Agency

Restatement (2nd) Agency, Section 1- Formation of Agency

1. Manifestation of consent [assent] by principal
2. That the agent shall act on principal’s behalf and subject to principal’s control
3. Consent [assent] by the agent so to act for the principal

Gordon v. Doty (nice teacher lending her car)  court says agency existed because Doty
gave her keys, gave conditions, and Gordon accepted.

Restatement (2nd) Agency, Section 140- Agency vs. Creditor-Debtor

Creditor who assumes control of his debtor’s business…may become a principal…with
liability for acts and transactions of debtor in connection with his business
Comment: “merely exercising veto power…by preventing purchases or sales above
specified amounts does not thereby become a principal”
Comment: Creditor becomes a principal when it exercises de facto control over conduct of
debtor

Restatement (2nd Agency, Section 14K- Agency vs. Buyer-Supplier

One who contracts to acquire property from a third person and convey it to another is the
agent of the other only if agreed that he is to act primarily for the benefit of the other and
not for himself.
Comment: Factors indicating that one is a supplier and not an agent are:
1. Receives fixed price for property no matter what price paid by him
2. Acts in own name and receives title to property later transferred
3. Has an independent business in buying and selling similar property

Jensen Farms v. Cargill (Cargill is lender who showed some control)  Cargill was liable as
principal because they were regularly supervising Jensen and eventually controlled the
grain elevator. So not buyer-supplier and not creditor-debtor.
*Note: Cargill violated #3 of the comment

Types of Authority
Actual (Express or Implied)
Apparent
Inherent
Estoppel
Ratification

Restatement (2nd) Agency, Section 7- (Actual) Authority

Power of agent to affect legal relations of principal done in accordance with principal’s
manifestation of consent to agent
Note: There are two types express (actually telling someone to work on your behalf) and
implied (see below)
Restatement (2nd) Agency, Section 26- Creation of (Actual) Authority
1. Objective manifestation of principal
2. Agent’s reasonable interpretation of that manifestation
3. Agent’s belief that she is authorized to act for principal
Restatement (2nd) Agency, Section 35- When Incidental (Implied) Agency in Inferred
Acts that are incidental, usually accompany, or are reasonably necessary to accomplish a
transaction
Fills the gaps in express authority

Mill Street v. Hogan (men painting the church)  Although the Elders did not say “hire Sam”
they did say that a helper might be needed and there were incidents were Sam had helped
in the past, so it could be inferred that agency existed.

Restatement (2nd) Agency, Sections 8 and 27- Apparent Authority and Creation of
Apparent Authority
1. Objective manifestation from one party (apparent principal)
2. Which reaches a third party
3. Causing the third party to reasonably believe that another party (apparent agent) is
authorized to act for the apparent principal
 What counts as a manifestation by the principal?
 Direct communications from principal by letter/word of mouth
 Authorized statements of the agent
 Documents or other indicia of authority given by the principal to the agent
 Communications from third persons who have heard of the agent’s authority
from authorized or permitted channels of communication
 Appointing a person to a position like manager or treasurer which carries with
it generally recognized duties
 Communication to the public through signs or advertising
 Continuously employing the agent

370 v. Ampex (370 manager asks for specific salesman, but he only has limited authority) 
The contract that the salesman made with 370 is binding. A reasonably prudent person
needs to believe that the salesman had authority, and because there was no notification to
370, documents saying that the salesman is authorized to act, and it is reasonable to
presume that the salesman was not limited.

Restatement (2nd) Agency, Sections 8A, 161, 194, 195- Inherent Authority
Principal liable for acts done on his account that usually accompany or are incidental to
transactions agent authorized to conduct
Exists for the protection of persons harmed by or dealing with a servant or other agent
 R2d Agency §3(a): General Agent is an agent authorized to conduct a series of
transactions involving continuity of service.
 R2d Agency §3(b): Special agent is an agent authorized to conduct a single
transaction or a series of transactions no involving continuity of service.

Watteau v. Fenwick (England; Humble’s name was on the bar and the licenses, so it
appeared he owned it)  Court said there was inherent authority because it could easily be
assumed that someone who is ordering things at a bar with their name had the authority.

Restatement (2nd) Agency, Sections 82, 83, 91- Ratification

Retroactive approval of a previously unauthorized act
Affirmance through words, conduct, silence indicating consent
Requirement of intent and knowledge of all material facts
Botticello v. Stefanovicz (Botticello bought property from Mr. Stefanovicz under a belief he had the
“lease to own” provision, but Mrs. Stefanovicz never signed anything)  Court says NO ratification.
Marriage on its own does not prove agency relationship. Mary knew Botticello occupied the land,
and rented it…but did no act to ratify that Botticello would OWN the property. It isn’t even clear she
knew all the material facts (that there was an agreement to rent-to-own)

Restatement (2nd) Agency, Section 8b- Estoppel

Principal allows another (who has no authority) to create appearance of authority and does
not correct the misimpression
Reasonable belief by third party
Change in position of third party (reliance)

Hoddeson v. Koos Bros (ripoff furniture salesman)  Here, the department store allowed
the fraud to create the appearance of authority. They should have put in protocol like name
IDs or uniforms.

Restatement (2nd) Agency, Sections 4 and 321- Partially Disclosed Principal

Partially disclosed principal = third party has notice that agent may be acting for a principal
but has no notice of principal’s identity
Person purporting to make a contract with a third party for a partially disclosed principal is
a party to the contract

Restatement (2nd) Agency, Section 4- Disclosed Principal

Disclosed principal = at the time of the transaction conducted by the agent, third party knew
agent was acting for a principal and knew the principal’s identity
If agent is acting on behalf of a disclosed principal, the agent is not liable on the contract.

Restatement (2nd) Agency, Section 4- Undisclosed Principal

Undisclosed principal = third party has no notice that agent is acting for a principal
If agent is acting on behalf of an undisclosed principal, the agent is liable on the contract.

Atlantic Salmon v. Curran (plaintiff made fraud companies)  Court found the “agent” liable
because…The duty rests upon the agent, if he would avoid personal liability, to disclose his
agency and not upon the other to discover it. It is not enough that the other party has the
means of ascertaining the name of the principal. The agent either needs to bring to him
actual knowledge or else the agent will be bound.

Restatement (2nd) Agency, Sections 2 & 219- Respondeat Superior Liability

Master is subject to liability for torts of his servants committed in the scope of employment
 Master = principal who employs an agent to perform service in his affairs and
who controls or has the right to control the physical conduct of the other …
 Servant = agent employed by a master to perform service in his affairs whose
physical conduct in the performance of the service is controlled or is subject to
the right to control by the master
 Independent contractor = person who contracts with another to do something
for him but who is not controlled by the other nor subject to the others right to
control with respect to his physical conduct … may or may not be an agent

Servant vs. IC Factors

- Extent of control over details of work
- Engaged in distinct business or occupation
- Whether occupation us usually directed by employer or independently carried out
- Level of skill
- Who supplies tools and place of work
- Length of time of employment
- Method of payment (hourly or per job)
- Whether work is part of regular business of employer
 - If parties believe they are creating a master/servant relationship
- If principal is in business

Humble Oil v. Martin  Court found that this case had a “master-servant” relationsip. They
look at the control and the factors. Humble retained title until delivered to customers.
Humble place strict system of financial control. Humble had business discretion except for
hiring, discharge, employee payment. Humble furnished all equipment, advertising, medial,
products. Humble controlled hours of operation. Only Humble could terminate agreement.

Hoover v. Sun Oil  Court found that this case had an “independent-contractor”
relationship. Sun did not control day-to-day operations. Sun’s represenatives made weekly
visits, but they only made suggestions, not mandates. Sun did not assume any risk of
profit/loss. Sun did not determine hours. Sun and the IC had a mutual interest, not just
Sun’s. Either party could terminate agreement.

Restatement (2nd) Agency, Section 228- Agency & Acts Within the Scope of
Employment
Of the kind he is employed to perform
Within authorized time and space limits
Purpose to serve the master
If force intentionally used, use of force not unexpectable by the master

Restatement (2nd) of Agency, Section 229 Factors of Scope of Employment

 Act commonly done by servants
 Time, place & purpose of act
 Previous dealings between principal & agent
 How business is apportioned between different servants
 Act outside of enterprise of master or not entrusted to servant
 Master expectation that act will be done
 Similarity to act authorized
 Instrumentality furnished by master
 Departure from normal methods
 Act is seriously criminal

Ira Bushey v. U.S. (drunk seaman damages dry dock)  Lane’s return to the ship (though
drunk) was clearly to serve the government, even though no one is sure why he took the
action that caused the damaged. But the level of foreseeability in Respondeat superior only
requires that an employer could perceive that harm could flow from actions of their
employees (whether or not they take all precautions). The idea of a sailor who gets drunk
and negligently does damage is foreseeable. The government would not be liable if he was
doing something related to his personal life, but because they gave Lane access to the ship
and the wheels, negligence was foreseeable.

Restatement (2nd) Agency, Sections 2, 220- Liability for Torts of Independent

Contractors
General rule: One who hires an independent contractor is not liable for such contractor’s
negligent actions
Exceptions:
1) Retain control of manner and means of doing work;
2) Engages an incompetent contractor;
3) Inherently dangerous activity
  R2d Torts Section 416: One who hires an independent contractor to conduct
inherently dangerous activity requiring precautions is liable if contractor is
negligent in taking precautions
 Distinguish ultra-hazardous activities  If an activity is ultra-hazardous, you are
liable PER SE (no matter if IC was negligent or not)

Majestic Realty v. Toti Contracting (negligent demolish work ruins Majestic’s roof)  This
activity was inherently dangerous (not ultra-hazardous) and therefore this is an exception
to the run that employers are not liable for IC’s negligent actions. Although Toti was
innocent of direct negligence, the court said they should bear damages over totally innocent
Majestic (instill better hiring practices; only hire safe workers)

Franchises
Franchise = licensing system used in business
Franchisor = party that grants franchise rights by contract
 Franchisor obligations = license use of valuable name, logo and “system”

Franchisee = party that contracts for franchise rights

 Franchisee obligations = payment of royalties & advertising fees; must operate
within “system” (set forth in contract and/or operating manual)

Murphy v. Holiday Inn (guest is injured at Holiday Inn, but they say they were just licensor)
 Court holds that this franchisee contract did not establish a master-servant relationship.
The day-to-day operations were controlled by the hotel owner, not Holiday Inn. The
contract mostly protected Holiday’s trademark…it did not grant control.
Note: This case had boiler-plate language that disclaimed Holiday Inn from liability.
But the court doesn’t follow this. They say agency can arise even if the parties expressly
deny it. It just happens that in this case, the control factor shows that agency did not exist.

