Business Associations Outline

Section 1. Who is an Agent? Agency is the fiduciary relation which results from the manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and consent by the other so to act. Restatement (2nd) § 1. There does not have to be intent to create an agency relationship. If there is even language disclaiming an agency relationship, the relationship can still exist. It is the facts that matter. The agency relationship does not have to involve some matter of business, but only that where one undertakes to transact some business or manage some affair for another by authority and on account of the latter. It is not essential that there be a contract between the principal and agent, nor is it essential that both or either receive compensation. Restatement (2nd) § 16. Elements: - principal’s manifestation of consent to the agent - to a relationship in which the agent is to act on behalf of the principal - subject to the principal’s control - the agent’s manifestation of consent to the principal GORTON v. DOTY, (1937) Facts: A minor was injured on the way to his high school football game while riding in a privately owned car. A teacher at the school allowed the football coach to drive the car. The teacher told the coach that he could use her car if he alone drove it. The teacher was promised no compensation for the use of her car and did not receive any. The school district paid for the gasoline used on the trip to and from the game. Holding: The appellant did not say anything to Mr. Garst about loaning her car and he said nothing to her about borrowing it. Therefore, the evidence supports the finding that the relationship of principal and agent existed. Vicarious Liability – The principal is responsible for the acts of his agent. If Mr. Garst was acting as the appellant’s agent, the appellant was chargeable with the acts of her agent as fully and to the same extent as though she had been driving the car herself. • The court held that the fact that the teacher at least consented for Garst to act for her and in her behalf, is clear from her volunteering the use of her car upon the express condition that only Garst drive it. That Garst consented to act for her and on her behalf is clear by his act in driving the car. • The court noted that in a previous case the court held that the fact of ownership alone establishes a prima facie case against the owner because the presumption arises that the driver is the agent of the owner. • The majority focuses on control. The most important fact for the majority was that Doty didn’t just hand over the keys, she put limitations on it. 1

• To argue for Doty, you should focus more on the relationship in which the agent acts on behalf of the principal. Doty wasn’t really getting anything out of Garst driving the car. Therefore, Garst wasn’t acting on Doty’s behalf. • Another important aspect of this case is that it illustrates that an agency relationship be found even where there is no intent to create one, and where there is no contract or business transaction—merely that the agent will do some business for the principal JENSEN FARMS v. GARGILL, INC., (1981) Facts: Individual farmers sell their wheat to Warren, the local grain elevator. Then Warren sells the grain on the markets, first to Cargill. Warren bought the grain from the farmers on credit. The farmers are in trouble when Warren falters and there is nobody to pay the farmers. The farmers go after Cargill. Facts (elaborated): Cargill goes around to find grain elevators and Cargill provides financing in exchange for the grain elevators giving Cargill first choice to buy. However, one such elevator, Warren, became financially troubled and Cargill became involved in some of the operations of the grain elevator. Warren goes bankrupt owing both Cargill and the farmers. This suit is brought by one of the farmers against Cargill, claiming that Cargill was the principal and Warren was merely an agent of Cargill. Facts as to relationship between Cargill and Warren: -Warren drew money on Cargill's accounts and the checks used bore name of both Cargill and Warren -Cargill had the right of inspection of Warren's financial books -Warren could not make capital improvements without Cargill's consent -Warren could not become the guarantor of another's debt or further encumber its assets without Cargill's permission -Cargill had previously acted as agent for Cargill on various purchase and sale agreements -right before Warren went under, a representative from Cargill was sent to supervise the grain elevator, disburse funds and supervise income generated by the grain elevator Issue: Whether Cargill, by its course of dealing with Warren, became liable as a principal on contracts made by Warren with plaintiffs. The court held that Cargill, by its control and influence over Warren, became a principal with liability for the transactions entered into by its agent Warren. Rule: A creditor who assumes control of his debtor’s business may become liable as principal for the acts of the debtor in connection with the business. (Restatement Agency § 14 O). Comment a continues “the point at which the creditor becomes a principal is that at which he assumes de facto control over the conduct of his debtor, whatever the terms of the formal contract with his debtor may be.” In analysis of the Restatement approach, the court listed a number of factors on page 10 that showed de facto control. These factors are not to be considered in isolation, but in light of all the circumstances surrounding Cargill’s aggressive financing of Warren.


-Therefore, in representing a creditor, the lawyer’s job is to inform the creditor that if they undertake too much control, an agency relationship might be found, and thereby become liable for the debts of the new agent -it is up to the lawyer to inform, it is up to the creditor to determine what course of action to take. All the elements of agency could be found in this case. 1. Cargill manifested its consent that Warren would be its agent by directing Warrant to implement its recommendations. • regardless of the facts, one element of agency is that the principal consents to the agency—the court found that Cargill had consented to be the principal of Warren when it undertook to control the operations of Warren 2. Warren acted on Cargill’s behalf in procuring grain for Cargill as the part of its normal operations which were totally financed by Cargill. -Means questions what about the "on behalf of" element of agency: -Warren was supplying Cargill with the type of grain that Cargill was really interested in obtaining -Warren served as the "conduit" between the grain farmers and Cargill who is interested in buying this type of grain 3. An agency relationship was established by Cargill’s interference with the internal affairs of Warren, which constituted de facto control of the elevator. • The course of dealing with Warren was a “paternalistic relationship” in which Cargill made the key economic and kept Warren in existence. Although Warren paid considerable interest on the loan, the reason for the relationship was not to make money as a lender, but to establish a source of market grain for its businesses. Does it matter that Warren was lying to Cargill? Yes. It matters in that Warren may have liability to Cargill, but Cargill is NOT released from vicarious liability. The more control that a potential principal exercises the more likely an agency relationship will be found. A franchise is more like a distribution relationship. It is not intended to be an agency relationship. Section 2. Liability of Principal to 3rd Parties in CONTRACT A. The Agent’s Authority – mere consent to be an agent does not grant any authority to the agent, and therefore the agent can do nothing. The principal must express the scope of the agent’s authority Types of Authority 1. Actual: Express and Incidental (Implied) 2. Apparent 3. Ratification Actual Authority (express and implied) 1. Express Authority – the power of the agent to affect the legal relations of the principal by acts done in accordance with the principal’s manifestations of consent to him. Restatement (2nd) § 7 a. Manifestations from the principal to the agent – ie. “sell my car” 3

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2. Implied/Incidental – Unless otherwise agreed, authority to conduct a transaction includes authority to do acts which are incidental to it, usually accompany it, or are reasonably necessary to accomplish it. Restatement (2nd) § 35 a. Necessary to get the job done – ie. Place ads, collect money Apparent Authority –the power held by an agent or other actor to affect a principal’s legal relations with 3rd parties when a 3rd party reasonably believes the actor has authority to act on behalf of the principal and that belief is traceable to the principal’s manifestations. Restatement (3rd) § 2.03 – manifestations from the principal to the 3rd party. When dealing with APPARENT AUTHORiTY always make sure to explain what was REASONABLE for the 3rd party to believe. 1. Inherent – a term used in the restatement to indicate the power of an agent which is derived not from authority, apparent authority or estoppel, but solely from the agency relation and exists for the protection of persons harmed by or dealing with a servant or other agent. Restatement (2nd) § 8A. 2. Estoppel – Change in Position – Restatement (2nd) § 8B 1. a person who is not otherwise liable as a party to a transaction purported to be done on his account, is nevertheless subject to liability to persons who have changed their positions because of their belief that the transaction was entered into by or for him, if a. he intentionally or carelessly caused such belief, or b. knowing of such belief and that others might change their positions because of it, he did not take reasonable steps to notify them of the facts. 2. an owner of property who represents to 3rd persons that another is the owner of the property or who permits the other so to represent, or who realizes that 3rd persons believe that another is the owner of the property, and that he could easily inform the 3rd persons of the facts, is subject to the loss of the property if the other disposes of it to 3rd persons who, in ignorance of the facts, purchase or otherwise change their position with reference to it. 3. change of position, as the phrase is used in the restatement of this subject, indicates payment of money, expenditure of labor, suffering a loss or subjection to legal liability. • If the principal informs a 3rd party that the agent has the authority to negotiate the price for the guitar, does the agent have the authority to accept an offer from the 3rd party even if the principal hasn’t informed the agent of this authority? Yes. This falls under apparent authority. • If a customer walks onto a car lot, it is reasonable for the customer to think the salesman has the authority to sell a car. If the owner then thinks the price was too low, he remains bound by the sale. Ratification – the affirmance by a person of a prior act which did not bind him but which was done or professedly done on his account, whereby the act, as to some or all persons, is given effect as if originally authorized by him. Restatement (2nd) § 82. Ratification requires acceptance of the results of the act with an intent to ratify, and with full knowledge of all the material circumstances. Ratification always involves 2 critical questions: what types of acts constitute an affirmation by the principal? Second, what effect should we give to that affirmation? Affirmance is either: Restatement (2nd) § 83 (a) a manifestation of an election by one on whose account an authorized act has been done to treat the act as authorized, or (b) conduct by him justifiable only if there were such an election. MILL STREET CHURCH OF CHRIST v. HOGAN, (1990) 4

but the Church never communicated this to Bill. When Bill realized he needed help. o The circumstantial evidence includes that acts and conduct of the parties such as the continuous course of conduct of the parties covering a number of successive transactions. o Even though the Church discussed a specific person to hire this time. It cannot be proven by mere statement. o Maintaining a safe and attractive place to worship is a desire of the Church. Sam believed that Bill had the authority to hire him because Bill had done so in the past. • In the past the Church had allowed Bill to hire his brother or other person to assist on projects. Settlement negotiations continued for a few years. Petty was discussed but the elder mentioned that Petty would be hard to reach. he talked with a church elder about who to hire. In the past. This may be proved by evidence of acquiescence of the principal with knowledge of 5 1. • There was no express authority for Bill to hire Sam. and one for which it would hire an agent. The court found that Shiboleth had express. • Implied Authority – actual authority circumstantially proven which the principal actually intended the agent to possess and includes such powers as are practically necessary to carry out the duties actually delegated. Actual Authority: expressly granted authority either orally or in writing. the Church had hired Bill for similar jobs. Dweck sued alleging that Nasser had already accepted through his agent. Thus. No evidence suggests that Bill was told that he had to hire Petty. 2. and he had been allowed to hire his brother. Thirty minutes into the job Sam fell off a ladder and broke his arm. • Bill needed to hire an assistant to complete the job for which he had been hired. (2008) Facts: The original lawsuit arose from Nasser removing Dweck as President and CEO. When Shiboleth. However. . Implied Authority: authority that the agent reasonably believes he has as a result of the principal’s actions. • Shiboleth and Heyman both testified that Nasser granted Shiboleth authority to settle the litigation. Sam Hogan. agreed to a settlement offer from Dweck. • In this case. The church decided that Bill could hire Gary Petty to assist. Nasser’s attorney for 20 years. it did not inform Bill of the new development. • The person alleging agency and resulting authority has the burden of proving that it exists. o It must be determined whether the agent reasonably believes because of present or past conduct of the principal that the principal wishes him to act in a certain way o The nature of the task or job may be a factor o Existence of prior similar practices is one of the most important factors – specific conduct by the principal in the past permitting the agent to exercise similar powers is crucial. after stalling a few weeks Nasser decided to reject the offer. However. The only moment for pause was that Sam used to be a member of the church but wasn’t at the time of this job. Shiboleth. the court found implied authority. • Bill had implied authority to hire Sam. implied and probably apparent authority to accept an offer. DWECK v. the dispute seemed to be over. regardless of Nasser’s objection to these terms. • Nasser consistently told Shiboleth and Heyman that he would “blindly” sign a settlement at their direction. he is bound by the settlement agreement approved by Shiboleth. as a helper. NASSER. The church could have argued that this fact should have alerted Bill that he didn’t have authority to hire Sam anymore. Bill hired Sam. Sam was paid by the Church for the 30 minutes of work.Facts: The church hired Bill Hogan to paint the interior of the church. The Church treasurer even paid Sam for his 30 minutes of work. but it can be established by circumstantial evidence. Sam then filed for workers’ compensation.

tripling. if the agent was considering expanding the contract by doubling. at some point the lower price would be much lower than the 3rd could believe was a reasonable offer and the principal may not be held to the extreme lower price. FENWICK. This may not be practical however. The owners had instructed Humble not to purchase certain items. For the owners to protect themselves. B. exercised his option to purchase. that he was acting for his wife. Are the real owners liable? Yes. the principal is probably liable. and in accordance with the agreement.000 for a lease with an option to purchase. • What if the true owners put their name over the bar so that 3rd parties know of their existence? Someone sells Humble some stuff that the owners have told Humble not to buy. and therefore the true owners may be held liable. the P can bring an action against the A for the difference in price. The principal is liable for any contract that Humble entered into that a normal bar manager reasonably had the authority to enter into. and then Humble disappears. can buy some liquor. 3. Ratification BOTTICELLO v. Also. Humble had apparent authority. as her agent. However. and such knowledge and acquiescence may be shown by evidence of the agent’s course of dealing for so long a period of time that acquiescence may be assumed. (1892) Facts: Humble manages a bar but does not own it. • Under the Restatement (2nd) there cannot be apparent authority because the principal is hidden and the 3rd party cannot know of the principal. Humble did buy some of these items on credit and wasn’t able to pay. The trial court granted specific performance against Walter and Mary.the agent’s acts. was then aware of the fact that Walter did not own the property outright. The plaintiff took possession. Walter and the plaintiff agree upon a price of $85. • The court finds that Humble had inherent authority. if there are too many possible 3rd parties. Apparent Authority: A principal is bound by an agent’s apparent authority which he knowingly permits the agent to assume of which he holds the agent out as possessing. WATTEAU v. 6 . made improvements. The seller then brought this action to recover from the actual owner. • Reasonable? If there is a contract in place and the agent is considering expanding it. • Nasser’s actions in connection with the settlement negotiations and his course of dealings with Shiboleth over 20 years make clear that Shiboleth had at least implied authority to settle the litigation. However. STEFANOVICZ. However. incidental costs for equipment in the same line as specified in the contract would probably be reasonable. The defendants refused to honor the purchase and the plaintiff commenced this suit. It probably wouldn’t be reasonable for the 3rd party to believe the agent has authority to double the contract. or to his own attorney. IT IS REASONABLE for the 3rd party to think Humble. Botticello became interested in the property. The agreement was signed by both Walter and the plaintiff. Neither the plaintiff nor his attorney. or more. as a bartender. Walter never represented to the plaintiff or the plaintiff’s attorney. During the negotiations Mary stated that she would not sell the property for less than that amount. • When an agent makes a deal for less than he is authorized and the P is held to the lower price. nor Walter’s attorney. (1979) Facts: Walter and Mary Stefanovicz owned a farm as tenants in common. under the Restatement (3rd). they could take away apparent authority by telling the 3rd parties that the agent does not have the authority to purchase these items. the agent probably needs to check with the principal.

the fact that the principal receives its proceeds does not make him a party to it. Apparent authority v. estoppel – for estoppel there has to actually be a change of position. before this is true. C. nor establishes her knowledge of all the material circumstances surrounding the deal. the principal can be held to that price regardless of whether payment has been made. When apparent authority is present there does not have to be a change in position for the principal to be held to the contract.• The court held that Walter was not acting as Mary’s agent nor did Mary ratify the agreement. o That one spouse tends more to business matters than the other does not. The items never arrived and upon investigation the store discovered that the salesman did not work at the store and pocketed the money. the other requisites for ratification must first be present. There is no apparent authority because the principal never held him out as an agent. o Walter never purported to be acting on Mary’s behalf. If someone with apparent authority quotes a price for something. Hoddeson brought this action hoping to require the store to honor the purchase. (1957) Facts: Hoddeson went to a furniture store and was approached by a man who purported to be a salesman. Thus if the original transaction was not purported to be done on account of the principal. “unique occurrences where solely through the lack of the proprietor’s reasonable surveillance and supervision an impostor falsely impersonates in the place of business an agent or servant of his. KOOS. • Walter was not Mary’s agent when he entered into the agreement. However. • Mary did not ratify the agreement by her behavior. • Estoppel has 3 elements: o The principal through acts or omissions creates the appearance of authority o 3rd party reasonably in good faith relies on the act or omissions o 3rd party changes their position on this reliance to his/her detriment • The court lays out a fairly narrow standard in this case. BROS.” o The duty of the business requires reasonable care and vigilance to protect the customer from loss occasioned by the deceptions of an apparent salesman. o However. o MOST DAMAGING – Walter never signed any documents as agent for Mary prior to this agreement. Estoppel HODDESON v. CURRAN. o Marital status alone cannot prove the agency relationship.. estoppel may be applicable. (1992) 7 . o The finding neither indicates an intent by Mary to ratify the agreement. Hoddeson purchased several items and went home to await there arrival a few weeks later. ATLANTIC SALMON v. absent other evidence of agreement or authorization. o The fact that they owned the farm as tenants in common does not make one an agent for the other. constitute the delegation of power as to an agent. • The plaintiff also makes the argument that Mary ratified by receiving its benefits and by failing to repudiate it under the Restatement (2nd) § 98. which is essential to effective subsequent ratification. • The “salesman” is not an agent.

with reference to whether. Restatement (2nd) § 4 1. If the other party has no notice that the agent is acting for a principal. It is the agent’s obligation to fully reveal it. • Factors for determining whether or not sufficient control exists to impose a master/servant. the safest thing to do. is to ensure that there are proper indemnification clauses in the contract. Restatement (2nd) § 2(2) • The master does not have to actually exercise control over what the agent does. at the time of a transaction conducted by an agent. • If the agent is working on behalf of a private or partially non-disclosed principal. If the other party has notice that the agent is or may be acting for a principal but has no notice of the principal’s identity. whether by the time or by the job o (h) whether or not the work is a part of the regular business of the employer 8 . principal/agent. a person purporting to make a contract with another for a partially disclosed principal is a party to the contract. 3.Facts: The defendant was trying to avoid personal liability by claiming that the business he was running was actually a corporation he had started previously but had since become insolvent.” • In order to avoid personal liability on a contract entered into by him on behalf of his principal. Servant versus Independent Contractor A master is subject to liability for the torts of his servants committed while acting in the scope of their employment. Restatement (2nd) § 220(2) o (a) the extent of control which. • It is not the 3rd party’s duty to seek out the identity of the agent’s principal. your principal requires that you do not disclose his name. the one for whom he acts is an undisclosed principal. outside of not being an agent. the other party thereto has notice that the agent is acting for a principal and of the principal’s identity the principal is a disclosed principal. • If as an agent. the principal for whom the agent is acting is a partially disclosed principal. by the agreement. in the locality. the master may exercise over the details of the work. Restatement (2nd) § 219(1). Liability of Principal to 3rd Parties in TORT A. the work is usually done under the direction of the employer or by a specialist without supervision o (d) the skill required in the particular occupation o (e) whether the employer or the workman supplies the instrumentalities. tools. and the place of work for the person doing the work o (f) the length of time for which the person is employed o (g) the method of payment. the agent can be held liable for enforcement of the deal unless the agent actively discloses that he is (1) working as an agent and (2) the identity of the principal. 2. an agent has a duty to disclose that he is acting in a representative capacity AND the identity of his principal. o (b) whether or not the one employed is engaged in a distinct occupation or business o (c) the kind of occupation. A servant is an agent performing services in the master’s affairs whose physical conduct is controlled or is subject to the right of control by the master. Section 3. he merely needs to have the right to control the agent’s physical performance of the assigned task. • Unless otherwise agreed. If.

as the principal or master of Betsy-Len. the provider of gas. Schneider. The test to be applied in these types of cases is “whether the oil company has retained THE RIGHT to control the details of the day-to-day operation of the service station. He may or may not be an agent. Before the employee secured the car it rolled down a hill and struck Martin and 2 of his children. Does Humble have THE RIGHT to sufficient control over Schneider to create the master/servant. but rather in law what it actually is. It is the element of continuous subjection to the will of the principal which distinguishes the agent from other fiduciaries and the agency agreement from other agreements. Martin wants to sue the owner of the individual gas station. Restatement (2nd) § 2(3). Of course Sun wants Barone to succeed but Barone is ultimately responsible for the loss. The relationship of the parties does not depend upon what the parties themselves call it. Inc. When an agreement. the individual owner.o o (i) whether or not the parties believe they are creating the relation of master and servant (j) whether the principal is or is not in business An independent contractor is a person who agrees to carry out some task but is not subject to the principal’s control in doing so.. principal/agent relationship? • Who is primarily financially responsible? Humble – in charge of ¾ of the “net public utility bills” • The court held that the main object of the enterprise was the retail marketing of Humble’s products with title remaining in Humble until delivery to the consumer. (1975) Facts: Mrs. INC. and Humble. MURPHY v.” • Who is bearing the risk of loss? Barone. considered as a whole. MARTIN. the principal is automatically liable. no liability can be imputed to Sun from the allegedly negligent acts of Smilyk. establishes an agency relationship.. SUN OIL COMPANY. MCDONALD’S CORP. B. Therefore. Murphy injured herself while visiting a Holiday Inn which was independently owned and operated by Betsy-Len Motor Corporation. HUMBLE OIL v. HOLIDAY INNS. (1965) Facts: There was a fire at a service station and the injured wanted to hold the individual owner and the gasoline provider liable. the parties cannot effectively disclaim it by formal consent. (1997) 9 . • Sun had no control over the details of Barone’s day-to-day operation. HOOVER v. If the agent was negligent. • It doesn’t matter whether the principal was negligent in its management of the agent. The critical test is the nature and extent of the control agreed upon. The only tort question is whether the agent was negligent. (1949) Facts: Love left her car with a service station employee. Tort Liability and Apparent Agency MILLER v. Murphy sued Holiday Inn. control or influence over results alone being viewed as insufficient.

appears that there must be detrimental reliance -but. and d. principal/agent relationship and sued McDonald’s Corp for her injuries. Scope of Employment Restatement (2nd) § 228 1. there has to be an affirmative holding out to a 3rd party. by a purpose to serve the master. then the “principal” is liable for a harm or damage caused by the justifiable reliance -THUS. Was the sign sufficiently visible to the public. and allocates to the franchisor the right to exercise control over the daily operations of the franchise. • The crucial issues are whether the principal held the 3rd party out as an agent and whether the plaintiff relied on that holding out. is one sign by itself sufficient to remove the impression that defendant created through all of the other indicia of its control that it presented to the public? • Another argument that a plaintiff would have if a true master/servant. 10 . It seems that the court determined that an Apparent Agency relationship existed. Conduct of a servant is within the scope of employment if. If force is intentionally used by the servant against another. Miller then alleged the master/servant. seems that can only recover to the extent of the damage (similar to Estoppel theory and recovery) -This seems to be almost exactly the same as Estoppel Theory Argument -but. It is of the kind he is employed to perform. under Apparent Agency test. -Key factors for Apparent Agency: -“principal” holds “agent” out to public as an “agent” -public justifiably relies upon the care or skill of the apparent agent -if the public does justifiably rely. FN 4 pg 56: -Apparent Agency: creates agency relationship where such a relationship does not in fact exist. b. but said that the Apparent Authority issue was a jury question to be resolved back at the trial court. Apparent Agency – one who represents that another is his servant or agent and thereby causes a 3rd party justifiably to rely upon the care or skill or such apparent agent. This case highlights the distinction between Apparent Authority and Apparent Agency.Facts: Miller bit into a sapphire stone while eating a Big Mac in an individually owned McDonald’s. but only if: a. It occurs substantially within the authorized time and space limits. at least in part. the use of force is not unexpectable by the master. • The possible existence of a sign identifying 3K as the operator does not alter the conclusion that there is an issue of apparent agency for the jury. whereas under traditional Estoppel Theory. It is actuated. the “principal” can be bound by a mere omission Actual Agency exists making McDonald’s vicariously liable for 3K’s negligence if the franchise agreement goes beyond the stage of setting standards. in this instance. Really need to look at OneNote notes. the way in which the stone came to be in the burger was specifically under the specified methods that the franchisor imposed upon C. principal/agent relationship couldn’t be found – if the principal made the representations that made the appearance of agency and the 3rd party justifiably relied on the representations. c. • Another important aspect of this case is the ways in which in the Agreement the parent corporation designated the methods by which the franchisee was to conduct business.

then an independent contractor -is there an exception to no vicarious liability for person hired as an independent contractor 3. (If you have sailors. If you have sailors. it is foreseeable that might get drunk and do something stupid—especially on the docks). Reasonable precaution is not what counts. The court means that something that is foreseeable in the nature of the work. . An act may be within the scope of employment although consciously criminal or tortious. Once a court has established that a master/servant. unless there was something that the employer could have done to prevent it Scope Of Employment: What to look for: 1. Lane’s conduct was not so “unforeseeable” as to make it unfair to charge the Government with responsibility.) Is there an employee/servant relationship -if yes. turned some wheels on a drydock wall on the way back to his barracks. . Restatement (2nd) § 231 1. a different thing from the foreseeably unreasonable risk of harm that spells negligence. then respondeat superior -if no. o Means argues that there was some evidence of serving the master under the facts:  has to return to ship to carry out his duty  Navy gives them a time to be back to the ship • The court comes up with a foreseeability test. “What is reasonably foreseeable in this context (of respondeat superior) is .) If there is not an EE/ER relationship. then prob not going to be within scope of employment.Note: Many courts now hold that to be outside the scope of employment. you have to take reasonable precautions. it is foreseeable that some of them might get drunk and do stupid stuff. the employee must be on a “frolic and detour. -Note on Intentional Torts: if you commit an intentional tort done purely for personal pleasure. returning from shore leave.” o In tort. The court says that “while Lane’s return to the Tamaroa was to serve his employer. Something that is foreseeable in the nature of the work being done. UNITED STATES. Is this within the scope of employment? • The court rejects the application of the purpose (motive) test from Restatement (2nd) § 228(1)(c).” Meaning: total abandonment of work for the employer. then no vicarious liability for ER -might also do apparent agency analysis under this prong 2. if something is foreseeable. then was the tort committed in the scope of employment (purpose to serve ER test) -if yes. then is there apparent agency? -apparent agency: -was there representation creating appearance of relationship -was there reasonable reliance -was there some detriment as a result of reliance IRA S. BUSHEY & SONS v. This foreseeability analysis is different from a foreseeability analysis that is involved with tort. principal/agent relationship exists the court will find any way it can to include the conduct of the servant within the scope of employment. This caused a ship to partially flood. (1968) Facts: A drunken sailor. no one has suggested how he could have thought turning the wheels to be” serving his employer.) If there is not an exception. • This stands for the minority Friendly’s Foreseeability Test 11 .

