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Business Organizations

Spring 2014

I. Overview
a. Main Questions re: Law
i. When/why does the law recognize a business as a distinct entity?
ii. What are the different legal forms for businesses?
iii. How does the law influence the different structures/operations?
iv. What rights/duties does the law impose on businesses/business owners?
b. Main Questions re: Other
i. What are a business goals?
1. Primary Goal: to maximize utility ($, personal satisfaction, helping others, etc.)
a. Maximize utility for the owners
b. Why not max social utility? would make disincentive for creation of business
2. Why does society care about businesses?
a. Organize labor and capital efficiently
i. Produce goods and services that benefit society
b. Create uniformity in the market allows for complex commercial transactions
to occur
3. Limitation of liability, tax structure
ii. How do they obtain capital?
iii. What are the different ways business/owners make money and how is it distributed?
iv. What financial tools do businesses use to help them meet their goals?
v. What do lawyers have to do with all this?
c. Main Goals of Biz Orgs
i. Maximize social utility by promoting the creation and operation of businesses (bc businesses
benefit society)
ii. Provide rules that will resolve disputes that arise w/in businesses and btw businesses and third
parties in a societally-optimal manner
d. How does the law incentivize the creation of businesses?
i. Protect owners from certain types of liability
ii. Define legal relationships to help individuals feel secure enough to interact w/ businesses
e. Conflicts
i. Owners v. Agents/Management (A.P. Smith case, CEO v. Shareholders)
ii. Owners v. Owners (Majority Owners v. Minority Owners)
iii. Business v. Stakeholders a.k.a. any person or business that is influenced by the business (BP v.
Gulf of Mexico residents, employees, etc.)

II. What Do Businesses Do?
a. A.P. Smith Mfg. Co. v. Barlow (SC NJ 1953)
i. Facts: President OBrien recommends to Board of Directors of AP Smith to give $1,500 to
Princeton stockholders disagreed and said it the contribution wasnt authorized
1. Shareholders want declaratory judgment to declare the donation invalid and rescind it
a. All the excess money of a corp belongs to the shareholders they dont want the
Board of Dir to give away their $!
ii. Court: Contribution was valid (intra vires)
1. Historically, under common law, such contribution allowed if benefits the corp
2. In 1930, a statute was passed (after incorporation, pre donation) that allowed any corp to
provide philanthropic funds to institutions
a. Board of Directors/CEOs have wide discretion when managing the company
i. Want to be in a state where there is no liability for the charitable
b. The state has the power to pass laws that modify every corps articles of incorp.
EXAM based on answers to the problems
Closed book/note
IL and Delaware follow RUPA (UPA 1997) they are default rules that
apply to partnership unless the agreement says otherwise

c. This is in the favor of public policy
b. Notes
i. Who owns AP Smith? The shareholders. They are suing the company itself.
ii. A business is a separate entity
iii. Real persons are agents of the corporation
iv. A business with more than one owner that is a corporation can distribute and use its funds in
ways that are opposed by at least some owners
v. Ultra vires acts of a person/corp deemed outside the authority
vi. I ntra vires acts of a person/corp deemed inside the authority
vii. Problem of Close Corporations
1. A corp makes a transaction that a shareholder dislikes. If its a publicly traded company,
a disgruntled shareholder can sell his shares
a. But if this isnt an option, what else is there? (not many options)
b. Derivative action not generally an option for charitable donations
c. Get a place on the Board or get other stockholders to threaten the Board

III. ACCOUNTING Financial Statements
i. Income Statement computes the profit of a business for the period in question (usually 1 year)
1. Profit before taxes = Revenue Costs
2. What happens when you obtain an asset to be used for longer than 1 year?
a. Charge the full cost to the term that asset was required OR
b. Divide the cost across the # of terms the asset will be used
i. Depreciation when equipment gets less valuable each year, part of it is being
used up
3. Net Income = PBT Taxes
4. Looking @ two most recent income statements Can find out what the company did, where it
spent money, how it changes over time, etc.
a. Cant see actual cash earned or spent depreciation
ii. Cash Flow Statement measure of how much more or less cash a business has at the end of the year than
it had at the beginning of that year
1. Net income
2. + Depreciation (spreads a one-time cash cost over a period of time distorts the picture of what
the companys cash reserves were at a period in time)
3. Amounts actually spent during that period (Investments)
a. Investment money spent to purchase equipment
i. When business buy something to use for more than one year this is an
investment and only depreciation appears on income statement
ii. If business buy something to use up in one year this is an expense and the total
amount appears on the income statement
4. Cannot tell how much $ the company has doesnt include starting or ending amount (but usually
that is included on the CF statement)
iii. Balance Sheet snapshot, sets forth the current book value of a company
1. Categories
a. Assets things that the company owns that has value (aka stuff, ie. accounts receivable,
cash, land)
b. Liabilities what the company owes (ie. accounts payable, wages owed to employees,
c. Equity what is left over after you subtract liabilities from assets
2. Assets = Liabilities + Equity
3. 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
iv. Why keep these statements?
1. Auditors
2. Manage funds efficiently
3. Inform investors
v. Keep in mind:
1. Problem: if a company takes out a loan thats more than equity
2. Relying on book value alone is a bad idea because:
a. You dont know the full value of whats depreciated,
b. Some of the values might be off (they are estimated conservatively, not very precisely)
c. No cash flow or profit numbers
d. Need to know what the market is like
3. Hypo a company makes $5K in net revenue per year. Should it be bought for $100K? $50K?
a. Need to know the market will revenue go up or down?
b. What else can you invest in? Opportunity costs what is riskier? Making an investment or
fully buying the company?
b. Accounting Fraud
i. Main feature: false financial statements
1. Off-balance-sheet moving liabilities off the balance sheet
ii. Sarbanes-Oxley Act attempts to clarify responsibilities of auditors, company management, boards/audit
1. Section 404 company must evaluate its own internal controls and must do so w/ procedure that
evaluate the design of those controls and test their operating effectiveness
a. Auditors then audit managements assessment and opine on the state of internal controls of
the company

IV. Legal Structures for Businesses
Main Questions
-Who owns this business?
-Who manages this business?
-Who gets the profits?
-Who is liable for business liabilities?
-How are business proceeds taxed?
i. Sole Proprietorship a person undertakes a business w/o any formalities associated with other forms of
organization; the individual and the business are one and the same for tax and liability purposes
ii. Corporation a tax paying entity
1. Income is taxed twice: (1) corporation pays tax on income; (2) owners of corp pay tax on that part
of corps earnings that is distributed to them as dividends
iii. General Partnership like a SP for tax/liability, earnings are distributed according to the partnership
agreement, taxes paid only at the personal level on the partners share of that income
1. Partners are jointly and severally liable
iv. Limited Partnership like a SP for tax/liability
1. General partner assumes the management responsibility and unlimited liability // the limited
partner has little voice and is not individually liable for companys debts (acts like a shareholder)
v. Limited Liability Company (LLC) developed to provide protection from liability of a corp and the
protection from double taxation of a partnership
1. Owners of LLC not individually liable for companys debts
2. LLC is not a tax-paying entity income taxes only paid once by owners of LLC when part of the
companys earnings is distributed to them

V. Sole Proprietorship
a. Sole Proprietorship a person undertakes a business w/o any formalities associated with other forms of
organization; the individual and the business are one and the same for tax and liability purposes
i. Only one owner he manages, makes profits, is liable, pays taxes
b. Agency (RST 2d 1)
i. P manifests consent to have A act on his behalf and under his control A consents
ii. (1) Fiduciary relation + (2) manifestation of consent by one person (principal) to another
(agent) that the other (agent) shall act on his (principals) behalf and subject to his (principals)
control + (3) consent by the other (agent) to so act.
1. Fiduciary duty to act with the highest degree of honesty/loyalty toward another person
and in that persons best interest
2. Examples of Agency employer/employee
3. Concerns
a. When is a business/owner liable for the actions of its agent/employee?
i. Types of Liabilities
1. Contractual
2. Tortious
ii. Why have liability?
1. You will trust a company more knowing it is willing to take the
blame for errors of the agent people wouldnt want to deal
with agents if liability didnt trace back
2. Dont want third-party to be undercompensated
3. Dont want to hold the agent liable if they were a puppet
4. Companies wont hire risky people; put employees in risky
situations, etc. more cautious
c. Contractual Liability
i. P will be liable for CLs created by A, when A had one of three things:
1. Actual Authority
2. Apparent Authority
3. Inherent Agency Power

ii. Authority
1. Actual Authority manifestations from P to A that A reasonably believes create
a. P simply tells A that A is empowered to act on Ps behalf in accomplishing
some task
i. P takes an action towards A and A reasonably believes he has authority
through this action
1. Example: John, please go buy me green shoes.
a. John is the A, you are the P
b. Actual Express v. Actual Implied
i. Actual Implied A has the authority to do what is reasonably necessary
to get the job done, even if P did not spell it out in detail, includes
authority to do acts which are incidental to it, usually accompany it, or
are reasonably necessary to accomplish it
1. Example: John set up a dinner party
a. John, A, has implied actual authority to call dinner
c. *Liability limited to actions within the scope of authority granted*
2. Apparent Authority P does not really authorize A to act on his behalf / Apparent
Authority is created by manifestations by P to a third party (TP)
a. Manifestation must be (1) attributable to P (2) must get to TP (3) must lead TP
reasonably to conclude that A is an agent for P
b. P has liability regardless of whether he actually authorized A
c. Example: I tell A, you dont have authority to buy cheeseburgers, but yesterday
I told cheeseburger guy that A does have the authority. I will be liable if A goes
and buys cheeseburgers
i. P must be held to this contract so as not to blame TP for the secret
convo btw P and A
ii. P can avoid liability by not saying such things to TPs
3. Inherent Agency Power power of A to bind P to deals with TP
a. P has created an agency relationship with A
i. (ie. a chef in a restaurant has the authority to do XYZ, P is liable for
chefs XYZ actions)
ii. Protect the TP who doesnt know better
b. Subset of Apparent Authority e.g. 1) name a CEO, 2) TP knows a CEO, 3)
CEO(A) does something
4. PROBLEMS pg. 36
a. Yes, Actual Authority (P told A that its part of her job to buy food)
i. Propp is legally obligated to pay for the food.
ii. Agee is his agent and is not obligated to pay for the food.
1. Where a Principal is KNOWN then the Agent is not a party to K
b. Yes, Apparent Authority (A had bought food in the past from TP so TP thinks
this is ok)
i. Propp is legally obligated to pay for the food
1. A is not a party to the K!
ii. A is liable to P for violating fiduciary duty
c. No authority at all.
i. Cooks normally do not have this authority.
1. A did not enter into a K not contractually liable
2. A has tortious liability to newspaper for fraud/misrep
ii. Can an agent create his own authority? (ie. cook told newspaper she was
the owner)
1. NO, there is no Principal not fair to hold P liable to something
it didnt do and had no idea of
d. Tort Liability
i. Agency Relationships
1. Master-Servant Relationship tort liability
a. P has complete or near complete control over As actions R. 2d 220
b. P only liable for actions taken by A that are within the scope of As employment
2. Non-M/S someone hired to do a job, but not told specifically how to do it i.e.
Independent Contractor, Auditor parts of the task cannot be controlled by the P no
tort liability, only contractual, see above
ii. Respondeat Superior
1. Vicarious liability Ps liability is vicarious and does not depend on Ps being negligent,
P must control the details of how a job is to be done, tort must be committed w/in the
scope of employment
a. Frolic not w/in scope = No liability for P
b. Detour still w/in scope during the course of completing his duties = liability
for B
2. PROBLEMS pg. 39
a. Servantes is a servant
b. CEO of GM is a servant b/c the master is the Board of Dir Pilot is servant
(although a bit more unclear b/c specialized training but the airline can tell them
what to do Accountant not a servant
i. If your accountant burns someone while doing your taxes, you are not
liable b/c he is not your servant (you arent exercising control, you dont
know how to do your taxes)
c. P liable for S burning P specifically tells S that his job description doesnt
include burning customers P is still liable, its still within the scope of
employment, you cant cut stuff out to free yourself from liability
i. S is liable for his own tort everyone always liable for own negligence
d. S injures a pedestrian otw to work, is P liable?
i. No, this is outside the scope, even if part of your job is to commute
ii. S is liable for his own tort
e. P hires A as cook, but then A hits a customer on the head (S not liable)
i. A is liable for her tort
ii. P is not liable for As tort b/c its outside the scope of employment
f. Can P eliminate need to hire attorney simply by purchasing insurance?
i. No insurance doesnt solve problems like these
iii. Attorney-Client
1. Hayes v. National Service Industries, Inc. (CtofApp 11th Cir 1999)
a. Facts: Robin Hayes attorney entered a settlement agreement with APs lawyer
on Hayes behalf. Hayes argued that she did not give her lawyer the authority to
do so
b. Court: Rogers (the lawyers) actions were valid
i. He was acting w/in the scope of his employment
ii. He had apparent authority
1. Doesnt matter for contractual liability if Rogers told AP he had
authority or not but it could be a breach of fiduciary duty
2. Attorneys have apparent authority unless CL tells APs
lawyer that he doesnt
iii. His authority is determined by the representation agreement btw client
and the attorney
iv. If 3
party knows that attorney does not have authority, the K isnt
binding otherwise 3
partys belief in authority must be reasonable
iv. Franchises and Other Business Relationships
1. Miller v. McDonalds Corp (Or.Ct.App 1997)
a. Facts: P found a sapphire in her Big Mac and went directly to McDonalds Corp
to sue. McD said that it did not own that restaurant but the franchise owner was
3K and P should sue him
b. Court: McD was the proper party
i. Tigard McD was an agent of McD Corp bc McD had given 3K full
instructions/details on how to run the franchise
1. The more detailed the control the more it seems like a
master/servant relationship
ii. Is McD Corp liable for the tort of his franchisee?
1. YES
a. Court looks at the amount of control McD had over the
c. Agency by Estoppel / Apparent Agency
i. I know someone out there is acting as my agent even if theyre not. I do
nothing to stop others from acting as my agent, so I can be held liable
for their actions
d. **Most courts say that franchisee-franchisor relationships are not agency
relationships! And NO MASTER/SERVANT relationships = just a contractual
relationship cannot bind one another
e. How Sole Proprietorships Grow
i. Funding by the Owner
1. Increase Personal Equity owner puts in $ himself
a. No obligation to pay back lowers risk
2. Debt owner takes out a loan
a. Legally obligated to pay back, usually with interest increases risk to business
(repayment) and ownership (loss of control)
ii. Funding from Entities (other than owner)
1. Equity funding investment business receives for selling part ownership in the business
2. If sole-proprietorship uses, they are no longer a sole proprietorship
iii. Risks
1. Ownership (loss of control equity)
2. Risk to Lender/Third Party my not be repaid guaranteed amount (when lender)
Equity lender has higher risk but also potential for higher return
3. Risk to Business (repayment) Equity lower risk to business owner; Debt higher risk
to business b/c established payment schedule
iv. As an owner, how can you make it safer for someone to lend to you?
1. Secured Interest (collateral)
2. Co-Signing
3. Short term lending
4. Give lender control in managerial decisions of the company (i.e. on the board)
a. Problem: too much control makes the loan look like equity Bank profit tied to
businesses profit
i. Idea Does the person lending money seem like an owner?
1. Control OR Financial stake tied to success of operation
b. Other control options: loan covenants including promises that creditor makes
to not do certain things
5. Flexible Repayment Terms (i.e. 5% of net revenue will go towards repaying the loan)
v. Sharing Profits w/a Lender
1. In re Estate of Fenimore (Del 1999)
a. Facts: Mrs. S gave her brother a bunch of money and he had creditors after him;
Villabona = debt, ? if Mrs. S is debt or equity
b. Court: this is a partnership, Mrs. S gets nothing, Villabona gets all inheritance
i. Based on 7 of UPA ~ Partnerships = share in profits, unless an
exception applies
1. Agreement says agrees to divide the profits from each vehicle
2. Called it an advance, not a loan more like an equity
contribution ~ return was primarily tied to profits
ii. UPA Priority: those who are not members of the partnership, their debts
have to be paid off before the debts of the partner
c. Notes
i. If you want this to just be a sole proprietorship, make sure the lender
has no control over the company, is just giving a loan, etc.

