Download Corporations – Gabaldon – Fall 2002

Corporations
Fall 2002, Gabaldon
I.
PROFESSIONAL RESPONSIBILITY
A. Conflict of Interest – MR 1.7
1. reasonableness AND
2. clients’ informed consent
a. written? – old rule no, new rule in some jurisdictions req. written consent
3. Conflict of Interest exists if:
a. rep of one client will be directly adverse to another cleint OR
b. significant risk that representation of one or more clients will be materially
limited by lawyer’s responsibilities to another client, a former cleint, a 3p, or the
personal interest of the lawyer
4. Can represent anyway if:
a. REASONABLY belief the lawyer will be able to provide competent and diligent
representation
b. not prohibited by law
c. DOES NOT involve the assertion of a claim by one client against another in the
same litigation
d. informed consent
B. Transactions with Clients – MR 1.8
1. fair terms AND
a. Lawyer CANNOT enter an unfair / unreasonable transaction w/ client EVEN IF
the terms are fully disclosed and client consents
2. reasonable opportunity to seek independent cousel (you need to tell
them they should) AND
3. client’s informed consent
a. Presumptively UNFAIR / voidable by client – burden is on lawyer to prove
that transaction was fair
b. Malpractice? – not necessarily malpractice if trans is not in compliance w/ 1.8
(indicative but not dispositive w/r/t standard of care)
C. Representation of the Partnership – who is the client?
1. ABA – the entity is the client
2. some states – you represent the individual partners if you represent the
partnership
3. Lawyer can represent both an individual and his organization IF there is no
problem under MR 1.7
D. Duty to the organization when a constituent threatens harm – MR 1.13
1. if lawyer knows a member / partner / officer / director / employee is engaged or plans
to engage in an act that is
a. related to the representation AND
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b. violation of a legal obligation of the organization or of the law AND
c. is likely to result in substantial injury to the organization
2. lawyer should proceed as is reasonably necessary in the best interests of the
organization
3. probably means working your way up the hierarchy…
E. Unauthorized Practice
1. distinguishable from competence to advise on laws of another jurisdiction
a. can be competent to advise on the laws of a jurisdiction in which you are not
admitted
b. CANNOT go to that jurisdiction to advise UNLESS you are admitted there
2. crossing state boundaries w/ client to negotiate – most states usually tolerate
occasional intrusions
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II.
INTRO TO PRIMARY BUSINESS FORMS
A. 7 Types / 4 Factors Chart
Sole
Proprietorship (w/
ee or Lender)
General
Partnership
Limited
Partnership
Corporation
Limited Liability
Company (LLC)
Limited Liability
Partnership (LLP)
Limited Liability
Limited
Partnership
(LLLP)
Ltd Liability
Control
Taxation
Proprietor
Name &
Filing
----------
Unltd. for
proprietor
Unltd. for partners
General partners
----------
Pass-through
Unltd. for general
partners; Ltd. for
limited partners
Ltd. for
shareholders
Ltd. for members
General partners
YES
Pass-through
Board of
Directors
Members
YES
YES
2-Tier
(but Sub. S)
Pass-through
Ltd. for partners
General partners
YES
Pass-through
Ltd. for general
partners; Ltd. for
limited partners
General partners
YES
Pass-through
Pass-through
B. Classifications
1. Corporations vs Unincorporated Associations (the traditional
classification scheme)
a. Unincorp’d Assn’s – suitable for firms W/O publicly traded securities, have
become more popular as limited liability options become available
b. many older laws assume that all businesses are either general partnerships or
corporations – newer forms are analogized to one or the other
2. Closely Held vs. Publicly Held
a. problematic b/c businesses exist on a continuum, sometimes aren’t clearly one or
the other
C. 7 Types
1. Sole Proprietorship (w/ or w/o ee’s)
a. owned by a single person
b. UNLIMITED PERSONAL LIABILITY
i.
no legal distinction b/t the owner and business
c. pass-through taxation
d. no filing requirement to create
e. *** Profit-sharing TENDS to say “co-owners” – where profits are shared,
probably NOT a sole proprietorship (1914 § 7)
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2. General Partnership
a. 1914 UPA § 6 – Association of One or More Persons to carry on as Co-owners a
business for profit
b. UNLIMITED PERSONAL LIABILITY
c. “Default” Business form
i.
can be created by oral agreement, conduct (no filing req)
ii.
usually results when business starts w/ no planning
d. Dissolution
i.
1914 § 31 - dissolved AT ANY TIME by the express will of ANY ONE
partner (or by death of any partner)
ii.
1997 § 601-807 – dissociation and dissolution distinguished, any partner
can still dissociate at any time
e. pass-through taxation
3. Limited Partnership
a. composed of one or more General Partners and one or more Limited
Partners
i.
gp’s
 Unltd personal liability
 control
ii.
lp’s
 Limited Liability BUT
 Conditional on them NOT exercising control of the company
 if they do exercise control, unlimited personal liability to ANY 3P who
relied on it
b. Filing req – failure to file = GP
c. Pass through taxation
4. Corporation
a. Limited Liability for all investors and participants
b. filing requirement
c. Two-Tiered taxation
i.
income is taxed once at the corporate level and again on a personal
level
d. Closely Held vs Publicly Held – key differences
e. composed of Shareholders, Directors, Officers (one person can be all three)
5. Limited Liability Company (LLC)
a. Like a Corporation BUT easier to operate
i.
“Members” can control directly
ii.
no separation b/t directors and shareholders
iii.
none of the formality req’s of a corp
b. Filing req
c. pass through taxation
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i.
the newest business form
6. Limited Liability Partnership (LLP)
a. Limited Personal Liability
i.
like a GP, but partners have NO PERSONAL LIABILITY for firm
obligations exceeding the assets of the partnership
7. Limited Liability Limited Partnership (LLLP)
a. variation on the LP, not very popular
b. No personal liability for the General Partners, still no personal liability for the
Limited Partners
c. passthrough taxation
d. filing req
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III. INTRO TO AGENCY LAW
A. Definitions
1. Agency
a. Rest 1.01 – fiduciary relationship
i.
Principal manifests consent to Agent that A shall act on P’s behalf and
subject to P’s control, and A consents to so act
b. Rest 1.02 – parties’ labelling of the relationship irrelevant
c. Rest 1.03 – manifestation of consent to Agency relationship through written, oral,
conduct
d. Consensual arrangement – can be terminated by either party at ANY TIME by
giving notice to the other party (regardless of any agreement b/t them) (Rest 3.09)
i.
Apparent Authority does not automatically terminate thereby
2. Agent
a. one who acts on behalf of the principal
3. Principal
a. he who exercises control over the agent, on whose behalf the agent acts
4. Servant / EE
a. Agent subject to PHYSICAL CONTROL by the master
i.
how much control – “central to the job”
ii.
ex – Gabaldon is an employee, even though GWLaw doesn’t tell her what
to teach or how to teach it (only where and when)
5. Independent Contractor
a. may or may not be an agent
b. contracts w/ another to do something, but IS NOT subject to Physical Control in
performance of the undertaking
B. Types of Authority
1. Actual
a. exists if A REASONABLY BELIEVES that P wished A to so act (Rest 2.01)
i.
Scope (Rest 2.02)
 acts or types of acts designated by the P, as the A reasonably
understands them
 includes acts necessary and incidental to achieving P’s objectives
b. created
i.
by Manifestations of the P to the A (oral, written, conduct if P is on
notice that conduct will be so interpreted)
c. Termination (Rest 3.09)
i.
P revokes A’s authority by giving A notice
ii.
notwithstanding any agreement b/t them – CAN ALWAYS revoke
authority
iii.
doesn’t automatically terminate apparent authority
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2. Apparent
a. power of A to impact P’s legal relations w/ 3p based on 3p’s REASONABLE
BELIEF that A has actual authority to act for P (Rest 2.03)
b. created (Rest 2.03)
i.
by Manifestations from P to 3P
 NOT from A’s manifestations to 3P
 Agents cannot create their own apparent authority!!!!
ii.
by the position of A in a company / organization and 3p’s reasonable
beliefs about what that position entails
c. terminated (Rest 3.10)
i.
when it is no longer reasonable for 3p to believe A has authority
 ex – P calls 3p and tells him “we fired A”
3. Inherent
a. arises by implication from other Actual or Apparent authority, including by
the position A holds
i.
ex – manager of a store has inherent authority to set price of goods. So,
Boss is bound to Customer by Mgr’s markdown EVEN IF Mgr was expressly
told by Boss “don’t mark anything down” (no actual authority) and Boss said
nothing to Customer (no apparent authority)
4. Incidental
a. authority to do incidental acts relating to the transaction authorized
5. Implied Authority
a. ALL authority may be created express or implied
i.
can be created by implication from prior course of conduct by the P
ii.
can be implied by the A, creating Actual Auth OR implied by 3p, creating
Apparent Auth
C. Types of Principals (Rest 1.04)
1. Disclosed
a. when A and 3p interact, 3p has NOTICE that the Agent is acting on behalf of
P, AND has NOTICE of P’s identity
b. Notice = knew, had reason to know, should’ve known
2. Partially Disclosed
a. 3p had NOTICE that A was acting on behalf of a P, but no notice of P’s identity
3. Undisclosed
a. 3p had NO NOTICE that A was acting on behalf of a P when 3p and A interacted
i.
ie – A appeared to be acting on his own behalf
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D. Ramifications of Agency Law – Creation of Liability
1. When is the Principal liable to 3p?
a. K liability
i.
when the K was authorized (A had ANY form of authority – actual,
apparent, inherent, incidental, implied)
b. Tort
P intends the Agent’s actions or consequences thereof – P is therefor
an independent tortfeasor
 ex – “Louie, break his legs”
 IC or EE is irrelevant
ii.
P is negligent in hiring, instructing etc.
 IC or EE is irrelevant
iii.
authorized but unintended (but instructions not negligently given)
 ex – P is giving instructions to A, phone cuts out at crucial time w/o P’s
knowledge, A follows instructions (minus the crucial part) and causes
harm
 P is liable, regardless of EE or IC
iv.
respondiat superieur (Rest 2.04)
 Employer is responsible for torts of their EMPLOYEES while acting
IN THE SCOPE of their employment
 n/a to Independent Contractors – generally, P is not responsible for
torts of an IC
i.
2. When is the Agent liable for acts taken on behalf of P?
a. K
i.


ii.
iii.


disclosed principal – NO, A not liable
ex – you can’t sue the clerk at Barnes & Noble personally b/c you know
they’re acting on behalf of the company (P)
Reasonable person standard applies to determination of whether
someone is acting as an agent, who the principal is, etc
partially disclosed – YES, A is liable
ex – securities brokers may line up a seller or sell the house’s own shares,
Buyer thus knows that there’s a P involved but doesn’t know who
undisclosed – YES, A is liable
ex – Disney trying to assemble vast tracts in NoVa to build American
Heritage park, don’t want to reveal who’s buying. If they back out of the
K, is A liable? YES (P is liable as well)
b. Tort
i.
agents are always responsible for their own torts
3. When is 3p liable to P?
a. K
i.
YES - 3p IS LIABLE UNLESS
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 undisclosed principal AND
 K is of a type that would be non-assignable
b. Tort
i.
YES, if 3p commits a tort and damage to P was forseeable, 3p is liable
(no special agency rules apply)
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IV. PARTNERSHIPS
A. Usefulness / Utility of a Writing
1. could be necessary for Statute of Frauds
2. avoid future disagreements, helpful in court, identifying trouble spots, plans for death
or retirement
3. NOT MANDATORY
B. Allocation of proficts or losses (distinguish liability to 3ps)
1. Subject to Agreement
2. Default Rules (1914 § 18, 1997 § 401)
a. profits shared equally
i.
all partners share equally in profits after expenses are paid (including
those due to partners) (18(a))
b. losses follow profits
i.
all partners must contribute to losses according to share of the profits
(18(a))
c. no remuneration for services to p’ship (18(f))
d. p’s are entitled to indemnification (18(b))
i.
partnership must indemnify partners w/r/t payments made and personal
liabilities incurred by him in the ordinary course of business for the
preservation of the business and its property
ii.
includes overpayment (more than share owed) paid by any partner on a
loss, capital loss, etc.
e. contribute to losses INCLUDING those of the contributed capital (18(a))
i.
according to share of the profits
f. proportionate sharing if one or more partners is insolvent (40(d))
i.
partners will contribute in relative proportion to their profit shares the
additional amount owed by an insolvent partner
ii.
ex – A 60%, B 20%, C 20%, $8,000 loss, C is insolvent
 A&B are j&s liable in tort, j in K, C would have to indemnify if he ever
got $ again
 A = 6 / 8 = 75%
 B = 2 / 8 = 25%
 C’s share of the loss is 20% of 8000 = 1,600
 A pays his $4800 share + 75% of C’s 1,600 share (additional $1,200)
 B pays his $1600 share + 25% of C’s $1600 share (additional $400)
iii.
rule is for dissolution only, applied before dissolution b/c no other
practicable way to do it
g. ranking distributions on liabilities of the partnership (40(b))
i.
owed to creditors OTHER than partners
ii.
owed to partners OTHER than for capital or profits
iii.
owed to partners for capital
iv.
owed to partners for profits
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v.
Richert v. Handley – losses include losses of capital contributed by
partners, are liabilities to be repaid BEFORE dividing profits – Generally, you
figure out how much $ the company is short and then divide it equally (case
involved failed timber venture); no renumeration unless agreed on by parties
C. Liability of partners to 3ps for acts of the Partnership
1. UPA 1914
a. tort – joint and several (15(a))
i.
ii.
IF act is w/in regular course of business OR w/ the authority of co-partners
INDEMNIFICATION under 18(b) + interest under 18(c) if one partner
pays entire jment in a tort suit (gets proportional share from others)
b. K – joint (15(b))
i.
revised UPA and most states make this j&s as well
2. UPA 1997
a. tort & K – both joint and several liability (306)
i.
all partners are J&S liable for obligations of the p’ship
3. Effect of filing an LLP election (*see IV E 3)
D. Law Firm Partnerships
1. Types of partners, effect on liability and obligations to contribute
a. 2 Level P’ship – Income Partners and Equity Partners (they put in cash)
b. Staff Atty / Of Counsel – more like ee, not partners
2. points worth generalizing
a. fiduciary duties terminate w/ the p’ship
b. Business Judgment Rule (BJR) (*see also Corporate BJR)
i.
applies in case of negligence or alleged negligence, NOT selfdealing/loyalty issues
c. duty to beneficiary may affect conclusions about possibility of duties to others
(*see corporate similarities)
E. LLPs
1. History
a. grows out of Texas problems w/ malpractice and negligence claims against law
firms following S&L failures
i.
invented by law firms to protect their partners
2. Narrow v. Broad approaches
a. Texas – narrow (limited liability only for tort claims)
i.
ii.
iii.
limits liability only for negligence or malpractice
personal liability for K liabilities, etc.
didn’t cover obligations of partners to indemnify other partners or to
contribute to assets on winding up
iv.
personal liability on those who supervised those who committed the
negligence or malpractice
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b. 1997 UPA – broad (limited liability for both tort and K claims)
i.
no personal liability of partners for K or tort or other obligations of the
p’ship, by contribution or otherwise (306(c))
 partners will still be personally liable for THEIR OWN TORTS (their own
malpractice, fraud, or negligence in representation)
3. Effect of LLP election
a. Liability to 3p’s
i.
Partners are not personally responsible for any obligation of the
p’ship incurred while it is an LLP (306(c))
b. contribution / indemnification
i.
no personal liability for contribution to capital losses or other losses
either (in the broad shield statutes)
 right to contribution for payments made on behalf of the p’ship (401)
 duty to contribute to partners losses, incuding capital losses
4. notice to 3p NOT req’d except for the name inclusion requirement
a. ex – Hamner, Vaughan, and Franker, LLP
5. Miscellany
a. *see various corporate law doctrines, including piercing the corporate veil
i.
p61 N9 – many believe the LLP “shield” is more porous than the corp veil
b/c of problems w/ multi-state practice, is new p’ship created whenever
anyone enters or leaves the firm, etc.
6. Recognition state-to-state
a. Art 11 (1997 UPA)
i.
need “Statement of Foreign Qualification”
ii.
LLP is governed by the law of the state in which it is formed – governs
relations b/t partners and liability of the partners for obligations of the p’ship
b. unclear / not universally accepted – see p 62 N9
F. Management / Ability to Bind the Partnership
1. §§ 9, 18 of 1914 UPA
a. § 9 Partner Agent of P’ship as to P’ship Business
i.
(1) Every Partner is an Agent of the P’ship
 acts apparently in the ordinary course of the p’ship business bind the
p’ship UNLESS the Partner has NO AUTHORITY and the 3p knows
that
ii.
(2) P’ship NOT BOUND if act is not apparently for the carrying on of the
business of the p’ship in the usual way
b. § 18 Rules Determining Rights and duties of Partners
i.
SUBJECT TO AGREEMENT
ii.
(e) All partners have EQUAL RIGHTS in the mgmt and conduct of
the p’ship business
iii.
(h) differences in ordinary course of business – Majority of Partners
 unanimous consent to do any act in contravention of agmt b/t the Partners
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2. actual / inherent authority
a. by agreement
i.
can be agreed to by the parties amongst themselves
 IS RELEVANT to liability to 3ps BUT ONLY if the 3p knows about the
restriction in the agreement
b. default rules
i.
equal rights
ii.
majority rule
 in absence of “voting shares” agreement, count noses (not
profit percentages)
 differences decided by the majority
 if p has specifically agreed not to do something, can’t act in contravention
of that – not binding to a 3p that knows of the restriction on authority
(9(4))
iii.
w/in usual course of p’ship business
 burden on  to show Agent’s authority in order to enforce
against the Principal
c. Nabisco v. Strand – one member may not unilaterally restrict the actual
authority of another partner absent an express written provision in the
p’ship agmt – Freeman and Stroud have a GP food store, Stroud tells Nabisco he
“will not be responsible for any bread ordered” (no apparent authority), Freeman
orders bread anyway, Stroud is liable for his share of the costs. Freeman has
Actual Authority b/c it’s in the ordinary course of business, Stroud is not a
“majority” so he can’t take away Freeman’s power.
3. apparent / inherent (remember effect of past practice in creating
apparent authority)
a. Smith v. Dixon – need only Apparent Auth OR Actual Auth, not both Managing Smith is instructed by Family of Smiths (they have a GP farm
business) not to sell below $225K, he sells for $200K. Smiths are bound – he had
no Actual Authority (he’s not a majority of the family), but he does have
Apparent Authority (Dixon had no way of knowing what the bottom line was).
b. Terminating Apparent Auth (Cf 9(1))
i.
P’ship must give notice to the Partner of termination of the authority AND
ii.
3p must have notice that authority no longer exists
c. Look to:
i.
Scope of P’ship Business
ii.
Prior Practice of the Partnership
 remember – P’ship creates the authority (by acquiescing, etc), NOT the
individual partner
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4. effect of statement of p’ship authority under 1997 UPA
a. 1997 § 303
P’ship may file a statement of p’ship authority that can place limits on
authoriy of some / all the partners to bind the pship
 P’ship is bound by the Grant of Auth in a filing in favor of a person
who gives value w/o knowledge to the contrary
 NO CONSTRUCTIVE NOTICE - person not a partner is NOT
DEEMED TO KNOW of the limitation merely b/c it is on file in the
statement
ii.
Different rules for real property
 if filing precludes the transfer, constructive knowledge (even if the 3p
doesn’t check the filing)
b. How it plays out
i.
i.
If 3p checks the filing
 No Filing – back to 1914 version search for Apparent authority / Actual
Authority (look at scope of p’ship business, past practices of the p’ship,
inherent authority)
 Filing Permits – P’ship will be BOUND by the grant of authority in the
filing
 Filing Precludes – 3p is now on notice of a potential problem
 *** this helps 3p avoid litigation in the future (no real reason to look
if you expect litigation or don’t care)
ii.
If 3p DOESN’T check the filing:
 No Filing – back to 1914 version search for Apparent Authority / Actual
Authority (look at scope of p’ship business, past practices of the p’ship,
inherent authority)
 Filing Permits – P’ship is STILL BOUND CONCLUSIVELY (303 has no
requirement of reliance)
 Filing Precludes – no constructive knowledge or presumption, so back
to 1914 version search for Apparent Authority
5. Importance of Scope of the p’ship business (Rouse and Roach cases)
a. burden of proof on  (3p) to prove what’s w/in scope of the
business
b. creative argumentation in Roach
i.
looked at negligence in counselling a client receiving a loan NOT at
liability for partners act w/in the ordinary scope of the business
c. estoppel / past practice (silence can equal assent to expand scope)
i.
must be practice / assent of the FIRM, not the individual partner (agents
cannot create their own authority)
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d. Rouse v. Pollard – Partner gets Ms. Rouse’s $, invests it fraudulently. His Law
Partners are NOT LIABLE b/c it wasn’t part of the “usual business” for a
law firm, Agents can’t create their own authority (might be different if all the
Partners had known and done nothing – might’ve created Actual / Apparent
authority by implication) – problem = how is Ms Rouse supposed to know what
law firms “usually do” when she can’t rely on the individual assertions of the
partners?
e. Roach v. Mead -  asked lawyer what to do w/ proceeds of a business sale lawyer
had assisted him with and lawyer said “give it to me, I’ll pay 15%”. Seeks
repayment from the law firm when lawyer goes broke. Law firm is found liable
BECAUSE  loaned the $ to lawyer AND expected the sound legal advice a
lender would usually get from his lawyer = NEGLICENCE for not giving
appropriate advice in connection w/ a loan (not because taking loans from clients
is w/in scope of p’ship business)
6. Liability of New Partners for Prior Bad Acts (17)
a. New Partners are liable for prior bad acts of existing partners BUT only to the
extent of their capital contribution (17)
i.
1997 306(b) – no personal liability for p’ship obligations incurred prior to
admission as a partner (SAME THING – intended to keep the 1914 scheme)
G. Duties of Partners to each other
1. Meinhard v. Salmon – Duty to Notify / Finest Loyalty
a. standard stated – punctilio of honor the most sensitive, finest loyalty
b. minimum necessary (maybe not sufficient) = NOTICE to other partners
i.
notify your Partner(s) that the proposition has been placed before you
so the P’ship has a chance to compete
c. importance of scope of the partnership, including scope in time and
geography
i.
dissent in Mv.S says their p’ship didn’t extend beyond the original
lease, so no duty
ii.
if the opportunity was somewhere far away, might be different duty
owed
d. Meinhard v. Salmon – M and S have a joint venture (partnership of limited
purpose that ends when the purpose is completed) to exploit lease of Bristol
property, near end of the term the lessor goes to S and suggests renewal plus
adjoining properties. S accepts behind M’s back, M sues – M wins and gets the
joint venture continued b/c S failed to live up to standard of conduct required of
partners
2. 1914 UPA § 21 Partner Accountable as Fiduciary
a. (1) Every Partner must account to the partnership for any benefit, and hold as
trustee for it any profits derived by him w/o the consent of the other partnersss
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from any transaction connected w/ the formation, conduct or liquidation of the
p’ship or from any use by him of its property
b. not regarded as altering Meinhard v. Salmon standard – may require more
i.
ex – would 21 mandate S do more than tell M about the offer? YES –
he used p’ship assets to attract the business, so he would have to share
c. majority position is that you cannot modify this by agreement
3. 1997 UPA § 404, 103(3-5)
a. 404 – only fiduciary duties a partner owes to the p’ship and th eother partners are
the duty of loyalty and duty of care set forth in subsections b & c.
i.
(b) – Duty of Loyalty
 account to the p’ship and hold as trustee for it any property, profit, or
benefit derived by the partner in the conduct and winding up of the
p’ship business or derived from a use by the partner of p’ship
property, including the appropriation by a partner of a partnership
opportunity
 refrain from dealing w/ the p’ship in the coduct or winding up as or on
behalf of a party having an adverse interest to the p’ship
 refrain from competing w/ the p’ship in the coduct of the p’ship business
before the dissolution of the p’ship
ii.
(c) – Duty of Care
 limited to refraining from engaging in grossly negligent or reckless
conduct, intentional misconduct, or a knowing violation of the law
(e) – no violation of the duty of care / loyalty merely b/c the partner’s
conduct further’s his own interst
b. 103(3, 4) – partners CANNOT eliminate the duty of loyalty / care in the
partnership agreement
i.
can identify specific types of activities that do not violate the duty of
loyalty (so long as not manifestly unreasonable)
ii.
cannot unreasonably reduce the duty of care
c. disclaims anything beyond the statute, including the flowery language of
Meinhard v. Salmon
i.
MERELY GIVING NOTICE TO THE OTHER PARTNERS
WOULD NOT BE ENOUGH!!!
iii.
4. no application if it’s a loss (not symmettrical)
a. Ex - S borrows $1000 from the partnership and
i.
bets on a winning horse – M gets 1/2 the profits
ii.
incurs a debt to a loan shark – M doesn’t share the loss b/c loans w/
gangsters aren’t w/in scope of p’ship business
H. Partnership Property
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1. distinguish partnership property from individual partners’ interest
in the p’ship
a. 24 – Extent of Property Rights of a Partner – Tripartite Scheme
i.
ii.
iii.
rights in specific partnership property
interest in the p’ship
right to participate in mgmt of the p’ship
b. 25 – Nature of a Partner’s Right in Specific P’ship Property
i.



