the
merger.
(2) The passage of time has made the 1976 position of the parties difficult, if
not impossible, to restore.
(3) In these circumstances, the interests of the corporation and of the
plaintiffs will be furthered best by limiting the plaintiffs’ remedy to an
assessment of damages.
d. Rescissory damages must be determined based on the present value of the
Patriots, that is, what the stockholders would have if the merger were rescinded.
C. De Facto Non-Merger*
D. LLC Mergers
1. VGS, Inc. v. Castiel (Del. Ch. 2000).
a. Castiel formed VGS, LLC for the purpose of pursuing a FCC license to build and
operate a satellite system. The LLC had only one member, VGS Holdings, Inc.
Ellipso, Inc. joined as a second member, followed by Sahagen, LLC as a third
member.66 The units were distributed as follows: 660 units to Holdings, 260
units to Sahagen and 120 units to Ellipso. Castiel had the power to appoint,
remove, and replace 2 of the 3 members of the Board of Managers. Castiel
named himself and Tom Quinn. Sahagen named himself as the third member of
the Board. Disagreements between Castiel and Sahagen soon arose about how to
manage the LLC. Sahagen convinced Quinn to oust Castiel and together they
acted by written consent to merge the LCC into VGS, Inc. The LCC ceased to
exist and its assets and liabilities passed to VGS. The incorporators did not name
Castiel to the board of the corporation. 67
b. Section 18-404(d) of the LCC Act states in pertinent part:
Unless otherwise provided in a limited liability company agreement, on any
matter that is to be voted on by manager, the managers may take such action
without a meeting, without prior notice and without a vote if a consent or
consents in writing, setting forth the action so taken, shall be signed by the
managers having not less than the minimum number of votes that would be
necessary to authorize such action at a meeting.
(1) Therefore, the LLC Act, read literally, does not require notice to Castiel
66
Castiel controlled both Holdings and Ellipso. Sahagen, LLC was controlled by Peter Sahagen, an
aggressive venture capitalist.
67
On the same day as the merger, Sahagen executed a promissory note to the corporation in exchange for
two million shares of stock. VGS also issued 1,269,200 shares of common stock to Holdings, 230,800 shares of
common stock to Ellipso, and 500,000 shares of common stock to Sahagen Satellite. Thus, Holdings and Ellipso went
from having a 75% interest in the LLC to having only a 37.5% interest in VGS.
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before Sahagen and Quinn could act by written consent. The LLC
Agreement does not purport to modify the statute in this regard.
(2) Purpose of W ritten Consent. Section 18-404(d) has yet to be interpreted
by this court or the Supreme Court. Nonetheless, it seems clear that the
purpose of permitting action by written consent without notice is to
enable LLC managers to take quick, efficient action in situations where a
minority of managers could not block or adversely affect the course set
by the majority even if they were notified of the proposed action and
objected to it.
(a) Not Intended to Clandestinely Deprive. The General Assembly
never intended to enable two managers to deprive,
clandestinely and surreptitiously, a third manager representing
the majority interest in the LLC of an opportunity to protect
that interest by taking action that the third manager’s member
would surely have opposed if he had knowledge of it.
(b) Action by W ritten Notice Only By Constant Majority. Application
of equity requires construction of the statute to allow action
without notice only by a constant or fixed majority. It cannot
apply to an illusory, will-of-the wisp majority which would
implode should notice be given.
c. Duty of Loyalty. Sahagen and Quinn each owed a duty of loyalty to the LLC, its
investors and Castiel, their fellow manager.
(1) Agreement Doesn’t Rely on Equity Interest Voting. It may seem somewhat
incongruous, but this Agreement allows the action to merge, dissolve or
change to corporate status to be taken by simple majority vote of the
board of managers rather than rely upon the default position of the
statute which requires a majority vote of the equity interest.
(a) However, Sahagen and Quinn Knew of Castiel’s Control Plan.
Instead, the drafters made the critical assumption, known to all
the players here, that the holder of the majority equity interest
has the right to appoint and remove two managers, ostensibly
guaranteeing control over a three-member board.
(b) W hen Sahagen and Quinn, fully recognizing that this was
Castiel’s protection against actions adverse to his majority
interest, acted in secret, without notice, they failed to discharge
their duty of loyalty to him in good faith.
d. Breach of Duty of Loyalty Abrogates Protection of Bus. Judgment Rule. It should be
clear that the actions of Sahagen and Quinn, in their capacity as managers
constituted a breach of their duty of loyalty and that those actions do not,
therefore, entitle them to the benefit or protection of the business judgment rule.
II. Takeovers
A. Introduction
1. Cheff v. Mathes (Del. Ch. 1964).
a. Purpose of Entrenchment. In an analogous field, courts have sustained the use of
proxy funds to inform stockholders of management’s views upon the policy
questions inherent in an election to a board of directors, but have not sanctioned
the use of corporate funds to advance the selfish desires of the directors to
perpetuate themselves in office.
b. Maintain Proper Business Practices. Similarly, if the action of the board were
motivated by a sincere belief that the buying out of the dissident stockholder was
necessary to maintain what the board believed to be proper business practices, the
board will not be held liable for such decision, even though hindsight indicates
the decision was not the wisest course.
2. The court in Cheff essentially applies the business judgment rule.
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a. Reasonable Investigation/Plausible Business Purpose. Courts initially dealt with the

