Biz Orgs Outline

In choosing a business organization, there are two primary considerations:

1. Limited Liability:
Limited liability is a product of state law.

The owners of the business may want to limit their personal/individual

exposure to liabilities of the business, so that if the business fails or there is a
catastrophic liability associated with the business, the business will fail but the
individuals personal assets will be protected.

2. Tax Treatment:
Tax treatment is a federal income tax law.

There are two types of tax treatment:

Flow Through Tax: the entity itself doesn't pay income tax; the income flows
through to its owners who in turn pay the income tax directly on their
individual returns.
o One level of tax.
o Certain entities have to be doubly taxed because they are public entities

Double Taxation: the business entity, if it is showing a profit, will pay an

income tax (corporate income tax) on its profit, and when those profits are
distributed onto its owners (dividend), the owners will pay a personal
income tax on those dividends, so the profits are being doubly taxed.

Basic Legal Forms of Business Organization

Sole Proprietorship:
o The sole proprietorship is the simplest form of business organization. There is no
state filing.
o A sole proprietorship results when a person has decided to run a business, but
without incorporating the business or forming it as an LLC or some other type of
entity.
o In a sole proprietorship, there is no legal distinction between the business and the
owner (who, of course, is called the sole proprietor).
It is almost always a wise idea for the sole proprietor to separate her personal
finances from the businesss finances, such as by having separate bank
accounts and accounting records.
o There is both good news and bad news in the sole proprietorship.
The good news is that the business, not being a separate entity from the
owner, does not pay taxes. If the business generates taxable income, the
owner must report this income on her personal tax return and pay taxes on it.
The sole proprietors obligation to pay taxes based on the businesss income
hardly sounds like good news.

The bad news about the sole proprietorship is that the owner is personally
liable for all of the businesss debts and obligations. This is because there is no
legal separation between the sole proprietorship and the sole proprietor.

Partnership: Must have 2+ members

o General Partnership: no specific filing that has to take place with the state
(similar to sole proprietorship in the sense that 2 people can start a business
without filing to create one)
Unlimited liability and joint and several liability if one partner is uncollectable,
the other partner may have to pay 100% of the liability
Partners pay taxes individually

Two or more partners who start a business without being required to file with
the state.

In terms of liability, the general rule is that partners in a partnership are jointly
and severally liable for the debts and obligations of the partnership. It is worth
pausing here to consider how serious joint and several liability is for
defendants. If defendants are jointly and severally liable for a claim, the
creditor may recover the full amount owed from any single defendant.

o Limited Partnership (LP): limited liability for limited partners, who invest into
the entity they are passive investors, and if there are big liabilities within the
partnership, the limited partners will lose their investment but they wont have to
be individually liable.
LPs are similar to general partnerships in that they have flow-through tax
treatment. But in an LP there are two different types of partners:
General Partners, and
Limited Partners

Typically in an LP there must be at least one general partner (or perhaps a few)
and several limited partners.
The advantage of being a general partner is control:
o Except to the extent otherwise provided in the limited partnership
agreement, the general partner has full decision-making authority over
the LP.

The disadvantage of being a general partner is liability:

o Much like partners in a general partnership, the general partner in an LP
will be personally liable for the LPs debts and obligations. On the other
hand, limited partners have no control over the LP (except to the extent
the agreement grants them voting rights), but will not be personally
liable for the LPs debts and obligations except in unusual circumstances

In the real world, a partner itself can be another business entity, so what
ends up happening is that the general partner is an entity with limited
liability.
o Limited certain members wont have to pay the business debt

o Limited Liability Partnership (LLP): very state specific

Some states allow for LLP without a general partner with unlimited liability

o Corporation: generally, corporation owners are shareholders, who have limited

liability.
The great advantage of the corporate form is limited liability:
Shareholders of a corporation arent personally liable for the corporation s
debts and obligations.
Like partnerships, corporations have been around for centuries. Unlike a
partnership, which has partners and perhaps employees, the cast of
characters in a corporation is relatively crowded: there are shareholders;
directors; and officers and otheremployees.

The shareholders arecalled the owners of thecorporation but have

surprisingly little control over it in their shareholder role.
The shareholders annually elect the directors, who are given general
authority to run the business. Although the directors could make nearly
every business decision that the corporation must make, typically it is more
efficient to delegate some decision-making power to officers (and other
employees).

o Limited Liability Company (LLC)

LLC is the most popular entity
Takes the limited liability of a corporation
The LLC gets flow-through tax treatment
LLCs are sometimes called the best of both worlds because they combine the
desirable aspect of corporate status (limited liability for owners) with the
desirable aspect of partnership status (flow-though tax treatment).
As a general rule, the owners of an LLC (called the members) will not be
personally liable for the debts and obligations of the LLC.
If the LLC files bankruptcy, then the worst that will happen to a member is
that the value of her interest in the LLC will dwindle to zero.
Meanwhile, the LLC will be treated as a partnership for tax purposes if there
are multiple members, and treated as a disregarded entity if there is only
one member.
In other words, the LLC gets flow-through tax treatment.
The LLC form is not subject to the restrictions on S corporations under
the IRC.
Sources of Law
State Law
o State in which organization is formed governs it internal affairs.
Internal Affairs Doctrine: the state of the organization of the entity will control
its internal affairs (how you organize your internal affairs depends on your
state of organization, even if you operate in a different state).

Generally, the law of the state where the entity is formed will govern the
internal affairs of the entity, that is, the relations between the owners of the
entity and the managers of the entity.
EX: assume that a corporationis incorporated under Delaware lawbut is
physically located in anddoes all of its business in Texas. Delaware law will
control itscorporate governance, as well asany disputes between the
corporations shareholders, directors and officers. Thus, if the shareholders
sue the directors claiming that the directors breached the fiduciary duties
that they owe to the corporation, then Delaware law will apply in that
lawsuit. One does not have to litigate the matter in a Delaware court, but
the court in which the lawsuit is filed must apply Delaware law to the case.

o The rules for how a business entity is governed, and for resolving disputes
between the businesss owners and its managers, are found in the law where the
business is incorporated or organized, not where it is physically located.
Many US corporations are organized in Delaware because it has the most
developed case law in business law, so it dominates with publicly traded
companies.
External affairs are governed by the state in which the company operates (FL,
not Delaware), because a third-party is involved.
Balance Sheet & Income Statement:
Balance Sheet:
o Statement of assets and liabilities
o Purpose is to show the financial condition of a business as of the date of the
statement.
o Assets Liabilities = Owners Equity
o Assets = Liabilities + Owners Equity

Income Statement:
o Statement covering a period of time.
o Purpose is to give a summary of earnings between balance sheet dates.
A and B Partnership Company Balance Sheet
Assets
Liabilities & Equities
Cash
$5,000
Note
$5,000
Property
$2,000
Inventory
$1,000
+ Equities
$5,000
Machinery
$2,000
$10,000
$10,000
Assets
$10,000
Liabilities
$5,000
Liabilities
$5,000
+ Owners Equity $5,000
Equity
$5,000
Assets
$10,000
Income Statement Following the First Month of Business
Sales
Expenses
Profit
$3,000
Cost of Goods Sold
$1,000
$1,000

+ General Expenses
$1,000
Total Expenses $2,000
New Balance Sheet Giving Effect to the $1,000 Profit
Assets
Liabilities & Equities
Cash
$6,000
Liabilities
$5,000
Property
$2,000
Inventory $1,000
+ Equities
$6,000
Machinery $2,000
$11,000
$11,000
Assets (cash) have gone up by $1,000 because of the $1,000 profit
Total assets have gone up to $11,000, liabilities have stayed the same, so owners
equity must go up to $6,000 to balance the two sides.