VI. Partnerships
-Who owns this business?
-Who manages this business?
-Who gets the profits?
-Who is liable?

a. What is a Partnership?
i. A partnership is a business with more than one owner
1. Sometimes a partnership is a separate entity
2. Only partners pay tax on the business profits
ii. RUPA 103 general rule = relations among/between partners are governed by the partnership
1. Partnership agreements act like Ks private agreements
2. Dont need to be filed aka a default form of business structure unless the party takes
action to become LLC or something else
3. Partner fiduciary duties are mandatory as specified in RUPA/UPA
4. If partners fail to agree RUPA provides other default rules [UPA 18]
iii. Theories of Partnerships both are right, most use entity
1. Entity the partnership is a legal entity of its own RUPA 201
a. If a partner withdraws/dies, the partnership can continue
2. Aggregate the partnership is the aggregate of its partners
a. If a partner withdraws/dies, the entire partnership is destroyed
b. Partnership Agreements
i. Agreements not needed, but highly recommended
ii. Lawyers not needed unless there are disputes between partners
iii. 103(a) partnership agreements can change any default rules except for those under 103(b)
iv. KNOW THE CATEGORIES IN 103(b) Partnership agreement MAY NOT eliminate
1. 103(b)(3-5) Fiduciary Duties
2. 103(b)(6-8) When A Partnership Is Ending
3. 103(b)(8) cannot vary dissolution rights in 801(4)-(6)
4. 103(b)(9) Vary the law applicable to a LLP under 106(b) Dont need 2 know
5. 103(b)(10) Partnership agreements cannot restrict rights of third parties
v. Problems: Partnership Agreements p. 66-67
1. 3a-c = all valid
2. 3.1 = probably, but not well drafted ambiguous, everyone or majority
3. 3.2 = Would want unanimity for payments of net profits to partners because may need
equity to remain in the business and be reinvested; but not for payments to creditors of
the business b/c it would interfere with daily operation of businesses
4. 3.3 = might indicate some difference, BUT, still ambiguous
5. 3.5 = No, 103(b)(10) states the p-ship agreement may not limit the rights of 3d parties
& everyone is liable for their own negligence
c. Property Interests
i. UPA 8(1)/ RUPA 203 Property acquired by a partnership is property of the partnership and
not of the partners individually
1. Property can be transferred to partnership or a partner in p-ship capacity
2. Partnership that entered the partnership but wasnt transferred is part of the p-ship
ONLY IF it was bought with partnership assets
3. If something is bought in the partnerships name or bought by C as partner of Company
B then it is partnership property
ii. Why do we care?
1. For tax reasons
2. In case of litigation
3. Control If the partnership owns it, they all have to decide on control
4. In case of partnership dissolving need to know what needs to be divided and how
iii. Problems: Partnership Property p.67
1. 1) see above; 2) N, presumption arises only if purchased w/p-ship assets; 3) Y, indicated
by the name on the receipts; 4) Y, purchased by p-ship; 5) Capels money Blackacre
titled to BB = p-ship property, Capels money Blackacre titled to Capel = non-
partnership property
d. Partnership Decision-Making aka Management
i. Default Rules
1. RUPA 401(f) In the absence of an agreement to the contrary, matters arising in the
ordinary course of the business may be decided by a majority of the partners
2. RUPA 401(j) an extraordinary measure requires the unanimous consent of the
partners for a grant of authority outside the ordinary course of business, unless the
partnership agreement provides otherwise
a. Extraordinary Amendments to the partnership agreement & matters outside
the ordinary course of the partnership business
b. Although the text of the UPA is silent regarding extraordinary matters, courts
have generally required the consent of all partners for those matters. See, e.g.,
Paciaroni v. Crane, 408 A.2d 946 (Del. Ch. 1989); Thomas v. Marvin E. Jewell
& Co., 232 Neb. 261, 440 N.W.2d 437 (1989); Duell v. Hancock, 83 A.D.2d
762, 443 N.Y.S.2d 490 (1981).
ii. Conflicts
1. UPA third party has to actually know that a person does not have authority to enter
into such management decisions or else the partnership is bound
2. RUPA third party only has to receive notice
iii. Problems: P-ship Decision-Making p. 68-69
1. As long as ordinary, can do without Ps consent
2. Need Ps consent
3. Yes, in partnership agreement and not unreasonable
4. UPA 9(1) + 9(4), yes, the p-ship is bound unless the person had knowledge of a
restriction on a partners authority; RUPA 301(1) provides that a person who has
received a notification of a partners lack of authority is also bound.
5. UPA the term knowledge embodies the concept of bad faith knowledge arising
from other known facts; RUPA only actual knowledge
a. RUPA 102(d) can give a notification of a restriction on a partners authority
to a person dealing with that partner; may be effective upon delivery, whether or
not it actually comes to the other persons attention
i. To that extent, the risk of lack of authority is shifted to those dealing
with partners.
6. Yes, RUPA405(b) A partner may maintain an action against the partnership or
another partner for legal or equitable relief, with or without an accounting as to
partnership business, to: (1) enforce the partners rights under the partnership agreement;
(2) enforce the partners rights under this [Act], including: (i) the partners rights under
Sections 401, 403, or 404; (ii) the partners right on dissociation to have the partners
interest in the partnership purchased pursuant to Section 701 or enforce any other right
under [Article] 6 or 7; or (iii) the partners right to compel a dissolution and winding up
of the partnership business under Section 801 or enforce any other right under [Article]
8; or (3) enforce the rights and otherwise protect the interests of the partner, including
rights and interests arising independently of the partnership relationship.
a. But RUPA remedy is Bullshit
b. If there was contractual entitlement OR
c. CL Tort Breach of Fiduciary Duty
e. Fiduciary Duties
i. Fiduciary duty to act with the highest degree of honesty/loyalty toward another person and in
that persons best interest
1. An agent has a fiduciary duty to the principal, not vice versa
2. UPA does not list what fiduciary duties are owed these states have to rely on common
3. RUPA 404
a. 404(b) - Duty of loyalty
i. To account to the partnership and hold as trustee for it any property,
profit, or benefit derived by the partner in the conduct and winding up of
the partnership business or derived from a use by the partner of
partnership property, including the appropriation of a partnership
ii. To refrain from dealing with the partnership in the conduct or winding
up of the partnership business as or on behalf of a party having an
interest adverse to the partnership; and
1. E.g. contracting with the p-ship where they benefit more than
the p-ship
iii. To refrain from competing with the partnership in the conduct of the
partnership business before the dissolution of the partnership.
iv. 103(b)(3) Partnership agreement may NOT eliminate the duty of
loyalty under Section 404(b) or 603(b)(3), but:
1. (i) the partnership agreement may identify specific types or
categories of activities that do not violate the duty of loyalty, if
not manifestly unreasonable; or
2. (ii) all of the partners or a number or percentage specified in the
partnership agreement may authorize or ratify, after full
disclosure of all material facts, a specific act or transaction that
otherwise would violate the duty of loyalty;
b. 404(c) - Duty of care
i. Refraining from engaging in grossly negligent or reckless conduct,
intentional misconduct, or a knowing violation of law when acting on
partnerships behalf
ii. 103(b)(4) Partnership Agreement may NOT unreasonably reduce the
Duty of Care under 404(c) or 603(b)(3)
1. 603(b)(3) the partners duty of loyalty under Section 404(b)(1)
and (2) and duty of care under Section 404(c) continue only
with regard to matters arising and events occurring before the
partners dissociation, unless the partner participates in winding
up the partnerships business pursuant to Section 803
c. 404(d) Duty of good faith and fair dealing when engaging in partnership
duties applies all the time!
i. General contractual duties, not actually a fiduciary duty
ii. 103(b)(5) Partnership Agreement may NOT eliminate the obligation
of good faith and fair dealing under Section 404(d), but the partnership
agreement may prescribe the standards by which the performance of the
obligation is to be measured, if the standards are not manifestly
ii. Meinhard v. Salmon (NY 1928)
1. Facts: Salmon entered a lease agreement with Gerry and another agreement with
Meinhard to share some P+ would cover L equally; Salmon power to manage building
a. Right before the Gerry lease was going to expire, Gerry told Salmon about a
proposal to lease 5 properties and build one giant building
b. Salmon agreed, but Meinhard was not informed
c. Meinhard sued for an interest in the new building breach of fiduciary duty
2. Court (Cardozo): In favor of Meinhard
a. New lease was an extension and enlargement o/t subject-matter of the old one
b. Joint adventurers (ie. partners) owe to one another the duty of loyalty (fiduciary
duty) when opportunities arise during the course of the relationship related to
the partnerships existing scope of operations
i. Opportunity was an incident of the existing enterprise S had a duty to
disclose to M + he could have competed for job
3. Dissent (Andrews): The new lease btw Gerry/Salmon was very different from the
original; joint venture not a partnership limited object and design
4. Notes
a. Contrarian School of Economic Thought business people ought to be free to
agree to the terms of their relationship, with minimal statutory imposition
b. A joint venture is not a legal category. This was a partnership.
iii. Policy
1. Social/economic environment will benefit more (aka maximize utility) by having
fiduciary duties to regulate certain behaviors
a. We want people to act properly but they will also have the freedom to contract
iv. Questions: p. 75
1. Loyalty/Care to partnership and partners good faith and fair dealing in all (not FD)
2. Loyalty/Care cant be eliminated, but can be limited, can ask for permission - end if
disassociated. Otherwise, cant be eliminated.
f. Liability
i. Of Partnership
1. 3
party can sue partnership for: Ks entered by its agents & torts committed by its agents
2. RUPA 405(b) a partner can sue the partnership to enforce her rights under RUPA or
the partnership agreement (not permitted under UPA)
ii. Of Partners
1. RUPA 305-307 Partners are jointly and severally liable for all obligations of the
partnership (tort and K)
2. UPA 15 partners are jointly (but not severally) liable in K [must sue all partners];
BUT are jointly and severally liable in tort [can sue 1 or more partners]
a. A partner is liable for torts of another partner even if the first partner had
nothing to do with this
iii. Problems: Partnership and Partner Liability p.77
1. 1.1-Yes 305(a), 307(b)-p-ship directly sued; 1.2-Yes, everyone liable for own
negligence; 1.3-Yes, J+S liable for obligations of partnership
2. First go after p-ship assets, then A
3. 1
ACE, then A for any deficiency 307(d)
4. 1
ACE, then A (personally liable and judgment against p-ship)
5. Yes, from the partnership may require contribution from the partners 401(c)
6. Easier to get personal guarantees from all people than to have to go after partnership
iv. 307(c) A successful plaintiff cant collect her judgment from partners individual assets until
exhausting partnership assets
v. 401(c) the partnership is liable for the individuals tort and the partnership has the obligation to
indemnify all the partners
vi. LLP (Limited Liability Partnership) public filing of a doc that serves as notice that partners
will not be personally liable for what the partnership does
1. RUPA 306(b) A person admitted as a partner into an existing partnership is not
personally liable for any partnership obligation incurred before the persons admission
as a partner;
2. RUPA 306(c) An obligation of a partnership incurred while the partnership is a
limited liability partnership, whether arising in contract, tort, or otherwise, is solely the
obligation of the partnership
a. A partner is not personally liable, directly or indirectly, by way of contribution
or otherwise, for such an obligation solely by reason of being or so acting as a
partner. This subsection applies notwithstanding anything inconsistent in the
partnership agreement that existed immediately before the vote required to
become a limited liability partnership under Section 1001(b)
g. How Does a Partnership Business Grow? Financing
i. Existing Owners
1. Partnership agreements contain provisions that state:
a. The vote/events that trigger the obligation to contribute
b. The amount of each partners contribution obligation
c. The time in which to make the additional contribution
d. The consequences of a failure to contribute
2. UPA/RUPA do not have default rules
3. Hypo
a. What happens if 4/5 partners kick in additional capital and the last one doesnt
do anything?
i. Consider the 4/5 contributions to be loans so they will be repaid
ii. Rebalance the percentage of partnership shares/control
b. Vests a lot of power in the managing partner
ii. Outside Lenders Consider risk/return and who the loan is guaranteed by
1. Leverage the use of debt to finance a business
a. Any action that multiplies the potential gains/losses of a business increasing a
business leverage
b. Taking on debt will increase the leverage by using borrowed money to purchase
more than it can afford via equity alone, the business increases potential return
on investment if things go great, but risks putting itself in a worse position is
things go south (due to debt payment obligations)
iii. Additional Owners (ie. Investors)
1. Want to establish the % age share that a given amount of equity would receive
2. ROI = Potential Dividends/Total Investment in business [debt+equity]
3. ROE(quity) = Potential Dividends/Equity Investment
4. Legal Issues
a. RUPA 401(i) requires the consent of all existing partners unless the
partnership agreement provides otherwise
i. Or 401(j) an extraordinary act needs unanimity = amendment
b. RUPA 306(b) a new partner is not personally liable for partnership obligations
incurred before his admission as a partner
iv. Problems: New Partners p.81
1. No, must have unanimous decision to amend a partnership agreement, not in ordinary
course of business so majority is insufficient
2. Existing Lease No; Anticipated Construction Yes, if LLP not personally unless sign
h. Earnings from Business Operations: Profits
i. Making Money
1. A business owner makes money by:
a. Being paid a salary by that business
i. RUPA 401(h) a partner is not entitled to remuneration for services
performed for partnership, except for reasonable compensation for
services rendered in winding up the business of the partnership
1. Most partnership agreements agree to change this rule
b. Distribution of all or part of the profits from that business
i. RUPA 401(b) each partner is entitled to an equal share of the
partnership profits, if the agreement does not state otherwise
c. Selling his interest in the business
i. RUPA 502 the only transferable interest of a partner in the partnership
is the partners share of profits and losses of the partnership and the
partners right to receive distribution
ii. Why cant you sell management authority?
1. Partnerships as voluntary contributions and its not fair for
someone to just switch out favors the aggregate theory
iii. If you sell your interest, you still RETAIN management authority
1. And RETAIN liability for p-ship obligations
2. And RETAIN fiduciary duties to partners and p-ship
d. Reinvestment of partnership earnings - P.81 if nothing in agreement then
majority wins if in the ordinary course of business (this includes determining
what to do with earnings)
2. Problems: Partnership Profits p.82-83
a. 33k each of no provision in agreement
b. Enforced b/c in agreement 66k, 16.5k Propp, 16.5 Agee
c. Capel NOT entitled to payment 2/3 of distribution does not = 2/3 of voting
d. Can compel a distribution BUT the partnership must pay off all debts before it
can make a distribution cant force a distribution if the p-ship has negative
value 807; could sell off stuff to make distribution (loyalty okay; care only
violated it grossly negligent)
i. Sale of Ownership Interest Back to the Partnership
i. Buy-Sell Agreements
1. Sale of partnership interests (1) back to the partnership or (2) to other partners
a. Can be made via a (1) new K or can be a (2) clause in the partnership agreement
2. Even w/o a buy-sell agreement, a partner has the power to compel the partnership to pay
for her interest by withdrawing from the partnership
a. RUPA 602(a) any partner has the power to dissociate (withdraw) at any time
i. Cannot alter this rule!!
b. RUPA 602(b) If the withdrawal violates the partnership agreement, occurs
before expiration of partnership term (does not have to be definite time can be
as long as Obama president or #4 p.86), or satisfies any other circumstance in
602(b), it is wrongful
i. Consequences
1. 602(c) Damages caused by dissociation
2. 701(h) Partner will be paid out whenever the partnership is
supposed to end
ii. A partner in a partnership at will, with neither a specified end date or
specific undertaking to complete, can quit at any time without it being
c. 701(b) how much will he be paid? Distributional share under 807(b)
i. Look at higher of:
1. Liquidation value (selling assets individually) of partnership OR
2. Selling the business as one entity
d. UPA no right to withdrawal??
ii. Creel v. Lilly (MD 1999)
1. Facts: Creel owns Nascar memorabilia to expand the business, takes on 2 partners
and then dies (leaves poorly executed partnership agreement)
a. Creels wife wants them to sell the business (liquidate) and give her Mr. Creels
b. Other partners disagree and offer to buy his share out
i. List the book value of the business and apply Creels percentage
2. Court: UPA governs (during phase-in period) but there is no forced sell; the agreement
shows the intent to allow remaining partners for purchase
a. UPA mandates forced sell
b. RUPA no obligation to force sell, gives non-withdrawing partners the option
of dissolving it liquidly or buying out the withdrawing partners share
3. Selling the corp as a whole brings in more money than selling the assets separately
a. Problems: its a lot more likely to find buyers for assets than for an entire
b. Look at Book Value vs. Market Value no finding of goodwill so they required
payment of proportionate share of book value
c. If no agreement = dissociation b/c of death and buyout price of dissociated
parties interest would be determined by the larger of the share of liquidated
value or Sale value
j. Disputes
i. Partnership v. outside Third Party
1. Look to: relevant partnership statute, then agency principles (actual/apparent)
ii. Partner v. Partner
1. Look to: provisions of the partnership agreement, then provisions of relevant partnership
statute, then agency principles
iii. Liability 702
1. Of dissociated partner when partnership doesnt wind up after dissociation, w/in 2 years
of dissociation, AND TP doesnt know (RUPA) or have notice (UPA)
k. Partnership Endgame
1. Lists certain times when you must liquidate and when you must continue on (buy-out)
ii. Buy/Sell agreement built into partnership agreement the right of the partner to buy out or sell
their interest
1. Problems: everyone wants their own share, if the firm was going to continue theres a
chance they wouldnt get their rightful share
2. How to deal: say that the partner gets his percent share of book value
a. Problem: book value can significant diverge from actual value
b. How to deal: we will have an appraiser to come in and value all the assets, or
come up with a formula that takes into account book value and other accounting
i. If someone dies then you can use the valuation scheme to cash them out
iii. Dissolution, Winding Up, Termination
1. When a partner dies or withdraws, there are two choices:
a. The remaining partners can purchase the departing partners interest and
continue the partnership business or
b. The partnership can dissolve, liquidate, and terminate
2. Dissolution
a. Definition someone has withdrawn from the partnership
b. The partnership continues for the limited purpose of winding up the business
c. UPA the withdrawal of any partner will cause dissolution
d. RUPA uses Dissociation; doesnt automatically mean the partnership is
dissolved Entity-theory
i. 601 A partner is dissociated from a partnership upon the occurrence of
any of the following:
1. Express notice that partner wishes to withdraw in the future;
2. Event in p-ship agreement causes the partners dissociation;
3. Expulsion pursuant to p-ship agreement;
4. Expulsion by unanimous vote of other partners unlawful,
transfer of substantial part of that partners interest has
occurred, no right to continue for whatever reason; partnership
where partner has been dissolved and its business is being
wound up
5. Expulsion by judicial determination upon application
6. Bankruptcy or similar financial impairment
7. Death or incapacity
8. Distribution by a trust-partner of entire p-ship interest
9. Termination of an entity partner
ii. 801 A partnership is dissolved, and its business wound up
1. Partnership is at will w/notice of non-dissociated partners
express will to withdraw
a. Withdrawing partner can force liquidation
2. Partnership for a definite term or particular undertaking
a. Can not be forced to liquidate by a partner who
withdraws prematurely in violation of the p-ship agmt
b. If one of the partners dies or wrongfully dissociates
before the end of the term, the partnership will be
dissolved only if half of the remaining partners vote in
favor of dissolution within 90 days after the dissociation
3. Event agreed to in p-ship agreement
4. Unlawful to continue
5. On application by a partner, a judicial determination
6. By judicial determination based on equity to transferee of a
partners transferrable interest
a. Rights of a transferee under this section cannot be
varied in the partnership agreement 103(b)(8)
iii. 802 A partnership (a) continues after dissolution only for the purpose
of winding up its business, SUBJ ECT TO
1. (b) Agreement of all partners (except wrongfully dissociating
partner) to waive the right to have the partnerships business
wound up and the p-ship terminated
a. Resume carrying on business and liability after
dissolution and before waiver remains
b. Rights of a third party under 804(1) or arising by
conduct in reliance on the dissolution before knowledge
of waiver may not be adversely affected
iv. Death does not cause dissolution (but does cause dissociation RUPA)
3. Winding Up
a. 807(a) assets must be applied to discharge its obligations to creditors,
including, to the extent permitted by law, partners who are creditors any
surplus must be applied to pay in cash the net amount distributable to partners in
accordance with their right to distributions under subsection (b)
b. Comment 2 partner whose debt has been repaid by the partnership is
personally liable, as a partner, for any outside debt remaining unsatisfied, unlike
a limited partner or corporate shareholder
i. Accordingly, the obligation to contribute sufficient funds to satisfy the
claims of outside creditors may result in the equitable subordination of
inside debt when partnership assets are insufficient to satisfy all
obligations to non-partners
1. 306 not personally liable for any p-ship obligation before
becoming a partner
ii. All debtors should be treated the same
iii. Required contributions are considered assets of the p-ship
c. When completed, p-ship entity terminates
4. RUPA Default Rules (401, 807) Unless partners agree to the contrary
a. The partners share responsibility for losses from operation of partnership and
partners losses from investment in partnership 401(b)
b. The amount of each partners loss from her investment is determined from her
partnership account 401(a), 807(a)-(b)
c. When the partnership is dissolved, the partnership is legally obligated to pay
each partner an amount measured by the balance in her partnership account
i. 401 The amount in each partners account will be =
1. The value of investment (not including labor)
2. Minus distributions to partner
3. Plus an equal share of whatever remains after paying creditors
a. If there are ISF then loss divided equally
d. If a partner has a negative balance, he must contribute additional funds in the
amount of the negative balance
5. Kovacik v. Reed (Cali 1957)
a. Facts: K told R (defendant) that K had an opportunity to do work for Sears and
asked R to be his job superintendent. K invested $10K and promised R hed
share the profits 50/50. K did not ask R to agree to share any loss and R didnt
offer to do so. Rs only contribution was his own labor
i. K informed R that the venture was unprofitable and demanded
contribution from R
b. PP: TC said that R agreed to share the profits/losses and owed of loss to K
c. Court: reversed, found for R
i. In the absence of an agreement to the contrary, the law presumes that
partners/joint adventurers intend to participate equally in profits/losses
1. Exception: when one partner contributes only money capital
against only anothers skill, labor, then in the event of a loss,
each party would lose his own capital (what he initially
contributed, person cant receive a salary)
ii. This case decided under UPA (split everything btw partners unless it
falls within this exception)
1. Under RUPA, labor doesnt count as contribution
d. Partnership Account
i. Details what each partner put into the partnership
ii. This is a default rule under RUPA
iii. Do not need to agree to partnership accounts to have them
iv. Expulsion
1. If there is no partnership agreement, there are no rules for expulsion
2. RUPA 601(3) expulsion does not require dissolution, but requires remaining parties to
buy them out UPA has aggregate theory so it would have to dissolve
3. Bohatch v. Butler & Binion (Tex 1998)
a. Facts: Bohatch reported to firms managing partner that another partner was
overbilling Pennzoil she was told to look for other employment, reduced her
tentative distribution share to zero, and did not pay 4 months of monthly draw
b. Issue: Is there an exception to this rule that a partnership has a duty not to expel
a partner for reporting suspected overbilling by another partner?
c. Court: No duty
i. Partners have a duty of loyalty and good faith, fairness, honesty, but
there is no obligation to remain partners
1. A partnership exists solely b/c the partners choose to place
confidence/trust in one another
2. There is no fiduciary duty that creates an exception to the at-will
nature of partnerships for whistle blowing
ii. Policy: the threat of tort liability for expulsion would force partners to
remain in untenable circumstances to their own detriment
iii. However, the firm did breach its K when it didnt pay monthly draw
(but no fiduciary duty = no damages for mental anguish/punitive)
v. Freeze Out
1. Where holders of the majority interest force a minority owner to sell/give up her interest
2. Page v. Page (Cali 1961)
a. Facts: Partners entered an oral agreement where each partner contributed $43K.
Even though the partnership ended up being profitable, Plaintiff wanted to
terminate partnership
i. D said P acted in BF and that upon the dissolution, he will receive very
little $
ii. D said P used his superior financial position to push out D so P can
acquire the whole business and receive 100% of the profits
1. P has a $47K from his corp which funded the partnership
b. Court: D failed to prove P acted in BF
i. P had the power to dissolve the partnership by express notice
1. This is an at-will partnership, P could pull out at anytime
ii. The dissolution is only wrongful if it was done in BF and violated Ps
fiduciary duties
c. How to avoid this:
i. Require appraisal and then auction-based sale upon dissolution will
help ensure that partner reqd to unwillingly dissolve gets the fair
market value and assets arent poached
ii. Set a term so its not at will
vi. RUPA 103(b)(6)
1. Can only modify a partners ability to withdraw/dissociate by requiring notice in writing
l. Wrap-Up
i. Sole Proprietorship v. Partnership
1. Goals
a. Want to maximize social utility by promoting businesses
i. Its not hard to create these structures and the rules provide definitions
b. Want to provide rules that will resolve disputes and promote efficiency and trust
i. We have default rules to fall back upon
2. Whats missing?
a. Limited liability neither of these forums protect owners from the business
i. Debts are paid from the owners