“Tenancy in Partnership” – co-holding of property w/ his partners
equal right to possession for partnership purposes, no right to posession
for other purposes w/o consent of the other partners
not assignable / severable (except in connection w/ assignment of right of
all the partners in the same property)
partner’s right in specific p’ship property is not subject to attachemnt or
execution except on a claim against the p’ship
at death, interest in specific p’ship property vests in the surviving partners
not subject to dower, courtesy, allowances to widows heirs or next of kin


c. 26 – Nature of Partner’s Interest in the Partnership
i.
his share in the profits and surplus
ii.
same as personal property
d. 27 – Assignment of Partner’s Interest in the P’ship (Profit only)
i.
Assignee DOES NOT get right to manage, call for accounting, get
information on the business
 Assignee gets right to profits the Assigning Partner would’ve received
 Assignee DOES NOT have to share losses
ii.
does not dissolve the p’ship
2. rights of creditors of individual partners
a. charging order
i.
28 – Partner’s interest in P’ship subject to Charging Order
 interest of the partner can be put into receivership to pay off an
outstanding judgement against that partner
 charging order can be foreclosed on and sold
 ex – A’s spouse wants child support, asks Ct for charging order
 Charging Order tells Partnership to pay A’s share of profits to Spouse
 if forcclosed on, Spouse gets proceeds of the sale, Buyer gets the
stream of income in the future from A’s interest
b. foreclosure
i.
charging order can be foreclosed on and partner’s interest in the p’ship
sold
c. NOT mgmt of the partnership
i.
ii.
no right to manage or to bind the partnership can be transferred (see 27)
32 – Dissolution
17
 assignee can call for dissolution after the specified term / end of the
undertaking OR
 at any time if the p’ship was “at will” when assignment was made /
charging order made
3. rights of partnership creditors
a. 1914 40(h & I)
i.
ii.
partnership creditors have priority with regard to p’ship property
individual creditors have priority with regard to individual property of the
partners
b. Fed B.R. Rules preempt in most cases
partnership creditors have PRIORITY for p’ship property
partnership creditors have PARITY with individual creditors for
individual property
iii.
1997 UPA gives no priority rules in deference to this
i.
ii.
4. Differences b/t 1914 and 1997
a. 1997 § 501-504, 203-4, 302
b. Partnership as an ENTITY holds property (203)
i.
no “tenancy in partnership”
c. No contention that management is a property right
d. no priority rules for partnership creditors, b/c Fed BR Rules pre-empt in most
cases
I. Partnership Accounting
1. Balance Sheet
a. *** Assets – Liability = Equity ***
b. “Snapshot” of partnership’s business at a moment in time
i.
date specific
ii.
must ALWAYS balance
c. Equity is the ownership interest of the investors
i.
Ownership / Net Worth
Assets
measly bank acct
personal property
Liabilities
$1000
$4000
-----------$5000
Debt
$100,000
Equity / Net Worth
<$95,000>
------------$5000
2. Income Statement / Statement of Profit and Loss
a. *** Revenue – Expenses = Profit or Loss ***
b. represents profits or losses from operations
i.
quaterly or annually, period specific
18
3. Historical Cost Basis (rather than FMV)
a. original value of assets (ex – prices they were purchased for) W/O subsequent
adjustment for variations over time
i.
NOT value the assets would bring if liquidated
b. BUT include periodic annual charge for depreciation of assets
4. Depreciation
a. an expense represented on Income Statement / in value of item on Asset side on
Balance Sheet
5. relationship of financial statements to valuation of the enterprise
a. book value  fair market value (usually)
b. “Book Value” = Equity = $150,000
c. FMV has to do with rate of return on similar investments, amt of risk
Assets
Cash
$20,000
Accounts Receivable
$80,000
Inventory
$100,000
Fixtures (net of depreciation)
$40,000
Truck (net of deptreciation)
$10,000
-----------$250,000
Liabilities
Accounts Payable
Notes Payable to A
$70,000
$30,000
Equity
Partner’s Capital
$150,000
------------$250,000
6. Partner’s capital accounts
a. sum of contributions, minus withdrawls, and plus or minus profit / loss
b. equals equity portion on balance sheet (Equity = Assets – Liabilities)
c. Note: Partner B may wish to w/draw some amt of money (say $10,000) – A may
object b/c the company doesn’t have a lot of cash, but B has a right to do so
anyway
Opening
Partner A
Partner B
$100,000
0
Income for
Year
$25,000
$25,000
Drawing for
Year
0
0
Closing
$125,000
$25,000
------------$150,000
J. Partnership Dissolution
1. vocabulary
a. dissolution
i.
29 – Dissolution Defined
 change in relation caused by any partner leaving the p’ship
19
ii.
iii.
30 – Partnership NOT terminated by Dissolution
 continues until the winding up of partnership affairs is completed
31 – Causes of Dissolution
 W/o violation of the agreement b/t the partners