Company Then Borrows $2,000

Liabilities & Equities
Note
$5,000
Note
$2,000

Assets
Cash
$8,000
Property
$2,000
Inventory $1,000
Machinery $2,000
+ Equities
$6,000
$13,000
$13,000
Borrowing $2,000 increases our assets (cash) by $2,000
Liabilities also go up by $2,000 owners equity stays the same

A & B Withdraw $1,000 Each

Liabilities & Equities
Note
$5,000
Note
$2,000

Assets
Cash
$6,000
Property
$2,000
Inventory $1,000
Machinery $2,000
+ Equities
$4,000
$11,000
$11,000
Cash goes down to $6,000 liabilities are the same, so owners equity must decrease
by $2,000

Agency Law

RTA 1.01: Agency Defined

o Agency is the fiduciary relation that arises when one person (principal) manifests
assent to another person (agent) that the agent shall act on the principals behalf
and subject to the principals control, and the agent manifests assent or otherwise
consents so to act.

RTA 1.03: Manifestation

o A person manifests assent or intention through written or spoken words or other
conduct.

RTA 3.01: Creation of Actual Authority

o Actual authority is created by a principal's manifestation to an agent that, as
reasonably understood by the agent, expresses the principal's assent that the
agent takes action on the principal's behalf.

RTA 2.01: Actual Authority

o An agent acts with actual authority when, at the time of taking action that has
legal consequences for the principal, the agent reasonably believes, in
accordance with the principals manifestations to the agent, that the principal
wishes the agent so to act.

RTA 2.02: Scope of Actual Authority

o An agent has actual authority to take action designated (expressed) or implied in
the principal's manifestations to the agent and acts necessary or incidental to
achieving the principal's objectives, as the agent reasonably understands the
principal's manifestations and objectives when the agent determines how to act.
Actual Express Authority: the literal words or actions of the grant authority
by P to A.
A principal has expressly communicated to an agent the power to perform
some act on the principals behalf. However the scope of an express grant
of authority may well be an issue. The ultimate test is whether a reasonable
person in the agents position would interpret the principals communication
to encompass a particular act.

Actual Implied Authority (incidental authority):

Acts usual and incidental to the act directly authorized, including acts
reasonably necessary or generally considered appropriate to
accomplish the agency.

An agent has implied actual authority when the principal does not
expressly confer authority but the principals words or conduct,
reasonably interpreted, causes the agent to believe that he has authority.

An agent's interpretation of the principal's manifestations is reasonable if it

reflects any meaning known by the agent to be ascribed by the principal
and, in the absence of any meaning known to the agent, as a reasonable
person in the agent's position would interpret the manifestations in light of

the context, including circumstances of which the agent has notice and the
agent's fiduciary duty to the principal.

RTA 3.02: Creation of Apparent Authority

o Apparent authority is created by a person's manifestation that another has
authority to act with legal consequences for the person who makes the
manifestation, when a third party reasonably believes the actor to be authorized
and the belief is traceable to the manifestation.
Apparent authority does not arise from the acts of the agent.

RTA 2.03: Apparent Authority

o Apparent authority is the power held by an agent or other actor to affect a
principal's legal relations with third parties when a third party reasonably believes
the actor has authority to act on behalf of the principal and that belief is traceable
to the principal's manifestations.
The fact that one party performs a service that facilitates the other's business
does not constitute such a manifestation.
Ex: By clearing securities trades for another firm, a securities broker does
not make a manifestation to customers of the firm sending the orders that
it acts with the authority of the clearing firm.

An agent has apparent authority in dealing with a third person when the
principals words or conduct, reasonably interpreted, causes the third person
to believe that the agent has authority.

An agent may have apparent authority to act even though as between himself
and the principal, such authority has not been granted.

RTA 3.04: Capacity to Act as a Principal

o An individual has capacity to act as principal in a relationship of agency if, at the
time the agent takes action, the individual would have capacity if acting in
person.
o The law applicable to a person that is not an individual governs whether the
person has capacity to be a principal in a relationship of agency as well as the
effect of the person's lack or loss of capacity on those who interact with it.
o If performance of an act is not delegable, its performance by an agent does not
constitute performance by the principal.

RTA 3.05: Capacity to Act an Agent

o Any person may ordinarily be empowered to act so as to affect the legal relations
of another. The actor's capacity governs the extent to which, by so acting, the
actor becomes subject to duties and liabilities to the person whose legal relations
are affected or to third parties.

Agency law involves the relationship between at least two, but usually
three, persons:
o The principal, which is the person on whose behalf work or some task is being
done;
o The agent, which is the person doing the work or performing the task; and
o The third party, which is the person with whom the agent deals on behalf of the
principal.

Why do we need agency law?

o We need agency law in order to have a legal way to bind a principal with a third
party to an agreement/contract. The principal may be a fictitious entity that
cannot, on its own, sign a contract.

What is the purpose of a principal acting through an agent?

o The principal wants the agent to act on its behalf to tie it to a binding contract.
We will have binding contracts between the principal and the third party as
long as the agent acts with authority.

For a binding contract:

o Agent has authority
Actual, or
Apparent
o Principal ratifies the act
Ratification: agent had no authority at the time that he entered into the act,
but principal later approves it (retroactive).

There are four ways to determine whether the principal is contractually

bound to the third party due to the agents actions:
1. If the agent acted with actual authority;
2. If the agent acted with apparent authority;
3. If a person is estopped from denying liability; and
NOT ON EXAM
4. If a person ratifies an unauthorized act.

Strictly speaking, only the first two categories involve a true agency
relationship (and even apparent authority may be held by a person who is
not an agent).
o In other words, a principal may be estopped from denying liability resulting from
the acts of a person who was technically not her agent.
o Similarly, a principal may ratify the unauthorized actions of a non-agent (or an
agent), in which case the actions will be treated as if they had been authorized.

