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Business Associations 1) Introduction a) Epstein-Freer View and Roberts-Shepard View i) Most people who start businesses do it to make money. (1) The defining characteristic of a business is that economic activity is organized for the purpose of earning a profit. b) Roberts-Shepard View i) A business is some form of activity that is organized to "create value" for its owners. (1) A business must create a profit in some sense, but not necessarily in the conventional sense. ii) Shepard's View (1) Believes that the goals of businesses can be broader than just earning profit. (a) Businesses are not formed just to make money, but to help people. c) Business Structures i) Law makes careful distinctions between business structures (1) Who the owners are (i.e. shareholders, partners, sole proprietor) (2) What rights and obligations the owners have (3) Whether the business itself is a legal entity separate from the owners. d) Businesses are the forum for economic activity, the objective of which is often to earn an economic return, profit, or other increased value to the proprietor. 2) Views of Other Gonster Machers a) Friedman's View i) In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business. (1) His responsibility is to conduct business in accordance with the owners' desires. (a) Thus, the executive is the agent of the individuals who own the corporation. (i) He is, however, a person in his own right and has duties or other social responsibilities that he assumes on his own. 1. In this capacity, he is acting as a principal, not an agent. a. He is spending his own money or time or energy, not the money of his employers or the time or energy he has contracted to devote to their purposes. (ii) Only one social responsibility of a business 1. To use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game. a. Friedman says that any action taken should benefit the company in some manner. There must be a nexus between the action and the benefit. ii) Agency: 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. RESTATEMENT (SECOND) OF AGENCY §1 iii) Principal: The one for whom action is to be taken. Id. iv) Agent: The one who is to act. Id.
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A.P. SMITH MFG. CO. V. BARLOW - (1953) Facts AP Smith manufactures valves, fire hydrants and special equipment for the water and gas industries. Its board of directors adopted a resolution which set forth that it was in the corporation's best interest to join with others in donating $1500 to Princeton University. The stockholders questioned this action, and the corporation issued a declaratory judgment action in the Chancery Division and trial was had. The President of the company testified that such donations were expected by the community, and that the donations create a favorable environment for their business operations. Stockholders Argument b) 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. c) NJ statutes which expressly authorize the contribution may not constitutionally be applied to plaintiff, a corporation created long before their enactment. Holding d) A donation by AP Smith was intra vires, or within the authority of the board of directors. i) At Common Law, a manager could not disburse any corporate funds for philanthropic or other worthy public cause unless the expenditure would benefit the corporation. (1) However, control of economic wealth has passed from individual entrepreneurs to dominating corporations, and thus public support has developed for corporations to make reasonable philanthropic donations. (a) Such contributions have been sustained upon liberal findings that the donations tended reasonably to promote the corporate objectives. (i) Modern conditions require that corporations acknowledge and discharge social as well as private responsibilities as members of the communities within which they operate. (2) Further, state legislation adopted in the public interest and applied to pre-existing corporations under the reserved power has repeatedly been sustained the US Supreme Court. ii) The donation is valid. There is no suggestion that it was made indiscriminately or to a pet charity of the corporate directors in furtherance of personal rather than corporate ends. It was a lawful exercise of the corporation's implied and incidental powers under common-law principles and that it came within the express authority of the pertinent state legislation. NOTES and Rules e) The MBCA and other corporate codes now expressly authorize corporations to make charitable contributions. i) However, there are scholars who still contend that corporate giving, if it is permitted at all, should be strictly limited to those situations where the benefit to the firm in the form of higher expected profits is clear and compelling. (1) Friedman: If managers to do anything with property other than what the
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f) g) h) i)
shareholders want them to do would be to expropriate resources that do not belong to them. The law views a business as a separate entity, a separate legal person A body of law has developed to control the actions that separate entity or person Real persons act for that corporation as agents A business with more than one owner can distribute and use its funds in ways that are opposed by at least some of its owners.
How does the owner of a business make $$ from the Business? j) She can receive distributions of all or part of the money the business has earned. k) She can sell all or part of her ownership interest in the business for more than she paid for it. How does the Owner know how much money the Business has made and how much the business is Worth?
Business entities are required to keep “appropriate accounting records,” and to make these records available to the owners. MBCA §§16.01(b) and §16.02(b)(2). i) Businesses typically maintain several financial statements, which are provided to investors, the company’s managers, and to the public and public enforcement authorities. (1) Without these accurate reports, the company can go under without the managers or public knowing before it is too late. ii) Types of Financial Statements
(1) Income Statement: Computes profit during a given period, usually a year.
(a) Ex: Sales – Cost of Goods Sold (COGS) - salaries = Profit Before Taxes (PBT). (i) Depreciation changes this analysis 1. A company which purchases a machine for 5K, which is expected to last for more than 5 years, it would be misleading to add the entire 5K into the expenses in year 1. a. The profits from the machine would be understated in year 1, and overstated in subsequent years. (b) An income statement does not show how much cash a business may be generating or using up in a given year. (i) This is because some entries in the income statement, such as depreciation, do not represent any actual movement of cash.
(2) Cash Flow Statement: Measures the cash made available to a business from its
operations during a given period. (a) It is a measure of how much more cash a business has at the end of the year than it had at the beginning of that year. (i) Generally, an income statement is converted into a cash flow statement by the following formula
iii. ii. (a) It is a snapshot of a particular moment in a business’ history. i. (c) An increase in a balance sheet liability account can result in an increase in the cash account on the balance sheet and an increase in cash flow. Assets a. 3. 2. (b) Time Value of Money: The principle that money currently possessed will not be worth as much in the future. Liabilities a. (b) An increase in a balance sheet asset account other than cash results in a decrease in cash flow. Conservatism: Data should be conservative – they should present the firm’s financial data in an accurate way. (ii) If the assets are all of the company’s things that have value. What the company owes. and the liabilities are all the “claims” on that value. but err on the side of understating its revenues and the value of its assets. it is called an expense. What is left over after a business subtracts the liabilities from the assets.com 1. Accounts Receivable (money owed to the company) and machinery. (3) Balance Sheet: Shows the company’s assets. (ii) When company buys something that it will use up in a year. Assets. i. and the total amount appears on the income statement. then is an investment and only the depreciation appears on the income statement. and on overestimating its costs and liabilities. any debts. 4 - . Cash flow = profits from income statement + depreciation – net change in balance sheet asset accounts other than cash + net change in liabilities and funds from new issues of stock.Downloaded From OutlineDepot. liabilities and the owners’ “equity” in the business. Accounts Receivable are not depreciated but may be written off. will not be worth 100K later. Owner’s Equity a. (d) NOTE (i) When a business buys something that will be used for more than one year. Land. then the difference between the two is the value of the business to the owners – The owners equity. (i) 3 Main Sections 1. Ex: Wages payable. NOTES - Matching: Costs or expenses should be “booked” in the same period as the revenues those expenditures helped generate. Ex: Cash. (i) 100K now. Buildings. like cash are NOT depreciated b/c they don’t get used up. The things that the company owns that have value.
(1) In well-functioning governance systems. in terms of tax status. the public shareholders rely upon the board of directors. c) Corporation i) Most common legal structure for large businesses.Downloaded From OutlineDepot. then the price of the stock should go up. “pass-through” form. ii) Treated like a proprietorship for tax and liability purposes. (1) Corporation’s owners are generally protected from personal liability. b) Sole Proprietorship i) A person undertakes a business without any of the formalities associated with other forms of organization. (1) Individual and business are one and the same for tax and liability purposes. the individual and the business are also one and the same. ii) Does not pay taxes as a separate entity. iii) For liability purposes. ii) Motivation for Fraud (1) If the numbers are good. the corporation must also pay tax on its income just like a real person. d) Partnership i) Business entities that consist of 2 or more owners. iii) Taxes are paid only at the personal level on the partner’s share of the income 5 . such as a partnership or a limited liability company. who in turn delegate a fair amount of responsibility for the oversight of the company’s accounting to its audit committee. (i) Corporation pays a tax. exposure to legal liabilities. then the owners of the corporation pay a tax on the part of its earnings that are distributed to them as dividends. 4) What are the Legal Structures for Businesses? a) Decision regarding a business structure is driven chiefly by the objectives of the business’ founder and firms’ investors. (1) The individual reports all income and deductible expenses for the business on her personal income tax return. (b) This double taxation creates powerful incentives for those enterprises that anticipate distributing earnings to use a tax-advantaged. and flexibility in the operation and financing of the business. then fundamental performance is good. i) It seeks to protect the owners of public companies.com 3) Sarbanes-Oxley Act and Corporate Governance a) Congress passed this in reaction to the perceived breakdown of financial accounting and corporate accountability in the wake of the financial scandals in the 2000 time frame. i) 2 Important Differences in Business Structures (1) Tax Treatment of Business’ profits (2) Liability exposure of the owners for the business’ debts and other potential liabilities. (a) In exchange for this protection. (2) Maximum tax rate on corporate income is 35%.
(i) The owner reports the business’ income on a personal tax return and pays the taxes on that income (at his personal rate). i) Problems with a Sole Proprietorship i) Employees and Agency Principles (1) In a sole proprietorship. but only corporations b/c they don’t want to be held personally liable. g) How do you Choose? i) Who will the owners be? (1) If the investors and owners will be a small group of individuals. (1) Owners are not individually liable for the company’s debts. ii) What are the Capital Requirements and cash flow characteristics of the business likely to be? Sole Proprietorship: Chapter 2 h) Most common form of business i) The business and its owner are the same actual person and the same legal person. ii) The LLC is not a tax paying entity. (a) If the business will require Venture Capitalists. unless the owner files papers to create some other structure.com (1) This is called “pass through” taxation. iv) Each partner is jointly and severally liable. (1) Income taxes are only paid once – by the owners of the LLC when a part of the company’s earnings is distributed to them. then they typically won’t invest in LLCs. and the people who own the business. (a) Therefore. the relationship between employees and owner is largely 6 . (1) There is no legal separation of the business. (1) A partnership that has both limited and general partners. ii) Somewhat like a corporation for tax purposes. (b) Limited: Similar to a shareholder. such as a corporation. as is an LLC. his business is automatically a sole proprietorship.Downloaded From OutlineDepot. the owner is responsible for the debts and obligations of the business. the people who manage the business. (2) No need to draft any legal document and no need to file anything. e) Limited Partnership i) Like a partnership or proprietorship for tax purposes. (a) It is the “default” structure for a business with one owner. (a) General: Assumes management responsibility and unlimited liability for business. f) Limited Liability Company (LLC) i) A business structure to provide both the protection from liability of a corporation and the protection from double taxation of a partnership. a partnership of some form is clearly a possibility.
iii. 1. Master has control over the day to day performance of the agent’s task. ANALYSIS: 1) is there an agency relationship. Does not apply in all cases of agency. Agency is a “fiduciary relation” ii. The Conduct manifests that one will do something for another.§§26. 2. Master has the right to control the details of how the servant does the job. i. iii. There must be some “manifestation of consent by a principal to an agent that the agent shall act on the principal’s behalf and subject to the principal’s control.Downloaded From OutlineDepot. RSA §7. Manifestations must be attributable to the Principle. (ii) Actual Authority: Created by manifestations from the principal to the agent that the agent reasonably believes create authority.” RSA §220. 1. b. Agency is the result of conduct. Restatement (Second) of Agency (RSA) a. a. ii. Express: P tells A that A is empowered to act on P’s behalf in accomplishing some task. §1 i. Must lead the 3rd party reasonably to conclude that the agent is an agent for principal. 2) Is there express or apparent authority to act (cite the elements of express and apparent . 2. Implied: Agent has the authority to do what is reasonably necessary to get the assigned job done. apply §140 to determine if the principal will be liable to the 3rd party for the agent’s actions. (b) Third Parties and Agency (i) Authority: Power of the agent to affect the legal relations of the principal by acts done in accordance with the principal’s manifestations of consent to him. even if P did not spell it out in detail. Finally. 1. §8 & §27. and not of the words used. Must get to the 3rd party 3. A deal by your agent with a 3rd party binds you if the agent had “authority to bind the principal.com a matter of contract law. Master is liable for the torts of a servant only if the tort was 7 . (a) Agency (i) Involves a delegation of a duty or goal of one person (principal) to another person. who is in charge. (iv) Respondeat Superior: A principal may be liable even though he is not personally negligent. (agent) 1. (iii) Apparent Authority: Created by manifestations by Principal to a 3rd party. 1. Applies only to a subset of principal and agent relationships called “master/servant. 27. Consent by the agent so to act.
even though the attorney may not have had express authority to settle. Franchises and other Business Relationships . Vicarious tort liability comes from the fact that the person engaging someone controls the details of how the job is to be done. The attorney for the 2 parties settled the case.The law of agency provides the foundational structure for many of the legal consequences that follow from the relationship between a lawyer and a client. Lower court found that there was at least apparent authority despite the fact that the attorney believed he had actual authority to settle the case. Torts of ICs are generally NOT attributable to the person who hires him. ii. Holding The attorney’s authority is determined by the representation agreement between the client and the attorney and any instructions given by the client.com committed within the scope of employment. but is not told specifically how to do it. and National filed a motion to enforce the settlement agreement. but was a mere franchisor and 3K was the 8 . who is hired to do a job. Hayes rejected the settlement. notwithstanding the customary boilerplate provision in the franchising agreement that the parties do not intend an agency relationship. iii. Servant: §2 states that a servant is employed by a master to perform a service in his affairs whose physical conduct in the performance of the service is controlled or is subject to the right of control. NATIONAL SERVICE INDUSTRIES. Servant must be distinguished from an independent contractor. but an agency will arise if a franchisor/principal has the requisite degree of control over the franchisee/agent. FRANCHISORS AND VICARIOUS LIABILITY Facts Miller bit into a Bic Mac and suffered an injury when she bit into a heart-shaped sapphire stone embedded into the sandwich. MCDONALD’S CORPORATION – (1997). i. The client is therefore “bound by his attorney’s agreement to settle a lawsuit. The trial court granted summary judgment to McDonald’s on the ground that it did not own or operate the restaurant. as well as the relationship between an individual and a law firm. NOTES . RSA §219 b. if the opposing party was unaware of any limitation on the attorney’s apparent authority. HAYES V. INC – (1999) Facts Hayes sued NLS and its parent company alleging wrongful discharge from her employment as a sales representative.An agency relationship involves consent and control.Downloaded From OutlineDepot. MILLER V.