 by termination of the definite time or particular undertaking
 by express will of any partner when no definite time is specified
 by express will of all partners who’s interests have not been assigned
 by the expulsion of any partner in bona fide accord w/ the p’ship agmt
In contravention of the agmt b/t the partners
 where circumstances don’t permit a dissolution under any other
provision of the section
 by express will of any partner at any time
by the death of any partner
by the bankruptcy of any partner or the p’ship
by decree of Ct under 32
b. winding up
30 – p’ship is not terminated until it is wound up
partners have similar rights and duties as during normal course of the
p’ship business
iii.
settling of claims, resolving issues, distributing property, liquidation of
property, application of property
i.
ii.
c. termination
i.
the p’ship ceases to exist
d. liquidation
i.
selling off assets to get cash to settle claims, pay off debts
e. application of property
i.
like liquidation, done during winding up
2. power vs. right to dissolve
a. ALWAYS have power to dissolve a p’ship, even if you don’t have
the right
i.
ii.
P’ship is consensual
may have to pay K damages for violating the p’ship agreement
iii.
Right to dissolve exists in AT-WILL p’ships
b. Collins v. Lewis – L and C have a p’ship for a term of years (30 yr term of their
lease). C seeks to have the court dissolve the p’ship before the 30 yrs are up b/c L
breached the p’ship agmt by failing to make the cafeteria profitable. Ct finds
instead the C is the one who breached the p’ship agmt – SO – under “Unclean
Hands” doctrine, C cannot get an equitable remedy like dissolution from the court
20
b/c he’s in breach. (Note that L could get dissolution, but if he got it he’d have to
pay back C’s initial investment as an equal share in losses, so he would never ask)
c. (32) doesn’t specifiy any different result for Collins v. Lewis - doesn’t address
unclean hands problem
3. dissolution is not wrongful if
a. at-will partnership 31(1)(b)
i.
no specified term or particular undertaking
b. provided for by agreement
c. ordered by a court on behalf of a non-breaching partner
i.
(32) – Dissolution by Decree of Court
 shall decree dissolution whenever:
 partner is a lunatic
 partner becomes incapable of performing his part of the p’ship agmt
 partner guilty of such conduct as tends to affect prejudicially the
carrying on of the business
 partner willfully or persistently commits breaches of the p’ship agmt
(or otherwise behaves such that it is not reasonably practicable to carry
on the business in p’ship w/ him)
 business of the p’ship can only be carried on at a loss
 other circumstances render a dissolution EQUITABLE
4. consequences of dissolution
a. default rules § 38, 42
i.
§ 38 – Right of Partners to Application of P’ship Property
 election of ANY PARTNER to allow business to continue OR force
application of property to pay p’ship liabilities and then divide the
remaining assets
 when dissolution is NOT caused in contravention of the p’ship agmt.
ii.
§ 42 – if business is continued, dissolving partner may elect
b/t having his interest paid out or a having a future profit
share based on amt. of the “conceptual loan” of his interest
(FMV, not book value)
 Hindsight Election
 Share of Profits is determined b/t date of dissolution until the $ is paid
 Dissolving partner can thus wait around and see in hindsight whether
it’s better to get profits or pay out of interest as of date of dissolution
(gives incentive to pay the estate PROMPTLY)
iii.
Cauble v. Handler – estate of deceased partner Cauble allows the business
to continue after his death (they are 50/50 partners), sues for amount owed.
Amts should be based on FMV, not book value of the p’ship. If business
continues, estate has right to share of profits. The P’ship should pay costs of
an accounting.
21
iv.
v.
(41) – Rights of Persons Continuing the Business
 creditors of dissolved p’ship are creditors of continuing
business
8182 MD Association, LP v. Sheehan – partnership, including Sheehan
sign a lease, Sheehan leaves the firm, other partners join, occupancy begins,
other partners leave, partnership breaches the lease dissolves and becomes
judgment proof. Sheehan signed the lease himself, so privity of K says he’s
bound (same if someone else signed for p’ship on his behalf). The newer
partners are liable b/c of “privity of estate” – the old p’ship dissolved when
Sheehan left BUT assigned it’s lease to the new p’ship (Ct implies assignemnt
b/c the new p’ship paid rent and occupied the building) (NOTE that even w/
an LLP election, they’d only be off the hook if the real estate agent didn’t
ask for personal guarantees AND they made the election prior to signing
the lease)
b. agreement – can agree to the consequences of dissolution in the
p’ship agreement
i.
freedom of K
 usual ways of “cashing out” are fixed sum, book value, future earnings %,
appraisal, capitalization of earnings
ii.
UNLESS
 duress
 unconscionability
 public policy (including client freedom of choice w/r/t lawyers)
 Cts will not enforce law firm p’ship agmts that prohibit partners from
competing w/ the firm (client choice issue)
iii.
Adams v. Jarvis – one doctor retires from a medical partnership agreement
w/ 2 other doctors. Ct says (1) p’ship agreement cannot literally stop
dissolution from happening BUT (2) can agree to what consequences
dissolution will have – here this means he gets no share of accounts receivable
5. Liability of retiring partner § 35 & 36
a. Retiring Partners need to make sure creditors know about the dissolution +
publish notice of dissolution in newspaper (to take care of unknown future
creditors)
i.
terminate Actual and Apparent authority by both dissolving AND giving
notice to creditors
 thus, the other Partners can’t bind the “p’ship”, making retired partner
liable
b. 35 – Power of Partner to Bind P’ship to 3ps after Dissolution
i.
Partner CAN bind:
 by any act part of winding-up
 by any ordinary transaction (same as if no dissolution) IF 3p:
22
 had extended credit to p’ship prior to dissolution AND had no
knowledge or the dissolution OR
 had never extended credit before BUT knew of the p’ship before
dissolution AND had not knowledge of dissolution AND no notice
of dissolution printed in a newspaper of general circulation at
place(s) where p’ship business carried on
ii.
“Silent Partner” liability for after-dissolution deals is satisfied ONLY
from p’ship property (no personal liability ) IF
 that partner was unknown as a partner to 3p when the deal was made AND
 Silent Partner = so inactive that business reputation not dependent or
involved w/ that partner
c. 36 – Effect of Dissolution on Partner’s Existing Liability
i.
dissolution does NOT discharge the existing liability of any
partner
ii.
Partner MAY BE DISCHARGED BY AGREEMENT b/t himself, the
creditor and the person or p’ship continuing the business
 such agmt can be INFERRED by course of dealing b/t creditor having
knowledge of the dissolution and the person / p’ship continuing the
business
 ex – if Creditor knows Partner has retired, and continues to deal w/
successor corporation, Partner is released from his pre-retirement
obligations to Creditor
6. Partners conduct in anticipation of dissolution
a. owe fiduciary duty still
i.
minimum = requirement of full and fair information to the remaining
partners
 OK = preparing to compete
 renting space, preparing letterhead
 BAD = lying about plans to leave, not disclosing which clients you
plan to take w/ you
 ee’s who leave will also be liable b/c fiduciaries of their employer (if
they steal clients)
ii.
burden is on departing parties to establish that what they did IS FAIR
b. Meehan v. Shaughnessy – 3 partners in a law firm are big rainmakers and want to
leave and form their own firm. P’ship agmt says “continues indefinitely” so AT
WILL p’ship, leaving is not itself a breach. Prior to leaving, prep client list and
deny several times that they are going to leave. When it comes out that they’re
leaving, they contact the clients but resist giving list to the firm. P’ship agreement
provides for a “fair charge” to be paid for any client you take with you
(preserving client choice so not void against pub policy). Ct forces them to
disgorge all profits made representing those they took unfairly.
23
7. Expulsion by K
a. opportunity to provide by K for what the consequences will be
can ALWAYS expel someone (power to dissolve the p’ship), regardless of
agmt – question is whether its wrongful or not
ii.
(31(1)d ) – dissolution is NOT WRONGFUL if it is by the expulsion of
any partner from the business bona fide in accordance w/ such a power
conferred by the agmt b/t the partners
iii.
Gelder Medical Group v. Webber – Partner in a medical group is expelled
for having a bad personality, covenant in the p’ship agmt says if you’re
expelled you can’t compete w/in 30 miles of the town. Ct says “freedom of
K” – he agreed to it, so he’s bound (*** not same for lawyers)
i.
b. Standard for exercising right to expel
i.
expulsion for self-gain is prohibited
 “bona fide” - can expel for good reason or no reason but not for bad
reason (s/a refusal to violate a law, race, unfair financial gain of the p’ship
s/a day before big contingency fee comes in, etc.)
ii.
otherwise, broad right to expel w/o it being wrongful
iii.
Bohatch v. Butler & Binion - New Partner at a firm suspects overbilling
by older partner, reports to the firm mgmt. Client says “no overbilling”,
matter ceases, firm expells New Partner. She sues for wrongful expulsion.
Majority says can expel whenever for any reason, fundamental schism created
by accusations, practical difficulty of maintaining a p’ship w/ someone you
hate. Concurrence says you can discharge someone for bad jment, which she
apparently used here (b/c she was wrong in how she handled it). Dissent
says bad public policy to allow discharge of whistleblowers.
8. Differences b/t 1914 and 1997 UPA w/r/t dissolution
a. Vocabulary
1914 “dissolution” becomes 1997 “dissociation”
 meaning – one or more partners drop out
ii.
1997 “dissolution” means “termination” or what occurs when the business
is to be discontinued and its affairs wound up
i.
b. No more Profit Elections (as in Cauble v. Handler)
701(a, b) – if partner dissociates but business does not dissolve, that
partner’s interest in the p’ship is to be purchased for a buyout price
determined according to (b)
ii.
1914 allowed outgoing partners to choose b/t “buyout” and continued
profit share
i.
c. Public Statement of Dissolution / Dissociation
i.
terminates lingering apparent authority
 replaces newspaper notice in 1914
ii.
805 – Statement of Dissolution – filed publicly
24
 90 days after filing, everyone is on Constructive Notice that there is no
more p’ship (therefore former partners can NO LONGER bind the p’ship,
b/c all 3ps are deemed to know there’s no authority)
iii.
704 – Statement of Dissociation
 90 days after filing, everyone is on Constructive Notice that Dissociated
Partner is no longer a Partner
 thus, no longer bound (can’t be liable for subsequent p’ship acts)
K. Inadvertant Partnership
1. In Fact or Actual
a. Defined in 6
i.
ii.
Association of 2 or more people to carry on as co-owners a business for
profit
 says NOTHING about intent, planning, etc.
look at substance of the relationship NOT LABELS
b. Profit Sharing as Prima Facie Evidence of P’ship - 7
i.
ii.
(7(4)) – receipt of a share of the profits (*** NOT the same as sharing
gross returns) of a business is prima facie evidence that he is a partner in the
business UNLESS the profits were received in payment
 as a debt by installments or otherwise
 as wages to an ee or rent to a landlord
 as an annuity to a widow or representative of deceased partner
 as interest on a loan
Entitlement
 Smith v. Kelly suggests that its ENTITLEMENT to profits that’s relevant,
not merely receiving them
iii.
Martin v. Peyton - ∆s did not intend to be partners, expressly said so in
their agreement. Ct looks at whether the money they put in was really a loan,
says YES, everything they did was consistent w/ prudent lender’s actions. No
power to bind, no power to manage, Yes info re/ books, Yes veto power,
option to become p’s at any time, retained security interest
c. Indicia of Co-owners
i.
negative v. positive powers
 positive powers (right to manage, ability to bind the p’ship) 
OWNERSHIP
 negative powers (veto power)  not ownership (prudent lender)
ii.
iii.
Co-ownership v. loan $ to the p’ship
Profit Sharing v. Gross Return Sharing
25
 profit sharing  OWNERSHIP
 gross return sharing  not ownership
iv.
Other Factors
 agreements to share losses  OWNERSHIP
 extent to which profit share constitutes the recipients ONLY remuneration
from the business  OWNERSHIP
 characterization by the partners – more influential when dispute involves
only the partners themselves
d. Role of Partners Intent – NOT DETERMINATIVE
i.
litigation by 3ps
 “actual / de facto” p’ship can be argued by 3ps as well
 intent not as relevant
ii.
amongst the partners
 Intent more influential here
 as b/t themselves, why not give weight to what the partners agreed to
 Manifestations to 3ps are not enough to create a p’ship w/r/t the
partner’s themselves, can indicate what the actual agmt was if unclear
 Smith v. Kelley – Ct finds no p’ship even though Smith was held out to
the public and the IRS as a partner – there was no agmt b/t him and the
others that he was a partner, he had no mgmt power, he made no asset
contributions. (Ct looks heavily at what partners intended / agreed to,
look at substance and conduct only as “confirming” the testimony of
the parties) Manifestations to 3ps are NOT ENOUGH to create a p’ship
as b/t the partners themselves (apparent authority) BUT can indicate what
the actual relationship was if agmt unclear
2. Inadvertant P’ship by Estoppel – Liability to 3ps
a. general rule – 3p can get p’ship by estoppel to make A liable for B’s actions IF
they can show that they reasonably relied on representations made by A that a
p’ship existed and changed position in reliance on those representations
i.
must be transaction specific (not merely reputation)
b. 1914 § 16 Partner by Estoppel
i.
representation of p’ship (oral, written, conduct)
 AND reliance (on the faith of which)
 AND GIVES CREDIT to the actual or apparent p’ship
ii.
Ex – In Smith v. Kelly:
 would Smith be liable for office supplies bought by firm? YES – if they
relied on his being a partner (no liability as partner in fact)
 malpractice suit against the firm – is Smith liable? probably YES –
malpractice involves some sort of privity of K w/ the firm (not under the
Young v. Jones interpretation though)
26
 Smith liable if customer slips and falls on ther floor? could argue YES,
but probably not what 16 was designed for
c. 1997 § 308 Liability of Purported Partner
i.
representation of p’ship (oral, written, conduct)
 reliance on which
 ENTERS INTO A TRANSACTION w/ the actual or
purported p’ship
d. Young v. Jones -  sues PriceWaterhouse US (to get p/j in South Carolina as well
as deep pocket) when audit done by PriceWaterhouse Bahamas is faulty and
results in poor investment.  alleges that PWUS and PWB are actually partners
but this argument fails b/c no co-ownership, profit sharing, etc. 2d argument is
P’ship by estoppel (based on representations that they are one firm by PWUS). Ct
says “NO” b/c  didn’t rely on PWUS’s assertions
27
V.
FEDERAL INCOME TAXATION
A. Progressive Tax System
1. higher proportional tax at higher income levels
B. Marginal Tax Rate
1. rate of tax applied to the next $1 earned
2. ex – 5% on first $10K of income, 10% on next $10K of income
a. make $20K, you pay
i.
5% of $10K = $500
ii.
10% of $10K = $1000
iii.
500 + 1500 = $1500 Total Tax Bill
C. Effective Tax RAte
1. Avg rate paid on all income earned, factoring in the different marginal rates
a. $1500 / $20000 = x%
b. x = 7.5%
c. NOT 15% (adding the marginal rates)
D. Capital Gains Tax Treatment
1. lesser tax rate applied to sale of assets held for more than a minimum period of time
E. Corporate Taxation v. Individual Taxation
1. Taxed at different levels (rates listed on separate schedules)
F. 2-Tiered Corporate Taxation
1. Income Earned by a Corporation and distributed to shareholders is taxed at BOTH
LEVELS
a. Ex – assume tax rate is 10% for both corp and individual, corp earns $20,000 and
distributes $18,000 to shareholders
i.
$20,000 x 10% = $2000
ii.
$18,000 x 10% = $1800
iii.
Total Tax = $3800
iv.
Effective Tax Rate of 19%
G. Minimizing Impact of 2-Tier (Lawfully)
1. Zeroing Out Strategy (works well for the closely held corp)
a. pay shareholders w/ amounts of $ deductible by the corporation as expenses (ex –
salaries, rent on property owned by shareholder, interest on loans made by the
shareholder)
i.
thus, no profits to be taxed at the corp level
ii.
only tax paid is by the individuals
b. CAN’T make these payments unreasonably inflated
2. Accumulation / Bailout Strategy
a. reinvest capital in the corporation (don’t pay dividends)
28
i.
retained earnings tax penalty if you hold onto too much for too long, but
can be avoided by plowing it back into legitimate corp activities
b. corporation pays income tax on the profits, individual investors aren’t taxed
until they sell their shares at a gain (and are taxed at the lower capital gains
tax rate)
i.
ultimate bailout is death – heirs get to deduct FMV for the shares on the
day of death, sell them the next day and there’s no gain so no taxable income
AT ALL (just inheritance taxes, etc)
H. Check the Box
1. Unincorporated entities that are not publicly traded can elect 2-Tier
or Pass-Through Taxation
a. can only change election every 5 years
2. prior to “Check the Box” we had the Kitner regulations to determine who gets passthrough taxation if unincorporated – must have 2 or fewer of the bottom 4 to get passthrough
a. association + business w/ division of profits (both p’ships and corps have these)
b. continuity of life
c. centralized mgmt
d. limited liability for all investors
e. free transferability of interests
f. LPs would set up for termination on death of general partner and no liability for
general partner; LLCs don’t have centralized mgmt and would eliminate free
transferability or continuity of life to get pass-through
I. Sub-Chapter S
1. Qualifying Corporations can elect subchapter S
a. provides a type of pass-through taxation (not as favorable as true p’ship
taxation)
2. To Qualify:
a.
b.
c.
d.
less than 75 shareholders
no non-resident aliens as shareholders
no business trusts of a certain type as shareholders
only one class of stock
i.
exception w/r/t voting rights
J. Corp. Tax rate for less than $75K in income is currently LOWER than
p’ship taxation
1. may wish to elect corp taxation to take advantage of this
2. may wish to create several small corporations instead of one large one
29
VI.
OTHER UNINCORPORATED FORMS
A. Limited Partnerships
1. Filing and Name Requirement
a. must be created by filing
b. defective filing = General Partnership = unlimited personal liability for everyone
2. Taxation
a. Check the Box – 2-Tier or Pass-Through
3. Governed by ULPA
a. UPA is a gap filler when ULPA doesn’t cover an issue
4. Limited Partners
a. must be at least 1 LP
b. LPs have no personal liability, CANNOT control the p’ship business
c. Factors Creating Liability for Limited Partners – ULPA 303(b)
p170 of text
i.
(a) Management and Control of the p’ship
 liable ONLY to persons who transact business w/ the p’ship
reasonably believing based on the LPs conduct that he is a GP
ii.
(d) Used of the LP’s name
 LP is liable to creditors who extend credit w/o actual knowledge that
the LP is NOT a GP
iii.
304(a, b) Mistaken Belief w/r/t LP status
 If X makes a contribution and erroneously but in good faith believes
he is an LP (not a GP) he is ONLY liable to 3ps who ACTUALLY
believed he was a GP at the time of the transaction
 no liability for transactions after he corrects the mistake through
appropriate filing
iv.
ex – side agmt b/t X and Y that X (GP) will act on behalf of Y (LP) and
subject to his control?
 X is acting as the agent of Y as an undisclosed principal
 X could end up w/ full liability
 Y could also be liable
 agency principals apply
d. Factors that DO NOT create Liability for Limited Partners –
ULPA 303(b)
i.
ii.
iii.
iv.
v.
vi.
vii.
being a contractor / agent / ee of the limited partnership
being a contractor / agent / ee of the general partner
being a officer / director / shareholder of a corporate GP
consulting w/ or advising the GP w/r/t business of the p’ship
acting as a surety for the p’ship or otherwise guaranteeing its obligations
taking action to bring or pursue a derivative action
requesting / attending meeting of the partners
30
viii. Proposing / Approving / Disapproving (by voting or otherwise) one of
the following (VETOS ARE OK)
 dissolution of the p’ship
 sale, exchange, lease, mortgage, pledge of all or substantially all assets
 incurrence of indebtedness other than in the ordinary coursse of business
 change in nature of the business
 admission or removal of a GP
 admission or removal of an LP
 transaction involving a potential conflict of interest
 amendment to the p’ship agreement
 other matters the p’ship agreement say can be subject to the approval or
disapproval of LPs
ix.
winding up of the p’ship
5. General Partners
a. must be at least 1 GP
b. GPs have unlimited personal liability, can control the p’ship
i.
mgmt IS centralized – in the GPs
ii.
LPs have no personal liability, CANNOT control the p’ship
c. Can have corporation as GP
i.
ii.
X, Y, Z are LPs of Sample LP
HypoCorp is the GP, X, Y, and Z are its officers, shareholders, and
directors
iii.
allocate 1% of profits to GP (will be taxed as 2-Tier), 99% of profits to the
3 LPs (taxed as pass-through)
 X, Y, Z now have limited liability, pass-through taxation, AND mgmt
control of Sample LP
iv.
what if name is “X LP” (not Sample LP)?
 ULPA 303(d) – 3ps who rely on name of human being may assume that
person is a GP
 X is now liable to such 3ps
6. fiduciary duties of general partners
a. includes officers and directors of a corporate general partner
b. In re Usacafes, LP Litigation – duty not to use control of the p’ship property for
the benefit of the corporate director at the expense of the limited partners of the
p’ship (possibly more balancing if shareholders of corp were not co-terminus w/
the officers and directors)
B. LLCs
1. filing and naming requirements
2. Characteristics
31
a. Limited Liability for All Members
i.
liability can be varied under articles of formation
ii.
still subject to veil piercing if abuses
b. Partnership Taxation available under check the box
c. LLCs as asset protection devices
i.
many states don’t permit foreclosure by creditor
 Must use a charging order § 504(a)
 SO put non-income producing stuff in an LLC, charging order is worthless
b/c no income and creditor can’t foreclose
3. management / control – “Chameleon”
a. much can be modified by agreement
b. default rules (different from jurisdiction to jurisdiction)
i.
often default to a General Partnership type management
ii.
can opt for a centralized, corporate-type management structure among the
members
c. Elf Atochem North America, Inc v. Jaffari and Malek, LLC - Corp limited
partner tried to go against LLC Mgmt Agmt by claiming the suit was a derivative
suit against the other member of the LLC, claiming that LLC itself was not a party
to the mgmt agmt (claiming the LLC was hurt by Jaffari’s management of it). Ct
says all the parties signed, refuses to consider the LLC as a separate entity.
Shows importance of freedom of K in LLCs.
4. growing in popularity BUT
a. filing fees can be an impediment in some places - may be higher than corp fees
b. not appropriate if you plan on going public some day
c. unpredictability / unanswered questions can also be an impediment for some
5. Analogy to Corporation or General Partnership, as context dictates
a. this is how the unanswered questions get answered
b. Poore v. Fox Hollow Enterprises – Del Ct holds that LLC cannot represent itself
in court, must retain lawyer admitted to Delaware Bar as counsel. Analogizes an
LLC to a Corporation – it is a fictional entity, can act only through it’s agents so
needs a lawyer admitted in Del. P’ship would be able to represent itself in court,
regardless of whether member is an atty, where admitted (just as individuals can
come before the court pro se)
c. Meyer v. OK Alcoholic Beverage Laws Enforcement Commission – P’ships can
get liquour licenses under OK law, corporations can’t. Ct rules that LLC is like a
corporation, so it can’t get a license. Reasoned that rule was intended to keep
limited liability entities from getting licenses, so LLC should be treated like a
corp.
6. Fiduciary Duties
a. DE allose LLCs to adopt whatever type of fiduciary regime it wants
b. can’t agree out of Duty of Loyalty OR Good Faith / Fair Dealing
32
33
VII. DEVELOPMENT OF CORPORATE LAW
A. Generally restrictive origin
1. in past – limited duration, limited purposes, minimum capital requirements
B. Progressive liberalization and why
1. race of the lax
2. less suspicion of corporations (contrast w/ increased suspicion over Enron in the past
year)
C. Preeminence of Deleware
1. in other states, in other countries’ codes
2. we look at the MBCA instead
D. Internal Affairs Doctrine
1. Foreign (other state) Cts should apply the law of the state of incorporation to issues
relating to the internal affairs of a foreign corporation
E. Structure of Corporations
1. Shareholders
a. mere investors
i.
types – common, preferred (if only one, common)
ii.
classes vary based on vote, dividends, equity in the corp
b. NOT agents merely by being shareholders
2. Directors / Board of Directors
a.
b.
c.
d.
make decisions for the corporation
elected by the shareholders
NOT agents of the corp (not acting on its behalf)
Chairperson
i.
elected by the Board
ii.
originally to preside at meetings
iii.
now powerful, role defined in bylaws and by resolutions
3. Officers
a. appointed by Board of Directors
b. Which officers? – look at the bylaws!
i.
someone must keep and authenticate corporate records (“Secretary”)
ii.
older statutes – Pres, VP, Treas, Sec mandatory
iii.
now – CEO, COO, CIO, CFO, etc.
F. Theories of Corporateness
1. Entity Theory
a. Traditional
b. rights and duties of a fictional human being
c. can only act through it’s agents
2. Nexus of K Theory
a. useful to acknowledge the relationships b/t real
3. Progressive
34
VIII. FORMATION OF A CORPORATION
A. Where
1. Delaware
2. Home state
3. Factors
a. monetary analysis of cost of incorporating, paying franchise fees in multiple
states, substantive laws of the state of incorporation
B. How
1. Incorporators
a. 2.01 – One or more persons may act as an incorporator or incorporators of a
corporation by delivering articles of incorporation to the Sec of State for filing.
b. Under who’s name the corporation is formed
i.
responsible for corp records filing and contact person to the state
incorporation office
ii.
often the attorney, attorney’s secretary, a parlegal at the office, etc.
c. NOT the same as promoters
i.
have no liability from acting as an incorporator
ii.
only power is to name the initial Board of Directors (unless the initial
Board is set forth in the articles of incorporation)
d. why don’t shareholders do this? – they don’t exist yet
2. Articles of Incorporation – 2.02
a. mandatory components
i.
ii.
name for the corporation (in accord w/ 4.01)
number of shares the corp is authorized to issue
 6.01 – AoI must prescribe the classes of shares and the number of
each class
 distinguishing designation for each class if more than one
 preferences, limitations, and relative rights of the class must be
described in AoI prior to issuance of those shares
 must include 1 or more classes w/ unlimited voting rights AND 1 or
more classes that together are entitled to receive the net assets of the
corporation upon dissolution
 6.02 – AoI may allow the Board of Directors to determine in whole or
in part the preference, limitations, and relative rights of any class of
shares or one or more series w/in a class
iii.
street address of corp’s initial registered office and name of initial
registered agent at that office
 often the attorney’s office (for process servers, info / communications
from the state)
iv.
name and address of each incorporator
b. discretionary components
i.
name and addresses of initial directors
35
ii.
purposes for which the corporation is organized
 3.01 says “any lawful business” unless something more specific is stated
 can be limiting…
iii.
managing the business and regulating affairs of the corporation
 provisions you want to be HARD to change later
iv.
par value of shares
v.
personal liability for shareholders if desired
3. naming restrictions – 4.01
a. must include corp, inc, co, ltd, etc
b. may not create language implying a purpose other than one permissible under
3.01 (unlawful businesses, outside the scope of your purposes if you limited them,
businesses that must be organized under other statutes, like banks)
c. must be distinguishable on the records of the Sec of State from
i.
names of corporation incorporated or authorized to do business in the state
ii.
names reserved or registered under 4.03
 4.02 – Reserved name – person protects future desired name
 4.03 – Registered name – foreign corporation protects name from use by
others
iii.
fictitious name adopted by a foreign corp b/c its real name is not available
iv.
name of a not-for-profit corporation incorporated in the state
d. “DBA”
i.
don’t have to use legal name all the time
ii.
can use any fictional name you want for transacting your business
iii.
so long as no TM, unfair competition issues
4. effectiveness of filing the Articles of Incorporation
a. 2.03 – Incorporation
i.
ii.
Corporate existence begin when the articles of incorporation are filed
filing of articles by Sec of State is CONCLUSIVE PROOF that the
incorporators satisfied all conditions precedent to incorporating
 except in proceeding by the state to cancel or revoke the incorp or
involuntarily dissolve it
b. 1.25 Filing Duty of Sec of State
i.
Sec of State files AoI by recording as filed ON THE DATE AND
TIME OF RECEIPT
ii.
if Sec of State refuses to file, must return it w/in 5 days after delivery
w/ an explanation of why not filed
iii.
Duty is ministerial
 if he refuses to file doesn’t affect the validity of the document, the
correctness of info therein, no presumption that doc is valid or invalid or
that info is correct or incorect
c. 1.23 Effective Time and Date of Document
i.
document accepted for filing is effective
36
 at the date and time of filing
 at the time specified as the effective date in the document
ii.
delayed effective date no more than 90 days later
d. if backlog at Sec of State office – Stamped Retroactively
C. Ultra Vires – formation is time to think of powers & purposes
1. historical – powers & purposes, actions that exceed them are ultra
vires
a. Ultra vires acts are NOT enforceable agains the corporation
b. Corporation has no power to act outside scope of its authority
i.
Ashbury Ry. v. Riche - Corporation not liable to Riche b/c owning and
operating a railway line was ultra vires (their purpose was to sell and lend
railway equipment, act as mechanical engineers and general contractors)
c. policy – protect shareholders who relied on narrow purposes clause to guard
against unwanted expansion of the business
d. BAD because allows the corp to act irresponsibly and then disavow the acts as
ultra vires
2. modern - effects of statutes
a. MBCA § 301 Purposes
i.
engaging in any lawful business
ii.
UNLESS a more limited purpose is set forth in the AoI
b. § 302 powers
i.
do all things necessary and convenient to carry out its
business and affairs
 ALSO: specific provisions including:
 (13) to make donations for the public welfare or for charitable,
scientific, or educational purposes
 subject to modification in the AoI
ii.
implicit reasonableness limitations
 Theodora Holding Corp. v. Henderson – THC is a shareholder in ADI,
sues ADI and its majority share holder Henderson b/c ADI made a gift of
a huge tract of land to a foundation set up by Henderson. THC says “no
corporate POWER to make such a gift”. Ct says (1) yes, statute gives
power to make charitable donations and (2) reasonableness of the gift is
implicit in the statute and this gift is reasonable b/c w/in what IRS
considers deductible (indicia, not dispositive)
c. § 304 Ultra Vires
i.
can only challenge validity of corporate action as ultra vires
 in proceeding by SH against the corp to enjoin the act
37
 ct can enjoin act if equitable, all parties affected are parties, may award
damages to corp or 3p b/c of enjoining
 Inter-Continental v. Moody – if shareholder is enlisted by corp to
challenge the transaction, he would not be able to do so b/c he’d be
acting as an agent of the corp (not as a shareholder). “the mere fact
that a corporation representative may have given notice of the suit and
suggested it might be wise for the stockholder to intervene does not
make the stockholder an agent of the corporation”. Who is paying the
atty fees for the challenge may be indicia of agency (if the corp is
paying) or not agency (if the shareholder is paying).
 in proceeding by the corp against a former / current director, officer,
ee, agent
 by the Atty General
ii.
Kings Hwy Corp v. FIM’s Marine Repair Service, Inc. – Kings Hwy rents
property to FIM’s for purpose of operating a movie theater, then seeks to
avoid the lease under ultra vires (is this fair to FIM’s? – NO – obviously
Kings Hwy knew the purpose of the lease, just want out b/c better offer). Ct
says 3p CANNOT argue ultra vires. ONLY the shareholders in a derivative
suit, the Atty General, the corp in an action against a former or present officer
or director
D. Premature Commencement
1. Promoter’s liability
a. defined – person who takes initiative in founding and organizing the business of
an issuer
i.
who can sue them?
 co-promoters
 investors
 corporation
 creditors
b. duties to co-promoters (like partners)
i.
ii.
high fiduciary duty
at minimum = full disclosure
c. fraud to investors
i.
Federal Securities Laws – fraud is bad
d. fraud on the corporation (*see self-dealing)
i.
“Old Dominion Split” – promoter made sale / loan to corporation at a
VERY high price, only the promoters were officers / sh / dir – Sup Ct says
“OK”, no possibility for fraud
38
e. promoter’s Ks (promoter and 3p make a K knowing no corp has
yet been formed)
i.
Promoter is bound unless agreement to the contrary
ii.
burden on promoter to show agreement to the contrary
 Intent not to bind the promoter need not be express, can be implied
 look to /s/ format as indicia (also look at language of the K)
 Boss Hotels Co, Inc.
by _______/s/_________
its __________________ (title s/a Pres, Secretary, VP, etc)
 optimal solution for promoter is EITHER
 put “promoter not personally bound” in the K OR
 have the corp formed and ready to go, put language in about not
binding the promoter
iii.
other possible characterizations
 parties intended no present agmt b/t the 3p and the promoter
 = an offer to the future corp by the 3p
 revocable by 3p
 K b/t the 3p and the promoter stating that if for any reason the corp
doesn’t perform, the promoter is liable
 promoter’s K, so he’s liable
 Promoter’s liability ends when the corp adopts the K AND the 3p
acknowledges the promoter’s liability is extinguished
 Option K – promoter provides some type of consideration to keep a K
offer open
 promoter has no liability
iv.
Stanley J. How Inc v. Boss – promoter makes a K w/ architect, signs as
“agent for a Minn. corp to be formed who will be the obligor”. Corp is
formed, makes partial payments, then abandons the project. Boss is liable b/c
no intent expressed by architect NOT to bind him, corp can’t be bound before
it’s formed, presumably they intended him to be bound
f. Defective incorporation
i.
CL
 de jure
 corp complied w/ all the mandatory provisions but messed up on
directives (ex – publishing 3x)
 good against ALL (including the state)
 de facto
 defective incorporation has occurred – one or more statutory
requirements are not satisfied
(1) valid law under which corp can be organized
(2) attempt to organize under it
(3) actual user of the corp franchise
39
(4) good faith in claiming to be and in doing business as a corporation
 good against ALL except the state
 by estoppel
 person seeking to hold the officer personally liable has K’d or dealt w/
the association in a manner recognizing or effectively admitting its
existence as a corporation
 good ONLY against specific party (specific to dealings w/ them)
 Cranson v. IBM – IBM sues Cranson personally for debt owed.
Cranson had signed AoI on 5/1, was told they were filed by his atty,
enters Ks, AoI actually filed 11/24. Ct says Cranson has no liablity b/c
IBM dealt w/ him as if corporation, relied on its credit not his
ii.
conclusive filing statutes
 2.03(b) – Incorporation
 filing of AoI by Sec of State is conclusive proof that
incorporators satisfied all conditions precedent
 question as to whether this has a negative implication that if
no filing, no corp (rejection of estoppel, de facto)
 Robertson v. Levy – DC CASE - Levy takes over lease from Robertson as
corp, corp makes one payment then stops, no corp formed until after lease
created. Ct says Levy is liable b/c NO CORPORATION EXISTED.
Statute says “If certificate exists, corporation exists de jure”. Ct says, by
negative implication, if no certificate exists, no corporation exists.
Rejects estoppel, de facto, de jure. Statute also says that if you assume
to act on behalf of corp before it exists you are j&s liable.
 Cranson v. IBM – MARYLAND CASE - ct still says estoppel, don’t use
negative implication of their statute to conclude that if no certificate, no
corp
iii.
“assume to act” statutes and “purport to act” statutes
 2.04 Liability for Pre-incorporation Transactions
 All persons purporting to act as or on behalf of a corporation,
KNOWING there was no incorporation under this Act, are jointly
and severally liable for all liabilities created while so acting.
 Harry Rich Corp v. Feinberg – FLORIDA – Feinberg is shown AoI
that he believes have been properly filed, makes a K, they try to hold
him personally liable. Ct says no liability under “assume to act”
statute b/c should be construed to impose liability only when
individual has actual or constructive KNOWLEDGE that no corp
exists
iv.
effect of promoter’s knowledge that corporation has or has
not been formed
40
 2.04 – only liable if you KNEW there was no incorporation
 protects from both K and Tort liability
v.
active vs. passive promoters (queasy)
 ex – what if A is passive, B is managing investor in the corp and they
KNOW there was no incorporation – is A liable for B’s actions?
 Cts inclined to say “if you weren’t a corporation, you were partners, so
A is liable”
vi.
continuing confusion w/r/t negative implications (appears settled in
DC though - Levy)
2. Corporate Liability against the promoter
a. disparity among jurisdictions w/r/t whether corporation must ratify/adopt/enter a
K to be bound by it
i.
can’t “ratify” a K made before formation of corp
 ratification is effective as beforehand authorization of the agent
 can’t give prior command if you didn’t exist
ii.
can adopt Ks made before corp formed
b. corporation can do this formally or informally (as by accepting
benefits w/o complaint)
i.
McArthur v. Times Printing Co – McArthur signs K w/ corp not yet
formed to be advertising person for 1yr. Corp is formed, performs for a while,
then fires McArthur. McArthur argues they became a party by performing for
a while under the K (corp can’t be bound before formed). Ct says assumption
of the K can be IMPLICIT as by performing under it w/o complaint.
E. First Acts by Board of Directors – by meeting or unanimous written
consent
1. Adopt by-laws
a. officer’s titles, when to have meetings
b. usually done by BoD, can be done by shareholders
c. bylaws have status of a Board Resolution – can be changed by the Board
2. Election of Officers, set their salaries
3. start minute book
4. approval of stock certificates
5. decide to issue shares and for how much
a. direct appropriate officers to issue them
6. corp bank accout (banking resolution)
a. authorize officers to draw on it
7. Promoters
a. ratifying Ks
b. reimbursing for out of pocket costs
41
IX. DISREGARD OF THE CORPORATE ENTITY
A. Shareholder Liability (not officers, directors, ee’s)
1. “True” piercing cases - Approaches
a. fraud
i.
ii.
sufficient to pierce
comes up in K cases (not in tort b/c no wilfull dealings)
b. various factors + injustice/inequity
i.
undercapitalization as a very important factor
 role of insurance
 role of statutory determinations w/r/t financial responsibility, minimum
insurance requirements, etc.
ii.
failure to follow formalities re/ record keeping, BoD
 SD Baatz suggests need a causal relationship w/ harm here
iii.
fund siphoning
iv.
façade for acts of the shareholder
c. other approaches (Gabaldon believes things like the MO approach (domination +
injustice + cause) boil down to something like “various factors”)
Jurisdiction
NY – Bartle
SC – DeWitt
SD – Baatz
∆
Corporation
Individual
Individual
Claim
K
K
Tort
Result
∆ wins
∆ loses
∆ wins
MO – Telecom
DE – Fletcher
Corporation
Corporation
Tort
Tort
∆ wins
∆ wins
Approach
Fraud / misleading
Injustice + various factors
Inequity by reference to
factors, possible causal
requirement b/t failing
and harm occured
3 elements under MO law
Fraud OR Alter Ego
d. Bartle v. Home Owner’s Co-op – veterans form cooperative corporation to
provide low cost housing, sole purpose is to avoid personal liability. Ct looks for
fraud, misrepresentation in the business’s conduct that caused injury to the 
e. DeWitt v. Flemming Fruit –Flemming has a one-man corp that mkts fruit on
behalf of growers and gives them proceeds less transportation costs and
commission. He fails to give $ to the transporter DeWitt. Ct pierces, holds
Flemming personally liable. Ct says “injury to  + injustice + factors”
i.
Factors – need combination
 gross undercapitalization
 failure to observe corporate formalities
 non-payment of dividends (indicia of siphoning? unreasonable salary?)
 siphoning of funds by dominant shareholders
 non functioning of the BoD
42
 absence of corporate records
 corp is a “shell” – façade for acts of the shareholders
f. Baatz v. Arrow Bar – Baatz are struck by drunk driver who was given liquor
while already intoxicated at Arrow Bar. Bar owners had incorporated. Ct looks
for use of corp to promote inequity / injustice. Ct says no piercing:
i.
presumption of separate entity, burden on  to show veil should be
pierced.
ii.
personal guarantee of some obligations does not imply guaranty of all
debts
iii.
Alter Ego - requires showing they were so intertwined w/ their business
that suggests its inequity to escape liability
iv.
undercapitalization – bad but only if you say why its bad
v.
failure to observe corp formalities – no relationship b/t failure to use
naming reqs (Inc) and the harm that occurred
g. Radaszewski v. Telecom -  injured by driver for wholly owned subsidiary, wants
parent to pay when subsidiaries insurance co is insolvent and can’t pay. Ct says
no piercing b/c they had insurance, no fault that ins co is insolvent.
i.
3 Part Test
 Control
 not mere stock control
 domination of finances, policy, business practice w/r/t the transaction
in question
 comingling of funds? overlapping of officers / dirs?
 Fraud / Injustice
 control used by parent to perpetuate unlawful or fraudulent act on 
 UNDERCAPITALIZATION can be a proxy for fraud
 factor in liability insurance in calculating capitalization (if tort case)
(1) NY squib case – most cts will be swayed to not pierce if amt of
insurance meets the statutorily required minimum
 Proximate Cause of the injury complained of
h. Fletcher v. Atex – Fletcher buys keyboards from Atex, wants to sue parent Kodak
for injuries caused by them. Ct says either Fraud or Alter Ego, no fraud. No
piercing b/c no Alter Ego b/c factors aren’t present.
i.
Alter Ego Factors – operated as a single economic entity
 undercapitalization
 corporate formalities – records, functioning BoD
 failure to pay dividends
 siphoning of corp funds to the parent / sh
 façade for dominant sh activities
ii.
What you CAN do w/o getting pierced
 Cash Mgmt arrangements (one bank account for family of corps)
 approval of major transactions (small ones might be domination)
 overlapping Boards (same dirs as parent)
43
 stocked Board bad (composed of ees controlled by parent)
 have literature that makes the relationship ambiguous
 personal guarantees – guaranteeing one is not guaranteeing all
 reports – prudent parents want them, not domination
2. Other theories
a. shareholder did “it” (i.e. hit the pedestrian, defrauded the customer, etc.)
b. personal guarantee
i.
ii.
prevalent in closely held corporations
Statute of Frauds issue if not in writing
c. statutory interpretation - Bestfoods
i.
Bestfoods (shareholder liable under CERCLA b/c of direct operator
liability, not veil piercing)
B. Reverse Piercing Cases, Other Disregard of Corporate Entity
1. Factors – cts tend to discuss the same factors from veil piercing cases
a. BUT additional discussion of policy / purposes of the disregard (ie social security
benefit, homestead exemption, etc)
2. Reverse Piercing
a. Cargill v. Hedge – family has a farm that they’ve put into a corporation. corp
creditor gets foreclosure on the farm. family says ct should disregard the
corporation and allow them to keep the farm under the “homestead exception”
which stops foreclosure on family farms. Ct looks at family ownership of the
corp, Alter Ego, no lease from corp to the family, says they get exemption. Based
on policy of homestead exception.
3. Disregard of Corporate Entity
a. NOT same factors as vp – look at underlying policy issues
b. Stark v. Fleming – Stark puts her farm and house in a corporation, begins to draw
a $400 salary, purpose is to qualify her for Soc Sec benefits. Ct says motive
(benefit to the single sh) not determinative, she followed corp formalities so corp
shouldn’t be disregarded (should look instead at what a reasonable salary for her
was)
c. RoccoGrandi v. Unemployment Compensation Bd. of Review – Family
corporation “lays off” its members during slow times, they collect unemployment
benefits where self-employed persons could not. Ct says can disregard the corp
entity, decide whether they get the bene’s or not based on them as self-employed
(policy based decision). They don’t get benes.
C. Equitable Subordination (called “Deep Rock” doctrine on the Fed level)
1. same factors as in veil piercing cases
2. different consequence – reordering of payment in insolvency proceedings
a. Pepper v. Litton (US 1939) – Litton is sole sh of Dixie Splint Coal Co, puts corp
in br and then puts in a claim for back salary. Ct says his claim is subordinated to
that of Pepper (on a lease), so Litton gets paid only AFTER Pepper and other
44
creditors are fully satisfied. Normally sh status has no affect on your br priority.
Ct looks at traditional vp factors.
45
X.
FINANCIAL MATTERS
A. Vocabulary
1. Capital
a. debt
i.
kind of capital that must generally be repaid
ii.
earns interest not dependent on earnings
iii.
interest is deductible by the corp, taxable to the investor
b. equity
i.
synonymous with ownership
ii.
composed of contributions from owners and retained earnings
c. hybrid securities - having some characteristics of debt, some of equity
d. rate of return - earnings of an investment, expressed as a percentage of the
amount invested
2. shares
a. class – all authorized shares of a corporation having identical rights
b. series – subset of a class of shares, terms of which are set by Board of Directors
(w/in limits in AoI)
c. stock
i.
units of ownership in a corporation
ii.
MBCA excludes promissory notes or services in exchange for stock
d. authorized – total number of shares of each class permitted to be issued in the
Articles of Incorporation
e. issued – shares that have at any time been registered in the name of a holder
f. outstanding shares – in the hands of a holder other than the corporation
g. treasury shares – shares that have been issued and then repurchased by the
corporation, but have not been retired (corporation is holding them) (until they are
sold again)
i.
under ineligible consideration statutes, could be sold for promissory notes
or future services
3. Articles of Incorporation
a. sets forth number of shares a corporation MAY issues
b. if more than one class, gives info on rights of each class
4. Types of Stock
a. common stock
i.
one or more classes that taken together have:
 right to vote on elections and other matters AND
 entitled to net assets of the corporation after allowances for debt
b. preferred stock - having a priority in payment of dividends AND/OR
distributions in liquidation
c. participating preferred – entitled to a specific dividend AND a share of the
additional distributions (profits) in certain circumstances (after common stock has
been paid a certain amount, shares receive dividends along w/ the common)
46
d. senior security – 1st in the order of priority of pay off
e. redeemable / callable
i.
can be repurchased at the option of the corporation
f. convertible - debt or shares that can be exchanged for another security under
certain conditions
g. upstream conversion – conversion from a lower class of stock to one w/ superior
rights
h. dividend
i.
distribution from current or retained earnings
 not deductible by corporation, taxable to investor only if corporation has
earnings and profits
ii.
for preferred stock
 cumulative dividend – preference carries over year to year
 noncumulative dividend – preference lasts for only one year, doesn’t
carry over (begins anew each year)
 partially cumulative dividend
5. Repurchase of Shares
a. sinking fund / protective provision - requirement that corp set aside a certain
amount each year for the redemption of securities
b. subscription agreement – people agreeing to purchase shares prior to issuance
c. call – corp exercising its option on call-able shares to repurchase those shares
d. put – K by which shareholder can sell his shares back to the company at a
specified price in specified circumstances AT HIS ELECTION (if unrestricted,
the sh can threated corp by threatening to exercise it at an inconvenient time; if
too restricted, minority sh may not be able to protect self adequately)
6. Capital Accounts
a. par value – assigned value for shares (historically represented amount for which
they would be issued)
b. stated capital
i.
includes par value of all outstanding shares
ii.
includes amount for which no par shares are issued (unless allocated by
BoD to capital surplus)
c. capital surplus - includes amount raised from sale of shares in excess of par
value of the shares
d. earned surplus / retained earnings
i.
portion of shareholder equity
ii.
represents amounts earned but not distributed yet
e. paid-in capital
i.
sum of stated capital and capital surplus
ii.
issue price of each share outstanding
7. Issuance of shares
47
a. par value – assigned value for shares (historically represented price for which
they would be issued)
b. no par stock – stock w/ no par value
i.
allowed under 1969 - entire consideration received for them (issue price)
constitutes stated capital unless BoD reallocates w/in 60 days (§21)
c. bonus shares – shares for which nothing was paid
d. discount shares – shares issued for cash but less than par value of the shares
e. watered stock – stock paid for w/ property worth less than the par value of the
shares
f. watered stock liability
i.
consequence of failure to pay par or payment by ineligible consideration
ii.
liability up to the par amount
iii.
MBCA 6.22 (BoD determines whether consideration is adequate for
issuance of shares) otherwise nonexistent under new MBCA
g. ineligible consideration
i.
promissory notes and future services
ii.
doesn’t exist under new MBCA
iii.
doesn’t apply to treasury shares (even under old statutes)
iv.
intended to protect investors / creditors
8. Debt Securities
a. debt
i.
kind of capital that must generally be repaid
ii.
earns interest not dependent on earnings
iii.
interest is deductible by the corp, taxable to the investor
b. debenture – unsecured corporate obligation typically known as a security
c. bond – corporate obligation known as a security and secured by lien or mortgage
on property
d. zero coupon bond – pays no interest, sells at a substantial discount from face
amount (no coupons b/c no interest payments to be made, make $ on it by
reselling at face value)
i.
portion of difference b/t face amount and sales price is taxed to holder
annually
e. thin corporation – high debt / equity ratio
i.
= undercapitalization
ii.
risks recharacterization of debt as equity
f. straight debt – safe harbor from recharacterization as equity
i.
uncondition promise to pay certain sum of money
ii.
not contingent on profits or borrower’s discretion
iii.
non-convertible (to another type of security)
iv.
issued to one who would be eligible shareholder under Subchapter S (no
non-resident aliens, business trusts, etc.)
g. recharacterization of debt as equity
i.
if undercapitalized (thin corporation), IRS may decide to do this
ii.
lose deductibility advantage of debt, may cause loss of SubS election by
creating a 2d class of stock
48
h. leverage – permits borrowers to earn more on borrowed funds than the cost of
borrowing them
i. junk bond – below investment-grade debt instrument
9. Taxation
a. interest – return to investor deductible by the corporation, taxable to the investor
b. dividend – return to investor only if corporation had earnings and profits
i.
not deductible by corporation
ii.
taxable to investor
c. recharacterization of debt as equity – undercapitalization risks this
recharacterization (lose deductibility advantages, may create additional class of
stock and thus destroy SubS election option)
d. zero-coupon bond – portion of difference b/t face value and sales price is taxed
to holder annually
B. Accounting Conventions
1. 1969 vs. 1984 MBCA
a. Par Value
69 – opt out of par
 req’d to elect no par, otherwise AoI must state par
ii.
84 – opt into par
 can elect par but not necessary (not meaningful in ’84 terms)
 no need for “no par” election in the AoI
i.
b. Eligible consideration
69 – promissory notes and future services are not eligible consideration for
the issue of shares (§ 19)
 Watered Stock liability created by payment of ineligible consideration
 n/a to re-sale of Treasury shares
 also, obligation to pay the consideration for which the shares were issued
(§ 25)
ii.
84 – promissory notes and future services ARE eligible consideration
 Watered Stock liablity – NO LONGER EXISTS based on type of
consideration
 6.20 – whatever the BoD deems “adequate” is fine (conclusive
determination by Board)
 § 6.22 - continued obligation to pay agreed-upon consideration
i.
c. 84 eliminates concept of stated capital and capital surplus
(present in ‘69)
2. Accounting for Issuance of Par Value Shares, No Par Shares
a. *** restrictions only apply to ISSUANCE (n/a to resale of the shares)
b. Oldest Coherent Scheme
i.
investors pick par value, all shares sold at that value
49
 *** preferred stock is STILL generally sold at its par value
ii.
therefor, no dilution
 Dilution =
 A buys shares for $5
 B buys shares for $10
 2 shares are issued, each is worth $7.50  B’s interest is diluted
iii.
paying less than par = obligation to the corporation
iv.
if you issue for less than par
Assets
Liabilities
cash
$50,000
obligation of shareholders to pay up to
stated capital
$100,000
par in the future
$50,000
------------------------$100,000
$100,000
c. 1969 MBCA §21
i.
if issued w/ par value
 stated capital = sum of par value of shares outstanding
 capital surplus = rest of the issue price of shares outstanding
 if 1000 shares of $1 par sold at $100, corp then earns $50K
Assets
Liabilities
cash
$150,000
stated capital
capital surplus
earned surplus
-------------$150,000
$1,000
$99,000
$50,000
-----------$150,000
must make a “no par” election in the AoI
 if issued w/ no par value
 everything goes into stated capital, BoD can reallocate to capital
surplus under § 21
 PROBLEM – if no par and you go to a state that bases franchise
taxes on par value, tax gets based on issue price and is thus very
high
iii.
best bet is to issue for low par
ii.
d. 1984 MBCA
i.
no need for AoI can designate a par value but not necessary
ii.
no stated capital or capital surplus
Assets
Liabilities
cash
$150,000 Paid in Capital
$100,000
Retained Earnings
$50,000
----------------------------$150,000
$150,000
50
C. Watered Stock Liability
1. ’69 MBCA
a. § 19 – Ineligible Consideration (promissory notes, future services)
i.
can pay in cash, property (including intangible), labor or services
previously performed
ii.
jment of BoD or shs as to value of consideration is conclusive (absent
fraud in the transaction)
b. § 25 – obligation to pay full consideration for which the shares were issued
(this creates watered stock liability for no-par shares as well)
c. § 18 – no issuance for less than par
2. ’84 MBCA
a. 6.22 – obligation to pay agreed upon consideration for the shares
b. 6.20(c) – BoD must determine that consideration offered is “adequate” for
the issuance of shares
i.
conclusive determination by BoD
ii.
no need to determine $ value, just that its “adequate”
3. Hanewald v. Bryan’s Inc – corp issues 100 shares of $1000 par stock, Bryans don’t
put up the full amount so they are liable to a creditor up to $100,000 under § 25 of the
1969 MBCA. Moral: Don’t issue high-par stock
D. Ineligible Consideration
1. ’69 MBCA - promissory notes, future services
a. § 19 – no promissory notes or future services to pay for shares
b. N/A to Treasury Shares (under ’69 MBCA)
i.
Treasury Shares can be used to pay for services in the future
2. Non-existent under ’84 MBCA
a. 6.20 – whatever BoD is willing to take is fine (anything of value or benefit to the
corp)
i.
can escrow shares paid for w/ future services or promissory notes
b. 6.22(a) – continued obligation to pay the agreed-upon consideration
E. Taxation
1. Deductions / Taxation
a. Income for services is taxable
i.
shares issued for services are taxed as income to the recipient
b. interest on debt is deductible, taxable to the creditor as income
c. dividends paid to sh’s aren’t deductible, taxable as income to the sh
2. Debt Financing
a. Benefits – Leverage
i.
leverage = ability to make more w/ borrowed $ than it costs to borrow it
51
 Ex – borrow $1000 at 5%, invest it in the stock market and make 10%;
you now have $1100; pay off the principal and the $50 in interest; you’ve
made $50
ii.
if unable to get capital any other way, debt is only option
b. Dangers of Too Much Debt
i.
Recharacterization of debt as equity
 might affect deductibility
 interest paid to creditor on debt is deductible, dividends paid to shs
aren’t
 might create a second class of stock, eliminating SubS option
 “Straight Debt” is a safe harbor
(1) if it’s straight debt can’t be recharacterized as equity so as to
eliminate SubS election
(a) uncondition promise to pay certain sum of money
(b) not contingent on profits or borrower’s discretion
(c) non-convertible (to another type of security)
(d) issued to one who would be eligible shareholder under
Subchapter S (no non-resident aliens, business trusts, etc.)
(2) IRS can still say “not deductible”
 Factors in Recharacterization (there are 13)
 lender took “too much” risk
 payment schedule is unusually favorable
 consistent failure to pay when due
ii.
Other Risks of too much debt
 poor business jment – you don’t make as much as you thought you would
 undercapitalization / thin corporation – consequences for veil piercing and
equitable subordination
F. Business Planning Exercise
1. Factors
a. What they did for desired control arrangements – voting rights
b. profit sharing desires – dividend rights
c. rights in the event of dissolution (redistribution of wealth)
i.
can have shares that vary as to liquidation rights but this destroys SubS
d. tax consequences – deductibility, SubS election, salary is deductible as an
expense
e. eligible consideration issues
f. watered stock / obligation to pay (liability)
2. Ex – A and B Furniture Company – A wants to contribute $100,000 and no
more; B wants to be the manager w/ no capital contribution; they want to share
profits equally
a. Issue 1000 shares at $100 par, B gets 1000 shares for his future services
i.
B has watered stock liability
ii.
under ’84 MBCA this would work BUT B would get 50% of A’s
$100,000 if the corp dissolved
52
b. Issue 200 shares at $1 par; A pays $100,000 for 100 shares; B gets 100 shares
after working for 2yrs (amount of time they agree his services equal A’s capital)
i.
B will get slammed on taxes when they’re issued to him all at once if
business is successful (the shares are worth a lot)
ii.
B is at A’s mercy for 2 years – he has only a K right against A
c. $1 par; A pays $100,000 for 100 shares; B pays $100 for 100 shares
i.
B has a tax issue – he only paid $100 for 50% of a corp worth $100,000,
so he’s gonna have to pay taxes
ii.
if corp dissolves tomorrow, B gets $50,000 (problem for A if the corp
dissolves w/in the 2yr period it takes B to “earn out”)
d. A gets Class A stock; 10,000 shares for $100,000, one vote per share; B gets
Class B stock – 10 shares for $100, 1000 votes per share
i.
they can now control equally
ii.
if they dissolve, A will walk away with 10,000/10,010ths of the corp
assets and B w/ only 10/10,010ths
iii.
BUT B won’t get half the profits unless the dividends are skewed
 once dividends are skewed, no more SubS election
e. A and B each buy 10 shares for $100, A then loans the corp $99,800
i.
corp is now thin / undercapitalized (only $200 in equity and $99,800 in
debt)
f. A and B each buy 10 shares of common stock for $100; A then buys 9,980 shares
of preffered for $99,800; preferred stock has no dividend
i.
profits and control are split 50/50 BUT
ii.
tax bill is maximized – no SubS election, no interest to deduct
53
XI.
REGULATION OF ISSUANCE OF SECURITIES
A. State “Blue Sky” laws
B. Federal Law – Securities Act of 1933
1. Unlawful
a. §17 – fraud in connection w/ offer or sale of a security
b. § 5 – unlawful for ANYONE to offer / sell unregistered securities UNLESS
exemption to registration applies
i.
BROAD definition of “offer” – any attempt to give for value
 ex – free stock for registering on internet site IS an offering of stock
2. Exemptions Available
a. 3(a)
i.
3(a) Exempt Securities (always exempt from registration
requirement, no matter who’s selling them)
 issuer specific
 ex – certain securities issued by governements
ii.
3(a)(11) – Transactional Exception for INTRAstate sales
 Intrastate sales – going naked under the statute
 to residents of a single state
 issuer is a resident of that state or incorporated in that state
 issuer is doing business in that state
 Rule 147 Safe Harbor – you are “doing business in” a state IF
 80% of assets are in that state
 80% of income comes from the state
 80% of proceeds used in that state
 what if you have only 79%? may still be w/in 3(a)(11) exemption, just not
as sure a thing b/c naked under the statute
b. 3(b) – SEC can adopt exemptions at its discretion in the public interest
i.
new - § 28 says SEC has UNLIMITED discretion – they’ve mostly used it
to make their own inflation adjustments
c. § 4 – Exempt Transactions
i.
4(1) – “personal” re-sale transactions
 transactions by OTHER than an issuer, underwriter, or dealer
ii.
4(2) – “PRIVATE OFFERINGS”
 transactions BY ISSUERS NOT involving a public offering are
EXEMPT from registration requirement
 covers most “Mom and Pop” operations (issuing shares only to
themselves and their immediate family)
 Can “go naked” under 4(2) OR enter one of the “Safe Harbors”
described in Reg D
 Ralston Purina Test for Public Offerings
(1) Burden is on ISSUER to prove that offerees meet criteria
54
(a) small group – no bright line test based on #
(b) ability of the investors to “fend for themselves”
(c) access to the information req’d under registration
(2) EXECUTIVES as a group would be EXEMPT
(3) just giving out a packet of info would not be enough
(4) ONE BAD APPLE – criteria must apply to EACH AND EVERY
investor stock was offered to
 SEC v. Ralston Purina – naked under the statute – RP offers stock to
“key employees”, don’t register it b/c they claim they are 4(2) exempt
b/c PRIVATE OFFERING. Includes those who ask for stock, eligible
for promotions, ambitious, etc. – results in motley crew of issuees.
Sup Ct says it was PUBLIC OFFERING, citing policy of protecting
those who wouldn’t have access to corp info by giving them that info
under registration
d. Regulation D Safe Harbors
i.
504 (under 3(b) discretion of SEC)
 issue less than $1,000,000 in 12 months
 # of purchasers – unlimited in # and attributes
 ONLY FOR COMPANIES WHO DON’T REPORT UNDER ’34
ACT
 no general solicitation AND you must restrict re-sale UNLESS exempt or
registered under a state law
 AGGREGATION CONCERNS
 unrelated to need of the offerees for protection
ii.
505 (under 3(b) discretion of SEC)
 issue less than $5,000,000 in 12 months
 # of purchasers
 unlimited # of accredited investors
 less than or equal to 35 unaccredited investors
 no general solicitation AND must restrict re-sale
 AGGREGATION CONCERNS
 is NOT premised on the need of the offerees for protection
iii.
506 (under 4(2) Private Issue Exception)
 unlimited amount of capital
 # of purchasers
 unlimited # of accredited investors
 less than or equal to 35 unaccredited investors who are
“SOPHISTICATED” w/r/t financial matters
 no general solicitation AND must restrict re-sale
55
iv.
aggregation of $ amt
 applies to 504 / 505 (506 has no cap on $ amount)
 no subsequent offerings under rule that would put aggregate $ amount
over the limit for the previous 12 months
 lose subsequent exemption, NOT prior one
v.
Integration – 502
 6 month integration Safe Harbor
 if it happens more than 6 months apart, it won’t be Integrated
 Integration = treating 2 issuances as one; lose exemption for BOTH
offerings
 applies to BOTH limits on $ amounts and # of purchasers
 Factors (indicia - not dispositive, not a “majority of factors” test)
 single plan for financing
 same class of securities offered
 sales made at same time
 same type of consideration received
 same general purpose for the sales
vi.