This “conduct” is conduct interfering with the employee’s performance of his work. (1981) Imputing an intentional tort committed by an agent to the principal. within the meaning of Miller.• o o   How this foreseeability differs from foreseeability in tort: in tort. it is reasonable for one side to bring the contract into evidence because both parties have agreed to these terms. Facts: A pitcher for the Orioles. But.” • The court held that constant heckling by fans at a baseball park would be. The plaintiff has to show “that the employee’s assault was in response to the plaintiff’s conduct which was presently interfering with the employee’s ability to perform his duties successfully. GRIMSLEY. when both parties to the contract. MANNING V. These fans had been heckling Grimsley. 12 . Inc. • For the plaintiff involved with the Conoco owned store. However. conduct. as an important related factor is whether the use of intentional force is unforeseeable by the master. Argue this “presently interfering test” when the intentional tort is outside the scope of the employment. the individually owned stores and Conoco.e. Inc. he must show that the employee was acting within the scope of her employment. • Rule: for a plaintiff to recover damages from an employer for injuries resulting from an employee’s assault it must be shown that the employee’s assault was in response to the plaintiff’s conduct which was presently interfering with the EE’s ability to perform his duties successfully • This appears to be different from the Restatement test—Restatement test. (2000) Facts: There were 3 incidents involving alleged discrimination of minorities at Conoco branded or Conoco owned gas stations. • The terms of an agreement or contract are not important when a 3rd party is involved. has given consent for the branded stores to act on its behalf and that the branded stores are subject to the control of Conoco.” This control is control over the way things are done. while warming up in the bullpen. These plaintiffs must “show that Conoco. are in dispute.. but the Agreement does not establish that Conoco has any participation in the daily operations of the branded stores nor that Conoco participates in making personnel decisions. • The plaintiffs involved with the Conoco branded stores assert that Conoco was a principal for the actual owners of the stations. by way of the “presently interfering test” even where it is arguable that it is outside the scope of the employment. you look at fault for not taking reasonable precautions Friendly only looks at whether you could have foreseen it happening: doesn’t take the AC:SC into effect doesn’t look at whether preventable The majority rule is the purpose to serve (motive) test from the Restatement. o The court held that the Agreements entered into by the individual station owners and Conoco offers guidelines to the stores. The court examines the factors in the Restatement (2nd) § 228. in the instance of an intentional tort focuses upon whether it was unexpected D. i. Statutory Claims ARGUELLO v. CONOCO. threw a ball at a 90deg angle from the pitchers mound into a group of fans. INC.

Restatement (2nd) § 379 i. “Frolic and detour”? – as a defense a. if looking under the more traditional negligent hiring analysis. Time and space? a. Fiduciary Obligation of Agents Three principal Fiduciary Duties 1. Liability for Torts of Independent Contractors MAJESTIC REALTY ASSOCIATES v. Foreseeability 5. he is not liable for the negligent acts of the contractor in the performance of the contract. Care and Skill a. Ordinarily. TOTI CONTRACTING CO. in addition. an independent contractor not having liability insurance might be deemed an incompetent contractor • However. to exercise any special skill that he has. (1959) Facts: An independent contractor was hired to demolish a building. i. There are certain exceptions. Conduct of kind employed to perform? 2. Use of employer’s materials? 3. who conducts an independent business by means of his own employees. caused damage to an adjoining building as well. and while doing so. where he engages an incompetent contractor • So. one might argue that he was incompetent Factors for Scope of Employment: 1. 1. a gratuitous agent is under a duty to the principal to act with the care and skill which is required of persons not agents performing similar gratuitous undertakings for others. Unless otherwise agreed. b. Motive/purpose to serve? 4.o The court finds that the purpose of the employee’s interaction with the customer was to complete the sale of gas and other store items. inherently dangerous activity Means argues that it is difficult to distinguish negligent acts of the independent contractor and hiring an incompetent person -if the independent contractor acts negligently. a paid agent is subject to a duty to the principal to act with standard care and with the skill which is standard in the locality for the kind of work which he is employed to perform and. to do work not in itself a nuisance. Force “not unexpectable”? a. Restatement (2nd) § 382 13 .e. E. 3. where the principal retains control over the aspect of the activity in which the tort occurs 2. total abandonment Section 4. 1. it is unsettled whether hiring a financially insolvent independent contractor would constitute hiring an incompetent contractor because of the prevalence of liability insurance purchased by most independent contractors—such that. where a person engages a contractor. the focus is upon whether the person hired can perform the job adequately for which they were hired to do.. 2.

Conduct by an agent that would result in a breach of duty under one of the previous sections does not constitute a breach if the principal consents to the conduct. To deal in good faith with each principal. to allow the cargo trucks to pass by without being questioned. even if in doing so the ER’s tools are not damaged in any way whatsoever. Otherwise deals fairly with the principal b. The fact that the agent acts for the other principal or principals . Unless otherwise agreed. has reason to know. It was found that as an officer he was not constrained by civilian policy. General Rule: a servant cannot use the tools of the employer to profit. the agent i. an agent is subject to a duty to obey all reasonable directions in regard to the manner of performing a service that he has contracted to perform. Unless otherwise agreed. In obtaining the principal’s consent. has reason to know. Unless otherwise agreed. The principal’s consent concerns either a specific act or transaction. or should know would reasonably affect the principal’s judgment unless the principal has manifested that such facts are already known by the principal or that the principal does not wish to know them. or should know would reasonably affect the principal’s judgment unless the principal has manifested that such facts are already known by the principal or that the principal does not wish to know them iii. Restatement (2nd) § 387 1. which were given to him by the crown. Loyalty a. To disclose to each principal i. 2. and he was involved in some sort of smuggling ring. Restatement (2nd) § 385 1. an agent is subject to a duty to keep. Obedience a. an account of money or other things which he has received or paid out on behalf of the principal. using his uniform. 3. This case is distinguished from cases where the service merely gives the opportunity of making money. o This is the distinguishing factor: using his position as agent specifically to obtain the benefit 14 . 4. b. 2. Otherwise to deal fairly with each principal. An agent who acts for more than one principal in a transaction between or among them has a duty a. Discloses all material facts that the agent knows. Restatement (3rd) § 8. These duties are modifiable under certain circumstances. REGEM. were the only reason why the plaintiff was able to get this money.06 1. or acts or transactions of a specified type that could reasonably be expected to occur in the ordinary course of the agency relationship.i. Duties During Agency READING v. • There was no harm to the government in this case. and render to his principal. Acts in good faith ii. an agent is subject to a duty to his principal to act solely for the benefit of the principal in all matters connected with his agency. All other facts that the agent knows. • The use of the uniform and his position. He was using his position as an officer. A. and c. provided that a. (1948) Facts: There was an army officer who had a lot of money that was unaccounted for. and ii.

SINGER. 15 . He would keep the difference in price for himself.Classic Hypothetical: agent is charged with care of his master’s horses and agent makes money on the side by charging people to ride the horses. The court held that this practice was inconsistent with the obligations of a faithful agent or employee. while employed in this capacity he started acting as a broker. and the expenditure of time and money. constituting a part of the good will of a business which enterprises and foresight have built up. Black Letter: even if in best interest of principal. Duties During and After Termination of Agency: Herein of “Grabbing and Leaving” TOWN & COUNTRY HOUSE & HOME SERVICE v. the court does make the point that merely starting a new business in the same line of business that previous principal worked in was not sufficient to constitute a breach of the fiduciary duty because there were no trade secrets involved in the second business that was derived from working with the first. Singer had broad powers of management and conducted the business activities of Automotive. agent enriches himself by using the property belonging to the principal (horses) and despite the fact that the property is not damaged in any way (actually might make the property better off because the horses need exercise) the principal would be able to seize the profits made by the agent using the principal’s property. Plaintiff alleges this list was a “trade secret. • Is something material? Would a reasonable person want to be aware of the information? • What Singer calls (title) his side line business (activity) does not determine the question whether it was competitive but an examination of the nature of the business must be made. In this capacity he was Automotive’s agent and owed a fiduciary duty to it.” The court holds that a former employee may not solicit the employer’s customers whose availability as patrons cannot readily be ascertained but whose trade and patronage have been secured by years of business effort and advertising. GENERAL AUTOMOTIVE v. (1963) Facts: Singer works as general manager of business and affairs for Automotive. When orders would come in that he believed Automotive couldn’t perform or couldn’t match another company’s price. • Singer was bound to exercise of the utmost good faith and loyalty so that he did not act adversely to the interests of Automotive by serving or acquiring any private interest of his own. He is more adept at machine work and pricing than anyone. an agent cannot obtain secret profits using his position as agent. an expert in this field. Restatement (2nd) §§ 402–404: Means argues that these state the rules of Singer and Reading Restatement (2nd) § 124(a) ? B. NEWBERY Facts: Defendants stopped working for the plaintiff. He was also bound to act for the furtherance and advancement of the interest of Automotive. who operated a house cleaning business. But. Singer would accept the order and have another company perform the work. However. Plaintiff alleges that the defendant basically stole the list of clients while employed in order to generate business for the company the defendants were planning to start. However. the customer list is different due to the time and effort the previous principal took to procure them as customers. He never notified Automotive of this practice.

The agent is entitled to use general information concerning the method of business of the principal and the names of the customers retained in his memory. Partnerships Section 1. Has no duty not to compete with the principal. (c) As an annuity to a widow or representative of a deceased partner. This will take away Actual and Implied authority. supplies. U. c. Has a duty to the principal not to take advantage of a still subsisting confidential relation created during the prior agency relation. the agent: a. whether or not in competition with the principal. etc. and other associations U. but would likely shift toward employee/er relationship (one argument to counter this is to argue that one is the brains and one is the money) 16 . To terminate Apparent. if not acquired in violation of his duty as agent. Restatement (2nd) § 396 – Using confidential information after termination of agency 1. on his own account or on account of others. Unless otherwise agreed.P. d. § 2 – a “person” includes individuals. This may not always work for Apparent Agency. (b) as wages of an employee or rent to a landlord. Has a duty to the principal not to use or to disclose to 3rd persons. after the termination of the agency. partnerships.A. though the amount of payment vary with the profits of the business. (e) As the consideration fro the sale of a good-will of a business or other property by installments or otherwise -the prima facie evidence of partnership can be rebutted by showing some other reason for sharing of profits Other Considerations: -other evidence of parties’ intent can also rebut the presumption -sharing profits and losses is an IMPORTANT factor -is there any control of management -is there a joint sharing of control of property and management -have both people contributed to capital -if one person has put in all capital (building. but no such inference shall be drawn if such profits were received in payment: (a) as a debt by installments or otherwise.A.P. A partnership is an association of two or more persons to carry on as co-owners a business for profit a. written lists of names. b. corporations. (d) As interest on a loan.) then it could be a partnership. General Partnership does not require any formal agreement (just like agency) in writing to constitute a partnership (determined by facts just as in agency). General note: an agency will terminate when the task of the agency relationship has been achieved. Has a duty to account for profits made by the sale or use of trade secrets and other confidential information. What is a Partnership? And who are the partners? Uniform Partnership Act § 6 – Partnership Defined 1. in competition with the principal or to his injury.Restatement (2nd) § 118 – communication by either principal or agent that the relationship is over does so. trade secrets. it is wise to contact 3rd parties to notify them that the agency relationship is over. § 7(4) The receipt by a person of a share of the profits of a business is prima facie evidence that he is a partner in the business. or other similar confidential matters given to him only for the principal’s use or acquired by the agent in violation of duty.

Chesire to act as a cashier and receptionist for his beauty shop. **An agreement which says that one wil not share in losses will not be considered conclusive—if a partnership is established by the facts. However.General Partnership: -partners have unlimited liability -all partners are on same footing (share profits and losses equally) -all partners have an equal obligation Limited Partnership -earlier attempt to create business form that is a hybrid of corporation and general partnership -separates limited partners and general partners -must formally create a limited partnership by specific filings (formal process) -general partner has all of the liability—thus there is a requirement of a general partner (usually the managing partner) -limited partners look like shareholders in a corporation—no liability because passive control -therefore. The rights of the parties on dissolution – exactly the same as if Chesire had quit employment The court held that the element of co-ownership as required by U. both personal and partnership returns) but not to anyone else 8. not conclusive 3. reluctant to obligate himself for more. The court also talks about the sharing of profits being prima facie evidence of a partnership but said that no such inference will be drawn if profits were received in payment as wages for an employee. Partners Compared with Employers FENWICK v. The ownership and control of the partnership property and business – Fenwick contributed all the capital and received all capital upon dissolution 5. The conduct of the parties towards 3rd parties – do the parties hold themselves out as partners? – The parties held themselves out as partners towards the Commission (income tax returns. Fenwick. The obligation to share in losses – did not exist 4. the agreement’s language and intention would carry more weight. Shortly thereafter. Fenwick’s strongest argument for the existence of a partnership is the profit sharing. A written contract is not required for a partnership. (1945) Facts: Fenwick hired Mrs.P. In the agreement the relationship is described as a partnership. Community of power in administration – Fenwick retained all power of control in the agreement 6.A. The right to share in profits – existed in this agreement – however. then despite the agreement saying not liable for losses. UNEMPLOYMENT COMPENSATION COMMISSION. The intention of the parties – the agreement suggests partnership but is not conclusive – Fenwick’s testimony persuades the court that the intention was to provide a new compensation scheme for Chesire 2. 1. If this were a dispute between Fenwick and Chesire.P. § 6 is not present in this case. you must also have limited partners. U. There are several elements that the courts have used to determine if a partnership existed. offered to enter into an agreement that would provide Chesire with more money if the business warranted. the court rejected this because the profit sharing agreement was merely meant to be another way to compensate Chesire for her work. Chesire asked for a raise. The language in the agreement – the agreement calls the parties partners but it excludes Chesire from most of the ordinary rights of a partner 7. one may indeed be jointly and severally liable individually for any debts of the partnership** 17 . § 6 does not say anything requiring a written contract.A. but limited partners cannot have control A.

Partners Compared with Lenders MARTIN v. subject to any agreement between them. By decree of court under § 32 B. by the following rules: (e) All partners have equal rights in the management and conduct of the partnership business -*but. where some control is shared but not equally: -the default rule is that co-partners share control equally -but. PPF required Hall to take out a life insurance policy. and Freeman are three guys that have several million dollars to invest. Mr. b. either before or after the termination of any specified term or particular undertaking d. By the bankruptcy of any partner or the partnership 6.How do you set up a partnership like relationship. PPF retains certain rights: inspection rights.A. the question still remains whether in 18 . a. By the termination of the definite term or particular undertaking specified in the agreement. veto speculative transactions. can enter the firm by buying 50% of any of the members. U.A. (1927) Facts: KNK is a firm involved in a lot of speculative business and they are on the verge of bankruptcy. § 18 – The rights and duties of the partners in relation to the partnership shall be determined. PPF also have the signed resignations is a drawer of each member of the firm. PEYTON. Hall of KNK is a good friend of Mr. as noted above. you can contract around this default rule A key problem for Fenwick in this case was “Fenwick continued to have complete control of the management of the business. The court rules that PPF are not partners with KNK. By the express will of any partner when no definite term or particular undertaking is specified c. The investors stand to get 40% of the profits with a certain minimum and maximum. By the express will of all the partners who have not assigned their interests or suffered them to be charged for their separate debts. Perkins.P. By any event which makes it unlawful for the business of the partnership to be carried on or for the members to carry it on in partnership 4. By the expulsion of any partner from the business bona fide in accordance with such a power conferred by the agreement between the partners 2. Although the intention of the parties was to avoid liability as partners and they defined their relationship as not creating a partnership. § 31 Causes of Dissolution Dissolution is caused: 1. Without violation of the agreement between the partners. Peyton. In contravention of the agreement between the partners. Peyton and persuades them to invest their money in KNK.” U. each member of KNK is required to assign to the trustees their interest in the firm. entitled to inspect the firm books. where the circumstances do not permit a dissolution under any other provision of this section. you can easily contract around the default rule Burden of Proving Partnership: on whoever is trying to argue that a partnership existed. They also have the option to buy up to 50% equity in the firm.P. by the express will of any partner at any time 3. By the death of any partner 5.

C.” PPF claimed that they loaned the money to KNK and that the share in profits was designed to be a payment for a loan. not profit sharing. Partnership by Estoppel U. a. even though the person is not in fact a partner. Estoppel Theory -has to have been some representation that there is a partnership -detrimental reliance 19 . and others who have either made or consented to the representation are bound by the person’s acts as if they were partners with the person represented as their partner. or with one or more persons not actual partners. whether the representation has or has not been made or communicated to such person so giving credit by or with the knowledge of the apparent partner making the representation or consenting to its being made. such that you have sufficient control to protect your investment. then the person who was represented as a partner is liable on the transaction as if the person were a partner. and if he has made such representation or consented to its being made in a public manner he is liable to such person. but not cross that threshold of too much control such that a partnership is found and the investors then become personally liable for the debt of the company invested in. given credit to the actual or apparent partnership. If a person represents himself as being a partner in an enterprise (or allows others to make the representation) and a 3rd party reasonably relies on the representation and as a result does business with the enterprise.fact they agree to so associate themselves with the firm as to “carry on as co-owners a business for profit. he is an agent of the persons consenting to such representation to bind them to the same extent and in the same manner as though he were a partner in fact. who has. partners have unlimited personal liability. as a partner in an existing partnership or with one or more persons not actual partners. or consents to another representing him to any one. • Merely because the transaction involved the transfer of securities and not of cash does not prevent its being a loan • PPF were not allowed to initiate any transaction as a partner may do. in a general partnership. When a person represents himself.A. he is liable to any such person to whom such representation has been made. When a person has been thus represented to be a partner in an existing partnership. They may not bind the firm by any action of their own • The court construed all of the various provisions included in the agreement that benefit PPF as necessary precautions to loaning $2 million worth of securities Why isn’t Hall treated as an agent of PPF? -because the control by PPF was not to the extent of the control in Cargill -Cargill was doing almost everything except day-to-day business of grain silo -elements tending toward partnership: -allowed to initiate transactions as partners can -allowed to bind the firm via the transactions -neither of these elements are present in this case -the controls in this case are creditor-protection devices and are not about trying to control the business Practice Pointer: you want a happy medium. When a partnership liability results. -Remember: as partners.P. with respect to persons who rely upon the representation. he is liable as though he were an actual member of the partnership 2. on the faith of such representation. § 16 – Partnership by Estoppel 1.