VII. Corporations
a. A corporation is a separate legal entity and its owners (shareholders/stockholders) are generally not
personally liable for the corps debts, dictated by state law
i. Limited Liability: the most an owner risks is the amount she paid for stock
ii. Public (publicly traded stock, large) v. Close (not publicly traded stock, small)
iii. Why entity theory?
1. We need something to blame and be liable other than the owners, which you cant do if
there isnt limited liability
b. Sources of Corporate Law
i. State Statutes
1. Model Business Corporation Act
2. Delaware General Corporation Law
ii. Articles of Incorporation, Bylaws, Agreements
1. AoI: A corp. does not exists until AoI are property executed/filed with appropriate state
agency (Secretary of State) MBCA 2.03
a. Can be filed by a corp. or an individual
b. Very basic info
i. MBCA 2.02(a):
1. Must set forth (1) Name, (2) # of Shares Authorized to Issue (3)
Street Address and Registered Agent (4) Name/Address of Each
2. May set forth (1) names and addresses of the individuals who
are to serve as initial directors; (2) provisions not inconsistent
with the law: duration, shareholder liability/non-liability,
procedures for dealing with self-dealing procedures, etc
ii. Delaware:
1. Name is more detailed, include inc, corp, ltd, etc to signify
what type of higher corp structure,
a. Cant include the word bank unless registered
b. Want to make sure that it is more transparent when you
are dealing with a corporation
2. Statement of Purpose (usually generic)
3. More detail about stock
4. Stock issuance requirement makes sense so potential stock
buyers will know whats available and what their percentage of
ownership will be
c. Purpose
i. Give notice to the world - Know who will be responsible
ii. Know if authorized to issue certain amounts of stock
iii. Maintain efficiency/organization
d. Why not more information required?
i. Want maximum flexibility
2. Bylaws: Adoption of bylaws is not required but recommended, bylaws are a completely
internal doc
3. What if Bylaws and AoI conflict?
a. Articles win
b. Sometimes governance procedures are included in the articles instead of the
bylaws . . . WHY? More difficult to change the AoI
iii. Case Law interpret and apply provisions in corporate statutes and corporations articles and
bylaws & act as gap-fillers
iv. Federal Statutes
c. Promoter = someone acting on behalf of a corporation that is not yet formed **not tested on**
i. Corporation never formed . . . P knew it wasnt a corporation at the time
1. P jointly and severally liable for anything he signs, whether signing on behalf of the
entity OR if he signed his name individually MBCA 2.04
2. Mitigated liability If he tells TP there is no corporation yet
3. Non-promoters can be liable if acting as a partnership (before incorporation); can also
make an equitable argument
ii. A corporation is liable on a lease once it takes an action to adopt it
1. Why? Corporation didnt exist at the time, not fair to hold it liable for what the promoter
2. How does this happen?
a. Ratification = the affirmance by a person of a prior act which did not bind him
but which was done on his account (implied)
b. Novation = an agreement that the corp. will replace the promoter on a lease
iii. Liability of Promoter post Incorporation
1. Still liable via agency law
2. How to get Promoter off the hook?
a. Agree to Indemnify P for any contractual obligations
b. Novation all parties agree
d. De Facto v. De J ure
i. De facto in practice, but not actually legal (against the law)
1. If everyone believes that a corporation exists, then courts will act as if it actually does
exist and will isolate them from liability
a. More and more states are abandoning this idea b/c its very easy to incorporate
b. Based on good faith
2. MBCA 2.04 still personally liable if you take actions on behalf of a non-existent
principal (even if in good-faith belief)
a. Other parties to the non-existent corporation are j/s liable based on a general
b. Not liable
i. If belief filed Must be reasonable e.g. mail
ii. You think filed and TP knows it hasnt been
ii. De jure in accordance with the law, a corp. actually formed
e. I ssuing Stock
i. MBCA/Delaware require corps to say how much stock they can sell
ii. Classes: Preferred, Common, and Par Value
1. AoI usually specify how many of each
2. Preferred stock = a class of stock to be treated more favorably than another class
(common stock)
a. Why issue preferred stock?
i. Can sell it for a different value
ii. Can use it to satisfy creditors
3. A share of common stock confers a certain amount of ownership/rights
a. Amount of ownership depends on the # of stock actually issued and outstanding
4. Common Stockholders
a. Receive dividends
b. Vote on Board of Directors (aka participate in management decisions_
c. Are owners of the corporation
d. % of assets received if corporation is sold
5. Preferred Stockholders
a. No voting rights
b. Preference in dividends can give more dividends per share
c. Liquidation rights preference that you get paid x amount per share before
common shareholders are paid
d. Convertibility to common stock
i. Preferred stock can be turned into common stock (2-4-1 or fee to
e. Redemption rights force the corp. to buy the stock from you call-ability
6. Why use preferred stock? (a finance company would do something like this)
a. Cant get debt & Dont want to leverage @ rates they can get
b. Dont increase your fixed payment, debt-obligations
c. More security for preferred stock buyer than common stock still risky in the
case of bankruptcy
iii. Par value = the minimum price for which a corporation can issue its shares
1. Only regulates the issuance price
a. Corp only gets $ from a stock when it issues it.
2. Purpose: capitalization (get $ into your corporation at the beginning as you are issuing
your stock money goes into a stated capital account containing all par value $)
a. Protect parties from under-capitalized incorporation money stays in the
account as security
b. States wants to make sure corps arent running around committing torts and K
breaches without paying damages
3. Not all that relevant anymore used to be a requirement in all states only a few still
have it **May still be on the bar**
a. The shares would be priced so low, that the amount retained was useless
b. Assume market/reputational costs will protect tort claimants and that creditors
will be smart enough to require security in contracting
iv. Problems
1. 1) Can issue stock in exchange for land, any tangible/intangible property or benefit;
includes: a promise of future services, goodwill (come up w/amount), a release of a
claim against the corporation; 2) No; 3) Yes; 4) $2 per share = $6k; 5) Yes, can sell for
less than par value when a secondary sale maybe the market value is lower and this is
all she can get for it tax write-offs for loss in value; 6) Yes, would want to make sure
property is valued for at least as much as par value ~reasonable valuation~ or statement
from BoD saying they value as much; 7) prob doesnt care, might get pissed if avg share
was 100 and then later they were available at 50, but there is not necessarily a
relationship between par and actual value ~generally just a floor for the initial sale; 8) if
you buy for higher than par value you run the risk that more shares will be issued that
dilute her ownership interest and depending on the price, it would effect the value of her
v. Capital
1. Stated capital = the aggregate par value of all issued shares of par value stock
a. Cannot be distributed to shareholders
2. Capital surplus = funds for issuance of stock in excess of par
a. May be distributed back to shareholders in dividends
f. State of I ncorporation
i. The laws of the state of incorporation become default rules that govern internal affairs
1. Internal affairs = procedures for corporate actions and the rights/duties of directors,
shareholders, and officers
2. The companys internal affairs do not include rights of third parties
ii. Foreign corporation = a corporation that does significant business in a state other than that in
which it is incorporated
1. Must also register in the state in which the business is being conducted
2. Must also pay respective fees to those states
iii. What determines where a company will incorporate?
1. Corporate statutes and Common Law contender for choice of law
2. Taxes, corporation fees (initial and annual)
3. Where it will primarily do business foreign/domestic
b. If you do business in other states, choice of law may dictate that the law of the
other state apply e.g. Tort cases where the victim is a resident of that state
4. ~50% of corporations are out of Delaware Why?
a. Corporate governance issues will be adjudicated by courts in the state of
incorporation & Delaware has a specialized judiciary for corporations have
significant knowledge of the area, especially bankruptcy
b. A lot of precedent has been developed b/c so many companies have incorporated
there gives you some guidance when evaluating certain disputes
c. Gives corporations maximum flexibility ** maybe not so much anymore **

VIII. How Does A Corporation Operate?
a. Liability Default: shareholders are not personally liable for acts/debts of the corp beyond the amount
of their investment in the corporation
i. Why? Because we want them to provide services that we need
ii. Why should we be concerned? Think of the puppies. If they kill the puppies, then
Compensatory & Societal Harm want to deter stupid shit
b. Contractual Exception: third parties often refuse to extend credit to a corp w/ limited assets unless the
shareholders agree to be personally responsible (personally guarantee payment)
c. J udicial Exception Piercing the Corporate Veil
i. Dewitt Truck Brokers, Inc. v. W. Ray Flemming Fruit (1976)
1. Facts: Flemming was corps principal shareholder, orally promised P that he would
personally pay for the fruit transportation if corp did not
a. Oral promise was not enforceable b/c surety ship requires SOF
b. P asked court to pierce the corp veil and hold Flemming liable for his corps
failure to pay
2. Court: Flemming is personally liable
a. Inadequacy of capital is the most common reason to pierce the CV
i. Other factors: non-payments of dividends, if corporation is a faade for
the operations of the dominant shareholder
b. Flemming owned 90% of corp outstanding stock, he did not follow corporate
formalities, the corp functioned for the financial advantage of Flemming
i. Courts want there to be a clear separation btw shareholders and the
d. How to Pierce the Corporate Veil
i. Fraud e.g. lying to induce people into K with the corporation
ii. Instrumentality/Alter Ego Theory: if the corp and individual are the same thing, there is no
reason to give the individual immunity for the corps actions
1. Some jurisdictions say you must also have injustice to pierce the CV
2. Much easier when there is a smaller or closely held corporation
a. As a general rule, will not be able to pierce a publicly traded company
iii. Factors/Actions that may pierce the CV: individual determination
1. Not protecting the interests of justice
2. Undercapitalization no funds sufficient to pay out people in the ordinary course of
business, this is a judgment sometimes there are legal standards, e.g. insurance cos
a. Whether it should factor into the analysis is what type of claimant it is
i. Should factor for tort claimants, BUT NOT contractual claimants (could
have procured promises from corp)
b. At what time do we care about undercapitalization?
i. At the time of incorporation best explanation is that you want to make
sure the owners have a stake in the game and if they invested a lot at
the beginning then they would be expected to want it back
3. Failure to follow corporate formalities e.g. absence of corporate records
a. Confusing why we care, but the justification is never that clear
i. Contract claimants we dont really care b/c they entered into the deal
ii. Tort claimants it wouldnt factor into their decision
4. Non-payment of dividends (very rare) generally irrelevant, BUT consider siphoning
5. Siphoning of funds difficult to differentiate between legitimate/illegitimate
transactions; e.g. what is an exorbitant salary?
6. Solvency of debtor corporation again, difficult to establish standards
7. Non-functioning of other officers/directors
8. Corporation is merely a facade
e. Other Corporations as Shareholders
i. Subsidiary a corporation whose stock is owned by another corporation
ii. Parent Corporation the corp that owns a majority/all of another corps outstanding stock
1. Not liable for Ks, torts, obligations of subsidiary corp unless there is a K or judicial
a. Pierce corp veil
b. Direct liability P participated in act of Subsidiary
c. S acting as Agent of P
2. Corporation Trees (one company has shares in another company that has shares in
another) Why do companies have subsidiaries?
a. Isolate parts of a business for liability reasons*
i. If there is a claim against one subsidiary, just close it down and the rest
arent affected
b. Isolate parts of the business for credit/sale
i. Isolate revenue streams for repayment of credit and other debts
ii. Simplify insurer/lenders analysis in determining loan transactions
c. Tax reasons / choosing state laws
d. Avoid regulation
i. There are industry/sector specific requirements you dont want applied
to all parts of your corporation so subsidiary only has to comply with
those regulations ex. airline industry
iii. In re Silicone Gel Breast Implants (Alabama 1995)
1. Facts: Bristol is the sole shareholder of MEC. Bristol had extensive control over MEC
(set wages, approved hiring, maintained $, controlled board)
a. Bristol argued that it is not directly liable or liable under the piercing of the CV
for MECs breast implants
b. MECs Assets 57 million demand note & Insurance policy w/2 billion limit
2. Court: Bristol is liable
a. MEC is so controlled as to be the alter ego or mere instrumentality of its
b. It would be unjust to allow Bristol to avoid liability basically just a fairness
justification for applying the alter ego theory. . . wouldnt happen if rich whities
3. Class Notes
a. Piercing the CV should be applied rarely
b. Principal/Agent Theory a court could find that a subsidiary is acting as an
agent of the parent corp (principal)
c. Only cases that have a high percentage chance of winning go to court and then
only 40% of those are successful others are settled
i. More successful in K than tort situations, BUT this is probably b/c of
the settlement factor
iv. Enterprise Liability corporations that (although technically separate) are commonly owned and
engage in one enterprise should be treated as a single legal entity for purposes of liability
1. When assets are shifted to try to insulate from liability
a. P shift asset to GP (would create another veil problem and would be more
difficult) or a separate subsidiary
i. One of Ps assets are the other subsidiary corporations so if they dont
pay, you can go after those assets i.e. this doesnt protect
ii. Transfer to another random this is a fraudulent conveyance
2. Only natural persons have limited liability if a business owns another business then the
debt of the subsidiary is also the debt of the parent company
3. Rejected in US, but forms of it exist in tax, bankruptcy, etc.
4. Walkovszky v. Carlton (1966)
a. All cabs are individual corps. Parent corp has a lot of $ and suit is brought
against one of the subsidiaries. Plaintiff wants to pierce the veil. How can we
protect the assets?
i. Transfer assets to another subsidiary
ii. Transfer assets to the parent of the parent (this is a fraudulent
conveyance of equity)
iii. You cant do anything really!
f. Decisions for the Corporation
i. Three Primary Groups
1. Owners (shareholders) little control, a mere symbol of ownership
2. Officers
a. The only individuals who are agents of the corp bind and create liability
b. Do the day-to-day work: manage company, implement macro-level decisions
made by board
3. Board of Directors
a. Make the corps most important decisions
i. Business performance and plans, major risk that corp is or will be
exposed to, performance of officers, compliance, hiring officers, e.g.
Chik-fil-A being closed on Sundays, diversifying into new business, etc.
b. BofD of a small corp has the same tasks as that of a big corp
i. Most commonly the shareholders in a small corp, BUT not required
ii. May do lower level type decisions when small
ii. McQuade v. Stoneham (1934)
1. Facts: P and D (stockholders) directors had agreement to keep respective officer/director
positions: Stoneham as president, McGraw as vice-president and Plaintiff as treasurer; P
was not renewed as treasurer or director, not b/c of misconduct, but b/c he had conflicts
with D
a. Ps Argument - McQ: agreement that he entered with McGraw and Stoneham
provided for each of them to use their best endeavors to keep each other in
their respective positions
b. Ds Argument - S: agreement was invalid because it granted authority to
shareholders for a decision that is normally left to the judgment of directors.
2. Court: Found for D (the agreement is unenforceable)
a. Can agree to be directors, BUT
i. An agreement controlling how directors exercise their judgment is
illegal constrains directors authority to make decisions as they see fit
1. Directors have to act in business interest
b. Voting agreements among directors are void and against public policy
iii. Villar v. Kernan (Maine 1997) Shareholders Decisions instead of Directors Decisions
1. Facts: V (49%) and K (51%) went into the pizza business agreeing to never get a salary.
Eventually Stephan came in and owned 2% of the shares
a. K entered a consulting agreement with the business to get a salary with his 50%
and Ss 2% V sues for breach of oral K
2. Court: Maine law precludes an action for breach of an oral contract between two
shareholders of a closely held corporation prohibiting their receipt of salaries from
a. The original agreement must have been in writing to be enforceable
i. Such agreements are okay if: Must be in articles of incorp, or if its an
amendment, must be agreed upon by all shareholders, and after the
agreement is made anyone who acquires shares must have notice or
actual knowledge of the agreement
b. So, K was allowed to keep his salary
3. If you are in a closely held corporation and you have minority share, you are kind of
screwed. Only remedy would be to sue for breach of fiduciary duty if one of the
owner/directors breached. Otherwise you cannot force someone to buy/sell shares
g. Shareholders Decisions About Directors and Cumulative Voting
i. Duties
1. Elect directors
2. Remove directors
3. Approve fundamental corporate changes
4. Pass shareholder proposals **wont really talk about
ii. Voting (for director elections only, not fundamental changes) **State Law OR AoI Determine**
1. Straight Voting
a. A separate election for each seat on the board
b. Each shareholder gets to cast her number of shares in any way she wants for
each of the separate elections
c. A shareholder owning a majority of the stock will be able to elect every director
2. Cumulative Voting
a. One at-large election in which shareholders cast vote
b. Each shareholder gets to multiply the # of shares she owns times the number of
directors to be elected
c. Protects minority shareholders only get to pick just over the seats if majority
shareholder as opposed to Straight where the majority SH would pick all
d. Where allowed, cumulative voting limited to election and removal of directors
e. If elected under cumulative voting, you wont be removed if you maintain that
many supporters in a vote to potentially remove
3. Delaware 141(k) removal with or without cause, BUT if a board has staggered terms
you need cause
a. Staggered elections provide an opportunity to dilute minority SH
4. MBCA 8.08 with or without cause
iii. Fundamental Changes
1. Fundamental corporate changes req. shareholder approval
a. Electing board of dir and taking them out this is shareholder action
b. Fundamental Changes are shareholder reactions to decisions of the BoD
i. Amendment of AoI
ii. Merger with another corporation
iii. Dissolution
iv. Acquisition
v. Sale of all or substantially all of the assets of the corporation
c. Only use straight voting
d. Most states require majority some require supermajority
i. Usually default rule and can be changed by AoI
iv. Where Shareholders Vote and Who Votes
1. Annual Meeting meeting held annually, required where elections occur
a. Special meeting any other meeting of shareholders
i. By-laws or AoI say when special meetings will be held
2. Record Owner a person who has the legal right to vote at an annual or special meeting
of shareholders; owners dont necessarily get physical stock certificates now
a. Mutual fund: I give them $, they invest in stuff, I get returns, but I do not
personally own any shares so the mutual fund gets to vote, I dont
3. Record Date only record owners as of that date are entitled to notice of and a vote at
the meeting Even if you sell your share after this
a. MBCA date between 70 and 10 days
b. Delaware date between 60 and 10 days
4. Street Name Ownership an investor buys shares through a broker; the depository
company, maintained by a group of brokerage firms, holds the certificate and is shown
as the owner in the corps record; investor is shown as the owner in the brokerage firms
5. Proxy a person entitled to vote authorizes another person to vote for her; written form
is the proxy that allows someone to be your proxy
a. A proxy that does not address revocability will be revocable
b. A proxy is irrevocable only if it both (1) states that it is irrevocable and (2) is
coupled with some interest in the stock
i. Bank will take over voting rights in shares of a corporation to give
someone a loan
c. Can specify how you want someone to vote and they have to comply
d. Default effective rules: Delaware 212(b) 3 years, MBCA 7.22 11 months
v. Shareholder Proposals
1. Can force shareholder votes on certain issues
a. Corporate Governance
b. Timing of Elections
c. Executive Compensation limit CEOs pay b/c paid too much
d. Corporate Social Responsibility (CSR) Issues use no labor from China
2. Not binding, they are more recommendations pretty ineffective
vi. Shareholders Inspection Rights
1. Every state provides shareholders access to corporations books and records (some also
have a CL right to inspect)
2. Limits on what shareholders can have access to generally screened financial data
vii. Shareholder Voting Agreements
1. Types
a. Voting Pooling I enter a K with another shareholder and we all agree to vote
the same way on all issues
b. Voting Trusts we create a trust, transfer all of our rights to the trust, and the
trustee has the right to vote (one legal entity) more difficult to go rogue
2. Ringling Bros-Barnum & Bailey v. Ringling (Delaware 1947)
a. Facts: Mrs. Ringling (315) and Mrs. Haley (315) had an agreement where they
would act jointly in exercising their voting rights. Mr. North was 3rd
shareholder (370); If they failed to agree, the arbitrator (Karl Loos) would make
a final decision.
i. Stock pooling agreement each selected two members and then used
their remaining votes to select a fifth member of their choosing
1. Mr. Haley, the VP went to jail and North visited him changed
ii. The two did not agree on the 5th director Ringling went to Loos who
decided that they should vote for Mr. Dunn
1. Mr. Haley (as Mrs. Haleys proxy) attempted to vote his wifes
shares and Mr. North didnt agree to anything at all
2. Haley said that the agreement is invalid b/c it vests power in a
non-party (Loos)
b. PP: Vice Chancellor said the agreement was valid and that the decision of the
arbitrator was binding specific performance
c. Court: Agreement is valid, will not invalidate election
i. Doesnt matter what the voters motives are because he has no legal
duty to vote at all
ii. Arbitration provision okay as deadlock-breaking maneuver unless at
least one of the parties entitled to cast at least half of the their combined
votes is willing to that it be enforced
iii. Mrs. Haleys votes should be rejected, but not Mr. Norths b/c he didnt
sign onto the agreement 3 Ringling votes and 3 North votes
d. MBCA and Delaware valid agreement; remedy would be specific performance
(expressly provided for in MBCA)
h. Responsibilities Of A Corporations Decisionmakers* And To Whom Are They Responsible?
i. Fiduciary Duties
1. Duty of Care
2. Duty of Loyalty
3. Obligation to engage in good faith and fair dealing
ii. Who Owes Fiduciary Duties To Corporation?
1. Shareholders do not have fiduciary duties to corp
2. Directors have fiduciary duties to corp through corporate law
3. Officers have fiduciary duties to corp through agency law
4. Liability arises when you analyze what hat the person was wearing when he made a
iii. Why do we have fiduciary duties?
1. Want to make sure that directors arent doing anything to hurt the company/constrain
their self-interested behavior, BUT Dont want to prevent directors from acting/taking
risks or doing what they need to do in order to be successful but we want to reign
2. If we didnt have them, no one would invest in companiesif you cant trust the people
running the company there is no reason to invest
iv. Terms
1. Inside Director: if a director is also an officer, employee, large shareholder of a
a. Generally dont like bias & conflict of interest
2. Outside Director: if a director is not an officer, employee, large shareholder of a
corporation but may have some financial relationship with corp
a. Usually govt requires certain amt of outside directior
3. Independent director: No financial relationship with the corp at all, except for whatever
salary they get for sitting on the board (sitting fees)
4. Why does it matter? If youre getting a lot of $ from the corp, you have a greater stake in
the success of the corp
a. Outside directors are not beholden to any other officers/directors, just have
connections to shareholders They are more independent
5. Derivative Suit
a. A shareholder who is upset by a board decision cannot sue on his own
derivative suit where the corporation itself sues the board
i. Shareholder animates the corporate puppet
i. What is it?
1. Act in the best interest of the company
2. Exercise good business judgment and ordinary care and prudence when making
decisions for the company
ii. How to breach? Action or Inaction
iii. Business judgment rule
1. It is not up to courts to resolve questions of business management unless there is fraud,
illegality, or conflict of interest (Shlensky v. Wrigley)
2. Standard is gross negligence to find director liability (Joy v. North)
a. The higher the risk the more diligent they should be, BUT generally not required
to look under every rock
3. A director has duty to inform oneself of all material information reasonably available to
him before making a business decision (Smith v. Van Gorkum)
4. Does not protect directors
a. Where board decisions are tainted by a conflict of interest
b. Rationality = decisions are completely wasteful (no way to benefit
corporation)/decisions lack a business purpose
c. Result from obvious and prolonged failure to exercise oversight and supervision
d. Fraud/Illegality
5. Justifications for:
a. Courts want to leave discretion to the boards
b. If shareholders arent happy, they can just vote a director in or out
c. Shareholders voluntarily undertake the risk of bad business judgment
d. After-the-fact litigation is an imperfect device to evaluate corp business
e. Potential profit often corresponds to potential risk
j. Breaching of Duty of Care By Board Action
1. Shlensky v. Wrigley (1968)
a. Facts: P is a minority stockholder in D corp (Chicago National Legal Ball Club) that
operates the Chi Cubs and Wrigley Field. Wrigley is the majority shareholder
i. P brought a stockholders derivative suit against directors for negligence and
mismanagement b/c they refused to install lights at Wrigley and schedule night
games which = $ losses
ii. P says that all other major league teams have mostly night games to maximize
iii. P says Wrigley refused to install lights bc of his personal opinions that baseball
is a daytime sport and it will deteriorate the surrounding neighborhood and that
Wrigley has dominated the rest of the directors
b. Court: Found for Wrigley
i. BJR It is not up to courts to resolve questions of business management
unless there is fraud, illegality, or conflict of interest
ii. Courts want to leave discretion to the boards
1. Directors do not need to follow the lead of other corps in the field
failing to follow the crowd is not a dereliction of duty
iii. This was decided on a M2D the court is saying that as a matter of law, there
was not a sufficient claim stated the court gives great deference to the
business judgment rule BJR
1. ** Should we allow Wrigley to care about the neighborhood when his
job is to create a return for investors/owners? **
a. Ehhh. Courts dont take this view
iv. If we allow shareholders to sue directors whenever they make a decision, we
destroy the respective roles.
1. If shareholders arent happy, they can just vote a director in or out
2. Joy v. North (1982)
a. Facts: Shareholder brought suit against Citytrusts officers/directors for breach of duty of
care (loans to developer) corps board appointed a special litigation committee
(supposed to be looking out for shareholders best interest) that said the suit should be
dismissed as to outside directors
b. PP: TC granted SJ for D corp
c. Appellate Court: found SJ was improper, there was genuine issue of material fact to
whether there was a breach of fiduciary duty
i. Need gross negligence for there to be liability
ii. Reasons for the Business Judgment Rule
1. Shareholders voluntarily undertake the risk of bad business judgment
2. After-the-fact litigation is an imperfect device to evaluate corp business
3. Potential profit often corresponds to potential risk
iii. Derivative suits involve 2 actions
1. Action against corp for failing to bring a specified suit
2. Action on behalf of corp for harm to it identical to one which the corp
failed to bring
iv. Committee Report
1. Outside directors cant be liable bc they had no info about the Katz
a. Lack of knowledge is not a defense
b. Ignorance itself is a breach of fid duty
2. Corps CEO dominated the management and board
3. There is general potential liability bc the bank subjected the principal to
risks of continuing extensions of substantial credit
d. Does the BJR apply to officers who are just officers?
i. In favor: lack of financial incentive to sue officers
ii. Technically doesnt apply to officers
3. Smith v. Van Gorkum (1985) BJ R/duty of care/corporate organization
a. Facts: Have more tax credits than liability want to buy another corporation in order to
write off additional credits Van Gorkum didnt want to do it
i. TransUnions CEO negotiated a deal to sell TU (cash out merger) to Prizker for
$55/share (market share $38, he said $18) technically he cant sell shares he
doesnt own, he was just drunk and made the deal
1. Didnt tell the other directors until they attended a special meeting and
were asked to approve the sale
2. Leverage Buyout (LBO) Company 1 gets a loan and uses it to buy
Company 2s shares with cash
ii. Van Gorkum only informs 2 directors in a 20 minute oral presentation both
think it is a low price and that they can do better
iii. Directors approve merger, then shareholders, relying on directors decision,
approves merger
b. Court: reversed TC finding for the Directors (based on BJR) and remanded for an
evidentiary hearing to determining the fair value of the shares provided damages to
extent value exceeded
i. Officers use statute as protection - Delaware 141(e) says directors can rely on
reports to make their decision, but this court says that reports means physical
written reports
ii. New component of the duty of care and BJR: duty to inform oneself of all
material information reasonably available to them before making decisions
1. The directors did not inform themselves and acted on blind reliance on
Van Gorkums representations
2. Not in good faith
iii. Possible Breaches of Duty of Care Conflict of interest Rest dont apply
1. Maybe if Van Gorkom has stock in the company, selling the stock will
benefit him BUT he would want the highest share price; could rebut
by saying he is old and just wants to cash out
2. 5 inside, 5 outside directors some people think they may lose their
job (that they get paid) = not substantial enough to create a conflict
c. Dissent: stresses the experience of the directors directors of this caliber are not taken in
on a fast shuffle, they were more than qualified to make on the spot business judgments
and the BJR should protect them
d. Notes/Broad Issues
i. Judiciary is looking for procedural shortcomings, not the actual decision itself
ii. Roles when is judicial policing of roles appropriate?
1. Van Gorkom overstepped his role: attempting to force a merger by
setting things up that essentially forced their hand (didnt ask for a time
to determine price, put a time restriction on the decision and limitation
on shopping around)
2. Board did not act in its role by making an informed decision should be
in the best decision of the business owners i.e. shareholders
3. Shareholder also messed up they overwhelmingly approved it- could
only complain that they didnt get enough information or the
information they got was crappy
iii. Satisfying Duty of Care When Pricing Something
1. Hire expert (investment bank) to value for you or give price to see if fair
2. Shop around see how much people would pay to buy the company
3. Control Premium when you buy one share in a company with a bunch
of other shares, you just get the financial benefit. But if you buy all the
shares, you get the financial benefit and control over the company so
youll have to pay more for those shares
a. Merger Price - $55
b. Market Price - $18
c. Would need to find out if $37 was a sufficient CP. Hard to do.
4. Does not have to be exhaustive or go on forever must be reasonable
iv. Ways a Board Can Protect Itself From Liability
1. Confer with general counsel about what you should do
2. Have a lot of process, have a long meeting with lots of docs and the
courts will be reluctant to scrutinize it
3. Studies/shopping around might do too much to be safe, but we have
decided this is the better result
4. Have a shareholders vote give a ton of accurate info and they vote to
approve the merger, you can essentially claim that they ratified the
merger couldnt go in VG
v. Aftermath of Van Gorkum RAINCOAT PROVISIONS
1. It became hard to get directors and officers insurance
2. Delaware 102(b)(7)
a. Applies only directors, not officers
i. Why? Officers can negotiate indemnity provision in
their employment contracts
b. Allows corps to eliminate or limit personal liability of a director
from monetary damages for breaching a fiduciary duty so long
as it doesnt attempt to eliminate:
i. Breach of a duty of loyalty
ii. Liability for acts not in good faith/constitute intentional
iii. Liability for a knowing violation of the law
iv. Liability for a director personally benefitting from
transaction (improper benefit basically DoL)
c. Can still bring a suit against directors for equitable relief
i. E.g. undoing the merger, just not damages
ii. Why take monetary damages out?
iii. Lots of P lawyers bringing meritless suits so they can
settle them and get attorneys fees
3. MBCA 2.02(b)(4)
a. Same as Delaware statute
k. Breach of Duty of Care by Board I naction
1. Barnes v. Andrews (1924)
a. Facts: when P took over the company as receiver of Liberty Starters Corporation, he
found it w/o funds and very little on the sale of its assets
i. D (former director)s only attention to affairs of the comp consisted of talks with
the pres as they met occasionally golfing; went to 1 of 2 board meetings during
b. Court: D is guilty of misprision of office (violation of duty) but not liable to the corp b/c
P (Barnes, the receiver of the corp) hadnt shown that had D performed his duty, the loss
would have been avoided
i. Directors arent expected to interfere individually in the actual conduct of a
companys affairs but they have an individual duty to keep themselves informed
in some detail
1. D made no effect to keep advised of the actual conduct of corp affairs
2. Also, he was only one directorwould be better off trying to sue the
whole board
ii. Ascertainability of loss hard to determine actual amount of loss
iii. Majority View: burden of proof on P to show causation
1. Delaware: when P proves D breached duty = liability; burden of proof
shifts to D to show there was no causal relationship btw breach and
damages (affirmative defense)idea that the director has better access
to information, judicially it is more efficient than requiring P to sue
c. MBCA 8.30(b) and 8.31(a)-(b)
i. Ps must show that Ds breach proximately caused damages
2. In re Caremark Intl Inc. Derivative Litigation (Delaware 1996)
a. Caremark is a healthcare company (huge and employ a lot of people) Shareholders
brought suit alleged directors violated their duty of care by failing to supervise conduct
of Caremark employees Caremark was getting kickbacks
i. Ps settlement express assurances that Caremark will have a more central,
active supervisory system & attorneys fees paid by the corporation
1. Derivative suit settlements (like class actions) require court approval
2. Plaintiffs Attorneys brought the suit to rack up hours and get a
settlementin the short term this screws over the shareholders (the
company had to pay out all the claims & now they have to pay
attorneys fees) might get some benefit in the long run if the
monitoring system makes significant improvements but nothing good in
the short term
b. Court: Settlement in favor of Ps approved
i. Directors can be liable for (1) negligence or (2) losses arising from an
unconsidered failure of the board to act
ii. Graham v. Allis-Chalmers Mtg Co.
1. This court limits the holding of Graham: absent grounds to suspect
deception, neither corporate boards nor senior officers can be charged
with wrongdoing simply for assuming the integrity of employees
iii. Breach of Duty of Care Analysis
1. Can be liable for this breach by action (BJR) or inaction
a. Ordinary business decisions by regular employees can create
liability for the business, BUT that might not be evidence that
the directors arent doing their job
2. Only a sustained, systematic failure of board to exercise oversight will
establish lack of good faith that is necessary to find liability
iv. After Caremark Graham not sufficient,
1. Board has affirmative duty to have some type of monitoring system,
but courts will be deferential to the Board as to whether the system
was good or not
a. This type of monitoring would likely be done by an external
third party to come in occasionally and audit compliance
b. Internal provisions in employee handbooks and instruction to
employees on what the law is (mandatory training, etc), periodic
compliance reports
3. McCall v. Scott (2001) **Modern Rule in Action**
a. Facts: P shareholders allege that Columbias senior management, w/ Board knowledge,
devised schemes to fraudulently increase revenue/profits and provided incentives for
employees to commit fraud. Delaware corporation
b. PP: TC dismissed suit for failure to comply w/ requirements of shareholder derivative
suit TC also said that Caremark can only be violated intentionally
c. Court: there is a substantial likelihood of liability for intentional/reckless breach of duty
of care
i. Overcoming the waiver of liability raincoat provision does not require
intentional conduct somewhat less than intentional
ii. If you have actions that manifest a lack of GF by directors, that can be enough
for director liability
iii. Court was influenced by the fact that the directors had experience
4. What will a P allege in a complaint that asserts a directors neglect of duty? Negligence not
enough; gross negligencenot w/raincoat; recklessDelaware (only requires not in good faith,
intent not required) or intentionalMBCA
5. Judge director on what knowledge they have & dont expect them to go out and get more
knowledge; e.g. when people have a lot of particularized experience we expect them to use it
6. Sarbanes-Oxley Act: wanted to increase the internal accountability of businesses through
increased public disclosure of financial information, forcing the companies to have tougher
policing mechanisms for themselves via audit committees & requires a certain number of outside
directors to serve on boards and participate on the auditing committees
7. Structural Bias Theory Directors will help each other out to get what they want, even if they
are independent with no stake in the company may still do things for an inside director for a
favor later