takeover dilemma by a judicial slight of hand. To ascertain whether an
entrenchment motive lurked behind a takeover defense, courts adopted a process
oriented standard. The courts accepted defensive action if the incumbent board
could point to a “reasonable investigation” (preferably by outside directors) into a
plausible business purpose for the defense–thus showing the absence of an
entrenchment motive. Once this was done, the challenger bore the difficult
burden of proving the board’s dominant motive was entrenchment.
3. Greenmail. During the ‘80s, the purchase by a corporation of a potential acquirer’s stock,
at a premium over the market, came to be called “greenmail.”
a. IRS Response. In 1987, the IRS enacted § 5881 which imposes a penalty tax of
50 percent on the gain from greenmail, which is defined as gain from the sale of
stock that was held for less than two years and sold to the corporation pursuant to
an offer that “was not made on the same terms to all shareholders.”
B. Development
1. Two-Tiered Front-Loaded Cash Tender Offer. Ex. P could offer to buy 51 percent of the
stock at $65 (the front end), and announce that will thereafter merge S Corp. into his own
firm in a transaction that pays $55 cash per share for the remaining 49 percent of the stock
(the back end). 68
2. Unocal Corp. v. Mesa Petroleum Co. (Del. 1985).
a. Issue. The validity of a corporation’s self-tender for its own shares which
excludes from participation a stockholder making a hostile tender offer for the
company’s stock.
b. It is now well-established that in the acquisition of its shares a Delaware
corporation may deal selectively with its stockholders, provided the directors have
not acted out of a sole or primary purpose to entrench themselves in office. Cheff
v. Mathes.
(1) The only difference is that heretofore the approved transaction was the
payment of “greenmail” to a raider or dissident posing a threat to the
corporate enterprise. All other stockholders were denied such favored
treatment, given Mesa’s past history of greenmail, its claims here are
rather ironic.
c. Two-Part Analysis. W hen a board addressed a pending takeover bid it has an
obligation to determine whether the offer is in the best interests of the
corporation and its shareholders.
(1) Threat to Corporate Policy. There are certain caveats to a proper exercise
of this function. Because of the omnipresent specter that a board may be
acting primarily in its own interests, rather than those of the corporation
and its shareholders, there is an enhanced duty which calls for judicial
examination at the threshold before the protections of the business
judgment rule may be conferred.
(a) W e must bear in mind the inherent danger in the purchase of
shares with corporate funds to remove a threat to corporate
policy when a threat to control is involved. The directors are
of necessity confronted with a conflict of interest, and an
objective decision is difficult.
(b) In the fact of this inherent conflict, directors must show that
they had reasonable grounds for believing that a danger to
corporate policy and effectiveness existed because of another
68
Hence the term “cash-out merger.” The tender offer is “front-end loaded” because the front end offers a
higher price ($65) than the back end ($55). A two-tiered offer can be “coercive” even if the front end is any-and-all
offer rather than an offer for 51 percent of the stock.
-119-
person’s stock ownership.