Problem 2-1: Your wealthy uncle recently died. In his will, he established a
testamentary trust for your benefit and funded it with $1 million. The will directs the
trustee of the trust to prudently invest this money on your behalf, to use it to pay

your educational expenses and, when you have completed your education or
reached the age of 30 (whichever occurs first), distribute any remaining amounts to
you. Big National Bank was designated as the trustee of this trust and has accepted
this position. You are currently in law school and are 24 years old. Is Big National
Bank your agent?
o This is a fiduciary relationship, but the element of control is lacking.
o A beneficiary is not a principal the beneficiary has no control over the bank as
an agent
o This is a trust relationship, not an agency relationship.

Problem 2-2: John is an adult who suffers from mental delusions, which greatly
worries his relatives. Johns father, Bill, petitioned the probate court to have a
guardian and conservator appointed for John. The court appointed Bill as Johns
guardian and conservator. Is Bill an agent for John?
o Not an agency relationship.
o This is a Guardian & Ward relationship.
o This is not a principal-agent relationship. The ward cannot be in control of the
guardian.
o So, not all fiduciary relationships are agency relationships.

Problem 2-4: ABC Catering hired Jessica as an office manager. Is Jessica an agent
for ABC Catering?
o Yes an office manager is an agent of the employee.
Employment relationships are a subset of agency relationships. All
employment relationships are agency relationships but not all agency
relationships are employment relationships.
An employee has a fiduciary responsibility to the employer.
The employee, by agreeing to work there, is agreeing to be subject to the
control of the company.
This doesnt mean that all employees have a lot of authority, but they are still
agents of the employer.

Problem 2-5: Yesterday, your roommate mentioned that she was going to go to the
hardware store today. Before you left the apartment this morning, you put a note and
a $10 bill on the kitchen table. The note said: Use this money to buy me a good
screwdriver. After she awoke and read the note, your roommate took the money and
went to the hardware store. Is your roommate your agent? If so, for what purpose?
Does it matter that she is not being paid for her actions?
o Yes, by taking the $10 the roommate is under the control of the other
roommate.
o The fact that she wasn't compensated does not take away the agency relationship
it is gratuitous.
o By taking the note and the money, the agent has accepted to be subject to the
principals control.

Problem 2-6: Johann was planning to sell his car, but didnt get around to doing so
before he left for a vacation in the Bahamas. Before he left, Johann asked his friend
Rhonda if she would be willing (for a $100 fee) to help him sell his car. Rhonda
nodded her head, and Johann handed her the keys to his car, telling her that she
should negotiate the best price she could, but not less than $8,000. When Rhonda

went to pick up the car from Johanns house, she discovered it was covered with mud
and full of fast food wrappers and other garbage. Thus, Rhonda decided to take the
car to the car wash, where she got the super wash, which cost $15. Instead of
paying the $15, Rhonda convinced the car wash to bill Johann for it upon his return
from vacation. Rhonda also decided that the car would look nicer with flames painted
on its sides. Thus, Rhonda agreed with Tom, the owner of Local Auto Garage and
Detailing, that he would paint flames on the car, at a cost of $1,000. Rhonda gave
Tom a $50 deposit and told him that Johann would pay the rest of the bill. Tom
agreed to paint the flames by the next week. Under the theory of actual authority, is
Johann obligated to pay for the car wash? Is he obligated to pay for the painted
flames? (If not, what happens to the $50 deposit?)
o Agency relationship created (manifestation is head nod, taking keys, etc.)
o Johann is the principal and Rhonda is the agent with respect to selling this car for
no less than $8,000.
o Johann is obligated to pay for the car wash because he impliedly authorized
Rhonda to clean it
o Actual express authority is to sell the car, but its implied that the car needs to be
made suitable for sale.
o Adding the flames to the car was not reasonably implied as necessary to achieve
Johanns goal.
o Assuming there was no apparent authority, Johann is not obligated to pay for the
flames unless he later ratifies the act.

o Problem 2-7: Maynard Moneybags is a wealthy and successful businessman who

has a passion for collecting historical artifacts. Maynard was thus very excited
when he heard that Suzanne Franklin, the great-great-great-great granddaughter
of Benjamin Franklin, wanted to sell Bens famous kite. However, Maynard did not
want to have his purchase reported in the news media. Thus, Maynard contacted
a famous museum director, Pam Pretentious, and asked her to approach Suzanne
about purchasing the kite on his behalf, but without revealing his identity to
Suzanne. He told Pam that he would pay her $5,000 for her services, and that she
could pay any price up to $1 million for the kite. Pam informed Suzanne that she
wanted to purchase the kite on behalf of a wealthy friend. After some
negotiations, Suzanne agreed to sell the kite for $875,000. In the meantime,
however, Maynard began to wonder whether he should be spending his money on
historical artifacts. Is Maynard obligated to purchase the kite from Suzanne?
Yes. An agency relationship was created between Maynard and Pam.
He had given her actual express authority to purchase the kite for up to $1
million.
o It doesnt matter that Suzanne was not aware of Maynards identity.

o Problem 2-8: Does your answer to Problem 2-7 change if the purchase price had
been $1.1 million rather than $875,000?
Yes, because the actual express authority was to buy the kite for no more than
$1 million.
Purchasing the kite for $1.1 million means Pam is acting outside her express
authority.
There are no facts that indicate the presence of apparent authority.
o If Maynard does not ratify the $1.1 million purchase, Suzanne cannot
look to Maynard to pay for the kite. Suzannes only course of action
would be against Pam.
o Problem 2-9: Does your answer to Problem 2-7 change if Pam had told Suzanne
that she wanted to buy the kite for herself rather than on behalf of a wealthy
friend?
No this would be an undisclosed principle, and assuming that the purchase
price was under $1 million the purchase would be expressly authorized.
o Problem 2-10: Recall Johann and Rhonda from Problem 2-6 above. Assume that
Rhondas friend Samantha was present when Johann asked Rhonda to help him
sell his car and handed her the keys. A few days later, however, Johann called
Rhonda from the Bahamas and told her that he had changed his mind and that
she should not sell the car. Nonetheless, when Samantha asked Rhonda later that
day whether the car was still for sale, Rhonda said yes. Samantha then offered
Rhonda $8,000 for the car, and Rhonda accepted her offer. Is Johann obligated to
sell the car to Samantha? If so, is Rhonda liable to Johann? See Section 8.09 of
the Restatement.
Rhonda did not have actual authority to sell the car because Johann revoked
the authority.
There could be a case for apparent authority and that would bind Johann to sell
the car to Samantha.
If Johann must sell the car to Samantha, then Rhonda could be liable to Johann
for breach of her fiduciary duty.
No. The identity of the principal does not have to be known to the third party in
order to enter into a binding contract. This would be an undisclosed principal.
Assuming the purchase price was $875,000, this would be expressly authorized
and would be binding on M and S.
Why use an undisclosed principal?
o Real estate, if youre trying to acquire several properties at one time and
dont want people to hold out on selling their property because of an
increase in property values (say the purchaser was Disney)