Who are accredited investors? 501
banks
corporations worth more than $5million
directors / executive officers of the issuer (or of a general partner of that
issuer if an LP)
millionaires
high income individuals (more than $200,000 in each of past 2 years or
$300,000 if filing jointly w/ spouse)
e. Regulation A – “Mini Registration” (under SEC 3(b) discretion)
i.
less than $5,000,000 offering
ii.
file a detailed offering circular
 not as elaborate as full registration
 still very expensive
C. Definition of a Security
1. 2(a)(1) – any note, stock, bond, debenture, … “investment K” … voting-trust
certificate, etc.
2. Investment Contract
a. Howey Test – What is an Investment Contract
i.
investment of $
 can be any valuable consideration
ii.
in a common enterprise
56
 multiple investors (horizontal) – all Circuits accept this as commonality
 promoter / investors (vertical) – minority of Circuits accept this as
iii.
commonality
profits to be expected primarily from the managerial or
entrepreneurial efforts of OTHERS (not the investors own efforts)
 efforts must come AFTER the $ is invested
 SEC v. Howey – Howey sells 6 ft wide strips of “orange groves” to out of
state dentists w/ promises that he will plant the trees, water the trees, sell
the fruit and remit the profits. SEC says the interest the dentist’s bought is
a security. Sup Ct says it IS a security b/c they put up $, it was a common
enterprise, efforts were to be those of the promotor / sibling corporation
b. Applications – discussed general outcome w/r/t
i.