It didn’t discuss what would happen at the end of the 20 year term if there was an opportunity to extend the lease. Cardozo A. there is no evidence that credit was extended on the basis of any representation or a partnership existing between the two affiliates. • If PW—Bahamas and PW—US are partners by estoppel. is then the standard of behavior. the duty of the finest loyalty. constitute an association of person to carry on. o Terms of the Joint Venture: 20 . PW—US would be jointly and severally liable with PW—Bahamas for everything chargeable to the partnership of the two firms. • The plaintiffs contend that a Price Waterhouse brochure describing PW as a worldwide organization lends someone to believing that all PW offices are partners. but the punctilio of an honor the most sensitive. Not honesty alone. (1992) Facts: Plaintiffs invested over a half-million dollars in a South Carolina bank and the funds disappeared. • Also. (1928) Facts: • Salmon leased the Hotel Bristol for 20 years and spent $200.” – J. In the alternative. owe to one another. “Joint adventurers. but he is too busy so he says he’ll send his partner -plumber does not indeed have a partner.000 to transform it into shops and offices. The court notes that the plaintiffs do not assert that the brochure was seen or relied on by them in making the decision to invest. business for profit. Introduction MEINHARD v. plaintiffs allege that they are operating as partners by estoppel. A trustee is held to something stricter than the morals of the marketplace. • They had a written agreement. but contacts another plumber (independent contractor) -independent contractor plumber does shoddy work -you want to sue the original/normal plumber -you can do this under partnership by estoppel theory YOUNG v. Also. • The court doesn’t buy the plaintiff’s argument. as owners. Also. Many forms of conduct permissible in a workaday world for those acting at arm’s length are forbidden to those bound by fiduciary ties. while the enterprise continues. Price Waterhouse—Bahamas issued an audit letter regarding a company and the plaintiffs invested this money on the basis of that financial statement. Section 2. • Therefore. if the two partnerships are partners by estoppel. there is no partnership by estoppel. The financial statement was falsified. the individual partners of PW—US would then be jointly and severally liable for the negligent acts of the PW—Bahamas partnership. The plaintiffs assert that PW—Bahamas and PW—US operate as a partnership. PW—US doesn’t make any distinction between itself and foreign offices. when advertising. like copartners. JONES.Classic Example: -you call the plumber that you normally contract with. SALMON. The Fiduciary Obligations of Partners Partners owe each other a fiduciary duty of loyalty.

alone and would alone enter the project. Means makes note that if they had they placed a clause in the agreement. The important fact here is that the new lease encompassed and enlarged the old lease. • Salmon signed the new lease for himself without telling Meinhard anything about it. Gerry. he might have had a right to hold it out for himself. underlet. • Salmon received the opportunity solely as a result of his position as manger of the Hotel • Meinhard brought suit wanting a piece of the action.000 and Salmon was to pay Meinhard 40% of the net profits for the first 5 years and 50% for the years after. then there is no duty to allow the other co-adventurer to compete Means says that he is not sure whether a “heads-up” is sufficient. lease. to take place at the end of the initial 20 years. same rules for partnership apply to joint ventures • After a few bad years the “coadventure” turned very profitable. owned several lots adjacent to this lot and desired to lease them all together for development. but a duty of loyalty to allow Meinhard the possibility to enter into the new agreement? The court held that Salmon had a duty as managing “coadventurer” to inform Meinhard of this potential new lease. for himself and another. o the lessor did not know that Meinhard was the “silent partner” • Salmon negotiated this deal. o Salmon had the sole power to manage. as an active partner.o this was a joint venture between Salmon and Meinhard. Meinhard may have chosen to compete for the award. The fiduciary duty includes a very strong duty of disclosure. or whether the duty extends to actually allowing the other person to compete It is important to note that that the opportunity presented itself solely as a result of position as managing partner and it related to the same location as the original joint-venture: -it might be different if the second opportunity is different from that involved in the joint venture 21 . You can’t keep anything from the firm. He owed a duty to Meinhard to notify him of the negotiations. o the writing was silent on any obligations that they have to each other at the end of the 20 year joint venture • *KEY characteristic of JOINT VENTURE: limited in time • but. leaving Meinhard in the cold. If the lessor had offered Salmon an opportunity far removed from the initial site. wherein Meinhard is mainly the money man o Meinhard was to pay half of the $200. then a different result might have come about For example: if a business opportunity comes up as a result of position as managing person toward the end of the joint venture. have a duty imposed on him solely based upon his position as managing partner? o Did Salmon have not only a duty to tell. at least Meinhard would have been aware that the relationship was ending. o The parties would bear any losses equally. Salmon held the lease as a fiduciary. • The lessor. and operate the building. • Issues: o Did Salmon have a duty to tell Meinhard of the new opportunity? o Did Salmon. After nobody else would take on this project he pitched the idea to Salmon. since only through disclosure could the opportunity be equalized. The fact that Salmon alone was in control of the venture obligated him even more to disclose.

The partnership agreement required that a majority of the limited partners must approve such a move. or benefit derived by the partner in winding up of the partnership business or derives from a use by the partner of partnership property (2) to refrain from dealing with the partnership in the conduct or winding upon the partnership business as or on behalf of a party having an interest adverse to the partnership (3) to refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership (c) a partner’s duty of care to the partnership and to the other partners in the conduct and winding up of the partnership business is limited to refraining from engaging in grossly negligent or reckless conduct. you do have a duty to tell someone about an opportunity that came up solely as a result of association with joint venture or partnership -this is the minimum that is required. but others you cannot PERETTA v. not enough. As a result 50. (2008) Facts: DRAWING FROM NOTES PDC wanted to merge the partnership with PIP. If PIP’s votes were not counted.2% of the partnership and PDC and PIP were owned by the same person. or a knowing violation of the law UPA § 103: Effect of Partnership Agreement. 22 .Rule: when you are in a joint-venture or partnership.2% according to the percentages already cast. after full disclosure of all material facts.. INC. profit. PIP owned 18. PIP split its 18. it is not settled whether additional requirement of actually allowing the other partners or co-adventurers to compete for the new opportunity is required UPA § 404: General Standards of Partner’s Conduct: (a) The only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care set forth in subsections (b) and (c) (b) A partner’s duty of loyalty to the partnership and the other partners is limited to the following: (1) to account to the partnership and hold as trustee for it any property. Nonwaivable Provisions (b) The partnership agreement may not: -eliminate the duty of loyalty under Section 404(b) or 603(b)(3) -the partnership agreement may identify specific types or categories of activities that do not violate the duty of loyalty. if not manifestly unreasonable -you can’t just say in Partnership Agreement that there is no duty of loyalty. Opting Out of Fiduciary Duties -You cannot completely disclaim fiduciary duties by simply placing such a disclaimer in the agreement -policy: -fiduciary duties are really about filling in things that the parties left out themselves during agreements and talks -there is a policy that the fiduciary duty is inherent in the partnership agreement -some things you can contract around. a specific act or transaction that otherwise would violate the duty of loyalty B.7% voted to approve the merger. only 46% of the unaffiliated limited partners voted to approve. When counting the votes. but you can say what constitutes a duty of loyalty -all of the partners or a number or percentage of the partners as specified in the partnership agreement may ratify. intentional misconduct. PROMETHEUS DEVELOPMENT COMPANY.

MEEHAN v.A. the court said that not all self-interested transactions violate the duty. Grabbing and Leaving U. they decided to give only 30 days. • The law permits a partnership agreement to vary or permit ratifications or violations of the duty of loyalty only if the provision doing so is not “manifestly unreasonable.A. The firm asserted that Meehan engaged in improper conduct in withdrawing cases and clients from the firm. Although the partnership agreement called for 3 months notice. SHAUGHNESSY. fiduciaries may plan to compete with the entity to which they owe allegiance. § 103(b) – The partnership agreement may not:  (3) eliminate the duty of loyalty under § 404(b) but: • (i) the partnership agreement may identify specific types or categories of activities that do not violate the duty of loyalty. However. o The question is not whether the interested partner is benefited. Meehan owed this duty. a specific act or transaction that otherwise would violate the duty of loyalty • The court holds that the applicable statute mandates that conflicted actions be ratified by disinterested voter elections. and refrain from acting for purely private gain. C.” • The plaintiffs allege that this was a self-dealing transaction that violated this duty. and partners may not take advantage for themselves at the expense of the partnership.P. provided that in the course of such arrangements they do not otherwise act in violation of their fiduciary duties. It is “manifestly unreasonable” to allow interested directors to vote in the ratification. made reasonable efforts to avoid continuances. • It is well settled that partners owe each other a fiduciary duty of the utmost good faith and loyalty. and in inducing employees to join the new firm. and worked on discovery. As a fiduciary. (1989) Facts: Meehan left the law firm. 23 .A. after full disclosure of all material facts.P. the burden is on the defendant to show complete good faith and fairness to the other limited partners. • Allowing an interested partner to participate in a ratification election subverts the very purpose of ratification itself. • Therefore. o Partnership is a fiduciary relationship. § 404(b)(2) – “to refrain from dealing with the partnership in the conduct or winding up of the partnership business as or on behalf of a party having an interest adverse to the partnership. a partner must consider his partners’ welfare. • A partner who seeks a business advantage over another partner bears the burden of showing complete good faith and fairness to the other. or • (ii) all of the partners or a number or percentage specified in the partnership agreement may authorize or ratify.” o U. but whether the partnership or the other partners are harmed.P. While continuing to work at the firm they settled cases appropriately. Ratification by disinterested partners meets this burden. if not manifestly unreasonable. • However.The relevant statute for this case stated that a partner’s duty of loyalty required a partner U. § 20 – Duty of Partners to Render Information Partners shall render on demand true and full information of all things affecting the partnership to any partner or the legal representative of any deceased partner or partner under legal disability. Meehan conspired with others at the firm over the period of a few months. tried cases. The defendants claim that Meehan violated fiduciary duties and breached the partnership agreement.

as a cotenant in all partnership property. Putnam deeded her interest in the Frog Jump Gin Company to the Shoafs. § 26 – Nature of Partner’s Interest in the Partnership A partner’s interest in the partnership is his share of the profits and surplus PUTNAM v.P. U. § 20  3 times Meehan affirmatively denied to his partners. 24 . What to do when want to dissolve Law Partnership: -several PPR rules apply -clients have a right to their choice of representation: -if you are competing for a client. a co-partner owns no personal specific interest in any specific property or asset of the partnership. Putnam brought this suit to recover a share of any recovery that resulted from the embezzlement litigation. you cannot represent to them that they have no choice and must remain with the firm or partner that is leaving -you cannot disparage another lawyer when competing for a client Section 3.A. that she would be relieved of any liability arising from the Frog Jump.” Therefore. on their demand. Partnership Property U.A. o A partner has an obligation to render on demand true and full information of all things affecting the partnership to any partner – U. The real interest of a partner is the partner’s interest in the partnership which is defined as “his share of the profits and surplus. obtained an unfair advantage over his former partners in breach of his fiduciary duties. • A partner’s possessory right is not the partner’s “interest” in the assets of the partnership. Therefore. § 25 – Nature of a Partner’s Right in Specific Partnership Property The right in specific partnership property is the partnership tenancy possessory right of equal use or possession by partners for partnership purposes. The partner’s interest is an undivided interest.• Meehan did. Putnam wanted out of the business because of the large liability. and (3) his right to participate in the management.P. (1981) Facts: Mrs.P. The partnership owns the property or the asset. Mrs. After this deed was executed. the Shoaf’s new accountant found that the old accountant had embezzled a large amount of money.A. his secrecy concerning which clients he intended to take. For this reason a conveyance of partnership property held in the name of the partnership is made in the name of the partnership and not as a conveyance of the individual interests of the partners. He has no right to possess such property for any other purpose without the consent of his partners. o A co-partner owns no specific personal interest in any specific property or asset of the partnership. through his preparation for obtaining clients’ consent.P. That interest is the partner’s pro rata share of the net value or deficit in the partnership. a co-partner owns no personal specific interest in any specific property or asset of the partnership. The partnership owns the property or the asset.A. (2) his interest in the partnership. Putnam contracts with the remaining partners in Frog Jump Gin Company that by selling her half-interest in the company to the Shoafs. U. that he had any plans for leaving  He delayed giving his partners a list of clients he intended to solicit until after he had obtained authorization from a majority of them despite the fact that the partners had asked earlier. and the substance and method of his communications with clients. § 24 – Extent of Property Rights of a Partner The property rights of a partner are (1) his rights in specific partnership property. SHOAF.

P. in situations such as this.A. Where to look for Authority: 1. 2.) What is the history of their duties and authority 3. and the act of every partner. § 18(e) – All partners have equal rights in the management and conduct of the partnership business U. therefore the status quo must remain. there is a problem with a partner trying to bring another partner into the Partnership by private agreement o the law does not allow a partner to transfer partnership interest o the default rule is that the partnership must vote to allow a new partner—cannot have one partner simply transfer partnership • What could Mrs. Every partner is an agent of the partnership for the purpose of its business. for apparently carrying on in the usual way of business for the partnership binds the partnership. (1959) Facts: Stroud and Freeman disagree from which company they will purchase bread. but no act in contravention of any agreement between the partners may be done rightfully without the consent of all the partners.A.P. Freeman then purchased from Nabisco anyway. unless the partner so acting doesn’t have the authority to act in the particular matter. o Stroud lacked authority to limit Freeman’s authority. it is important to know what the previous status quo had been (See above section “Where to look for Authority”) • Even if one partner owns 90% and the other owns 10%.) Partnership Agreement: where they contract around status quo 2.o Therefore.” Therefore. and the 3rd party knows that he has no such authority. • Also.” • Stroud could not restrict the power and authority of Freeman to buy bread because such a purpose was an “ordinary matter connected with the partnership business. § 18(h) – Any difference arising as to ordinary matters connected with the partnership business may be decided by a majority of the partners. unless there is an agreement to the contrary each partner has an equal right to management and one vote. Freeman’s actions bound Stroud. An act of a partner which is not apparently for the carrying on of the business of the partnership in the usual way does not bind the partnership unless authorized by the other partners. • Freeman was general partner with Stroud and as such had under the U. U.A.P. Stroud told Freeman and told him not to buy from Nabisco and contacted Nabisco and informed them that Freeman didn’t have the authority to purchase bread from Nabisco. 25 .A. STROUD. § 9 – Partner Agent of Partnership as to Partnership Business 1. Putnam’s quitclaim deed is not legally effective because it purports because it purports to convey an interest that she under the law does not actually have to convey • All Putnam had to convey was her interest in the partnership so the question is: did Putnam intend to convey her interest in the partnership to the Shoafs? There is no doubt she intended to convey her partnership interest. Putnam have done? o Under UPA 27(1). she could have transferred her rights to profits Section 5.) Industry Practice NATIONAL BISCUIT COMPANY v.P. o Therefore. Mrs. “equal rights in the management and conduct of the partnership business. The Rights of Partners in Management U.

it is likely that a court will side the partner resisting the change. but establish that all partners are equally situated (which is not really the case in most partnerships) SUMMERS v. the partner wanting to change and hire another person needed to have majority vote to change the established practice.P. Dooley repeatedly voiced his objections to the hiring. if one was unable to work.e. but third partner in business that takes Stroud’s side: -you then have a majority vote and not so unusual as to require unanimous vote and could remove the authority to buy bread B. He had not majority vote so he had to continue paying his share for the bread. The business was operated by the two men. When there is a deadlock between 2 partners. Stroud because in this case one of the partners incurred a loss to himself knowing of his partner’s objections. Dooley became unable to work and provided a replacement at his own expense.Additional Hypothetical: A. § 18(h) provides that “any difference arising as to ordinary matters connected with the partnership business may be decided by a majority of the partners. DOOLEY. In Stroud. he would provide a replacement at his own expense. He didn’t remain silent and therefore ratify the actions of his partner. U. When Dooley learned of this he refused to pay for the employee out of partnership funds. there wasn’t really a common practice of hiring other people. the normal practice was for two people to do the work. since he made the change anyway he had to bear the cost alone. In Nabisco. the loss was incurred by a 3rd party. Here. b. In Summers. has contributed 94% of the capital) -would want to see if there was anything in Partnership Agreement -If no Partnership Agreement. the partners had already been purchasing bread from that company. the normal practice was to buy bread from that company. Therefore. Several years later Summers approached Dooley about the prospect of hiring an additional employee. Dooley had knowledge but never accepted. 1. • For ratification. • Dooley was not responsible for compensating the new employee since a majority of the partners did not consent to the hiring of the 3rd man. Disregarding Dooley’s wishes Summers hired an additional employee.) Same facts as above. Unanimous Vote -things not in the normal business of the partnership (ex: Amending the Partnership Agreement) require a unanimous vote 26 . there has to be (1) knowledge and (2) acceptance.A. • This case is distinguished from National Biscuit v. Therefore. the partner wanting to change and buy somewhere else had to have a majority vote to change the established practice.) Same facts but Stroud has a 94% interest in the company (i.” Hiring an additional employee is an ordinary matter. • Summers argued that Dooley has reaped the rewards of the additional worker and therefore should be estopped from denying the need and value of the employee. then working under the default rules -the default rules do not look at share interest. and has by his behavior ratified the act of Summers hiring an additional person. and by informal agreement. Therefore. (1971) Facts: Summers and Dooley entered into a partnership to operate a trash collection business. Dooley refused this idea. a. if one of the partners is trying to change an established practice. Summers brought suit for half of the new employee’s compensation. He had no majority vote to make the change. Does Summers have actual authority? In Nabisco.

not being a partner in the partnership. by any wrongful act or omission of any partner acting in the ordinary course of the business of the partnership or with the authority of his co-partners. then partner has a right to indemnification for this personal costs from the partnership. the concealment of which does not produce any profit for the offending partners or any financial loss for the partnership as a whole. DAY v. He alleges that certain misrepresentations about the results of the merger had the effect of voiding his approval of the merger. Specifically.A. § 18 – Rules Determining Rights and Duties of Partners If a partner incurs any personal liability in conjunction with carrying on of the normal business of the partnership. o Under the default rules (U. The essence of a breach of fiduciary duty between partners is that one partner has advantaged himself at the expense of the firm.A. acquire for himself a partnership asset. Day was reduced from chairman of a committee to co-chairman. The agreement specifically stated that only a majority was needed to approve a merger. office. including positions on committees was incorrect. Day also alleges a breach of fiduciary duty by beginning merger negotiations without consulting the partners that were not on the executive committee.) a merger is probably a fundamental matter (extraordinary) and would therefore require a unanimous vote. • Under the S&A partnership agreement Day couldn’t have stopped the merger even if he had insisted that the new agreement have a clause stating that he would remain chairman. • Partners have a duty to make a full and fair disclosure to other partners of all information which may be of value to the partnership.P. or any penalty is incurred.P. the partnership is liable therefore to the same extent as the partner so acting or omitting to act. loss or injury is caused to any person. o Nor did the partners acquire any more power within the firm as the result of the alleged withholding of information from the plaintiff. U.P. not may he divert to his own use a partnership opportunity o He must not compete with the partnership within the scope of the business • The plaintiff’s allegations concern the failure to reveal information regarding changes in the internal structure of the firm. Mere ordinary business matters require a majority of the partners under the default rules. SIDLEY & AUSTIN.A. the provision that no partner would be worse off in any way as a result of the merger. • The basic fiduciary duties are: o A partner must account for any profit acquired in a manner injurious to the interests of the partnership. The firm began talks to merge and eventually did merge. § 13 – Partnership Bound by Partner’s Wrongful Act Where. Plaintiff became unhappy with the new arrangement and resigned. He led the effort establishing a D. Means’ Take on this case: shows how much a court will allow a Partnership Agreement to diverge from the default UPA rule 27 . such as commissions or purchases on the sale of partnership property o A partner cannot without the consent of the other partners. (1975) Facts: Plaintiff was a lawyer in S&A based in Chicago. o No court has recognized a fiduciary duty to disclose this type of information.-When looking at required votes: -always have to determine whether in the normal course of business or not -ordinary: majority vote -extra-ordinary: unanimous vote U.C.

-Winding Up: -repay partnership contributions -repay debts as paid by partners -distribute profits -pay off creditors -BUT . where the circumstances do not permit a dissolution under any other provision of this section. 4. § 29 – Dissolution Defined The dissolution of a partnership is the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on as distinguished from the winding up of the business. .A. partner willfully or persistently commits a breach of the partnership agreement. Partnership Dissolution U. b. partner has been guilty of such conduct as tends to affect prejudicially the carrying on of the business d. § 30 – Partnership not Terminated by Dissolution On dissolution the partnership is not terminated. U. .P. By decree of court under § 32. § 31 – Causes of Dissolution Dissolution is caused: 1. By the express will of any partner when no definite term or particular undertaking is specified. By the expulsion of any partner from the business bona fide in accordance with such a power conferred by the agreement between the partners.P.A.P. either before or after the termination of any specified term or particular undertaking. where a partner has been declared a lunatic by a judicial proceeding or is shown to be of unsound mind b. By the bankruptcy of any partner or the partnership. By the express will of all the partners who have not assigned their interests or suffered them to be charged for their separate debts. there may be persons that do what is most rational for their self but is irrational for the collective good – prisoner example Section 6. By the termination of the definite term or particular undertaking specified in the agreement.-the UPA rule about requiring unanimous approval of a merger was allowed to be superseded by the majority rule in the Partnership Agreement -The Executive Committee in this case very much resembles a corporation. don’t forget that this is just a default rule and can be contracted around in Partnership Agreement -DISSOLUTION IS NOT THE SAME THING AS TERMINATION OF THE PARTNERSHIP U. By any event which makes it unlawful for the business of the partnership to be carried on or for the members to carry it on in partnership. 2. In contravention of the agreement between the partners. By the death of any partner. partner becomes in any way incapable of performing his part of the partnership contract c. or conducts himself in any way such that it is not reasonably practicable to carry on the partnership 28 . a. c. a. 6. but continues until the winding up of partnership affairs is completed. 5.A. by the express will of any partner at any time. Without violation of the agreement between the partners. d. but S&A is still considered a partnership Collective Action Problem: in a group of people. 3.

. or the payment secured by bond approved by the court. provided they secure the payment by bond approved by the court. § 38 – Rights of Partners to Application of Partnership Property 1. A partner who has caused the dissolution wrongfully shall have: i.P.A. then dissolution accomplished B. either by themselves or jointly with others. 2. The partners who have not caused the dissolution wrongfully. if they all desire to continue the business in the same name. When dissolution is caused in any way. subject to (2)(a)(ii).P.e. can still dissolve. b. to have the value of his interest in the partnership. business of the partnership can only be carried on at a loss other circumstances render a dissolution equitable The consequences for dissolution in contravention of the partnership agreement under U. -if no definite term of undertaking or partnership. Each partner who has not caused dissolution wrongfully shall have i. he shall receive in cash only the net amount due him from the partnership. unless otherwise agree. either by payment or agreement under § 36(2).) as a matter of law (via court order) A. then . during the agreed term for the partnership and for that purpose may possess the partnership property. the value of his interest in the partnership at the dissolution. All the rights specified in (1). The Right to Dissolve OWEN v. as against his co-partners and all persons claiming through them in respect of their interests in the partnership. less any damages caused to his co-partners by the dissolution. But if dissolution is caused under § 31(1)(d) and the expelled partner is discharged from all partnership liabilities. as against each partner who has caused the dissolution wrongfully. but in ascertaining the value of the partner’s interest the value of the good-will of the business shall not be considered. ascertained and paid to him in cash.A. but must do it rightfully -if done in breach of Agreement. and the surplus applied to pay in cash the net amount owing to the respective partners. § 31(2) are explained in U. § 38(2). may have the partnership property applied to discharge its liabilities. each partner. If the business is not continued under the provisions of (2)(b) all the rights of a partner under (1). UPA Section 31 (as outlined in class): -Partnership can be dissolved by: A. (1941) 29 .A. to damages for breach of the agreement. but might face consequences under UPA § 38(2) -if no violation. COHEN. except in contravention of the agreement. If the business is continued under (2)(b) of this section the right as against his co-partners and all claiming through them in respect of their interests in the partnership. ii. and in like manner indemnify him against all present or future partnership liabilities. less any damages recoverable under (2)(a)(ii) of this section. or pay to any partner who has caused the dissolution wrongfully. When dissolution is caused in contravention of the partnership agreement the rights of the partners shall be as follows: a. may do so. f. . The right. and to be released from all existing liabilities of the partnership.P.) express will of partner -next question to ask: Is there a violation of the Partnership Agreement by dissolving? (bad faith breach of Agreement) -a partner always has the power to dissolve partnership. U. and ii. c.