i. 3 Types: Usurping Corp Opportunity, Directly Competing, Both sides of transaction
ii. Breaching Duty of Loyalty by Competing With the Corporation
1. Jones Co., Inc. v. Frank Burke, Jr. (NY 1954)as a result of his behavior lapse, several
of Duane Jones officers began a new competing agency while still employed with Jones
and then quit after incorporating the new agency
a. One of the directors told Jones of their intention to either buy him out or start a
new company. Incorporated the new business while they were still directors and
officers; then made offer to Jones putting a gun to his head
b. Ultimately, the new agency took many of Jones former accounts
c. Court found former officers violated their duty of loyalty
i. Actions benefitted themselves via destruction of Ps business
2. Officers and Directors have fiduciary duties under corporate law and agency law
liability would not change
a. Can go beyond fiduciary law and go into K and employment law to prevent
directors and officers from stealing clients anti-poaching clause
iii. Breaching Duty of Loyalty by Usurping A Corporate Opportunity
1. Issues
a. Whether a particular opportunity counts as a corporate opportunity
i. Particular opportunity the corporation would have been interested in,
asset or service K
b. What actions would a director have to take to avoid liability (purify a
transaction) for entering into a transaction that might be a corporate
i. Form over function if you follow the process youre okay
1. Like calling shotgun
2. Northeast Harbor Golf Club, Inc. v. Harris (1995)Nancy Harris, Pres of the Golf Club
agreed to purchase Gilpin property on her own and didnt disclose her plans to the board
prior to purchase. When she told them, Board took no action
a. 1979 Purchased Gilpin property in her own name and told board @ august
meeting. Board took no action. Found out about via listing agent who thought
club would be interested.
b. 1985 Harris told Board that she had purchased Smallidge property but had no
plans to develop it. Board took no action. Postmaster informed b/c he does.
c. 1990 bought the property adjoining Smallidge parcel to golf course
d. 1988 Harris began to obtain approval for Bushwood property Board grew
e. 1991 after Board went through substantial change in membership, resolved
that the proposed housing development in Bushwood would be contrary to best
interests of corp.
f. PP: TC found that Club would have been unable to purchase either G or S
properties for itself said Harris did not breach her fiduciary duty as Pres bc
she acted in GF
i. Line of Business Test if there is presented to a corp officer/director a
business opportunity which the corp is financially able to undertake, and
is in the line of the corps businessthe law will not permit the
officer/director to seize the opp for himself
g. Court: TC judgment vacated/remanded
i. Weaknesses of LofB Test
1. Club is not in the business of developing real estate, but might
still be in their interest to buy surrounding property
2. Corps financial ability unduly favors the insider director or
executive who has command of the finances of the corp
h. ALI Test 5.05 (know this) p.241
i. First corporation must show it is a corporate opportunity
1. An opportunity to engage in a business activity of which a
director becomes aware b/c (1) of their role in the corporation
i.e. person offering to them would expect them to offer to the
corporation, (2) through their use of corporate information or
property, if opportunity is one that the person should reasonably
be expected to believe would be of interest to the corporation, or
(3) any opportunity closely related to a business in which the
corporation is engaged or expects to engage
ii. Then corp must show it was
1. Either, 1) Not offered
a. Effective = Must first offer the corporate opportunity to
the corporation and make proper *disclosure of conflict
of interest and *the corporate opportunity
2. Or, 2) Offered but not rejected properly
a. In advance by disinterested directors
b. In advance by a disinterested superior where the offeror
is a senior executive who is not a director, in a matter
which satisfies the BJR
c. In advance (or ratified) by disinterested shareholders
and rejection isnt a waste
3. Defense where offered but not rejected properly that the
Rejection was Fair
i. Harris didnt make full disclosure so she breached her duty
3. Broz v. Cellular Information Systems, Inc. (Delaware 1996)
a. Facts: Broz is director of CIS and sole stockholder/Pres of RFBC (CIS
competitor). Mackinac owned a cell phone license and approached Broz about
RFBC acquiring the license. Mackinac did not contact CIS bc it had just
emerged from bankruptcy. Broz bought the license w/o disclosing or obtaining
approval of CIS board, but he did tell CIS CEO and 2 board members who both
said CIS wouldnt acquire the license.
i. At the same time, PriCellular was engaged in acquiring CIS and was
also interested in the licenses
b. PP: Broz breached his fiduciary duty by not formally presenting the opportunity
to the corporation
c. Court: Broz did not breach his duty
i. If the corp is a target of an acquisition by another company which has an
interest/ability to entertain the opportunity, the director of the target
company doesnt have a fiduciary duty to present the opportunity to the
target company
d. Why Broz did not breach
i. Broz became aware of the opportunity in his individual capacity
ii. CIS not financially capable of exploiting the opportunity
iii. CIS did not have a clear interest in the opportunity
iv. The Corp Opp doctrine only applies where the fiduciarys seizure of an
opportunity results in a conflict btw his duties to the corp and his self-
interest CIS was aware of Broz conflicting duties
v. If the director believes that the corp is not entitled to the opp, then he
may take it for himself
e. Delaware: presentation to the board is a safe harbor and will immunize a
director but it is not required
4. Corporate Opportunity Doctrine (Delaware) **FOCUS ON THIS ONE**
a. Corporate officer/director may not take a business opportunity for his own if:
i. The corporation is financially able to exploit the opportunity
ii. The opportunity is within the corporations line of business
iii. The corporation has an interest or expectancy in the opportunity
iv. By taking the opportunity for his own, the corporate fiduciary will be
placed in a position inimical to his duties to the corporation
b. No one factor is dispositive
c. Corollary
i. Director/Officer may take a corporate opportunity if:
1. The opportunity is presented to the director in his individual,
not corporate, capacity
2. The opportunity is not essential to the corporation
3. The corporation holds no interest/expectancy in the opportunity
4. The director has not wrongfully employed the resources of the
corporation in pursuing the opportunity
5. Hypo
a. Marty Steward is CEO of a company and was given stock as part of his
compensation. Company still has other shares authorized to issue. Marty sells all
his shares in the market. If shareholders wanted to sue Marty for breach of duty
of loyalty. What would their theory of loyalty be?
i. What opportunity has been taken from the corporation?
1. Corp could have issued the stock and gotten money instead of
giving it to Marty (Marty usurped the corps opportunity to
make $)
ii. Ultimate answer: NO BREACH
1. Selling stock isnt within the companys line of business
2. Practically, an officer shouldnt be prevented from selling stock
just b/c there are non-issued authorized shares
iv. Breaching Duty of Loyalty by Being on Both Sides Interested Director Transactions
1. What is an appropriate type of transaction? Fair process, Fair substance, Both?
a. MBCA 8.60-8.63
2. HMG/Courtland Properties, Inc. v. Gray (1999)
a. Facts: Gray/Fieber were 2 of 5 directors of HMG. Gray was its principal
negotiator in real estate transactions negotiated major sale to NAF
i. Fieber owned interest in NAF, disclosed the interest to board, abstained
from voting
ii. Gray also owned an interest, but did not disclose interest, and did vote.
Fieber knew this, but didnt say anything
b. Court: Gray/Fieber breached their fiduciary duties of loyalty/care and defrauded
the company
c. Delaware 144 interested director transactions arent void if there is:
i. Procedural if satisfied we look to BJR (not exculpatory-court must
look at BJR), if not go to Total Fairness
1. Full disclosure and ratification by Board of Directors or
superior officers
2. Full disclosure and ratification by Shareholders
ii. Substantive Total Fairness Test
1. Transaction is fair at the time authorized financial and
economic factors + any other relevant factors
d. Proof of such undisclosed self-dealing is sufficient to rebut the presumption of
the BJR and invoke entire fairness review
i. Fair Dealing not here
1. Gray was interested in taking a position on the buyers side
ii. Fair Price
1. How do we know Gray/Fiber didnt taint the price to HMGs
e. Because neither disclosed Grays interest, plaintiff's board accepted a
disadvantageous price when a properly motivated negotiator could have done
materially better Nondisclosure constituted fraud
v. Corporate Waste no business person of ordinary sound judgment could believe they received
adequate consideration wont withstand scrutiny under BJR
1. Buying gold b/c price will go up not unreasonable, despite the fact it may be risky and
may be wrong
2. 2 mil development in undeveloped company/start-up chance it will pay off
3. 2 mil to save the pugs charity donations are not waste b/c it could raise PR and
goodwill of the company (pugs in Starbucks sweaters), passes BJR
4. Check for 2 mil to directors nephew for unknown reasons waste DUH
5. Co. continuing to pour money into a company that would never pay back North v. Joy
vi. Cookies Food Products, Inc. v. Lakes Warehouse Distributing Inc. (1988)
1. Facts: Herrig owned 2 businesses. Cookies board asked Herrig to hold distribute
Cookies BBQ sauce via his company Warehouse Distributing Inc. this was a huge
a. 1981 Cookies majority shareholder (LD Cook) wanted to sell his stock
sold to Herrig who became Cookies majority shareholderreplaced a majority
of the board, extended terms of the distributorship agreement AND
i. Herrig developed a new, less expensive product (taco sauce) and the
board paid him a royalty fee for the recipe
b. Company was successful BUT isnt paying out dividends to its shareholders
c. Minority shareholders claimed that sums paid to the majority shareholder and
his companies grossly exceeded their value to the corporation
i. Claimed that the Herrig breached his fiduciary duty because he failed to
disclose fully the benefit that he would gain from arrangements to
distribute the corporation's products
2. PP: TC said Herrig breached no duties
3. Court: Herrig breached no duty
a. Iowa Process Defendant Director(s) has burden to prove no self-dealing
i. Disclosure (or knowledge) and ratify Process
ii. If yes, analyze (BJR)
iii. If no, Total fairness
iv. PLUS Defendant must show Good Faith and Fair Dealing
1. Court should use its independent business judgment to
determine if D acted in good faith, honesty, and fairness in self-
b. Herrigs services to the corporation were neither unfairly priced nor inconsistent
with the corporation's interesttype of market test (not that egregious of an
increase, and he is contributing uniquely to the corporation)
c. Statutes placed the duty of managing the affairs of the corporation on the board
of directors, not the shareholders
i. All the directors knew of Herrigs interest so theres no need for
4. Dissent: Herrig failed his burden of proof that the $ he received was fair
5. N1. Only a director still would have fiduciary duties; only a SH no fiduciary duties
a. BUT! sometimes a Majority SH will have fiduciary duties in a close corp
6. N2. MBCA fairness is always an issue in self-dealing Def must show GF+FD
a. MBCA approach will look at the deal after it happens, so ultimately looks at
whether the transaction was successful, Delaware will only look at the
transaction itself under the BJR
7. Know DELAWARE approach and Cookies approach
8. Closely held corps if you want to sell your stock, its hard b/c theres no public market
a. How to avoid? Have a provision in articles, by-laws and say that if a shareholder
wants out, corp has to buy it at X rate OR put restrictions on ones ability to sell
vii. Legislative Update
1. S-O Act prohibits any publically traded corporation from directly/indirectly lending or
extending credit to its own officers/directors
a. A corporation must adopt a code of ethics for its top officers as to how to deal
with conflicts of interest
i. MBCA 8.30-8.31
1. Post Van Gorkum, lots of provisions allowing corps to cut liability for breach of duty but
not for acts not in good faith
ii. Harder to show lack of GF (aka BF) than breach of duty of care (gross negligence)essentially
has an intent element baked in
1. Ex: Director intentionally acts with a purpose other than advancing the best interests of
the corp
2. Ex: Director acts with intent to violate applicable positive law
3. Ex: Director intentionally fails to act in face of a known duty to act, demonstrating a
conscious disregard for duties
iii. Executive Compensation
1. Govt has tried to curb excessive executive compensation by forcing to disclose
compensation, changing the tax laws for CEO salaries over 1mil failed
a. CEOs demand more pay/golden parachutes after seeing what similarly situated
companies are getting paid
b. Cant isolate just the executive pay from an analysis of similar companies will
never have companies that similar
c. Exec pay is such a small part of overall revenue that it will rarely come into an
investors decision whether to buy shares
2. S-O 951 non-binding shareholder votes @ least every third years; assesses the
acceptability of officers compensation packaging Fair or NOT Fair
a. Very rare for anywhere near a majority saying not fair and where they do say
its excessive, it doesnt matter and there is nothing that can be done unless they
can get a majority vote to control the board of directors
3. Why does this happen?
a. Some governance body is asleep at the wheel Warren Buffet says they are tail-
wagging puppy dogs that are aimlessly following the suggestion of consultants
b. Officers are doing something beyond what they should be doing to inflate their
own compensation
c. The whole system is flawed and even if everyone did everything properly,
compensation would still be inflated
iv. In re The Walt Disney Company Derivative Litigation (Delaware 2006)
1. Facts: Eisner (Disney CEO) chose Michael Ovitz to succeed him. Ovitz was leading
partner/founder of Creative Artists Agency and told Disney he wouldnt give up his 55%
in CAA w/o downside protection
a. Disney knew Ovitzs salary would be high to compensate for him leaving CAA
b. Ovitz wasnt a good match and Disney let him go on a Non-Fault Termination
basis so he got a big severance package
2. Lawsuit: Shareholders sued the directors saying their approval of Ovitz violated
directors duty of care b/c they were insufficiently informed and they acted in BF
3. PP: TC found for the directors (BJR protects it)
4. Court: Found for directors
a. No breach of duty of care for contract severance terms or hiring b/c terrible
i. Directors knew the consequence of terminating Ovitz w/o cause because
they looked at:
1. Benchmark Options looked at what other CEOs were paid
2. Ovitzs downside protection 20-25 million a year from CAA
ii. Bad employee looked rational at the time, cant look at other
information after the hiring to show there was a breach of duty
b. No bad faith
i. 3 Arguments of possible BF
1. Subjective fiduciary conduct motivated by actual intent to do
harm BF but N/A here
2. Lack of due care was a breach of GF fiduciary action taken by
reason of gross negligence and w/o malevolent intent
Although no breach of duty of care proven, this isnt bad faith
a. Gross negligence, w/o more, isnt BF
3. Conscious disregard for responsibility BF but N/A here
a. Does not involve disloyalty (as traditionally defined)
but is qualitatively more culpable than gross negligence
ii. Actions must be more egregious to violate duty of good faith than to
violate duty of care
c. Specific Examples of BF Intent to act contrary to corps best interests; Intent
to violate applicable positive law; Intentional failure to act in face of a known
duty to act, demonstrating a conscious disregard of his duties (Caremark) (no
monitoring-? Of whether intent also required)
d. Prof: Bad intent (including not advancing interest or corporation) or
Disregard of Positive Law or KNOWN duty (publically like duty to monitor)
regardless of intent, you will be held liable
i. Included under Duty of Loyalty b/c it cant be protected under raincoat
n. SHAREHOLDER SUITS: Derivative and Direct
i. Derivative: shareholder sues to vindicate the corporations claim
1. Must abide by procedural requirements
a. Deciding whether to bring suit is a management decision
b. Where directors may not make the decision to sue themselves, the shareholders
may take it upon themselves
i. Not a good business decision: cost of litigation>recovery or detrimental
to the business relationshipnot here
ii. Directors may have a questionable motive
2. Example
a. You invest in a public company that makes dolls. Companys treasurer starts
stealing companys product. Due to her theft, the companys profits suffer and
stock prices fall. Despite the fact that youve suffered a loss, you have no direct
cause of action against treasurer. Only the owner of the property shes taken
(corporation) has the right to file suit against her
b. Corp has K with Vendor and Vendor breaches K
i. Who decides what corp should do?
1. Officers (if its a low K) or Directors (if its more significant)
2. Shareholders would not take this over
ii. Shareholders would only bring suit if the directors/officers are involved
and wouldnt be expected to sue themselves
ii. Direct: shareholder seeks to vindicate a personal claim growing out of her ownership of stock
1. No procedural requirements
2. Example: Ds conduct injures only some shareholders
iii. Eisenberg v. Flying Tiger Line, Inc (2d Cir 1971)
1. Facts: P owned stock in Flying Tiger which formed a subsidiary called FTC which
formed another subsidiary called FTL. Flying Tiger merged into FTL, which now runs
the airplanes. Shareholders of Flying Tiger got stock in FTC, not FTL
2. Lawsuit: P said the mergers deprived him of any vote or influence
a. Ds said this is a derivative, not direct, suit and P must post bond (a procedural
requirement of a derivative suit)
b. P refused TC dismissed case b/c this is derivative suit
3. Court: this is a direct suit, P didnt have to post bond
a. Gordon v. Elliman this court limits this decision
i. An action to compel payment of a dividend is derivative the test is
whether the object of the lawsuit is to recover upon a chose in action or
to compel performance of acts in GF NOW this would be direct
b. Why would the company eliminate FT and create FT2?
i. Make airline only accountable to FTC, not shareholders
ii. To avoid having to comply with additional regulations if they were to
move into another industry
c. Was there actually an injury? (if he was min SH with no power)
i. He only has a few votes which would have affected nothing in prior if
not later
ii. For merger to have happened, would have needed SH approval; it was
approved, therefore he had his process
d. Court considered substantive diff between the corps
i. Generally, with cases like this if you dont like the merger, sell your
e. If cases are not asking for monetary damages or attny fees, its likely to be a
real suit that someone cares about
i. On the other side, attny fees might indicate a strike suit
4. Theres now a new statute look at the object of the suit
a. If winning will provide a judgment that benefits the corp derivative
b. If winning will benefit shareholders direct
5. Where the corporation has no right of action by reason of the transaction complained of,
the suit is not derivative***
iv. Procedural Requirements of a Derivative Suit
1. Stock Ownership Must own at the time the harm occurred
a. Dont want to encourage this type of litigation
b. Cant buy your way into litigation
c. If you buy later, youve suffered no injury b/c you buy at a price that reflects the
corporate malfeasance
d. **Some states allow you to be legit owner if you bought before the material
facts were publically known**
2. Security for Expenses
3. Demand on Directors (written) MBCA 7.42
a. Why?
i. Whether the corporation should bring suit is a management decision, so
the demand requirement places the issue before the people who should
be making the decisiondont want SH to contest all decisions
ii. Demand futility where demand upon the board would be futile
(Aronson test)
b. After demand
i. Board can accept the recommendation and authorize corp. to sue
ii. Board can reject demand
1. Shareholder can forget it
2. Shareholder can assert that board erred in its decision
essentially claiming a violation of BJR
a. Would have to show: 1) that board made decision w/o
any on-the-record-efforts to look like they were acting
seriously, or 2) that the decision was tainted by conflict
of interest
4. Marx v. Akers (NY App. 1996)
a. Facts: P (Marx) is an IBM shareholder, IBM has 18 member board, 3 are inside
directors; P sues alleging waste of corporation assets by paying excessive $ to
IBM exec (3 inside directors) and paying too much $ to 15 outside directors. P
didnt make demand on board
b. PP: case dismissed for failure to make demand (on 3 inside directors), and
demand waived for second claim (for paying too much $ to 15 directors) BUT
failure to state cause of action b/c voting on own pay is okay by statute
i. P didnt state with particularity
c. Court: case dismissed
i. Delaware Approach to Demand Futility** (Aronson)
1. P must allege particularized facts to create a reasonable
doubt that:
a. A majority of directors are disinterested and
independent AND
b. Challenged transaction was otherwise the product of
valid business judgment (procedural + substantive due
care = informed decision and terms of transaction were
2. If you can show that there is a dominant board member, you
dont need a majority
3. In Delaware if you make a demand, the court sees it as an
admission that the board is NOT interested a.k.a. tainted
a. So, as long as their No decision has some sort of
process, it will typically pass the BJR and youre done
ii. MBCA/ALI Universal Demand
1. Demand required in all cases, prohibits commencement of
proceeding w/in 90 days of demand
a. Exception: corporation will suffer irreparable injury
as a result of waiting for 90 days, OR when the
demand is rejected before 90 days
iii. New York**
1. P must allege with particularity that: (higher standard facts
that can be proven true or false that will answer the 3 parts; hard
to do when there hasnt been discovery)
a. Majority of directors are interested OR
b. Directors failed to reasonably inform themselves OR
i. This wont fall under BJR
c. Directors failed to exercise their business judgment
2. Court says P failed this. No particularity.
iv. Demand is excused BUT, P has failed all these standards need much
more to prove!
d. Notes
i. If P makes demand and its denied, then courts will usually respect that
decision unless its very obvious that the board is interested/dependent
ii. When demand is excused, you can file suit
1. Board will then argue that demand should not be excused
2. Board can also argue that it made an independent decision that
litigation is not worth pursuing
5. Motions to Dismiss By Board where Demand is Excused
a. Argument that the potential benefits from the corporations continuing the suit
are not worth the costscosts exceed recovery, or likelihood of success is poor
i. When claim is against a 3d party the Court will generally respect BJR
ii. When claim is of director wrongdoing, Court will not accept BJR b/c it
is in the directors best interest to have the suit dismissed
b. Special Litigation Committee (SLC) made up of disinterested directors to
decide whether it is in the corporations best interest to pursue the suit against
the interested directors
i. Is the SLC sufficiently independent??
c. Auerbach v. Bennett (NY App. 1979)
i. Facts: 3 person minority committee of a board decided to not prosecute
a shareholders derivative action b/c it wouldnt be in the best interests
of the company (4/15 directors are interested)
1. P says that any committee made of the board is legally infirm
ii. PP: TC grants SJ to corporation
iii. Court: SLC decision upheld granted SJ for corporation
1. Two possible complaints against SLC
a. Selection of procedures (ok for court to analyze this)
b. Substantive decision (outside scope of judicial review
b/c this is a business judgment)
2. Once the special committee was deemed to be impartial and
disinterested in the issue at hand, their decision is entitled to
deference by the court under the BJR
a. The committee is not dependent just b/c it was selected
by interested directors
b. SLC here was formed by a board that was mostly
innocent (11/15 directors were ok)
c. However, there has to be some process that the court
can evaluate to determine if it is fair
iv. This is more like the MBCA 7.44 approach will recognize SLCs and
will NOT review the substantive decision of the SLC, just process +
d. Zapata Corporation v. Maldonaldo (Delaware 1981)
i. Facts: Maldonado said demand futile b/c all 10 directors are defendants
(this would excuse demand under Delaware code)
1. 2 new outside directors placed on an Independent Investigation
Committee decided that the actions should be dismissed
ii. PP: Court of Chancery said that once demand is made and refused, a
stockholder has an independent, individual right to continue the suit
1. Denied corporations M4SJ, holding that the BJR was not
appropriate for dismissal of a stockholder's derivative suit
iii. SC (interlocutory appeal): rejected Court of Chancery
1. Boards decision to deny will be respected unless its wrongful
a. A committee of disinterested directors can properly act
for the corp. to move to dismiss litigation believed to be
detrimental to corp.s best interest
2. Two Step Process: Courts Role (for M4SJ)
a. Corporation has burden of proving SLC independence,
good faith, and reasonable investigation/process
b. Courts should apply their own business judgment to the
form + substance of SLC appointment and decision (If
satisfy BJR, M4SJ should be granted)
3. Whats in the best interests of the company?
a. Public policy avoid structural bias (directors will be
favorable to other directors); want to police directors
somehow but only to the extent that the shareholders
should have a right balance against strike suits
b. Professor: this is odd because courts constantly try to
stay out of companys business judgments do they
have the knowledge to make these decisions
v. Recovery in Derivative Suits
1. A recovery in a successful derivative case goes to the corporation
a. Settlement has to be approved by the court protects the individuals that are not
a part of the case to ensure their interests are well represented (like class actions)
2. How Directors Can Be Off The Hook for Paying Damages
a. Indemnification look at state statutes, AoI, Bylaws, Employment Ks, etc.
i. Required MBCA 8.52 ~ if a director is sued and they win on all
claims, then the corporation must indemnify them for all their legal
ii. Cannot Indemnify 8.51(d) ~ if director is found guilty of breaching
duties not in good faith
iii. Permitted 8.51 and 8.55 ~ any action that falls between these two areas,
the corporation can decide whether or not to indemnify the director
iv. Questions pg. 304
1. Y, Capel has right to be indemnified b/c she won on all claims.
2. N, Agee doesnt have right to be indemnified b/c he didnt win,
BUT corp can indemnify him if he proved he acted in GF and
reasonably believed he was acting in the corps best interests
v. Advancing fees can be done but lost of issues
b. Insurance MBCA 8.57 (Indemnification by 3d Party)
i. Directors and Officers Insurance (D&O)
1. No insurance will cover intentional illegal actions/breaches
2. Odd: theres certain acts you cant indemnify, but can insure
ii. Can be sued for stuff you did when you were on the board, even if you
subsequently leave the board
1. Must have D&O insurance at the time the suit is filed for
coverage even if you didnt have during the event in question