Restatement (2nd) Agency, Section 267- Apparent Agency

One who represents another as his servant or agent
Causing a third party to justifiably rely on care or skill of such agent
Is liable for harm caused by lack of care or skill of such agent

Miller v. McDonalds (diner is injured by eating a Big Mac)  Court holds McDonalds
summary judgment was improper because a jury could have found two principles: Agency
and Apparent Agency? McDonalds clearly controlled the restaurant. McDonald’s controlled
the operating analysis, mandated what supplies were used, mandated appearance,
mandated employee uniforms, mandating packaging, and listed strict standards for
food/beverage. Even though the contract said McDonald’s wasn’t liable, because
McDonalds went beyond setting standards and instead controlled…agency existed.
But there is also an issue of apparent agency (NOTE, this probably would have applied to
Holiday Inn if the issue had been raised) McDonalds held 3K out to be an agent due to the
control and Miller justifiability relied on McDonald’s standards of quality.

Restatement (2nd) Agency, Section 1- Fiduciary Relationship

“Agency is … [a] fiduciary relationship”
A fiduciary relationship is one involving trust and confidence
Agent must place principal’s interests over his/her own

Restatement (2nd) Agency, Section 387- Duty of Loyalty

Agent is subject to a duty to act solely for the benefit of the principal in all matters relating
to the agency
Reading v. Regen (Plaintiff took job sitting on truck to help people smuggle in goods by
wearing his army uniform on the truck)  Court held this was an improper use of his
uniform. Plaintiff was violating his duty owed to the employer to make money for his own.
Plaintiff owed loyalty, had a duty to act solely for the benefit of the principal.

Restatement (2nd) Agency, Section 388- Duty to Account for Profits Arising Out of
Employment
If Agent makes a profit in connection with transactions conducted by him on behalf of the
Principal, Agent must turn over profit to Principal
Example: Principal authorizes Agent to sell land for a fixed price. Agent makes a contract to
sell land to third party who makes a nonrefundable deposit. Third party does not conclude
the sale and forfeits the deposit. Agent sells the land to another person. Agent is under a
duty to Principal to turn the forfeited deposit over.

Restatement (2nd) Agency, Section 404- Liability for Use of Principal’s Assets
Agent must pay over profit if uses assets of principal in violation of a duty
Agent not liable for profits made by use of time to be devoted to principal unless he violates
duty not to act adversely or in competition with principal

Restatement (2nd) Agency, Section 393 – Competition as to Subject Matter of Agency

Agent under a duty not to compete with principal concerning the subject matter of the
agency
After termination of agency, barrier to competition ends§396(a)
 Exceptions: cannot use confidential information, no deceit, non-compete
contract clauses

General Automotive v. Singer (Singer was employed as general manager. He earned money
by collecting fees for quote and services for recommending services his employer couldn’t
do. So his employer didn’t get the business or the amount Singer was skimming off the top
to contract off)  Court said Singer was under the duty to disclose, he should have told his
employer about the orders coming in. He was directly competing with his employer.

Restatement (2nd) of Agency, Section 395, 396- Confidential Information

During agency, agent has duty not to use or disclose confidential info. After termination of
agency, agent has duty not to use…in competition with the principal or to his injury…trade
secrets, written lists of names, or other similar confidential matters…

Town & Country v. Newbery (Defendant worked for plaintiff’s company, when they left to
create their own company they used plaintiff’s list to solicit the customers)  Court says
that plaintiff’s list was their trade secret, they had worked for 3 years to build up that list. It
was not like a phone book. The methods of cleaning the house was not secret, but the
customer list was.
Partnership

UPA, Section 6(1)- Definition Partnership

An association of two or more persons to carry on as co-owners of a business for profit

Judicial Factors to Consider Existence of Partnership

 Intention
 Right to Share Profits
 Obligation to Share Losses
 Ownership and Control of Business
 Language in Agreement
 Conduct towards Third Parties
 Right of Parties Upon Dissolution
 Community Power in Administration

UPA, Section 7(4)- Sharing of Profits

Share of profits is prima facie evidence of partnership, but not if received as wages of an
employee or as interest of a loan

UPA, Section 18(e)- Equal Control Rights of Partners

All partners have equal rights in the management and conduct of the partnership business

UPA, Section 18(a)- Equal Sharing of Profits and Losses

Partners share equally in profits and losses

Fenwick v. UCC (Fenwick made Chesire “partner” to help set her salary)  Court says
partnership was not established even though there was a document that called the two
“partners”
 Right to share in profits (not conclusive, because not every agreement that gives
rights to share in profits is a partnership).
 Obligation to share in losses (Chesire was not to share in losses)
 Ownership and Control (Fenwick contributed capital, so he alone had control)
 Community Power in Administration (Fenwick had exclusive management control)
 Language in the agreement (they did label the agreement a “partnership”)
 Rights of Dissolution (essentially the same as if Chesire quit; she had no rights to
assets)
 Conduct toward third parties (only held themselves as partners for tax purposes)

Kovacik v. Reed (Kovacik gives capital, Reed gives labor, Kovacik wants Reed to pay 50% of
the losses (which is the default because they were to share 50% of the profits).  Court
says this rule doesn’t apply when only one party contributes capital BUT the RUPA 401(B)
readopts the loss-sharing rule of UPA 18(a), and the official comment specific rejects
Kovacik.

UPA, Section 15- Joint and Several Partner Liability

All partners are jointly and severally liable for debts and obligations of the partnership

Martin v. Peyton (really complex facts; main point is defendants helped Hall with his
business through weird financial dealings. Plaintiff claims defendants were partners, and
therefore were liable for its debts. Defendants claim they were creditors, not partners) 
Court said the defendants were not partners.

UPA, Section 16- Partnership by Estoppel

(1) If a person represents himself as a partner in an enterprise (or allows another to so
represent him) and
(2) A third parties relies on that representation and enters into a transaction with the
supposed partnership
(3) That person (who made the representation) is liable to the third party on that
transaction

Young v. Jones (PW-US and PW-Bahamas conflict)  Court does NOT find partnership by
estoppel. The main issue here is (2). The plaintiffs did not read the pamphlet before
making their decision. Furthermore, their reliance led to a transaction with a third party
bank, NOT with the partnership.
Note: Possibly should have tried apparent agency.

RULPA, Section 303(a)- Limited Partnership

A limited partner is NOT liable for obligations of a limited partnership UNLESS the limited
partner is also a general partner OR the limited partner takes part in the control of the
business (here, the limited partner is liable to the third party who transacts business with
the limited partnership and who reasonably believes based on the limited partner’s conduct
that he/she is a general partner).

RULPA, Section 303(b)- Limited Partner

Limited partner does not participate in control solely by consulting or advising with the
general partner on partnership business

Limited Partnership v. General Partnership

 Limited partnerships have to file certificates of limited partnership
 Limited partners have limited liability; general partners have unlimited
 Limited partners are passive investors; general partners do management
 Limited partners share in profits and losses based on their contributions
 Dissociation of limited partner does not dissolve partnership, unlike general partner

Holzman v. de Escamilla (two limited partners outvoting general partner)  Russell and
Andrews were listed as limited partners, with de Escamilla as the general partner. But the
limited partners decided what crops to plant, and de Escamilla was unable to remove funds
without one of the limited partners. So despite being called “limited,” Russell and Andrews
acted as general partners.

UPA, Section 21- Fiduciary Duty of Loyalty

Partner must account/hold as trustee profits/benefits deprived from any transaction
connected with property or use of its property

RUPA, Section 404(b)- Fiduciary Duty of Loyalty

Partners have duty of loyalty to account/hold as trustee profits/benefits derived from a use
of partnership property, including partnership opportunity.
Partners must refrain from conflict of interest transactions
Partners must refrain from competing before dissolution of the partnership.
RUPA, Section 404(c)- Fiduciary Duty of Care
Partner must not act in a manner that is grossly negligent or reckless or engage in
intentional misconduct of knowing violation of the law

Meinhard v. Salmon (Salmon and Meinhard enter into agreement where Meinhard lended
funds, then Salmon repays with profit, so the two were to bear losses equally- even though
Salmon had sole power to manage, lease, underlet, and operate. Salmon came upon
opportunity and took it, not telling Meinhard)  Court found that Salmon breached loyalty
by appropriating the benefit of the partnership without disclosing. He was taking the
opportunity for himself, not for the business. Salmon was secret and silent, which violating
the duty of loyalty.
Note: Court seems to advocate splitting 50/50, but giving Salmon one additional
share so he could make management decisions.
Note: 404(b) and 404(c) were not in place at the time of this case. BUT 404(c)
doesn’t matter, because no one was negligent.

UPA, Section 19 and 20- Partnership Information

Partners shall provide on demand true and full information of all things affecting the
partnership to any partner. Partners may inspect and copy partnership’s books.

RUPA, Section 403- Partnership Information

Partners may inspect and copy books and records
Partners are entitled to information from other partners and partnership that is needed for
exercise of partner’s rights and duties without making a demand (MUCH MORE STRICT).
Partner is entitled to other information upon demand.

Meehan v. Shaughnessy (Meehan, Boyle, later Cohen leave PC because they don’t feel like
they are being compensated for their work; they decided to take clients with them through
a letter on PC letterhead, and were deceptive when PC asked if they were leaving the firm)
 Court says MBC did not breach duties for handling cases for their own benefit (not
partnership’s) because there was a provision in the partnership agreement that they could
take clients; nor did they secretly compete with partnership. BUT court held they DID
unfairly acquire consent from clients/attorneys to withdraw cases because they didn’t give
clients an option. Furthermore, they lied on demand when PC asked if they were leaving.

UPA, Section 31(d)- Partnership Expulsion

Dissolution is caused without violation of the partnership agreement by expulsion of any
partner from the business bona fide in accordance with such a power conferred by the
agreement between the partners.
Essentially, you must deal in good faith with partners when you are going to fire
them.