ii.
iii.
iv.
v.







General P’ships
interest in GP is NOT usually a security b/c EVERYONE is doing the
work
expectation of profits not based on efforts of OTHERS, they’re based on
efforts of yourself as well
LP
Limited Partner interests ARE SECURITIES
expectation is that the General Partners will be making the effort in
management and entrepreneurship
LLC
need to look at the operating mgmt structure to figure it out
probably not
Stock in a Closely Held Corporation
Howey test suggests NOT a security BUT
Sup Ct has said it is b/c 2(1) definition explicitly includes “stock”
pyramid schemes
YES, often a security
 hard part is organizing the scheme (that’s the entrepreneurial /
managerial part)
 ex – “Learn to be Great” scheme – learning to be great apparently
involves giving seminars and convincing your friends to attend
AmWay is NOT a security

 Smith v. Gross – Gross sold earthworms to the Smiths w/ promise to
repurchase the baby worms at a stated price. It is clearly investment of $,
common enterprise, expecting profits. Is it solely from the efforts of
others (Smiths have to raise their own worms…)? Ct says that selling the
worms at a profit (not raising them) is the hard part - only way Smiths can
make money is if Gross builds up the worm market, so their expectation of
profit is based on the managerial or entrepreneurial efforts of others
57
vi.



vii.