were to be used. and allocates to the franchisor the right to exercise control over the daily operations of the franchise. 3K owned the restaurant under a license agreement with McDonald’s that required it to operate in a manner consistent with the McDonald’s System. but an IC. controlled. Despite the numerous specifications that 3K was bound to uphold. o Therefore.” The crucial issues are whether the principal held the 3rd party out as an agent and whether the plaintiff relied on that holding out. • The court believes that a jury could find that McDonald’s retained sufficient control over 3K’s daily operations that an actual agency relationship existed.com proper party to sue. Issue Whether there is evidence that would permit a jury to find McDonalds vicariously liable for those injuries because of its relationship with 3K. Miller was justifiably relying on McDonalds.Downloaded From OutlineDepot. If the franchise agreement goes beyond the stage of setting standards. McDonald’s required precise methods that 3K must fulfill McDonald’s regularly sent inspectors McDonald’s uniforms. menus. • It seems clear from the requirement of uniformity with other McDonald’s restaurants that 3K was an apparent authority of McDonald’s and that Miller was justifiably reasonable to believe that she was eating at a McDonald’s restaurant. Holding Reversed. an actual agency relationship exists. and managed it. RSA §267 – Apparent Agency o “One who represents that another is his servant or other agent and thereby causes a 3rd person justifiably to rely upon the care or skill of such apparent agent is subject to liability to the 3rd person for harm caused by the lack of care or skill of the one appearing to be a servant or other agent as if he were such. and any claims by a 3rd party would be solely against 3K. there was a provision that stated that 3K was not an agent of McDonalds. There is sufficient evidence to raise a jury issue under both actual agency and apparent agency principles. This agreement specified numerous different things that had to be strictly complied with. etc. - Miller went to the restaurant under the assumption that McDonald’s owned. recipes. - How does a Sole Proprietorship Grow? Funding by the Owner 9 .
Downloaded From OutlineDepot. for example. SHARING PROFITS IS A PARTNERSHIP!!! Facts Mrs. (d) If equity is sold to investors. (1) Debt Funding: A loan that the business is legally obligated to repay – generally with interest.5K over the course of a few years. they entered into an agreement by which 10 . m) Sharing Profits with a Lender i) The ultimate issue concerning whether a payment is a loan or an equity investment has significant legal meaning. although the business may choose to distribute some cash as dividends. then those investors share in the success of the company. i) 1st investment into a business almost always comes from the owner. it goes in as an investment (“equity”). (c) Debt has a fixed cost: the interest rate the business pays to borrow the money is the cost of those funds. (b) If someone provides equity funds the business is NOT legally obligated to pay anything. The investors have a right to have a voice in how we run the business. 1. according to a set schedule. as a form of collateral (2) Promise to pay the $$ back in a short time (3) Give the creditor some measure of control over the business (a) Seat on the board of directors of a corporation. the equity owner has no right to repayment if the business fails. However. 1. k) Overview of Debt and Equity i) All financing for a business is either 1) debt or 2) equity or 3) some combination of 1 and 2. the creditor is entitled to receive both repayment of the amount borrowed (“principal”) and interest on that principal. not as a loan to be repaid to the entrepreneur. Serge’s brother had borrowed an excess of 12. a. (3) Differences (a) When a business borrows money. Main Benefit of equity holders is ownership interest in the firm. IN RE ESTATE OF FENIMORE – (1999). (i) Owners give up a certain measure of control when they give up equity. l) Borrowing Money i) People can do several things to structure a loan so it will be perceived as low risk (1) Pledge personal or corporate assets against the loan. ii) When money goes into the business.com j) A business is often at greatest risk when it is just starting. (2) Equity Funding: An investment that the business receives for selling part ownership in the business. Subsequent to Serge giving the money to her brother.
Villabona came to collect on the brother’s debts to them. Serge did likewise.Downloaded From OutlineDepot. but at least one of these factors must be present. Holding The Court found that a partnership existed because she was to receive a share of the profits and the allocation of expenses. . Partnerships – Chapter 3 Partnership: A business with more than one owner. however. Serge argues that she gave a loan to her brother.Partnership itself DOES NOT pay tax on its profits o Partners pay tax on any distribution made to them.” Upon the brother’s death. in some other respects. What is Partnership Law? o Deals with the rights and obligations of partnerships and the rights and obligations of the partners. plural. . . Distinction without significance. 11 .Partnership: “An association of two or more persons to carry on as co-owners a business for profit.A partnership. o RUPA §201 Partnership: “An entity distinct from its partners. UPA §6(1) .Embraces an “aggregate theory” o It considers a partnership not as a separate legal person but rather is merely the aggregate of its partners.” o Obligations of a business operated as a partnership are also the obligations of its owners. Case law remains an important part of partnership law.com the brother and Serge would “divide the profits from each vehicle bought and sold.” UPA .” The agreement does not specify the giving of the money as a loan. and therefore the money remaining should first go to her.All statutory and common law definitions of a partnership refer to owners. It is not essential to the existence of a partnership that all partners have the right to make decisions and a duty to share liabilities on dissolution. is treated legally as an entity separate from its owners. She doesn’t want the court to consider her a partner with her brother because then the creditor (which she would be if she is considered to have given a loan) gets paid first. but as an “advance.
Primary Source (1) The partnership agreement (a) Relations among the partners and between the partners and the partnership are governed by the partnership agreement. o For those people who do not form agreements. UPA §5 and RUPA §104 o “the principles of law and equity” govern to the extent not provided by statute. - Problems in Operating a Business as a Partnership . and then common law agency principles.Under both UPA and RUPA. Who decides what the Partnership will do? . Look to the partnership agreement first.com • - Interprets the provisions in partnership statutes. o Although partnership agreements are not legally required. SALMON – (1928) 12 . (i) If the partners fail to agree upon a contrary rule. Partnership agreements are CONTRACTS Partnership agreements can change much of the statutory law that otherwise would govern. then to provisions of relevant partnership statute. (b) Therefore. A partnership is assumed if more than one person shares in a business’ profits regardless of the persons’ intentions. UPA and RUPA provide reasonable rules that most people would put in a partnership agreement if they had created one. the UPA and RUPA are fallback provisions (i) Apply only if the partners have not agreed to the contrary. 1. in the real world these documents are extremely important. o Disputes among the partners.Questions regarding who makes decisions for a partnership arise in two ways: o Disputes between the partnership and some “outside” 3rd party. Businesspeople should be left to structure their relationship as best suits them. Legal Problems in Starting a Partnership o Both sole proprietorships and partnerships do NOT require paperwork to establish them. partnerships can and do own property. MEINHARD V. o The individual partners do NOT own partnership property. RUPA or the UPA will provide the default rule.Downloaded From OutlineDepot. as well as gaps in these statutes.
and to put up a new. 13 . The new lease. there is. covering additional property. owe to one another. with a possible duration of 80 years. Joint adventurers. like copartners. o If this fact had been known to Mr. sharers in a common venture. he sued. was more nearly the purchase of the reversion than the ordinary renewal with which the authorities are concerned. o Authority is abundant that one partner may not appropriate to his own use a renewal of a lease. at a minimum. Salmon accepted Gerry’s proposal and entered into a lease and development agreement with Gerry. but when he learned of the deal. since only through disclosure could opportunity be equalized. Gerry wanted someone to lease all of these properties. merely a joint venture for a limited object. The very fact that Salmon was in control with exclusive powers of direction charged him the more obviously with the duty of disclosure. to end at a fixed time. while the enterprise continues the duty of finest loyalty. - - Dissent There was no general partnership. larger building. The agreement also provided that Salmon and Meinhard were to share any losses equally but that Salmon had the sole power to manage the building. though its term is to begin at the expiration of the partnership. Gerry. Salmon held the lease as owner in his own right. - To the eye of an observer. Holding Meinhard and Salmon were co-adventurers. a duty to disclose business matters. Gerry approached Salmon with a proposal.Downloaded From OutlineDepot. Right before the 20 year lease expired. NOTES When there is a fiduciary relationship. for himself and no one else. or lacking in reasonable candor. A managing co-adventurer appropriating the benefit of such a lease without warning to his partner might fairly expect to be reproached with conduct that was underhand. subject to fiduciary duties akin to those of partners.com Facts Salmon and Meinhard entered into an agreement whereby Meinhard would provide $$ for renovations to a building in exchange for a share of the profits from the building over the course of a 20 year lease. he have laid before both Salmon and Meinhard his proposal. to destroy the existing buildings. single. He held it for himself and another. containing many new and unusual terms and conditions. Meinhard was not a party not a party to this agreement.
o UPA §15 Partners are jointly. however. Applies to LLPs only – See page 30. the plaintiff must sue all of the partners together in a single suit. §305.Downloaded From OutlineDepot. Liability of the Partners Under RUPA. however. §307 – Actions by and Against Partnership and Partners . then it is not violative. • A third party can sue the partnership for the contracts entered by its agents and for the torts committed by its agent. If the modification is reasonable. 14 - . o With joint liability.A partnership may sue and be sued o An action may be brought against the partnership and. Thus. but NOT severally liable in contract but jointly and severally liable in tort.Liability of the Partnership o A partnership is a legal person or entity. §103 1.com - §404: General Standards of Partner’s Conduct o §404(a) Loyalty and care owed to the partners and partnership o §404(d) (ii) Good faith and fair dealing o These obligations cannot be eliminated. any or all partners in the same action. 306. Who is Liable for What to Whom? . • A judgment against a partnership can’t be satisfied from a partner’s assets unless there is also a judgment against that partner. partners are jointly and severally liable for all obligations of the partnership. the plaintiff is free to sue one or more of the partners. an elimination of a certain duty will be violative. to any extent not inconsistent with §306. a partnership can be held liable and can sue or be sued. and in those situations in (b) and (c) Person admitted as partner is not liable for any partnership obligation incurred before he becomes partner. In many cases. but can be modified to a degree. A judgment against partnership is not itself a judgment against a partner. . and 307. .§306 o All partners are liable jointly and severally for all obligations of the partnership unless otherwise agreed.A partner can sue the partnership to enforce her rights under RUPA or the partnership agreement. a. With joint and several liability.
New Investors . such provisions will state: Vote or events that trigger the obligation to contribute Amount of each partner’s contribution obligation Time in which to make the additional contribution Consequences of a failure to contribute. o Properly drafted.e.e. Investors) Financial Issues .com - A person trying to secure $$ of a partner may not get the assets of the partner to satisfy a judgment based on a claim against the partnership unless the partner is personally liable for the claim under §306 AND: o A judgment based on the same claim has been obtained against the partnership and a writ of execution on the judgment has been returned unsatisfied in whole or part. Additional Owners (i.Requires $$$ which usually comes from one of four sources: o Existing Owners o “Outside” Lenders . Huh? • You cannot go after a single partner’s assets unless you first exhaust the partnership’s assets first AND the partner is personally liable.Downloaded From OutlineDepot.Again. the cash from business operations that 15 .Earnings from the Business Operations Existing Owners . investors are going to be balancing risk and return. Outside Lenders Banks o See Chapter 2’s discussion concerning what a business can do in order to make a business venture appear less risky to a bank. o If risk is high.There is no statutory requirement that partners make initial or additional capital contributions. Common Method of Measuring Return on Investment o Compare the amount of cash flow (i. then the short or long-term return to the investor has to be high to induce the investment. o Partners themselves agree on capital contributions Look to the partnership agreement. How Does a Partnership Business Grow? .
Legal Issues Approval of New Partners .RUPA §401(i) o Requires consent of all existing partners unless the partnership agreement provides otherwise. .Partnerships should evaluate whether he partnership can earn a higher return than the partners could earn individually if the money were distributed to them.” Earnings from Business Operations . and the higher the rate of “return on equity” that the investor will look for. §401(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.Downloaded From OutlineDepot.§306(b) o A new partner is not personally liable for partnership obligations “incurred before the person’s admission as a partner.com could be paid to the business’ owners) with the amount of the owner’s investment in a business.Salary o Receiving all or part of the profits from that business o Law is found in the partnership agreement and other contracts and laws. An owner’s risk ad his “return on equity” are affected not only by the business’s cash flow but also by the business’s financial structure. How do the Owners of a Partnership Make Money? .” .Selling her interest in the business o Sale of Ownership Interest to 3rd Party Problems • Finding a buyer • Gaining any necessary approval from existing partners • Dealing with the question of “inherited” obligations (c) RUPA §502 (i) “The only transferable interest of a partner in the partnership is the partner’s share of profits and losses of the partnership and the partner’s right to receive distributions. the higher the risk to the owner. o Earnings should be distributed unless the partnership has some lucrative use for the funds. Liability of New Partner .” (2) Sale of Ownership Interest Back to Partnership 16 The higher the amount of debt a business has.