i) However, they satisfy that burden by good faith and
reasonable investigation.
(2) Reasonable in Relation to Threat Posed. If a defensive measure is to come
within the ambit of the business judgment rule, it must be reasonable in
relation to the threat posed. This entails an analysis by the directors of
the nature of the takeover bid and its effect on the corporate enterprise.
(a) Examples of such concerns may include: inadequacy of the
price offered, nature and timing of the offer, questions of
illegality, the impact on “constituencies” other than
shareholders (i.e., creditors, customers, employees, and perhaps
even the community generally), the risk of nonconsummation,
and the quality of securities being offered in the exchange.
(b) W hile not a controlling factor, it also seems that a board may
reasonably consider the basic stockholder interests at stake,
including those short term speculators, whose actions may have
fueled the coercive aspect of the offer at the expense of the
long-term investor.
d. Fairness. The concept of fairness, while stated in the merger context, is also
relevant in the area of tender offer law.
3. Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. (Del. 1985.
a. Business Judgment Rule. If the business judgment rule applies, there is a
presumption that in making a business decision the directors of a corporation
acted on an informed basis, in good faith and in the honest belief that the action
taken was in the best interests of the company.
(1) However when a board implements anti-takeover measures there arises
the omnipresent specter that a board may be acting primarily in its own
interests, rather than those of the corporation and its shareholders.
(a) This potential for conflict places on the directors the burden of
proving that they had reasonable grounds for believing there
was danger to corporate policy and effectiveness, a burden
satisfied by a showing of good faith and reasonable
investigation. In addition, the directors must analyze the
nature of the takeover and its effect on the corporation in order
to ensure balance–that the responsive action taken is reasonable
in relation to the threat posed.
i) The Rights Plan. Under the circumstances, it cannot
be said that the Rights Plan as employed was
unreasonable, considering the threat posed. Indeed,
the Plan was a factor in causing Pantry Pride to raise
its bids from a low of $42 a share to an eventual high
of $58. At the time of its adoption the Rights Plan
afforded a measure of protection consistent with the
directors’ fiduciary duty in facing a takeover threat
perceived as detrimental to corporate interests.
ii) Stock Exchange. The directors’ general broad powers
to manage the business and affairs of the corporation
are augmented by the specific authority conferred
under Delaware statute, permitting the company to
deal in its own stock. However, when exercising that
power in an effort to forestall a hostile takeover, the
board’s actions are strictly held to the fiduciary
standards outline in Unocal.
a) These standards require the directors to
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determine the bests interests of the

corporation and its stockholders, and impose
an enhanced duty to abjure any action that is
motivated by consideration other than a
good faith concern for such interests.
b. W hen Pantry Pride increased its offers, it became apparent to all that the break-
up of the company was inevitable. The significantly altered the board’s
responsibilities under the Unocal standards. It no longer faced threats to corporate
policy and effectiveness, or to the stockholders’ interests, from a grossly
inadequate bid.
(1) The directors’ role changed from defenders of the corporate bastion to
auctioneers charged with getting the best price for the stockholder at a
sale of the company.
(a) Other Corporate Constituencies. Revlon argued that it acted in
good faith in protecting the noteholders because Unocal permits
consideration of other corporate constituencies. Although such
considerations may be permissible, there are fundamental
limitations upon that prerogative.
i) Considerations Inappropriate W here Active Bidding
Engaged. A board may have regard for various
constituencies in discharging its responsibilities,
provided there are rationally related benefits accruing
to the stockholders. However, such concern for non-
stockholder interests in inappropriate when an auction
among active bidders is in progress, and the object is
no longer to protect or maintain the corporate
enterprise but to sell it to the highest bidder.
c. Lock-Ups. A lock-up is not per se illegal under Delaware law. Such option can
entice other bidder to enter a contest for control of the corporation, creating an
auction for the company and maximizing shareholders’ profit.
(1) However, while those lock-ups which draw bidders into the battle
benefit shareholders, similar measures which end an active auction and
foreclose further bidding operate to the shareholders’ detriment.
(2) The no-shop provision, like the lock-up provision, while not per se
illegal, is impermissible under the Unocal standards when a board’s
primary duty becomes that of an auctioneer responsible for selling the
company to the highest bidder.
d. Favoritism for a white knight to the total exclusion of a hostile bidder might be
justifiable when the latter’s offer adversely affects shareholder interest, but when
bidders make relatively similar offers, or dissolution of the company become
inevitable, the directors cannot fulfill their enhanced Unocal duties by playing
favorites with the contending factions.
(1) Market forces must be allowed to operate freely to bring the target’s
shareholders the best price available for their equity.
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JR C /Fall 2010/Fendler/B usiness A ssoc .