What could Owen have done differently? -could have written terms in Agreement as to obligations of the parties. Cohen constantly berated Owen claiming “I wear the dignity. c. equity may order the dissolution of a partnership where there are quarrels and disagreements of such a nature and to such extent that all confidence and cooperation between the parties has been destroyed or where one of the parties by his misbehavior materially hinders a proper conduct of the partnership business. due to the souring of the relationship. Shortly after creation differences arose with regard to the management of the partnership affairs and their respective rights and duties under their agreement. 30 . So . During this time part of the debt was paid off each week and each partner received $50/week. • The court seems to believe that Cohen was the cause of the disagreement. the court here did not determine whether a term of the partnership could be implied based upon the amount of time that it would take to repay the loan. • Under U. • There is a general rule that trifling and minor differences and grievances which involve no permanent mischief will not authorize a court to decree a dissolution of a partnership under U.” • Also.5 months. b. • The constant dissension over money affairs culminated in defendant’s appropriation of small sums from the partnership’s funds to his own use without plaintiff’s knowledge. what happens in regard to the loan? -Agreement said that Owen’s loan would be repaid out of profits. Owen seeks a judicial dissolution to avoid liability for breach of contract. § 32 the plaintiff made out a cause for judicial dissolution of the partnership. 1. Therefore. however. U.A. approval.P. A partner has been declared a lunatic in any judicial proceeding or is shown to be of unsound mind. Cohen could claim relief under § 38. -could have written in that failure to perform said duties would dissolve the partnership. The plaintiff brought this action to dissolve the partnership. Probably under § 32(f) and maybe (c) and (d).000 for equipment with the understanding that the amount so contributed was to be considered a loan to the partnership and was to be repaid to the plaintiff out of the prospective profits of the business as soon as it could reasonably do so. So. . the partnership could not be operated at a profit and therefore the loan could not be repaid in the manner specified by the Agreement. However.Facts: A partnership was created to operate a bowling-alley business. A partner becomes in any other way incapable of performing his part of the partnership contract. No fixed time for the partnership. there is considerable evidence demonstrating that the partners disagreed on matters of policy relating to the operation of the business. any partners that have made loans shall be repaid. since there were other bases for dissolving the partnership.P.P. The business operated at a profit the entire 3.” “The breach between the partners was due in large measure to defendant’s persistent endeavors to become the dominating figure of the enterprise and to humiliate plaintiff before the employees and customers of the bowling-alley. or consent. Agreement stated that the two of the partners would be paid equally. Profits declined. § 32. A partner has been guilty of such conduct as tends to affect prejudicially the carrying on of the business. the default rules step back in and hold that after the creditors have been repaid. § 32 – Dissolution by Decree of Court 1.A. The plaintiff advanced $7. On application by or for a partner the court shall decree a dissolution whenever: a.A. . Owen had to get court involved because there was no set term in the Agreement and Cohen might argue that the set time was the amount of time that it would take to repay Owen from the loan.

If default on this occurred Lewis would surrender his share to Collins. H. which was his obligation. or otherwise so conducts himself in matters relating to the partnership business that it is not reasonably practicable to carry on the business in partnership with him. and could reasonably have performed his obligation but for the conduct of Collins and that there was no rule which grants Collins. Collins has asked for judicial intervention to prevent Lewis from arguing this breach was wrongful • The court held that Lewis was competent. Thus Lewis met his obligation to manage the cafeteria. Lewis also made the required payment of $30K during the first year of operation to Collins in the form of paying $60K of the start-up cost that Collins was obligated to pay. Collins lost all faith in Lewis’s ability to operate the business. However. it became profitable for a few years. Then. The partnership agreement. The business was unprofitable for 8 years. e.B. PAGE v. H.) decides that he wants to pull out.d. (1955) Facts: The parties started a partnership to run a cafeteria. Collins has the power to dissolve but probably doesn’t have the right. Why is Collins bringing suit seeking a judicial dissolution? -under default rules. • As noted. Lewis was to run and manage the cafeteria and Collins was to provide the start-up cash. Lewis thought it would take $300K but it ended up being over $600K. PAGE. then Collins has some way to get his money back from the loans -however. the right to dissolution of the partnership. Collins asks the court for a judicial dissolution. Collins wants a dissolution of the partnership but can’t dissolve because of the 30 year lease term.B. Lewis paid this out of earnings of the business during the first year of operation. stated that Collins would be repaid $30K in the first year and $60K/year thereafter. The defendant says the partnership can’t be dissolved because the brothers had an understanding to continue the business until it paid for itself. under these circumstances. pursuit of this course opens him to possible liability for such damages as flow from the breach of contract. there is an opportunity to purchase the assets of the partnership. for 30 years. Just as the business becomes profitable the plaintiff (H. Real consideration is that H. The business of the partnership can only be carried on at a loss. if dissolution is not wrongful. As the major creditor.) operated a corporation that provided most of the materials to the partnership and is the major creditor of the corporation. Also. to terminate the partnership.B. Lewis guaranteed Collins against loss to the extent of $100K. LEWIS. COLLINS v. then it would breach the 30 year term of Agreement— therefore. would then be the sole owner (assuming that his brother did not have the capital to 31 . Collins has the ever present power. Each partner contributed $43K for start-up costs. The Partnership Agreement is entered into orally. Other circumstances render a dissolution equitable.B. if Collins dissolved the partnership. as opposed to the legal right. f.B. wanted to dissolve the partnership such that the assets of the partnership would end up in his hands. When the partnership is dissolved. A partner willfully or persistently commits a breach of the partnership agreement. • Collins failed to pay about $60K of the start-up cost.’s corporation might purchase the assets himself such that he would be a creditor to himself. One of the brothers (H. (1961) Facts: Brothers are partners in a linen supply business.

• Since there is no definite term or particular undertaking. § 31(1)(b) states that a partnership may be dissolved without violation of the agreement by the express will of any partner when no definite term or particular undertaking is specified.P. but it must be done in good faith.purchase the assets of the Partnership) and then H. the partnership is for the term reasonably required to repay the loan. All partnerships are ordinarily entered into with the hope that they will be profitable. if the company sells for some price. . The parties disagreed as to how management decisions should be made. they only owe the third partner X-85.A. the minority partner would have to come up with a lot more money to buy out the other two 32 .e. provided that they pay the other partners the value of their interest in the partnership at the time of the dissolution -In this situation. have right to damages from wrongful dissolvers -if the non-wrongful partners want to. The Consequences of Dissolution PRENTISS v. The power to dissolve a partnership at will must be exercised in good faith. just now that there is still is the possibility that a court may find that a term of the Partnership is set based upon the amount of time it will take to repay a loan from one or more of the partners. under UPA § 31(b) there is an absolute right for one partner to dissolve the partnership. because he would in some way be disadvantaged. whereas the other partner would owe much more (X-15)—i. therefore. There was no partnership agreement. Cohen as holding that when a partner advances a sum of money to a partnership with the understanding that the amount contributed was to be a loan to the partnership and was to be repaid as soon as feasible from the prospective profits of the business. (1973) Facts: Three people enter into a partnership to purchase and manage a shopping center. Prentiss failed to contribute his proportionate share of the operating losses.B. but this will be very fact-specific and we have yet to see a case where a court has so held. • The court notes that the defendant is protected by the fiduciary duties of co-partners. B. but that alone does not make all partnerships for a term and obligate the partners to continue. the defendant failed to prove any facts from which an agreement to continue the partnership for a term may be implied. o Here. o So . o The court recalls Owen v. The partnership failed and Prentiss was excluded by the other partners. the plaintiffs should not be allowed to purchase the partnership assets at a judicial sale. the two partners that already had 85% stake in company. Prentiss claimed he was wrongfully excluded from the management of the partnership and therefore. Sheffel and the other partner own 85% and Prentiss owns the remaining 15%. could take advantage of the newly advantageous situation that led to the Partnership being profitable. Issue: Whether the Partnership was for a term? • U. it is possible for partners to impliedly include a term in the partnership agreement. SHEFFEL. they can continue to operate the business under the same name and for this purpose may possess the partnership property. Important Considerations at issue in this case: -When partnership is dissolved wrongfully: -each partner who have not caused the dissolution wrongfully shall have the rights specified in UPA §38(1) -each partner who have not wrongful. . The partnership was dissolved and partitioned. Sheffel participated in the sell of the center and was the highest bidder. • The court held that the defendant failed to prove any facts from which an agreement to continue the partnership for a term may be implied. A partner may not by use of adverse pressure “freeze out” a co-partner and appropriate the business to his own use. Based on this.

Sheffel was willing to pay more than any other bidder and therefore.P. In contrast. • To continue in business pursuant to the statutorily-granted right of the party not causing the wrongful dissolution. • Upon Dale’s notice of termination. does include the value of good will. Dale then wrote a letter terminating the partnership. Prentiss made more money. After a few years the partners disagree.P. Actually. U.A. physically ousted Dale and became the day-to-day manager of the partnership. Prentiss failed to show how he was damaged by Sheffel’s participation in the sale.P.A. terminable only upon mutual approval of the parties. Meersman moved into an office on the business premises. Meersman claimed wrongful breach of the Partnership and refused to return trademarks or patents to Dale. the revised U. • Further.-How could this situation favor the minority partner is an indirect way? -the other two partners might pay more than real value of the partnership since they only have to come up with 15% • The court rejected this allegation.P. The court didn’t find any indication that the exclusion was done for the wrongful purpose of obtaining the partnership assets in bad faith rather than being merely the result of the inability of the partners to harmoniously function in a partnership relationship. The wrongful termination necessarily invokes the provisions of the U. Meersman elected to continue the business pursuant to U. Dale owns the intellectual property and Meersman has the money. the trial court properly rejected Dale’s good will evidence of the value of his patents and trademark in valuing its interest in the partnership business.A. § 38(2)(c)(ii) states that the value of the good will of the business shall not be considered. § 32(2) (b). so far as they concern the rights of the partners.A. • Means disagrees with this decision: o Meersman gets benefit of both the liquidated damages negotiated for in the Agreement. what value do we want to ascribe to that -Auction or Appraisal formula could be set in advance -setting terms in advance will minimize the risk of litigation down the road PAV-SAVER CORPORATION v. • The defendant didn’t cite any cases which have prohibited a partner from bidding at a judicial sale of the partnership assets. • Furthermore. (1986) Facts: Dale and Meersman are partners. Dale brought suit for dissolution of the partnership and return of his patents and trademarks. How to avoid such a problem in the future: -include a Buy/Sell Arrangement in the Partnership Agreement -if someone wants to leave the business. The agreement requires Dale to contribute the intellectual property. • The partnership agreement on its face contemplated a permanent partnership. the right to possess the partnership property and continue in business upon a wrongful termination must be derived from and is controlled by the statute. Prentiss had the opportunity to submit the highest bid and chose not to. It is undisputed that Dale’s unilateral termination was in contravention of the agreement. it is essential that paragraph 3 of the agreement – the return to Dale of his patents – not be honored. • Despite the parties’ agreement that Dale’s patents would be returned to him upon the mutually approved expiration of the partnership. but also gets the damages and benefits provided for under the UPA o It is important to note that the parties privately contracted for what they wanted damages to be— liquidated damages 33 . VASSO CORPORATION.

the remaining partners form a new partnership (under the default rules) 5. Partnership – management may be negotiated but default rule gives every partner an equal share of management power. Cost a. Corporations – pay twice – the corporation pays its corporate tax and then shareholders are required to pay taxes on dividends – limited liability i. General partnerships do not have it b. S Corporation: has flow through tax benefits. but also get the benefit of limited liability without the double taxation 34 . Corporation – centralized management structure – don’t have to bargain for it – corporate law gives the structure 6. then it pays corporate earnings tax.o Means feels that this court chose to enforce the UPA provisions over the privately negotiated terms in the Agreement—in contravention of the norm and in doing so the court has limited ability of partners to plan for future contingencies. Partnership – when a partner leaves. Corporation – there are some costs associated with the formation (filing fees. Corporation – free transferability of ownership – less true in closely held corporation 4. Chapter 3 The Nature of the Corporation Corporation v. right to bring lawsuit) – in many instances. but the partners are the ones who pay taxes on the profits b. Partnership 1. Continuity a. b. Flexibility a. then partners file notice of money made. Corporations do – when 2 corporations start a partnership the shareholders of the corporations are protected 3. then if the shareholders receive dividends. right to own property. etc…) b. Corporations – less flexible 8. Partnerships – simply must intend to form a partnership 2. Centralized Management a. then the shareholders are taxed on that as well 9. and if they decide to. the corporation is the only party that could bring suit if it is wronged b. Corporation – certain legal hoops to jump through to form – it is a legal entity under the law – there is a separation of ownership and control – lasts forever (no set term) – freely alienable (buy and interest and sell next day if you like) – limited liability – has certain constitutional rights under the law (free speech. Partnership – profits flow through and partners are taxed once – unlimited liability i. Formality a. the partnership is dissolved. Partnership laws are easier to alter – almost anything in the default rules may be modified by a partnership agreement b. if partnership makes $10. if Corporation makes $10. Transferability of Ownership a. Limited Liability a. Partnership may be difficult to get out of b. Tax a. Corporation – lives despite shareholders buying and leaving b. No costs to form initial partnership 7.

C Corporation: does not have flow through taxation (double taxation is imposed) one way to avoid double taxation is to pay dividends as salary salaries of EE’s of corporation can be deducted from corporation’s taxes LLC: option of flow through taxation or standard corporate taxation can select the management system thus.10.02. forming a corporation as the vehicle for investment by other people o line up the investors 35 . is beginning to supplant the corporation in many contexts • There are 3 key players in the Corporate structure (one person can inhabit more than one role) o Shareholders – provide the capital – do not have any say in how the company is run – elect the board of directors – residual right to profit – only time the shareholders vote matters is with extremely important (fundamental) decisions such as a merger and voting for board of directors – don’t have right to demand that dividends be paid in any given year o Directors – locus of power and authority (make most of the business decisions) – hire and fire the officers – set compensation for the officers – makes its decisions by majority rule – determine the policy of the corporation – decide whether to pay dividends – can delegate some powers to committees of the Board o Officers – day-to-day control of the business – report to the board of directors How to create a corporation? • Decide where to incorporate – the law governing the corporation will be determined by the state in which the corporation is incorporated o “Internal Affairs Doctrine”: the state law where the corporation is created/incorporated will govern the internal affairs of the corporation. Promoters and the Corporate Entity • Promoter o a term referring to a person who identifies a business opportunity and puts together a deal. a. a. 11. b. c. 2. thus.03 o Must file articles of incorporate with the state you chose  When Articles of Incorporation are filed and duly stamped. b. anything external to the corporation will be governed by other laws (choice of law principals). the corporation is started o Create bylaws – the corporation’s constitution (not filed and not publicly available)  Bylaws are not required to be filed with the Secretary of the State in the state of incorporation • Organizational Meeting: o Elect board of directors o Open a corporate bank account o Corporate Tax Identification Number o Issue stock o Etc… • Promoter: someone who decides to start the corporation and does some of the groundwork for starting the corporation There are explanations of the HYPOs from page 182 in the notes on page 17. the major advantage of choosing the state of incorporation is such that you can select the laws that will govern the internal affairs of the corporation • How to Incorporate: See Model Business Corporations Act 2. Section 1.

The corporation was not technically formed at the time the contract was made.04: Liability for Pre-Incorporation Transactions -promoter will be liable when contracts on behalf of corporation not yet formed (policy is to protect third parties) -to relieve the promoter of liability on a contract after the corporation is formed. • The rule is stated as: o “We believe the defendant. An attempt to incorporate under a valid statute b. The De Facto corporation: a. Good faith – they thought they were incorporated – weren’t aware of the defect 36 . Camcraft then defaulted on its obligation and refused to deliver the vessel. INC. If the promoter didn’t include this right in the contract. • The court decides that Camcraft must deliver on its promise to deliver the boat. However. The promoter can go to the company and ask for a novation.. CAMCRAFT. should not be permitted to escape performance by raising an issue as to the character of the organization to which it is obligated. INC. The court essentially uses an estoppel theory. 1. There are some exceptions to this general rule. having given its promise to construct the vessel. contracts will need to be made – such as: leases. (1982) Facts: A promoter contracted with Camcraft for Camcraft to build a 156 foot supply vessel. The corporation was planned to be formed in Texas when the contract was made but was instead incorporated in the Cayman Islands. The defendant claims that since the corporation was incorporated in a different jurisdiction than that represented in the contract they shouldn’t have to perform. Once the corporation is formed it can adopt the contract but the other company will still be able to impose liability on the promoter. the corporation must adopt the contract—the corporation cannot ratify the contract because could not have been bound before formation SOUTHERN—GULF MARINE CO. etc. v. The promoter should include a provision in the contract that relieves the promoter of liability when the corporation is formed.o may have assets they intend to sell to the corporation o is an agent of the corporation with all the duties that encompass the agent/principal relationship (but this relationship ends at some point) Before the corporation is technically formed during the formation process. The promoter usually ends up in this role. the people on the other end of the contracts will want someone to guarantee the contracts since they can’t hold the corporation liable (since the corporation isn’t yet formed). Model Business Corporations Act 2.” • The court finds nothing in the record that indicates that the substantial rights of Camcraft were affected by the plaintiff’s de facto status. This would bring about a new contract which would not include the promoter’s name. There is a general principle that if there is one thing wrong with the incorporation process there is no corporation formed and the courts will not recognize it as a corporation.. Another option for the promoter to avoid personal liability is for the promoter to create a LLC (holding company) which enters into contracts before the corporation is actually formed. he will have to rely on novation (the previous contract is terminated and a new contract is entered). unless its substantial rights might thereby be affected. The down side to this approach is the promoter is at the mercy of the company to grant the novation.

000) is held by each corporation. CARLTON. or “pierce the corporate veil. • Courts will disregard the corporate form. repairs. to succeed on this argument. o Means argues that plaintiff’s strongest argument is that the divisions into the different corporations is merely a façade—that in fact they are only one business entity  but. supplies. including Seon. No one is acting in bad faith. a shareholder of a corporation is not personally liable for the acts or debts of the corporation except that he may become personally liable by reason of his own acts or conduct. each of which has 2 cabs registered in its name. even if the plaintiff can include all the corporations. employees and garaging (this is the kind of evidence that allows a plaintiff to reach all the corporations – however. unit and enterprise with regard to financing. Although seemingly independent. Walkovszky alleges these corporations are operated as a single entity. but there is just not a corporation in place c. Therefore. Examples of this would be shuttling their personal funds in and out of the corporations without regard to formality and to suit their immediate convenience. he should be able to recover from all of the supposed independent corporations owned by Carlton. The idea is fairness – a company is not allowed to go after supposed shareholders when it had no thought of being able to do so when it entered the contract Section 2.” whenever necessary “to prevent fraud or to achieve equity. (1966) NEW YORK Facts: The plaintiff alleges that he was severely injured when he was run down by a taxicab owned by Seon Cab Corporation. Carlton). Means says that plaintiff would have to prove something more such as comingling of corporation funds • The court holds that the complaint is barren of any sufficient particularized statements that Carlton and his associates are actually doing business in their individual capacities. The minimum required car insurance ($10.c. Carlton is a stockholder of 10 corporations. 37 . Good faith must be present d.) 2. he may not be able to include the shareholder. WALKOVSZKY v. A 3rd party has dealt with the promoter as if the corporation existed b. Corporation by Estoppel a.” • The court states that to determine whether liability should be extended to reach assets beyond those belonging to the corporation the rules of agency should be used.22 – Liability of Shareholders (a) A purchaser from a corporation of its own shares is not liable to the corporation or its creditors with respect to the shares except to pay the consideration for which the shares were authorized to be issued or specified in the subscription agreement (b) Unless otherwise provided in the articles of incorporation. The Corporate Entity and Limited Liability Piercing the Corporate Veil – Courts are very reluctant to pierce the corporate veil Model Business Corporation Act § 6. • Pierce the corporate veil? (foregoing going after the corporation and going after the shareholder directly) Walkovszky also asserts that he should be able to hold the shareholders personally liable because the multiple corporation structure constitutes an unlawful attempt to defraud members of the general public who might be injured by the cabs. They carry on like they should if the corporation had been properly formed (director’s meetings. etc. Walkovszky alleges.

but Shareholder does not have sufficient assets to cover.000.o Whenever anyone uses control of the corporation to further his own rather than the corporation’s business. (1995) DELAWARE 38 . PS then stiffed SL for the bill. SL sought to pierce PS’s corporate veil and render Marchese personally liable for the judgment owed SL. (1991) Facts: Sea-Land shipped peppers on behalf of Pepper Source (owned by Marchese). However. PS had been dissolved and even if it hadn’t been dissolved PS had no assets. SL then brought this action against Marchese and 5 business entities he owns. Reverse Veil Piercing: when you can get a Shareholder through veil-piercing. and then reverse pierce Marchese’s other corporations so they would be on the hook for the $87. but you discover that Shareholder has other corporations that he has not respected the legal entity nature of Corp B and Corp C—so you go after these other Corporations for money (See notes for important diagram on theories of liability) • Applying Illinois law – a corporate entity will be disregarded and the veil of limited liability pierced when 2 requirements are met: o There must be such unity of interest and ownership that the separate personalities of the corporation and the individual (or other corporation) no longer exist  To determine whether a corporation is so controlled by another to justify disregarding their separate identities the court focuses on 4 factors • Failure to maintain adequate corporate records or to comply with corporate formalities • The commingling of funds or assets (probably most important according to Means) • Undercapitalization • One corporation treating the assets of another corporation as its own o Circumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice  “promote injustice” – something less than affirmative showing of fraud – the court holds that simply because a party will be denied a judicially-imposed recovery is not enough –The court says that to pierce the corporate veil to avoid “promoting injustice” some “wrong” beyond a creditor’s inability to collect would result unless the veil was pierced. SL brings an action and wins. General Notes: -It will be very rare that a corporation being under-capitalized will be sufficient to pierce the corporate veil (because usually choose to pierce the veil because couldn’t recover from the corporation) SEA-LAND SERVICES v. he will be liable for the corporation’s acts. PEPPER SOURCE. o The common sense rules of adverse possession would be undermined o Former partners would be permitted to skirt the legal rules concerning monetary obligations o A party would be unjustly enriched o A parent corporation that caused a sub’s liabilities and its inability to pay for them would escape those liabilities o An intentional scheme to squirrel assets into a liability-free corporation while heaping liabilities upon an asset-free corporation would be successful IN re SILICONE GEL BREAST IMPLANTS.