If the withdrawal or dissociation violates the partnership agreement. (ii) Buyout price is the amount that would have been distributable to the dissociating partner under 807(b) if. Creel entered into a partnership agreement with Lilly and Altizer to form a general partnership called “Joe’s Racing. In 1994. Method of funding the payment e. Should address the following: a.” a. If the dissociation is wrongful. Remaining partners obligation to buy or do they have the option to buy? b. ***Pay attention to tax effects!! (3) Withdrawal of a Partner (a) UPA §29 (i) Dissolution: Change in the relation of the partners caused by any partner ceasing to be associated in the carrying on as distinguished from the winding up of the business. CREEL V. The partners refused. may be paid later. more importantly. the partner may be paid less than otherwise for her partnership interest and. The events which trigger an obligation or option c. (c) Winding Up: A liquidation of the business. RUPA §602(c) (e) RUPA §701: Purchase of Dissociated Partner’s Interest (i) If partner dissociated from partnership his buyout price will be determined by (b).Downloaded From OutlineDepot. after which the partnership will actually terminate. 1. (i) “Buy-Sell” Agreements 1. (d) RUPA §602 (i) Any partner has the “power” to dissociate withdraw at any time. (b) UPA §30 (i) On dissolution the partnership is not terminated. on the date of the dissociation. Creel died. 17 . the assets of the partnership were sold at a price equal to the greater of the liquidation value or the going concern value without the dissociated partner. or satisfies any other circumstance set out in §602(b). but continues until the winding up of partnership affairs is completed. His wife demanded that the partnership liquidated all of its assets in order to determine the proper amount to be given to Creel’s estate.” 9 months later. it is “wrongful. Creel began a retail business selling NASCAR racing memorabilia. LILLY – (1999) Facts In 1993 Mr. or occurs before the expiration of the partnership term.com (a) It is common for the partnership agreement or some separate agreement among partners to provide for sale of partnership interests back to the partnership or to other partners. How the selling partner’s interest is to be valued d.
com In their partnership agreement. then a forced sale of all partnership assets is unwarranted. Further. the winding up method was outlined in 7(a) was followed exactly by the surviving partners.” but it in no way mandates that this must be accomplished by a forced sale of the partnership assets. Paragraph 7(a) requires that the assets. COURTS MUST FIRST LOOK TO THE PARTNERSHIP AGREEMENT TO RESOLVE THE ISSUE. and if the estate wishes to sell this interest it must first be offered to the remaining partners. and income be “ascertained. Holding . Paragraph 7(a) was . Further 7(d) makes no mention of a sale or liquidations being essential in order to determine the deceased partner’s proportionate interest of the partnership. it is apparent that the partners did not intend for there to be a liquidation of all partnership assets upon the death of a partner. o The “termination” provision is really discussing the dissolution of the partnership and the attendant winding-up process that ultimately led to termination. G. NOTES Book Value: The cost of inventory.Downloaded From OutlineDepot. Issue Whether Maryland’s UPA permits the estate of a deceased partner to demand liquidation of partnership assets in order to arrive at the true value of the business. • 7(d) more appears to be a crude attempt to draft a “continuation clause” in the form of a buy out option by providing that the deceased partner’s share of the partnership goes to his estate. Partnership Endgame 18 . there was a crudely prepared section entitled “termination.” See page 117.WHEN CONFLICTS BETWEEN PARTNERS ARISE. o To hold otherwise vests excessive power and control in the estate of the deceased partner. liabilities.Maryland’s UPA does not grant the estate of a deceased partner the right to demand liquidation of a partnership where the partnership agreement does not expressly provide for continuation of the partnership and where the estate does not consent to continuation. o In this case. to the extreme disadvantage of the surviving partners. o When subsections (a) and (d) of paragraph 7 are read in conjunction. where the surviving partners have in good faith wound up the business and the deceased partner’s estate is provided with an accurate accounting allowing for payment of a proportionate share of the business.
807(a)-(b). and her share of the partnership’s profits and losses. o The problems of a dissolving partnership’s distributions to the partners “according to their interests” can be much more complicated. and terminate. the partnership entity is terminated. a bookkeeping device which keeps track of how much a partner puts into the partnership. • 4 basic concepts that need clarification: o Unless the partners agree to the contrary. Dissolution. o It is the beginning of the end. RUPA provides default rules to address the problems in §§401 and 807. the partnership faces 2 choices when a partner dies or otherwise withdraws from the partnership: o The remaining parties can purchase the departing partner’s interest and continue the partnership business [§701(a)-(b)]. and the partners are associated in the winding up of the business until winding up is completed. paying its debts. o Partnership continues for the limited purpose of winding up the business. or o The partnership can dissolve. Comment 2: RUPA §801 • “Dissolution” is merely the commencement of the winding up process. Winding up the partnership business entails selling its assets. and distributing the net balance. §§ 401(a). o When the winding up is completed. liquidate. - 19 . if any. if the partnership agreement does not fully address the problems.Downloaded From OutlineDepot. [§807(b)] Dissolution is not the end of the partnership. • The partnership entity continues.com 1. They share responsibility not only for losses from partnership business but also for partners’ losses from investments in the partnership. how much she has taken out of the partnership. §401(b) Amount of each partner’s loss from her investment in the partnership is determined from her partnership account. Winding Up and Termination as Endgame for the Partnership Under RUPA. to the partners in cash according to their interests.
• If a partner has a negative balance in his account (for whatever reason). . with the losses being shared by them in the same proportions as they share the profits.Downloaded From OutlineDepot. §807(b). Holding . - Summarizing §401. If there are insufficient funds to cover the creditors. this loss will be divided equally among the partners’ accounts.com When the partnership is dissolved. REED – (1957) Facts In 1952. the partnership is legally obligated to pay each partner an amount measured by the balance in her partnership account. Issue Whether or not a co-venturer who invests only his labor into a project can be held liable for financial loss as a result of the venture. Kovacik did not ask Reed to agree to share any loss that might result and Reed did not offer to share any such loss.Exception o Where one partner or joint adventurer contributes the money capital as against the other’s skill and labor. Kovacik informed Reed that the venture had been unprofitable and demanded contribution from Reed as to amounts which Kovacik claimed to have advanced in excess of the income received from the venture. Kovacik said he would supply the investment if Reed would perform the labor and they would split the profits 50/50. irrespective of any inequality in the amounts each contributed to the capital employed in the venture. §807(b). 20 . Kovacik and Reed entered into a joint venture whereby Kovacik would invest about 10K into a venture for some remodeling work for Sears. neither party is liable to the other for contribution for any loss sustained. he will have to contribute additional funds to the partnership in the amount of the negative balance. In 1953. the amount in each partner’s account will be: o Investment in partnership (-) Distributions received (+) equal share of anything left over after creditors are paid. KOVACIK V. Procedural History Trial court concluded that the two were to share equally all their joint venture profits and losses between them.General Rule: o In the absence of an agreement to the contrary. the law presumes that partners and joint adventurers intended to participate equally in the profits and losses of the common enterprise.
In 1991 the firm denied her a year end partnership distribution for 1990 and reduced her tentative distribution share for 1991 to 0. Expulsion as an Endgame for a Partner Expulsion is not expressly dealt with by RUPA. it had paid these 3rd parties with partnership funds that had been invested in the partnership by Kovacik.com - Rationale o Where one party contributes money and the other contributes services. then in the event of a loss each would lose his own capital – the one his money and the other his labor. and collected. In September. fairness. A partnership exists solely because the partners choose to place personal confidence and trust in one another. o The question was not whether creditors of the partnership would recover on their claims. Unless it is answered in the partnership agreement. that question will be answered by RUPA §807. 21 . • Charges of overbilling may have a profound effect on the personal confidence and trust essential to the partner relationship. and honesty in their dealings with each other with respect to matters pertaining to the enterprise. billed. the partnership had already paid its obligations to creditors. It had no more debts.Downloaded From OutlineDepot. . so she met with the managing partner and discussed this. 2. and imposes upon all the participants the obligation of loyalty to the joint concern and of the utmost good faith. and the firm voted formally to expel her from the partnership 3 days later.The partnership had ended. but whether Kovacik would recover anything on his investment in the partnership. she found new employment. She became concerned another partner was overbilling. Holding . BUTLER & BINION – (1998) Facts Bohatch became an associate at the officers of Butler & Binion in 1986. Issue Whether there should exist an exception to this rule by holding that a partnership has a duty not to expel a partner for reporting suspected overbilling by another partner. Shortly thereafter she was told that she should begin looking for other employment. She was made partner in 1990 and began receiving internal firm reports showing the number of hours each attorney worked. **In this case. She filed this suit in October 1991.General Rule: o The relationship between partners is fiduciary in character. BOHATCH V.
by use of adverse pressure “freeze out” a copartner and appropriate the business to his own use. Arguments Defendant believes that plaintiff is acting in bad faith and is attempting to use his superior financial position to appropriate the now profitable business of the partnership. losing about $62. The partnership’s major creditor was a corporation.There is no showing of bad faith or that the improved profit situation is more than temporary. . However. the dissolution 22 . threat. o Even though the UPA provides that a partnership at will may be dissolved by the express will of any partner. This corporation held a $47.Downloaded From OutlineDepot. this power. Each had invested about $43. Shortly thereafter. like any other power held by a fiduciary must be exercised in good faith. dispute this.000 demand note of the partnership. machinery. Issue Can a partner withdraw from a partnership so he can take the partnership’s business for himself? Holding . Plaintiff has the power to dissolve the partnership by express notice to defendant. concealment. PAGE – (1961) Facts The partners entered into an oral agreement in 1949 as partners in a linen supply business.com - The firm did not owe Bohatch a duty not to expel her for reporting suspected overbilling by another partner. the plaintiff wished to terminate the partnership. Partners may not obtain any advantage over him in the partnership affairs by the slightest misrepresentation. however. From 1949 to 1957 the enterprise was unprofitable. the business began to improve. and linen needed to begin the business.000 for the purchase of land. or adverse pressure of any kind. o A partner may not. A partner may not dissolve a partnership to gain the benefits of the business for himself.000. unless he fully compensates his co-partner for his share of the prospective business opportunity. regardless of whether the business is profitable or unprofitable. wholly owned by the plaintiff that supplies the linen and machinery necessary for the day to day operation of the business. o If it is proved that plaintiff acted in bad faith and violated his fiduciary duties by attempting to appropriate to his own use the new prosperity of the partnership without adequate compensation to his co-partner. PAGE V.A partner at will is not bound to remain in a partnership.
com would be wrongful and the plaintiff would be liable. What are the Legal Problems in Operating a Business as a LP? 1. the general partner has the same rights as a partner in a general partnership. RULPA establishes this as a default rule. • A corporation may be a general partner. LP statutes do not. • The general partners have the same rights and duties as partners in a general partnership. - B. o Rule of Thumb: General Partner decides. which is filed in public records. is liable for the debts of the partnership o The name and the address of the general partner must be set out in the Certificate of Limited Partnership. • Unless the LP agreement specifies otherwise. unlike the limited partners. What are the Legal Problems in Starting a Business as a LP? LPs to do not come into existence until there has been a public filing. for example. Limited partners are not personally liable for the debts of the limited partnership. 23 . however. RULPA §403. o Certificate of Limited Partnership document. they are subject not only to limited partnership laws but also to general partnership laws. usually with the secretary of state of the state of organization. What is a Limited Partnership and what is Limited Partnership Law? The most obvious difference between a limited partnership and a general partnership is that a limited partnership has limited partners. o RULPA §1105 In any case not provided for in this act. the provisions of the UPA govern. o Limited partnership (LP) must have at least 1 general partner. require that the general partner be an actual person. Because of the hybrid nature of LPs.Downloaded From OutlineDepot. Chapter 9: Limited Partnership and How Does it Work? A. Who decides what? This is answered in either 1) a LP statute or 2) a LP agreement. - C. LP statutes require that: o LP must have at least 1 partner This general partner. The more important document to clients is the LP agreement.
Inc. LPs are not liable for the acts or debts of the LP. To 3rd Parties - Each general partner of a LP is personally liable for the partnership’s debts to 3rd parties as if the partnership were a general partnership. which was the only general partner of the limited partnership. there is NO CONTROL TEST - 2. and Trenton assigned it to a limited partnership called Trenton LP. .” the LP had essentially become a general partner for liability purposes. but are not liable for what the business does.Downloaded From OutlineDepot. a general partner of a LP has the liabilities of a partner in a partnership . WILF – (2000) Facts Zeiger was supposed to receive 27K/year for 16 years after he had sold certain property to Trenton. o §303(a) Even if a limited partner exercises “control. Under ULPA. The contract for sale stipulated that Trenton could assign its property interests to another entity. o RULPA 403(b) Except as provided in this Act. Wilf’s Argument He maintains that in doing so. he was functioning as vice president of the Trenton. however. o They are more like shareholders of a corporation – they make an investment (which is at risk).RULPA §303(b)(6)(v) is the only provision in RULPA relating to removal of a general partner. ZEIGER V.” he will nonetheless be liable only when he acted in a way that caused a third party to reasonably believe that he was a general partner. After 2 years. o §303(b) Safe harbor provision which lists activities that will NOT constitute “control” by the limited partner. to persons other than the partnership and other partners. the payments ceased due to a failing project and Zeiger sought to hold Wilf personally liable for the payments.com NOTE . Inc. As the law developed. • By exercising “control. . 24 . it became clear that a LP who exerted “control” over the business of the LP would become liable for the acts and debts of the business. Who is Liable to Whom for What? a.