(Gross), what they bought is an investment K and therefor a security
subject to SEC regulation
rent-pooling agreements
YES, often a security
pooling of condo rentals when not occupied by owners, you get a pro-rata
share of the rent
 emphasis in selling you the condo is on the profit you’ll make by
renting
if they’re saying “this is a great place to retire and vacation” – NO
life insurance on the terminally ill
if you assemble a portfolio of policies, get them to say yes to the
agreement, then present to investors – NO (at least in DC – “like showing
a painting”, all the entrepreneurial / managerial effort has already been put
in)
if you get investors and THEN go around getting portfolio of policies –
YES, security
58
XII. OTHER CONSIDERATIONS WHEN ISSUING SHARES
A. Preemptive Rights
1. Preemptive Rights = right of a current shareholder to purchase a proportionate
amount of newly-issued stock at the issue price
2. CL origins
a. part of inherent rights of share ownership
b. Stokes v. Continental Trust Co. – Stokes has 221 shares of stock, out of 5000
total. Corp issues 5000 more shares to a firm of private bankers for $450 per
share. Stokes asks to be sold 221 of the new shares at par ($100/share). Ct says
he has no right to buy at par value BUT he has a right to subscribe to the
additional shares in proportion to his existing shares at the ISSUE PRICE.
Right exists unless the new shares are issued to pay for property for the
corporation or to effect a consolidation. Remedy for Stokes is the difference b/t
mkt value on the date of the sale – sale price (measure of dilution of his equity)
3. Governed by Statutes OR Constitutions
a. “opt in” or “opt out”
i.
ii.
iii.






Opt In
No Preemptive Rights unless corporation elects them in the AoI
ex – 6.30(a) MBCA 1984 – no preemptive rights except as described in
AoI
Opt Out
preemptive rights exist unless the AoI say they do not
19 states, including NY
Should you have preemptive rights?
publicly held corp – NO - why bother, just more work
closely held corp – YES – address parties concerns re/ control and equity
dilution
b. 6.30(b) MBCA – general formulation (corp can vary this in the AoI as they
wish)
i.
statement that “the corporation elects to have preemptive rights” means
the following excepts as altered by the AoI
 (1) right to acquire proportional amounts of new stock upon decision
of Board to issue them
 (2) shareholders may WAIVE preemptive rights (irrevocable if in
writing)
 (3) no preemptive rights w/r/t:
 shares issued as compensation to directors, officers, agents, employees
of the corp or its subsidiaries or affiliates
 shares issue to satisfy conversion or option rights created to privide
compensation to directors, officers, etc.
59
 shares authorized in the AoI that are issued w/in 6 months after
incorporation
 shares for OTHER THAN MONEY (ie property, services, land)
 (4) no preemptive rights to holders of preferred shares w/o general voting
rights
 (5) no preemptive right for holders of voting stock to acquire preferred
stock w/o voting rights
c. generally familiar w/ kinds of exclusions for preemptive rights –
6.30(b)(3)
i.
ii.
iii.
iv.
shares issued as compensation to directors, officers, ee’s
shares issued for property, services, land
shares w/ no voting rights
preferred shareholders have no preemptive rights w/r/t ANY class,
whether preferred or not
B. Dilution of Shares (sale at artifically depressed prices)
2. Duty to Treat Existing Sh’s fairly
a. Board of Directors has a fiduciary duty to treat Shareholders fairly in issuing new
shares in a closely held corporation.
b. can’t be forced to choose b/t dilution of equity and exercise of preemptive rights
3. Burden Shifting Device
a. Katzowitz Test
i.
 must show:
 close corporation AND
 issuance price is markedly below book value AND
 remaining shareholders / directors benefit from the issuance
ii.
burden then shifts to ∆
 show that there is a valid “business reason” for the low price of the
issuance
 ex – desperate need for cash and can’t sell the shares at book value or
above, assets of corp aren’t worth as much as book value suggests s/a
because of a real estate crash
b. Katzowitz v. Sidler – Squeeze Out - K, S, and L are equal shareholders. L and S
decide to make a loan to another corporation, K disagrees. L and S call a special
meeting w/o K and agree to issue 75 shares of new stock at $100 each. Book
value of the shares is $1800 each. L, S, and K each get a check for $2500 paying
fees and commissions the corp owed them + notice of the right to buy 25 more
shares at $100 each, in accordance w/ their preemptive rights. L and S buy, K
doesn’t. When the corp dissolves, K gets $3000 and L and S get $19,000 each b/c
K’s equity has been diluted. NY Ct App says corollary to preemptive rights is
not to have to choose b/t dilution of equity and exercise of preemptive rights.
60
c. Hypo – L and S issue the shares at $1800 each (book value) but do so at a time
when they KNOW K can’t possibly invest b/c of financial situation.
i.
book value test? n/a
ii.
duty to treat fairly? – its fair to do this if there’s a business reason for it,
not if they’re doing it just to force him out of control of the company
61
XIII. CONSIDERATIONS - DISTRIBUTIONS TO SHAREHOLDERS
A. Fiduciary Considerations in Distributions
1. Dividend
a. No requirement that dividends be paid, even if there is a surplus BUT
i.
can retain earnings for plant expansions, increase salaries to zero-out and
minimize tax burden, etc.
b. Board cannot w/hold in bad faith if a surplus is present
i.
bad faith has something to do w/ personal interest of the Board
members (Gottfried)
 Gottfried Factors
 hostility of the controlling faction against the minority
 exclusion of minority from employment by the corp
 high salaries, bonuses, loans made to the controlling officers (lessens
their need for dividends)
 majority may be subject to high income tax if substantial dividends are
paid
 existence of a desire by the controlling directors to acquire the
minority interests for cheap (Freeze-Out tactic)
ii.
any interest other than the corporate welfare = bad faith (Ford)
 Board must act in best interests of the shareholders - profitability
 need a reason like “plant expansion” or “building brand loyalty by
dropping prices” or “raising employee salaries in the face of competition
for their labors” to keep large amts of surplus around
 NOT “good of society” – purpose of corporation is (implicitly)
profitability for shareholders
 Gottfried v. Gottfried – minority shareholders complain that there have
been no dividends paid on common stock. Ct says shareholders can’t
complain unless bad faith w/holding. Bad faith is “in the personal
interests of the controlling group”. No bad faith w/holding here surplus is recent, shares have been redeemed (so s have gotten lots of
money from the corp recently, ∆ not trying to deprive), dividends are
NOW being paid, dividends have been paid in the past on the preferred
shares
 Dodge v. Ford Motor Co. (1919) – Minority shareholders complain that
Herny Ford is refusing to pay them large special dividends as he has in the
past, even though the corp made lots of money - he wants to lower prices,
expand plants / expand production so more people can have cars “for the
good of society” (they are receiving regular dividends as expected). Ct
says Board has duty to pay the special dividends, act in interests of the
shareholders – any w/holding not in the interests of the corp profitability is
bad faith.
62
Ford Balance Sheet #1 – they made 60% on initial $2mill investment
Assets
Liabilities
cash / bond
$54,000,000 Liabilities
$18,000,000
other (fixed assets)
$78,000,000 Shareholders’ Equity
stated capital
$2,000,000
retained earnings $112,000,000
-------------------------------$132,000,000
$132,000,000
Ford Balance Sheet #2 - $98mill in “stock dividends” = reinvestment, return “piddling”
(stock dividends par value amt impounded in stated capital if they have one)
Assets
Liabilities
cash / bond
$54,000,000 Liabilities
$18,000,000
other (fixed assets)
$78,000,000 Shareholders’ Equity
stated capital
$100,000,000
retained earnings $14,000,000
------------------------------$132,000,000
$132,000,000
2. Salary
a. burden to show reasonableness of salary is on the interested party (ie if
Director sets his own salary)
i.
 says “the salary he set for himself is too high. he’s a fiduciary of the
corporation, so he can’t do that”
ii.
∆ must then prove it was reasonable
iii.
Wilderman v. Wilderman – Ms. W claims that her ex-husband is paying
himself too much salary, the extra $ should go back in corp treasury and be
distributed as dividends. Ct says the salary they agreed on is clearly ok, the
discretionary bonus he gave himself he must prove was reasonable. Ct says it
wasn’t reasonable, he should give it back. She can then ask for div’s in
another action.
3. Redemptions / Repurchases
a. The Close Corporation Context
i.
Repurchase / Redemption
 when corp repurchases its own stock, it’s a distribution to shareholders
 transfer of $ from the corp to the shareholders
 as long as proportional, nothing changes w/r/t control, dividends, etc.
 BUT if shares are held by corp and then resold (not retired) they can
be resold for anything, even ineligible consideration, and control thus
disrupted
ii.
Some states – shs of a closely held corp are equivalent to partners as
far as fiduciary duty is concerned (M v. S)
63
 not universal
 DELAWARE rejects Donahue, rejects special rules for close corporations,
uses “apparent fairness” test (Nixon v. Blackwell, p452N9)
iii.
Equal Opportunity Doctrine
 shareholders may not sell shares back unless all other
shareholders have same opportunity at the same price
 application of the Meinhart v Salmon type duty – punctilio of honor
(1) duty belongs to the SHAREHOLDERS (not the directors of the
corp, b/c not all maj shareholders are on BoD)
 Close Corp Test (Donahue)
(1) small # of shareholders
(2) no ready mkt for shares
(3) majority shs participate in mgmt, direction, operation of the corp
 refinement of Donahue
(1) if corp can rebut - show legit business reason for not offering to
minority at same price
(2) minority  can then rebut – show less onerous alternative
 Donahue v. Rodd Electrotype Co – MASS. case - Donahue is a minority
shareholder, BoD offers to repurchase shares at $800/share to majority,
$200/share to minority. Ct says: where close corporation, duties of
shareholders to each other are like p’ship duties (punctilio of honor, etc.),
so need to offer to repurchase minority shares at same price.
b. Gaping void for NOT-close corporations – we talked about a reverse “issuance”
test, most likely filled by some sort of fairness test
B. Statutory Restrictions on Distributions to Shareholders
1. ‘69 MBCA - 45
a. Distributions so long as corp not Insolvent
i.
Out of Earned Surplus
ii.
“nimble dividends” – no earned surplus, can pay out of profit is the corp
has been profitable for at least the last 2 years
iii.
Out of Capital Surplus (§ 46)
 provided for in AoI OR
 majority of shareholders of each class of stock votes to approve
 Notice to shareholders that this is a return of capital, not a dividend
b. NO distributions out of stated capital
i.
flexibility in moving accounts from one acct to another
 § 69 / § 70 – can reallocate stated capital to cap surplus by approval of the
Board and vote by the shareholders
 § 21 – Stated Capital MUST equal sum of par values of shares outstanding
(unless no par, in which case BoD discretion)
c. Insolvency Test – inability to pay debts as they come due
i.
depends on long term debt vs short term debt
64
ii.
iii.
depends on how liquid assets are
ex – if short term debt is much larger than equity – how will corp pay off
the debts
2. ‘84 MBCA – 6.40
a. equity insolvency test AND
i.
ability to pay debts as they come due
b. balance sheet test (both tests must be satisfied)
i.
assets greater than liabilities after the distribution is made
 “overage” is what’s available for distribution
ii.
not governed by historical cost accounting
c. 6.40 – Distributions to Shareholders
i.
(a) Board of Directors may authorized distributions UNLESS
ii.
(c)
 (1) Equity Insolvency Test – distribution would make corp unable to pay
debts as they come due OR
 (2) Balance Sheet Test – total assets would be LESS THAN total
liabilities (plus amt needed to satisfy preferential rights of shareholders not
receiving the distribution at dissolution)
iii.
(d) Directors can base determination on financial statements prepared
based on reasonable accounting standards OR fair valuation OR method
reasonable under the circumstances
3. Impairment of Capital Statutes
a. Del – distributions from any surplus, avoid impairing stated capital accounts
i.
close in spirit to ’69 MBCA
ii.
allows “nimble dividends”
 crucial to attracting new shareholders to a corp w/ lots of debt – only need
profitability for 2yrs and dividends can be distributed
iii.
“reevaluation surplus”
 can examine FMV of all assets to get a surplus
 can’t just reevaluate the profitable assets and not the losing ones
 ex – assets are $50K in cash and land w/ historical value of $50K (what
was paid for it). Land is now worth $80K. So $30K reevaluation surplus
in the capital accounts.
4. directors’ personally liable
a. directors are personally liable if distributions are declared in violation of statutory
tests
i.
’69 MBCA - § 48
ii.
’84 MBCA - § 8.33
65
XIV. MANAGEMENT AND CONTROL
A. TRADITIONAL ALLOCATIONS
1. Strict Adherence to Traditional Allocations
a. Relvance
i.
Public corps
ii.
Close corps w/ potentially complaining minority (if there are ANY
shareholders not part of the agreement)
b. Shareholders can Contractually Agree on anything they can vote on
i.
principally
 removal / election of Directors including filling vacancies
 amendment of the bylaws
 call for shareholder’s meetings
ii.
Shareholders CANNOT agree on anything that’s the role of the Board
(election of officers, power to manage company, etc.)
c. McQuade v. Stoneham – McQuade is a shareholder, agrees w/ the other
shareholders that they will (1) continue to elect him as a director and (2) as
directors, they will continue to elect him as Treasurer. They pick a new treasurer
over his objections. Ct says Board gets to pick officers, so shareholders can’t
K on who they’ll be - Board’s independent business jment. Shareholders
CAN K on anything they get to vote on, including who the directors will be.
Dir’s can’t K on who they’ll elect as officers b/c have duty of using their own
business jment, can’t abrogate it by quid pro quo. Solution: they could give
him a long-term employment K (he could get damages if they fired him) OR
create new class of stock that you must have to be Treasurer and issue it to him
only
d. Matter of Auer v. Dressel – NY - Sh’s seek to compel a special stockholder’s
meeting (statute says a majority of sh’s can compel Pres to call a meeting for a
valid purpose). Pres refuses, stating they have no valid purpose. (1) endorse
previous Pres. Auer and call for his reinstatement – proper b/c sh’s can express
opinions, just can’t elect officers (2) amend bylaws to allow the sh’s to fill
vacancies on the Board – proper b/c sh’s can amend bylaws, can fill vacancies on
the Board (even though Board can also do so) (3) removal of directors – proper
b/c inherent in the CL power to elect them is power to remove for cause (4)
amend bylaws to change quorum req’s – proper b/c can fiddle w/ quorums in
bylaws unless AoI say no
2. Deviation from Traditional Allocations
a. Possible for Close corps w/ NO complaining minority
b. Slight Impingement + No Injury to Minority
i.
ii.
iii.
Some States (ex – NY)
Sterilizaton of the Board vs. Slight Impingement on Board’s control
Injury?
 Complaining Minority? – if ANY shareholders ARE NOT part of the
agreement, use bright line rule of McQuade
66
 minority who’s not part of agmt can complain b/c Board should always
have freedom to pick someone better (regardless of whehter person agreed
to is good too)
 “Slight Impingement Test” works only if ALL the shareholders are parties
to the agreement
iv.
Clarke v. Dodge – Clark owns 25%, Dodge owns 75%. They agree that
Clark will continue as general mgr of the corp so long as he is “faithful,
efficient, and competent”. Dodge attempts to fire him, Clark seeks specific
performance of the agreement. Ct says agmt is enforceable b/c only a “slight
impingement” on the power of the Board of Directors.
v.
Long Park v. Trenton Theaters – all shareholders agree to give one
shareholder all power to manage the company. Ct refuses to enforce b/c the
agreement “STERILIZED” the BoD
c. Galler v. Galler No Damage Test (Illinois)
Invasion of the Board’s power by Shareholder agreements permissible in
close corporations IF NO ACTUAL HARM TO:
 shareholders not a party to the agreement
 public interest (legislative prohibitions define public interest)
 creditors of the corporation (ie if not enough money left)
ii.
Galler v. Galler – 2 brothers are shareholders, agree w/r/t: amendment of
bylaws (OK – traditional allocation test); election of directors (OK –
traditional allocation test); declaration of specified amt of dividends (OK – no
injury test); widow’s annuities (OK – no injury test). Says close
corporations are special b/c Shareholders WILL be managing anyway, in
their role as directors AND NO EXIT available b/c no market for the
shares so they should be allowed to plan in advance
i.
d. Pursuant to statutory authorization
i.
ii.





Integrated Close Corporation Statutes (ex – Delaware)
file for incorporation under the special law for close corporations
look to that law for rules
Non-Integrated Close Corporation Statutes (ex – MBCA)
If you are a close corporation you make a statutory election and then:
 put provisions in the AoI OR
 get ALL Sh’s to agree in writing
general corp laws apply except to extent that AoI / agreement provide
otherwise
7.32 Shareholder Agreements
 Can, by agreement of ALL the sh’s in the AoI, bylaws, or written agmt
(valid for 10 years):
(1) eliminate or restict the BoD
(2) authorize distributions
67
(3) establish who shall be directors or officers, their term of office or
process for removal
(4) weighted voting rights, proxies among the Directors / Sh’s
(5) includes provisions for property/services provided by a Sh, dir,
officer, ee
(6) transfers to the Sh’s or someone else all authority to manage,
including provision for resolving deadlock
(7) allows dissolution by request of a Sh, or upon another specified
event
 need to note the existence of agreement conspicuously on front or back
of stock certificates
(1) if no notice, agmt still enforceable but buyer who buys w/o notice
can rescind purchase w/in 90 days of discovery of agmt
 ceases if security is ever listed on national exchange
e. COULD HAVE elected under a statute
i.
statutory scheme is NOT mandatory
 Cts disagree
 NY – OK so long as you could’ve elected, even if you didn’t bother
 DEL – you need to make the election to get the protection (Nixon v.
Blackwell)
ii.
Zion v. Kurtz – NY – Kurtz and Zion make shareholder’s agreement that
there can be no changes in policy or business of LWG unless holder of Class
A shares (Zion) agrees - complete sterilization of the Board. Ct says they
could’ve elected under the statute, agreement is still enforceable even though
they didn’t
f. Hypotheticals
i.
ii.
iii.
iv.
v.
vi.