the corporate form may be disregarded in the interests of justice o The totality of circumstances must be evaluated in determining whether a subsidiary may be found to be the alter ego or mere instrumentality of the parent corporation – there must be “substantial domination” o Factors to determine whether a subsidiary is the alter ego of the parent corporation – the biggest factor here was that Bristol permitted its name to appear on breast implant advertisements. injustice. not the exception o When a corporation is so controlled as to be the alter ego or mere instrumentality of its stockholder. Means argues that there really are two groups of facts: -Unity of Control between Bristol and MEC -Bristol is placing its name on everything (gives rise to direct liability and not corporate veil piercing) • Piercing the corporate Veil: o Potential for abuse of the corporate form is greatest when there is a single shareholder o Limited liability is the rule. The plaintiff is attempting to hold Bristol liable by piercing the corporate veil or through direct liability. Bristol put their name on MEC packaging in order to give rise to consumer confidence. packages.Facts: Bristol Myers bought MEC as the sole shareholder. MEC was basically controlled by members that were also members of Board and executives of Bristol. or inequity in a contract case do not in a tort situation – in tort. MEC was under-capitalized and relied upon Bristol as a bank. it appears that New York might even require a showing of inequity. and product inserts to improve sales [could allege that because of this there was apparent agency]  Parent and sub have common directors or officers  Parent and sub have common business departments  Parent and sub file consolidated financial statements and tax returns  Parent finances the sub  Parent caused the incorporation of the sub  Sub operates with grossly inadequate capital  Parent pays the salaries and other expenses of the sub  Sub receives no business except that given to it by the parent  Parent uses the sub’s property as its own  Daily operations of the two corporations are not kept separate  Sub does not observe the basic corporate formalities. injustice or fraud to pierce the corporate veil in a tort suit • Bristol could also be subject to direct liability: o If Bristol voluntarily assumes the undertaking it must do it correctly and not negligently – may be liable to 3rd parties for physical harm if  The failure to exercise reasonable care increases the risk of harm  He has undertaken to perform a duty owed by the other to the 3rd party  The harm is suffered because of a reliance of the 3rd party upon the undertaking 39 . MEC did not have a functioning Board of Directors (hardly ever had meetings). MEC and Bristol filed consolidated financial statements. or inequity in a TORT CASE in which plaintiff is seeking to pierce the veil o In Carlton. injustice. the injured party had no choice but to involve themselves with the corporation— seems that DELEWARE does not require a showing of fraud. such as keeping separate books and records and holding shareholder and board meetings • Delaware courts have not necessarily required a showing of fraud if a sub is found to be the mere instrumentality or alter ego of its sole stockholder • Many jurisdictions that require a showing of fraud.

a limited partnership. flow-through tax c.. Kaycee alleges that Flahive caused environmental contamination to the real property. New members need unanimous consent b. the court believes it can decide to disregard the veil of an improperly used LLC. there is no reason to find that Mannon and Baxter incurred general liability for their acts done as officers of the corporate general partner. file articles of incorporation 3.Limited Partnerships FRIGIDAIRE SALES CORP. directors. Default rules a. such that no showing of fraud. Commercial breached the contract and Frigidaire brought suit against Union. Limited Liability Corporations (LLC) 1. and no fraud or manifest injustice is perpetrated upon 3rd persons who deal with the corporation. Union was the only general partner of Commercial. However. the corporation’s separate entity should be respected. or injustice is required to pierce the corporate veil. and because in the eyes of the law it was Union. the court says that this concern does not justify a finding that limited partners incur general liability for their control of the corporate general partner. Limited liability Piercing the LLC Veil KAYCEE LAND AND LIVESTOCK v. a separate entity. Partnership. FLAHIVE. were limited partners of Commercial. inequity. (1977) Facts: Frigidaire entered into a contract with Commercial. member managed or manager managed – make this decision first 2. o The concern with corporate general partners is that they will have minimum capitalization and therefore minimum liability. Respondents. (2002) Facts: Kaycee entered into a contract with Flahive to allow Flahive to use the surface of its real property. cost of contracting (have to bargain for the terms you want or you are struck with the default rules 4. o However. They were also officers. who are also the corporation’s officers and directors. • The statute for LLCs reads that the members or managers of a LLC are not liable for a debt or obligation of the LLC. Mannon and Baxter. they should not enjoy immunity from individual liability for the LLC’s acts that cause damage to 3rd parties. and through their control of Union they exercised the day-to-day control and management of Commercial. the veil was not allowed to be pierced here because the officers and directors of the LLC respected the corporate form and did not comingle • The court holds that because Frigidaire entered into the contract knowing that Union was the only party with general liability. v. They controlled Union. o even though this is a contract case. • Parties may form a limited partnership with a corporation as the sole general partner. INC. UNION PROPERTIES. • If the members and officers of an LLC fail to treat it as a separate entity as contemplated by statute. Kaycee seeks to pierce the LLC veil and hold Roger Flahive (the managing member of Flahive) personally liable. Mannon and Baxter. conscientiously keep the affairs of the corporation separate from their personal affairs. and shareholders of Union. operating agreement – the LLC gives the maximum flexibility v. • When the shareholders of a corporation. 40 . which controlled the limited partnership.

(1971) NEW YORK Facts: Flying Tiger organized a subsidiary named FTC. Then the 3 corporations reorganized and merged Flying Tiger into FTL and only FTL survived. There are a lot of procedural hoops to jump through in order to sue derivatively.• Courts have to be careful when borrowing rules from corporation law or partnership law and imposing them on LLCs. Shareholder Derivative Actions Business Judgment Rule – insulates the managers from liability to the shareholders – if the manager has not violated the rule of loyalty. if you’re a shareholder. FLYING TIGER LINE. When deciding if it’s a direct or derivative action. the suit is individual and direct. LLCs will lose their effectiveness. The “laundry list” – Bristol 5. Rare 2. Is this a direct or derivative suit? Generally. • If the gravamen of the complaint is injury to the corporation the suit is derivative. but if the injury is one to the plaintiff as a stockholder and to him individually and not to the corporation. As a result the shareholders of Flying Tiger became shareholders of FTC. then make a policy argument: -case law is very in flux on whether rules related to partnership or corporations will apply to LLC Piercing the Veil Review: 1. when faced with the issue of whether piercing the corporate veil of an LLC is permissible: -Look to determine whether there is a state-specific statute that expressly allows veil-piercing of an LLC -if there is not a specific state statute on point. Overview:  Control/domination/unity of interest  Fraud or injustice – not just unpaid judgment (in contract cases in DE. So. 41 . because Wyoming was the first to address LLC and therefore did not mention it then. • A 3rd party worried about liability could ask for a personal guaranty regarding their liability while bargaining the contract. Equitable and fact based 3. If this is done too much. no showing required for tort cases in DE) 4. Advice for avoiding:  Observe formalities – do not commingle funds  Don’t act in bad faith – observe minimum insurance requirements Section 3. you would rather sue directly. the court will not review the business decisions Direct v. the key is “where is the harm in the first instance. INC. Court says that lack of statutory language should not be considered an indication of the legislative desire to make LLC members impermeable. • Suits are only derivative if brought in the right of a corporation to procure a judgment in its favor. Eisenberg is mad because he cannot vote on the directors of FTL (since FTL was born from the merger with Flying Tiger). There is no mention of LLC piercing in the statute here. Derivative Shareholder Suits EISENBERG v. but later states have followed and the issue has become more widespread thy are including it when they address LLC’s. FTC then organized a subsidiary named FTL..

including counsel fees. BENEFICIAL INDUSTRIAL LOAN CORP. The demand requirement is a recognition of the fundamental precept that directors manage the business and affairs of the corporation. which must make the decision whether or not to assert the claim. (1996) Delaware Facts: Grimes alleges that Donald (the CEO) has an employment agreement that constitutes a failure by the board to exercise due care and that the agreement provides for excessive compensation. B. but as representative of a class comprising all who are similarly situated. The due care. not for himself alone. Mismanagement and fraud extended over a period of 18 years and the assets wasted were said to exceed $100 million. Because of this the state has plenary power to impose standards of responsibility. DONALD. The interests of all these similarly situated people are represented by the one person. fairly and adequately represents the interests of the corporation in enforcing the right of the corporation • A stockholder who brings suit on an action derived from the corporation assumes a position of “a fiduciary character.COHEN v. This is part of the policy for derivative suits. • The distinction between a direct and a derivative suit depends upon the nature of the wrong alleged and the relief that could result if the plaintiff were to prevail. which may be incurred in a derivative action. Model Business Corporation Act § 7. • Therefore. • A stockholder filing a derivate suit must allege either that the board rejected his pre-suit demand that the board assert the corporation’s claim or allege with particularity why the stockholder was justified in not having made the effort to obtain board action. acting through its board of directors. waste and excessive compensation claims asserted here are derivative. was a shareholder of the corporation at the time of the act or omission complained of or became a shareholder through transfer by operation of law from one who was a shareholder at that time 2. If a claim belongs to the corporation. Furthermore. The Requirement of Demand on the Directors GRIMES v. It was unlikely that the board of directors would bring a suit to recover this money because the defendants were on the board of directors. Without them there may not be anyone to recover the money. states are allowed to impose liability and require security for the reasonable expenses.41 – Standing A shareholder may not commence or maintain a derivative proceeding unless the shareholder: 1. o One ground for alleging with particularity that demand would be futile is that a “reasonable doubt” exists that the board is capable of making an independent decision to assert the claim if demand were made.  Basis for claiming excusal would normally be: • Majority of the board has a material financial or familial interest • Majority of the board is incapable of acting independently for some other reason such as domination or control 42 .” He sues. (1949) Facts: Certain managers and directors engaged in a successful conspiracy to enrich themselves at the expense of the corporation. liability and accountability. it is the corporation. this representative is self-elected.

the board has made a business judgment. o If demand is made and rejected.• The underlying transaction is not the product of a valid exercise of business judgment.44 – Dismissal Means considers the Delaware and NY tests to be substantially similar. the board is entitled to the presumption of the business judgment rule unless the stockholder can allege facts with particularity creating a reasonable doubt that the board is entitled to the benefit of the presumption. a written demand has been made upon the corporation to take suitable action. and 2. 90 days have expired from the date the demand was made unless the shareholder has earlier been notified that the demand has been rejected by the corporation or unless irreparable injury to the corporation would result by waiting for the expiration of the 90-day period.42 – Requirement of Demand No shareholder may commence a derivative proceeding until: 1. • A court cannot recognize an agreement that has the effect of removing from directors in a very substantial way their duty to use their own best judgment on management matters. That judgment will normally receive the protection of the business judgment rule unless the facts show that such amounts. the corporation can control the proceedings o If demand is excused or wrongfully refused. He also alleges that the director defendants violated their fiduciary duties to IBM by voting for unreasonably high compensation for IBM executives. it invokes a form of alternative dispute resolution which might avoid litigation altogether o If litigation is beneficial. acting in good faith. MARX v. Model Business Coporation Act Sec. was a sharholder of the corporation at the time of the at or omission complained of or became a sharholder through transfer by operation of law from one who was a shareholder at that time. constitute waste or could not otherwise be the product of a valid exercise of business judgment. Model Code § 7. AKERS. o If a stockholder cannot allege excusal. he must make a pre-suit demand on the board • Demand serves several purposes o By requiring exhaustion of intracorporate remedies.41—Standing A Shareholding may not commence or maintain a derivitive proceeding unless the sharholder: 1. 7. determines that an individual warrants large amounts of money. He alleges that during a period of declining profitability the board engaged in selfdealing by wasting corporate assets by awarding excessive compensation to IBM’s executives and outside directors. fairly and adequately represents the interests of the corporation in enforcing the right of the corporation. (1996) NEW YORK Facts: The plaintiff commences a derivative action against IBM and the board without demanding that the board initiate a lawsuit. Model Business Corporation Act § 7. o If stockholder can show wrongful refusal. compared with the services to be rendered. the stockholder will normally control the proceeding • If a stockholder makes demand and is refused. and 2. • If an independent and informed board. he may still allege that demand was wrongfully refused. he may bring the suit with same standing as if demand had been excused as futile The abdication claim is an individual claim (direct). 43 .

this rule does not foreclose inquiry by the courts into the disinterested independence of (in this case) the members of the special litigation committee. the complaint shall set forth with particularity the efforts of the plaintiff to secure the initiation of such action by the board or the reasons for not making such effort – to show that demand would be futile a plaintiff must allege with particularity that: o A majority of the directors are interested in the transaction. C. UNLESS they can allege with specificity that demand would be futile MBCA has baseline rule that for all derivative suits demand must be made UNLESS the shareholder can allege with specificity that the corporation would suffer irreparable harm within the 90 day waiting period where demand is made. AUERBACH v. The board created a special litigation committee. Business Judgment Rule: grounded in the prudent recognition that courts are ill equipped and infrequently called on to evaluate what are and must be essentially business judgments – however. then any decision reached by the SLC is granted the protections of the business judgment rule. If indeed the corporation meets its burden and shows that the SLC is composed of disinterested members. The committee investigated and found that the litigation was not in the best interests of the corporation. The Role of Special Committees -There is a difference between DE and NY law on this topic. or  Director interest may either be self-interest in the transaction at issue. that both jurisdictions require demand be made. the test has 2 steps: 1.This is a derivative action because the board is using the corporation’s money to pay these high salaries. When a special litigation committee comes to the court claiming a derivative action should be dismissed. New York and Delaware are substantially similar in their requirement of demand be made—i. not just Marx’s money. or o The directors failed to exercise their business judgment in approving the transaction A plaintiff cannot simply name all the board members as defendants and solve the problem See Notes for diagram of various ways to get into court. The crux of the court’s inquiry under the first step of the New York rule is to determine whether the SLC is truly a disinterested committee composed of disinterested board members or officers. or a loss of independence because a director with no direct interest in a transaction is “controlled” by a self-interested director o The directors failed to inform themselves to a degree reasonably necessary about the transaction. (1979) NEW YORK Facts: The corporation found out that it had indirectly made payments constituting bribes and kickbacks in amounts totaling more than $11 million. Auerbach filed a derivative action alleging that present and former members of the board are liable to the corporation for breach of their duties to the corporation and should be made to account for payments made in those transactions. Corporation has the burden of proof to prove that SLC is disinterested: a. 44 . • NY law says that in a derivative action.e. BENNETT. b.

whether the motion to dismiss should be granted 45 . so long as the decision is not wrongful o If the board determines that a suit would be detrimental to the company. v. but even with the protections of the business judgment rule in place. i. the SLC merely rubber-stamped what the CEO advocated for 3. The board creates a supposedly independent committee to investigate. If after the corporation shows that the SLC is disinterested. • As to the methodologies and procedures best suited to the conduct of an investigation of facts and the determination of legal liability. the court may not use the guise of this to trespass in the domain of business judgment • New York’s Burden Shifting Rule is the majority rule ZAPATA CORP. good faith. When the motion to dismiss will NOT be granted: a. fiscal and other factors familiar to the resolution of many corporate problems. MALDONADO. (1981) DELAWARE Facts: Maldonado brought a derivative action on behalf of Zapata Corporation against 10 officers/directors alleging breaches of fiduciary duty for excessive compensation. and reasonableness • If this is not shown. the court may properly inquire into their adequacies. ethical. promotional. Plaintiff has burden of proof to show that SLC reached the wrong decision: a. Once independence of committee is proven by corporation. • A board has the power to choose not to pursue litigation when demand is made upon it. commercial. All members of the board were included because it related to the compensation of the entire board. • The basis of the motion is the best interests of the corporation • A court should apply a 2-step test to the motion (“Zapata Two-Step”) o The court inquires into the independence and good faith of the committee • The corporation has the burden of proving independence. ii. public relations. then the burden shifts to the plaintiff to prove that the Committee somehow made the wrong decision (but. the board’s determination prevails. Such attacks by the plaintiff will likely include such things as: SLC failed to take into account the required information. If plaintiff attacks the methodologies used by the SLC. o However. Demand is excused because the entire board is involved. the motion to dismiss is denied o The court should determine. then the corporation will be forced to respond and argue that the methodologies used by them were sufficient and in investigating the claim they acted in good faith. the plaintiff meets his burden of proof to show that the decision of the SLC to not go forward with the suit was wrong • The substantive decision of the committee is subject to the business judgment rule.2. applying its own independent business judgment. • Derivative suits enforce corporate rights and any recovery obtained goes to the corporation. If special litigation committee is indeed NOT disinterested—because if not disinterested. After an objective and thorough investigation of a derivative suit. o The decision includes the weighing and balancing of legal. The plaintiff can attack the various methodologies used by the SLC to reach their decision. then demand would have been futile and therefore demand would have been excused b. the committee may cause its corporation to file a motion to dismiss the suit. Committee is given business judgment rule treatment by court) b.

however. but in this instance it’s ok. even if the corporation does meet its burden to prove that the SLC is independent and disinterested. under Zapata the methods used to form the SLC AND the methodologies used by the SLC are not given business judgment rule treatment and BOTH burdens are on corporation (in Auerbach the burden to show the methodologies was on the plaintiff and ONLY the burden to show that the SLC was disinterested was on the corporation) -burden is on corporation to prove their methodologies are appropriate -this approach is drastically different from Auerbach because in Auerbach the burden was on the corporation to bring evidence and up to plaintiff to attack it—here.Zapata Two Step: For evaluating Special Litigation Committee under Delaware Law 1. the actual methodologies used by the Special Litigation Committee are analyzed by the court using a more stringent standard than the business judgment rule -in Auerbach the actual methodologies used by the SLC were given preferential business judgment rule treatment and the burden was on the plaintiff to show how the methodologies were improper. the court is doing all of the attacking and the plaintiff is relieved of this burden 2. (1953) Facts: The corporation had been donating money to Rutgers for years and decided it wanted to donate to Princeton. BARLOW. The president stated that it would create good will in the community and create a favorable environment for business operations. Have to know the difference between the Del and NY approaches to evaluate a special litigation committee. The gift must be reasonable 46 . He also stated that the corporation was furthering the self-interest of assuring good employees.P. The committee must show that it was independent and reached the decision in good faith and then it falls on the plaintiff to show that the committee was not fully independent. There must be some benefit to the corporation 2. CO. the corporation and the SLC’s decision will STILL NOT be granted preferential business judgment treatment -policy: to give more rights to shareholders when they really do have a valid suit -because there is a lot of “backscratching” on the Board of Directors—even the special litigation committee is made up of board of directors. which are on the Board with interested members—this is why the judiciary employs their own independent business judgment The New York rule is the majority view and is a burden shifting rule. No gifts to pet charities (entity receiving gift cannot have personal connection to giving corporation) 3. Section 4. The court says that corporations cannot just indiscriminately donate to charities. The Role and Purposes of Corporations A.) Court will use its own business judgment to determine whether the decision made by the committee is proper -this is a notable exception to the business judgment rule -unlike in Auerbach.) Establish that the Special Litigation Committee is truly independent and disinterested (same step as Auerbach) -at this stage. v. The shareholders questioned this. 1. SMITH MFG.

FORD MOTOR CO. or refuse to declare a dividend when the corporation has a surplus of net profits which it can.02(13) – Unless the articles of incorporation provide otherwise a corporation has the power “to make donations for the public welfare or for charitable. or educational purposes” How could charitable contributions help shareholders? -incalculable benefits to corporation -advertising -facilitating training of new employees -tax break -Means seems to believe that corporations should be able to give back to community. and quickly began making more money than they could count. without detriment to its business. or conflict of interest the court will not question his decision. have the power to declare a dividend of the earnings of the corporation. Ford 47 . Ford decided that no special dividends would be paid in the future and all extra money would be reinvested in the company. but to stay in line with corporation. This reduced the Dodge brother’s annual dividends by about $1 million. SHLENSKY v. scientific. Ford* Facts: Shlensky is a minority shareholder and wishes to force the Cubs to install lights at Wrigley Field so that the cubs can play night games. Distinguishing from Dodge v. Generally. or breach of that good faith which they are bound to exercise towards the stockholders. then it would seem odd to say that they can’t give which is another right of a citizen -goodwill is beneficial to corporation DODGE v. whereas it used to be in hands of private individuals..Model Code § 3. He alleges this will increase attendance and income. the courts should not interfere. therefore the corporations have to make up the giving now -if the law will recognize the corporation as a legal entity with legal rights. (1986) *Treat this case as the counterpoint to Dodge v. (1919) Facts: Henry Ford and the 2 Dodge brothers started Ford Motor Co. Ford owned 58% of the common shares. illegality. Courts of equity will not interfere in the management of the directors unless it is clearly made to appear that they are guilty of fraud or misappropriation of the corporate funds . and they alone. then courts have this requirement that it plays into business interest of the corporation Why allow corporations to make charitable contributions? -corporations do a lot of the giving and have the most money to give -the money is now concentrated in the hands of corporations. *This is a very unusual case where a corporate contribution is challenged by shareholder and shareholder actually wins* The rule is stated: It is a well-recognized principle of law that the directors of a corporation. WRIGLEY. and to determine its amount. the rule is that unless the director’s judgment is tainted with fraud. This court holds that unless the conduct of the defendants at least borders on one of the elements. and when a refusal to do so would amount to such an abuse of discretion as would constitute a fraud. divide among its stockholders.

When Van Gorkom says that Trans Union had the duty to shop around. skill. How does one explain the difference in price paid ($55) and the market price ($38)? -why isn’t it the case that any price over the market price is a good deal for the shareholders such that there cannot be a basis for breach of director duty? -“Intrinsic Value”: -a share of a company is much different from the value that comes with control of the company 48 . there really is just an honest disagreement between the Board and the plaintiff -it might be that the ridiculous amount of money at issue in Ford was also a distinguishing factor Chapter 5 The Duties of Officers. to get past protection of business judgment rule and make a case for breach of the duty of care. a well-known corporate takeover specialist and a social acquaintance. he could still make a lot of money on the deal). and diligence of a prudent person in a similar position -despite the phrasing of duty of care in terms of negligence. if they do not.30: Three Duties that we focus upon: A. Van Gorkom. (1985) DELAWARE Facts: Trans Union was contemplating a deal of some kind because they were unable to take advantage of certain federal income tax benefits. Directors. then they act negligently] (a) sounds like the Business Judgment Rule Model Code § 8. The Obligations of Control: Duty of Care Model Code § 8. Ford so much as said that his interest in his plan was giving back to the public) -in this case. a plaintiff must allege that Directors were grossly negligent The Model Code seems to call for a negligence standard but the case requires gross negligence. decided to meet with Pritzker. when becoming informed in connection with their decision-making function or devoting attention to their oversight function.e. VAN GORKOM. Senior management does not agree with the three day timeframe. the CEO. Van Gorkom did this without consulting the board or senior management.) Duty of good faith: (this really has been folded into duty of loyalty by some courts) C. Van Gorkom assembled a proposed price per share price for sale to present to Pritzker. Additional Facts: Pritzker makes an offer. was consulted. Pritzker agrees to shopping around.) Duty of loyalty: no conflict of interest. but places several conditions on the offer: says that the merger must go through within three days (to prevent shopping around). it moves the standard for liability to be more toward gross negligence -i.-no real input from owner that he is most interested in giving back (in Ford. Only Peterson. SMITH v. [this sounds like a simple reasonable person standard. shall discharge their duties with the care that a person in a like position would reasonably believe appropriate under similar circumstances. but ONLY if Pritzker was given an option to buy 1. even if the main merger did not go through.75 million shares at market price which was $38--$17 dollars less than the proposed merger price (so. and Other Insiders Section 1. Trans Union’s controller.30(b) – The members of the board of directors or a committee of the board. Pritzker told Van Gorkom that he was interested in the $55 cash-out merger proposal and requested more information on Trans Union. when the business judgment rule is applied.) Duty of care: directors and officers are supposed to use care. no self-dealing B.