o Problem 2-11: ABC Caterers hired Sam to work as an office assistant, answering
the telephone and performing other clerical tasks. One day, while Sam was alone
at the office, Maggie walked in and said that she needed a caterer for her
wedding, which was to take place two days later. (Maggies prior caterer had
suddenly gone out of business.) She then proceeded to explain to Sam the very
elaborate menu that was needed. Sam told Maggie that ABC Caterers would be
happy to cater her wedding and they each signed ABCs standard contract,

which Sam retrieved from a drawer in his desk. Is ABC Caterers obligated to cater
Maggies wedding?
Assuming Sam had no actual authority, did he have the apparent authority to
do this?
Sam was alone in the office, the sign on the door said ABC Catering, Sam
had access to the contracts leads to reasonable belief that there was
apparent authority.
o BUT, it was an elaborate menu, to be done two days later was this the
kind of thing that ABC normally did?
Could Maggie have reasonably believed that Sam had the authority to enter
into this contract?
This issue is more important than the final conclusion (can be argued either
way)
o Problem 2-12: Would your answer change if the owner of ABC Catering had
explicitly forbidden Sam from agreeing to catering contracts, but Maggie didn't
know that? What if Maggie knew that?
Apparent authority can be created without there being any actual authority, so
it doesnt matter that Sam had been forbidden. What matters is what Maggie
could reasonably believe.
If M knew that S had been forbidden, there is no apparent authority (if the third
party knows the actor has no authority, he cannot reasonably believe that
there was authority)
o Problem 2-13: International Conglomo Inc. (ICI) is a very large, multi-national
corporation. The President of ICI, Wendy Wilson, has negotiated for ICI to obtain a
$2 million loan from Big National Bank. Big National Bank has agreed to make the
loan. Does Wendy have authority to sign the loan agreement on behalf of ICI? If
you were legal counsel to the bank, what would you do? Would your answer
change if ICI were a very small company?
President could have authority to do such a thing in his job description, in the
corporate bylaws.
In corporate law, authority is generated from BOD, in bylaws, in contract,
etc.
The bank must ask for resolutions from the Board of Directors showing that W
has actual authority to enter into this contract, because the risk the bank runs
is assuming that the President has the authority to do something that it does
not have the power to do. Relying on apparent authority can be problematic.
If its a multi-national corporation, it might be reasonable to believe that the
corporation has the power to sign a $2mil contract. But if it were a smaller
company, there is no such reasonable expectation.
o Problem 2-14: Section 2.03 of the Restatement refers to apparent authority as a
power held by an agent. Is there a difference between a power and a right? Again,
consider Section 8.09 of the Restatement.
Power: our agent will be able to bind the principal without having the right to
do so, meaning that if the agent has apparent authority, it has the power to
bind the principal to the contract, but if it is not in right to do that, it has
breached a fiduciary duty to the principal

o Problem 2-15: Can an agent for an undisclosed principal have apparent

authority?
An agent for an undisclosed principal cannot have apparent authority because
apparent authority depends on the principals manifestations to the third party.
If the third party does not know the principal exists, this is not possible.
o Problem 2-19: Patty is the sole proprietor of Pattys Restaurant. For many years,
Alex was the purchasing manager for the restaurant and routinely ordered food on
behalf of the restaurant from Food Vendors, Inc. Typically, Alex ordered about
$5,000 of food from Food Vendors each week, usually on Wednesdays. One
Tuesday, Patty and Alex got into an argument and Patty fired Alex. The following
day, Alex, who was very upset at being fired, called Food Vendors, Inc. and
ordered $5,000 worth of food items. Is PRI obligated to pay for this food under the
doctrines of apparent authority and/or estoppel?
No actual authority because Alex has been fired.
What about apparent authority?
Pattys manifestations to Food Vendors: theyve been doing this for years
and it was never a problem.
Now, Patty has, by her conduct, given Food Vendors a reasonable belief that
Alex has the authority to order food.
How can you have authority after the termination of the agency relationship?
Restatement says agent or other actor, so agent authority can extend
beyond the termination of the agent relationship.
Ratification:
Ratification is the affirmance of a prior act done by another, whereby the act is given
effect as if done by an agent acting with actual authority.
o Ratification occurs after the fact.

The risk from the third partys perspective is that the principal may not ratify.

In order to ratify, the principal must know the material facts of the contract.
o Must know what they are ratifying.

All or nothing approach must ratify the entire contract or none of it

Can be done expressly or implicitly.

A person ratifies an act by

o Manifesting assent that the act shall affect the persons legal relations, or
o Conduct that justifies a reasonable assumption that the person so consents.
4.01

Problem 2-20: Casey Counselor recently graduated from law school and joined a
large law firm. Around the same time, she bought a house. Because she had very
few items of furniture and was too busy to buy more, Caseys house was largely
empty, other than a futon, an old couch, a dresser, and a few tables and chairs.
Knowing of Caseys situation, Caseys mother, Beth, decided to order some furniture
for her from the Lazy Shopper catalog. Beth convinced Lazy Shopper that she was

acting at Caseys request (which was not true), and that they should deliver the
furniture to Casey C.O.D., meaning that payment would be due upon delivery. Four
to six weeks later, Casey was relaxing on the old couch in her living room when the
doorbell rang. Two deliverymen were there with several cardboard boxes containing
furniture from Lazy Shopper. Is Casey obligated to purchase this furniture? What
facts would she need to know before she may ratify this transaction?
o No. There was no agency relationship.
o The only way we could have a binding agreement is if Casey ratifies it, which
would require her knowing the material terms of the contract and paying for the
furniture.
o She can also send it back, after which Lazy Shopper would have to look to Beth
for relief (Beth violated an implied warranty of authority).
Disclosed, Unidentified vs. Undisclosed Agency
Disclosed Principle:
o When the third party has notice the agent is acting for a principal and has notice
of the principals identity.
o Liability of Disclosed Principal:
The Agent has actual or apparent authority.
The Principal is bound to Third Party
The Third Party is bound to Principal
There is a contract between the Principal and the Third Party, and the Agent is
not a party to the contract and cannot be held liable for anything.
Agent is NOT a party to the contract unless agreed by third party and agent.