KAHN V. b. ICAHN – (1998) Facts Kahn brought this suit on behalf of AREP against AREP’s general partner API. LP. The defendant’s duties to AREP are defined by the Partnership Agreement that clearly permitted the Icahn Defendants to make the investments without bringing them to the limited partners. instead. directly or indirectly with the business of the Partnership. §303. The agreement between AREP and API provides that the general partner. o They may expand or restrict duties as they wish pursuant to the Delaware Revised Limited Partnership Act. it can only function through its officers.Downloaded From OutlineDepot. and that is precisely what Wilf was doing at all times when he acted concerning this enterprise. LP. may “compete. and the non-liability of a limited partner for such obligations. or that he relied on some impression that Wilf was a general partner of Trenton.” Holding . but argues that his actions were taken as a VP of Trenton. a corporate opportunity of AREP by failing to make the opportunities completely available to AREP and. o Zeiger’s argument rests on Wilf’s key role in the renovation project. keeping a percentage of the profits for his other endeavors and ventures. and thus there is no basis for any for any finding of personal liability against Wilf.com Holding . Wilf acknowledges that role. for himself. o There is no claim that Zeiger was misled.Icahn. Kahn alleged that Icahn breached his fiduciary duties to AREP and usurped.Delaware law permits partners to agree on their rights and obligations to each other and to the partnership. therefore will not hold Wilf accountable. 25 . To the Partnership and Partners A general partner in a LP has liability exposure not only to third parties for the obligations of the LP but also has liability exposure to the LP and to the limited partners for breach of fiduciary duties. Inc – the corporation which was the sole general partner of Trenton. and the general partner’s sole shareholder and CEO .Limited Partnership Law establishes a differentiation between the broad liability of a general partner for the obligations of a limited partnership. • Since Trenton is an artificial entity. • The clause in the partnership agreement was unambiguous that it authorized competition with the partnership.
Member-Managed • Decision-making authority of the members of a member-managed company is much like that of the partners in a general partnership. What are the Legal Problems in Starting a Business as an LLC? - An LLC is formed at the time of the filing of the initial certificate of formation in the office of the Secretary of State. with state statues being default provisions if there is no contrary provision in the operating agreement. §DLLCA §18-201. What are the Legal Problems in Operating a Business as an LLC? Who decides what? o Owners of an LLC can elect the form of management. - B. which sets out the rules that govern the firm. Who is Liable to Whom for What? 26 - . Chapter 10: LLCs A. • Operating Agreement will answer: o How to determine how many votes each member has o How to determine what matters require more than majority vote Manager-Managed • Decision-making authority is similar to a corporation with a board of directors. o The most important document is the Operating Agreement. members of an LLC enter an operating agreement. • Operating agreement will answer: o How members elect and remove managers and o What issues require a member vote. o Typically. generally referred to as members. plaintiffs can hardly be said to have a legitimate expectancy to be informed of relevant investments made by API. Delaware LLC Statute: • Gives great deference to the operating agreement. both: o Protection from liability for business’ debts o Same pass-through income tax characteristics of a partnership LLC law is primarily contract law.com o Therefore. What is an LLC and what is LLC Law? An LLC offers all of its owners.Downloaded From OutlineDepot.
He notified the company.Carson. • LLC statutes protect the owners from personal liability for these claims against the company. and was essentially brushed off about the prospect. There was an OA which stated that any “opportunity which comes to the attention of a Member to purchase cable television systems . An advantage over a limited partnership. argues that “offer” simply means that he must notify the members of the opportunity. Issue 27 . . and would not be deemed improper. LLC – (2000) Facts CLR has 3 owners: Lynch.com o Members’ Liability to 3rd Parties LLC is an entity. shall first be offered to CLR. Carson. CARSON COMMUNICATIONS. • Look to the operating agreement for specifics! o Fiduciary Duties Member Managed • Members owe fiduciary duties Manager-Managed • Managers owe fiduciary duties o Members doe NOT.” Another provision. and eventually he purchased the cable systems for himself about 3 years after he first notified the Board of CLR. . and creditors must collect from the LLC.Downloaded From OutlineDepot. alleging breach of OA. and Rainbow (hence CLR). . and breach of fiduciary duties. however. o There is NO general partner who is liable. and he carried out order and resolutions of the Board of Managers. Lynch sued Carson. however. and was given “general and active management” of CLR’s business. LYNCH MULTIMEDIA CORP. V. also said that any Member or Manager may engage independently or with others in other business ventures of every nature and description. Carson learned of an opportunity that certain cable systems might become for sale. He persevered on the matter. Lynch’s Arguments Carson could not fulfill the duty created by the OA unless he presented the other members with a no-strings-attached purchase offer at a properly called special meeting of the members. but to no avail. not its members. Carson was appointed as president of CLR. o Members’ and Managers’ Liability to the Company A member acquires her ownership interest in a LLC by making or agreeing to make a payment or other contribution to the company.
The initial capital contribution to Wyoming was about 50K. Lieberman then demanded a return of “his share of the current value of the company. How do the Owners of a Business Structured as a LLC make Money? OA provides how and when a LLC’s earnings are to be distributed to its members. A member also generally has the right to receive profits. LLC – (2000) Facts In 1994. o Statutory provisions are default rules: ULLCA §405. Carson informed the other members of CLR Video of certain opportunities to purchase cable companies. and at one point after the rejection of the proposal. o One interest is a member’s capital contribution. although the management 28 .COM. which a member may withdraw under certain conditions.com Whether Carson. The provisions must be read in context of the entire OA.” valued at around 400K (which was based on a recent offer from the Mossbrooks. Wyoming was formed by the Mossbrooks and Lieberman. • Only after the passage of several months or years. Lieberman was terminated as VP of Wyoming and required to leave the business premises. o A member’s interest usually grants him the ability to participate in management. Procedural History District court granted Wyoming’s motion for summary judgment and denied Lieberman’s motion for partial summary judgment. In 1995 the OA was amended to reflect an increase in capitalization of 100K due to two new members receiving 2. breached his OA and fiduciary duties owed to CLR. Overall. Wyoming accepted his withdrawal and approved the return of his 20K contribution. o Also. a member’s interest is transferable. WYOMING. In 1998.Downloaded From OutlineDepot. Lieberman’s interest remained the same. LIEBERMAN V. D. for example. the OA is plainly directed at permitting the members to enter into separate and additional business relations in the cable television industry. Holding No. The interpretation of “offer” proffered by Lynch must be rejected.A member’s interest in an LLC consists of economic and non-economic interests. Holding .5% interest. Lieberman’s contribution represented a 40% ownership interest in the LLC. did Carson independently acquire the companies. acting as president of CLR. Lieberman refused to accept.
The statute requires that the Articles of Organization be amended when the amount or character of contributions changes.Downloaded From OutlineDepot. Economists View of Corporations o A way to reduce transaction costs as compared to frequent transactions in markets.com rights of a transferee may be limited. which isn’t present here. • No statutory limit on how much money an owner of a corporation can make from her investment in a corporation o The most that she risks is the amount that she paid for the shares of stock. This is the limit of her liability. o The fact that he demanded the 400K indicates his unwillingness to forfeit his interest unless paid the 400K. Purpose of Corporate Law o The facilitation of cooperative activity that produces wealth. o Economists sometimes view the corporation as a set of contractual relationships among the suppliers of all of the corporation’s inputs. What is a Corporation and what is Corporate Law? A corporation is whatever the relevant state law says it is. However. o Nothing in the statute indicates that the FMV of a member’s interest is to be included in the amount to be paid to a member upon withdrawal of that member’s capital contribution. o Other state statutes allow for the FMV to be distributed. • The amount of a member’s contribution is a constant not subject to market fluctuations. o Every state has a general corporation statute which provides: Corporation is a separate legal entity and Owners (shareholders) are generally not personally liable for the debts of the corporation. - Chapter 4: Corporations A. there is no indication it has been canceled or forfeited. Court goes on to hold that the Wyoming statutes provide for the return of only the initial or stated capital contribution of a member. 29 - . but they contemplate dissociation. the court says that Lieberman has NOT forfeited his interest upon his withdrawal b/c he did not have an intent to do so. So the court looks to the Operating Agreement • There is nothing in the record indicating what became of Lieberman’s membership certificate.
03 o Where the articles are to be filed • §2. • There are important federal statutes that govern certain corporate activities.com o Economists are concerned about “agency costs. • MBCA §2. o Delaware does NOT require bylaws §109 Bylaws are not required to be filed with any state agent or agency • They are internal documents. Contracting Before Incorporating 30 - . almost every corporation does have bylaws.” Any employee or other agent of the corporation may have an incentive to benefit himself rather than the corporation. o Bylaws MBCA requires that a corporation adopt bylaws • §2. • In the real world. B. 4 Sources of Corporate Law o State statutes More than half the states have modeled their statutes in some measure on the MBCA. Bylaws and other agreements o Case Law Serves 2 corporate law functions • Cases interpret and apply the provisions in corporate statutes and in a corporation’s articles and bylaws.06(a) Traditionally. What are the Legal Problems in Starting a Business as a Corporation? Preparing the Necessary Papers o AOIs A corporation does NOT exist until the AOIs are properly executed and filed with the appropriate state agent or agency. so perhaps the MBCA is simply requiring what everyone does anyway. o Articles of incorporation (AOIs).02(a) o What AOIs must contain. this is not required. • Much of corporate law and lawyering attempts to control agency costs.Downloaded From OutlineDepot. • Cases fill gaps in the law o Federal statutes There is no general federal corporation statute.
the test for profit is the price paid by the corporation minus the price paid by the promoter. 31 . the corporation can recover her “secret profit.” o “Outstanding shares” consist of issued shares that the corporation has not reacquired A corporation can have more than one type (“class or series”) of stock. MBCA §6. o A promoter is liable to the corporation ONLY if the profit was secret.Downloaded From OutlineDepot. she has a duty to disclose to the corporation any profit she is making. converted or canceled. • If she fails to do so. Issuing Stock o Shares of stock are the units of ownership in a corporation. o Corporation sells its own stock Called an issuance o AOIs determine the number of shares a corporation may issue Called “authorized shares” o A corporation is not required to issue all of its authorized shares Shares that the corporation actually does issue are called “issued shares. the fiduciary duties attach and retroactively prohibit the promoter from making a secret profit on her dealing with the corporation.03 • A corporation may issue the number of shares of each class or series authorized by the AOIs. then it is preferred stock. - “Secret Profit” Rule o After a corporation is formed.com o Promoter: Someone acting on behalf of a corporation that is not yet formed.” o This recovery emanates from the fiduciary duties that the promoter owes to the corporation. When this happens. • When the corporation comes into existence. - VOCAB Preferred Stock: If the AOIs provide that a certain kind of stock is to be treated more favorably than the other class of stock. o Shares that are issued are outstanding shares until they are reacquired. a promoter might sell property to the corporation. There is no fiduciary duty and no secret profit liability for the promoters’ pre-incorporation transactions. o ANALYSIS Has the promoter made a profit? • For property acquired while he was a promoter.
com Common Stock: Type of stock that does not enjoy special treatment. Stated Capital: Includes the aggregate par value of all issued shares of par value stock. shareholders and officers. o It is a cushion to protect creditors. Costs of Incorporating in Delaware o Extra costs to incorporate (attorney’s fees. the corporation selects its home state or Delaware.MBCA and a majority of statutes have eliminated the requirements that AOIs provide a par value for stock and that corporations maintain a “stated capital” account. .Downloaded From OutlineDepot. Par Value: The minimum price for which a corporation can issue its shares. The laws of that state will then become the default rules that govern the “internal affairs. . - Chapter 5: How does a Corporation Operate? A. 32 .” o It can be sued for the actions of its agents. o Usually.The stated capital account cannot be distributed to shareholders. filing. . etc. Outstanding Stock: The amount of shares that have been issued and are in the hands of the public. Capital Surplus: Excess money from the stated capital which may be distributed to shareholders. Who is Liable to the Corporation’s Creditors? A corporation is an “entity” and a “person.) o Fees to State of Delaware o Making payments as a foreign corporation Foreign corporations transacting business in its state to “qualify to do so. even one in which there is no business activity.Par value affects only the issuance price. to ensure that the company retains at least some money to pay its bills. • Includes: o Obtaining authorization from appropriate state agency o Appointing a registered agent in the state o Filing annual statements in the state o Paying fees and franchise taxes to the state.” o Business can choose to incorporate in any state. Choosing the State of Incorporation and Qualifying as a “Foreign Corporation.” • Internal affairs include procedures for corporate actions and the rights and duties of directors.
DEWITT TRUCK BROKERS. o Exception: “Piercing the Corporate Veil” The courts will decline to recognize the general rule whenever recognition of the corporate form would extend the principle of incorporation ‘beyond its legitimate purposes and would produce injustices or inequitable consequences. Factors to Determine Whether the “Corporate Veil” should be Pierced 1. any situation where a business cannot acquire the funds they need). o General Rule: A corporation is a separate entity and its debts are not the individual indebtedness of its stockholders. V. in every case is to be decided in accordance with its own underlying facts. Failure to observe corporate formalities (i. The corporate veil may be pierced. which contracted with Dewitt for Dewitt to transport fruit that FFC was selling for a 3rd party on commission.e. Combine #s 1-3 with other factors clearly supporting disregard of the corporate fiction on grounds of equity and fairness. and so Dewitt asks the court to “pierce the corporate veil. W.” Procedural History District Court found that the corporate veil may be pierced and hold Flemming personally liable. MBCA §6. 33 . Dewitt wanted assurance that Flemming. Because FFC was struggling financially. He orally agreed to be responsible.22(b) There are contractual and judicial exceptions to the rule that shareholders are not personally liable for the acts or debts of the corporation.e. 3. its resolution is particularly within the province of the trial court. INC. siphoning. records. Substantial Ownership of stock in a single individual 2. Undercapitalization (i.This claim. o Since the issue is one of fact. payment of dividends. the principal shareholder. • Power to pierce the corporate veil is to be exercised “reluctantly” and “cautiously” and the burden is on the party asserting such a claim . o 3rd parties often refuse to extend credit to a corporation with limited assets unless that corporation’s shareholders agree to be personally responsible. This oral promise was not legally enforceable b/c of the statute of frauds.com - A shareholder’s protection from personal responsibility for the corporation’s liability is basic to the corporate structure and to corporate law.“Clearly Erroneous” standard applies and the District Court was not clearly erroneous.Downloaded From OutlineDepot. . would be personally responsible for payment. – (1975) Facts Flemming owned FFC. Issue May the corporate veil be pierced in this situation in order to hold Flemming personally liable for the debts of his corporation? Holding Yes. 4. RAY FLEMMING FRUIT CO. etc).