Lawlis v. Knightlinger & Gray (Lawlis was alcoholic lawyer; partnership agreement stated that a
partner could be expelled at any time for any reason, so long as 2/3 senior partners agreed)  Court
holds for firm, as Lawlis was terminated in accordance with the Partnership Agreement. There was
also no evidence of violation of duty of good faith- in fact Lawlis was treated very well with his
alcoholism and was given 8 months time before termination to find new employment.

UPA, Section 18(a) and (b)- Partnership Financial Investment and Return
Partners contribute capital and/or labor
Partners have right to indemnity against expenses and liabilities incurred in partnership
business. (If you have paid out money on behalf of the partnership, then partnership is
expected to pay you back.)
Financial return: Partners have right to
 Repayment of contribution
 Right to share equally in profits and surplus after payment of liabilities, and
 An obligation to contribute to losses sustained by partnership according to the
share in profits.

UPA, Sections 24, 25(1), 26- Extent of Property Rights of a Partner

1) Rights in specific partnership property. Partner is a co-owner with partners of specific
partnership and has right to use specific partnership property for partnership purposes, but
not for other purposes
2) Interest in the Partnership. Partner’s interest in partnership is share of profits/surplus
and is personal property.
3) Right to participate in management

UPA, Section 27- Assignment of Partner’s Interest

Assignee may only receive profits of assignor but may not participate in management or
require information or account of partnership transactions or look at the books unless there
is an agreement with the other partners. (So partners may only assign their economic
interests in the partnership. This is consistent with UPA 18(g), which says no person may
become member of partnership without the consent of all the partners).

Putnam v. Shoaf (Putnam pays to have Shoafs assume shares and all liability for partnership
debts; therefore Putnam would not be liable for future losses. Due to embezzlement of
bookkeeper while Putnam owned it, she and Shoaf both claim the money owed to the
partnership)  Court rules for Shoafs. Under the agreement, Putnam clearly conveyed her
right, title, and interest to Shoafs (assignment under UPA 27). Putnam wanted out, so she
should be out.

UPA, Sections 18(e), (g), (h), 9(3)- Default Voting Rules

Disagreements among partners are decided by a partnership vote. One partner = one vote,
even if contributions are not equal.
Ordinary business decisions are decided by majority vote.
Other matters require unanimous consent:
 Assign partnership property in trust to creditors/secure payment of debt
 Dispose of good will of partnership
 Do an act making it impossible to carry on partnership’s ordinary business
 Confess a judgment against partnership
 Submit a claim involving the partnership to arbitration
 Admit a new partner
 Contravene any agreement of the partners

UPA, Sections 9(1), 15- Partners as Agents

Each partner is an agent for partnership and binds the partnership when apparently
carrying on in the usual way of the business.
Exception: Partner has no authority to act for partnership in the matter that they are
and the third party KNOWS this
Partners are jointly and severally liable for debts and obligations of partnership

Nabisco v. Stroud (Stroud and Freeman are general partners; Stroud says he won’t take any
more bread deliveries, Freeman okays bread deliveries)  Court says every partner is an
agent and has the ability to bind the partnership when carrying on in the usual way of
business.(UPA 9, 15). And all partners have equal rights in management. Ordering bread is
in the ordinary business so Stroud cannot outvote Freeman (UPA 18)
Changing Management Rights by Contract
Default rules are often changed in the following areas:
 Delegating decision-making to a managing partner or executive committee
 Weighing partnership voting to reflect pro rata contributions to capital
 Changing the requirement of unanimous consent
 Requiring supermajority voting for important decisions
 Right to expel partners

Day v. Sidley & Austin (SA merges with other firm; Day votes in approval but becomes upset
after this determines he will lose his chairman position in the new merged firm)  SA
adopted structure where each partner did not have equal rights in management, but instead
had executive committee manage. When Day signed the partnership agreement giving
control to the executive committee to create, control, eliminate, restructure firm
committees, he waived his management rights. If management was important to him, he
should have contracted around it.

UPA, Section 30- Dissolution

A partnership is not terminated upon dissolution but continues until winding up of business
is completed.

UPA, Section 31- Causes of Dissolution

1) Without violation of partnership agreement, a partnership dissolves when
(1) At the end of a fixed term, or with consent of all partners if the partnership is for a term
(2) By Express will of any partner if the partnership is at will
(3) Upon the expulsion of a partner under a clause in the partnership agreement

2)With violation of the partnership agreement, if dissolution is not permitted by any other
section, by express will of any partner at any time (does this mean that if violated by
partner, then any partner can dissolve by expressing will?)
3) Business becomes unlawful
4) Death or bankruptcy of a partner or bankruptcy of the partnership
5) Court decree under Section 32

UPA, Section 32- Dissolution by Court Decree

Partnership may be dissolved upon application to the court if:
 A partner is insane or unable to meet requirements of the partnership agreement
 A partner is guilty of such conduct as prejudices carrying on the business.
 A partner willfully or persistently breaches the agreement or makes it not reasonably
practicable to carry on business with the partner
 Business can only be carried out at a loss

RUPA, Section 801(5)- Dissolution by Court Decree

Partnership is dissolved on application by a partner through judicial determination that:
 Economic purpose of partnership is reasonably frustrated
 Another partner has engaged in conduct relating to the partnership business that
makes it not reasonably practicable to carry on the business in the partnership with
that partner or
 It is not reasonably practicable to carry on the partnership business in conformity with
the partnership agreement

Owen v. Cohen (Cohen is breaching partnership, belitting Owen, possibly engaged in illegal
things. Owen wants dissolution because he made a loan, so he wants to get his share back)
 Under UPA 32, Court finds that the partnership can be dissolved because partner
(Cohen) willfully/persistently breached the agreement such that it made it not reasonable
or practical for Owen to carry on business with him.

Duration of Partnership
(1) At will- no limitation on duration  default rule
(2) Express term- for x number of years
(3) Implied Term- until sum of money is earned, until one or more partners recoup, until
certain debts are paid, until certain property is disposed of, etc.

Page v. Page (brother have partnership; brother #1 wants to pull out when it becomes
unprofitable because his other company is creditor; brother #2 says partnership for implied
term)  Court says NO partnership for implied term. Every partnership seeks to make
money, but this does not automatically imply a term to remain in business until profitable.
But the court does find that the plaintiff is breaching his fiduciary duty of good faith,
because his actions are for himself, not the partnership.

UPA, Section 38(1)- Right to Require Liquidation

If dissolution (caused in any way except in breach of agreement), partner may request
liquidation
Note: the default rule is that upon dissolution (caused in any way except in breach of
partnership agreement) any partner may request liquidation. But in practice,
partners often agree to continue the business because liquidation will not produce
maximum value to partners.

UPA, Section 38(2)- Right to Damages and to Continue the Business

If dissolution in violation of partnership agreement occurs, the non-breaching partner may
claim for damages against breaching partners and may continue the business and possess
the partnership property for that purpose. If business continued, breaching partner entitled
to receive value of his/her interest less damages but not including good will.

Pav-Saver v. Vasso (Wagner hates this place; says it got it wrong. Pav-Saver contributed IP.
Pav-Saver terminated, and according to the agreement had to pay equal payments over a 10
year period. Vasso continued business and wanted IP. Also wanted damages more quickly.)
 Court held that Meersman should get IP according to UPA; but that liquidated damages
should go to Meersman according to the contract. So what governs, contract or UPA?

UPA, Section 40(b)- Rules for Distribution; Payment of Liabilities

(1) Payment to creditors other than partners
(2) Payment to partners other than for capital or profit
(3) Payment to partners for capital
(4) Payment for partners for profit

UPA, Section 40(d)- Rules for Distribution

Partners must contribute the amount necessary to satisfy the liabilities in section 40(b)

UPA, Section 18(f)- Dissolution, Rule Against Extra Compensation

Partner not entitled to remuneration for acting in the partnership business except for
surviving partner receiving reasonable compensation for his services in winding up the
partnership (No partner is entitled to extra compensation for work performed in winding
up the business.)
Jewel v. Boxer (oral agreement to form partnership, oral agreement to not share profits
equally, but no written partnership agreement)  Court says it does not matter how much
time a partner spent on a case after dissolution, they cannot be awarded extra profit
(partners are prevented from scrambling to keep their files or competing to get more
lucrative cases).
Corporations

Corporations Partnership
Formalities required No formalities
Limited liability Unlimited liability
Free transferability Not freely transferable
Continuity At will
Centralized management Equal management rights
Double taxation Single taxation

Structure
Shareholders/stockholders are owners of business. They do not manage but delegate their
rights of management and control to the Board of Directors.

Directors make corporate management decisions and all policy decisions. But they are not
employees
Inside Directors: are directors AND officers
Outside directors: NOT officers (there should be a majority of these because board is
supposed to be unbiased/objective, and that happens less when you are employee
of company).
Officers are employees. They run the day-to-day management. Their power is delegated to
them by the Board of Directors.

Steps in Setting Up a Corporation

1) Decide you want to have a corporation. There are many choices for going into business and
pros and cons of each
2) Choose state of incorporation. You can choose any; not limited to principal place of business,
although many do that for tax reasons. We are studying DELAWARE.
3) Reserve corporate name (must be distinctive, indicate corporate status)
4) Draft, sign, and file the certification of incorporation
5) Hold the first meeting of directors (this is if directors are named in certificate; if not, hold
meeting of incorporators)
6) At the first meeting of directors, adopt by-laws (and take other actions)
7) Issue shares and accept paid in capital
8) Take steps to qualify as a foreign corporation in all states where corporation will be doing
business

Incorporators, Sections 101, 103, 107

101- Any person may incorporate a corporation by filing certificate with Division of
Corporation of Secretary of State
103- Signed, dated, paid fees
107- If no directors are named, incorporated manage business until directors are elected

Certificate of Incorporation, Section 102

Mandatory
Name (include the words “inc.” or “corp.”
Address
Business purpose (any lawful business)
Capitalization structure (shareholders have identical rights unless specified)
Incorporators’ names and addresses
Director’s names and addresses
Optional
 Management provisions
Provisions limiting powers of corporation, directors, shareholders
Provisions changing the voting rules of DGCL
Preemptive shareholder rights (if existing shareholders can buy new shares)
Limit on duration of business
Exceptions to limited liability of shareholders (unusual)
Limits on monetary damages for director breach of fiduciary duty

Requirement of Filing, Section 101(a)

-File with Division of Corporations in the Department of State
-Not until delivery to Secretary of Sate and payment is there a corporation
-Filed documents are public record (publicly available information)

Commencement of Corporate Existence, Section 106

-Corporations exist from the date of filing until dissolution

Registered Office, DGCL Section 131

-Registered office is required, though it does not have to be the place of business
-This place receives service of process within the state
-Must be a resident person or corporation

By-Laws, Section 108, 109

108- By-laws are adopted at organization meeting of directors/incorporators
109- By-laws may contain provisions on conduct of affairs; rights or powers of
shareholders, directors, and officers. The by-laws may be amended by directors until
payment of initial capital…after that, shareholders must vote to amend.
By-laws are not filed with Secretary of Sate

Promoter’s Liability
Liability for Pre-Incorporation Contracts:
-If promoter forms corporation later…
Can corporation become party to contract?
Can promoter avoid liability?
-If corporation is never formed or if promoter forms different corporation…
Who is liable?