Unidentified Principle:
o When the third party has notice that the agent is acting for a principal but doesnt
have notice of the principals identity.
o Liability of Unidentified Principle:
The agent has actual or apparent authority
More likely actual, because apparent authority is given by the principal
which would be difficult in this situation.
Principal is bound to third party.
Third Party is bound to principal
There is a contract between the Principal and the Third Party.
They can seek performance from each other.
The agent is a party to the contract unless the agent and the third party
agree otherwise.
o Because the third party should be able to look to the agent for
performance because they dont know who the principal is.

Undisclosed Principle:
o When an agent and a third party interacts, and the third party does not know that
there is a principal at all; as far as the third party knows, he is dealing with the
agent.
o Liability of Undisclosed Principal
The agent has actual authority.

The Agent cant have apparent authority because the third party is not
aware of the existence of the principal.
The Third Party is in contract with both the Principal and the Agent.
The Agent has to be on the hook because, as far as the Third Party is
concerned, that is the person theyre dealing with.
The Principal is bound to the Third Party who justifiably detrimentally relied and
the Principal didnt take reasonable steps to notify.

o Exceptions:
Misrepresentation of the lack of agency.
The agent misrepresents the lack of agency (saying there is no agency
affirmative misstatement), and where the principal and the agent
reasonably know that the third party would not have dealt with the principal
had the principal known

Problem 2-21: Mrs. Hatfield is known far and wide as making the best wedding
cakes east of the Mississippi River. Julia McCoy wanted to order one of Mrs. Hatfields
cakes for her upcoming wedding but knew that, if she were to walk into Mrs.
Hatfields shop she would be turned away, due to a longstanding feud between the
Hatfield and McCoy families. Instead, Julia asked her friend Wendy Mullins to order a
cake from Mrs. Hatfield for delivery in two weeks, specifying the type of cake that
she wanted. Wendy went to Mrs. Hatfields shop and ordered the cake and Mrs.
Hatfield agreed to prepare and deliver the cake to the address that Wendy gave her.
When asked by Mrs. Hatfield, Wendy stated that the cake was for her own wedding.
If Mrs. Hatfield discovers that the cake is really for Julias wedding, may she refuse to
perform the contract? What if she finds out after the cake has been delivered (and
eaten)?
o Undisclosed Principal (Mrs. Hatfield thought she was dealing with Wendy (through
an affirmative act).
o Wendy had actual authority to order the cake (she was expressly told to do so)
o Contract between the principal and the third party and between the third party
and the agent
Defense: Misrepresentation
o Julia and Wendy had reason to believe that Mrs. Hatfield would not have made the
cake for Julia due to the longstanding feud
o The third party can raise the defense of misrepresentation and avoid the contract
o If she finds out after the cake has been delivered and eaten, its too late to do
anything about it

Problem 2-22: Would your answer to Problem 2-21 change if Wendy had instead
stated that she was ordering the cake for a friends wedding?
o Unidentified Principal
o No misrepresentation because there has not been a misstatement
o No defense on behalf of Mrs. Hatfield.

Problem 2-23: Recall Maynard Moneybags, Suzanne Franklin, and Pam Pretentious
from Problem 2-7. Assume that Pam had explained to Suzanne that she was acting
on Maynards behalf and that Suzanne agreed to sell the famous kite to Maynard for

$875,000. However, although the kite was delivered to him, Maynard never paid the
purchase price and has now disappeared, taking the kite with him. May Suzanne
recover the purchase price from Pam?
o Disclosed Principal
o No contractual relationship between Pam and Suzanne because Suzanne knew
who the principal was and Pam had actual authority to buy the kite
o The contract exists simply between the principal (M) and the third party (S); the
agent (P) cannot be held liable

Problem 2-24: Would your answer to Problem 2-23 change if Pam had not told
Suzanne that she was acting on Maynards behalf, but had only told her that she was
acting on behalf of a wealthy friend?
o Yes because you have an unidentified principle.
o The agent and the third party are parties to the contract, so the third party can
recover from the agent.

Problem 2-25: Would your answer to Problem 2-23 change if Pam had simply told
Suzanne that she was buying the kite for her own personal collection?
o Nope, we have a contract between the Agent and the third party so we have an
undisclosed principle.
Undisclosed Principal there exists a relationship between the agent and the
third party, so the third party can recover from the agent
Problem 2-26: If there are different results in the prior three problems, what is the
policy reason for these differences? If you were acting as an agent, what steps
should you or would you take to minimize your chances of being held liable on the
contract?
o In the case of the disclosed principal, the third party has all the relevant facts and
can judge the credibility of the principal in deciding whether to enter into a
contract. In the case of unidentified or undisclosed principals, the third party does
not have all the facts and cannot judge the credibility of the principal.

Implied Warranty of Authority

A person who purports to make a contract, representation, or conveyance to or with
a third party on behalf of another person, lacking power to bind that person, gives an
implied warranty of authority to the third party and is subject to liability to the third
party for damages for loss caused by breach of that warranty, including loss of the
benefit expected from performance by the principal, unless
o The principal or purported principal ratifies the act as stated in 4.01; or
o The person who purports to make the contract, representation, or conveyance
gives notice to the third party that no warranty of authority is given; or
o The third party knows that the person who purports to make the contract,
representation, or conveyance acts without actual authority.

Situation where agent or other actor states that he is acting on behalf of a principal,
but it turns out that there is no actual or apparent authority

SOMEONE has to be on the hook. A purported agent who represents to another party
that he is working on behalf of another; he is giving the sense of having authority. If
that authority does not actually exist, the agent would be responsible for breach of
that warranty and any damages it may cause to the third party.

o Unless the principal later on ratifies it, or the other 2 examples

Problem 2-27: Recall Casey Counselor and her mother, Beth, from Problem 2-20
above. Assume that Casey decides to reject the furniture and send it back to Lazy
Shopper. May Lazy Shopper recover any damages from Beth?
o Yes, because someone has to be on the hook. Beth, by ordering on Caseys behalf,
had made a warranty that she had implied authority to act on Caseys behalf. A
breach of that warranty means Beth is responsible for loss or damages to the third
party.

Partnership Law

RUPA 101(6): Partnership

o An association of two or more persons to carry on as co-owners a business for
profit formed under RUPA 202, predecessor law, or comparable law of another
jurisdiction.

RUPA 101(10): Person

o An individual, corporation, business trust, estate, trust, partnership, association,
joint venture, government, governmental subdivision, agency, or instrumentality,
or any other legal or commercial entity.

Partnerships
o Sometimes called a default form of business because it isnt necessary to take
any formal steps to form a partnership.
All that is required is that the business meets the statutory requirements of a
partnership.
Partnerships do not need to file any documentation with the state to form a
partnership.
Partnerships may be formed inadvertently when two people decide to
associate for a profit-making venture.