If majority Sh demands a particular transaction, must the Board comply?
NO, but Sh will probably replace the Board at the next annual meeting if
they refuse
Can Sh remove a Director solely for not doing what the Sh wishes?
YES – ’84 MBCA 8.08
unless the AoI say “for cause only”
some statutes have default “for cause”, can opt for “any reason”
Can majority Sh demand a particular officer be elected?
NO, Board doesn’t have to be “yes-men”, but can be removed
Can Corp enter a long-term Management K w/ a non-director?
complete delegation may be against public policy
Can Board delegate its mgmt responsibilities to a committee of itself?
YES – 8.25
 delegation NOT irrevocable
 certain things like distributions, bylaw changes are NOT delegable
can one Board bind another by making a long-term ee K w/ an officer?
68
 YES – 8.43 – officer can be removed at ANY time BUT doesn’t affect his
K right to damages
B. BY SHAREHOLDERS – ACTS THEY MIGHT SEEK TO TAKE
1. Sources of Authorization
a.
b.
c.
d.
State Constitution, State Statutes
AoI, Bylaws
Case Law
layers – ex – authority to amend bylaws “for a proper purpose”
i.
just b/c they can amend, doesn’t mean they can ammend for any purpose
e. MBCA Specific Authorizations – there are something like 8
i.
8.03 Election of Directors
ii.
8.08 Removal of Directors
iii.
10.20 Amend the Bylaws / Articles of Incorporation
iv.
11.03 Merger
v.
12.02 Approve sale of assets not in the ordinary course of business
vi.
14.02 Approve dissolution / liquidation
vii.
8.63 Ratify conflict of Interest transactions
viii. 8.55 Indemnification of Officers and Directors
ix.
7.02 10% can compell calling of a shareholder’s meeting
x.
8.10 fill vacancies on the Board (BoD can do this too)
2. Vocabulary
a. election inspector – manages election, decides who gets to vote, counts votes;
his decision stands unless court says otherwise – 7.29
i.
Salgo v. Matthews – Court determines that (1) what election inspector
decides is the final word absent a challenge in court and (2) record owners,
not beneficial owners get to vote b/c beneficial owners can vote by getting a
proxy from the record owners, too hard if corp has an obligation to figure out
who beneficial owners are
b. registered owner / record owner – entitled to vote the shares; owner of the stock
listed on the corporate books
c. beneficial owner – shares were purchased by someone new but not transferred on
the books of the corp OR shares are held in a street name (ex – Morgan Stanley)
but are “really” owned by the beneficial owner
d. record date – date on which corporation determines record owners for purposes
of notice, eligible for voting at a meeting – whoever owns it on the books on that
date gets to vote the shares
i.
7.07 – no more than 70 days before the meeting
ii.
set by the bylaws or the BoD
iii.
if not fixed, is the day the first notice is delivered (7.05)
69
e. notice – corp must notify all shareholders eligible to vote of time, date, place of
annual or special shareholder’s meetings
i.
7.05 - more than 10 days before, less than 60 days before
ii.
no requirement of actual receipt – just mail it to shareholders at their
address of record
f. waiver – shareholders can waive notice by a signed writing (7.07)
i.
attendance at a meeting waives objection to lack of notice unless the
shareholder objects at the beginning of the meeting
g. annual meeting – corp must hold a meeting of shareholders every year at a time
set or fixed in accordance w/ the bylaws (7.01)
i.
primarily for annual election of directors
ii.
can address any purpose w/in ambit of shareholder control
h. special meeting – can be called by Board of Directors or by 10% of all
shareholders eligible to vote on an issue or by others specified in the bylaws
(7.02)
i.
limited to purposes specified in the notice of the meeting
i. quorum – number of attendees needed to take a binding vote
i.
7.25(a) – shares entitled to vote as a separate voting group may take
action on a matter only if a quorum of those shares exist at the meeting
 quorum equals a majority of the votes entitled to be cast on the matter
by the voting group (unless AoI or statute specify otherwise)
 amendments to quorum requirement and voting requirements must be past
by the greater of the proposed requirement or the requirement currently in
effect
j. dribbling quorum – meeting begins w/ quorum present, members then leave and
don’t come back in order to break the quorum and prevent a vote; prevented by
statute in the MBCA
i.
7.25(b) – once a share is represented for any purpose at a meeting, it is
deemed present for quorum purposes for the remainder of the meeting
k. voting group – group of shareholders that vote together on a particular issue
i.
7.25 – need a quorum of each group of shares entitled to vote as a separate
voting group
ii.
7.26 – Action by Single and Multiple voting groups – if an issue requires a
single voting group action is taken by plurality vote of that group; if an issue
requires multiple voting groups action is taken by independent plurality vote
of each group taken separately
iii.
10.04 – Voting on Amendments by Voting Groups – holders of a class of
shares are entitled to vote as a SEPARATE VOTING GROUP w/r/t actions:
 cxchange or reclassification of shares of that class into another class
70
 exchange or reclassification of shares of another class into shares of that






class
changes to the rights, preferences, or limitations of all or part of the shares
of the class
changing number of shares in the class into a different # of shares
increases to the rights, preferences, or number of authorized shares of
another class that, after the change, would have rights in dissolution that
are superior to those of the class
limit or deny an existing preemptive right
cancel or otherwise affect rights to accumulated but unauthorized
dividends
ex – Class A shares vote for 3 Directors, Class B shares vote for 2 – 2
voting groups
l. voting requirement – need a greater number of affirmative votes than negative
votes (7.25) UNLESS
i.
AoI says otherwise
ii.
election of Directors (7.28) – can opt for cumulative voting in the AoI OR
plurality of votes cast by the shares entitled to vote
m. plurality voting – Directors are elected by a plurality of votes cast at a meeting
where quorum is present 7.28
i.
unless modified by AoI
n. straight voting – each share gets one vote for every opening on the Board.
Majority shareholder can elect every member.
i.
ex – A owns 26 shares, B owns 74 shares. There are 3 slots on the Board
and directors run “at large”. A may thus cast 26 votes for each of 3 canditates
and B may cast 74 votes for each of 3 candidates.
 A1 gets 26, A2 gets 26, C gets 26 + 74, B1 gets 74, B2 gets 74
 the Board is therefor B1, B2, and C
ii.
Stancil v. Bruce – Howard votes 18,750 for himself and 18,750 for his
wife Clara (cumulatively), while Bruce votes straight 12,500 for himself,
12,500 for his wife Eva, and 12,500 for Sarah Barnes. Board is thus Howard,
Clara, and maybe Bruce. If Bruce had voted cumulatively for himself and his
wife, there would’ve been a four-way deadlock and the old board would’ve
stayed (old one wast Bruce, Eva, Howard)
o. cumulative voting – each shareholder has a number of votes equal to the number
of shares they hold times the number of Directors being elected. Increases
minority control on the Board by making it possible for a minority to elect a
director. 7.28 = no cumulative voting UNLESS the AoI say so (OPT-IN if you
want cumulative voting)
i.
if 50/50 and even # of Directors, they each get 50% of the Board
71
 if odd # of Directors, possible to Deadlock over who the odd director is
ex – A owns 26 shares, B owns 74 shares. There are 3 slots on the Board
of directors and directors run “at large”. A has 26 x 3 = 78 votes. B has 74 x
3 = 222 votes. A wants to assure her own election.
 A gets 78 votes, B1 gets 79 votes, B2 gets 79 votes, B3 gets 64 votes
 Board is A, B1, and B2
 A was assured of a slot by casting all 78 votes for herself – no way B can
divide 222 votes among three directors and give all of them more than 78
votes
iii.
ex – DEADLOCK – A owns 50 shares, B owns 50 shares. A wants to
assure her own election
 If there are 2 slots
 A gets 100, B1 gets 99, B2 gets 1
 If there are 3 slots (odd number)
 A1 = 76, A2 = 74, B1 = 76, B2 = 74 – deadlock on B2 vs A2
 A1 = 76, A2 = 74, B1 = 75, B2 = 75 – Board is A1, B1, B2
 A1 = 75, A2 = 75, B1 = 75, B2 = 75 – deadlock
 A1 = 76, A2 = 74, B1 = 77, B2 = 73 – Board is A1, A2, B1 (B voted
irrationally, A wins even by following conservative strategy)
ii.
p. formula for cumulative voting
i.
number of shares needed to elect one director = (S / (D + 1)) + 1
 S equals total number of shares voting
 D equals number of directors to be elected
 (S / (D+1)) is the maximum shares voted for a single person that is
insufficient to elect that person as director. Any share or fraction thereof
in excess of that amount is enough to elect a director
ii.
number of shares needed to elect n directors = (nS / (D + 1)) + 1
 n = number of directors you can elect
 S = total number of shares voting
 D = numver of directors to be elected
iii.
ex – if 9 directors to be elected
 (100 / (9 + 1)) + 1 = 11
 someone w/ 11% holding can guarantee election of one director
 if 3 directors elected
 (100 / (3 + 1)) + 1 = 26
 need to have 26% holding to guarantee election of one director
 if you have 90 shares and 3 directors
 (90 / (3 + 1)) + 1 = 22.5 + 1 = 23
 need 23% holding to guarantee election of one director
72
q. classification of directors / staggered board – can stagger the board so each
director serves for 3 years and only 1/3 of the Board is up for election in any
given year
i.
8.06 – divide the Board into 2 or 3 classes w/ as nearly equal numbers as
possible (traditionally, could only work for Boards w/ 9 or more Dir’s)
ii.
makes it more difficult for minority faction to elect a Director (see above –
you need more shares to elect 1 in 3 than 1 in 9)
iii.
makes take over attempts more difficult (if Directors can be removed only
for cause)
iv.
Humphrys v. Winous Co – Board of 3 directors being classified into 3
groups. Minority complains this means they can never elect anyone, thus
destroying the benefits of mandatory cumulative voting.
r. shareholder pooling agreement – Voting agreement. 2 or more shareholders
can provide for the manner in which they will vote their shares by signing an
agreement (7.31)
i.
specifically enforceable (Compare Ringling – Ct disallowed
nonconforming votes, did NOT specifically enforce the agreement)
s. proxy – shareholders may vote in person or “by proxy”. Proxy is appointed by
shareholder or his agent to vote or otherwise act on behalf of the shareholder
(7.22)
i.
valid for 11 months unless specifically stated longer on the appointment
form
ii.
REVOCABLE at any time UNLESS coupled w/ an interest
t. proxy coupled w/ an interest – proxy is revocable unless it is accompanied by an
interest. If accompanied by an interest and apppointment form conspiciously
states “IRREVOCABLE”, the proxy is irrevocable
i.
Interest = (7.22)
 appointment of a pary to a voting agreement created under 7.31
 appointment of a pledgee
 appointment of a person who purchased or agreed to purchase the shares
(but is not the record owner)
 creditor of the corp who extended cred under terms requiring the
appointment
 employee of the corp who’s employment K requires the appointment
ii.
revoked when accompanying interest is extinguished
u. voting trust – shareholders convey legal title to the trust, conferring on the trustee
the right to vote or otherwise act for them (7.30)
i.
can last no more than 10 year
ii.
can be extended by signing an extension agreement of not more than 10
years (effective for 10 years after the first person signs)
73
iii.
when voting trust agmt is signed, trustee prepares list of names and
addresses of the owners of beneficial interests in the trust and deliver copies to
the corp office
v. buy – sell agreement – one party is obliged to buy or sell to the other
i.
option – right of first refusal – if one party wishes to sell he must first
offer the shares on the same terms to the other
ii.
cross-purchase – one shareholder is obligated to buy from the other in
certain circumstances
iii.
redemption agreement – agreement that the corporation will buy back
shares from the shareholder under certain circumstances
iv.
Why do this?
 planning for a deadlock or disagreement
 could make the stock more attractive to investors in a small corporation
 protect a family investor, either by allowing them to keep control if shares
are offered to outsiders or to have an exit if they no longer want to
participate
 estate planning – in case of death of a shareholder, estate gets cash not
merely an interest in a business they can’t or don’t want to help run
w. action by written consent – shareholders can act w/o holding a meeting if there
is UNANIMOUS written consent. (MBCA 7.04)
i.
Delaware provides for MAJORITY written consent EXCEPT for election
of Directors (228)
ii.
convenient for small corporations
3. Control Devices – planning to help clients achieve the control
arrangements they choose
a. Quorum Req
i.
ii.
iii.
“majority” under statute - MBCA 7.25
can be raised in the AoI – 7.27
makes it harder to take action
 ex – if unaanimity is req’d to get a quorum, one shareholder can prevent
action by staying away
b. Voting Requirement
i.
ii.
iii.
if affirmative votes outnumber votes opposing – 7.25(c)
“plurality of a quorum” for directors under statute – MBCA 7.28
can be raised in the AoI – 7.27
c. Class Voting (Voting Groups)
i.
ii.
can be required by a specific provision in the AoI
Could create different classes, each w/ right to elect certain # of Directors
74
 (alternatively, create classes that must be owned to act as an officer or
Director and make them non-transferable)
iii.
MBCA 10.04 – only specifies voting groups for amendments affecting the
rights of classes of shares
iv.
8.04 – AoI may authorize election of all or specified number of
Directors by the holders of certain classes of authorized stock
d. Removal of Directors
8.08 – can be removed w/ or w/o cause
 for cause only – if AoI say so
 only at special meeting called for the purpose of removing him
ii.
8.08 – can only remove a Director elected by cumulative voting if the # of
votes for removal would’ve been enough to block his election originally
i.
e. Classification of the Board / Staggering the Board
8.06 – can divide the total Board into 2 or 3 groups each containing as
near to 1/2 or 1/3 as possible
 they serve for 2 or 3 years, only 1/2 or 1/3 is up for reelection in a given
year
ii.
can be used to reduce ability of minority to place a Director on the Board
iii.
reducing the # of members on the Board has same effect w/r/t power of
minorities
iv.
Humphry v. Winous Co – one statute mandates cumulative voting, another
allows for staggering the Board. Minority shareholders complain b/c Board
has 3 Directors and is staggered in thirds, so they never get to elect anyone.
Ct says statute doesn’t guarantee that minorities will get represented, just that
cumulative voting will be available to them.
i.
f. Shareholder Pooling and Agreements
i.
Is the Agreement Enforceable?
 Are they trespassing on the traditional allocations of power to the Board?
(McQuade)
 Are they a close corporation, but oppressing a minority? (Donahue)
 is it an illegal Voting Trust? (Abercrombie v. Davies test)

ii.
what Method of Enforcement?
 proxy – makes it basically self-executing (see below under “irrevocable
proxy”)
 worry about revocability
 worry about illegal voting trust
 no implied proxies – NEED EXPRESS proxy appointment form
 need specific enforcement
 injunction of non-complying votes (Ringling)
75
 Ringling Bros.-Barnum & Bailey Combined Shows v. Ringling –
Ringling and Haley agree to “act jointly” in all matters relating to their
stock – this way they can elect 5 directors regardless of what North
does (alone they can each elect only 2). If they cannot agree, arbitrator
to make a binding decision that they will vote in accordance with. 
Ringling seeks to enforce the agreement when Haley breaches it. ∆
says it is unenforceable as an illegal voting trust (statute said “no
irrevocable separation of ownership from voting power”). Ct says not
an illegal voting trust b/c arbitrator himself was not empowered to
vote, so agmt is enforceable. Ct disallows the non-complying votes, so
Board consist of North’s 3 candidates and Ringling’s 3 candidates w/
one vacancy to be filled at upcoming meeting.
g. Irrevocable Proxies
i.
ii.
iii.
iv.
v.
makes Shareholder’s Agreement SELF-EXECUTING
 no need to worry about getting specific performance or not in court
proxy appointment must conspicuously state “Irrevocable”
must be coupled w/ an interest 7.22
 appointments are coupled w/ an interest if the appointment is of:
 a party to a voting agreement created under section 7.31 (watch out
for trouncing on powers of the Board, presence of a potentially
complaining minority ie shareholders not party to the agreement)
 a pledgee
 a person who purchased or agreed to purchase the shares
 creditor of the corporation who extended credit on terms requiring the
appointment
 employee of the corporation whose employment K requires the
appointment
 (list is non-exclusive – generally, intended to ensure your interests are
parallel to that of the corp)
unclear whether a non-shareholder can be a party to a shareholder’s
agreement under 7.31
 thus, unclear whether an arbitrator under a shareholder’s agreement could
be given an irrevocable proxy
 under NY 620 – clearly ok to have a non-party involved in an agreeement
otherwise, revocable at any time
h. Voting Trust
i.
Abercrombie v. Davies test (for when a shareholder’s agreement is a
voting trust and thus subject to statute)
 voting rights of the stock are separated from the other attributes of
ownership (like getting dividends)
 voting rights granted are intended to be irrevocable for a definite period of
time
76
 principal purpose of the grant of voting rights is to acquire voting control
ii.
iii.
iv.
v.
of corporation
 ex – Ringling Brothers – no voting trust b/c arbitrator wasn’t actually
empowered to vote himself, just to make decisions
statutes - make sure the trust complies w/ statute in your state
 7.30 – Voting Trusts
 (a) one or more shareholders may create a voting trust, conferring on
the trustee the right to vote or otherwise act for them, by a signed
writing
(1) shares are transferred to the trustee
(2) trustee must submit a list of beneficiaries of the trust to the corp
 (b) valid for not more than 10 years from signing
 (c) can be extended in increments of not more than 10 years from the
date the extension is signed
statutory exceptions
Brown v. McLanahan – voting trust nearly over. Trustees who are also
debenture holders amend the AoI to confer voting rights on debenture holders
to the detriment of preferred shareholders (s). Ct says voting trust trustees
can’t benefit one class of beneficiaries over another, conferral of voting rights
on debenture holders not contemplated by statute.
Lehrman v. Cohen – 2 families each own 50% of Giant Food, each
entitled to elect 2 Directors. They create stock class AD that is allowed to
elect a 5th Director to break future ties. AD votes along w/ ∆ to make himself
President,  sues saying its an illegal voting trust and thus unenforceable. Ct
finds that attributes of ownership have not been separated from voting power
b/c AD stock didn’t diminish voting rights of  or ∆ stock, dilution was part of
capitalization of the company (used Abercrombie v. Davies). Ct says public
policy of voting trust statutes is preventing secret, uncontrolled combinations
of stockholders from acquiring voting control. Public policy suggests that
corporations should have broad powers to do stuff like what Giant did in order
to plan for future control issues.
i. Restraints on Transfer of Shares (6.27)
i.
form of commemoration of restraints
 must be in AoI
 must be referred to on front or back
 no need to be copied in full – can merely reference the AoI
 viusally conspicuous
 if conspicuous – CONSTRUCTIVE NOTICE
 if inconspicuous – still can’t sue if you had actual knowledge of the
restraint
 1.40(3) – Conspicuous
(1) reasonable person should have noticed it – includes different font,
italics, boldface, underlined, all caps, contrasting color
77
ii.
iii.
iv.
actual / constructive notice
reasonableness test
MBCA 6.27 – Restriction on Transfer of Shares or Other Securities
 (b) restriction is valid against holder / transferee if it is authorized by
this section AND its existence is noted conspicuously on the front or
back of the certificate (not enforeceable against someone w/ no notice of
the restriction)
 (c) authorized purposes
 maintain the corp status when it is dependent on the number or identity
of shareholders
 preserve exemptions under federal or state securities law
 for any other reasonable purpose
 (d) restriction may:
 obligate the Sh to first offer the corp or other persons an opportunity to
buy the shares
 obligate the corp or other persons to buy the shares
 require the corp or other persons s/a holders of a class of shares to
apporve the transfer (if not manifestly unreasonable)
 prohibit the transfer of shares to a designated person or class of
persons (if not manifestly unreasonable)
v.
Ling and Co v. Trinity Savings and Loan – restrictions on transfer set
aside by trial ct b/c message wasn’t conspicuous b/c it didn’t include the
whole agreement, merely a reference to the AoI and b/c the restriction was
unreasonable. Ct says it was conspicuous, reference to AoI is enough. Ct
says requiring the transferor to offer shares to every single shareholder first is
unreasonable restriction if many shareholder, but no showing of that made.
j. Buy – Sell Agreements
Option – right of first refusal
Cross-Purchase Agreement
 among or b/t shareholders
 one Sh has to purchase from another in certain circumstances
iii.
Redemption Agreement
 corp must repurchase
 can add provision saying that shareholders must do it if corp can’t (s/a
b/c of insufficient liquid assets)
i.
ii.
4. Deadlock and Dissention of Shareholders (can also occur on BoD but not
considered so bad b/c of fiduciary duties involved)
a. causes
i.
if cumulative voting and odd # of directors, can deadlock on the odd
director
 w/ even # up for election, each will get 50% of the Directors
78
b. planning to avoid it
i.
can put stuff in shareholders agreement
 buy / sell agreements
 triggering events s/a deadlock that automatically cause dissolution
(authorized in 7.32(a)(7))
 tiebreaker stock is an option (Lehrman v. Cohen)
ii.
8.10 (a) – Board of Directors can fill vacancies on the Board (so can Shs)
 if remaining Board members are less than a quorum, they can fill the
vacany by affirmative vote of a MAJORITY of the remaining members
 ambiguous under the ’69 MBCA
iii.
DON’T have an even # of Directors (invites deadlock)
c. judicial intervention - Dissolution
i.
statutes
 14.30 – Grounds for judicial Dissolution of Corporation
 The courts MAY dissolve a corporation:
 (2) in a proceeding by a shareholder, if it is established that:
(1) the Directors are deadlocked as to management of the corp, the
shareholders are unable to break the deadlock, and irreparable
injury to the corporation is threatened, or the business of the corp
can no longer be conducted to the advantage of the shareholders
generally, b/c of the deadlock
(2) directors have acted in a manner that is illegal, oppressive, or
fraudulent
(3) shareholders are deadlocked in voting power and have failed for
two consecutive annual meeting dates to elect successors to
directors whose terms have expired
(4) corporate assets are being misapplied or wasted
 14.34 – buy out option in lieu of Dissolution (ct ordered)
ii.
judicial discretion under statutes
 “object of corporate existence” test
 object is profit – if its still profitable, ct will not use its discretion to
dissolve
 cts tend to converge on “profit” b/c shareholders have divergent
interests beyond profit
 Radom v. Neidorff – brother wants to dissolve corp b/c sister is suing him
for breach of fiduciary duty, withholding his salary. Ct agrees that it has
power to dissolve the corp, but uses its statutory discretion to forgo doing
so. Ct says the business is profitable, dissolution would be good for him
(he can go start a new one), BAD for her b/c she can’t run this business
and its main “asset” is really his skill and good will which is not
distributable at liquidation + it’s a cash cow (probably couldn’t get same
return by reinvesting proceeds of liquidation). Note that they could agree
79
to appoint a neutral 3d director, brother can sue corp for his back pay, if he
leaves and forms a new company he’ll get sued for breach of duty, no
possibility of buyout b/c she doesn’t want to sell her shares or buy his.
creativity in decrees of remedy (no cases)
iii.
d. “exploiting” circumstances / unclean hands – someone takes advantage to
create / avoid deadlock
i.
breaking quorum requirements to fill vacancies (not advisable)
ii.
Gearing v. Kelly – Director stays away from Board meeting solely to
prevent a quorum from assembling. While away, 3 other members showed
up, one retired, the other 2 (not a quorum) filled the vacancy. Majority
refuses to allow her to complain b/c she caused it (unclean hands), uphold the
election of the 3d director. Note that what she wanted was another person on
the Board of her choosing, which she couldn’t get at shareholder’s meeting
election of 4 directors b/c she has 50%, the other side has 50%
C. DIRECTORS
1. Board action translates into AGENCY AUTHORIZATION
a. typically, they’re authorizing the officers to act
2. How Boards take valid action
a. meeting (including conference calls) 8.20
i.
ii.
iii.
iv.
v.