. o Personal jurisdiction exists if defendant has “minimum contacts” with the state where the court is located. but to go after the assets of related companies. not to impose liability on a corporation’s owners. not to go after the assets of a shareholder. A corporation whose stock is owned by another corporation is commonly referred to as a “subsidiary.Parent corporations are NOT liable for the contracts.A corporation can be a shareholder of another corporation. Enterprise Liability: Piercing the walls of one corporation. but instead to create personal jurisdiction over them. o A corporation may not be held liable for the actions of another company merely because it has an ownership interest in it. but by a constellation of corporations controlled by a central holding company. are commonly-owned and in reality engaged in one enterprise together should be treated as a single legal entity for purposes of liability. the various sectors being separately incorporated. the smaller the proportion of stock held by management. NOTES .” Subsidiary: A corporation. This is because the corporations were once independent and later acquired by the larger corporation or because the large corporations want to expand into different fields. . ignoring the subsidiary’s paraphernalia of incorporation. BOARD OF DIRECTORS AND OFFICERS 34 . subsidiary corporations wholly-owned or partly-owned.Corporations that. . B. although technically separate. Control Test • Liability will be attached to a parent corporation if the parent company exerts a direct intervention in the transaction.com **When one induces a creditor to extend credit to the corporation on such an assurance (as that made by Flemming). that fact has been considered by many authorities a sufficient basis to pierce the corporate veil. - Sometimes veil piercing is used. called the parent corporation. not by a single corporation. and other obligations of its subsidiary corporation unless there is a contractual or judicial exception to the rule that a shareholder is not liable for the acts or debts of the corporation. Who Gets to Make Decisions for the Corporation? The answer to “who decides what” varies with the corporation.As the scale of business enterprises enlarged. a corporation is often the only shareholder of another corporation. torts. the process of subdivision began. o Usually. 1.Downloaded From OutlineDepot. a majority or all of the outstanding stock of which is owned by another corporation. o Usually. o Ownership in large corporations is widely dispersed o No single shareholder owned sufficient stock to control the corporation’s agenda o Larger the corporation. directors and officers. a single large-scale business is conducted.
an agreement was entered into whereby Stoneham. still leaving Stoneham with a large portion of shares. As a part of the transaction. McQuade had paid Stoneham over 50K for the stock he had purchased. At trial. if a corporation has more than 4 or 5 shareholders. A director can also be an officer. o Board Members are NOT agents of a corporation or its shareholders. o Their important decision is when to sell their shares. SHAREHOLDER’S DECISIONS INSTEAD OF DIRECTORS’ DECISIONS 35 . This continued for a short time until Bondy was elected to succeed McQuade as treasurer. most shareholders play virtually no role in making decisions regarding the operation of the business. McQuade became treasurer. or policies or retaining individuals in office. it is the board of directors that is entitled to make the corporation’s most important decisions. o Their duty was to the corporation and its stockholders.Stoneham and McGraw were not trustees for McQuade as an individual.Downloaded From OutlineDepot. not the shareholders . AGENCY LAW DOES NOT APPLY TO BOD • AGENCY LAW DOES APPLY TO ITS OFFICERS - MCQUADE V. McQuade. Under the corporation codes of all states. salaries.Directors are the exclusive executive representatives of the corporation. Holding . STONEHAM – (1934) Facts Stoneham was majority owner of NEC and McQuade and McGraw each purchased 70 shares of his stock.com - Generally. charged with administration of its internal affairs and the management and use of its assets. who select CEOs and other corporate officers. o Shareholders select Board of Directors. . Stoneham had appointed for “outside” directors who all unanimously voted against McQuade in favor of Bondy. McQuade was therefore dropped as a director of NEC. before this had happened. • “Inside” Directors: Those directors who are also officers • “Outside” Directors: Those directors who are NOT officers. with McQuade being the only person voting for himself to remain as treasurer. to be exercised according to their unrestricted lawful judgment. and McGraw would appoint McQuade and McGraw as directors of NEC.NY has adopted a statute that permits shareholders of corporations with relatively few shareholders to enter into agreements controlling board decisions. Stoneham became president and McGraw VP.Courts will uphold shareholder agreements so long as they do not TOTALLY usurp or sterilize the Board’s power to manage its affairs SIDENOTE . o They manage the business of the corporation. **Board of Directors (BOD) should manage the business. 2. Apparently. A contract is illegal and void so far as it precludes the board of directors from changing officers. the evidence was fairly clear that Stoneham got rid of McQuade merely in order to get rid of him. except by consent of the contracting parties.
Villar’s Argument Villar argued that the oral agreement between Villar and Kernan not to receive salaries prevented Kernan from receiving anything. and a shareholder. officer. MBCA §8. They own too few shares to have any impact.” and Kernan received 51% and Villar receiving 49%. the manager of Ricetta’s acquired 1% from both Kernan and Villar. Stephan realigned with Kernan. They incorporated. and Villar and Stephan tried to buy Kernan out. This agreement was ratified at a BOD meeting where Villar wasn’t present. providing automatic 2K payments to him every week. but he refused. publicly-held corporation. the role of most shareholders in electing and removing directors is of little practical consequence. o Ex: 1 person can be a director.Because the language of subsection (1) of §618 refers to written agreements between shareholders. §211(b). stating that “no written agreement will be invalid. Cumulative Voting o Straight Voting: When there is a separate election for each seat on the board. calling it “Ricetta’s. an officer. o In large. Shareholder’s Role: o Make decisions about directors. Subsequently. the finances.com VILLAR V. The relationship deteriorated between Villar and Kernan. KERNAN – (1997) Facts Villar and Kernan agreed to go into the brick oven pizza business. Holding .Downloaded From OutlineDepot. • The shareholders in a position to call the shots will usually be other corporations that own many shares. Kernan entered into a “so-called consulting agreement” with Ricetta’s. Straight Voting v. 36 - - . Issue Whether Main law preclude an action for breach of an oral contract between 2 shareholders of a closely held corporation prohibiting their receipt of salaries from the corporation. Shareholders elect and remove directors. Villar operated the business and Kernan.03(c). or shareholder. This person is subject to different rules depending upon whether she is acting as a director.” Later on. SHAREHOLDERS’ DECISIONS ABOUT DIRECTORS AND CUMULATIVE VOTING One person can wear several hats simultaneously in the corporate setting. o To conclude otherwise would nullify the word “written. In 1994. They had orally agreed that “there would never be salaries. Del. Procedural History The Court agreed with Villar on the breach of contract issue.” 3.” it is logical to conclude that the legislature intended to validate only written agreements that meet the requirements of the statute.
- Shareholders’ Voting on Directors’ Decisions on “Fundamental Corporate Changes” o Certain fundamental corporate changes require shareholder approval Amendment of the AOIs Dissolution Merger Sale of all or substantially all of assets o o Because these things are not routine business decisions. the votes don’t disappear if voter loses). From here. This number gives you the amount of VOTES a shareholder has. To Cumulate: Take a person’s shares and multiply by the number of directors to be elected. • Who gets Notice/Gets to Vote 37 . §213(a).Downloaded From OutlineDepot. • Ex: 50 shares x 5 directors = 250 votes.e. o A person can allocate her votes as she sees fit.20(a). o If one voter’s vote trumps another.com o Each shareholder gets to cast her number of shares in any way she desires for each of these separate elections. o Person who has the legal right to vote at an annual or special meeting of shareholders is the “record owner. - 3 Differences b/t Voting on Fundamental Corporate Change and Electing BOD Shareholder vote on election or removal of directors is a shareholder action.” o Record Owners: Owners that the corporation keeps a record of. MBCA §§7. a reaction to the BOD action. • A shareholder vote on a merger or other fundamental corporate change is approval or disapproval of a BOD decision. the corporation codes do not leave them entirely to the board of directors. There may be a supermajority approval requirement NO cumulative voting Where Shareholders Vote and Who Votes o Annual Meeting: Meeting held once a year o Special Meeting: Any other meeting held within a year.05 and 7. Cumulative Voting: One at-large election in which the shareholders cast votes and the top vote getters would win the position. Calculating the Number of Shares needed for a shareholder to elect various numbers of directors: • [(N x S) / (D+1)] + 1 o N = Number of directors the shareholder wants to elect o S = Total number of shares voting o D = Total number of directors to be chosen at the election • NOTE o This equation gives the total number of SHARES. then the loser retains their votes (i. multiply this number by the number of directors being voted on. The corporation is required to send notice of annual meetings and special meetings to its record shareholders. Del.
whether the scope of inspection relief should be limited b/c of the possibility of conflicting interests between that 50% stockholder and the corporation. - KORTUM V.07(b) & 7. INC.05 70 days – Earliest 10 days – Latest Who Votes (and what are Proxies)? o A shareholder does not have to be present at the annual or special meeting to vote her shares. A proxy may be revoked even if it states that it is irrevocable o Shareholder’s Inspection Rights o Access to the corporation’s books and records can be important to a shareholder who wants to act in an informed and responsible way in exercising her right to vote. WEBASTO SUNROOFS. State corporation statutes provide for shareholder voting by “proxy. V.Downloaded From OutlineDepot. 2. Latest: 10 days before meeting o §§7. If a board member or stockholder’s purpose for inspecting a company’s documents is genuine and substantial. Holding No to #1. RINGLING BROS ET AL. Whether the inspection rights of a director may be limited by ordering the director not to disclose those records to the 50% stockholder that designated the director as a board member. o Proxy is a form of agency. and thus a principal may terminate an agent’s authority at any time. – (2000) Issue 1. o §213 – Delaware Earliest Corp. then they should have unrestricted access. RINGLING. Whether the plaintiff stockholder’s stated purpose for inspection is bonafide. Every state provides for access by statute. Yes to #2. and if so. subject to any reasonable restrictions. VOTING AGREEMENTS AMONG STOCKHOLDERS 38 . may give notice: 60 days before meeting.” • Means that the person who is entitled to vote authorizes another person to vote for her.com - The record owner at the record date The record owners as of that date are entitled to notice and a vote at the meeting.
What are the Decisionmakers’ Business Responsibilities? Management’s job is to create value for the owners. alleging that Wrigley was not acting in the stockholder’s best interests by failing to erect lights so the cubs could play night games b/c Wrigley believed that baseball is a “day game. 2. JOY V. BOARD HAS A DEGREE OF RESPONSIBILITY TO THE CORPORATION Facts North was Citytrust’s CEO and Schaff was its CLO during the period in question. Holding . and it is not objectionable that his motives may be for personal profit. DUTY OF CARE (i) Breach of Duty of Care by Board Action SHLENSKY V.Downloaded From OutlineDepot. or determined by whims or caprice. o Shareholders may lawfully contract with each other to vote in the future in such way as they from time to time determine.com - Generally speaking. §218(C) AND MBCA §7. illegality and conflict of interest.31 • Oftentimes. Shareholders Derivative Suit: A shareholder sues officers of a corporation on behalf of the corporation. Management was completely dominated by North. What are the Legal Responsibilities? A. o They are chosen to pass upon such questions and their judgment unless shown to be tainted with fraud is accepted as final. WRIGLEY – (1968). unless fraud is involved. North also exercise strong control over the activities of the 39 . What are the Responsibilities of a Corporation’s Decisionmakers and to Whom are they Responsible? 1. specific performance will be granted in the event of a breach. C. BUSINESS JUDGMENT RULE Facts Stockholder’s derivative suit. Business Judgment Rule: Court made Rule • Courts will respect a business’ call regardless of its stupidity.Directors are the decision-makers of a company. SEE DEL. NORTH – (1982). a shareholder may exercise wide liberality of judgment in the matter of voting.” Issue Whether a plaintiff may bring a stockholder’s derivative action against the board of directors of a company without asserting fraud. so long as he violates no duty owed his fellow shareholders.
After-the-fact judgment as to whether a decision was wise cannot be the basis for finding a board liable. ANDREWS – (1924) Facts Andrews took office as a director and his only attention to the affairs of the company consisted of talks with the president as they met from time to time.com BOD. holding that their conduct was not reckless. - Gross Negligence: Negligence + BJR (ii) Breach of Duty of Care by Board Inaction BARNES V. The record compels the conclusion that the BOD lacked valuation information adequate to reach an informed business judgment. a force of 40 . for that ignorance itself is a breach of fiduciary duty. o The fact that liability is rarely imposed upon corporate directors or officers simply for bad judgment and this reluctance to impose liability for unsuccessful business decisions has been doctrinally labeled the business judgment rule. Alternate relief was sought against the BOD. In fact board members were not given materials or agendas prior to meetings and requests for long range planning documents were left unanswered. or is so egregious as to amount to a no-win situation. consumer tastes or production line efficiency will rarely. Holding Reversed and Remanded. Members of the board were required to rely entirely upon Van Gorkum’s oral presentation of the proposal. BOARD MUST MAKE REASONABLY INFORMED DECISION Facts Class action seeking a rescission of a merger of the corporation into a new corporation. During his time as director. The BOD didn’t reach an informed business judgment on in voting to sell the company for $55/share pursuant to a merger proposal. o None of the directors had any prior knowledge that the purpose of the meeting was to propose a cash-out merger of Trans Union.Downloaded From OutlineDepot. if ever. VAN GORKOM – (1985). Holding . Court of Chancery granted judgment for the BOD. Business Judgment Rule (BJR) does NOT apply to situations in which the corporate decision lacks a business purpose.A corporate officer who makes a mistake as to economic conditions. be found liable for damages suffered by the corporation. SMITH V. is tainted by a conflict of interest. o Directors who willingly allow others to make major decisions affecting the future of the corporation wholly without supervision or oversight may not defend on their lack of knowledge.