Corporation By Estoppel
-Would earn a windfall if allowed to evade liability based on absence of incorporation
-Person acted as though he was dealing with a corporation
-Test (articulated in Southern Gulf)  were substantial rights affected

Southern Gulf Marine v. Camcraft (Barrett, promoter of Southern Gulf, signs contract with
Camcraft. He thinks that he will incorporate in Texas, but instead incorporate under foreign
country. Camcraft says they can breach)
 Court says that because formed in Caymen Island, doesn’t allow for default. They allow
“corporation by estoppel” because Camcraft would earn windfall if allowed to evade
liability.
 Test for Corporation by Estoppel (as expressed here): whether a SUBSTANTIAL right
changed/affected. This fails here because Southern Gulf was ready to pay, so where they
were paying from didn’t matter.
Note: Barrett signs both as an individual and as president of Southern Gulf, not yet
formed. If corporation is later formed, corporation can adopt the contract and assume
responsibility and can take over payments. But if Southern Gulf was never formed, then
promoter would be liable, as Barrett signed for himself and corporation.
De Facto Corporation
-If promoter tried in good faith to incorporate, had a legal right to do so, and acted as a
corporation
-If a client believes that lawyer took document, filed with Secretary of State, but forgets to
file and client acts like they are a corporation and carries on business like it, then courts
sometimes give the benefit of limited liability
-Good faith!

Enterprise Liability
-This is going after affiliated corporations (Walkovsky). But this was rejected in Walkovsky.
-Much more available assets by going after companies with same owner
-Idea is that you should ignore corporate separateness, argue that even though they are legally set up
as separate entitles, owner does not treat them as separate (co-mingle assets)
**Compare this to Piercing the Corporate Veil where Shareholder’s (not other corporations) personal
assets may be available to creditor; note; this also fails in Walkovsky

Walkovsky (person hit by cab sues Carlton who is stockholder of 10 cab corporations with 2
cabs each; he has minimal insurance in all of them)  majority says we can’t go after
Carlton because we can’t pierce the corporate veil…no evidence he was using the company
for his own benefit. Also no dice on enterprise liability because you can’t just go after
because same person owns…they have to be co-mingling and we don’t have good evidence
of that. Dissent says we should go after Walkovsky because he was committing fraud by
underfunding insurance.

General Rule of Limited Liability & Piercing the Corporate Veil

-Corporations are supposed to have limited liability, no personal liability.
-Courts SOMETIMES allow for personal limited (piercing the veil)
-Piercing allows you to go after the personal assets of a person, not after the asserts of other
corporations (that is enterprise liability).
-Requirements:
(1) Alter Ego: There must be such a unity of interest and ownership that the separate
personalities of the corporation and the individual no longer exist. This happens when
individuals use corporation for their own benefit. Often happens when only 1-2
shareholders.
Illinois uses Van Dorn Test:
*Failure to maintain corporate formalities
*Comingling assets/funds
*Under-capitalization
*One corporation treats assets of other corporation as its own
(2) Fraud or Injustice: Need MORE than creditor’s inability to collect
(3) SOME jurisdictions require to show Assumption of Risk, and only for contract cases.
Here, a contract creditor would need to engage in in transactions (how debt comes into
existence). Should have done due diligence (not applicable in Walkovsky or Sealand).

Sealand v. Pepper Source (Sealand ships peppers for PS, PS stuffs Sealand on the bill,
Sealand filed action for money. PS had dissolved a few months earlier, so Sealand couldn’t
recover, so Sealand wants to go against shareholder)  Court establishes test. Alter-ego is
satisfied- the corporate defendants where shareholder’s playthings, he co-mingling bank
accounts, he co-mingled the corporations. Court finds fraud is NOT met, but let’s Sealand
amend. They need to show fraud/injustice beyond right to receive payment (creditors can’t
win just because they’re creditors). Note: third prong not applied here.
Parent/Subsidiary Relationship and Substantial Domination Test
This allows plaintiffs to collect from parents for their subsidiaries. There is a piercing test
in parent subsidiary:
1) Alter ego/control/domination
2) Fraud/injustice

Factors to consider for Control/Alter Ego:

*Common directors & officers
*Common business departmentss
*File consolidated financial statements/tax returns
*Parent’s formation and financing of subsidiary
*Gross under-capitalization
*Parent’s payment of salaries and other expenses
*Parent provides all business of subsidiary
*Parent uses property of subsidiary
*Daily operations of both are not separate
*Subsidiary fails to maintain corporate formalities

Direct Liability
This theory is separate from piercing and is mostly based on negligence
Restatement (2nd) of Torts says that one who undertakes to render services is subject to
liability to third-party for physical harm due to a failure to exercise reasonable care if:
*Failure to exercise reasonable care increased risk of harm
*Undertaken to perform duty owed by the other to third party
*Harm by third party suffered because of reliance

Silicone- both Parent/Subsidiary and Direct Liability case (Bristol purchased shares of MEC and
exerted control over MEC, used their departments, approved their budget, set salaries, etc. Females
are injured by breast implants manufactured by MEC, but MEC is dissolved so they go after Bristol)
 Parent/Subsidiary: Court isn’t sure about prong #2, but there’s enough evidence to survive
summary judgment. Prong #1 is met because MEC is in no way independent (look to factors)
 Direct liability (essentially negligence theory); court finds that Bristol who undertook to render
services is subject to liability to third party for physical harm (women) due to failure to exercise
reasonable care (again, check test)

Shareholder Derivative Litigation

Derivative lawsuit= shareholder brings a lawsuit to remedy a wrong on behalf of the
corporation against directors, managers, or other shareholders. Directors/officers won’t
sue their friends, so we rely on shareholders to protect the corporation.
*Shareholder can only sue in equity
*No standing otherwise because they haven’t been directly harmed
Strike suit= a lawsuit that is brought in the hope of a settlement.
*Lawyers are the main people who benefit from these
*So although we like derivative lawsuits we don’t like strike suits

Cohen v. Beneficial (In NJ, statute says that in a derivative shareholder action, if a person
has less than 5% ownership or $50,000, they have to give security for corporation for
expenses to defendant the lawsuit in case corporation wins…this is to prevent strike suit.
Plaintiff wants statute thrown out)  Court upholds statute. Fees are reasonable, state has
legitimate purpose. Court finds this to be a substantive rule, not procedural matter that
would preempt federal rules.
Defendants win lawsuit, statute does not violate constitution. No due process or equal
protection violations
Direct Shareholder Actions vs. Derivative Shareholder Actions
Derivative lawsuit= injury to corporation
If recovery, it goes to corporation, not plaintiff shareholder
Sue on behalf of corporation to enforce rights of corporation
Usually allegations of mismanagement, waste, fraud, breach of fiduciary duty
If successful, corporation plays plaintiff’s fees
Two suits in one  stockholder sues corporation in equity to enforce corporate
rights
Direct lawsuit= injury to shareholder personally
Shareholder sues for their rights as shareholders
Usually denial/dilution of voting rights, compel dividends/inspection
Class Action= shareholders sue in their own capacity as well as on behalf of other
shareholders similarly situated
Group asserts individual direct claims through a representative
Plaintiff must be representative of other shareholder interests
From Tooley v. Donaldson, Lufkin, & Jenrette Inc
- How to determine whether a stockholder’s suit is derivative or direct
o (1) who suffered the alleged harm – corporation or suing stockholder
o (2) who would receive the benefit of any recovery / remedy – corporation or the
stockholders individually

Eisenberg v. Flying Tiger (Eisenberg was owner of original Flying Tiger, but the operating
assets were switched to their subsidiary, FTL, so Eisenberg’s shares, which were supposed
to be operating a business, is now just a holding company. Question is whether this is a
direct or derivative claim)  Court finds direct lawsuit. Look at who was harmed,
corporation or individuals! Eisenberg feels his shares have been diluted, or were just of a
different type (holding instead of aircraft company/shares). Although corporation is
arguing it’s corporation harmed (derivative) the court finds for Eisenberg because he
personally wanted a type of shares.

Demand Requirement & Demand Futility

Purpose of Demand:
*Allow dispute to be resolved by corporation outside of court
*Allow corporation to take over lawsuit if it is beneficial to corporation
*If demand is excused or wrongfully refused, shareholder can control
*Protect corporate boards from harassment and discourage strike suits
Demand Excusal, if Demand is Futile: (create reasonable doubt regarding board
independence)
1) Majority of Board has material financial or familial interest
2) Majority of Board is incapable of acting independently
3) Underlying Transactions are not product of valid “Business Judgment Rule”
**Note: don’t focus on #3

-New York Approach to Futility:

*Allege facts that share with particularity that majority of Board is interested in
transaction OR directors failed to inform themselves as reasonably necessary OR
directs failed to exercise business judgment.

Wrongful Refusal:
-If the board says no to demand, this claims that Board’s judgment is wrong
-This is difficult because Business Judgment Rule (presumed to run business in best interest
of the corporation)
-To overcome, the plaintiff must allege facts with particularity, creating reasonably doubt
that the board acted independently or with due care (note Grimes does NOT do this)

Grimes v. Donald (Grimes, a shareholder, sues CEO Donald and the Board of Directors
because he believes too much power was given to Donald. He thinks the Board should be
running the business, not Donald, and that too much money is given to Donald)
 Claim #1= Abdication. Court says this is fine. It is okay to delegate to people and the
Board does retain ultimate decision because they can fire Donald, even though he gets paid
a lot if they do. So Board is within authority.
 Claim #2 Derivate Claim/Demand claim  For derivative lawsuits, there is a
requirement that in order to proceed, you must first go to Board and make a demand that
the Board takes over the lawsuit and brings wrongdoers to justice. Here, Grimes did make
demand and Board said no. Because this happened we follow the “Wrongful Refusal
Doctrine” which is difficult to overcome because of Business Judgment Rule, so Grimes it out
of luck.
Grimes loses.