meeting 8.20
any means of communication by which all the directors participating may
simultaneously hear each other during the meeting (includes conference
call or video conferencing)
notice 8.22
regular meetings can be held w/o notice of time, date, place, purpose
special meetings MUST be preceded by AT LEAST 2 DAYS NOTICE of
time, date, place
waiver of notice 8.23
Director can waive notice by a signed writing at any time
appearing at the meeting waives any required notice to him unless he
objects at the beginning and doesn’t vote or assent to action at the meeting
quorum
8.24(a) – quorum equals a majority of the Board of Directors
 AoI can increase # for a quorum, can decrease it to NO LESS THAN
1/3 of the size of the Board
voting requirement
8.24(c) – affirmative vote of a majority of the Directors present in a
quorum
 AoI can increase # of Directors needed
b. unanimous written consent (8.21)
i.
need a writing signed by all Directors
80
3. After the Fact
a. if corp is arguing – can ratify or adopt the action to give the corporation
authority retroactively
b. 3p is arguing
i.
apparent auth by corp
 can be created expressly or by silence / acquiescence
ii.
silence / acquiescence – informal action
 can retroactively authorize an action already taken OR imply authority for
future acts of the same type
 Mickshaw v. Coca-Cola - Feinberg Secretary / mgr / Director of bottling
iii.
plant announces corp will pay salaries of draftees while they are at war.
Ee comes back from war, demands payment. Corp says Feinberg was one
director, another Director clearly knew and said nothing, the 3d director
never said anything either SO the corp is bound. EITHER b/c the BoD
approved by acquiescence (actual auth) OR b/c they appeared to acquiesce
by not objecting to the newspaper ad (apparent auth)
Inherent Power of Officers (see below)
D. OFFICERS / ACTIONS BY OFFICERS
1. review of types of authority
a. Actual
i.
Express Actual Authority – in advance or by ratification / adoption by
the Board
 sources = State Constitutions, statutes, AoI, bylaws, specific resolutions of
the Board of Directors
ii.
Implied Actual Authority – acts w/ KNOWLEDGE AND
ACQUIESCENCE of the Board of Directors
 can retroactively authorize an action already taken
 can create implied authority for FUTURE acts of the same type
b. Apparent – created by manifestations of the Principal to 3ps
c. Inherent – goes with the position
2. Inherent Authority of
a. Secretary
i.
ii.
authentication of records in binding manner
In re Drive in Development Corp – Secretary of DI certifies a loan
guarantee resolution. problem is that there never was a loan guarantee
resolution. Secretary clearly has no express or implied actual authority to
certify false resolutions BUT Ct says DI is estopped from denying the loan
guarantee b/c bank relied on Secretary’s certification. Ct says Secretary has
inherent authority to certify documents in a manner that 3ps are entitled to
rely upon (system wouldn’t work otherwise).
b. President
81
i.


ii.









rule – ordinary v. extraordiary Ks
Pres has apparent inherent authority to bind the corp for K’s in the
ordinary course of business
No inherent authority to bind the corp for K’s that are extraordinary
factors (in determining ord v extraord Ks)
nature of the K
specific officer who’s negotiating it
usual manner of conducting business
size of the corp
# of shareholders
circumstances giving rise to the K
reasonableness of the K terms
amount of $ involved
who the contracting 3p is
Lee v. Jenkins – President of the corp promises Lee a guaranteed pension
when hiring him, then dies. Corp says Pres wasn’t authorized to make that
promise, so the corp isn’t bound. There was clearly no actual authority, so
question is apparent inherent authority. Ct says Pres can bind the corp to Ks
in the usual course of business, not to extraordinary Ks. Ct says pension for
life isn’t extraordinary, much different from employment for life, which
would be extraordinary.
iv.
Black v. Harrison Home – only surviving shareholder / Director / officer
makes K and then tries to back out b/c only Pres and Sec acting together can
sell property (Sec is dead). Ct says she is not estopped b/c other shares are in
probate, might go to someone other than her, she wasn’t authorized. Ct says
no inherent auth for Pres to sell for the corp. the law has changed on this
point.
iii.
82
XV. SECURITIES ACT OF 1934
A. Registration, when required –securities must be registered under ’34 Act if:
1. traded on nat’l sec exchange (§ 12(a)) OR
2. issuer has in excess of $10,000,000 in assets AND 500 or more holders of any
class of EQUITY security (12(g)(1))
a. register the class w/ 500+ shs only (not necess all)
b. less than that amt of total assets OR less than 500 holders of the class AND not
listed on exchange– no need to register – EXEMPTION
3. ex – HypoCorp has $11,000,000 in total assets; 550 holders of its common stock and
50 holders of its preferred stock
a. common stock – must register, preferred stock – no need to register
4. ex – HypoCorp has $11,000,000 in total assets; 550 holders of its common stock, 550
holders of preferred stock, 550 holders of debentures
a. common stock – must register, preferred stock – must register
b. debentures – no need to register b/c NOT an EQUITY SECURITY
B. Consequences of Registration
1. subject to regulation of proxy voting
a. all solicitations subject to regulations (by management or by ‘others’)
i.
form – what’s on the proxy card
ii.
proxy statement – what information provided, what form, inclusion of
annual reports w/ financial data
iii.
what shareholder proposals must be included
B. EXCEPTION
i.
preliminary informal discussion b/t less than 10 shs
ii.
as long as you never ASK for proxy from the other person
2. reports (quarterly 10-Q, annual 10-K, special events 8-K)
3. tender offers, short swing trading rules
4. loses some 1933 act exemptions
a. 504 (under 3(b) discretion of SEC)
i.
issue less than $1,000,000 in 12 months
ii.
# of purchasers – unlimited in # and attributes
iii.
ONLY FOR COMPANIES WHO DON’T REPORT UNDER ’34 ACT
iv.
no general solicitation AND you must restrict re-sale UNLESS exempt or
registered under a state law
v.
AGGREGATION CONCERNS
vi.
unrelated to need of the offerees for protection
a. Reg A mini-registration for offerings under
C. Also includes Anti-Fraud provisions – these apply to EVERYONE who uses
“instrumentalities of interstate commerce” (regardless of whether registration under the
act is required
83
XVI. DUTIES OF OFFICERS AND DIRECTORS
A. Duty of Care
1. General Standard – Skill, Diligence, Prudence
a. Good Faith and Fair Dealing
b. Skill
c. Diligence = Process of Decision Making
i.
Smith v. VanGorkam negligence Std.
 if you can show defective decision-making process, can be a kind of
breach of duty of care
 no need to show “but for” causation of the injury to the 
 no plaintiff could EVER show that if the Board had met for a long
time w/ adequate information they DEFINITELY would have come to
a different decision
ii.
Smith v. VanGorkam – Supreme Ct of Del – CEO wants to sell subsidiary
corp, finds an impatient buyer who sets a 3-day deadline. BoD hold a 30
minute meeting at which the sale price of $55/share isn’t adequately
questioned. Ct questions not the substance of the decision but the PROCESS
by which it was made. Ct says the Board made an “UNINFORMED”
decision and thus don’t get the protection of the BJR. Ct used a gross
negligence standard
d. Prudence = Substance of the Decision
i.
BJR / violation if it amounts to “waste” (or if illegality, fraud,
conflict of interest)
 protected unless so risky and improvident no reasonable corp would do
this
 BJR basically protects Substance of the Decision (under the ALI
approach)
ii.
Litwin v. Allen – Bankers enter a K where they assume all risk of loss w/
no potential for gain, they lose a substantial sum of $. Ct attacks substance of
the decision and held that BJR did not protect them – they breached the duty
of care - (deal so risky and improvident that no reasonable banker would have
found it to be a good idea)
e. Analogous to Tort law
i.
identify duty
ii.
look for breach of the duty
iii.
causation – actual and proximate
iv.
harm to 
2. The BJR – Fraud, Illegality, Conflict of Interest (n/a if self-dealing)
a. Business Judgment Rule – no violation of Duty of Care unless showing made
by  that there was fraud, illegality or conflict of interest
i.
if the Board reached a decision, ct assumes it’s a good one
 presumes that Diligence / Prudence / Skill were there
84
ii.
presumption that there is no fraud, illegality, conflict of interest must be
overcome by challenging party
iii.
Shlensky v. Wrigley -  minority shareholders in the Cubs say the team
needs night games to be profitable and the directors refuse to install lights b/c
of personal preference and concern for the neighborhood (citing Ford v.
Dodge). Ct says Ford v. Dodge requires fraud or a breach of good faith duty
to shareholders. Shareholders can ONLY bring an action challenging
corporations internal affairs / jment of directors where there is fraud,
illegality, or conflict of interest in making the decision. Ct doesn’t address
decision making process.
b. protects judgments short of “waste”
i.
something so risky or improvident that no reasonable court would do the
same thing / won’t pass a minimum rationality test
 ex – if directors were financially crippling the company through a search
for interplanetary ball players, court probably wouldn’t tolerate it
c. BJR does NOT protect do-nothing directors
if the director didn’t go through the process to make a business judgment,
then the BJR doesn’t help them
ii.
can be a breach of duty of care to disregard duties as a director
i.
 Francis v. United Jersey Bank – Director totally disregards her obligations
as a member of the Board. Ct holds her responsible when the officers (her
sons) plunder the corp.
3. MBCA 8.30, 8.31 – looks like the Delaware statute
a. 8.30 – Standards of Conduct for Directors
i.
(a) act in good faith AND in a manner he reasonably believes to be in the
best interests of the corporation (about prudence / substance of the decision)
ii.
(b) duty when becoming informed to do so w/ the care that a reasonable
person in a like situation would find appropriate (about diligence / process of
decision-making)
b. 8.31 – Standards of Liability for Directors
i.
party asserting liability must establish that there is no election limiting
director liability in the AoI under 2.02(b)(4)
ii.
challenged conduct was
 not in good faith OR
 director did not reasonably believe was in the best interests of the corp OR
 was not informed to the degree the director reasonably believed was
appropriate under the circumstances
c. 2.02(b)(4) – Can limit director liability to corporation or its shareholders for
money damages by election in the AoI
i.
cannot disavow liability for
 amount of financial benefit wrongfully received by the director
85
 intentional infliction of harm on the corp or its shs
 unlawful distributions under 8.33
 intentional violation of a criminal law
4. statutory responses to VanGorkham
a. § 102 of Delaware Corp Code
i.
can limit liability of directors to the business judgment rule by
election in AoI
ii.
cannot limit for
 breach of duty of loyalty
 intentional misconduct
 knowing violation of law
 breach of good faith
b. VanGorkham “made mgmt tremble in their tassled Florsheims”
B. Duty of Loyalty
1. Self – Dealing
a. Defined – when Director of a Corporation enters a transaction w/ that same
Corporation
i.
Sinclair Test – receipt of benefit to the exclusion of minority shareholders
ii.
Remedy = avoidance of the transaction
Sinclair Oil Corp v. Lewis – minority shareholder in SinVen (subsidiary of
Sinclair) has 3 claims: excessive dividends paid (ct says NOT self dealing b/c
not receipt of benefit to the exclusion of the minority shs), denial of
opportuinites for expansion (ct says  didn’t show any available opportunities,
so Sinclair didn’t take anything away), breach of K (no b/c of common sense)
iv.
Marciano v. Nakash – Loans by directors of the corp to the corp. Other
directors say this is classic self-dealing, seek RECISSION of the transaction.
Ct says the transactions are VOIDABLE unless proven to be intrinsically fair
(∆ must prove the trans was fair to the corp in all respects – will be upheld)
iii.
b. flowchart
i.
Is it SELF DEALING? (use common sense and Sinclair)
 NO – use BJR / VanGorkham / Statute on business decisions
 YES
 Was it approved by a disintersted decisionmaker?
(1) NO
(a) CL ∆ must show fair
(b) 144(a)(3) fair when approved
(c) 8.61(b)(3) fairness test
(2) YES
(a) CL  can show unfair
86
(b) 144(a) as interpreted -  can show unfair
(c) 8.61 – disinterested approval intended by drafters to end the
question
c. Tests
i.


ii.


iii.

Common Law
If approved by disinterested decision maker
 BURDEN ON  to show it was UNFAIR to the corp
If not approved by disinterested decision-maker
 BURDEN ON ∆ to show it was FAIR to the corp
Del § 144 (FN on p812 of text)
(a) No K or transaction b/t a corp and its directors or a business the
director has a financial interest in is void or voidable solely for this reason
(or b/c the interested director attended or participated in the meeting
authorizing the transaction) IF
 (1) Full Disclosure of material facts of his interest is made to the
Board AND the Board authorizes the transaction in good faith by
affirmative vote of a majority of the disineterested directors, even
though the disinterested directors are less than a quorum
 (2) material facts are made known to the shareholders entitled to vote
thereon and the transaction is specifically approved by the
shareholders
 (3) K or transaction is FAIR to the corporation as of the time it is
authorized, approved, or ratified by the Board or the Shareholders
interpreted to allow  to show that the transaction was NOT fair, even if
approved by disinterested majority
MBCA 8.61(b)
(b) transaction may not be enjoined solely b/c the director or any person
w/ whom he has a personal, economic, or other association has an interest
in the transaction IF
 (1) director’s action was taken at any time in accordance w/ 8.62
 (2) shareholder’s action was taken at any time in accordance w/ 8.63
 (3) transaction is established to have been fair to the corporation ,
judged according to circumstances at the time the decision was made
2. Usurpation of Corporate Opportunity Doctrine
a. think about Meinhardt v. Salmon
b. Remedy = constructive trust
c. Northeast Harbor Golf Club, Inc. v. Harris – Member of the Board of Directors
for the golf course buys up property along the fairway, assures them she won’t
develop it and then does. Board asks Ct for a constructive trust so she can’t
develop the property. Ct adopts ALI approach and remands for trial ct to figure
out whether she violated the duty of loyalty by usurping a Corporate Opportunity.
d. be aware of historical approaches
87
i.
was it w/in the line of business of the corporation
 includes financial ability of the corp to have taken advantage of the
opportunity had it been offered to them
ii.
fairness
 amorphous, fuzzy
iii.
line of business + fairness
 compounds the errors of the two tests alone
e. ALI approach – Flowchart - Is it a corporate opportunity? 505(b)
i.
NO – director can take the opportunity
ii.
YES 505(a)
 was it offered to the corporation?
 NO – director CANNOT take the opportunity (brightline rule)
 YES
(1) rejected?
(a) NO – corporation took it, so director couldn’t have
(b) YES – by a distinterested decision maker (burden on  to show
this) OR nonetheless fair (burden on ∆ to prove this)? –
director can take it
f. § 505
i.
(a) Director may NOT take advantage of a corporate opportunity
UNLESS:
 director FIRST offers the opportunity to the corporation and makes
disclosure AND
 the corporation rejects the opportunity AND
 the rejection is:
 fair to the corporation OR
 the opportunity was rejected in advance, following disclosure, by
disinterested directors in a manner following the BJR OR
 the opportunity was rejected in advance, following disclosure, by
disinterested shareholders, and the rejection does not constitute waste
of corporate assets
ii.
(b) Corporate Opportunity =
 any opportunity which the director became aware of in connection w/
performance of functions as a director, under circumstances that should
reasonably lead the director to believe that the person offering the
opportunity expccts it to be offered to the corporation
 any opportunity which the director became aware of through the use of
corporate information or property, if the resulting opportunity is one that
the director or senior executive should reasonably be expected to believe
would be of interest to the corporation
 any opportunity to engage in a business activity of which a senior
executive becomes aware of and knows is closely related to a business in
which the corporation is engaged or expects to engage
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iii.
(c) Burden of Proof
 challenging party has the burden of proof
 if challenging party establishes that requirements of (a)(3)(B or C) were
not met (no rejection by disinterested decisionmaker), ∆ has burden of
proving that the transaction was fair
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