IX. How Do Corporations Grow?
a. Debt and Equity Capital
i. Debt
1. Debt must be paid back and is borrowed with interest
2. Lenders have no ownership in the corporation
3. Debt is preferred to avoid dilution/ownership rights of existing directors
a. Interest can be written off in taxes (lowers the cost of borrowing)
b. Will increase ROE
c. Debt is a lot cheaper and a lot less risk
ii. Equity
1. Equity is $ invested so that investors become owners of the firm
2. No obligation to repay equity, but it is conceivably paid back via dividends or when the
stock is sold ultimately more expensive to the existing owners (want to keep the profit)
3. More expensive to conduct an equity offering (underwriter, etc.) regulatory burden is
iii. Returns
1. RoI -
2. Return on Capital rate of return that a business earns on financial capital
a. EBIT Total Capital
3. Return on Equity
a. Net Income from T1 to T2 Total Equity Investment
i. The more you borrow, the more equity you have, the higher your ROE
is (i.e. leveraging)
ii. Risks of Leveraging
1. Creates fixed payment obligations
2. Increases chances of ending up insolvent
iii. What Prevents Unlimited Leveraging?
1. Financing institutions wont lend more $ b/c the fixed
obligations are too high
2. Higher interest rates
iv. What is the right level of debt?
1. Look at companies of a similar size in the same industry
2. Annual amount have to pay on debt to yearly CF (Coverage ratio: CF before finance
charges aka income: Debt Payment higher ratio the better)
v. Lawyer Duties in Borrowing More Money
1. Negotiating the Loan
a. Who is going to make the loan?
i. Assist to find the lender
b. What covenants will lender require?
i. Examples: limits on large expenditures, distribution restrictions
c. How is the corporation going to service the debt?
i. Secured transactions
d. What happens if the corporation defaults?
i. Major shareholders often required to personally guarantee payment
ii. Negotiate default provisions what constitutes default?
vi. Issuing More Stock
1. Preemptive Rights (common law rule) a shareholder w/ preemptive rights has the
right to purchase that number of shares of any new issuance of shares that will enable
him to maintain his percentage of ownership and avoid dilution
a. No requirement to exercise these rights
b. MBCA 6.30(b)(3)(iv) no preemptive rights when sold otherwise than for
i. Preemptive rights only apply when sold for money, not when given as
ii. Only applies to issuances, not if stockholders are selling as a secondary
sale (when Agee sells to Roger as Agees own private property)
2. Byelick v. Vivadelli (East. Dist. VA 1999)
a. Facts: VTIC Board (composed of the Vivadellis) eliminated shareholders
preemptive rights but then authorized 50K shares to Ds. This reduced Ps
ownership interest from 10% to 1%.
i. P alleged breach of fiduciary duty in a direct suit (exception to
derivative suits against close-corps)
b. PP: TC denied SJ for P.
c. Court: SJ denied for both parties, but burden is on Ds
i. Court looked to Donahue
1. A close-corporation is like a partnership, and the relationship
btw stockholders is one of trust, confidence, and absolute
2. In close-corps, an individual can bring a derivative claim as a
direct action
3. Why? Minority shareholders in close-corps need more
ii. Duty of Loyalty issuing furthered own interest not corporation, when
it wasnt offered to other as well (low price would also be a trigger)
iii. The common law of fiduciaries, with or without preemptive rights,
prohibits Ds from acting in this way
1. Burden on Ds to show (1) the fairness to the corporation of
approving the sale and (2) the actual sale (i.e. price)
d. Close Corp v. Public Corp: Sensibility of Preemptive Rights
i. $$$
1. PC possible $
2. CC possible $ (2
sale, dividend)
ii. Administratively
1. PC difficult
2. CC easy
iii. Powers
1. PC not really diluted b/c there are so many shareholders, stock
benefits are just $
2. CC diluted, the stock benefits are $ and control
iv. Public Market
1. PC stockholders can just go buy more in public market
2. CC no public market to buy more!
e. Market Cap = Price per share at which shares trade times the number of shares
vii. Venture Capital
1. Venture capital substantial equity investment in a non-public entity that doesnt
involve active control of the firm
a. Second tier/mezzanine financing when companies past the start-up stage need
additional $
b. Angels once-successful companies that have fallen on hard times call out to
c. Only 1/3 of VC companies succeed
i. VCs demand high returns because (1) the successful 1/3 of their
investments must cover the losses and (2) they cannot reduce risks by
diversifying and (3) unable to sell their stock at a fair price whenever
they choose
d. VC Special Rights
i. Downside protection
ii. Upside opportunities
iii. Voting/Veto rights
iv. Exit opportunities
b. Legal Constraints on Stock I ssuance
i. Registration
1. Underwriters an investment bank that draws up offering memo that is filed with the
SEC and offers selling advice
a. Two Bases
i. Firm Commitment basis underwriter buys all shares in the public
offering at the public offering price, less a negotiated discount, then
resells the shares to other investment bankers and the public
ii. Best Efforts basis underwriter uses its best effort to help find buyers
for the stock
ii. Questions pg 332
1. At what point:
a. Does the corp make $? When all the shares are sold.
b. Does the underwriter make $? Resale or upfront
c. Do the attnys make $? Monthly?
2. Tell her her % of ownership will probably decrease but there will be a public market for
her shares and she can sell them easily ~ makes liquid asset. Also, a company that is
going public is doing well. Can use money raised to do more.
iii. Legal I ssues in Securities Regulation
1. As long as full disclosure is made, govt wont prevent a security from being sold
2. Relevant Acts
a. Securities Act of 1933
i. Dictates rules for what you have to do when making a public offering
(i.e. file docs with SEC, can only sell after approval)
b. Securities Act of 1934
i. Requires corporations to make regular disclosures to govt/public and
people buying and selling on the secondary market cannot do certain
c. Fraud SEC 10b-5 no defrauding, dont lie or fail to disclose material
information; applies to issuances and secondary sales
i. Problems pg 336
1. Agees statement is clearly fraud and in connection with the
sale, so Agee is statutorily liable
a. Agee may also be liable under tort
2. Omissions count as misleading statements Agee is probably
still liable
a. Agee doesnt have tort liability bc he didnt take
affirmative action
X. How Do Corporation Owners Make Money?
a. Ways to Make Money
i. Dividends
ii. Salary (most common in close corps)
iii. Selling shares
1. Difficult for close corps because there isnt a public market
2. SH in a public market look to this primarily to make $, dont care about control
iv. Liquidation
b. Protection of Minority Shareholders
i. Amended dissolution statutes to include oppression as grounds for MS to force dissolution
ii. Enhanced fiduciary duties between shareholders of close corporations usually Maj duty to Min,
sometimes both to one another
c. Receiving Salaries
i. Who Decides Which Shareholders Get Salaries?
1. Wilkes v. Springside Nursing Home, Inc. (Mass. 1976)
a. Wilkes was paid a salary as a SH and owner of a nursing home forced out
and denied salary
b. Court: held for Wilkes bc majority SH didnt show a legit business purpose in
firing Wilkes
2. Hollis v. Hill (5th Cir. 2000)
a. Facts: P (Hollis) and D (Hill) founded FFUSA (50% shares each) which
marketed first lien MTG notes and other non-security products
i. Hill was director, president, in Houston // Hollis was director, VP, in
Melbourne, FL. Wives of both completed the board
ii. Hill believed Hollis wasnt carrying equal weight so he stopped paying
Hollis salary. Hollis offered solutions to the dispute, which Hill
rejected. Hill offered to buy Hollis interest but Hollis refused
iii. Hill took FFUSAs annuity business and put it in a sole proprietorship to
avoid a cease-and-desist order from Texas
iv. Hill stopped sending financial reports to Hollis, refused to let him see
the records. In 1998, Hill reduced Hollis salary to zero.
v. Hollis filed suit Hill fired Hollis and later, made a capital call to him
b. Issue: SH oppression breach of fiduciary duty by HILL as a SH/CO-OWNER
c. PP: TC said Hills conduct was oppressive and ordered him to buy Hollis
shares at the value on Feb 28, 1998 (the date the oppression began)
d. Court: Hill did oppress Hollis, but the value date should be Nov 1998
i. Court applies Texas law (choice of law) which says Nevada law governs
internal affairs doctrine
ii. Existence of Fiduciary Duty
1. The fiduciary relationship between Hollis/Hill was like a
partnership (only 2 SHs, no SH meetings or elections of board
or adherence to by-laws, money made principally by salary, not
a. Failure to observe corporate formalities like a
2. Court looked to Nevada case Clark v. Lubritz
3. Unique opportunities for abuse in close corps
4. Donahue duty btw controlling/minority SH = duty btw
partners in partnership
a. Close corps are treated differently because:
i. Small # of SH
ii. No market for shares
iii. Expectation of salary
iii. Various States
1. Delaware no fiduciary duties btw SH in CC
2. Mass yes fiduciary duties btw SH in CC
3. Nevada maybe fiduciary duties btw SH in CC
iv. Breach of Fiduciary Duty
1. Court looked to Wilkes (Mass)
2. SH in close corps owe each other a duty of utmost GF and
3. Process (Massachusetts test)
a. P shows there is a breach of fiduciary duty burden
shifts to Ds to show there is a legitimate business
purpose burden shifts back to P/SH to demonstrate
that the purpose could have been achieved through
means less disruptive to its SH interests
i. No fiduciary duty owed to employees so you
can fire someone as a bad employeeodd
4. Controlling SH cannot effectively deprive a minority SH of his
interest as a SH by terminating the latters employment or salary
v. Remedy
1. The presumptive valuation date in other states for buy-out
remedies is the date of filing of the law suit UNLESS
exceptional circumstances exist which require an earlier or later
date to be chosen
e. Dissent
i. Nevada (where FFUSA is incorporated) doesnt recognize a cause of
action for oppression of minority SHs
ii. Doesnt understand why majority follows Massachusetts law
f. Notes
i. **A majority/controlling SH has fiduciary duties in close corps**
ii. If someone has an employment K, then the roles of employee and SH
are very distinct. If there is no employment K, the roles are intertwined.
1. Here there was no K, means at-will punishing the maj SH
for firing the at will employee is a little odd, but it makes sense
b/c the violation is a fiduciary nature not K
a. Minority Shareholder oppression argument
2. If there was a K, he could have just sued for breach of K; were
K we look at that 1
and corporate law wont enter the picture
3. Where term K not fired for cause just sue
iii. Why did one party control over the other in this case where they were
equal shareholders? he was a pussy, could have taken to court at any
point in time based on 50%
iv. How to prevent this from happening at all?
1. Tie-breaker by statute or in AoI
2. Binding shareholders agreement McQuade v. Stoneham
v. What duty did Hill exactly breach?
1. Loyalty
a. Usurping corporate opportunity
b. Both sides of a transaction
2. Self dealing and in BF by depriving minority SH their rights,
etc. would be stronger if he had given himself a K
vi. Choice of Law choice of law decided by the law where case is filed
1. Case filed in TX internal affairs doctrine
a. Substantive law of state of incorporation Nevada
2. Looked @ Nevada law nothing applicable
a. Nothing applicable from Delaware
b. Massachusetts has a stance
vii. No legal right to receive the same salary just b/c you are equal SH and
running the company
viii. No oppression claim or breach of fiduciary duty just because one party
is getting paid a bit less/more than the other need more
ix. Clark breach employment agreement / salary not here, actions taken
w/out Clarks knowledge here he knew
x. Wilkes SH may have wanted to get out, not like
ii. Legal Limits on Salaries
1. Corporation must pay taxes on its income after deducting ordinary and necessary
business expenses (i.e. salaries) not others (i.e. dividends, SH distributions)
a. Entices corporations to pay people a lot and not pay dividends
2. Exacto Spring Corp. v. Commissioner of Internal Revenue (7th Cir. 1999)
a. Facts: Exacto paid its cofounder, chief exec, and principal owner $1.3M and
$1M in 93/94. IRS said it shouldnt be more than $381K/$400K.
i. 26 USC 161(a)(1) allows a business to deduct from its income its
ordinary and necessary business expenses, including a reasonable
allowance for salaries or other compensation for personal services
actually rendered
b. PP: Tax Ct found that it should be $900K/$700K
i. Tax Court applied 7 Factor Test
c. Court: Found for Heitz
i. Rejected 7 Factor Test
1. Nondirective
2. Factors have no clear relation to each other or primary purpose
of 26 USC 162(a)(1) which is to prevent dividends from being
disguised as salary
3. Gives too much authority to courts
4. Invites making of arbitrary decisions
5. Corps run risks in determining a level of compensation that may
be indispensible to success
ii. Threat greater when there is a small/close corporation
iii. I ndirect Market Test / I ndependent I nvestor Test
1. What is the rate of return to the owners investment? The higher
the ROR (adjusted for risk) that a CEO/manager/etc. can
generate, the higher the salary Must actually do work
a. Look at similar companies ROR and compare to
companies ROR
b. If ROR is higher than average, then presumably he
should get a chunk of it
2. CEOs salary is presumptively reasonable
a. Rebutted by proving the increased return has nothing to
do with the persons work
b. If there is intent to dodge taxes by paying a salary
instead of dividends, that also violates the statute
SO, dont write it down!
c. Heitzs salary was approved by other owners/minority
SH who had no incentive to disguise a dividend as a
salary no BF
iv. Shareholder Approval Helvestons method
1. Shareholders agree to pay a certain amount, they consider it to
be reasonable
2. More consistent with the BJR process check, 7 factor and
Posners are both on the substantive merits of the decision
3. Why is this not the case? not really corporate law issue, its a
tax law issue. . .
3. Giannotti v. Hamway (VA. 1990)
a. Facts: Ps (minority SH) sued Ds (majority SH) for authorizing and making
payments from corporate funds to themselves for directors fees and officers
salaries grossly in excess of the value of services rendered AND acting in BF,
refusing to declare dividends
b. PP: TC found for Ps and ordered corporate dissolution, refused Ps request to
orders Ds to restore assets. Court appointed receiver to liquidate corporate assets
i. Court said Ds were oppressive and breached fiduciary duties by freezing
out Ps
ii. Courts can liquidate if waste or fraud is proved
c. Court: found for Ps
i. Fiduciary Duties = director of a private corporation cant, in any
transaction in which he is under a duty to guard the interests of the
corporation, acquire any personal advantage, or make any profit for
ii. Burden shifted onto Ds
1. When directors of a close corporation elect themselves and set
their own salaries and all are accused, its impossible to have a
disinterested board
a. P has to prove that the board is interested or else the
BJR will apply and the salary will probably be upheld
2. If P has shown that there is self-dealing burden on directors
to prove that the transaction was fair and reasonable to the
corporation [Total Fairness = Fair Process + Fair Price]
iii. Why Ds lose = breach of duty + opression
1. Experience
a. Had very little qualifications to run a nursing home
2. Hourly Pay
a. Scope of work was limited five people were doing the
work of one
3. Libbie would be more profitable had it not been for excessive
iv. Liquidation is proper [corporate death penaltywhere oppression is so
bad, here is required by the state statute], recovering assets is not b/c
then the money would go back to the corporation and would siphon
down to the directors
v. Receiver appointed will have the opportunity to try to get money back
from the directors now that the corporation is being liquidated
d. Dissent
i. Ps havent suffered unusually only what minority SHs usually go
ii. Many different ways to value a corporationif another measure was
used, then the corporation may have been just as good as another
iii. The remedy, if any, would be a dividend, not liquidation
e. How could Ds have shown good faith?
i. Show comparison to other corporations, show the work they do to earn
the amount they are paid
f. Why sue for dissolution instead of money damages?
i. Hard to value
ii. Want their money out of the corporation this is closely held no
market for their shares, best way to get the most $$
1. Might be better return to sell the assets of the corporation now
than to wait into the future
iii. People really hate each other, and so we get weird law suits
iv. Might use for leverage in negotiationsmoney damages can be insured
against or indemnified
d. Receiving Dividends
i. General
1. A dividend is a special type of distribution, a payment to SH by the corporation out of its
current or retained earnings in proportion to the # of shares owned by the SH
a. Whether to pay dividends is a management decisions by board
b. SH in public corps might not care about dividends b/c theyd want that $ to go
back into the corporation so the value of stock will rise in case they want to sell
i. Helveston doesnt think this is very persuasive b/c if a company is
issuing dividends, more people are willing to buy stock in that company
& valuation doesnt work perfectly
c. SH in private corps (closely held/non publically traded) will want dividends b/c
they cant sell on the public market, so this is the only way to make $
ii. Approaches re: Dividends
1. MBCA Modern Insolvency Approach
a. MBCA 6.40(c) a corporation cannot declare dividends when insolvent or
when they would be insolvent after the distribution.
b. Definitions of insolvency:
i. 6.40(c)(1) Equity Test
1. If unable to pay its debts as they become due
a. PROBLEM: lots of speculation, dont really know what
you will look like in the future
ii. 6.40(c)(2) Balance Test
1. Look at assets and liabilities
a. If L > A no dividends (insolvent)
b. If L < A dividends ok
2. W/preferred stock you can create entitlements to payments for
distributions or for bankruptcyif these exist, the entitlements
are effectively added to liabilities on the balance sheet
c. MBCA 8.33(b) liability on directors for making distributions in violation of
d. Distributions are ok as long as the corp isnt insolvent and the distribution
doesnt render it insolvent
2. Traditional View **still exists in New York and Delaware**
a. Earned Surplus
i. May be used to pay distributions
ii. All Earnings All Losses Distributions previously paid = Earned
b. Stated Capital
i. Cannot be used for distributions
ii. Par value of issued shares
iii. Hypo
1. Par value of stock is $1 but we sell for $10.
a. Stated capital = $1
b. Capital surplus = $9
c. Capital Surplus
i. May be used to pay distributions
ii. Whatever is left over after $ is put in stated capital
d. No-Par (no minimum issuance price)
i. Directors are free to allocate funds btw stated capital and capital surplus
ii. BUT if they do nothing, funds go into stated capital and cant be used
for distributions
iii. Zidell v. Zidell (Or. 1977)
1. Facts: Arnold owned 3/8 stock, his brother and nephew 3/8, 1/4 respectively. Arnold
wanted a raise in salary, board refused, Arnold resigned and demanded dividends (which
wasnt customary practice for the corps)
a. Arnold: dividends are unreasonably small and not set in GF, while
salaries/bonuses increased
2. PP: TC said larger dividends should have been declared
3. Court: found for Ds
a. Duty of GF and fair dealing is discharged re: dividends if the decisions is made
in GF and reflects legit business purposes rather than private interests of those in
i. P has burden of proving BF
b. P left voluntarily and his dividends arent unreasonable
iv. Dodge v. Ford Motor Co. (Mich 1919)
1. Facts: Ford SH received high dividends Henry Ford refused to pay SH who then
went onto make Dodge sued
a. Henry Ford had legit business reasons for withholding dividends BUT he said he
wanted to use it to provide the public with cheap cars
2. Court found for Dodge re. issuing a dividend b/c Ford did not present a legit business
purpose, essentially saying it is wastebut the injunction was reversed, Ford could still
a. Court would not force a special dividend nowwould use the increase the
overall goodwill and public perception of the company
v. Sinclair Oil Corporation v. Levien (Delaware 1971)
1. Facts: Sinclair owned 97% stock of principal Sinven. P (Levien) owned 3K/120K of
Sinven stock. Sinclair nominates all members of Sinvens board. Sinven paid out
dividends in a period when it needed cash
2. PP: Chancellor found that Sinvens board was not independent and that Sinclair did not
sustain its burden of proving that the dividends were fair to the minority stockholders of
3. Court:
a. P has to meet its burden of proving that a dividend cannot be grounded on any
reasonable business objective OR that it was self-dealing
i. P didnt show that the dividends resulted from improper motives and
amounted to waste
b. If a dividend is self dealing apply intrinsic fairness standard
i. These dividends were not self-dealing apply BJR
4. Notes
a. If a company issues a dividend, apply MBCA or Traditional Approach to see if
its valid
b. Other than that, its very hard to invalidate a decision to pay a dividend,
especially when there is only one class of stock
c. Can pay a dividend from retained earnings in excess of retained earning from a
particular year
vi. To Whom Are Dividends Paid?
1. Types of Stock
a. Common Stock a class of stock with no preferences
b. Preferred Stock a class of stock with a preference, such as priority in the
receipt of dividends
c. Preferred Participating Stock a class of stock that gets paid first, but also gets
paid again, along with common shares, in which is left over after payment of the
d. Preferred Cumulative Stock a class of stock where dividends accrue and carry
over from year-to-year
i. If PCS isnt paid out in one year, then it accrues and they are owed that
for the next year
2. Problems
a. One
i. Class 1 10,000 common / Class 2 2,000 w/ $2 preference
ii. $40K dividend
iii. What are the payments?
1. $4000 to preferred (class 2, $2/share)
2. $36,000 to common (class 1, $3.60/share)
b. Two
i. Class 1 10,000 common /Class 2 2,000 w/ $2 participating preferred
ii. $40K dividend
1. $4000 to preferred participating
2. $36,000 to common and preferred/participating (so $3/share to
common and preferred/participating (36K/12K)
c. Three
i. Class 1 10,000 common/Class 2 2,000 w/ $2 cumulative
ii. $40K dividend
iii. No dividends over past 3 years
1. $6/share for cumulative + $2 current year = 8 x 2000 = 16K
2. $2.40 for common stock (24K/10K)
3. Fiduciary Duties and Shareholders
a. Majority SH has fiduciary duties to corporationin close corporations this
fiduciary duty also extends to other minority SHs
b. Majority SH cannot misappropriate corp assets
i. But what is a corporate asset?
1. Some lawsuits have claimed that a control premium is a
corporate asset (courts do not agree w/this!)
2. Under the law the CP belongs to the Majority Shareholder, they
can profit that and it is FINE . . but you can still end up with
liability see HYPO below
vii. Control Premium
1. Control Premium: when a buyer is willing to pay an amount over the bare value of the
stock b/c ownership of the block of stock carries with it the power to control the
direction of the corporation
a. Stacked Board allows the buyer, who is the new controlling SH, to have her
people take control of the board
2. DeBaun Hypo
a. Facts
i. Pug Corp Helvie owns 70%, Karl owns 10%, Pickles owns 20%
Helvie dies and Bank becomes executor of Helvies estate Bank
wants to liquidate Helvies shares
ii. Bank investigates potential purchasers of stock and likes bid made by
Sketchy Corp but see SC has a lot of bad creditor history Sketchy
Corp makes a much larger $250k bid but the deal is sketchy (50K cash +
200k profits from Pug Corp earnings in the future) Bank likes
Sketchy Corps officers so they agree
iii. Sketchy Corp now owns 70% of Pug Corp Pug Corp is thus run into
the ground (misappropriation of checks, payroll, accounts, etc.)
$250K in debt
iv. Pickles/Karl stop working at Pug Corp but still own stock
v. Bank sues SC for breach of purchase agreement
1. But Karl/Pickles sue Bank for breach of fiduciary duty when
selling the company, ultimately to a bad purchaser b/c it had
2. Breach of Loyalty took 250k to throw Pug Corp under the bus
a. Bank should have known SC would destroy
corporation, and as a majority SH, Bank held duties to
corporation and Pickles/Karl
vi. Pickles/Karl can sue Bank directly, but can also sue derivatively b/c
Banks actions hurt Pug Corp.
1. Direct is preferred b/c Pickles/Karl will actually see the $ as
opposed to it going back to Pug Corp which is controlled by SC
b. Outcome
i. Bank would be liable if it had knowledge or sufficient facts to raise
suspicion that SC would screw the corporation over
3. ALI Principles of Corporate Governance: controlling SH can sell their shares but they
breach duty of fair dealing if:
a. They dont make disclosure regarding transaction to other SH
b. If its apparent from circumstances that purchaser is likely to violate duty
of fair dealing
4. Perlman v. Feldmann (2d Cir. 1955) **this case is wrong and Helvie doesnt like**
a. Facts: Feldman owned 37% in public company and it was the controlling
i. Feldmann is also CEO and chairman of board of Newport Steel; Buyers
(Wilport) wanted a source of supply of steel that was becoming hard to
obtain b/c of Korean War
1. Feldmann Plan: we will charge a set price but will pick who to
sell to and ask them for interest free advances (loans) so the
actual price will be more than whats set
ii. D sold stock to Wilport that included compensation for the sale of a
corporate asset, a power held in trust for the corporation by Feldmann as
its fiduciary. The power was the ability to control the allocation of
product in a time of short supply, through control of board
Feldmanns board resigned, Wilports nominees were elected
1. Market price of share = $12
2. Feldman sells for $20/share
iii. SH says this shows that Feldman sold a corp asset (the asset of picking
who gets our steel aka the Feldman Plan)
1. Why dont they go after Wilport for breach of duty of loyalty?