DGCL 141(C)(2)- Special Litigation Committees & Demand Requirement

Board may designate 1 or more committees, each consisting of 1 or more directors. The
Board committee may exercise all the powers and authority of the full board.

Note, also, 141(a)- Business Judgment Rule. The business and affairs of the corporation
shall be managed by or under the direction of the Board of Directors.

There is a rebuttable presumption that directors and officers carry out their functions in
good faith, after sufficient investigation, and for valid business reasons.

Special Litigation Committees

- Special Board Committees  permitted under DCGL Sec. 141(c)(2). The board may
designate 1 or more committees, each consisting of 1 or more direction. Board committee
can exercise all powers and authority of the full board.

Zapata (Maldonado, shareholder, initiated a derivate suit alleging breach of fiduciary duty against
certain officers and all the directors. He claimed demand futility because all the directors were
named as defendants. Here, the board picked 2 people that were NOT on the Board (independent)
when the wrongdoing occurred (as committee). Board says they will abide by whatever the
committee decided.)  Court looks at two things:
1) Look at independence and good faith. Are they independent? Do they investigate? Here, the test
seems to be met.
2) If #1 is met, the court applies its own independent business judgment to determine whether
committee made the right choice. So they set aside Business Judgment Rule to determine whether
litigation should go ahead or not.

Oracle (more recent than Zapata; shareholder sues directors for insider trading, so Oracle sets up
special litigation committee. The directors put 2 Stanford professors on the committee because they
weren’t on the Board at the time of the alleged wrongdoing. Their decision would be binding. They
recommend not taking action)  Court finds that they did intensive investigation, were not
compensated, weren’t there at the time of the incident, did not benefit, were financially independent
BUT there was a SOCIAL tie. There was professor/student relationship as well as friendships within
Stanford, enough to jeopardize independence.
Court denied SLC to terminate lawsuit because they were not truly independent.

Corporate Philanthropy
Delaware General Corporation Code 102(A)(3)
 -Certificate of Incorporation shall set forth nature of the business. It may say “any
lawful act or activity.” It may also contain restrictions.

Delaware General Corporation Law 124

-No act or transfer of property shall be invalid because ultra vires (outside the
power) but lack of capacity or power may be asserted.

Delaware General Corporation Law 122

Every corporation shall have power to
* Sue/be sued
*Acquire/dispose of real or personal property
*Conduct business within or without this state
*Appoint officers; wind up and dissolve
*Make donations for the public welfare or for charitable, scientific or
educational purposes (no limitation to amount as to permissible gift, but case law
has limitations)
*Make contracts
*Borrow/lend money
*Pay pensions
*Buy life insurance for benefit of directors/officers/employees/shareholders

California Corporation Code 207(3)

Power to make donations regardless of specific corporate benefit for the public
welfare, community fund, hospital, charitable, educational, scientific, civic or similar
purposes

New York BCL Section 202(a)(12):

Make a donation irrespective of corporate benefit for the public welfare or
community fund, hospital, charitable, educational, scientific, civic, or smaller
purposes and in time of war or another national emergency

Pennsylvania Code 102(d):

Directors may in considering the best interests of the corporation consider the
effects of their actions on any and all groups affected by such actions, including
shareholders, employees, supplies, customers, creditors, communities in which
offices or other establishments of corporation are located

Smith v. Barlow (Corporation wanted to give $1,500 to Princeton, but shareholder wants
that money to go to benefit of shareholder, so they say that gift is ultra vires (outside the
power))  Currently, you can conduct business in anyway that is lawful. Here, New Jersey
statute says there is public interest in allow corporations to make gifts to charities. Court
says that in order to sustain a gift, the gift should be made to benefit society/public benefit.
It also must advance interest of corporation in some way. Also must be modest/reasonable
amount. The court sees some logic in that customers and Princeton grads might come back
to your company because you benefitted society, so it’s upheld. Must be voluntarily made
and reasonable belief that the gift will aid public welfare and advance the needs of the
corporation.
Boards Acting for Interest Other Than Shareholders

Dodge v. Ford Motor (Ford is controlling shareholder/on Board, Dodge are minority
shareholders…Ford wants to change dividends such that the regular one gets paid but the
special dividends funds long-term expansion plain. Dodge says the goal should be to
advance shareholder interests, not charity)  Court holds for Dodge. They think Ford’s
discretion went too far (focus on short term).
*This case seems wrong because they didn’t note how long-term expansion would
create more profit in the long-term for shareholders.
*Does not reflect the modern view
*Failed to look at conflict between Dodge bros and Ford
*Raising wages  made good business sense / wasn’t a move to turn the business
into a charity. When wages were higher, turnover decreased dramatically

DGCL Section 170(a)

Directors may declare and pay dividends out surplus or net profits, subject to the
restrictions in the certificate of incorporation.

Hunter v. Roberts  “it is a well-recognized principle that directors alone have the power to
declare a dividend and determine its amount. Courts of equity will not interfere in the
management of the directors unless....they are guilty of fraud or misappropriation of the
corporate funds, or refuse to declare a dividend when the corporation has a surplus of net
profits… and when a refusal would amount ot abuse of discretion as would constitute
fraud or breach of good faith.

Wrigley (Shareholder wants lights on the field (more games, more profit), but Wrigley
doesn’t want baseball at night & doesn’t want to disturb community)  Court holds that
Business Judgment Rule lets Wrigley decide. Plaintiff couldn’t establish abuse of discretion,
illegality, conflict of interest. There is also no evidence that plaintiff showed lack of lights
damaged profits).
*So modern viewpoint (Berle-Dodd debate) is that corporations should primarily
serve shareholders but they can have non-main purpose to serve outside
constituencies and charities.

The new Corporate Social Responsibility

- Corporate Social Responsibility  companies voluntarily decide to respect and protect the
interest of a broad range of stakeholders and to contribute to a cleaner environment and
better society through active interaction with all.
- Corporate Social Responsibility goes beyond compliance with the laws to capture
voluntary initiatives to do more than what is legally required
- Supported by company level, industry level, and international codes of conduct
o Developed by business, civil society, national governments and intergovernmental
organizations.
- Areas of Coverage
o Core labor standard, Green Environmental standards, Reject Bribery and corruption
of government officials to facilitate business, and Respect Human Rights
LLCs – Module 4
ULLCA 201-
LLC is a legal entity distinct from its members. LLC comes into existence when the articles
are filed.
*Hybrid. Limited liability (corporations) + flow through tax (partnership)
Required elements:
- Name of company
- Street and mailing address of the principle office
- Name and address of company’s registered agent

Option Elements
- Other provisions that are not inconsistent with Section 105(c) and (d)

Corporate Characteristics
Limited Liability
Free Transferability
Continuity of Life
Centralized Management, vs member management

ULLCA 202- Amendment of Articles of Organization

-One or more persons (“organizers”) may form LLC, consisting of one or more members, by
filing articles with Secretary of State
-LLC comes into existence when articles filed with SOS

ULLCA 203- Contents of Articles of Organization

-Name of Company
-Address
-Name and address of agent for service of process
-Name and address of organizer
-Term, if there is one
-Whether manager-managed and name/address of managers
*Manager-managed LLC is similar to corporation where management is delegated to
a board. If you don’t indicate this, then it is presumed that every member is
responsible.
-Liability of members for debts and obligations, if applicable

ULLCA 204- Amendment of Articles of Organization

-Must be filed with state

Westec v Lanham (Westec contracted with Clark, who said he was agent of Lanham.
Business card had Clark’s name, Lanham’s address, and PII- but didn’t say what PII is) 
Court pretty much decides this based on agency. Clark is dismissed as a disclosed agent.
Lanham could have avoided liability by disclosing he worked for PII, a LLC. (Court rejects
idea that companies are put on constructive notice by filing of a LLC.)
LLC notice provision does not supplant the common law rule of agency on the agent’s
liability on a contract with a partially disclosed principle.
Does not mean that third parties always have constructive notice
Rationale: defendant’s argument exaggerates the plain meeting. Would be invitation to
fraud to apply the notice provision. Lanham could have stated that PII was LLC by putting it
on business card ect. And protected himself that way.
ULLCA 105(a)- Operating Agreement (Like By-Laws)
-Members of LLC may enter into Operating Agreement to regulate conduct of business and
relations among members, managers, and company.
-Members may not change provisions of the ULLCA specified in 103(b), such as the duty of
loyalty, duty of care.
-Unless changed by the Operating Agreement, the default rules of the ULLCA apply.

Note: 105(b): The Operating Agreement may not:

*Unreasonably restrict a right to information (Section 408)
*Eliminate the duty of loyalty
*Unreasonably reduce the duty of care
*Eliminate the obligation of good faith, although it may determine the standards of
the obligation
*Vary the right to expel a member
*Vary the requirement to wind up the LLC’s business
*Restrict the rights of a member other than manager, member

Elf v. Jaffari (Elf files derivative lawsuit against Jaffari, claiming mismanagement. But there
is an arbitration agreement)  So court dismisses the lawsuit. Operating agreements have
a lot of freedom of contract.

ULLCA 303- Limited Liability in LLCs and Piercing the Veil

-Debts, obligations, liabilities of the LLC belong solely to the company
-Members or managers are NOT personally liable for debts, obligations, and liabilities of the
LLC, whether arising in contract, tort, or otherwise.
-Failure to observe formalities or requirements for exercise of powers of management are
NOT a ground for imposing liability
-Members can become liable for debts etc. IF they so consent in writing and include a
provision in articles

Kaycee v. Flahive (Flahive has no assets and caused environmental contamination. Kaycee
wants to hold Roger (manager) individually liable)  Courts hold that piercing is allowed
for LLCs. But the circumstances you need to justify piercing may be different from that of
corporation (the factors for corporation is listed in Sealand).

ULLCA 407- Styles of Management

ULLCA 407(a)
- LLC is member-managed unless the operating agreement specifies otherwise.

ULLCA 407(b) – Member-managed

- Management is vested in members
- Members have equal rights in management
- Differences on ordinary business matters are decided by majority vote of members
- Affirmative vote or consent of all members required for taking actions outside the ordinary
course of business or for amending the operating agreement.