Means argues that there really is not a standard for procedural due care for Boards. questioning those who compiled the information Means argues that in situations such as this. Any recovery would be paid directly to the shareholders. looking into data. what can they do to protect themselves from liability? -consulting an investment bank. the directors of a corporation acted on an informed basis. the court is not interested in getting into substance—i. in good faith and in the honest belief that the action taken was in the best interests of the company o “informed decision” – have the directors informed themselves prior to making a business decision of all material information reasonably available to them o There was no informed business decision here  The directors were not adequately informed as to Van Gorkom’s role in forcing the sale of the company and in establishing the per share price  Uninformed as to the intrinsic value of the company  Under these circumstances. a ratification by the shareholders in Smith probably would remove liability from the board because the shareholders rely on the board to ensure that the best deal is done.02 – Articles of Incorporation (b) The articles of incorporation may set forth: (4) a provision eliminating or limiting the liability of a director to the corporation or its shareholders for money damages for any action taken. it is not an adequate basis o Also. . or any failure to take any action.” Although shareholder approval is required for a merger (it is a fundamental decision). But . as a 49 . but absent other sound valuation information. they were grossly negligent in approving the sale after deliberating 2 hours o The board relied completely on Van Gorkom’s representations – there were no written documents  Directors may rely on in good faith on reports made by officers – oral representations are not reports o A substantial premium is one reason to recommend a merger. how can a Board of Directors reach a price that properly takes into account “intrinsic value” • This is a direct suit because it affects the shareholders directly. what the proper number is—but the court is very interested in looking at the process the Board utilizes Model Code § 2.-buying a share is only getting right to potential dividends -buying company is buying control of whole company: -buying ability to install the Board of Directors -you always pay a premium to buy control -with this said. thus. . There isn’t really a harm to the corporation because the corporation will not exist anymore.e. shareholder ratification will only insulate the Board from liability where the Board has fully informed the shareholders before shareholder voting. the market wasn’t really tested prior to approval for a better price A combination of the fiduciary duties of care and loyalty gives rise to the requirement that “a director disclose to shareholders all material facts bearing upon a merger vote. • Gross negligence is the proper standard for determining whether a business judgment reached by a board of directors was an informed one • Business Judgment Rule – a presumption that in making a business decision.

The employment agreement included downside protection because Ovitz was making so much at his other job. Inc. Van Gorkem -can exculpate the Board of Directors for breaches of the duty of due care -but. the burden shifts to the Board member to show that all the transaction as a whole was fair to the corporation and to the shareholders Model Code § 8. but for some legal reason lacks de jure legal title to that office o Ovitz did not assume his duties until after the agreement and the possible severance package were negotiated • Ovitz did not breach his fiduciary duty by demanding full payout under the contract once he was terminated 50 . The claim is for a breach of fiduciary duty and waste of assets. The relationship went downhill and Ovitz was paid a $130 million severance package. or good faith) have? -removes the protection of the business judgment rule -means that the burden shifts to the Board of Directors to show that all the circumstances were in the best interest of the corporation and the shareholders -Cinerama.02 effectively overrules Smith v. except liability for (A) the amount of a financial benefit received by a director to which he is not entitled. v. but court still found that the CEO had done all he could do to get the best price and therefore CEO was not personally liable -even if a Board member is self-dealing.. The Obligation of Good Faith Only directors who rely in good faith on corporate books and records or reports from corporate officers or certain advisors are “fully protected” against shareholder claims.33. loyalty. Technicolor: no business judgment rule applied. CANNOT exculpate the Board of Directors for breaches of the duty of loyalty or good faith (aspect of duty of loyalty in most jurisdictions) What effect does finding a breach of fiduciary duty (either due care. Disney begins to think about someone to replace Eisner one day. (B) an intentional infliction of harm of the corporation or the shareholders. (2006) DELAWARE Facts: Ovitz previously worked for a very lucrative company of which he had majority control.33 – Liability for Unlawful Distributions (a) A director who votes for or assents to an excessive distribution is personally liable to the corporation for the amount that exceeds what could have been distributed without a violation Section 3. (C) a violation of § 8. Eisner heavily endorsed Ovitz and eventually began trying to bring him in as President. IN re THE WALT DISNEY CO. and o the agreement and the essential terms of a possible severance package had been negotiated by that point • Ovitz was not a de facto officer o de facto officer – one who actually assumed possession of an office under the claim and color of an election or appointment and who is actually discharging the duties of that office. • Ovitz did not breach his fiduciary duty to Disney by negotiating the employment agreement o He had no fiduciary duty until he formally assumed office.director. MBCA 2. So. or (D) an intentional violation of criminal law.

sound judgment could conclude that the corporation has received adequate consideration o That the payment to Ovitz constituted waste is meritless – when the payment was made. . Subjective Bad Faith – conduct motivated by an actual intent to do harm – action in this category clearly gives rise to a cause of action 2. but AmSouth did not 51 . RITTER.• The court found that Disney did not follow “best practices” in negotiating Ovitz’s compensation but the committee’s process did not fall below the level required for a proper exercise of due care o The committee and the board were adequately informed of the material facts  The committee knew that in the event of a non-fault termination Ovitz’s severance package would be in the ballpark of $130 million  There is no exhibit in the minutes that discloses the estimated value of the accelerated options in the event of an NFT but knowledge was established by other evidence • Good Faith is not a separate duty – it is encompassed in the duty of loyalty – the court talks about subjective bad intent. Disney was contractually obligated to do so Black Letter – unless you can overcome the business judgment rule. engage in a general monitoring of corporate affairs. or maybe good faith. you will not be able to challenge compensation levels. a director must have rudimentary understanding of the firm’s business and how it works (but not required to have a hand in running business). The corporation failed to file Suspicious Activity Reports (SARs) and was fined millions of dollars by the government. keep informed about the firm’s activities. The plaintiffs allege that this is the board’s fault and they wish to recover the $50 million from the board. Gross negligence alone is not enough to constitute bad faith and trigger a cause of action 3. To overcome the rule a plaintiff must allege with some specificity violation of the duty of care. The government determined that at least one EE suspected a banking client was engaged in illegal activities. the plaintiffs must show that the exchange was so one sided that no business person of ordinary. (2006) DELAWARE Facts: This was a derivative suit against 15 former and present directors. loyalty. STONE v. attend board meetings regularly. and routinely review financial statements. . A Conscious Disregard For One’s Responsibilities – falls between #1 and 2 – this type of action gives rise to a cause of action So . OVERSIGHT At the very least. then the burden shifts back to the Board member or Board to show that the overall transaction was in the best interest of the corporation and the shareholders • The court holds that the waste claim isn’t a valid argument o To recover for corporate waste. and you are unlikely to be able to overcome the business judgment rule We want the business judgment rule to protect directors because if they can be held liable for everything that goes wrong. they won’t take any risks. Intentional Dereliction of Duty. Lack of Due Care – action taken solely by reason of gross negligence and without any malevolent intent a. if a case can be made out that a Board member or the Board breached their fiduciary care of loyalty/good faith. an intentional dereliction of duty The court talks about 3 categories of bad faith: 1.

file the SAR. Therefore, the plaintiffs argued that the failure of the EE could be imputed to the Board of Directors due to their duty of oversight. This case shows that oversight is included in the fiduciary duty of good faith/loyalty and not under the duty of due care because the board had a clause inculpating the Board from liability for breach of duty of due care. • Clearly derivative because there has been a harm to the corporation for which the directors are allegedly responsible – also, the $50 million, if recovered, would go to the corporation • Demand o To excuse – the court must determine whether or not the particularized factual allegations of a derivative stockholder complaint create a reasonable doubt that, as of the time the complaint if filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand o Can the director’s personal liability be exculpated by a provision in the certificate of incorporation? Such a provision protects directors from monetary liability for a breach of the duty of care, but not for conduct that is not in good faith or a breach of the duty of loyalty  The duty of loyalty encompasses the duty of good faith – liability arises from the duty of loyalty  Lack of good faith is a necessary condition to loyalty  Lack of good faith does not automatically mean fiduciary liability  Failure to act in good faith may result in liability because the requirement to act in good faith is a subsidiary element of the duty of loyalty • Failure to exercise oversight doesn’t invoke the business judgment rule as a defense because to use that rule the board has to make a business judgment What is the standard for assessing a director’s potential liability for failing to act in good faith in discharging his or her oversight responsibilities? 1. Caremark – a director’s obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system exists and that failure to do so under some circumstances may render a director liable for losses caused by non-compliance with applicable legal standard 2. Disney – a failure to act in good faith requires conduct that is qualitatively different from, and more culpable than, the conduct giving rise to a violation of the fiduciary duty of care (gross negligence) 3. Systematic or repeated failure or just utter failure to do what is normally done in the industry a. in a heavily regulated industry, to stay in compliance with duty of good faith, must at the least make sure following regulations and implementing systems to ensure compliance with regs 4. The gross negligence standard for alleging a breach of duty of good faith is not the same gross negligence standard for breach of duty of due care a. the test for breach of duty of good faith focuses more on state of mind—has to be willful and conscious decision not to do your job Necessary conditions to invoke director oversight liability: 1. the directors utterly failed to implement any reporting or information system or controls 2. having implemented such a system, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention Where directors “utterly fail” to act in the face of a known duty to act, thereby demonstrating a conscious disregard for their responsibilities, they breach their duty of loyalty by failing to discharge that fiduciary obligation of good faith. 52

• The court holds that the board had adequate oversight with regard to suspicious activity. The board established an information and reporting system and the system was designed to permit the directors to periodically monitor compliance. In Ryan v. Lyondell, the court held the good faith duty was very narrow – only if directors knowingly and completely fail to undertake duties – this is the current standard in DELAWARE – not easy to make this showing Importance of Alleging Breach of Loyalty/Good Faith -if a plaintiff makes out a prima facie showing that there has been a breach of loyalty or god faith, then the court will not give the Board of Board member the protections of the business judgment rule Review – DELAWARE 1. Good Faith a. Part of loyalty b. Conscious disregard/utter failure – very narrow concept 2. overlap of fiduciary duty analysis and derivative litigation standard a. same poky issues b. fiduciary claims may be litigated twice 3. impact of exculpation on derivative litigation Note: Business judgment rule protects decisions, not failure to act – unless we can identify a decision not to act Corporations may now protect the board from a breach of the duty of care by incorporating that in the articles of incorporation, but cannot exculpate from breach of duty of loyalty or breach of good faith. Since cannot insulate Directors from liability under either loyalty OR good faith, whether one is actually within the other is of a bit less of a concern. Section 2. Duty of Loyalty A. Directors and Managers BAYER v. BERAN, (1944) NEW YORK Facts: The Celanese Corporation started an advertising campaign and the CEO’s wife was one of the singers used in the campaign. This is a derivative action. • The business judgment rule yields to the rule of undivided loyalty. This rule is designed to avoid the possibility of fraud and to avoid the temptation of self-interest. • Personal transactions of directors with their corporations tend to produce a conflict between self-interest and their fiduciary duty. When challenged, they must be examined with the most scrupulous care. o If there is any evidence of unfairness or undue advantage, the transactions will be voided o The burden is on the director not only to prove good faith but also to show its inherent fairness from the viewpoint of the corporation and those interested therein 53

• A conflict of interest does not necessarily mean that there is a breach of the duty of loyalty o Because there is a possible conflict, the entire transaction must be subject to the most rigorous scrutiny to determine whether the action of the directors was intended to subserve some outside purpose, regardless of the consequences to the company, and in a manner inconsistent with its interests o If there is sufficient evidence of self-dealing element, then the protections of the business judgment rule is thrown out the window o Anytime that there is an allegation, alleged with specificity, of self-dealing, then the court will look at the allegation with a scrupulous eye • The CEO acting alone and getting the board’s approval later was allowed in this case. o The general rule is that directors acting separately and not collectively as a board cannot bind the corporation o The court didn’t enforce this rule here because the board ratified the renewal of he broadcasting contract, which worked as a ratification of all prior action taken in connection with the radio advertising o Also, each board member was consulted individually before the action was taken and each gave their approval • The business judgment rule does not apply here because there is a conflict of interest and the allegation is of a breach of the duty of loyalty. The wife’s connection with the program removes the decision from the business judgment rule. Model Code § 8.61(b) – a directors conflicting interest transaction may not give rise to an action if: (1) directors’ action respecting the transaction was taken in compliance with § 8.62 (2) shareholders’ action in compliance § 8.63 § 8.62 • if the transaction has been authorized by the affirmative vote of a majority (but no fewer than 2) of the qualified directors – after required disclosure provided that o the qualified directors have deliberated and voted outside the presence of and without the participation by any other director AND o where the action has been taken by a committee, all members of the committee were qualified directors, and either the committee was composed of all the qualified directors on the board or the members of the committee were appointed by the affirmative vote of a majority of the qualified directors of the board § 8.63 • if a majority of the votes cast by the holders of all qualified shares are in favor of the transaction after o notice to shareholders describing the action to be taken, o provision to the corporation of the information referred to in subsection (b), and o communication to the shareholders entitled to vote on the transaction of the information that is the subject of required disclosure, to the extent the information is not known by them • (b) – before the shareholders’ vote, the conflicted director shall inform the secretary or other officer or agent of the corporation, in writing, of the number of shares that the director knows are not qualified shares, and the identity of the holders of those shares Difference under MBCA and DE law 54

-under DE law, since the other directors did not know of the wife singing, they could not have had a conflict of interest because the majority of the board did not know of the conflict -under the MBCA, the directors would have had to have known of the conflict before they could have been deemed okay to ratify the transaction Notes on the problems on p346 on p29 of class notes D. Ratification FLIEGLER v. LAWRENCE, (1976) DELAWARE Facts: A shareholder derivative suit against the officers and directors – It is alleged that the defendants wrongfully usurped a corporate opportunity to Agau, and that all defendants wrongfully profited by causing Agau to exercise an option to purchase that opportunity. The board of directors formed the closely held USAC Corporation and purchased some antimony properties. These properties were a “raw prospect” at this time. Agua did not have sufficient capital at the time to undertake merely a “raw prospect” so the USAC Corporation was more capitalized and could undertake some of the exploratory work to determine whether it would be profitable to undertake the venture. The board then transferred the land to Agau for 800,000 shares of Agau stock. A few months later the exercise of this option was approved by a majority vote of the shareholders. Issue: What is the proper level of analysis here? Business judgment rule or more rigorous scrutiny? • Normally, shareholder ratification of an “interested transaction” shifts the burden of proof to an objecting shareholder to demonstrate that the terms are so unequal as to amount to a gift or waste of corporate assets • However, here, the majority of shares in favor of exercising the option were cast by defendants in their capacity as shareholders. Only 1/3 of disinterested shareholders voted o Therefore, ratification has not been established here • The defendants must show that the transaction is intrinsically fair to the corporation Duty of Loyalty: Typology 1. self-dealing – over-compensation 2. corporate opportunity – when does an investment opportunity belong to the corporation and not to an individual board member 3. competition B. Corporate Opportunities -Corporate Opportunity is merely a specific kind of duty of loyalty problem -DE law: to determine whether corporate opportunity doctrine operates is to determine whether the new opportunity is in the same line of business as the corporation for which the person serves as a director BROZ v. CELLULAR INFORMATION SYSTEMS, (1996) DELAWARE 55

he will be in a conflict of interest with the corporation • From Means: o Corporation has financial ability to exploit o Line of business o Interest or expectancy o Embracing opportunity would create conflict between director’s self-interest and corporation • In this case: o CIS was financially capable of exploiting the license opportunity o The license opportunity may be within CIS’s historical line of business – however. is one in which the corporation has an interest or a reasonable expectancy. CIS was in the process of divesting its cellular license holdings o CIS did not have an interest or expectancy in the opportunity – the entire CIS board testified that the opportunity would not have been of interest even absent CIS’ financial difficulties and CIS’ then current desire to liquidate its cellular license holdings o There was conflict of interest created by Broz’s purchase of the license – Broz comported himself in a manner that was wholly in accord with his obligations to 56 .41.Facts: Broz is the sole stockholder of RFBC. the self-interest of the officer or director will be brought into conflict with that of the corporation. and 9 days later. He consulted with the members of the board individually and was told that CIS was not interested in the license. the court stated the doctrine: o If there is presented to a corporate officer or director a business opportunity which the corporation is financially able to undertake.41 – to bring a derivative suit a shareholder must have been a shareholder at the time of the act or omission complained of or became a shareholder through transfer by operation of law from one who was a shareholder at that time • A corporate fiduciary agrees to place the interests of the corporation before his own in appropriate circumstances • In Guth. Mackinac. decided to sell its license to provide cell service in a certain part of Michigan. He is also a member of the board of CIS. Broz purchased the license for RFBC. at this time. and by embracing the opportunity. Pricellular lacks standing to bring this suit because they weren’t a shareholder when Broz purchased the license • § 7. Pricellular. • Under Model Code § 7. is from its nature. was negotiating a purchase of CIS and was negotiating the purchase of Mackinac’s license. Pricellular purchased CIS. the director cannot seize the opportunity if: o The corporation is financially able to take advantage of the opportunity o The opportunity is in the line of the corporation’s business o The corporation has an interest or a reasonable expectancy o AND If the director exploits the opportunity. a corporation engaged in the business of providing cellular telephone service. in the line of the corporation’s business and is of practical advantage to it. a publicly held corporation and a competitor of RFBC. Another corporation. the law will not permit him to seize the opportunity for himself • So. another company. Broz was interested in purchasing this license. Ultimately. The plaintiffs allege that Broz violated the doctrine of corporate opportunity. About the same time.

a director will not be liable for taking advantage of a business opportunity if he first brings it to the attention of the corporation and: 57 . The executives made millions through this process. INC. safe harbor provision is dispositive IN re EBAY.• • • • CIS – He was very careful not to usurp any opportunity which CIS was willing and able to pursue – he only competed with an outside company. Broz had to show that he completed his fiduciary duties to CIS Broz was under no duty to consider the contingent and uncertain plans of Pricellular in reaching his determination of how to proceed Who the opportunity is presented to first may be a more or less persuasive fact but will not be dispositive on either side “Safe Harbor Provision”: formal presentation of the opportunity to the Board of Directors gives the benefit of safe harbor under the business judgment rule—that the Board made the business judgment that they would not pursue the opportunity.70 – Business Opportunities 1. therefore. eBay shareholders brought a derivative suit alleging that the corporation was entitled to these IPO opportunities. you want to always make a formal presentation o An informal presentation to the Board members individually will NOT be dispositive like the safe harbor provision. (2004) DELAWARE Facts: Goldman Sachs handles the IPO for eBay and is eBay’s investment banking advisor. Model Code § 8. o To protect oneself against this possible claim.. the eBay executives cannot reap the secret profits which they received solely as a result of their position. Pricellular Broz had the burden of proof in this case – there was an appearance of conflict because Broz was on CIS’s board and was the sole stockholder of a competitor – therefore. The court analyzed the 4 guidelines from Broz • eBay had the financial means to exploit these opportunities • This was in eBay’s line of business – eBay had more than $550 million invested in equity and debt securities • The facts alleged suggest that investing was integral to eBay’s cash management strategies and a significant part of its business • Saying that IPOs are risky is not an answer – eBay was never given an opportunity to turn down the IPO allocations as too risky • The court really seems to focus on the idea that these IPO opportunities were given to the executives to induce further eBay business Means argues that the stronger argument here is the traditional secret profits analysis rather than under the corporate opportunity doctrine: -the individual eBay executives received the opportunity solely as a result of their position as agent for the principal (eBay). Goldman has given the executives at eBay early buying opportunities for other IPOs in order to reward the business from eBay and to entice eBay to continue using Goldman.

with respect to the contracts the intrinsic fairness test must be applied while the business judgment rule is applied regarding the dividends o Under the intrinsic fairness test. You may vote your shares in your own best interest. This will often come up when there is a parent/subsidiary corporation.63 c.a. There are 3 different claims: 1. or employees of corporations in the Sinclair complex. (1971) DELAWARE Facts: This is a derivative action because Sinclair forced Sinven to pay out more money than Sinven is bringing in and Sinclair is exploiting Sinven. C. Sinven is in Venezuela but could exploit opportunities elsewhere if Sinclair wasn’t in the way • Sinclair did breach contracts for which Sinclair is liable. Sinclair nominates all members of Sinven’s board of directors. SINCLAIR OIL CORP. Almost all were officers. When this happens. Sinclair owes a fiduciary duty to Sinven. action by qualified directors disclaiming the corporation’s interest in the opportunity is taken in compliance with the procedures set forth in § 8. the conflicted director shall make prior disclosure to those acting on behalf of the corporation of all material facts concerning the opportunity that are then known to the director Notes on the Zapco problem from p356 in class notes p31. contract breach by Sinclair 2.62 or b. excessive dividends 3. the only time that the intrinsic fairness test will be applied is when there has been self-dealing on the part of the parent corporation which is detrimental to the subsidiary corporation  Intrinsic Fairness Test: • major factor is that the burden shifts to the parent corporation to show that the transaction viewed as a whole was intrinsically fair to the corporation and to the shareholders 58 . As a practical matter that shareholder has control over the corporation. LEVIEN. shareholders’ action disclaiming the corporation’s interest in the opportunity is taken in compliance with the procedures set forth in § 8. stockholders do not have a fiduciary duty. By reason of this domination. The directors were not independent of Sinclair. directors. the action claims that the corporation is harmed. the burden is on Sinclair to prove that its transactions with Sinven were objectively fair o The intrinsic fairness test applies when a parent has received a benefit “to the exclusion and at the expense of the subsidiary”  in parent/subsidiary corporation context. Therefore. The exception is that some shareholders have disproportionate power. the shareholder has a fiduciary duty to the minority shareholders. There was no problem with the dividends o There was self-dealing with the contracts but not with the dividends • Therefore. Sinclair owned 97% of its subsidiary Sinven. v. Dominant Shareholders Normally.

that of Transamerica.) cumulative stock: dividend payments carry over until dividends can be paid -4.20 cumulative dividend. business and affairs of Axton. • The majority has the right to control. It had a market value of $20.) convertible stock: at election of stockholder. as much so as the corporation itself or its officers and directors • There is a difference when a shareholder is voting strictly as a shareholder and as a director o When voting as a director.) redeemable stock: can get cash value for stock.000. In that case. dividends usually get paid before dividends to the common stockholders -3. at $60/share with accrued dividends. corporation has right to exercise right to repurchase stock at a certain price. directorate. Class A shareholders have the right to convert each share of A stock to an equal share of Class B stock. it occupies a fiduciary relation toward the minority. • Transamerica should have gained notice to Class A shareholders regarding the new value of the business. but when it does so. but most other forms are not -5. common stock is usually not redeemable. (1947) Facts: Transamerica bought stock periodically that ultimately gave it control of Axton-Fisher. Axton’s main asset was leaf tobacco.) 59 .) preferred stock: holders have some preference over common stock holders. common convertible.) common stock: ordinary stock that entitles owners to residual value of corporation. Class A stock was callable at any quarterly dividend date upon 60 days notice to the shareholders. causes the subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of. and not exercising an independent judgment in calling the Class A stock DIFFERENT TYPES OF STOCK -1.o The fiduciary duty must be accompanied by self-dealing for the intrinsic fairness standard to apply  Self-dealing occurs when the parent. he represents all stockholders and cannot use his office as a director for his personal benefit at the expense of stockholders • The court says that the directors were voting in favor of their special interest.000. by virtue of its domination of the subsidiary. your stock can be converted into other forms of stock -Note: these categories can be combined (preferred redeemable. Classes A and B shared the excess but A was entitled to twice as much as B. Class B shareholders were entitled to $1. Sinclair received these products to the detriment of Sinven’s minority shareholders ZAHN v. etc. and the minority shareholders were not able to share in the receipt of these products o If the contract is breached. Transamerica executed plan to allocate this huge increase in value to itself and cut out the other classes of stock. but the shareholders did not know it. financial policies. However. Upon liquidation of the company. Transamerica dominated the management. whatever class of stock that was in default gained voting rights equal share for share with the Class B stock. Class A stock is entitled to $3. TRANSAMERICA CORPORATION. and detriment to.60 cumulative dividend. voting rights -2. Then A would have converted to B and received far more than $60/share. Class B has the voting rights unless dividends haven’t been paid 4 successive defaults in the payment of quarterly dividends. the minority shareholders of the subsidiary • There was no self-dealing with the dividends because there was a proportionate share paid to the minority shareholders o Sinclair received nothing from Sinven to the exclusion of its minority shareholders because of the dividends o Motives behind dividends are irrelevant unless the plaintiff can show they amounted to waste • Self-dealing surrounded the contracts o Sinclair received the products produced by Sinven.