What types of business entities are not partnerships?

o Business associations organized under other statutes are not partnerships.
Those statutory associations include corporations, limited partnerships, and
LLCs.
Relationships that are called joint ventures are partnerships if they
otherwise fit the definition of a partnership.
An association is not classified as a partnership, simply because it is called a
joint venture.
An unincorporated nonprofit organization is not a partnership under RUPA,
even if it qualifies as a business, because it is not a for profit organization.
o RUPA 202(b): Formation of Partnership
An association formed under a statute other than this Act, a predecessor
statute, or a comparable statute of another jurisdiction is not a partnership
under this act.

Problem 3-1: May ABC Corp. and DEF Corp. form a partnership?
o Yes two persons creating an association for profit (two corporations can form a
partnership)

Problem 3-2: If Amir, Bob, and Catrina form a partnership but later decide to
incorporate their business, will the business be both a corporation and a partnership?
o No an entity cannot simultaneously be a corporation and a partnership

Formation of a Partnership
o Is it possible that two (or more) people can form a partnership without intending
to do so? (Problem 3-3).

Without subjectively intending to do so

o Who would argue that a partnership has been formed when the partners did not
intend to do so? (HINT: Under RUPA 306, partners are jointly and severally liable
for the debts of the partnership).
Yes Why would anyone want to argue that a partnership exists if the parties
did not subjectively believe they were creating a partnership? Partners are
jointly and severally liable for each others debt. From the creditors
perspective, it means they can collect 100% of what they are owed from just
one of the partners. So, a creditor might argue that a partnership has been
formed. It may have transacted business with one of the purported parties who
is now gone or insolvent, so it wants to collect from someone who was a
partner with that person.

In determining whether a partnership is formed, the following rules apply:

o RUPA 202(c)(1): Joint ownership by itself does not create a presumption
that a partnership exists
Joint tenancy, tenancy in common, tenancy by the entireties, joint property,
common property, or part ownership does not by itself establish a partnership,
even if the co-owners share profits made by the use of the property.
o RUPA 202(c)(2): Sharing of gross returns does not create a presumption
that a partnership exists
The sharing of gross returns does not by itself establish a partnership, even if
the persons sharing them have a joint or common right or interest in property
from which the returns are derived.
Gross Returns Expenses = Profits
o RUPA 202(c)(3): Profit sharing creates a presumption that a partnership
exists
A person who receives a share of the profits of a business is presumed to be a
partner in the business, unless the profits were received in payment:
Of a debt by installments or otherwise;
For services as an independent contractor or of wages or other
compensation to an employee;
Of rent;
Of an annuity or other retirement or health benefit to a beneficiary,
representative, or designee of a deceased or retired partner;
Of interest or other charge on a loan, even if the amount of payment varies
with the profits of the business, including a direct or indirect present or
future ownership of the collateral, or rights to income, proceeds, or increase
in value derived from the collateral; or
For the sale of the goodwill of a business or other property by installments
or otherwise.

Default vs. Mandatory Rules

RUPA 103(a): Except as otherwise provided in RUPA 103(b), relations among the
partners and between the partners and the partnership are governed by the
partnership agreement. To the extent the partnership agreement does not otherwise
provide, RUPA governs relations among the partners and between the partners and
the partnership.

RUPA 103(b): The partnership agreement may not

1. Vary the rights and duties under 105 except to eliminate the duty to provide
copies of statements to all of the partners;
2. Unreasonably restrict the right of access to books and records under 403(b);
3. Eliminate the duty of loyalty under 404(b) or 603(b)(3), but:
a) The partnership agreement may identify specific types or categories of
activities that do not violate the duty of loyalty, if not manifestly unreasonable;
or
b) All of the partners or a number or percentage specified in the partnership
agreement may authorize or ratify, after full disclosure of all material facts, a
specific act or transaction that otherwise would violate the duty of loyalty;
4. Unreasonably reduce the duty of care under 404(c) or 603(b)(3);
5. Eliminate the obligation of good faith and fair dealing under 404(d), but the
partnership agreement may prescribe the standards by which the performance of
the obligation is to be measured, if the standards are not manifestly
unreasonable;
6. Vary the power to dissociate as a partner under 602(a), except to require the
notice under 601(1) to be in writing;
7. Vary the right of a court to expel a partner in the events specified in 601(5);
8. Vary the requirement to wind up the partnership business in cases specified in
801(4), (5), or (6);
9. Vary the law applicable to a limited liability partnership under 106(b); or
10.
Restrict rights of third parties under RUPA.

Default: If you have a partnership, the partners may not have agreed on anything
re: how theyre going to govern their business; in any instance in which they have
not agreed on a certain matter, the RUPA will fill in the gaps and will be the
partnership agreement. If the partners dont like what the default rules say, they
need to create an explicit partnership agreement

Default rules are rules that are going to apply generally to the partners, internally

The partners as between themselves may generally agree to do whatever they want,
but there are some restrictions

The relationship of the partners with third parties will have MANDATORY rules the
third parties rights cannot be affected

RUPA 107: Partnership Subject to Amendment or Repeal of Act

o A partnership agreement does not necessarily have to be in writing.

It can be express, implied, written, or verbal.

The way weve done things forever.

Ownership of Property By a Partnership

General Rule:
o Property acquired by a partnership is property of the partnership and not of the
partners individually.
o Property belongs to a partner if it is acquired in his name without an indication of
the persons status as a partner or an intent to be used for the partnership
(rebuttable presumption) even if the property is ultimately used for partnership
purposes.

Under the RUPA, is a partnership an entity separate from its owners? May
a partnership hold title to property in its own name?
o RUPA 201: Partnership as Entity
A partnership is an entity distinct from its partners.
A limited liability partnership continues to be the same entity that existed
before the filing of a statement of qualification under Section 1001.
o RUPA 203: Partnership Property
Property acquired by a partnership is property of the partnership and not of the
partners individually.
o RUPA 204. When Property Is Partnership Property
a) Property is partnership property if acquired in the name of:
1) The partnership; or
2) One or more partners with an indication in the instrument transferring
title to the property of the person's capacity as a partner or of the
existence of a partnership but without an indication of the name of the
partnership.
b) Property is acquired in the name of the partnership by a transfer to:
1) The partnership in its name; or
2) One or more partners in their capacity as partners in the partnership, if
the name of the partnership is indicated in the instrument transferring
title to the property.
c) Property is presumed to be partnership property if purchased with partnership
assets, even if not acquired in the name of the partnership or of one or more
partners with an indication in the instrument transferring title to the property
of the person's capacity as a partner or of the existence of a partnership.
d) Property acquired in the name of one or more of the partners, without an
indication in the instrument transferring title to the property of the person's
capacity as a partner or of the existence of a partnership and without use of
partnership assets, is presumed to be separate property, even if used for
partnership purposes.