ULLCA 407(C) – Manager-Managed LLC

- Matters related to activities or affairs of company are decided exclusively by managers, or if
more than one, by a majority of managers
- Managers have equal rights in management
- Affirmative vote or consent of all members required for taking actions outside the ordinary
course of business or for amending the operating agreement.
- Managers must be designated, removed, and replaced by a majority of members
ULLCA 301- Agency of Members and Managers
-In member-managed LLC:
*Each member is an agent of LLC for purpose of its business. Acts of members for
apparently carrying on ordinary business of LLC bind the company unless there was
no authority and third party knows this.
*Acts not for apparently carrying on ordinary business binds if authorized by the
other members.
-In a manager-managed LLC:
*A member is not an agent solely by reason of being a member
*Each manager is an agent and binds the company if apparently carrying on
ordinary business of LLC, unless the manager had no authority to act on that matter
and third party had notice.
*Act of a manager not for apparently carrying on ordinary business binds company
only if authorized as required by ULLCA 404.

ULLCA 409- General Standards of a Member’s and Manager’s Conduct

-Members owe duty of loyalty and care to member-managed company and its other
members
-409(b)  Duty of Loyalty:
*Accounting for profit from use of property of LLC and appropriation of corporate
opportunity
*Refrain from acting adversely to the LLC’s interests, refrain from competing with
the company in the conduct of its business before dissolution
-409(c)  Duty of Care:
*Duty of care is to refrain from engaging in grossly negligent or reckless conduct,
willful or intentional conduct, or knowing violation of the law.
*Do not engage in gross negligence or reckless conduct, intentional misconduct,
knowing violation of law

-409(i)  Fiduciary Duty  Manager in a manager-managed company owes dame duties

prescribed for members. Members who do NOT manage owe NO duties.

McConnell v. Hunt Sports (McConnell and Hunt formed CHL to get a hockey league. Hunt
acted for CHL and wouldn’t make deal with NHL. After continuous rejection, McConnell
accepted the deal on his own, not for CHL. The operating agreement said members could
compete and weren’t prohibited or restrict from any venture that could be competitive with
CHL)  Court agrees that fiduciary duties can be waived. There is freedom of contract.
Even though fiduciary duties are recognized, the members waived them so it’s okay.
*Also note Hunt broke the agreement that said “no member may take any action on
behalf of the company unless approved by a majority. So Hunt acting for CHL
without approval wasn’t okay.
*This was a member-managed company. Not manager-managed!

 But 103(b) says Operating Agreements can’t eliminate duty of loyalty?

ULLCA Dissolution
701- Events of Dissolution
702- Winding up after Dissolution
Filing articles of termination
704 – Disposing of known claims by giving notice to creditors
705- Disposing of other claims by publishing notice to creditors in a newspaper
Other claims are barred
707- Creditors must be paid first (including members)
Members are entitled to return of contributions
705(d)(2)- Member liability to creditors is up to the amount received in distribution
New Horizons v. Haack (Haack’s LLC entered into debts. She claims limited liability. There
was a problem with the way Haack conducted herself in resolving the business. No
evidence of how she distributed the accounts. Not sure if she pocketed it or gave it to
creditors)  Court holds that there are statutory steps she needed to do to dissolve. Haack
doesn’t get protection of FRE 705(d)(2) because the court assumes she pocketed the
remaining funds so she has to pay a claim for that amount (the amount she could have
pocketed).
 Suppose she proved she put $2000 into business, she had paid Kickappoo’s debts and
then pocketed $500. Then New Horizons shows up with $1000. Her liability would be
for $500, because she would be limited to the amount she received. This set of facts
assumes she follows correct procedures.
Board Management Separate from Mergers
DGCL 141(a)- Board Authority:
- Business and affairs of corporation shall be managed by or under the direction of a Board of
Directors

DGCL 141(b)- Board Composition and Action:

- Composed of one or more members (fixed in bylaws or certificate).
- The majority of the total number is called a Quorum (it can be reduced to 1/3 in the bylaws).
- A valid board action is a vote of majority of directors present at a meeting with quorum
present (note this can require a supermajority in certificate or bylaws).

DGCL 216- Shareholder Voting

- Majority of shares entitled to vote shall constitute a quorum at a stockholder meeting (again,
can reduce to 1/3 in certificate or bylaws).
- A vote of majority of those present or represented by proxy shall be the act of the
stockholders (except for the election of directors, which shall be elected by plurality).

Cash Out Merger Approval

Acquiring Company = pay shareholders of target company the value of their shares
Target Company = merged out of existence and shareholders have no interest if resulting
company
*Target Company’s shareholders protected by fiduciary duties of directors.
DGCL 251(b)- Board Approval: Board of each merging corporation shall adopt a
resolution approving an agreement of merger and declaring its advisability

DGCL 251(c)- Stockholder Approval: Merger agreement shall be submitted to

stockholders for approval. A majority of shares entitled to vote must approve and if it is
approved, a merger agreement is filed and becomes effective

Note Exception…
DGCL 141(e)- Good Faith Reliance on Records and Reports
In performing their duties, board members may rely in good faith on records of
corporation and on information, opinions, reports, statements presented to the
corporation by corporation’s officers or employees

Smith v. Van Gorkom (Here, Board approved merger at only price bid on, after 2 hours of
consideration, no documentation, no valuation study…nothing except the word of CEO.
They gave shareholders insufficient/incorrect information and they ratified it too)  Court
held they violated duty of care because it wasn’t sufficient to take on faith what CEO said
and spend such little time debating it. Shareholder ratification doesn’t occur because of bad
information. Exception of 141(e) is not met because Van Gorkom did tell them things but
there was no information, opinion, report, or statement that classifies (it has to be more
concrete than speculation!) So duty of care is violated.
Issue: Were the actions of the board subject to protection under business judgment rule?
Holding  no, they did not make a fully informed decision.
In response to this case we have…
DGCL 102(b)(7)- Limits on Director Liability
Certificate of incorporation may contain provision eliminating or limiting personal liability
of director for monetary damages for breach of fiduciary duty EXCEPT:
*Duty of Loyalty
*Lack of good faith, intentional misconduct, knowing violation of law
*Violation of Section 174 on dividends
*Transactions in which director derived improper personal benefit

Fiduciary Duty of Care

Kamin v. American Express (Shareholder derivative action where shareholder wants Am

Express to keep DLJ shares for $8 million tax savings instead of selling them for capital loss
of $25 million; allege violation of duty of care)  Court finds that directors did not violate
duty of care. They showed rational business decision making that included (convening,
talking, researching, weighing pros/cons). They had solid rationale that they wanted to
keep Am Express shares up by selling DSJ shares. So test = gross negligence, and here
there was no gross negligence alleged with specificity.

Duty to Monitor

Bad company:
Francis v. United Jersey Bank (Woman inherits 48% shareholder + director from husband.
Two sons, also directors, are misappropriating funds, which would have been obvious if she
had paid attention)  Court says she needed to acquire a rudimentary understanding of the
business, keep informed, stay current with corporate activities, not shut eyes to corporate
misconduct (general monitoring, not detailed inspection), and must maintain familiarity
with financial status of corporation. Instead, she just stayed boarded up in her house…
completely passive. Business Judgment Rule doesn’t cover her when she didn’t do anything.
Standard of care  ordinary care a director would have in the same

Good company:
In Re Caremark (Law prohibits kickbacks for Medicaid referral. Caremark starts to get in
trouble, so when they became aware they discontinued management fees, created internal
and external audits, created ethics handbook, created ethics hotline, created a compliance
officer, etc.)  Court holds to approve settlement because the directors were the opposite
of passive. When the Board became aware they put in reasonable compliance measures.
Standard for review  fair and reasonable
Court must consider the conduct of the directors
Court approved settlement, even though it involved a series of steps in furtherance of
before and not monetary payment.

Duty of Loyalty

NYBCL 713- Conflict of Interest Transactions

-Covers contracts between corporations AND a director or corporation in which a director
has a substantial financial interest or is a director or officer
-No contract involving an interested director is void or voidable because the director was
present/voted in favor if:
*Disclosure and valid board approval without counting vote of interested director
 *Disclosure and contract approved by shareholders
*In other cases, show fairness and reasonableness

Bayer v. Beran (Company decides to advertise on radio program where president’s wife is a
singer. Business Judgment Rule didn’t automatically shield this decision because conflict of
interest…president was choosing between the company’s best interest and his wife) 
Court uses strict scrutiny and upholds the decision. The company was benefitted by
revenue coming in. The costs to air the advertisements seemed reasonable. The wife
wasn’t being paid much. So although there is side benefit…there is also a corporate benefit.
So it looks like court upholds because it’s a fair contract.

DGCL 144(a)- Ratification

Interested director/officer transaction is not void/voidable if
(1) Material fact disclosure and disinterested director approval
(2) Material fact disclosure and shareholder approval
(3) Or contract is fair

Corporate Opportunity (sub-branch Duty of Loyalty)

Delaware Test  Guth v. Loft
1) Financial Ability
2) Same line of Business
3) Interest or Expectancy
4) AND Taking opportunity would create conflict between self-interest and interest of
corporation

Broz v. Cellular Information Systems (Broz is president of FRBC and director of CIS. He
takes opportunity that someone who was considering acquiring CIS wanted)  This case
fails the Guth test. The same line of business test was met. But three aren’t. CIS didn’t have
the financial ability to buy the license. They did not have interest/expectancy because they
were divesting themselves of licenses. And there was no conflict because Broz approached
CIS about it first. So test isn’t met. Formal presentation to the board and rejection  NOT
required before individual can take the opportunity but may act as a safe harbor.
If the corporation rejects the corporate opportunity, then director may take it.

In Re eBay (In return for business, Goldman Sachs gave certain directors stock options at a
lower price that they could turn around and sell for higher. They’re accused of a kickback…
Goldman Sachs giving directors these instead of the corporation.)  Court says Guth test is
met. eBay definitely had financial ability. It was in the same line of business, as stocks were
part of their cash-management strategy. The corporation definitely would have expected
this after spending money…rather than it going to individual directors. And taking this did
conflict because the corporation was never given the opportunity that the directors took.
So directors lose.
Fiduciary Duties of Parent-Subsidiary
-Note: a parent/subsidiary doesn’t automatically mean that the parent should run the
business of the subsidiary. But when there is no independent board, and the board of the
subsidiary is the board of the parent…the parent controls and therefore has fiduciary duties.