IN RE CAREMARK INT’L. A board has the right to rely on subordinates IF reasonable.If there are NO apparent damages. a director cannot be held accountable. Only a sustained or systemic failure of the board to exercise oversight will establish the lack of good faith that is a necessary condition to liability. and it is this duty which Andrews failed. o Absent grounds to suspect deception.Criminal violations do not automatically give rise to breach of fiduciary duties.Where a director exercised a good faith judgment.It must be demonstrated that the accused director’s slothfulness was a cause of the company’s loss. Holding .Causation . they have an individual duty to keep themselves informed in some detail. NOTE . o However. Holding . .” o Unconsidered failure of the board to act in circumstances in which due attention would have prevented loss. he would have learned that there were delay in getting into production which were putting the enterprise in most serious peril.Breach of Duty of Care may arise in 2 situations: o Board decision that results in loss b/c decision was ill advised or “negligent. if he had done so. 2. NOTES 1. 3. and. Andrews was bound to inform himself of what was going on with some particularity.While directors are collectively the managers of the company they are not expected to interfere individually in the actual conduct of its affairs. A shareholder’s derivative suit was filed alleging that the directors violated their duty of care by failing to supervise the conduct of Caremark employees. SCOTT – (2001) 41 .com officers and employees was hired at substantial salaries. however. INC. DERIVATIVE LITIGATION – (1996) Facts Caremark. MCCALL V. settled for violation of Medicaid and Medicare violations for over $250 million. A complaining shareholder must establish some linkage between the director’s bad behavior and corporate loss . 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. Plaintiff must show that a defendant’s dereliction caused harm to the corporation.Downloaded From OutlineDepot. a health provider. he or she should be deemed to satisfy fully the duty of attention. Funds of the company were steadily depleted. .
FRANK BURKE. McCall sustained significant losses b/c of health care fraud. wanton conduct) . it is unclear whether some reckless acts or omissions may be excluded from the protection of provisions under Del. o Duty of Loyalty. but should have known) . o However. while still in its employ. Gross Negligence – Objective (Slightly less than recklessness. began a new competing agency. JR. INC. • Gross negligence does not necessarily include intentional conduct.com Facts Similar to IN RE CAREMARK. §102(b)(7) Gross negligence is the standard for measuring a director’s liability for a breach of the duty of care. (i) Competing with the Corporation JONES CO.Intentional conduct NOT necessary to be liable and recklessness is not necessarily intentional. CEOs and similar executives get paid a lot of money. Holding . Once the new 42 . DUTY OF LOYALTY - Duty of Care cases arise when executives or board members were lazy or dumb in the decision making process. Issue Whether there was a substantial likelihood of liability for intentional or reckless breach of the fiduciary duty of care. The defendants alleged and the District court agreed that a director need to have intentionally acted to harm the corporation. began to suffer hard times because of “behavior lapses” by its founder Duane Jones. asserts that the executives or board members were greedy and put their own financial interests ahead of the interests ahead of the interests of the corporations and its shareholders.Sometimes substituted by courts for intent. Several of the company’s officers. o Shareholders may sometimes sue derivatively. – (1954) Facts Jones. They lured to the new agency both Jones’s key employees and many of its clients..Downloaded From OutlineDepot.Difference b/t recklessness and gross negligence is unclear Negligence – Objective standard (duty of care and breach) (iii) The Special Case of Executive Compensation Basically. V. Gross negligence is the standard. however. Intent – Subjective standard Recklessness – Objective (May not have know. B. asserting that the directors’ approval of massive compensation violated their fiduciary duties. Inc.
the disloyal officers resigned from Jones. Holding . the self-interest of the officer or director will be brought into conflict with that of his corporation. she began purchasing property around the golf club. . and o by embracing the opportunity. o The disclosure-oriented approach provides a clear procedure whereby a corporate officer may insulate herself through prompt and complete disclosure from the possibility of a legal challenge. Over time. as to bring the transaction within that class of cases where the acquisition of the property would throw the corporate officer purchasing it into competition with his company. Eventually.Downloaded From OutlineDepot. o it is in the line of the corporation’s business. 71 of Jones’s 132 employees were employed by the new agency. HARRIS – (1995) Facts Harris was president of a golf club. V.com agency got on its feet. o is of practical advantage to it.Court discussed the Line of Business test: DELAWARE USES THIS TEST o If executive or director is aware of a business opportunity that the business is capable of undertaking. 43 . Holding .” (ii) Usurping Corporate Opportunity NORTHEAST HARBOR GOLD CLUB. Issue What is the extent of the duty of loyalty? Whether the opportunity of the golf club “was so closely associated with the existing business activities . Then. Disclosure of the opportunity is a MUST. Eventually the BOD brought suit alleging breach of loyalty and usurpation of corporate opportunity. without the BODs knowledge or previous consent. She continued doing this over a period of time. o Each of these defendants was “prohibited from acting in any manner inconsistent with his agency or trust and was at all times bound to exercise the utmost good faith and loyalty in the performance of his duties. the law will not permit him to seize the opportunity for himself. directors or employees of Jones fell below the standard required by the law of one acting as an agent or employee of another. The requirement of disclosure recognizes the paramount importance of the corporate fiduciary’s duty of loyalty. . INC. o they have an interest or reasonable expectancy in the opportunity.The conduct of the individual defendants as officers.
Downloaded From OutlineDepot. a competitor of CIS. Issue Whether or not Broz ursurped CIS’s corporate opportunity? Holding . V. Must look to the totality of the circumstances. Mackinac approached Broz about the possibility of RFBC (Broz) acquiring its license. the failure of the director to present the opportunity does not necessarily result in the improper usurpation of a corporate opportunity. Broz bought the license for RFBC without making formal disclosure to and obtaining the approval of the CIS board. however he did mention it to a couple members of the board. Corporation has an interest or expectancy in the opportunity By taking the opportunity for his own. - (iii) Being on both sides of a deal with the corporation (“interested director transactions”) HMG/COURTLAND PROPERTIES. LOFT’S elements of Usurpation of Corporate Opportunity o A corporate officer or director may not take a business opportunity for his own if: Corporation is financially able to exploit the opportunity. o A corporate fiduciary agrees to place the interests of the corporation before his or her own in appropriate circumstances.Although a corporate director may be shielded from liability by offering to the corporation an opportunity which has come to the director independently and individually. – (1996) Facts Broz was a director of CIS and was the sole stockholder and President of RFBC. CELLULAR INFORMATION SYSTEMS. Also. GRAY – (1999) Facts Gray and Fieber are two of the five directors of HMG. - Court cites GUTH V. INC. the corporate fiduciary will thereby be placed in a position adverse to his duties to the corporation. o It is a factual question not be decided by reasonable inference from objective facts. which bought and sold real estate. Fieber owned 44 . with Gray negotiating. INC. BROZ V. HMG was negotiating a major scale of HMG real estate to NAF.com o Corporate opportunity is defined broadly Includes: • Closely related to a business in which the corporation is engaged. Opportunity is within the corporation’s line of business. PriCellular was attempting to acquire CIS.
market value. a shareholder sues to vindicate the corporation’s claim. does NOT disclose his interest to HMG and votes on the sale. – (1971) Facts Eisenberg owned stock in Flying Tiger. they have the burden of establishing its entire fairness. which operated a freight and charter airline. Flying Tiger formed a wholly owned subsidiary. and any other elements that affect the instrinsic or inherent value of a company’s stock. In this case. Fieber and Gray failed to persuade the court that HMG would not have gotten a materially higher value had they disclosed Gray’s interest. in the same position as Fieber. Then Flying Tiger merged into FTL. oftentimes a shareholder is required to send a “demand” to the board. how it was initiated. - D. Gray. Fair Price • Relates to the economic and financial considerations of the proposed merger. o The suit is “derivative” because the shareholder’s right to bring it “derives” from the corporation’s right. EISENBERG V. Fieber knew of Gray’s interest but fails to disclose Gray’s interest to the other directors. INC.Downloaded From OutlineDepot. and how the approvals of the directors and the stockholders were obtained.com an interest in NAF and discloses that interest and abstains from voting on the proposed sale to NAF at the HMG directors meeting. 45 . sufficient to pass the test of careful scrutiny by the courts. called FTC and FTC formed a wholly owned subsidiary called FTL. negotiated. • Therefore. Where directors stand on both sides of a transaction. FLYING TIGER LINE. Holding Fieber and Gray breached their fiduciary duties of loyalty and care and defrauded the company. including all relevant factors: Assets. earnings future prospects. Who Sues and Who Recovers? 1. WHAT IS A DERIVATIVE SUIT AND WHY DO WE HAVE THEM? In a derivative suit. structured. o The concept of entire fairness has two components Fair Dealing • When the transaction was timed. requesting that action be taken on behalf of the company. and FTL tool over the airline. disclosed to the directors. A small shareholder should not be permitted to tie up a corporation in expensive litigation without some assurance to the corporation that it will not be out of pocket if the suit is a loser.
by an appropriate type of class suit. . o Derivative Suit: Plaintiff-Shareholder steps up to assert the corporation’s claim. In a class action. to its stockholders. Holding No. the suit is derivative.com Shareholders. HOW DOES A DERIVATIVE SUIT COMPARE TO A CLASS ACTION? Although derivative suits and class actions share some characteristics. Security for costs could not be required where a plaintiff does not challenge acts of the management on behalf of the corporation. but not FTL (which ran the business). Test o Whether the object of the lawsuit is to recover upon a chose in action belonging directly to shareholders. • Eisenberg is claiming that Flying Tiger is interfering with the plaintiff’s rights and privileges as stockholders. however. He was pissed that he was now the minority owner of a corporation that owned another corporation that ran an airline. Issue Whether Eisenberg should have been required to post security for costs as a condition to prosecuting his action. he is. 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 owe to the corporation. o Class Action: A class representative sues on behalf of a class of claimants who are similarly situated.Downloaded From OutlineDepot. Flying Tiger’s Argument Eisenberg’s case was a derivative suit and he was required to post a bond. and through it.If the injury is one to the plaintiff as a stockholder and to him individually and not to the corporation. The representative also asserts a personal claim. If the crux of the complaint is injury to the corporation. 46 . nobody is asserting a claim on behalf of the corporation. they are fundamentally different procedural devices. the suit is individual in nature. 2. Eisenberg sued. enforcing a right common to all the shareholders which runs against the corporation. - Where a shareholder sues on behalf of himself and all others similarly situated to enjoin a proposed merger or consolidation he is not enforcing a derivative right. received stock in FTC. Eisenberg’s Argument This action deprived him of any vote or influence over the affairs of the corporation that now runs the airline. Reversed.
DEMAND ON DIRECTORS - Statutes impose upon the derivative suit plaintiff a requirement that she make a written demand on the directors that they assert a claim allegedly existing in favor of the corporation. would raise questions of good faith or conceivably fraud which would never be shielded by that doctrine. Marx also appears to allege that the director defendants violated their fiduciary duties to IMB by voting for unreasonably high compensation for IBM executives. AKERS – (1996) Facts Marx alleged that during a period of declining profitability at IBM the director defendants engaged in self-dealing by awarding excessive compensation to the 15 outside directors on the 18-member board. BENNETT – (1979).Downloaded From OutlineDepot. NEW YORK LAW Facts A derivative suit was brought against 4 board members out of a 15 member board. Demand is excused because of futility when a complaint alleges with particularity that a majority of the BODs is interested in the challenged transaction. o Proof that the investigation has been so restricted in scope. MARX V. then the court will look at the substance of the decision. Holding . Holding 1.com 3. The special litigation committee dismissed the suit. it may not under the guise of consideration of such factors trespass in the domain of business judgment. 2. 47 .While the court may properly inquire as to the adequacy and appropriateness of the committee’s investigative procedures and methodologies. • If there was not a fair process. If there was a fair process then the BJR applies. 3 of the director members of the special litigation committee joined the board after the suit was brought. Issue Whether the Business Judgment Rule applies in its full vigor to shield from judicial scrutiny the decision of a 3 person minority committee of the board acting on behalf of the full board not to prosecute shareholder’s derivative action. so shallow in execution. AUERBACH V. or otherwise so halfhearted as to constitute a pretext or sham.
Corporation should have burden of proving independence. 5. DELAWARE LAW Holding . 2 Step Test applied by the court. . 6. A judge is therefore required to police the terms of the proposed settlement or dismissal to ensure they are fair to everyone before the court and those who are not present but may be affected. - A board may delegate authority from the board to disinterested persons.Downloaded From OutlineDepot. applying its own independent business judgment. etc. good faith and a reasonable investigation. 1. there may be some question as to whether one can have a derivative suit tried to a jury. rather than presuming independence.com ZAPATA CORPORATION V. o Derivative suits and class actions have more at stake. the named parties are not the only people who can be affected. 2. A board may delegate authority from the board to disinterested persons. 4. 48 . and this committee can exercise all of the authority of the board to the extent provided in the resolution of the board. whether the motion should be granted. the parties may settle at will. good faith and reasonableness. • Court has wide discretion to demand that notice be given to people affected. Court should inquire into the independence and good faith of the committee and the bases supporting its conclusion. COURT APPROVAL OF SETTLEMENT OR DISMISSAL In routine. and this committee can exercise all of the authority of the board to the extent provided in the resolution of the board. RIGHT TO JURY TRIAL Because a right to jury trial generally attaches only at law. the shareholder must either: o Make a demand on the corporation’s directors OR o Show that the demand should be excused (futility of demand).A stockholder does not necessarily have a continuing right to control litigation if the board dismisses an action. MALDONADO – (1981).The court should determine. . Court has discretion in granting the motion. non-representative litigation. DEMAND ON SHAREHOLDERS Before bringing a derivative suit.
rather than intentionally dishonest. which is triggered when the claims are made. 2. Chapter 6: How does a Business Structure as a Corporation Grow? Basic Choices for a Business to procure money: o Borrow o Sell interests in corporation 49 . Most insureds want a broad definition of the term “claim” because most D&O policies provide “claims made” coverage. • These statutes typically distinguish when the corporation is required to indemnify and when the corporation may indemnify a director. not when the alleged wrongful conduct occurred. o Under some statutes. o Defense costs are incurred by the insureds and typically indemnified by the corporation.Downloaded From OutlineDepot. RECOVERY IN DERIVATIVE SUITS Recovery in successful derivative case goes to the corporation. which then seeks reimbursement from the carrier for the amounts paid.” E. AOIs. INDEMNIFICATION Directors do NOT have a common law right to indemnification for any judgment or settlement that they have to pay or for the litigation costs they incur in connection with their corporate duties. the defendants may be able to recover their attorneys’ fees from the shareholder if the court finds that she sued “without reasonable cause. o Most courts will allow the successful shareholder to recover her costs from the losing litigant and her attorneys’ fees from the corporation. bylaws and contracts between the corporation and its directors. conduct causing economic injury.com 7. o D&O insurance typically covers “loss” arising from claims made against directors and officers for negligent. WHO REALLY PAYS? 1. o An agent has a right to be indemnified by its principal. but a director is not an agent of the corporation. The legal bases for a corporation’s indemnification of a director are found in indemnification statutes.57 authorizes a corporation to buy liability insurance for its directors and officers. INDEMNIFICATION MBCA §8.