b. PP: TC dismissed case b/c the rights associated with the block of stock were
normal and Ps didnt prove that the sales price was not fair. This was a control
premium not a corporate asset
c. Issue: are Ps entitled to a share of the control premium?
d. Court: Found for Ps
i. The facts demonstrate that there was a shortage of steel and Defendants
took advantage of this to obtain a market premium for their shares
1. Feldmann was the president and dominant shareholder, and in
both positions he owes a fiduciary duty to minority shareholders
not to let a personal interest override the interests of all the
2. Feldmann had a duty to share the control premium with other
ii. This is an odd case b/c theres no fraud or looting and once Wilport took
over, Newport actually became more profitable
1. There was no asset that was actually being sold off they still
had the option to decide who got to buy the steel either way
2. There was no inappropriate benefit obtained by Feldmann
selling his shares
3. Could only show DeBraun type case is if it was apparent to
Feldmann that Wilport was going to waste the steel aka throw it
in the ocean
e. Dissent: what duty did Feldmann violate?
f. See note 6 and 7 p. 452 on what happened after sold to steel companynew
managers increased profitability and shareholders benefited.
i. No breach of fiduciary duty.
5. Rule from DeBraun + Perlman:
a. There is only liability for controlling SH when he sells to a looter or when he
obviously is selling a corp asset to get the $ himself
e. Selling Shares
i. Intro
1. Default rule: stock can always be sold to another party
a. Close corp does not have an obligation to purchase SH shares
2. Fiduciary Duty in Public Corps
3. Fiduciary Duty in Close Corps like partnerships
4. Fiduciary Duty in Partnerships strongest
ii. Equal Access Rule
1. Donahue v. Rodd Electrotype Company of New England, Inc. (Mass 1975)
a. Facts: Harry Rodd (majority SH-81) resigned as director of Rodd and sold 45 of
his shares. Later, Donahues (minority SH-45) asked the corp to buy their share
on the same terms given to Rodd, but were told that the corp wasnt in a
financial position to do so
i. Ps argument: breach of fiduciary duty and failure to give equal opp
ii. Ds argument: stock purchase was w/in powers of the corp and there is
no right to equal opp
b. PP: TC found that the transaction was in GF and w/ inherent fairness App Ct
c. Court: Ds breached their fiduciary duties to Ps (this holding limited to close
corps only!)
i. The duties owed btw SH in a close corp = those in a partnership
1. A close corp presents opportunities for majority SH to
oppress/disadvantage minority SH
a. Minority SH cant cause dissolution or sell their shares
in a market, so they need another remedy
i. Direct Suit for breach of fiduciary duty
ii. Breach of Fiduciary duty would usually be a
derivative suit in a typical corporation b/c it
would be the corporation harmed
ii. Rule: if a SH whose shares are purchased was a member of a controlling
group, the controlling SH must cause the corp to offer each SH an equal
opp to sell a ratable # of his shares to the corp at an identical price
iii. Relief
1. Option 1: remit purchase price with interest (what P requested)
2. Option 2: remit purchase price alone (equal opportunity)
d. Problems with Selective Repurchasing of stock creates a liquid market for a
non-liquid assettaking something that there is normally no market for and
creating a market for it & where one person is in control = a preferential
distribution of assets and a breach in fiduciary duty
iii. Buy-Sell Agreements MBCA 6.27
1. A contract that requires the corporation or the majority shareholder of the corporation to
purchase shares in specified situations or restricts who you can sell your shares to
2. Important and should be included in your corporation bylaws (esp. close corps)
a. Combats lack of market, and fear that control might suddenly shift
b. It should establish what triggers an obligation to sell and buy stock and the
purchase price and where the money comes from
c. People dont include them because of ignorance, lack of professionalism, some
people will fear that talking about these with co-owners will damage the
business relationship they are trying to establish
3. Elements
a. Funding Considerations
i. Corporate Assets corporation would take out a loan
ii. Sinking Fund regular contributions made by each owner to ensure that
$ is available to meet buy-sell Ks
1. Problem: ties up too much capital, cash is not available
iii. Life insurance for death/disability of SH
b. Types of Trigger/Buy-Sell Agreements
i. One-Way enables or obligates an identified 3rd party to acquire a
deceased or departing owners interest in the business
1. Easy to fund 3rd party can establish fund for the purchase or
buy life insurance on the owner
a. 3rd party must be named as a future purchaser in the
buy-sell agreement
2. Used by: close corporations, sole proprietorship
ii. Cross-Purchase obligates surviving owners of a business to pro-rata
purchase a deceased owners interest directly from decedents heirs
1. Used by: partnerships
iii. Entity (or Stock) Redemption entered into by both the owners and
the business
1. Each owner agrees to sell his interest in the business back to the
business upon a triggering event and business agrees to
purchase such interest
2. Used by: corps
iv. Wait and See owner (or his estate) is obligated to sell but business
entity is not obligated to buy the deceased owners interest
1. Corp has the option to buy if refused, surviving SH can buy
if any left over, corp has to buy
2. Used by: corps
c. Valuing a Business
i. Hard to figure out how much share should be worth and how much non-
controlling shares should be worth
ii. Method Book Value (most common) establishes a value for business
based on past/present financial position, general economic conditions,
book value, earnings
d. Restrictions on transfers of shares are OK as long as they comply with state
requirements- MBCA says generally you can
4. Jordan v. Duff & Phelps, Inc. (7th Cir 1987)
a. Facts: Jordan (P) offered opportunity to buy stock in D corporation based on
buy-sell agreement which required him to sell stock back to corporation at book
value when employment ended Jordan quit and sold stock back but later
learned that D corporation was negotiating a merger which would have raised
price of his shares by 28x
i. D corp had policy allowing employees fired to keep stock for 5 years
(Jordan didnt know this)
ii. Jordan got a new job and told chairman of board he was quitting.
Chairman didnt tell him anything about a merger.
iii. Jordan stayed with D comp until end of year so he could get the book
value of the stock for 1983 and not 1982.
iv. Jordan says the negotiation details were material facts that should have
been disclosed to him before he left the corporation
1. D wants his stock back
v. D says that Jordan quit on Nov 16 and nothing that happened after that
date matters
b. PP: TC granted SJ for D
c. Court: SJ not granted, remanded for trial
i. 2 Issues must go to jury: (1) whether info withheld was material (2)
whether sale took place on Nov 16 or Dec 30
1. Corp did value the stock as of Dec 31, so a jury could assume
that this was the date of sale
a. If it happened at the later date, then the company should
have disclosed the information; if it was at the earlier
date, then the company probably didnt have to disclose
2. Corp says remaining silent isnt lying
a. Close corps buying their own stock have a fiduciary
duty to disclose material facts
ii. Guiding factors when determining under Securities Rule 10(b)-5
1. Likelihood of the event of a merger
2. Magnitude of the event
5. Berreman v. West Publishing Company (Minn. 2000)
a. Facts: Berreman bought stock subject to buy/sell agreement which said that if he
wanted to sell his stock, West could buy it back at book value Bs stock
bought at book value on June 1, 1998
i. Until West announced possibility of sale, West directors had publicly
expressed their commitment to remaining privately held
ii. P claims that West had a duty to disclose that it was considering a sale
of West before Berreman retired and sold his stock back to West
b. PP: TC granted SJ for D
c. Court: found for D
i. One who stands in a confidential/fiduciary relation to the other party to
a transaction must disclose material facts about the corporation
1. An omitted fact is material if there is a substantial likelihood
that a reasonable SH would consider it important in deciding
how to vote
ii. Probability Magnitude Test (is a fact material?) balancing of both
indicated probability that event will occur and the anticipated magnitude
of the event in light of the totality of the company activity
1. Low probability that the merger would ever occur regardless of
the magnitude
XI. Corporation Endgames
a. Intro
i. Fundamental Changes (requires the vote of SH too)
1. Types
a. Amendment of Articles of Incorporation
b. Dissolution
c. Merger
d. Sale of substantially all of corporations assets
2. Procedure
a. Board of directors must approve fundamental change
b. Board must notify SH of its recommendation that change be approved
c. Special meeting of SH held at which SH vote on the change
i. Quorum minimum # of votes needed to approve a measure
d. If change is approved, SH who opposed the proposed measure have a right to
force corporation to buy them out
e. Corp is required to inform the state of the change by filing a doc w/ Sec of State
3. Voting Requirements (straight voting only)
a. MBCA: majority of those actually voting or present (most states)
b. Delaware: majority of the shares entitled to vote
c. Traditional: approval by 2/3 of the shares entitled to vote
d. Liberal Approach: majority and vote if there are 6000 people at a meeting, on
this particular issue only 5000 can vote. If a majority of that 5000 are in favor,
then the measure passes
4. Hypo
a. We have 10,000 shares. 6000 show up. 5000 vote. 2501 approve measure.
i. MBCA: need 3,001 shares in favor to pass
ii. Delaware: need 5,001 shares in favor to pass
iii. Traditional: need 6,667 shares in favor to pass
iv. Liberal: passes bc a majority of the people who voted approved the
b. Dissolution
i. Voluntarily look to specific state statute for how dissolution works
1. Board approves the dissolution SH vote on the proposal
ii. Involuntary
1. Judicial Giannotti
2. Administrative if you dont file your taxes/file docs, Sec of State can dissolve you
3. Creditor-Originated unpaid creditor can force corporation into bankruptcy/dissolution
if the unpaid balance is so exorbitant
iii. Corp can continue only for the limited purpose of winding up
c. Merger - 11.07 MBCA
i. Types
1. Direct
a. Target Acquiring = Acquiring survives
2. Forward Triangle
a. T Subsidiary = S+A survive
3. Reverse Triangle
a. S T = T/S+A survive (A controls T/S)
b. Purpose: T will most likely have non-transferrable Ks
ii. Purpose of Merger
1. Avoid creditors liability will mostly follow the acquiring
2. Get rid of minority SH (so no one can sue you for breach of fid duty)
3. Change state of incorporation
iii. Shareholder Protection
1. SH of both surviving and disappearing corporation have 4 forms of legal protection:
a. Sue for the directors who approved the merger for breach of common
law/statutory duty of care (Van Gorkum)
b. Vote against the merger
i. MBCA 11.04 initially, both boards of a merger have to approve it and
then SH have to vote except
1. 11.04(g) exceptions to SH vote
a. If corporation is going to survive the merger (i.e. is the
acquiring corporation)
ii. Delaware
1. Requires the acquiring corporation to vote as well if:
a. Merger changes Articles of Incorporation and
b. Causes acquiring corporation to issue 20% or more
extra stock
c. Assert the dissenting SH right of appraisal (in exchange for the right to veto the
i. MBCA Ch 13 / Delaware 262
ii. A SH who properly asserts her dissenting SH right of appraisal can
compel the corp to pay her in cash the fair value of her shares as
determined by a judicial appraisal process
1. To exercise right of appraisal: statutory right, basic idea is that
you must vote against merger or not vote, then you must make a
demand on the corp that you dont accept, then you can file an
appraisal suit. Sole purpose of the suit is to determine the worth
of the stock, not to challenge overall validity of the merger.
2. Mergers dont always occur on a cash basis
iii. Procedures for Exercise of Right to Appraisal (changes by statute)
1. Once merger price is set, you must notify SH that you object to
2. Vote against merger or abstain from voting
3. Within a certain time period of approval, you have to notify
board of fair value of stock (in your opinion)
4. Appraisal Action determine the value of the company
d. Sue the directors who approved the merger for breach of common law/statutory
duty of loyalty e.g. board approving merger of acquiring co. and they get
lucrative co., both sides of the deal (min SH of one and Maj SH of another),
dealing individually at the expense of another
iv. HMO-W Inc. v. SSM Health Care System (Wisc 2000)
1. Facts: SSM formed HMO-W and all SSM SH became minority SH in this close corp
(20%). HMO-W proposed a joint venture with United
a. Before SH approval, HMO-W retained Valuation Research to value its net assets
final report estimated value bte $16.5M-$18M
b. HMO-Ws board voted to approve merger SSM voted against the merger and
demanded payment of their dissenting shares
c. HMO-W abandoned the VR report and the new appraiser said the corps value
was $7.4 so SSM was paid based on this calculation
d. SSM said HMO-W was estopped from using the new appraisal bc it had
represented the VP report to SH
2. PP: Ct of App reversed TC judgment applying minority discount.
3. Issues
a. Does a minority discount apply in determining fair value of dissenters shares?
b. Can a court making a fair value determination consider evidence of unfair
dealing? YES
4. Court: agreed with Ct of App, minority discount cannot be applied to determine the fair
value of dissenters shares in an appraisal proceeding
a. An involuntary corp change approve by majority requires as a matter of fairness
that a dissenting SH be compensated for the loss of the SHs proportionate
interest in the business as an entity
b. Circuit Court (in the best position to gauge credibility of witnesses) said HMO-
W didnt make a material misrepresentation to its SH and that the initial VR
report was flawed
i. SSM failed to establish that it relied to its detriment on the VR report
and that but for the report SH wouldnt have approved the merger
c. SSMs Estoppel Argument: HMO has to stick to its 1st valuation bc they later
did something fraudulent
i. Delaware View: HMO cant be stuck w/ their initial value, but SSM can
bring separate suit for fraud, just cant do this in an appraisal action
ii. ALI View: inconsistent representations of value can be relevant court
adopts this rule and is willing to hear this argument
1. BUT circuit ct considered this and said no fraud, so this court
will stick to that decision
2. A fair value determination of a dissenters shares may
include consideration of unfair dealing in the valuation of
those shares
d. Why no minority discount?
i. Focus of fair valuation is not the stock as a commodity but rather the
stock only as it represents a proportionate part of the enterprise as a
whole. A minority discount would inflict a double penalty on the
ii. Ct is basically saying that when doing an appraisal value, theyre
considering what the value would be if they dissolved the corp and
distributed assets to all shareholders. Must look at total value of the
firm and give them a pro rata share of their ownership no minority
v. Summary:
1. Why appraisal rights suck
a. Hard for shareholders to know if theyre getting a fair value or not.
b. Shareholders get nothing under an appraisal action until the action is complete,
which includes appeals. The shareholder will be losing money the entire time.
c. Some states require shareholders to pay all of their litigation fees. Even if you
can get the money back, fronting it is pretty scary.
d. The method of valuation that cts used to use frequently (DE Block method)
wasnt very realistic and didnt really get at the real value.
2. DE Block method looked at: net asset value; avg earning per share; market value of the
d. Sue for Breach of Fiduciary Duty of Loyalty
i. If Corp A wants to buy another & secretly agrees to a pricey consulting deal with the other Corp
that only benefits them & not the corporation as a whole breach of loyalty
ii. Weinberger v. UOP, Inc. (Delaware 1983)
1. Facts: Signal became interested in acquiring UOP Signal became 50.5% SH of UOP
have 13BoD and Signal puts on 6 and of the 6, 5 are officers of Signal; CEO of UOP
retires and they replace with another Signal employee
a. 2 Signal officers also on the UOP board conducted a feasibility study to
determine the acquisition of the balance of UOP outstanding stock
determined a good price of up to $24/share told CEO of UOP that the price
would be $20-21/share as part of a merger agreement
b. CEO Crawford retained Lehman Bros to conduct a fairness opinion and they
said $20-21 was a good price
c. Proposal: $21/share, merger must be approved by majority of UOPs
outstanding minority shares voting at the SH meeting, and that the minority
shares voting in favor (in addition to Signals 50.5% interest) would have to be
at least 2/3 of all UOP shares
i. Proxy statement sent to SH did not disclose the hurried method of the
Lehman Bros report or that Signal had a study done
ii. BoD participated in the meeting, the Signal directors didnt vote, 7 non-
signal voters approved it unanimously so it went to SH for vote (~56%
of the minority SH vote, 51.9% of total minority in favor)
2. PP: TC said the merger was fair to P and other minority SH, found for Ds
3. Court: reversed TC, found for P breach of duty of loyalty **triggers fairness test**
a. Concept of Fairness (2 elements):
i. Fair dealing (not present)
1. Price not negotiated with Signal
2. Outside UOP directors didnt have good material (Lehman Bros
report hurried)
3. Minority SH denied info that Signal once considered the price
of $24/share
4. Report by Signal Officers Prepared with inside info
ii. Fair price (not present)
1. On the date of the merger, the stock was worth at least
2. On remand, P must use the new method of valuation to show
that $21/share was not a fair price
b. Valuation
i. Delaware Block (outdated)
1. Doesnt require a valid business purpose, just looks at fair
dealing and whether there are directors on both boards/sides of
the deal
ii. New Method any techniques acceptable in the financial community to
value stock
c. Remedy in this Situation for Breach of Fiduciary Duty
i. Money Damages Diff in value for what they should have gotten and
what they actually got OR
ii. Rescission undo the merger
1. $$$ threaten to try to get a higher settlement value (public)
2. Close corporation more likely to use b/c they actually use to
make a living
d. Business Purpose Requirement is not necessary in this case (used to be a
requirement in Delaware but it isnt now) Massachusetts would require
4. Note: if there is no breach of fiduciary duty, then you cant ask for appraisal, but if there
is a breach, you can bring a 2nd suit
5. Notes
a. Cash-out merger: extinguish minority interest
b. Freeze-out: not much say in the matter, maybe unwilling
i. **Probably not a freeze-out here b/c majority of minority SHs approved
if in a state where only overall majority is required it would be
iii. Coggins v. New England Patriots Football Club, Inc. (Mass. 1986)
1. Facts: Sullivan created the American League Professional Football Team of Boston, Inc.
and contributed his AFL franchise as his share, 9 other persons contributed $25K for
10K shares voting stock each
a. Corp later sold 120K non-voting shares to public at $5/share
b. Sullivan ousted from presidency/operator of corporation Sullivan obtained
ownership/control of all 100K voting shares of Corp (then named Old Patriots)
at $102/share
i. Sullivan took out loans, the conditions of which were that the assets of
the corporation were pledged to secure them and covenants that
prioritized their accelerated repayment
c. Sullivan organized New Patriots and merged the two corps (1976):
i. Voting stock of Old Patriots extinguished, nonvoting stock exchanged
for $15/share
ii. Mass every class of share must approve a merger by a majority even
if non-voting share
d. P (Coggins) was serving in Vietnam and did not want to sell direct suit
2. PP: TC found for Coggins (there was a breach of fiduciary duty b/c there was no
legitimate business purpose eliminate min. SH for sole purpose of paying personal
debt) P was entitled to rescission, but court was not undoing the merger
3. Court: found for P, but rescission is not feasible b/c the case is 10 yr old
a. Dangers of self-dealing and abuse of fiduciary duty are greatest in freeze-out
situations where controlling SH and corporation director choose to eliminate
public ownership
i. Corp director duty = further legit goals of corporation
1. Corp director must demonstrate how the merger furthered these
b. Mass. Rule (and NY) different from Delaware re: breach of fiduciary duty:
i. Look to purpose of merger (need a business purpose for merger and a
legit business reason for approving the merger)
ii. If none breach of fiduciary duty to minority SH
c. Ds Burden: (1) merger was for a legit business purpose (2) merger was fair
to the minority
i. Business Purpose (failed)
1. P must establish interested director (self-interest)
2. Burden shifts to D:
a. D must prove business purpose
b. D must prove entire fairness
3. Sole reason for merger was to restructure and allow Sullivan to
meet his financial obligations under the loan
4. Pre-merger status satisfied the NFL policy requiring majority
ownership by single individual/family, no need to continue the
ii. Fair to minority (didnt discuss)
d. Remedy Damages only to parties that voted against the measure, did not
turn in shares and did not perfect their appraisal rights (AR would have given
them a remedy not entitled to two)
i. Value of shares at time of judgment over what was given (cant really
be determined ended up being around $80 per share)
1. Need to determine the present value of the stock on the theory
that the merger had not taken place
ii. Prof says this is basically impossible
e. Which is better Delaware or Mass?
i. Legitimate shouldnt look into BJR
ii. Too easy to come up with bullshit answers
iv. Hypo: Pug corp wants to do a cash-out merger w/ Small corp, but CEO of Pug corp is concerned
that there may be a suit that small corp breached fiduciary duties for approving the merger. Pug
ct wants to minimize the chance of litigation:
1. Replace the interested directors w/ independent directors (their only interest is their
salary). So appoint a bunch of independent directors & only have these directors
negotiate & vote on the merger.
2. Follow standard processes as if Small corp was not a subsidiary of Pug corp
3. Get the highest percentage of SH approval of Small Corp as possible
4. We want the negotiations to appear as though they were at an arms length dont rush
market study, actually discuss the price
5. Develop a biz purpose as to why merge (depending on what state were in) and make
sure it is in the minutes
6. Get market study from an independent 3
party that says the merger is fair
7. Prof says even all of these things together may not totally insulate them from litigation,
but its still a good idea for them to do them b/c it will help them win
e. Sale of Substantially All The Assets
i. How it differs from merger:
1. If your corporation doesnt dissolve immediately upon selling all assets to another
corporation, then this is NOT a merger
2. Merger = one corporation where once there were two
3. Not a fundamental change do not need SH approval
ii. General Rule: buyer of a corporations assets is not liable for the selling corporations debts (or
tort claimants)
1. A corporations sale of assets doesnt automatically terminate its existence (winding up)
iii. Ex: Pug Corp can give Small Corp money, and Small Corp will give Pug its only asset, the dog
grooming biz. This establishes same result as a merger.
1. In a merger, Small Corp would merge into Pug Corp & Pug would be liable for all of
Small Corps liabilities. In this situation, creditors can still go directly after Small Corp.
(check comment about successor liability)
iv. Franklin v. USX Corp. (Cali 2001)
1. Facts: Franklin and hubby filed suit against USX b/c she contracted mesothelioma as a
result of childhood exposure to asbestos carried home by her parents who worked in
Western Pipe & Steel (WPS)
a. Franklin said USX was WPS successor so it was liable
b. History: WPS purchased by Con Cal (asset sale + assumption of liability) who
sold transfer assets to Con Del (sale of assets only) who later merged into US
Steel who changed its name to USX
2. PP: found for Ps, USX is the successor of WPS
a. The transaction btw Con Cal and Con Del was a de facto merger
3. Issue: does the corporate acquisition constitute a de facto merger or a mere continuation?
a. Was adequate cash consideration paid for the predecessor corps assets?
i. If yes no liability
4. Court: USX is not the successor of WPS
a. USX would be liable if inadequate consideration was paid for the acquisition.
i. Significance: ensures that the selling corp has the means to satisfy any
claims against it
1. Want to make sure Con Cal gets enough $ that, if needed, it
could pay off Franklin for her cancer
ii. Consideration was valid!
iii. Court looks at the transaction between Con Cal and Con Del as long
as the is not in a worse position and the consideration was not a token
amount, they will not be liable look at Marks factors on pg. 511
5. Where one corp sells/transfers all of its assets to another corp, the latter is not liable for
the debts/liabilities of the former unless:
a. The purchaser expressly or impliedly agrees to such assumption
b. The transaction amounts to a consolidation or merger of the two corporations
c. The purchasing corporation is merely a continuation of the selling corporation
i. Ex: Pres of Corp A buys Corp B and Pres becomes Pres of Corp B
d. The transaction is entered into fraudulently to escape liability for debts
i. Ex. Con Cal created Con Del, sold assets to Con Del to avoid debts
incurred by Con Cal
e. For Liability to be imposed on successor:
i. Need both:
1. Inadequacy of consideration
2. One or more persons were officers/directors/or SH of both
6. Notes
a. The form of a transaction can dictate a certain legal result even though youve
substantively done something else so you can sell all of your assets and then
agree to dissolve and if youve received ownership in the purchasing corp, it
looks like a merger