Sinclair Oil v. Levien (Sinclair owns 97% of Sinven and Levien is minority shareholder.
There are three main conflicts) 
*Claim that Sinclair was hurting Sinven by giving dividends  Business Judgment Rule.
Minority shareholders get what majority shareholder gets, so standard rule.
*Claim that Sinclair was Denying Business Opportunities  Business Judgment Rule. No
self-dealing. Levien couldn’t point to any opportunity that belonged to Sinven and was
given to someone else.
*Other Subsidiary of Sinclair keeps breaching contract with Sinven, but no punishment 
This is Intrinsic Fairness (harder than Business Judgment). Because Sinclair was getting
the benefit of the breach of contract, they benefitted to the disadvantage of the minority
shareholders.

Flieger v. Lawrence (Lawrence wants to sell property to Agau. The board rejects it, but then
officers/directors as individuals form company, USAC, to acquire the property and develop
it. They then have option contract where they sell all of their shares in USAC for 800,000
shares of Agau. Majority of shareholders ratified this option contract. Plaintiff derivative
action to recover the shares)  Directors say they are protected by ratification under DGCL
144(a) when shareholders ratified. Court says no. Can’t get disinterested director approval
because they’re all interested. Shareholder ratification doesn’t count because you need
majority of disinterested and apparently that didn’t happen here either. But court does
uphold as the contract being fair because the shares were of value and could generate profit
for the corporation.
Securities Regulations
Securities Act of 1933
-Primary market: company makes money by selling securities to public. IPOs.

Securities Act of 1944

-Secondary market: investors actively trade with other investors
-SEC set up; they were delegated authority by Congress

Scope:
-Disclosure provisions
-Anti-fraud provisions
-Regulating markets and market professionals

What is a Security?
Securities Act of 1933, Section 2(a)(1)
Security means (unless the context otherwise requires) any note, stock, treasury stock,
bond, debenture, evidence of indebtedness, investment contract, or in general any interest
or instrument commonly known as security. (Note LLC membership interest is not listed)
-Implications of calling an investment opportunity a “security”  Disclosure and
anti-fraud provisions apply.

Howey Test: Investment Contract

*Investment of money
*In a common enterprise
*With the expectation of profits
*To come solely from the efforts of others

Landreth Timber Test: Stock

*Dividends
*Negotiability
*Can be Pledged or Hypothecated
*Voting Rights
*Capital Appreciation

Economic Realities Test: aren’t bound to someone’s label, but as to how something was
used in practice. (Just because you call something stock doesn’t mean it’s stock)

General practice: If you bought stock from…

Close corporation  probably security
General partnership  probably not; because not solely from efforts of others
Limited partnership  probably security; limited partners not allowed to manage
LLC  If not manager in manager-managed LLC, probably. If member-managed, then more
difficult argument. But no general rule because LLCs are hybrids.

Robinson v. Glynn (Robinson agreed to invest in GeoPhone contingent that it used

technology. He was told it did, so he bought certificates labeled as “shares” and “securities.”
Robinson thinks its securities fraud, under Section 10(b) of the 1934 Act. Main issue is
whether he even belongs in federal court.
 Court says no. LCC investment interest is not security (investment contract or
stock).
  Howey test, the element that fails is that the profits are to come SOLELY from the
efforts of others. Robinson had extensive powers of control, so he was not solely
depending on others. Court notes that he was not a passive investor, had
information, was able to select financial avenues for business as he was a treasurer
of the LLC.
 Landreth Timber test fails because it was not negotiable. Robinson was required
to sell it back to the business, not an individual.
 Finally, economic realities test tells us not to look at labels, but practice. So court
concludes it is not a security.

Registration and Exemptions from Registration

Securities Act of 1933 Section 5

It is unlawful to sell or offer for sale securities in interstate commerce unless securities are
registered with the SEC. Issuer must provide discloser in a prospectus (this is portion of
registration statement that goes to investor…not whole registration statement goes to
investor).
Exemptions: Certain types of securities, like U.S. government securities. Certain
types of transactions, like private placement.

Securities Act of 1933- Section 4(2)

The provision of Section 5 shall not apply to transactions by an issuer not involving a
public offering (but no definition of public offering)

Ralston Purina Test  Do this FIRST

Did the offerees need the protection of the registration provisions of the 1933 Act or were
they able to fend for themselves. This turns on access to information…did the person have
information provided to them via disclosure document or do they have access to get
information from within? If no, then it should have been registered.

Factors (this SUPPLEMENTS the above test and should be done AFTER it)
*Number of offerees and relationship to each other and the issuer
*Number of units offered
*Size of the offering
*Manner of the offering

Doran v. Petroleum Management (totally screwed because instead of getting returns on

investment, he owes bank for company’s loan. Question is whether company is selling
security and whether that security has to be registered. The lower court said he didn’t need
info because he was sophisticated investor)  Court says we don’t care if he’s a
sophisticated investor. He still needs adequate information. If you are sophisticated and
don’t have disclosure, then it doesn’t matter. The court remands it for defendants to show
that all offerees had access to the information that would have been provided in a
registration statement given to offeree had it been an registered public offering. Access 2
ways  registration information or access to files that would allow them to understand all
the information necessary to make informed decision about investment.

Types of Securities
Type of Cash Flow Rights Liquidation Rights Voting Rights
Security
Common Stock Residual and Residual Yes
Discretionary Dividend
Preferred Stock Fixed and discretionary Medium Contingent
div. (cumulates if not
 paid)

Bonds Fixed and certain interest Highest None.

payment

Anti-Fraud Topic #1- Section 11 Fraud in the Registration Statement

Securities Act of 1933, Section 11  Covers within Registration Statement
- Material misstatement or omission in a registration statement is actionable fraud.
o *What is Material? Information that an average prudent investor ought reasonable
to be informed about before purchasing the registered security.
- The person acquiring such security has an EXPRESS private right of action (buying a
security…you do not have to show causation, loss, reliance, etc.)
o *There is no question private parties have standing to sue because statute says they
have standing to sue.
- You can sue company, people who signed the registration statement, directors (even if they
didn’t sign), and outside experts who helped prepare the statement, such as accountants,
engineers, appraisers, and underwriters.
- Lawyers can’t be sued just for being lawyers. They can be sued if they are also a director.
- Subject to defenses of loss causation and due diligence
- Remedy = damages

Defenses:
-Loss causation: reason you lost money was not because of misstatement/omissions, but
because there was some other reason (example: stock market crash)
-Due diligence

What is Due Diligence:

Expert Non-Expert
Expertise Portion Reasonably believes, after No reason to believe information is
reasonable investigation, false
that info is true
Non-expertise No liability Reasonably believes, after
Portion reasonable investigation, that info
is true

Escott v. BarChris (bowling alley securities)  Due diligence defense case. Essentially no
one meets the above chart
- Issues  1 - Was there a misrepresentation or omission in the registration statement. 2 – If
yes, then were they material? 3 – did the defendants satisfy their burden of proving a
defense (due diligence)
- Ruling  there were misstatements or omissions in both the financial portion and the
narrative portion of the registration statement.
o Were they material?? Materiality is a threshold issue. Definition  information that
an average prudent investor ought reasonably to be informed about before
purchasing the registered security
 Court holds that the misstatements / omissions were material in both the
financial and narrative portion
o Did defendants establish due diligence defense? if they do, they can avoid legal
liability
 Court looks at each defendant individually and used this chart to determine
if defendants could escape liability. Can have defense on one side and not
the other (expertise and non-expertise)
Section 11 of 1933 Act: Fraud in Registration Statement
- Serves DETERRENCE function
- Reaches material misstatements or omissions in the registration statement
- Sec. 12  material misstatements / omissions OUTSIDE registration statement
- Section 11 and 12 create EXPRESS private rights of actions.

Securities Act of 1933, Section 12  covers outside of a registration statement

(Like Section 11, Express Private Rights of Action)

Anti-Fraud #2-
Securities Exchange Act 1934: Section 10(b)  Cause of Action
It shall be unlawful for any person to use or employ (in connection with the purchase or
sale of any security) any manipulative or deceptive device or contrivance in contravention
of the rules and regulations of the Securities and Exchange Commission.
*Most widely used anti-fraud provision
-Defective corporate disclosure
-Insider Trading
-Fraud in dealings with broker-dealers and customers
*IMPLIED Private Right of Action  courts have to imply standing
-Scienter (knowing state of mind)
-Reliance
-Causation
-Damages

Rule 10b-5  More specific; choose the most applicable of the 3

It shall be unlawful for any person
(a) To employ any device, scheme or artifice to defraud
(b) To make material misstatements and omissions
(c) OR to engage in any act, practice, or course of business which operates as a fraud or
deceit upon any person

Theories:
Classic Rule Against Insider Trading  10(b) and Texas Gulf
Tippees  Dirks
Misappropriation  O’Hagan

In Re Cady Roberts (SEC Case 1961, we didn’t read it)  SEC recognized common law duty
of corporate insiders to disclose inside information when dealing in securities.

SEC v. Texas Gulf (there was drilling going on with good findings. The company 1) bought
securities on the good oil news before it was released to the public and 2) lied in publicly
denying the find) 3 issues:
- Prohibition of Insider Trading: When insiders, those with access to non-public
information, have information…they have it for a purpose to do their work and make
business decisions. It was confidential when they bought the stock, so they misused the
information for personal gain.
- Standard of Materiality: test= would a reasonable investor want to know the information
in making investment decisions. Here, the information was speculative. When information
is speculative courts START with Reasonable Man Standard and then NEXT move to the
Probability Magnitude Test:
o *Weigh the probability of something happening with the magnitude of that event.
Here, the probability of a ore strike was high and the magnitude of the impact of the
company would be large. So it was material.
 - In Connection Requirement  Company says they aren’t liable because the ore strike
wasn’t in connection with purchase/sale of securities. Court disagrees, says it is enough
when there is false information if the investors can show you knew what you were putting
out was not correct and investors would rely on it.

Chiarella v. United States (Supreme Court 1980 case, we didn’t read, person in printing
business read a document he was printing and was able to figure out a corporate
transaction)  Court says no liability because Chiarella did not have a relationship of trust
with shareholders of company in whose stock he traded
- The fact the person got inside information doesn’t mean automatic liability; mere possession
is not enough.
- Only liability when there is a breach of a fiduciary duty.
- The duty to abstain arises from a relationship of trust between a corporation’s shareholders
and employees. Duty does not arise from mere possession of material inside information.