or artifice to defraud. bad faith 2. directly or indirectly.) general catch-all phrases: investment contracts. anything commonly known as a security -context clause: although courts have sometimes held that something is a security. Materiality – would a reasonable investor consider this to be important 4. or course of business which operates or would operate as a fraud or deceit upon any person. scheme. it is not a derivative suit. Must show that the disclosure of an 60 . The issue is the materiality standard for information relating to merger discussions. This is a direct suit because the shareholders are suing on their own behalf. To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made. practice. The allegation is that the shareholders are being hurt directly. notes of indebtedness. in the light of the circumstances under which they were made. To employ any device. 10(b)(5) gives a private right of action. then red flags should go off that it might indeed be as a security and thus be subject to securities laws -Two broad categories -1. bonds -2. To engage in any act. Rule 10b-5 – Employment of Manipulative and Deceptive Devices It shall be unlawful for any person. Reliance – if failure to disclose. (1988) Facts: The plaintiffs allege that the company lied about participating in merger talks which caused the plaintiffs to sell their stock at a price less than what they would have received if they had waited until the merger was executed. Important first step in Securities Analysis: determine whether your client is dealing with a security -if security. Damages BASIC INC.SECURITIES LAW 1. v. • In the proxy-solicitation context an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. LEVINSON. reliance is presumed 5. by the use of any means or instrumentality of interstate commerce. or c. then subject to Securities Act and Securities and Exchange Act -any involvement with investment contract. Rule 10(b)(5) is a broad anti-fraud provision allowing private individuals to bring suit.) stocks. in connection with the purchase or sale of any security. notes. b. it is a personal right of action. Proximate cause – some connection with sale or purchase of securities (lie or omission led to buying of securities) 3. or of the mails or of any facility of any national securities exchange. Scienter – attempt to deceive. if under the total circumstances the court finds that it should not be treated as a security and be subject to the Securities Act and Securities and Exchange Act. a. not misleading. the court may do so Common law elements of fraud: Federal Law is supposed to incorporate elements of common law fraud 1.

and then determine if the merger discussions were material • materiality depends on the significance the reasonable investor would place on the withheld or misrepresented information • The “fraud on the market” theory helps the plaintiff show reliance. may be presumed for purposes of a Rule 10b-5 action. there was a voluntary disclosure of material information that was a misrepresentation—if they do decide to make a statement. If the directors have misled the market. • What could have the Board of Directors done differently here? o use “no comment” both when it is unequivocally no and when there are some negotiations going on 61 . • Rule 10b-5 actions are not fiduciary violation actions. therefore. an investor’s reliance on any public material misrepresentations. • To fulfill the materiality requirement there must be substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available. • The court adopts the following test for materiality: o Materiality will depend upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light to the totality of the company activity o It is something to be determined on the basis of the facts in each case o To assess “probability” – look to indicia of interest in the transaction at the highest corporate levels  Some indicia of interest: • Board resolutions • Instructions to investment bankers • Actual negotiations between principals or their intermediaries o To assess “magnitude” – consider the size of the 2 corporate entities and of the potential premiums over market value  No one event or factor short of closing the merger need be either necessary or sufficient to render merger discussions material • However. just because something is material doesn’t mean it has to be disclosed. The theory says that you aren’t relying on the direct statements of the directors.omitted fact would have added something to the overall wealth of information in the market which could affect investor’s decision. Silence absent a duty to disclose is ok. then they cannot omit material facts or misstatements • Materiality Standard o Where the impact on the target of the merger is certain and clear:  to fulfill the materiality requirement there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available o Where the event is contingent or speculative:  Materiality will depend at any given time upon a balancing of both the indicated probability that the event will occur AND the anticipated magnitude of the event in light of the totality of the company activity  The fact finder must gauge the interest in the transaction at the highest corporate levels and the magnitude of the transaction to the corporation. they have misled the shareholders as well. in this case. A “no comment” statement will often be viewed as an omission. You are relying on the market to reflect what the directors have said. • Because most publicly available information is reflected in market price. o However.

There are genuine disputes over how to run the company. such that they would lose the protection of the business judgment rule 62 . The court says that shareholders should be fully and truthfully informed as to the merits of the contentions of those soliciting their proxy. The Levin group wants an injunction prohibiting the O’Brien group from continuing these practices. MGM. LEVIN v. and it is our policy not to disclose information is sufficiently settled”  might depend upon on use of “no comment” in industry  there are some situations where “no comment” is not okay.. as personal disputes can be framed as policy disputes • Insurgent Reimbursement: o if insurgents are successful. but should be okay in merger negotiations PROXY FIGHTS What is a proxy? A shareholder gives someone else the ability to vote on their behalf – revocable at any point. phrase it as such “a company of our size is always looking at ways to improve the business by ways of mergers. Also. but would run against a possibly duty of loyalty conflict. INC. • This is more than a dispute resulting from animosity between the groups. Personality Disputes in Proxy o there has to be some meaningful corporate policy difference in order for current management to be reimbursed from shareholders through corporation in their proxy solicitation o whereas. then they can be reimbursed for costs associated with proxy solicitation PROVIDED THAT that the proxy battle was policy-based o but. • The decision as to the management of the corporation rests entirely with the stockholders. plaintiffs say that the defendants used MGM funds to pay for attorneys and PR and proxy solicitation organizations in their attempt to retain control of the corporation. • Incumbents – subject to the business judgment rule may spend reasonable amounts on soliciting proxies • Policy Disputes v.. o The proxy statement filed by MGM notified shareholders that MGM would bear all cost in connection with the solicitation of proxies. They also seek $2.500. they want the court to order that any proxies obtained with these methods not be counted. no right to be reimbursed. It also discusses the employment of the law firm and PR firm. Plaintiffs complain of the manner. as a practical matter. Specifically. where the fight is not over policy. but. but is merely a personal grudge between incumbents and insurgents then the current management cannot be reimbursed from shareholders through corporation for proxy solicitation costs even if disclosed AND ratified by shareholders  shareholders cannot ratify reimbursement for proxy solicitation costs when the real issue is merely personal and not policy  reasoning: if it is merely a personal dispute. (1967) NEW YORK Facts: There is a dispute between the Levin group and the O’Brien group flows from a conflict for corporate control between the two groups. must get authorization for reimbursement from shareholders  they could choose to reimburse themselves without shareholder approval. • The court finds that the incumbents have not used illegal or unfair means of communication.000 from the individual defendants on behalf of MGM. method. and means employed by defendants in the solicitation of proxies for the annual meeting of MGM shareholders. such as require judicial intervention. etc. then there is no real benefit to the corporation o but. contracts.

$106.3 million shares) wants the return of $261. The differences between the new and old boards went to the policies of the corporation.000 was paid to the old board by the new board after the change of management to compensate for the remaining expenses of their unsuccessful defense.. FAIRCHILD ENGINE & AIRPLANE CORP.000 was spent out of corporate funds by the old board while still in office in defense of their position. which you intend to present at a meeting of the company’s shareholders – should state as clearly as possible the course of action that you believe the company should take 2.000 to reimburse the corporation for funds spent to compensate the 2 sides in a proxy contest. Shareholder Proposals Rule in question is 14a-8 of the Securities Exchange Act Rule 14a-8 – Shareholder Proposals 1. a director may spend corporate money if: 1. (1955) NEW YORK Facts: In a derivative action. they win or can prove that they benefitted the corporation D. not purely personal power 2. the successful challengers may be reimbursed by the corporation for their expenditures in a proxy contest by affirmative vote of the stockholders • The expenditures must be in the belief that the best interests of the shareholders and the corporation will be furthered. ROSENFELD v. there is an affirmative vote by the shareholders 3. directors may not spend any amount they wish As an incumbent director in a proxy contest. then even if it was truly a policy dispute. and they must be fair and reasonable.000 was paid to the new board and was expressly ratified by a 16 to 1 ratio majority vote of the stockholders. the expenditures are reasonable and bona fide 2. they believe the policies are in the best interests of the corporation? As a challenger in a proxy contest. $127. they have the right to incur reasonable and proper expenses for solicitation of proxies and in defense of their corporate policies • Also. the insurgents would have to show that their reimbursement would be intrinsically fair to the corporation and the shareholders o if insurgents lose. then no right to reimbursements There are a few T/F questions on page 35 of class notes. Your recommendation that the company take action. $28. a new director may be reimbursed by the shareholders if: 1. What is a proposal? a. the plaintiff (who owns 25 of the 2. for the purpose of persuading the stockholders of the correctness of their position? 4. • When directors act in good faith in a contest over policy. • However. Who is eligible to submit a proposal? 63 . the expenditures are reasonable and proper 3. in good faith.• in this situation. it is a contest over policy.

000 in market value. what info about me must be included? a. What procedures must the company follow if it intends to exclude my proposal? a. number of voting shares you hold – the company may instead include a statement that it will provide the information upon receiving an oral or written request. If it relates to an election for membership on the board i. Must I appear personally at the shareholder’s meeting to present the proposal? a. You or your qualified representative 9. If it substantially duplicates another proposal that is to be included l. Name and address. If it relates to specific amounts of dividends 10. 13. If it directly conflicts with one of the company’s own proposals to be submitted to shareholders at the same meeting j. 6. Who has the burden of persuading the Commission or its staff that my proposal can be excluded? a. and you have failed to adequately correct it (also within 14 days) – the company doesn’t have to notify about problems that can’t be remedied. An explanation of why the company believes that it may exclude the proposal iii. it would cause the company to violate any law to which it is subject c. the burden is on the company to show that it is entitled to exclude 8. The proposal ii. Must file reasons with the commission 80 days before filing its definitive proxy statement b. No more than one for a particular shareholder’s meeting 4. Violation of law – if implemented. but only after it has notified you of the problem (within 14 days of receiving the proposal). May I submit my own statement to the Commission responding to the company’s arguments? a. If it relates to the redress of a personal claim or grievance against the company or any other person – it needs to be designed to benefit other shareholders at large e. The company is allowed to include its own arguments opposing the proposal 64 . The company may exclude the proposal. If I have complied with the procedural requirements. How many proposals may I submit? a. on what other bases may a company rely to exclude my proposal? a. 7. Yes 12. A supporting opinion of counsel when such reasons are based on matters of law 11. of the company’s securities entitled to be voted on the proposal at the meeting for at least 1 year by the date you submit the proposal – must continue to hold them through the meeting 3. The company must file 6 paper copies of: i.a. It is deals with substantially the same subject as another one that have been previously included in the company’s proxy materials within the preceding 5 calendar years m. Improper under state law – if the proposal is not a proper subject for action by shareholders under the laws of the jurisdiction of the company’s organization b. Must have continuously held at least $2. If the company would lack the power to implement the proposal g. What if any of #1-4 is not complied with? a. If it deals with a matter relating to the company’s ordinary business operations h. If the company has already substantially implemented the proposal k. If the proposal relates to operations which account for less than 5% of the company’s total assets for the most recent fiscal year – and is not otherwise significantly related to the company’s business f. may not exceed 500 words 5. If the company includes the proposal. If it is contrary to any of the Commission’s proxy rules d. Except at otherwise noted. How long can the proposal be? a. or 1%. Including any supporting material.

The corporation is trying to keep this proposal off the proxy statement. once narrowly and once broadly. You have to have at least 51% send back a proxy or show up.LOVENHEIM v. The SEC will review the proposal and review the corporation’s response and decide what they think the outcome should be. Shareholder Inspection Rights There is nothing in the federal proxy rules requiring the corporation to give you the shareholder list. but the federal rules do not impair any rights you may have under state law. and 65 . Therefore. This is not allowed under Rule 14a-8(i)(1). INC. They are trying to gain control by buying enough shares. the levels are below the 5% threshold – they claim that the language applies only to economic significance AFSCME v. (1985) Facts: Plaintiff owns 200 shares. • When does proxy solicitation matter? When there is a disputed issue or a battle for control. ANACONDA CO. a shareholder may add a proposal to the corporation proxy statement that will also be voted on. (1976) NEW YORK Facts: Crane announced a proposed offer to exchange up to $100 million for as many as 5 million shares of common stock of Anaconda. The qualified shareholder has a right to a proposal unless it falls into an exception which the corporation has a burden to show. The court holds that this interpretation will trump unless the agency can show a good reason to change the interpretation REVIEW: • What voting rights do shareholders have? Usually meet once a year to vote on major decisions. • The alleged exception in this case says “not otherwise significantly related” to the company’s business. AIG. • Question 10 tells the corporation how to exclude a proposal. v. o The first interpretation was narrow and occurred when the rule was promulgated. • Plaintiff obviously doesn’t like the procedure – why not try to include a proposal to have the corporation not do business with companies that engage in the procedure? o That would be challenging the policy of the directors would be taking control away from the directors. o The court holds that the meaning of significantly related is not limited to economic significance o Iraquois argued that the pate gross sales represented a net loss – therefore. He wants to add a proposal to the proxy statement seeking a committee to check out the force-feeding of geese to supply Iroquois’s pate.. • Why solicit shareholder proxies? Because you have to have a forum to decide the directors and decisions and most shareholders will not show up. Anaconda had been sending to its own shareholders that the this was a bad deal. IROQUOIS BRANDS.. E. CRANE CO. On a limited basis. battles for the shareholder list are fought under state laws. (2006) • Does the Rule 14a-8(i)(8) exception apply narrowly to mean that is only includes the election of specific members or broadly to mean that it includes all election procedures? • The SEC has interpreted this rule twice.

HONEYWELL.02 • Absolute right to bylaws.. • The NY Business Corp law statute1315 says that access must be permitted to qualified shareholders: o On written demand o Subject to denial if the petitioner refused to furnish an affidavit that the “inspection is not desired for a purpose other than the business” of the corporation o That the petitioner has not been involved in the sale of stock lists within the last 5 years • The court holds that a qualified shareholder may inspect the corporation’s stock register to ascertain the identity of fellow stockholders for the avowed purpose of informing them directly of its exchange offer and soliciting tenders of stock • Also. a shareholder desiring to discuss relevant aspects of a tender offer should be granted access to the shareholder list unless it is sought for a purpose inimical to the corporation or its stockholders STATE ex rel. accounting records and shareholder lists) only if proper purpose – shareholder has burden to show proper purpose for these records Delaware Code 220 • Stockholder inspection for purpose reasonably related to interest as stockholder o Shareholder must prove a proper purpose to inspect corporate records other than shareholder lists 66 . minutes or shareholder meetings. Access to shareholder lists is an exception.Crane will only get junk bonds.35 million shares. Delaware law governs here because Honeywell is incorporated in Delaware – Internal Affairs Doctrine – the law of the corporation’s state of incorporation governs the “internal affairs” of the corporation. He then buys 100 shares of Honeywell so that he can have a voice inside the corporation. • Under Delaware: o Shareholder must prove a proper purpose to inspect corporate records other than shareholder lists o Proper purpose – must be situated like other shareholders  If you bought shares for political reasons. learns of Honeywell’s participation in the Vietnam War. PILLSBURY V. Anaconda continues to deny them claiming that Crane’s purpose is not for the business of the corporation.g. By the 2nd request. etc… • Additional records (e. Anaconda refused Crane’s first request for the shareholder list on the basis that Crane didn’t own any stock. INC. (1971) Facts: Pillsbury. articles of incorporation. opposed to the war. Crane owned 2. He states that his purpose was to persuade Honeywell to cease production of munitions. He wants a list of shareholders • Honeywell is a Delaware corporation doing business in Minnesota. However. you are not similarly situated  Proper purpose contemplates concern with investment return Model Code 16.

The agreement stated that if they couldn’t agree Mr. Control in Closely Held Corporations RINGLING BROS. they were able to place 5 out of 7 directors on the board without any votes from the 3rd shareholder. NCR CORPORATION. There is no publicly traded stock. North with regard to every seat on the board. would act as arbitrator. RINGLING. The model code has some specific provisions that only apply to close corporations. • The court finds that the Haleys’ failure to exercise her voting rights in accordance with the arbitrator’s decision was a breach of their contract. o That is why the Ringlings and the Haleys cannot outvote Mr. (1991) NEW YORK • NY statute gives NY citizens that own stock in foreign corporations the right to inspect. The same law applies. If you are going into business with only a few other people. (1947) DELAWARE Facts: There were 3 shareholders to the business. there was a disagreement with regard to the 5th seat. 3. shareholder’s burden SADLER v.—BARNUM & BAILEY v. a former attorney to both.32(1) – huge departure from normal corporate law. b. After arbitration. The xfs and the Ringlings entered into a contract to agree on who should be elected to the board. There are relatively few shareholders. you are not in the same situation as if you simply bought some stock of IBM. What is a close corporation? a. § 7. 67 . What law governs? a. o Know the difference between cumulative and straight voting. The Ringlings allege that the Haleys are bound by the arbitrator’s decision. Loos instructed. o This number is the number of votes each person may vote for all seats collectively. When it came time to vote.• Corporation has the burden of proof for denial of shareholder list • Otherwise. the Haleys didn’t vote the way Mr. This is an exception to the internal affairs doctrine which would normally give the law of the state of incorporation control CLOSE CORPORATIONS 1. o Cumulative is a way of ensuring that minority shareholders have a say in the election of the board. 2. By agreeing this way. Why do the differences matter? a. Section 3. A close corporation is a corporation. • The corporation used cumulative voting for the directors – this is only allowed if the articles of incorporation state it is possible o The number of shares owned by each person is multiplied by the number of seats on the board. Loos. The agreement stated that the arbitrator’s decision would be binding on the parties. They Haleys claim that the agreement was invalid or at least revocable.

The agreement also stated each person’s salary. • The court says that the stockholders may not. an agreement was entered. STONEHAM. Defendants did not keep their agreement to use their best efforts.30 – Voting Trust • Shareholders may create a voting trust. As part of the transaction. control the directors in the exercise of the judgment vested in them by virtue of their office to elect officers and fix salaries. He then sold 70 shares to McQuade and McGraw. by agreement among themselves. (1936) NEW YORK 68 . Stoneham and McGraw didn’t vote. McQuade was dropped as a director as well.31 – Voting Agreements • 2 or more shareholders may provide for the manner in which they will vote their shares by signing an agreement for that purpose – this agreement is not subject to the provisions of § 7.30 o Must be in writing o No time limit • A voting agreement is specifically enforceable o Make sure there is a provision for tie-breaks to avoid deadlock MCQUADE v. The other 4 directors were specifically chosen by Stoneham and were in his control. (1934) NEW YORK Facts: Stoneham became the owner of a majority of the stock of a baseball team. The 7 directors were to vote on this. someone else was voted to replace McQuade as treasurer. After a few years of smooth running. At the next stockholders’ meeting. conferring on a trustee the right to vote or otherwise act for them.o Model Code § 7.28 – shareholders are entitled to multiply the number of votes they are entitled to cast by the number of directors for whom they are entitled to vote and cast the product for a single candidate or distribute the product among 2 or more candidates Model Code § 7. • Directors may not by agreements entered into as stockholders abrogate their independent judgment • Stockholders may combine to elect directors o The power to unite is limited to the election of directors o Not extended to contracts placing limitations on the power of directors to manage the business of the corporation by the selection of agents at defined salaries • An employment contract for McQuade would have worked better CLARK v. They voted for the other guy. The agreement said that the 3 parties would use the best efforts to continue each as directors and as officers. DODGE. by signing an agreement setting out the provisions of the trust o Must be in writing • Notification of this trust must be sent to the corporation • Not valid for more than 10 years – can be renewed but also not for more than 10 years Model Code § 7.

Dodge then failed to use his stock and position as director to maintain Clark’s positions. (1964) ILLINOIS Facts: Ben and Isadore Galler are equal partners in a drug company. GALLER. The agreement states that Dodge would so vote his stock and so vote as a director that the plaintiff (a) should continue to be a director. Isadore. Clark disclosed the formula to Dodge’s son. but they went ahead and executed the agreements. There is a minority shareholder. They decided to enter into an agreement for the financial protection of their families. and their wives. They enter into an agreement that would ensure Clark’s position in the corporation if he would reveal the formula to another person. The agreement stated that there shall be a 4 director board and that the shareholders will cast their votes for Ben.Facts: Clark and Dodge are the sole owners of 2 businesses. After Ben’s death.” Clark will also receive ¼ of the net income of the cops by salary or dividends. Clark owns 25% and is the only person to know a secret formula and Dodge owns the other 75%. Where the directors are the sole stockholders. his/her spouse may elect the replacing member. even though it impinges slightly upon the board provision of the statute. If one of the 4 dies. (b) should continue as its general manager so long as he should be “faithful. Ben fell into bad health. there seems to be no objection to enforcing an agreement among them to vote for certain people as officers Model Code § 7. as long as they don’t endanger: Stockholders Creditors The public Or violate a clearly mandatory statute The court finds nothing wrong with several controversial provisions: 69 .000 will be paid every year. • Is the contract illegal as against public policy? No • The court holds that if the enforcement of a particular contract damages nobody – not even the public – there is no reason to hold it illegal. • • o o o o • The court finds that this agreement is valid and enforceable There is no reason why they shouldn’t be able to agree as they wish. a dividend of $50.32 – Shareholder Agreements • o • • o o o o o o If you’re in a close corporation and everyone agrees. you can do whatever you want Including establishing “who shall be directors or officers of the corporation” Allows shareholders to eliminate the board or restrict its authority Unanimous written agreement required Valid 10 years unless otherwise agreed Stock certificates must be marked conspicuously Ceases to be effective when corporation goes public Fiduciary liability attaches to those who control corporation – can’t eliminate those duties Limited liability still available Incorporators can act as shareholders GALLER v. efficient and competent. If the earned surplus of the business reaches a specified amount. Isadore decided not to honor the agreement.

the minority may attempt to show that the business purpose could have been achieved through a less harmful alternative course of action • Here. o There was no showing of misconduct on Wilkes’s part as a director. he was not reelected as a director or as an officer. and Riche began to exclude Wilkes. Pipkin sold his shares to Connor. • The court says that stockholders in a close corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another. the stockholders decided to sell a portion of the land to Quinn for a rest home. After many years. SPRINGSIDE NURSING HOME.. Later. He received the weekly stipend and was a director but never held any other office. the court says that there is no legitimate business purpose. Wilkes always completed his duties competently. This caused their relationship to deteriorate.o Duration – no statute or public policy against a provision lasting until the death of a member to the contract o Election of certain people to specified officers for a period of years is ok o No problem with the purpose of protecting family members  As long as there exists no detriment to minority stock interests. Riche. Quinn. INC. officer or employee of the corporation. INC. did the majority consider replacing themselves? INGLE v. incorporate and operate a nursing home on the lot. therefore it’s ok WILKES v. (1989) NEW YORK Facts: Ingle was hired by Glamore as sales manager with no express agreement between the parties establishing either the duration or conditions of employment. At the time of incorporation all the parties understood that each would be a director and each would participate actively in the management of the corporation. the majority have certain rights – selfish ownership – should be balanced against the concept of their fiduciary obligation to the minority o To evaluate the balance – the court must decide if there is a legitimate business purpose for its action o Burden is on the majority to show this business purpose • In response. Facts: Wilkes acquired an option to purchase a building and lot. Wilkes was able to negotiate the price higher than Quinn anticipated or desired to pay. • Wilkes could make a fiduciary duty argument that the other 3 are taking a disproportionately large benefit to the exclusion of Wilkes obtaining any benefit • What if the majority had found someone else that could do Wilkes’s job better at a lower cost? o Would that be a legit business purpose? o If the goal is to slash salaries. In a subsequent directors’ meeting. Pipkin. This duty is one of “utmost good faith and loyalty” • However. and Quinn decided to exercise the option. After a long illness. creditors or other public injury o The dividend requirement is valid – the minimum earned surplus condition is designed to protect the corporation and its creditors. the board voted to discontinue Wilkes’ salary. (1976) MASS. Each received a salary from the corporation for the work they performed which was between $35 and $100/week depending on what year you look at. Wilkes.. Connor. GLAMORE MOTOR SALES. Glamore and Ingle entered into a written shareholders’ agreement providing Ingle with 22/100 shares with an 70 . 2 years later.