i. Difference merger, the SH of merging/dissolving corp has to approve;
when you structure as an asset transfer, SH approval is not required
(remedy to a pissed off SH is breach of fiduciary duties)
b. If Torted upon may be able to recover under insurance of older corp
i. Could also try to pierce the corporate veil
v. SH Rights in Sale of All Assets
1. Delaware SH of buying corp have no appraisal rights nor the right to vote on their
corps buying the assets
a. The sale of substantially all the assets is a fund change only for selling corp
2. MBCA 13.03(a)(2) a SH is entitled to appraisal rights in the event that a corp is a party
whose shares will be acquired in the situation of this share exchange
f. Hostile Takeover
i. Any change in control where an outside entity gains control over a corporation over the
objection of that corporations board (Aggro corp = bidder, raider, shark, acquiring corp)
1. Purpose
a. Business opportunity (take over corp instead of ask for a license to operate their
b. Money (make more)
c. Target Corp is poorly managed, an underachiever
2. Types:
a. Proxy Contest
i. Acquiring Corp buys some shares from Target Corp, asks Targets SH
for its support in replacing incumbent directors in Target (through votes)
b. Tender Offers (often direct solicitations, must be announced publicly)
i. Acquiring Corp sends message to SH of Target Corp offering to buy
their shares (needs a majority to be controlling) for X amount (X is
higher than price on market) but will only buy those shares if (#) is sold
ii. This is a premium for control need to incentivize SH to relinquish
iii. Consequences: share price goes down (SH say if the deal goes through,
and I buy now at $16/share, and the offer is $30/share, then I am making
a profit once the Acquiring Corp buys the shares back from me at
1. Reaction of Ts Board: not happy b/c it might be kicked out
3. Defensive Measures
a. Poison Pills we make a change to bylaws that says (if someone (aka Acquiring
Corp) gets a low percentage of the company, it triggers a right to the SH to buy
more stock at low prices)
i. Makes it difficult for the Acquiring Corp to buy out the SH
ii. Basic idea: board creates a right of its SH to buy more stock at under-
market prices to make it harder for the Acquiring Corp to purchase
enough stock to takeover
b. Crown Jewel Acquiring looks at Target and wants to take over for a particular
reason (aka they have a good burrito business) makes tender offer Target
makes K with Third Party that, if Acquiring takes over, Third Party will buy
i. Basic Idea: If a change in control happens in Target, Third Party has the
option to buy that particular asset of the business at a cheap price.
Acquiring cannot ignore this preexisting K
c. Pacman Acquiring says it will buy all of Targets shares but Target says no,
we will buy all of Acquiring shares
d. People Pill Acquiring gets enough control of Target but a large chunk of
directors/officers say, if the change of control happens, we quit
e. LockUp a couple entities are bidding on Target and Target can tell one of
them that it has the first option and wont negotiate with others
f. Staggered Board 1/3 elected each year and add a provision that says directors
can only be removed for cause
i. Effect on Takeover: Acquiring cant kick directors off the board unless
theres cause, so it has to wait for 2 years to have control (2/3 of board)
g. Other
i. Target can try to drive up its stock price by issuing a bunch of dividends
which causes people to want to buy stock
ii. Target can try and buy back a lot of its stock
iii. Target can do something to take on a ton of debt
ii. Question is have the officers Breach of Fiduciary Duty
1. Acquiring corp could make a tender offer to small corp that is way above market value
Board enact takeover defenses and kill the deal
a. Breach: they destroyed the opportunity to benefit the SH/Corp
iii. Takeover Defenses
1. Unocal Corp. v. Mesa Petroleum Co. (Del. 1985) governance has the possibility of staying in
a. Facts: Mesa offered two-tier tender offer:
1. 1st Tier: buy 37% of shares at $54/share
2. 2nd Tier: buy the rest with junk bonds at $54/share
a. Bonds subordinate them to other creditors (will only
be paid off if things go well)
ii. Trick: SH would rush to sell their shares for 1st tier b/c they dont want
to be stuck with the junk bond
iii. Unocal Response: self-tender
1. Unocal buys its own shares at $72/share non-junk bond
kicks in if/when Mesa acquires majority
2. Unocal excludes Mesa from the offer b/c its counter-intuitive to
include the SH who initiated the conflict
3. Problem: if 1st tier still goes through, Unocal will be $72 in
debt per share
b. PP: TC said it has to offer Mesa the same offer, cant exclude
i. TRO could do if they could prove valid purpose and fair
c. Arguments
i. Mesa: Unocal board breached duty b/c they were trying to benefit
themselves (they could redeem their own stock for $72/share)
1. Unocal should prove total fairness
ii. Unocal: the tender offer was inadequate/coercive and not in the best
interest of corp and this is justification for board to deter the tender offer
on behalf of the corp
Unocal Test
d. Court: No breach of fid duty! Unocal can exclude Mesa from its repurchase of
its own shares
i. Not automatic BJR need enhanced scrutiny before BJR applies
ii. Two Steps
1. A reasonable corporation-centered belief that the tender
offer is a threat
a. Decision made in GF and upon a reasonable
investigation pursuant to a clear duty to protect the
corporate enterprise
b. Threat = inadequate consideration, coercive
c. Good indicators: independent directors
2. Proportionality: the defensive measure must be reasonable
in relation to the threat posed
3. 1 + 2 = BJR applies and probably protected unless waste or
willful/wanton activity
a. BJR shareholder proves
b. Two-part test for takeover board must prove
i. Quality of decision under two steps will be
judged a bit stricter but not entirely idiotic
c. ALI test for takeover plaintiff probably has to prove
iii. Greenmail wants to get a ton of shares, not necessarily a majority in
order to force the directors to buy the shares back at a higher price to
retain control of the corporation
e. Aftermath
i. SEC has nullified Unocal and said it must include Mesa and cannot
make a tender offer that discriminates against Mesa
ii. Cannot have a 2-tier offer if you offer $54/share for 51%, and
everyone tenders, you have to pay them
2. Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. (Del. 1986) when change of control is
a. Facts: Pantry Pride made a tender offer to Revlon SH for $47.50/share price
too low so Revlon makes its own tender offer for Notes with a face value of
$47.50 and covenants restricting Revlons ability to incur additional debt, sell
assets, or pay dividends unless approved by Revlon independent directors (some
SH take this offer)
i. Oct 3 Revlon agreed to LBO with Forstmann for $56/share who
agreed to assume Revlons debt of Notes and Revlon would waive the
covenants tied to previous issued notes
1. Revlon publicly announced this shares plummeted
2. Noteholders pissed, cant go back on covenants
ii. PP made higher bid (56.25), Forstmann went even higher (57.25
w/waiver) and threatened to withdraw its offer if the following wasnt
1. No-Shop Clause for a better deal
2. Break-Up Fee money paid to buyer if deal falls through
3. Lock-Up of Crown Jewels can buy essential asset of corp at
set price if another corp trys to take over cant be ignored
iii. Revlon accepted PP sued for breach of fiduciary duty (they already
owned shares of Revlon)
b. PP: TC found Revlon directors breached their duty of care
c. Court: found for P, Revlon breached duty of care
i. Two Step Process (via Unocal apply flexibly)
1. Good faith + Reasonable Investigation
2. Responsive action is reasonable in relation to threat posed
Revlon Test
ii. Revlons self-tender was ok! BUT, after the bidding war commenced,
ignoring PP was not ok
1. Duty not to the note-holders!
a. A breach to protect noteholders at expense of SH only
look at equity!
i. Equity (SH) v. Debt (Noteholder)
iii. When PP increased its offer, it became apparent that break-up of the
corp/loss of control was inevitable
1. At this point, the duty of the board changed from (A)
preservation of Revlon as a corp entity to (B) maximization of
corps value at a sale for SH benefit
a. Duty to Obtain Best Price For SH
d. Principal benefit of accepting the Forstmann offer was to directors who avoided
personal liability to a class of creditors to whom the board would have owed no
further duty under the circumstances
i. Financing was b/s argument
ii. Price ended auction prematurely and couldve gotten a better price
iii. Noteholder considerations not permissible to be relevant
e. Difference from Unocal
i. In Unocal, b/c there was only one bidder, you can take into
consideration creditors and noteholders
1. Most deferential to board
ii. In Revlon, once you realize theres a change in power, you cannot
consider people other than SH, and you cant take defensive measures to
retain control (but can do others that have nothing to do with control)
1. Less deferential to board
2. Small exception when corp is going into bankruptcy and they
know they are going into bankruptcy
3. Paramount Communications, Inc. v. QVC Network (Del 1994)
a. Facts: Paramount (majority board independent) was interested in a merger
met with Viacom to discuss fell through
i. Paramounts CEO told QVC Paramount wasnt for sale
ii. Viacom learns QVC is going to tender offer & decided to restart
negotiations with Paramount
iv. Viacom raised its bid (but basically kept same provisions as original
bid) Paramount merge into Viacom
1. Poison Pill No Shop Provision (carve out where not shopping
would be a breach of fiduciary duties) Option to buy 19.9%
Viacom shares w/debt if merger falls through
v. Despite the public announcement of the merger, QVC proposed its own
merger @ $80/share
1. 30 cash/50 QVC shares & Provided evidence of its financing
2. QVCs offer was not accepted
b. PP: granted prelim injunction stopping Paramount from going through with the
merger in favor of QVC and SHs
i. Second offer = $80/share all cash & remainder of shares will be bought
out with QVC shares than cash
ii. Viacom willing to renegotiate merger terms after this offer is made
1. Ended up doing tender offer of $85/share (cash/shares) +
convert remaining shares to Viacom shares
iii. QVC comes back offering $90/share + better 2
c. Court: found for QVC Breach of Paramounts fiduciary duties
i. Paramount directors had an obligation to take the max advantage of the
current opportunity to realize for SH the best value reasonably available
1. Obligations:
a. Be diligent/vigilant in examining the transaction and
b. Act in GF
c. Obtain and act on, all material info reasonable available
d. Negotiate actively and in good faith **with all
bidders**and when doing so try to advance the SH
ii. Enhanced Scrutiny (exists when):
1. Threatened diminution of current SH voting power
2. The fact that an asset belonging to public SH (control premium)
is being sold and may never be available again
3. Traditional concern of Delaware court for actions that
impede/impair SH voting rights
iii. Enhanced Scrutiny (key features):
1. Adequacy of decision-making process
2. Reasonableness of directors action
3. A break-up of a corp does not have to be present/inevitable
before directors are subject to enhanced judicial scrutiny
4. Certain typically where 2 or more bidders
iv. Revlon Duties Triggered When:
1. Corp initiates an active bidding process to sell itself or effect a
business reorganization involving a clear break-up of the corp
(this case)
2. In response to a bidders offer, a target abandons its long-term
strategy (aka self-ownership) and seeks an alternative
transaction involving the breakup of the company
v. Breakup of control typically means SH control (aka over 50% going to
someone else)
4. Lyondell Chemical Co. v. Ryan (Del. 2009)
a. Facts: Lyondell (10 directors independent) was told that Basell was interested in
acquiring Lyondell but Ly said the price was inadequate
i. Schedule 13D signaled to market that company was in play*disclosure
to SEC that company was buying a percentage of Lys share
ii. Directors took a wait and see approach
iii. Basell in negotiations with Huntsmann but told Ly that it needed any
answer ASAP so it could get out of the Huntsmann deal
iv. 2 short Ly board meetings agreed to proposal
1. Ly got a concession from Basell
v. 99% of SH agreed to the Boards decision
b. PP: TC said an unexplained inaction might be a disregard of fid duty
c. Issue: did the directors fail to act in GF and breach duty of loyalty?
i. No breach of duty of care for directors raincoat provision in AoI
ii. No breach of GF may be rush and not the best, but not BF
iii. No breach of loyalty no particular benefit to directors
d. Court: SJ for directors
i. The Revlon duty to seek applies only when a company embarks on a
transaction on its own initiative or in response to unsolicited offer
that will result in a change of control doesnt apply here
1. Wait and see approach is ok, the duty doesnt arise until
directors began negotiating the sale
ii. Breach = if directors knowingly, completely failed to undertake their
iii. Might have breached duty of care by agreeing to deal so fast but there
was raincoat provision
1. Directors are inoculated and since the only valid claim is lack of
GF and directors didnt do something bad, then theyre ok
iv. In Revlon, the duty isnt to take every step possible to maximize SH
value. Liability will be imposed if you fail to even try.
iv. For these tests know: What standards do they set forth? When do they apply?
v. Federal/State Regulation of Hostile Takeover
1. Williams Act requires disclosures by bidder, and substantial rules that limit a bidders
high-pressure tactics and fraud
2. Amanda Acquisition Corporation v. Universal Foods Corporation (7th Cir. 1989)
a. Facts: Amanda existed for the sole purpose of acquiring Universal Foods
tendered offer at 30.50 if 75% of stock is tendered eventually made it to $38
i. Three Generations of Takeover Statutes
1. 1st: no takeovers w/o public official approval conflicted with
Williams Act struck down
2. 2nd: if acquiring corp buys 51% of share, unless a majority of
the non-tendering approve the transaction, then the 51% shares
lose voting rights no conflict w/ Williams Act
3. 3rd: Delay
a. If a hostile takeover happens, acquiring gets majority of
target corp and target board doesnt approve, then there
is a period when no fundamental changes can be made
i. Delaware 203: 3 year terms that applies to
anyone who obtains 15% or more of stock and
prohibits them from making certain
fundamental changes
ii. These are opt-outable. Not mandatory.
ii. WI Takeover Statute: no firm can engage in a business combination w/
an interested SH for 3 years after interested SH stock acquisition date
unless the board approved it
b. PP: DC said statute valid
c. Issue: Amanda wants the WI statute declared preempted by Williams Act and
inconsistent w/ Commerce Clause
d. Court: not preempted, not inconsistent
i. Williams Act (procedure), WI Statute (substance)
1. Williams Act: covers tender offers: timing, disclosure
2. WI just regulates substance of the offer (benefits for the bidder)
XII. Limited Partnerships
a. General
i. LP v. LLP
1. LLP everyone is a gp but every partner enjoys limited liability for partnership debt
a. Creatures of state statute, no default form
b. Limited liability for all partners, all on the same level
c. Still used in trusts/estate planning/long term-management intensive real estate
2. LP structurally different, limited partners less than GP
a. How many partners? As many GP and limited partners as you want. Technically
need at least one of each
b. Who can be a partner? Anyone
ii. Limited Partnerships must have at least one general partner (GP is liable for business debts)
1. Limited partners are not personally liable for debts of the LP usually the people
kicking in the $
2. Do not come into existence unless theres a public filing
3. Analogy
a. LP = SH, GP = officer
iii. How to avoid personal liability in a LP
1. LLLP limited liability limited partnership
2. Put a corporation in place as a general partner
iv. General Partner
1. RULPA 403(a) GP has the same rights as a partner in a general partnership
a. Each GP is personally liable for the partnerships debts to third parties
b. Manage the partnership
c. All general partners make decisions by majority
v. Limited Partners
1. Dont have much of a say very limited influence in partnership decisions
a. Exception: GP can designate a Lp as an agent to do something
b. Generally Lp cannot bind the company
2. Default Rule:
a. If a limited partner exercises control of a partnership, they open themselves up
to liability of the partnership debts
3. RULPA 303 Safe Harbor (Limitations to Default Rule)
a. RULPA 303(b)(6)(v) if the limited partnership agreement permits Lps to
remove a GP, the exercise of this authority will not by itself cause the Lps to
lose their limited liability
b. **RULPA 303(a) even if a Lp exercises control the Lp will nonetheless be
liable only when he acted in a way that caused the third party reasonably to
believe that the Lp was instead a general partner
4. **ULPA 2001 abandons control test altogether
a. Why?
i. Certainty: Limited partners dont always know what they can/cant do;
this has become very outdated
ii. Other limited structures (ie. LLC, LLLP) allow partners to participate in
management while enjoying limited liability.
vi. RULPA v. ULPA (2001) know 303 of both
a. Tacks the state statute rules onto RULPA
b. RULPA 303(b)(6) there are certain managerial actions that the limited
partners can take that would not constitute control and thus would not cause
them to lose their limited liability
c. RULPA 303(b)(1) a limited partner is not liable simply by being an officer,
director, or SH of a general partner that is a corp
2. ULPA Comprehensive on its own
a. If it doesnt answer a question, then the court has to figure it out on its own
vii. Piercing the Corporate Veil v. Limited Liability and Control
1. Control is kind of like piercing the corporate veil in that it pierces the limited partners
limited liability
2. 303 is straightforward whereas piercing the corporate veil is fuzzy:
2 factors neither dispositive (alter ego or fraud theories) and the courts seem to weigh
them, more outcome determinative standard. At least here we have a list, if something
falls within the list its not control, but we can see similarities
-Business entities enjoying limited liability
viii. Process
1. Public filing with Secretary of State (limited partnership)
a. No filing with general partnership
b. Purpose of Filing: notice to the world! When creditors do business with the
limited partnership, there should be something they can check to see who has
limited liability
i. Name partners address registered agent
2. Write up a Partnership Agreement not required but a good idea
a. Why? Want to see a meeting of the minds at the creation and want a fall-back
document when there is disagreement
b. Zeiger v. Wilf (NJ 2000)
i. Facts: Zeiger (P) was approached by Novick/Goldberger with proposal to renovate Ps property
and P would receive $27k/year for 16 years as a consulting fee w/o doing much work. Wilf came
on as the deep pocket
1. Trenton Inc. was purchaser and agreement was assigned to Trenton LP
a. Trenton LP = Limited Partners: Midnov, CPA (Wilf), Albanese, Zeiger
(Plaintiff), General Partner: Trenton Inc.
2. At no time did P (Zeiger) believe Wilf (VP of Trenton, Inc. the GP) or CPA were taking
any personal responsibility for the project would have thought better of the claim if
this was true
a. P is basically saying Wilfs actions in LLP he was acting like a GP
ii. PP: TC granted SJ for Wilf
iii. Court: SJ for Wilf
1. His actions come under the Safe Harbor RULPA 303(b)(6)
a. Mere participation in control does not impose liability on a limited partner
b. Wilf was functioning as the responsible corporate officer
iv. Could have tried to pierce the corp veil to get after Wilf, BUT no alter ego or fraud per say
many of the factors may have been met but there is not really a clear answer
v. Corporation was bankrupt and had no money
1. Generally, tort claimants more sympathetic and might have a better shot, but it will still
depend on the facts would have to be lack of corporate formalities or something else
c. When will the General Partner be liable to the Limited Partners and the Partnership?
i. Tort liabilities for breaching fiduciary duty
ii. RULPA does not address GPs fiduciary duties have to look back at underlying UPA or RUPA
1. ULPA copies RUPA 404
d. Kahn v. Icahn (Delaware 1998) RULPA
i. Facts: Kahns brought derivative action on behalf of AREP against AREPs general partner API,
APIs sole SH and CEO Ichan, and a corp affiliated with Ichan
1. AREP LP Gen Part: API (run by Ichan), Limited Part: Kahns
a. Partnership Agreement: any partner may have other business interests and may
2. Ps Allegations: Ichan breached his fiduciary duty to AREP and usurped for himself a
corp opportunity of AREP by failing to make the opportunities completely available to
AREP and, instead, keeping profits for Bayswater (the corp he affiliates w/)
3. Ds argument: the partnership agreement says that a GP can compete with the business
of the partnership
a. P says theres a difference between competing and usurping
ii. Court: dismissed Ps claims this court affirms
1. Factors of a Corporate Opportunity
a. The opportunity is either essential to the corp or is one in which it has an interest
or expectancy
b. The corp is financially able to take advantage of the opportunity itself
c. The party charged with taking the opportunity did so in an official rather than
individual capacity
2. Traditional fiduciary duties are defaults that may be modified by partnership agreements
a. Why more modification in a limited partnership as opposed to general
i. A partnership is a default form (anyone can form one). Anyone going
into a limited partnership has to opt in
3. ULPA 2001 305 LP would not get fiduciary duties to GP by taking control even
though they would be liable to a third-party for business debts
e. In re USAcafes, L.P. (Delaware 1991) Duties the Manager of Corp GP owes to LPs
i. Facts: P claims that the sale of its assets to an independent entity, under which Ds received side
payments, breached Ds fiduciary duty to P b/c D consequentially accepted a lower offer price
for Ps assets
1. USACafes, LP = General Partner: USACafes General Partner, Inc. (owned by Wyly
bros), Limited Partners: various investors
ii. General Partner agreed to a deal selling the LP and a bunch of the assets to Mesa for $$
1. Breach of Duty of Loyalty didnt get enough $$, directors (Wylys) of GP all got
substantial side payments
2. Defendants argue as directors they owe FD to corp, Corp as gp owes FD to lps, but that
there is no transitive property
iii. Court: found for Ps
1. Directors of a corporate general partner owe a fiduciary duty to a LP
a. Cant let the puppet masters avoid FD to LP
2. Analogy to Trust Law
a. Corporate trustee who holds a bunch of assets he cant act against the interest
of the beneficiaries (has fid duties towards them)
i. Corporate trustees owe fiduciary duties to beneficiaries (as do the board
of the corp trustee)
3. Could have won a judgment against the Corp GP for breach of fiduciary duty but would
likely have to breach the corporate veil to get any money from Wylys
4. If there is no bad guy but we are arguing GP acted in its best interest but it isnt in the
LPs best interest if they satisfy their fiduciary duties to the corp but the corp has
breached fiduciary duties to the partnership
a. Corporation can be GP, but when you get these nested business structures, there
is a policy debate that you shouldnt have limited liability for corporations that
own corporations
b. Could deal with this issue contractually state what satisfies duties and what
procedures, if followed, will not be a breach
iv. General Partner owes fiduciary duties to limited partners unless partnership agreement
states otherwise!
f. How Owners of LP Make $ (RULPA 503, 504)
i. Being employed by the LP and receiving salaries
ii. Sharing in distributions of the earnings of the business
1. General Partnership: allocated equally between each partner
2. Limited Partnership: allocated in proportion to the contributions of each partner
a. Why? GP probably isnt kicking in any money, but is obviously doing more than
the lps
iii. Selling the ownership interest for more than it cost
1. RULPA/ULPA limits a lps ability to sell/transfer her interest to a 3rd partner by
limiting what a third buyer will get (distribution rights, but no management/information
rights unless the agreements otherwise provides)
a. Can sell $ interest, but not management interests (i.e. voting)
2. General partners can get rid of all their rights!
a. If a GP sells all of its interest and there are other GPs, then its not problematic
i. Sell distribution rights and lose management rights
b. If a GP sells all of its interest and its the only GP, then the LP has to dissolve
UNLESS all lps agree to continue the business and be the new GP
iv. RULPA if you want out, you can force the partnership to buy you out
1. Limited partner must give 6 months written notice to withdrawal
2. General partner can withdraw at will
3. Why?
a. Because GPs are liable, we want them to have the chance to exit
b. Not concerned with giving lps freedom b/c theyre not liable but b/c they put in
the most $, we want to give the partnership time to deal with the loss of capital
from the lp withdrawing
g. LLPs
i. Attempts by the state to create business structures that allow individuals to limit their liability
w/o forming a corporation
1. LP = 2 partner system (hierarchical)
2. LLP = flat structure (only one type of partner and all of them enjoy liability protection
from partnership debts)
ii. Liability is limited, not non-existent
1. However, if one partner does something bad, the partnership will be liable but the other
partners will not be
iii. Governed by state statutes that tack onto RUPA and UPA
1. In some states, LLPs are only available for people offering professional services (i.e.
certified) California, NY (non-exhaustive)
a. Some states only immunize other partners from certain actions
2. In most states, anyone can create an LLP
iv. Benefits
1. LP = clear who has authority (distinction btw GP and lp)
a. Better to have one partner generally liable for partnerships debts
b. 3rd parties will know that they can recover from the general partner and/or the
partnership so it would probably charge a lower interest rate
2. LLP = all partners have the ability to bind the partnership
a. 3rd parties can only recover from the partnership
v. Dont worry about LLLP