Tippee Liability Test

1) Tipper breached a fiduciary duty.
*Mere possession does NOT give rise to a duty to disclose
*Existence of breach turns on receipt of PERSONAL benefit by tipper
*Temporary insiders (like accountants) may become fiduciaries
2) Tippee knew or should have known of breach.

Dirks v. SEC (he is a broker, gets information from insider Secrist. Dirks didn’t own stock,
didn’t invest stock, but he did tell investors who traded. He also investigated on his own
and went to the newspapers. But SEC sees Dirks as law-violated, not whistle-blower. Dirks
isn’t subject to the traditional rule because he is not an insider)  Supreme Court pretty
much upholds Chiarella.
- Insider trading is not extended to someone who is a tippee. There is a test, but this fails
because the insider, Secrist, got no personal benefit. He was just trying to be a whistle-
blower, not benefit himself.
- For tippee liability, Dirks requires that the insider-tipper will benefit, directly or indirectly,
from his disclosure
- The benefit test encompasses “whether the insider receivers a direct or indirect personal
benefit from disclosure (pecuniary gain or reputational benefit that will translate into future
earnings)
- The elements of fiduciary duty and exploitation of nonpublic information also exist when an
insider makes a gift of confidential information to a trading relative or friend.

Salman v. U.S – Maher gave information to his brother Michael who gave information to
Salman (Michael’s friend and Maher’s brother in law). Salman used information for trading.
Salman was indicted because he knew or should have known that Maher breached his
fiduciary duty.
- Court rejects that the Tipper has to receive something of value in exchange for information.
- Endorses Dirks for personal benefit test  same effect if Maher had traded on the
information himself and gifted the profits. Gift of information
- How close does the family / friend relationship have to be? Unanswered here

Misappropriation
-Outsider violates 10b/10b-5 when he trades on material non-public information in breach
of a duty owed to the source of such information.
-Disclosure to source of information absolves the breach.

14(e) of 1934 Act and SEC rule 14e-3(a)

14(e): In connection with a tender offer, it shall be unlawful to make material
misstatements or omissions or engage in fraud, deception, or manipulation.
14e-3(a): ONLY APPLIES TO TENDER OFFER AND INSIDER TRADING. If a tender offer has
been commenced, it is unlawful to purchase or sell securities on the basis of material inside
information the trader knows information obtained from offeror, issuer, or any officer,
director, partner, or employee to either offeror or issuer

U.S. v. O’Hagan (O’Hagan is partner a law firm who is representing Grand Met who is making a tender
offer for Pillsbury, which is confidential. But O’Hagan began purchasing stock options in Pillsbury
and sold after public announcement)  No classic rule (you must be an insider to Pillsbury). No
tippee (no tipper affiliated with Pillsbury giving information for personal benefit.
So third theory. An outsider violates when he trades on material, non-public information by
breaching a fiduciary duty owed to the source of that information. Here, O’Hagan owed a duty
to his law firm and his client. He should have disclosed! SC accepts the misappropriation theory as
a basis for liability on the Section 10(b) counts.
 O’Hagan also challenged 14-e-3 and says it should be struck down because it doesn’t
require that someone breach a duty. Says it’s in excess of SEC’s authority. But court upholds,
deferring to SEC.
 He should have disclosed to his client and it would cure the breach of duty.

Securities Act of 1934, Section 16(b)- Short Swing Profits

-Vehicle Congress intended to go after Insider Trading…still enforced!
(But now 10b and 10b-5 are more important)
Who: Someone who is a director, officer, beneficial owner (more than 10% of
common/preferred stock of the business) of a public company regulated by the SEC
What Activity: The person (listed above) purchased and sold OR sold and purchased
securities of their own company within a six-month time frame and gained some profit.
Remedy: Disgorgement of profits

- Section 16(b)  for the purpose of preventing the unfair use of information which may have
been obtained by such beneficial owner, director, or officer by reason of his relationship
to the issuer, any profit realized by him from any purchase and sale or any sale and
purchase of any equity security of such issuer…within any period of less than six
months…shall inure to and be recoverable by the issuer… This subsection shall … not
cover any transaction where such beneficial owner was not such both at the time of the
purchase and sale or the sale and purchase of the securities involved.

Reliance Electric v. Emerson Electric (Emerson purchased 13% of Dodge in a tender offer to take
over Dodge but failed. Dodge was purchased by Reliance. So Emerson was a minority shareholder.
They wanted to unload their stock without the rule applying. So (a beneficial owner) they sold
3.24% of their stock to a unrelated part and in a SECOND transaction (different date and party) sold
the remaining 9.96%)  Court says they are only liable for the profits of the FIRST sale. A literal
reading of the rule says you are only liable if you are covered, and they weren’t covered after the first
sale.
 Note: This rule does not care at all about state of mind. Just if you qualify or not.

Indemnification- DGCL 145

- Delaware corporations have power to indemnify, grant advances, and insure covered
persons as specified.
- Covered persons: any person who becomes a party to lawsuit by reason of service as a
director, officer, employee, or agent
-Indemnification permitted (MAY)
*145(a): third party suits; expenses and judgment; acted in good faith
*145(b): derivative suits; expenses; acted in good faith
-Indemnification required (MUST)
*145(c): expenses; if defendant was successful was on the merits
-Advancements:
*145(e): Corporation MAY grant advances with written undertaking to repay if not
entitled to indemnification.
-Insurance:
*145(g): Corporation may insure covered persons against liability

Waltuch v. Conticommodity (Conti and Waltuch (employee) was engaged in fraud. Lawsuits
were settled by Conti. Waltuch was named as defendant but was dismissed. $2.2 million in
legal fees…different lawsuits though)
 Court holds first, the good faith requirement of 145(a) CANNOT be contracted around,
even though many provisions in statutes can be changed by contract/Articles of
Incorporation. Court doesn’t want to reward people for bad faith. He doesn’t get $1 million
because no good faith shown.
 Court holds that Waltuch was successful on the merits of the case, even though he was
dismissed. Not being found liable = successful. So he gets reimbursed for $1.2 million.

Proxy

Purpose: Must have certain number of people holding stock to be present (person or proxy).
But only those present can vote. Because majority won’t show, proxy must happen.
Uses: Solicit shareholder votes needed to hold meeting and take valid shareholder action
Fights: For corporate control. Incumbents want to keep control. Insurgents want to take
control.

DGCL 211(b)- Requires Annual Meeting of Shareholder for Election of Directors

DGCL 212(b)- Permits Use of Proxies

Levin v. MGM (O’Brien is incumbent; Levin is insurgent (wants to take over control). Levin
loses and sues that O’Brien’s group used excessive expenditure of corporate money…
proxies cost a lot)  Court says expenditure is fine because shareholders have a right to be
fully informed. Incumbents don’t have to step aside and let insurgents take over. They have
the right to expend corporate money. But court notes that proxy fight needs to be over
policy…not just wanting to stay in power. No illegal / unfair means used so expenditures
were fine, but limitations exist.
*Limitations  (1) proxy fight must turn on policy
- (2) Excessive amounts
- (3) Unfair / illegal
- (4) Violation of federal exchange commission rules
*When incumbents reimburse themselves.

Rosenfeld v. Fairchild Engine (Insurgent group actually wins. So the incumbents reimburse
themselves (valid policy fight) and insurgents got reimbursed because shareholders voted
that they could be)  Court upholds all reimbursements.
- Incumbents may charge firm for proxy contests and insurgents may be reimbursed IF they
win AND shareholders ratify.
- Expenses were reasonable and regarded policy
- Who can be reimbursed?
o Incumbents  because they have good faith right to defend their positions
 Policy, reasonable and proper expenses, actions were taken in best interest
of corporation (not personal power)
o Insurgents  shareholders can reimburse successful contests
 Shareholders voted unanimously to do so. (ratified)

Proxies: Regulation
 - State law on cost reimbursement
o Annual meeting of shareholders with uncontested board election: Incumbents may
charge the firm for proxy cosys
 Limits imposed by courts (4 above)
o Proxy contest: Incumbents may charge firms for proxy costs.
 Insurgents may be reimbursed if they win and if shareholders ratify
- Federal Law
o Sec. 14(a) of 1934 Act requires proxy solicitations for reporting companies must
comply with SEC rules
 SEC rules required disclosure to accompany proxy solicitation, specify form
of proxy card, require prior filing and review of proxy statement and proxy
card, prohibit false and misleading proxy solicitations
o SEC Rule 14a-8: Shareholder Proposals
 Definition  recommendation or requirement that company and/or board
take action which you intend to present at meeting of shareholders
 Company must include information in proxy statement and identify
it in form of proxy subject to procedural limitations and the right to
exclude
 Procedural limitations
 Must own $2000 or 1%
 May submit one proposal not to exceed 500 words
 Management must include unless it can meet burden of showing proposal
may be excluded for one of the reasons set forth
 Must notify shareholder and give opportunity to correct
 Must file reasons with SEC
o SEC Rule 14a-7  common carrier obligation  management must mail
shareholder materials or provide shareholder with a list of names and addresses of
other shareholders

Shareholder Inspection Rights

Ability of shareholders to obtain shareholder list or other corporate records regulated by
state law

NYBCL 1315
*Shareholder must have at least 5% of outstanding shares
*Must give 5 days demand in writing to business
*Types of records you can get are limited
*Must provide affidavit saying you’ll only use list for certain, legitimate purposes

Crane v. Anaconda (Crane is trying to take over Anaconda, but they don’t want it. They are
shareholder that wants stockholder list to reach out to shareholders directly to buy their
stocks)  Court agrees with Crane, that there is proper purpose to inform shareholders of
valuable exchange offers. Anaconda doesn’t have any reason besides trying to keep
themselves in office.

DGCL 220 (broader than NY)

*Any stockholder
*Written demand
*Request to inspect during normal business hours
*Can request shareholder list, also books and other records (but there is a higher burden of
proof for books/records than there is for shareholder lists)
Pillsbury v. Honeywell (Pillsbury is protesting Honeywell during Vietnam war. He buys
stock so he can essentially expose the company from the inside)  Court says that you need
proper purpose. Proper purpose is an economic argument, NOT politically, as is the case
here.