(c) That he has an independent business in buying and selling

second agent becomes a subagent of the original principal.

(c) an understanding between the parties that the principal will be

b. Partially Disclosed (Unidentified) – Agent is personally liable 8

2. By: John Doe

3. By: John Doe

5. Restatement (Third) of Agency § 2.04. Respondeat Superior.

the question, the instrument as a whole indicates a master-servant relationship

claimed satisfied the control test to establish the principal-agent relationship. 11

unexpectable by the master.

granted in favor of the ski resort and remanded for trial.

IV. Fiduciary Obligation of Agents.

8. Restatement (Third) of Agency § 8.08. Duties of Care, Competence, and

occupied as a servant of his master.

b. The Uniform Partnership Act defines a partnership as an association of “two of

2. Martin v. Peyton (N.Y. 1927).

C. Grabbing and Leaving

(d) A partner wilfully or persistently commits a breach of the partnership agreement, or

not merely by reason of the substitution of a successor personal representative; or

2. Uniform Partnership Act § 38. Rights of Partners to Application of Partnership

corporation, some courts treat the firm as a de facto corporation.

to which it is obligated, unless its substantial rights might thereby be affected.

contended that the corporate veil should be pierced.

readily apparent that plaintiff would face formidable barriers in

free corporation would be successful.

(a) his failure to exercise reasonable care increases the risk of

Furthermore, the directors and officers are under a duty to the

(2) Purposes of the Demand Requirement

(a) A demand would be futile if a complaint alleges with

shareholders will relate inversely to the

(3) W rongful Board Refusal. A board decision to cause a derivative suit to be

proper balancing point

C H A PTER F O U R : T H E L IM ITED L IABILITY C O M PA N Y

“pass through” taxation–the business’ profits (whether distributed or not)

law apply notwithstanding the LCC Act’s statutory notice rules.

iii) Derogation of the Common Law. Statutes in derogation

a limited liability company and the conduct of its business.”

that the W yoming legislature gave any consideration to whether the

relationship occurs when a person, without a privilege to do so, induces or otherwise

providing written notice to its known creditors containing

take with which on disagrees.

II. Duty of Loyalty

A. Directors and Managers

purpose and the company received the full benefit thereof.

c. Breach of Fiduciary Duty Trigger Entire Fairness Standard?

(B) Through the use of corporate information or property, if the resulting

stockholders. As such, these dividends were not self-dealing. Therefore,

disinterested board of directors, was here effected at the

1. In re The W alt Disney Co. Derivative Litigation (Del. 2006).

instance, where the fiduciary intentionally acts with a

particularized factual allegations of a derivative stockholder complaint create a

a. Exempt Securities/Exempt Transactions. Because of the expense and the restrictions,

a. The knowledge naturally in the possession of a director as to the condition of a

corporate trust must not during the period of non-disclosure deal

be available only for a corporate purpose, and

sale, or the sale and purchase, of the security involved...”

policy, and appoint officers to carry out that policy.

surrounding circumstances reveal.

E. McQuade v. Stoneham (N.Y. 1934).

a. Generally Revocable. Generally, a proxy is revocable by the shareholder, even if

corporations other than close corporations.”

(1) Deprivation of Corporate Offices & Employment. “Freeze outs” may be