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o Use earnings if available A. BORROWING MORE MONEY − Who is going to make the loan? − What covenants will the lender require? − Lenders reduce risk by requiring financial and operational commitments from the borrower until loan is paid. − How is the corporation going to service the debt (i.e. Pay the monthly interest and then repay the loan? − What happens if the corporation defaults? − Lenders oftentimes require personal guarantees. B. Issuing More Stock 1. To whom? a. Preemptive Rights and other Rights of Existing Shareholders
Existing shareholders can be protected from dilution of their percentage of shares with “preemptive rights.” − Preemptive Rights: A shareholder with preemptive rights has the right to purchase that number of shares of any new issuance of shares that will enable the shareholder to maintain her percentage ownership. − MBCA § 6.30 − Do NOT provide for automatic preemptive rights. They must be in the AOIs. − Preemptive rights only apply to transactions involving CASH.
BYELICK V. VIVADELLI– (1999) Facts Byelick owned 10% of VTIC. The Vivadellis owned the remaining 90%. In 1996, the Vivadellis eliminated the shareholders' preemptive rights which were provided for in the bylaws. VTIC's director’s then issued 50K additional shares to Vivadelli. This reduced Byelick's ownership interest in the company from 10% to 1%. Byelick alleged that the issuance constituted a breach of fiduciary duty. Vivadellis' Claim Say that Byelick's breach of fiduciary duty claim as an attempt to gain preemptive rights, which were lawfully eliminated by a properly conducted board meeting. Procedural History Trial court denied summary judgment motion. Issue
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Was denial of summary judgment proper when Byelick alleged a breach of a fiduciary duty when the Vivadellis eliminated Byelick's preemptive rights, issued 50K extra stocks for themselves thereby diminishing his ownership percentage? Holding Issue should be decided at trial. 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. - A lawful amendment of a corporation's AOIs to eliminate preemptive rights requires: − No violation of fiduciary duties is involved − Procedures required to effectuate such amendment are allowed.
Even where preemptive rights are not provided to shareholders in the AOIs or the by-laws, a director’s fiduciary duty nonetheless constrains the issuance of shares. − Issuance of shares at favorable prices to directors or the issuance of shares on a nonproportional basis for the purpose of affecting control rather than raising capital may violate that duty.
b. Selling to Venture Capitalists What and Why is Venture Capital?
Venture capital is a substantial equity investment in a non-public enterprise that does not involve active control of the firm. − Most often associated with high-tech companies. Most companies that seek venture capital are unstable and risky. − 1/3 of venture capital-financed companies wind up in bankruptcy. − Venture capitalists demand high returns because the successful 1/3 must cover the losses generated by the other 2/3, as well as the high transactions costs that venture capitalists pay in seeking, monitoring, and evaluating their investments. Venture Capitalists usually obtain a significant voice in the control of the firm.
Venture Capitalists: A shareholder, but a shareholder with special rights including: 1. Downside protection: requires the venture capitalists to be paid first the company's assets are sold off. 2. Upside Opportunities: Right to acquire additional stock at a predetermined price 3. Voting and Veto Rights 4. Exit Opportunities: Right to sell the shares back to the corporation. c. Selling to a Person or to the Public
A corporation can sell stock to a few people or to thousands. − If a corporation goes “public” there are rigorous registration requirements that federal and state laws impose on some stock sales.
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2. What are the Legal Constraints on How a Corporation Issues its Stock? a. Registration Requirement for Public Offerings. (i) Some of what your clients might have learned about securities registration in business school. Why Go Public − Raise money − Public markets are viewed as the largest and least expensive source of capital. How much $$ to Raise − Most companies tend to use a public offering to raise enough money to meet anticipated needs for at least 2 years. How many additional shares to sell? − Company will first calculate what it is currently worth: − Price/share [x] # of shares outstanding. − The price/share is a reflection of the voting that takes place every day in the stock market on these relative values. − The number of shares sold must equal the number bought.
Companies that have not started yet: − To calculate current value: − Look at comparables that are publicly traded and determine the market value of these enterprises. − Ex: If several fast food chains sell for about 20 times the past year's earnings, then Bubba's Burritos should be worth about 20 times its expected future earnings. − If Bubba's Burrito's expects to earn 10 million, then it should be valued at 200 million. − Once the company has estimated what its entire business is worth, it will then divide that sum by the number of shares outstanding. − This results in the value per share.
How does a Corporation make a Public Offering? − A public offering is about a registration process filed with the SEC and the marketing of the stock by an underwriter. − An underwriter manages the process of drawing up the offering memorandum that is filed with the SEC. − It is responsible for advice on structuring the offering, pricing the securities, and maintaining a market for the securities after the offering. Where does the money come from? − Underwriting activities are conducted on either a “firm commitment” or a “best efforts” basis.
not the underwriter.Downloaded From OutlineDepot. Close Corporation: A business entity typified by 1) a small number of stockholders. − They involve the 1933 Securities Act and the 1934 Securities Exchange Act. − Most underwriters work on a best efforts basis. − Underwriter bears the risk that the shares cannot be resold at the offering price. − 34 Act: Provides information to the markets for new securities and resales by requiring many corporations continually to provide detailed public reports about their operations. . − Federal securities law is a product of the 1929 Market crash and the New Deal of the 1930s. Best Efforts: Money comes from the public. 53 .” Both legislative and judicial efforts have been made to ease the plight of the “oppressed” close corporation shareholder. − Underwriter then resells the shares to other investment bankers and the public. less a negotiated discount. − The corporation bears the risk that shares cannot be sold at the offering price. − Requires a company issuing securities will first file a detailed and extensive “registration statement” with the SEC and will provide a copy of the main part of that registration statement (“the prospectus” to all people to whom the securities are offered. − This can be reduced somewhat by ensuring that the offering price is not set until very late in the offering process. o Many state legislatures have amended their dissolution statutes to include “oppression” by the controlling shareholder as a ground for involuntary dissolution of the corporation. − 33 Act: Governs the issuance of securities by the corporation itself. as well as a return on the money paid for their shares. 2) the absence of a market for the corporation’s stock.Close corporation shareholders “usually expect employment and a meaningful role in management.com − Firm Commitment: Underwriter buys all of the shares in the public offering from the issuing company at the public offering price. − (ii) Some of what you can learn about securities regulations from the SEC website. and 3) substantial shareholder participation in the management of the corporation. Some courts have imposed an enhanced fiduciary duty between close corporation shareholders and have allowed an oppressed shareholder to bring a direct cause of action for breach of duty. Rather than buying the stock itself and then reselling it. the underwriter instead uses its best efforts to help the issuer to find buyers for the stock. Chapter 7: How do the Owners of a Corporation Make Money? An owner of a business makes money either because she receives all or part of the money that a business earns or because she sells her ownership interest.
whether the district court erred in granting a retroactive buyout remedy? Holding Yes. which marketed first lien mortgage notes and other nonsecurity financial products. Both were 50% owners of FFUSA. placed it into a sole proprietorship without first consulting Hollis. they nevertheless held that certain actions by a director. o Court concedes that many of the actions by Hill fall within the business judgment rule. Issue Was a duty of loyalty breached by Hill and. a fiduciary relationship was created not unlike that in a partnership. Hollis filed suit. with Hill as president and Hollis as VP. The Court ordered Hill to buyout Hollis for nearly 800K.With only 2 shareholders and management responsibilities divided between them. RECEIVING SALARIES FROM THE CORPORATION MBCA §8. however. applying Nevada law. Who Decides Which Shareholders Get Salaries? HOLLIS V.Downloaded From OutlineDepot. receive much different treatment when the corporation only has a few shareholders. Hill told Hollis that his position commanded no salary. Hill stopped sending FFUSA financial reports to Hollis. . concluded that Hill’s conduct was oppressive and ordered him to buy Hollis’ shares in FFUSA. Eventually. if so. Procedural History District court. Hill took FFUSA annuity business and without Hollis’ knowledge. Hill stopped paying Hollis’ salary and rejected all of Hollis’ proposals to resolve the dispute.” 1. to which Hollis demanded his right to inspect the reports.com A. and holds that the duty existing between controlling and minority shareholders in close corporations is the same as the duty existing between partners. A fiduciary duty existed between Hollis and Hill.01: Generally authorizes the board of directors to manage “the business and affairs of the corporation. They came to a temporary agreement. but problems resurfaced. . Close corporations present unique opportunities for abuse because the expectations of shareholders in closely held corporations are usually different from those of shareholders in public corporations. 54 . alleging shareholder oppression. including that director.Court applies Massachusetts law. HILL – (2000) Facts Hollis and Hill jointly founded FFUSA. During the dispute.
was the order of dissolution and liquidation of the corporate assets and business proper? Holding Yes. What are the Legal Limitations on Salaries? EXACTO SPRING CORP. Including other aspects. Hamway also charged that Libbie refused to declare dividends on Libbie common stock which should have been declared. COMMISSIONER OF INTERNAL REVENUE – (1999) . 2.67 in compensation.” 55 . GIANNOTTI V. the board received $2. alleging that Libbie’s board members were authorizing and making payments from corporate funds to themselves for directors’ fees and officers’ salaries “grossly in excess of the value of the services they have rendered to Libbie. the greater the salary he can command.Downloaded From OutlineDepot. . Procedural History Chancellor found in favor of the plaintiffs and ordered the dissolution of the corporation. o Indirect Market Test The owner pays the manager a salary and in exchange the manager works to increase the value of the assets that have been entrusted to his management • The higher the rate of return that a manager can generate.” In facts in 1985. HAMWAY – (1990) Facts Hamway and others filed a complaint against Libbie. o Does not necessarily mean fraudulent conduct and is not synonymous with the statutory terms “illegal” or “fraudulent. for every dollar of profit earned. the ratio of compensation to profits was 4 to 1.com o A controlling shareholder cannot effectively deprive a minority shareholder of his interest as a shareholder by terminating the latter’s employment or salary has been widely accepted.Oppressive means conduct by corporate managers toward stockholders which departs from the standards of fair dealing and violates the principles of fair play on which persons who entrust their funds to a corporation are entitled to rely.” and if so. Hamway asked the court to order the liquidation of the assets and business of Libbie. V. Issue Was the BOD’s actions “oppressive.Courts are not the proper authority to determine appropriate salaries for corporate officers.
What is a Dividend? Dividend: A special type of distribution. - ZIDELL V.Most corporations do not pay dividends. o The court applied various factors in its analysis: Time spent working Responsibilities Qualifications Knowledge Outside interests Who is actually running the operation Because the trial court’s finding of oppression in this case is not plainly wrong or without evidence to support it. RECEIVING DIVIDENDS FROM THE CORPORATION 1. Capital Surplus: When a corporation issues par stock. where the directors elect themselves as officers and set their own salaries. o Assets > Liabilities Traditional Approach: A > L + Earned Surplus o The distribution may come from different funds or accounts. May not use this to make distributions. o This includes closely held corporations - Under the MBCA §6. ZIDELL – (1977) 56 . the court notes that it is hesitant to question the reasonableness of a corporate officer’s compensation when it is set by a disinterested board. it is impossible to have a “disinterested board.” Court analyzed the status of the BOD’s employment and determined they were part-time employees with little knowledge of the industry. • Consists of all earnings minus all losses minus distributions previously paid. a payment to shareholders by the corporation out of its current or retained earnings in proportion to the number of shares owned by the shareholder. o However. the court refused to say that the trial court abused its discretion in decreeing dissolution.Downloaded From OutlineDepot.40(c).com - Further. Earned Surplus or Retained Earnings: Value generated by the business itself. - - B. o Stated Capital: The amount of money accumulated as a result of establishing a par value for stock. a distribution is proper so long as the corporation is not insolvent and as long as the distribution does not render the corporation insolvent. . the surplus over the par value may be used to make distributions.