Who Decides What the Partnership Will Do?

What does the partnership agreement say about the management rights of
the partners?
o Management Rights: each partner has equal rights in the management and
conduct of the partnership.

In the absence of an agreement (default rule):

o Do partners each have an equal right to manage the partnership?
RUPA 401(f): Each partner has equal rights in the management and conduct
of the partnership business.
o How do partners vote on ordinary matter concerning partnership business? What
vote is necessary to pass an ordinary measure? See RUPA 401(j).
Partnership Business: A majority vote is required to decide a difference arising
as to a matter in the ordinary course of business of a partnership.
One partner = One vote, regardless of the amount of capital contributed.
o How do partners vote of matters outside the ordinary course of business? What
vote is necessary to pass such a measure? See RUPA 401(j).
The consent of all partners is required to settle a dispute arising outside the
ordinary course of business. (Unanimous Vote)
Adopting the partnership agreement in the first place requires a unanimous
vote.

Authority of Partners
Are partners agents of the partnership? See RUPA 301(1).
o Yes, partners are agents of the partnership.

Do partners have apparent authority to bind the partnership in the

ordinary course of business? See RUPA 301(1).
o Partners also have apparent authority
o By admitting or promoting someone as partner, you are giving the outside world a
reasonable belief that the person is authorized to act on behalf of the partnership
in the ordinary course of business

Does a partner have the authority to bind the partnership to a transaction

outside the ordinary course of business? If so, under what circumstances?
See RUPA 301(2).

o This is a mandatory rule because it affects third parties.

Is RUPA 301 a default or mandatory rule? See RUPA 103(b)(10).

o An act of a partner which is not apparently for carrying on in the ordinary course
of business binds the partnership only if the act was authorized by other partners.
o No apparent authority outside the ordinary course of business there must be
actual authority.

Fiduciary Duties of Partners

Partners owe a duty of loyalty and duty of care to the partnership and the
other partners. See RUPA 404(a).
o Duty of loyalty: a duty to account to the partnership and hold as trustee for it any
property, profit, or benefit derived by the partner in the conduct and winding up of
the partnership business
o A duty to refrain from conflicts of interests
o A duty to refrain from competing with the partnerships business

What is a partners duty of loyalty? See RUPA 404(b).

o The partnership agreement may create exceptions
o A partner's duty of loyalty to the partnership and the other partners is limited to
the following:
To account to the partnership and hold as trustee for it any property, profit, or
benefit derived by the partner in the conduct and winding up of the
partnership business or derived from a use by the partner of partnership
property, including the appropriation of a partnership opportunity;
To refrain from dealing with the partnership in the conduct or winding up of the
partnership business as or on behalf of a party having an interest adverse to
the partnership; and
To refrain from competing with the partnership in the conduct of the
partnership business before the dissolution of the partnership.

What is a partners duty of care? See RUPA 404(c).

o Duty of Care: refraining from engaging in grossly negligent or reckless conduct,
intentional misconduct, or a knowing violation of law.
o Low standard, can be heightened (but not lowered)
o A partner's duty of care to the partnership and the other partners in the conduct
and winding up of the partnership business is limited to refraining from engaging
in grossly negligent or reckless conduct, intentional misconduct, or a knowing
violation of law.

Who is Liable for What to Whom?

May a partnership sue or be sued in its own name? See RUPA 307.
o A partnership may sue and be sued in the name of the partnership.

Under what circumstance is the partnership liable for any loss or wrongful
act of a partner? See RUPA 305(a).
o A partnership is liable for loss or injury caused to a person, or for a penalty
incurred, as a result of a wrongful act or omission, or other actionable conduct, of
a partner acting in the ordinary course of business of the partnership or with
authority of the partnership.

Are partners personally liable for liabilities of the partnership? See RUPA
306(a).
o All partners are liable jointly and severally for all obligations of the partnership,
unless otherwise agreed by the claimant or provided by law
o NO LIMITED LIABILITY

What does joint and several liability mean?

o Joint and several liability: Partner A, B, and C are jointly and severally liable for
debt to creditor. Creditor (third party) can choose to go after Partner A alone to
collect. A would have to pay 100%, regardless of how A, B, and C had agreed to
share their losses. A can then seek indemnification/contribution from B and C
Liability of Enforcing Judgments
If a creditor gets a judgment against the partnership, is such judgment
automatically enforceable against the partners?
o No, a judgment against a partnership is not by itself a judgment against a partner.
A judgment against a partnership may not be satisfied from a partners assets
unless there is also a judgment against the partner.
So, the partners need to be named in the lawsuit along with the partnership
o RUPA 307(c): A judgment against a partnership is not by itself a judgment
against a partner. A judgment against a partnership may not be satisfied from a
partner's assets unless there is also a judgment against the partner.

May a creditor satisfy a judgment from a partner without first exhausting

the partnerships assets? What if the partner was the tortfeasor?
o You are always able to sue a single partner as the tortfeasor. The creditor must
first exhaust the partnerships assets then the creditor can go after the tortfeasor
under J&S Liability.
o RUPA 307(d): A judgment creditor of a partner may not levy execution against
the assets of the partner to satisfy a judgment based on a claim against the
partnership unless the partner is personally liable for the claim under Section 306
and:
1) A judgment based on the same claim has been obtained against the
partnership and a writ of execution on the judgment has been returned
unsatisfied in whole or in part;
2) The partnership is a debtor in bankruptcy;
3) The partner has agreed that the creditor need not exhaust partnership assets;

4) A court grants permission to the judgment creditor to levy execution against

the assets of a partner based on a finding that partnership assets subject to
execution are clearly insufficient to satisfy the judgment, that exhaustion of
partnership assets is excessively burdensome, or that the grant of permission
is an appropriate exercise of the court's equitable powers; or
5) Liability is imposed on the partner by law or contract independent of the
existence of the partnership.
Indemnification/Contribution
May partners agree to share their losses in any way they wish? If so, is
their agreement binding on third party creditors? See RUPA 401(k).
o No. This section does not affect the obligations of a partnership to other persons
under 301

If a partner pays more than his share of partnership debt, does he have
any recourse? From the partnership? From the other partners?
o RUPA 401(b): Each partner is entitled to an equal share of the partnership profits
and is chargeable with a share of the partnership losses in proportion to the
partner's share of the profits.
o RUPA 401(c): A partnership shall reimburse a partner for payments made and
indemnify a partner for liabilities incurred by the partner in the ordinary course of
the business of the partnership or for the preservation of its business or property.

Exhaustion Rule: judgment creditor has to go after the assets of the partnership
unless the partner was personally liable (ex: was the tortfeasor)
o The exhaustion rule applies only if theyre not individually liable or have cosigned on a contract to be liable.
o Indemnification: whatever partnership agreement says affects internally but it
cant alter the rights of a third party.
o Contribution: If the partner pays more than his share of the debts they may
seek contributions from other partners.