Barbuto. He owns a building which Malden leases and which Barbuto receives rent from the corporation. Walter received some form of compensation up to 1995. and Jordan. Facts: Malden is a corporation that was owned in thirds by Walter. they may deprive minority shareholders of corporate offices and of employment by the company. About 15 years later. The plaintiff had not participated in any company decision-making.  In these examples. After several years. arises among those operating a business in the corporate form that have only the rights. • A minority shareholder in a close corporation. • If you want a different result. An employment contract would solve the problem for Ingle. by that status alone. Walter died in 1997 and the plaintiff inherited his shares. JORDAN. • The court defines the fiduciary duty as requiring the “utmost good faith and loyalty. precluding termination except for cause. A year later. The next day.the squeezers may refuse to declare dividends. duties and obligations of stockholders and not those of partners. acquires no right from the corporation or majority shareholders against at-will discharge. Glamore repurchased all of Ingle’s stock. who contractually agrees to the repurchase of his shares upon termination of his employment for any reason. neither Walter nor the plaintiff. • No duty of loyalty and good faith akin to that between partners. the defendants have failed to hold an annual shareholder’s meeting for the previous 5 years. Walter made requests that Malden repurchase his shares but neither the articles of organization nor any corporate bylaw obligated Malden or the defendants to purchase the stock of a shareholder. has received any compensation. you have to bargain for it.” • Majority shareholders in a close corporation violate this duty when they act to “freeze out” the minority o Freeze Out -. Jordan received a salary as an employee at a rate set by Barbuto and himself. they may drain off the corporation’s earnings in the form of exorbitant salaries and bonuses to the majority shareholder-officers and perhaps to their relatives. BRODIE v. The new shareholder agreement stated that Glamore could repurchase all shares of a stockholder if that stockholder shall cease to be an employee of the corporation for any reason. they may cause the corporation to sell its assets at an inadequate price to the majority shareholders. Since then. The defendants have failed to provide her with financial information she has requested. The agreement also included a repurchase clause in favor of Glamore.option to purchase 18 more. Barbuto received director’s fees until 1998. (2006) MASS. or in the form of high rent by the corporation for property leased from majority shareholders. his wife. the majority frustrates the minority’s reasonable expectations of benefit from their ownership of shares 71 . He also participates in a profit-sharing plan and has the use of a company vehicle. Ingle was voted out of his corporate positions and fired from his employment. Also. they issued 60 additional shares which were all purchased by Glamore and his two sons. Walter was no longer involved in the company’s day-to-day operation and only met with Barbuto and Jordan 2-3 times per year.

(1981) MASS. She was only notified of the meeting in 73 three hours before the meeting was held. Atlantic purchased the land from Wolfson. They made Muir several offers for her shares but they were for less than market value. The original plant burned down. gave their wives company paid perks. COPPOCK. The others wanted increased dividends. Because of the deadlock the money wasn’t spent. Muir. and Burke. and  Hindering her ability to sell her shares in the open-market • The proper remedy for a freeze out is to restore the minority as nearly as possible to the position she would have been in had there been no wrongdoing. SMITH v. Disagreements soon started between Wolfson and the other shareholders. and voted Gillam a $30. Crow divorced his wife. so then had a fiduciary duty ALASKA PLASTICS. This provision had the effect of giving to any one of the 4 a veto in corporate decisions. Zimble. Each of the 4 was issued ¼ of the stock. in 1970. ATLANTIC PROPERTIES.  Denying her access to company information. o Wolfson’s refusal to vote in favor of any dividends went beyond what was reasonable o He recklessly ran serious and unjustified risks which were inconsistent with any reasonable interpretation of a duty of “utmost good faith and loyalty” o Switched roles of minority and majority stockholders. and she rejected them. and Crow formed the Alaska Plastics corporation with each owning 1/3 of the stock. Alaska also purchased another competing company without ever consulting Muir. Included in the by-laws and the articles of corporation was a provision requiring 80% of the stock issued to ratify any decisions the board makes. or 74. (1980) Facts: Stefano. The others warned Wolfson of possible penalties levied by the IRS related to unreasonable accumulation of corporate earnings. INC. INC. He then started a corporation (Atlantic) with Smith. Gillam. 72 . 72. Wolfson wanted the earnings devoted to repairs and improvements of corporate property. She was never notified of the annual shareholders meeting in 71. Facts: Wolfson purchased some land.000 salary. 9 years later. Muir was getting nothing for shares. such that by the time this case came to trial the only producing corporation was the newly acquired subsidiary.. The 3 directors voted themselves annual director’s fees. who took ½ of his shares. The other directors made themselves the Directors and officers of the new subsidiary corporation as well. • There may be times when the majority needs protection from the minority • To what extent may the minority use a veto power without a violation of the fiduciary duty referred to in Wilkes.• The court analyzes a “freeze out” in terms of the plaintiff’s reasonable expectations of benefit o Defendants had interfered with the plaintiff’s reasonable expectations by:  Excluding her from corporate decision-making. v. so minority with 90% provision/ veto power was really like the majority. Wolfson continued his opposition to dividends and the IRS fulfilled the others prophecy by levying fines for 7 years.

such as death of a shareholder 2. or otherwise oppressive conduct by the majority shareholders • this forced dissolution is an extreme remedy i. or fraudulent o A shareholder may also seek liquidation when corporate assets are being misapplied or wasted There are 4 ways that a forced buy-back usually occurs 1. oppressive. a purchase may be justified as an equitable remedy upon a finding of a breach of a fiduciary duty between directors and shareholders and the corporation or other shareholders • the practical difference between a forced buy-back of shares and forced dissolution might not be that big • usually. courts have the power to provide equitable remedies that are short of complete dissolution. It stated that Talcott would materially breach the contract if Haley’s position became one of less importance. if the court orders dissolution. illegal. The employment contract stated that Haley’s bonus would be ½ of the net profits after Talcott’s initial loan was repaid. thus. It also provided that ½ of any proceeds relating to a sale of the Grill would go to Haley. The contract also said that Talcott wouldn’t remove Haley unless he sold the business. a buy-sell agreement – a provision in the articles of incorporation or by-laws that provides for the purchase of shares by the corporation. even if there is not a statute explicitly providing for these other remedies 3. statutory – shareholder may petition the court for involuntary dissolution of the corporation • typically requires a showing that plaintiff shareholder shows fraudulent. there is a chance that the directors are disguising dividends as director fees in order to exclude certain shareholders (in this case Muir) • Statute says that a shareholder may bring an action to liquidate the assets or a corporation upon a showing that the acts of the directors or those in control of the corporation are illegal. shareholder may demand a statutory right of appraisal (we aren’t studying this – just know that it exists) 4. They chose to create and operate the Grill as an entity solely owned by Talcott. TALCOTT. such as a merger.• Constructive Dividends – regardless of how a corporation labels expenditures. very rare • as an alternative approach—not rooted in statute—the equitable remedy of rather than dissolving the business (which is severe) then a judicially created right to force the majority to “buy out” the minority shareholder’s shares • theory behind this: because court can dissolve. contingent upon the occurrence of some event. (2004) DELAWARE Facts: Haley found the location of Redfin Grill and Talcott contributed substantial start-up costs. upon a significant change in corporate structure. 73 . with Haley’s rights and obligations defined by an employment contract. if they are not made for the reasonable value of services rendered to the corporation. the majority will settle with the minority shareholder HALEY v. some portion of payments may be characterized as constructive dividends o When director’s fees are being paid without any dividends being paid.

so allows the dissolution. Tricky bc they had a buy/sell agreement. negotiated for this and thus the court should not get involved o Means argues for a middle ground—courts should enforce negotiated bargains even if “unfair” if freely bargained for. o He would be liable for the loan. and the court here does bring in corporate rules. so if it defaulted. rather than what the parties themselves call themselves—what matters under partnership law is whether the parties were in a partnership relationship  then turn to the facts: • share profits • but don’t appear to share control • don’t appear to share liability • Principal Issue: Whether Haley can have the LLC dissolved? • The parties had negotiated an exit agreement. Howev. LLC to take advantage of the option to purchase the land. o If Haley used the exit mechanism. Haley responded that he viewed the note as wrongful termination. However. Most cts would say too bad you don’t have to dissolve business. Haley is now seeking a statutory dissolution of the LLC. • Haley could make the argument that the agreement relating to the Grill creates a partnership. rather than just pointing to the employment agreement  partnership can be determined by the facts. but he wouldn’t be sharing in the return anymore. This led to “some kind of confrontation. so not a well drafted buy/sell agreement. what would you argue? o the private parties. not an employment agreement o were both parties subject to liability as well as sharing the profits ??? o Means ask what is it about partnership that even allows this argument. he would still be liable for the personal guaranty on the loan. The LLC took out a mortgage to which Haley and Talcott individually signed personal guaranties for the entire amount of the mortgage.Talcott acquired an option to purchase the land under the Grill and sold Haley the right to participate in this option for $10. so ct shouldn’t give a dissolution. • If you wanted to argue that despite the exit mechanism being a bad deal for Haley the court doesn’t have the power to order dissolution. A couple years later the parties formed the Matt & Greg Real Estate. both of whom were sophisticated parties. Haley was under the impression that the relationship would be reformulated to give him a direct stock ownership interest in the Grill. From here there relationship deteriorated. but where it is obvious that the parties did not foresee a given circumstance (“incomplete bargaining”) then the court should have power to reform the contract or provide a substitute remedy • Extra Notes: this is a LLC involved. but it didn’t provide sufficient guidance. is that talcot would still be personably responsible for the LLC’s mortgage. but this is not always the case—court first turned to LLC.” Talcott sent Haley a letter purporting to accept Haley’s resignation. and the court here turned to corporate principles—not always the case o What other options relating to the LLC besides dissolution could the court do? 74 . the court finds that it is not equitable to force Haley to use the exit mechanism. Ct finds it would be inequitable to enforce the buy sell agreement.

LLC Model Code Chapter 14 – Dissolution § 14.02 – Dissolution by Board and Shareholders • The board may propose dissolution to shareholders • To be adopted o Board must recommend dissolution to shareholders unless there is a conflict of interest o Voting shareholders must approve • Board may condition dissolution on any basis • Corporation must notify all shareholders of the meeting and state that dissolution will be considered • Unless articles or the board require a greater vote. adoption shall require approval of the shareholders at a meeting at which a quorum consisting of at least a majority of the votes entitled to be cast exists § 14.20 – Grounds for Administrative Dissolution • If: o o o o o The corporation doesn’t pay taxes or penalties Doesn’t deliver its annual report Is without a registered agent or office in the state That the above has been changed The period of duration stated in the articles of incorporation expires § 14.30 – Grounds for Judicial Dissolution 75 . have an appraiser come in and give fair market value rental for the property and order Redfin to pay that to Matt and Greg.05 – Effect of Dissolution • A dissolved company continues corporate existence but no business except that required to wind up and liquidate including o Collecting assets o Disposing of properties o Discharging liabilities o Distributing remaining property among shareholders o Every other act required to wind up and liquidate • Dissolution does not o Transfer title to the corporation’s property o Prevent transfer of its shares or securities o Change voting requirements or provisions regarding directors and officers o Prevent commencement of a proceeding by or against the corporation o Alter a proceeding pending by or against the corporation o Terminate the authority of the registered agent of the corporation § 14.

• The relationship among shareholders in a close corporation is analogous to that of partners.” The agreement was designed to facilitate the purchase of the shareholder’s stock upon death. one or more shareholders may elect to purchase all shares owned by the petitioning shareholder at the fair value of the shares PEDRO v.34 – Election to Purchase in Lieu of Dissolution • In a proceeding by shareholders to dissolve. neither of which could identify about $140. or if a living shareholder wished to sell. honestly. Each brother had an equal vote.000 went missing.• May dissolve a corporation o In a proceeding by the attorney general if:  The corporation obtained its articles through fraud. The brothers executed a “stock retirement agreement. Carl. oppressively.32 – Receivership or Custodianship • The court may appoint a receiver or custodian to wind up and liquidate § 14. and fairly with other shareholders • Defendants claim no breach of fiduciary duty because the corporation’s value was not diminished 76 . At Alfred’s insistence. the shareholders are unable to break the deadlock. and Eugene Pedro each owned 1/3 of The Pedro Companies (TPC). TPC hired 2 different accountants to investigate the missing funds. A couple months later Alfred was fired and all of his pay and benefits were discontinued. the relationship between Alfred and his brothers deteriorated. Owing a fiduciary duty includes dealing openly. or fraudulently  The shareholders fail to elect new directors for 2 consecutive annual meetings  Corporate assets are being misapplied or wasted o In a proceeding by a creditor if:  The creditor’s claim is a judgment not satisfied and the corporation is insolvent or  The corporation admitted in writing that the claim is due and owing and the corporation is insolvent § 14.000. The 2nd accountant testified that he was refused access to numerous documents. When $330. and irreparable injury to the corporation is threatened  Or business can no longer be conducted to the advantage of the shareholders. PEDRO. or  The corporation has continued to exceed or abuse the authority conferred upon it by law o In a proceeding by a shareholder if:  Directors are deadlocked in the management. All three worked in the business for all or most of their adult lives. Each brother received the same benefit and compensation. because of the deadlock  The directors will act illegally. (1992) Facts: Alfred. and that he was dismissed before following up on over 20 leads.

Furniture business loses money. Jr. the court says that an action depleting a corporation’s value is not the exclusive method of breaching one’s fiduciary duties • In determining whether to order equitable relief. Malcolm Sr. Malcolm Sr. mobile home park is only profitable business. All of the parties have been members of the board. Ownership was originally split between the granddad’s wife and his son. Each plaintiff received about $800. Plaintiffs own 19% of the voting shares. and economic security for his family • In this case. stepped down. because the fiduciary duty was breached. became the CEO after Sr. The defendants refused this proposal. salary. Harbor manufactures furniture and operates a mobile home park.o However. Jr. HARBOR FURNITURE MFG. fair and reasonable manner in the operation of the corporation o The reasonable expectations of the shareholders as they exist at the inception and develop during the course of the shareholders’ relationship with the corporation and with each other  Reasonable expectations include a job.. it is not sufficient to dissolve the business 77 . Neither plaintiff has ever been involved in the operation of the company. the court shall consider o The duty all shareholders in a close corporation owe one another to act in an honest. however. Relationships deteriorated when the plaintiffs decided it would be best to reorganize the corporation and cut the furniture business. the court awards the plaintiff 100% of the value of his shares instead of the 75% of net book value for which the parties bargained • The court also found that there was an implied employment contract for life o Therefore. the court gives the plaintiff the total of the salaries he would have received until his expected retirement age STUPARICH v. or a buy-out. Jr.. Plaintiffs did receive substantial dividends. dissolution. owns 51% of the voting shares. Jr. INC. (2000) Facts: Harbor Furniture was founded by plaintiff’s grandfather. sisters are passive.000 in dividends in 12 years.’s wife and son also worked for the business and were compensated.’s son. has been involved in the day-to-day operation of Harbor for 35 years.. Jr. • The relevant statute provides for the involuntary dissolution of a corporation where liquidation is reasonably necessary for the protection of the rights or interests of the complaining shareholder or shareholders. a significant place in management. is the brother of the two plaintiffs. received compensation for this. Jr. They never really allowed plaintiffs to present the proposal. • The court characterizes dissolution as a “drastic remedy” • Central Takeaway: is a family breakdown such as this a situation where tensions are high between majority and minority shareholders sufficient for a court to order dissolution of the corporation? o simply because you cannot get along with one another. A dispute arises over whether the furniture business should be cut off and then focus solely on the profitable mobile home business. Furniture business provides employment for brother.

the minority shareholders have little ability to exit – the minority having a veto power is not a good answer 2. Wilkes test ii. Brodie v. Is there a legitimate business purpose – if so. and therefore most other states would follow this line of reasoning • This is not a hard and fast rule: there is one case (Stumpf) cited in the decision where the court did allow involuntary dissolution ATLAS FOODS CASE (SC CASE) Father began food distribution business with sons. Almost any modification of corporate law is ok as long as all the shareholders agree and no 3rd parties are hurt 3. Employment contracts c. but that carried over into the business. There is a duty of loyalty ii. The court is very reluctant to read into the agreement things that aren’t there b. Sinclair – can’t pay disproportionate benefits (this is some protection) iii. The majority shareholders are attempting to force out the minority shareholders.o courts will require something inherently problematic with the business for a court to dissolve. Delaware – minority approach – you should have negotiated for whatever type of action you are seeking i. How do courts respond? a. Issue: What is the standard for minority shareholder oppression? Reasoning: Directors or management have acted in manner that is illegal. Starts with a lack of exit – in a close corporation. Buy-sell agreements – not easy to draft but it’s one of the better options b. What planning options are available? a. The minority shareholder does not accept offer from majority to buy him out. citing that it was significantly less than what the minority shareholder thought his shares were worth. Jordan – reasonable expectations 78 . is there a less damaging way to obtain that business purpose iii. Family had falling out regarding a matter unrelated to the business. want to look for evidence of freeze-out -Court here did find freeze-out—evidence that minority shareholder was excluded and as additional evidence of freeze-out was the lowball offer to buy minority shareholder’s shares -same language as Model Code Review of Shareholder Oppression 1. what is the problem? a. Massachusetts – majority – fiduciary duty i. Cumulative voting – will give the minority a seat on the board at least d. purely personal conflicts will not be sufficient under statutes for a court to dissolve the corporation  this decision was from liberal CA. fraud -Court should look for evidence of genuine abuse rather than merely a simple power struggle.

Frandsen announced that he was exercising his right of first refusal at $62/share.) • It is settled law that. Know model code chapter 14 for this approach ZETLIN v. the agency began to discuss selling the primary asset (the bank) to another bank. (1986) Facts: The primary asset of the agency was a majority of the stock of a bank. 52% to the “majority bloc” and the rest to other non-family members. If Frandsen declined. If you can’t show reasonable expectations. JENSEN—SUNDQUIST AGENCY. conversion of a corporate opportunity. What happens here though is that the extra money the majority shareholders are receiving are for an intents and purposes money that the minority shareholders would have received had there been a tender offer for the whole company. FRANDSEN v. (The likely reason that the majority received a premium price was because it would give the buyer control of the corporation.iv. Frandsen brought suit. He sold 8% to Frandsen. that controlling interest at a premium price • Minority shareholders are not entitled to inhibit the legitimate interests of the other shareholders Notes: Notice the difference between just buying the shares of the majority versus making a tender offer for the entire company. If the majority bloc offered to sell its shares. The eventual agreement was for the bank to merge into a bank subsidiary of the other bank and for agency shareholders to be paid $62/share. and a purchaser is free to buy. The majority basically argues that you would pay more to make a tender offer for the whole corporation. Jensen was the sole owner of the agency. The stockholders would end up with cash and the other assets of the agency. INC. Despite this. The agency would sell its shares in the bank at $88/share and then liquidate. absent looting of corporate assets. 79 . In 1975. the court is going to be reluctant to read into the agreement c. HANSON HOLDINGS. Frandsen insisted on certain protective provisions. a controlling stockholder is free to sell. INC. Some states have given statutory power to the courts to make equitable decisions ii. therefore you can pay us a premium to simply buy majority control via the shares. The agency restructured the deal.. fraud. and defendants own about 44% of the company (this is a controlling interest in the company—effectively control the corporation). In 1984. or other acts of bad faith.. Statutory dissolution or buy-out i. Defendants/Majority sold their shares for a premium. Zetlin owns about 2% of business. it had to give Frandsen a right to buy the shares at the offer price. Minority shareholders claim that they should also be paid the premium price as well. the court says that this process (buying majority shares rather than tender offer for whole company) is acceptable. the majority bloc had to offer to buy his shares at the same price at which it sold its own shares. (1979) NEW YORK Facts: The plaintiffs were trying to obtain some of the premium paid to other shareholders.

not a sale of stock that would have triggered Frandsen’s right of first refusal. then the contract was not a simple agreement for the sale of office to one having no ownership interest • By purchasing 28. The seller would then cause a special meeting of the board and cause nominees of Essex to be elected in the vacant spots. (1962) NEW YORK Facts: Essex contracted to purchase 28. by virtue of the voting power carried by this stock. On the day of closing Yates (the president and chairman of the board). Essex brought this suit claiming that the shares were actually worth more than they had contracted to pay. it could have elected a majority of the board of directors. rejected the form of payment from Essex. • Well settled in NY that it is illegal to sell corporate office or management control by itself (that is. o In a merger.3% isn’t practical control 80 . The agreement stated that if Essex requested at least 10 days before closing the seller would deliver the resignations of the majority of the board members. accompanied by no stock or insufficient stock to carry voting control) • However. the burden should be on Yates to prove that 28. they are extinguished Notes on problem on p676 in class notes p46 ESSEX UNIVERSAL CORPORATION v.3% Essex would have most likely have practical control making it entirely proper for the contract to contain the provision for immediate replacement of directors o Therefore.• The court holds that the right of first refusal is a right to buy the shares of the majority bloc if they are offered for sale o There would be no offer of sale if the agency simply sold some or all of its assets and then liquidated • The court holds that the original transaction was a merger. Essex did make this request. the shares of the acquired firm are not bought.3% of the stock of Republic Pictures Corporation. upon the advice of his lawyer. if. YATES.

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