Procedural History Trial court declined to rule that defendants acted in bad faith but held that larger dividends should have been declared in order to allow Zidell a reasonable return. Factors showing bad faith • Intense Hostility • Exclusion of Minority from Employment • High salaries. however. and the board declined. Zidell resigned. The court then ordered a much larger dividend than that set by the board. Zidell wanted a pay raise. that duty is discharged if the decision is made in good faith and reflects legitimate business purposes rather than the private interests of those in control. SINCLAIR OIL CORPORATION V. alleging that they were paying out too much in dividends (nearly 38. The other 5/8 was owned by Zidell’s brother and his brother’s son. the customary practice had been to retain all earnings in the business rather than to pay dividends and Zidell agreed while he worked there. its relationship with Sinven must meet the test of intrinsic fairness.000. Arnold contended that these dividends were unreasonably small and not set in good faith.000 in excess of its profits). Levien sued Sinclair. A dividend was declared and paid on the 1973 earnings of each corporation. LEVIEN – (1971) Facts Sinclair (parent corp. o Insofar as dividend policy is concerned. or bonuses or corporate loans made to the officers in control • The fact that the majority group may be subject to high personal income taxes if a dividend is paid • Existence of a desire by the controlling directors to acquire the minority stock interests as cheaply as possible. In 1973. Prior to his resignation. Holding . However. who were not independent of Sinclair. Sinclair nominated all members of Sinven’s BOD. Procedural History Chancellor held that because of Sinclair’s fiduciary duty and its control over Sinven.Downloaded From OutlineDepot. Levien attacks these dividends on the ground that they resulted from an improper motive – Sinclair’s need for cash.com Facts Zidell owned 3/8 of issued and outstanding stock of 4 affiliated different corporations that bought and sold scrap metal.) owned about 97% of Sinven’s (a subsidiary of Sinclair) stock and Levien was a minority shareholder.Those in control of corporate affairs have fiduciary duties of good faith and fair dealing toward the minority shareholders. he demanded a dividend be paid. once Zidell quit. 57 .
To Whom are Dividends Paid: Preferred. Participating.Under this standard.Court does not believe that the Intrinsic Fairness Test (IFT) must be applied to a dividend declaration by a dominated board. but also gets paid again. the burden is on Sinclair to prove. 2. o Ex: If there is a case of self-dealing. . it will likely apply. Cumulative? Although all shares in a particular class must have identical rights. subject to careful judicial scrutiny.” than another. o Preferred means “pay first. Cumulative Preferred Stock NEED IN-BETWEEN NOTES What are the Legal Duties Applicable to Buying or Selling Stock? 58 . that its transactions with Sinven were objectively fair.” Preferred Participating Stock: Stock that not only gets paid first.com Intrinsic Fairness Test .Downloaded From OutlineDepot. These shares get paid pursuant to its preferred stock status and get paid again with the funds that will also be paid to the common stock holders.” Common Stock: Class without such a preference is generally referred to as “common. If a plaintiff can meet his burden of proving that a dividend cannot be grounded on any reasonable business objective. The BJR should have applied. one class can have greater rights. o 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. Sinclair’s Argument The transactions between it and Sinven should be tested by the Business Judgment Rule. Preferred Stock: Class of stock with a preference is generally referred to as “preferred” o A typical preference for a class of stock is priority in the receipt of dividends. but at times it may apply. or “preferences. Issue Did the Chancellor err when holding that Sinclair must satisfy judicial scrutiny pursuant to the Intrinsic Fairness Doctrine? Holding Yes. then the courts can and will interfere with the board’s decision to pay the dividend.
SEC’s argument When tipees come into possession of material ‘corporate information that they know is confidential and know or should know came from a corporate insider.” There must be an inherent unfairness involved where one takes advantage of information intended to be available only for a corporate purpose and not for the personal benefit to anyone.Two elements for establishing a Rule 10b-5 violation: o Existence of a relationship affording access to inside information intended to be available only for a corporate purpose o Unfairness of allowing a corporate insider to take advantage of that information by trading without disclosure.CHIARELLA COURT o Anyone who regularly receives material nonpublic information may not use that information to trade in securities without incurring an affirmative duty to disclose. Issue Did Dirks violate the antifraud provisions of the federal securities laws by disclosing the nonpublic material information? Holding No. He openly discussed the information he had obtained with a number of clients and investors. Buying or Selling with Inside Information DIRKS V.com A. Some of these persons sold their holdings of Equity Funding securities. . o There must also be “manipulation or deception. Court reiterates the CADY/ROBERTS standard announced in CHIARELLA: . but only from the existence of a fiduciary relationship. 59 . Court then addressed when a person may inherit a fiduciary duty: .Court goes on to hold that a fiduciary duty attaches only when a party has legal obligations other than a mere duty to comply with the general antifraud proscriptions in the federal securities laws.” . SEC – (1983) Facts Dirks received material nonpublic information from “insiders” of a corporation with which he had no connection. or 3) was not a person in whom the sellers had placed their trust and confidence.A duty to disclose under §10(b) does not arise from the mere possession of nonpublic market information. .Downloaded From OutlineDepot.’ they must either publicly disclose that information or refrain from trading. 2) was not a fiduciary.There can be no duty to disclose where the person who has traded on inside information was not 1) the corporation’s agent. • 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.
Although O’Hagen was not working on this transaction. CLASSICAL AND MISAPPROPRIATION THEORIES APPLY Facts O’Hagen was a partner in a law firm. ***Remember the elements for a tippee are derivative. o A tippee assumes a fiduciary duty to the shareholders only when 1) the insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and 2) the tippee knows or should know that there has been a breach. O’HAGAN – (1997). He was indicted on federal charges. Procedural History O’Hagen was convicted and the 8th Circuit reversed.Downloaded From OutlineDepot. Issue Should O’Hagen be convicted under Rule 10b-5? Holding Yes.Classical Theory 60 . and O’Hagen sold the stock for a profit of $4. • Some tippees must assume fiduciary duties because the information given to them has been provided improperly. About 2 months before the offer was announced O’Hagen bought Pillsbury stock and options to acquire Pillsbury stock.com o A duty to disclose arise from the relationship between parties and not merely from one’s ability to acquire information because of his position in the market. There is no tippee without a tipper who violated a fiduciary duty to the source. Court discusses the “Classical” Theory and adopts a second “misappropriation theory” of Rule 10b-5. 1988. . The law firm represented Grand Met to help them tender an offer to acquire Pillsbury. This should not be interpreted to mean that tippees always are free to trade on the information.3 million. The offer was announced on October 4. The stock rose in price after the sale. ANALYSIS DIRKS RULE: a tippee can be liable but must be derivative from tipper: 1) Tipper liability exists when: a) insider (tipper) breached a fiduciary duty AND b) tippee knew or should have known that breach occurred AND c) Insider (tipper) received some personal benefit (not necessarily financial) 2) Classical theory also applies to others who become temporary fiduciaries of corporation UNITED STATES V. he learned of it.
o Holds that a person commits fraud in connection with a securities transaction. • A fiduciary who feigns loyalty to the principal while secretly converting the principal’s information for personal gain. Now R buys an additional 5% of A’s stock. EMERSON ELECTRIC CO. because he was about 10% when he made this purchase. o §16(b) says that a corporation may recover the profits realized by an owner of more than 10% of its shares from a purchase and sale of its stock within any 6 month period. That purchase is not covered under §16(b). defrauds the principal of the exclusive use of that information.Downloaded From OutlineDepot.RULE 10b-5 can be based on misappropriation of confidential information o Supreme Court adopts misappropriation theory 2 forms of misappropriation theory: • Rule 10b-5: deceptive conduct in connection w/ a securities transaction • knows or has reason to know RELIANCE ELECTRIC CO. provided the owner held more than 10% both at the time of purchase and sale. That sale is covered because he was above 10% when he made the sale.This case discusses Section 16(b) of the Securities Exchange Act of 1934. and thereby violates §10(b) and Rule 10b-5. – 1972 . his ownership was zero. o §16(b) applies only to large corporations – those required to register under §12 of the ’34 Act. in breach of a duty owed to the source of the information. . Misappropriation Theory o Purpose: 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. He then purchases 15% of A’s stock. using confidential information misappropriated in breach of a fiduciary duty to source of information is guilty of violating rule 10b-5. nonpublic information. Now R sells all 20% of A’s stock. That purchase is covered. A fiduciary’s undisclosed self-serving use of a principal’s information to purchase or sell securities. when he misappropriates confidential information for securities trading purposes. 61 . but who owe no fiduciary or other duty to that corporation’s shareholders. in breach of a duty of loyalty and confidentiality.Ex: R owns no stock in A. V. because immediately before the purchase. ANALYSIS RULE: A person who trades in securities for personal profit. . defrauds the principal.com - o Rule 10b-5 is violated when a corporate insider trades in the securities of his corporation on the basis of material.
A reasonable and adequate investigation of the buyer is necessary. - Common Law Duty of Selling Shareholder DEBAUN V.’s past record.Downloaded From OutlineDepot. asserting their right to recover for damage caused by First Western. Two minority stockholders sued First Western. First Western had knowledge that Mattison had judgments against him for a lot of money.” o That duty of good faith and fairness encompasses an obligation of the controlling shareholder in possession of facts 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. FIRST WESTERN BANK & TRUST CO. First Western owed a duty to the corporation and its minority shareholders to act reasonably with respect to its dealings in the controlling shares with Mattison. – (1975) Facts Mattison ran a color photography business into the ground after acquiring the majority of shares from First Western Bank (who acquired them as executor of the majority stockholder’s estate.In any transaction where the control of the corporation is material. .). he would be covered by the statute.). regardless of how much Bubba’s stock he owned. but did not pursue an investigation into the public records where a mass of derogatory information lay.com - If the person is an officer or director when he bought or sold.’s Assets at time of breach + Goodwill factor (computed on basis of future net income reasonably to be anticipated from Corp. Issue May a majority stockholder be held liable to minority stockholders when selling the majority of stock in a company without reasonable investigation? Holding Yes. PERLMAN V. Measure of Damages o Value of Corporation as a going concern at the time of breach = Corp. FELDMANN – (1954) 62 . §16(b) ONLY APPLIES WHEN THERE IS A PROFIT FROM PURCHASES OR SALES MADE WITHIN 6 MONTHS OF EACH OTHER. the controlling majority shareholder must exercise good faith and fairness “from the viewpoint of the corporation and those interested therein.
a power held in trust for the corporation by Feldmann as its fiduciary.Downloaded From OutlineDepot. was entitled to deal according to his own best interests. he should account for his gains. interested in securing a source of supply in a market becoming tight due to the Korean War. RODD ELECTROTYPE COMPANY OF NEW ENGLAND. o The same rule should apply to his fiduciary duties as majority stockholder. o When the sale necessarily results in a sacrifice of this element of corporate good will and consequent unusual profit to the fiduciary who has cause the sacrifice. as a majority stockholder. Rodd’s shares without first offering to purchase hers. She sued to rescind Rodd’s purchase of Mr. INC. 63 . which in the absence of fraud or foreseeable looting. He sold all his shares to Wilport. – (1975) Facts Donahue. pay the profit received from his sale of shares to the minority stockholders? Holding . for in that capacity he chooses and controls the directors. and thus is held to have assumed their liability.Both as director and as dominant stockholder.com Facts Feldmann was the dominant stockholder of a corporation which operated mills for steel sheet production. Thus. . • 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. end-users of steel. Fiduciaries always have the burden of proof in establishing the fairness of their dealings with trust property. Procedural History Court below held that the rights involved in the sale were only those normally incident to the possession of a controlling block of shares. Rodd’s shares. To Whom May a Shareholder Sell Her Shares? DONAHUE V.The corporate opportunities of whose misappropriation the minority stockholders complain need not have been an absolute certainty in order to support this action against Feldmann. Feldmann must account to the non-participating minority stockholders for that share of their profit which is attributable to the sale of the corporate power. a person stands in a fiduciary relationship to the corporation and to the minority stockholders as beneficiaries. Plaintiff’s Claim The consideration paid for the stock included compensation for the sale of a corporate asset. Issue Must Felmann. a minority stockholder in a close corporation. was angry that Rodd had purchased Mr.
The controlling group may not. o Just as in a partnership. o In this case. Holding .The close corporation bears striking resemblance to a partnership. Jordan resigned and Hansen did not volunteer any information about an upcoming merger. the relationship among the stockholders must be one of trust. 1983. confidence and absolute loyalty if the enterprise is to succeed. he was obligated to resell his shares back at book value to the corporation upon his leaving the company. Under his employment agreement.Close corporations buying their own stock.Downloaded From OutlineDepot. he lost out on about 430K because shortly after his resignation D&P announced a merger. JORDAN V. – (1987) Facts D&P was a closely held corporation where Jordan had acquired 188 shares of the company’s outstanding stock. like knowledgeable insiders of closely held firms buying from outsiders.. was the information material? Holding . whether or not Jordan was defrauded is a question for the jury. Issue Was B&P’s failure to disclose the merger to Jordan required. INC. Plaintiff asserted that West had a duty to disclose to him. have a fiduciary duty to disclose material facts. – (2000) Facts Plaintiff former employee alleged breach of fiduciary duty. As a result. DUFF & PHELPS. consistent with its strict duty to the minority. 64 . WEST PUBLISHING CO. the corporation cannot discriminate among shareholders when repurchasing shares. Stat. He resigned on November 16. and fraud. utilize its control of the corporation to obtain special advantages and disproportionate benefit from its share ownership. and if so. unfairly prejudicial conduct in violation of a Minn. BERREMAN V.com Plaintiff’s Claim Donahue urged that the distribution constituted a breach of fiduciary duty owed by the Rodds to her because the Rodds failed to accord her an equal opportunity to sell her shares to the corporation. 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. o In a close corporation. • Stockholders in close corporations must discharge their management and stockholder responsibilities in conformity with this strict good faith standard.
West merged with (Thomson) ended up paying much more for stocks than Berreman received when he retired. and if so. 65 . Probability: Measured by evaluating the indicia of interest in the transaction at the highest corporate levels Magnitude: Should be assessed by considering such facts as the size of the two corporate entities and of the potential premiums over market value. although they were not sure b/c West had far more shareholders than typical close corporations.Information is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. the court assumed for purposes of the case West was a close-corporation. The court then held preliminary discussions about merger are not material. that West directors had begun to consider the sale of the company.com before he retired and sold his stock back to the company. . did they violate a fiduciary duty to Berreman by a failure to disclose the fact that they were considering selling? Holding In this case. Issue Was the failure to disclose discussions among West’s own officers about the future of West. - Court then discussed the Probability-Magnitude Test: o Materiality will depend at any 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.Downloaded From OutlineDepot.
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