XIII. Limited Liability Companies
a. Overview
i. LLC offers all of its owners (members) both (i) protection from liability for the business debts
(like protection for SH) and (ii) same pass-through income tax characteristics of a partnership (or
1. Members = owners (can be individuals or any business entity)
2. Members make an initial contribution of value to the LLC in order to have a stake in its
a. Contributions recorded in the OA
b. Significant impact on voting/ownership rights
ii. Forming LLC
1. Filing with Sec of St
2. Naming: Delaware, must have LLC or Limited Liability Company
3. Conflicts btw Articles and OA
a. If a third party is dealing with the LLC and the only public doc is the Articles
and they rely on it, we will hold LLC to the articles
b. Internally, LLCs will rely on the Operating Agreement
4. Process: Partnership LLC
a. Statutes define conversion process
b. If statute is silent, you cannot convert, you would have to dissolve the entity and
then reform
iii. Operating Agreement
1. The most contractual of any other business forms not really enough default rules, must
have an agreement of some sort
2. Operating Agreements can vary any rule
a. Most common: fiduciary duty obligations can be modified/eliminated in an OA
b. Uniform LLC Act
i. Exceptions: [103(b)] cannot unreasonably restrict owners right to
records, eliminate duty of loyalty, cannot unreasonably reduce the duty
of care, cannot eliminate the obligation of GF/fair dealing, but can
modify what constitutes GF/fair dealing
c. Delaware
i. You can eliminate fiduciary duties at whim
iv. Who Decides What?
1. Member-Managed
a. Members owe fiduciary duties
b. Essentially operates like a partnership
c. The members are agents and can bind the LLC remember agency liability to
d. Each member has a right to vote
e. Operating Agreement can modify this stuff
2. Manager-Managed
a. Managers owe fiduciary duties (members do not)
i. OA can change this
b. Looks more like a corporation or LP passive v. active members
i. Member can be another business entity
c. Only the managers are agents and can bind the LLC
i. Members cannot bind the LLC
3. Degree of Power is decided via Operating Agreement or statutory provision
4. Problems pg 612
a. How does C know whether company is member or manager managed? Most
statutes require that cert of formation say which it is
i. C should know so it doesnt do business with someone who doesnt
have authority to act on behalf of the LLC (ie. a member in a manager-
managed LLC)
ii. Delaware does not require / ULLCA 301(6) requires to state if
b. Can members vote out a manager? Yes (unless the OA says otherwise)
i. Delaware if not OA otherwise, members all have equal management
rights and can vote out a manager
b. Who is Liable to Whom for What?
i. Members/managers of an LLC are not liable for LLCs debts
1. However, people are liable for their own debts
ii. Webber v. United States Sterling Securities, Inc. (Ct. SC 2007)
1. Facts: Orrs sent an unsolicited fax ad to P on behalf of Retail Relief LLC violation of
a federal law aka tort.
2. PP: Orrs moved for SJ says they were acting on behalf of Retail Relief TC granted SJ
for Orrs
3. Court: SJ for Ps
a. A member must do more than merely be a member in order to be
personally liable for an obligation of the LLC
i. Officials may be held individually liable for their tortious conduct,
even if undertaken while acting in their official capacity
b. Delaware 18-203(a) no member/manager can be held for company debt solely
bc of their status as a member/manager
i. Court says solely means if nothing else exists.
ii. Difference With Partnership Policy says that if one partner is liable, so
is the other, solely by being a partner even if he didnt do anything
iii. In re Suhadolnik (IL Bankruptcy 2009) Piercing the LLC veil if statute silent = litigation
1. Facts: Debtor owned LLC and Denmar claims the LLC is indebted to it and thus D is
personally liable for the debt b/c D treated the LLC as his alter ego wants court to
pierce the veil of the LLC
2. Court: Yes, you can pierce the veil of an LLC
a. When IL amended its LLC Act, it took language directly from the ULLCA
which states that a person would be actionable in contract or tort against the
member or manager if that person were acting in an individual capacity
i. This suggest that the legislature did not intend to bar individual
iv. Members and Managers Liability to LLC
1. Fiduciary duties owed by: Managers if Manager managed, members if mem-man
2. Lynch Multimedia Corporation v. Carson Communications, LLC (Kan 2000)
a. Facts: CLR (members: LMC/elect 3, Rainbow/elect 1, Carson/President/elect 1)
i. CLRs Operating Agreement said that members are free to engage in
business ventures except those to purchase cable tv systems.
ii. CLRs pres (Carson) told the members that Falcon might be for sale and
the members approve the possible acquisition.
b. Arguments:
i. Carson says his duty to offer the opportunity to the company was met
when he told the member that certain opportunities existed
ii. Lynch: Carson needed to present a no-strings-attached purchase offer at
a proper meeting
1. Tort: breach of fiduciary duty
a. Court says P didnt do a good job proving this
b. Also, the OA can change fiduciary duties.
2. Contract: breach of OA
a. Resolved by court below
c. Court: found for Carson
i. Offer = opportunity, not necessarily something that has to be accepted
ii. This would be a breach if there wasnt an OA
c. Making Money in an LLC
i. Salaries
ii. Distributions in operating agreement
iii. Selling Interest to Third Parties
1. Selling an interest in an LLC is problematic b/c there isnt a big market for it, like there
would be for stocks
a. Tricky: find a buyer, or there might be a statutory/OA restriction on the sale of
i. Delaware: if you sell your interest all you can do is sell your interest in
the gains/losses of the LLC, but no management rights transfer through
the sale
1. Like LP, unlike reg P, the management authority doesnt sit
with you either, it just goes away (unless remaining members
agree otherwise)
2. Many provisions prohibit voluntary sale of interests unless you offer to LLC first or
unless the LLC buys it for the same price as whats offered by outside party
a. Would want rules that regulate the transfer to prohibit certain types of transfers
(want to work with the people you choose) and also want to allow sales under
certain circumstances (if you retire you want to be able to liquidate)
b. Want to prohibit unfair sales (prob dont want unanimity but you also wouldnt
want a slight majority)
3. Lieberman v. LLC (Wyoming 2000)
a. Facts: The Mossbrooks and Lieberman created and Lieberman
put in $20K (40% interest). More people contributed, but Libermans interest
remained the same
i. Lieberman was terminated and demanded his share of the current value
aka FMV ($400K)
ii. Lieberman also asked to dissolve the company and distribute based on
proportion of contribution
b. PP: TC granted SJ for and said Lieberman was only entitled to
c. Court:
i. Members of the LLC elected to continue the LLC so Lieberman is not
entitled to distribution of assets
ii. If LLC had refused to pay the $20K, then Lieberman could have forced
dissolution under a statute in Wyoming, but this isnt the case
iii. Via OA: Lieberman had right to demand return of his capital
contribution, but did not have the right to demand dissolution and was
not entitled to distribution of assets
1. However, unsure whether Lieberman forfeited his interest upon
4. Lieberman v. Mossbrook (Wyoming 2009)
a. Facts: same as above, but now its found that Lieberman is neither a member nor
an investor, should have gotten the value of his shares
b. Court: found for Lieberman
i. Must treat his interest as if it was liquidated as of the day Liebermans
contribution was returned. So he should have gotten 40% of how much
the company was worth on that day