Liability of New Partners

Is a new partner liable for pre-existing partnership liabilities?
o RUPA 306(b): A person admitted as a partner into an existing partnership is
not personally liable for any partnership obligation incurred before the person's
admission as a partner

What about the new partners capital contribution? Could the new partner
lose his or her capital contribution to a pre-existing debt?
o The new partners capital contribution could be used/they can lose it and it is
owned by the partnership (can be used to pay off old obligations if the partnership
chooses).
o Look to where the debt was incurred not owed.

How do the Partners Make Money?

As a default rule, is a partner entitled to a salary from the partnership.
o RUPA 401(h): A partner is not entitled to remuneration for services performed
for the partnership, except for reasonable compensation for services rendered in
winding up the business of the partnership.

As a default rule, how do partners share profits and losses? Does it matter
how much capital a partner has contributed to the partnership?
o RUPA 401(b): Each partner is entitled to an equal share of the partnership
profits and is chargeable with a share of the partnership losses in proportion to
the partner's share of the profits.

Partners make money in a three-step process:

o Partnership generates a profit;
o Profit is allocated to a partners capital account (profit share determined by
partnership agreement; otherwise equal share by default);
o Partnership makes distributions to partners (note that the partnership is not
required to immediately distribute profits to partners, unless the partnership
agreement says so).

Sale of Ownership Interest to a Third Party

Does a partner have an interest in the partnerships assets? If not, what
interest does a partner have? Is it personal property? What if the
partnership only owns real estate?
o RUPA 501: Partner Not Co-owner of Partnership Property
A partner is not a co-owner of partnership property and has no interest in
partnership property, which can be transferred, either voluntarily or
involuntarily.
o RUPA 502: Partner's Transferable Interest in Partnership
The only transferable interest of a partner in the partnership is the partner's
share of the profits and losses of the partnership and the partner's right to
receive distributions. The interest is personal property.

May a partner transfer his or her partnership interest to a third party?

o No, not unless the partners agree to it.

If so, does that entitle the transferee to be partner? See RUPA 503.
o The transferee does not become a partner. He does not have fiduciary duties.

Assignment of Partnership Interest

What interest does the assignee have?
o RUPA 503(b): A transferee of a partner's transferable interest in the
partnership has a right:
1. To receive, in accordance with the transfer, distributions to which the
transferor would otherwise be entitled;
2. To receive upon the dissolution and winding up of the partnership business, in
accordance with the transfer, the net amount otherwise distributable to the
transferor; and
3. To seek under Section 801(6) a judicial determination that it is equitable to
wind up the partnership business.

What is the status of the transferor partner? Does he or she remain a

partner in the partnership?
o RUPA 503(d): Upon transfer, the transferor retains the rights and duties of a
partner other than the interest in distributions transferred.

Creditor of a Partner
Is a judgment creditor of a partner permitted to attach or levy against the
partnerships property?
o RUPA 501: Partner Not Co-owner of Partnership Property
A partner is not a co-owner of partnership property and has no interest in
partnership property, which can be transferred, either voluntarily or
involuntarily.

What happens if a creditor of a partner seeks to levy against the partners

partnership interest?
o RUPA 504: Partner's Transferable Interest Subject to Charging Order
RUPA 504(a): On application by a judgment creditor of a partner or of a
partner's transferee, a court having jurisdiction may charge the transferable
interest of the judgment debtor to satisfy the judgment. The court may appoint
a receiver of the share of the distributions due or to become due to the
judgment debtor in respect of the partnership and make all other orders,
directions, accounts, and inquiries the judgment debtor might have made or
which the circumstances of the case may require.

RUPA 504(b): A charging order constitutes a lien on the judgment debtor's

transferable interest in the partnership. The court may order a foreclosure of
the interest subject to the charging order at any time. The purchaser at the
foreclosure sale has the rights of a transferee.

RUPA 504(c): At any time before foreclosure, an interest charged may be

redeemed:
By the judgment debtor;
With property other than partnership property, by one or more of the other
partners; or
With partnership property, by one or more of the other partners with the
consent of all of the partners whose interests are not so charged.

RUPA 504(d): This act does not deprive a partner of a right under exemption
laws with respect to the partner's interest in the partnership.

RUPA 504(e): This section provides the exclusive remedy by which a

judgment creditor of a partner or partner's transferee may satisfy a judgment
out of the judgment debtor's transferable interest in the partnership.

Can the judgment creditor seize the partners partnership interest and
become a partner in the debtor partners place?
o No, the creditor can get a charging order.

o RUPA 504(e): This section provides the exclusive remedy by which a judgment
creditor of a partner or partner's transferee may satisfy a judgment out of the
judgment debtor's transferable interest in the partnership.

Withdrawal of a Partner
Dissociation of a Partner: Leaving of a partner from the partnership.

Dissolution of a Partner: The whole partnership going away.

Winding up: Selling all of the partnerships assets, etc.

Termination of a partnership: Also known as liquidation, after winding up occurs.

Dissociation
What events cause dissociation? See RUPA 601.
o Partners express will to withdraw
Cant be prevented from leaving the partnership RUPA 103(b)
Might be wrongful dissociation, but they CAN quit.
o Event agreed to in the partnership agreement as causing dissociation
o Partners expulsion pursuant to the partnership agreement.
o Partners expulsion by unanimous vote of the other partners
o Partners expulsion by judicial determination
o Partner becoming a debtor in bankruptcy
o The partners death
o Termination of a partner NOT an individual, partnership, corporation, trust or
estate.
o Buy out the partner who leaves. Youd have to evaluate their share.

Can the partnership agreement prohibit a partner from dissociating? See

o RUPA 103(b)(6): Vary the power to dissociate as a partner under Section
602(a), except to require the notice under Section 601(1) to be in writing.

In other words, does a partner always have the power to dissociate?

o RUPA 602(a): A partner has the power to dissociate at any time, rightfully or
wrongfully, by express will pursuant to Section 601(1).

Does a partner always have the right to dissociate?

o A partnership agreement cannot prohibit a partner from dissociating (but can
require it to be in writing). A partner will always have the power to dissociate, but
may not have the right to do so.

It could be a breach of Contract

o There are negative consequences associated with a wrongful dissociation.

Wrongful Dissociation
Does a partner always have the right to dissociate?
o The partnership agreement cannot prohibit a partner from dissociating. You can
require them to do so in writing, but the partner will always have the power to
dissociate. However, the partners may not have a right to dissociate. This is called
wrongful dissociation and there are consequences for wrongful dissociation.

When is a partners dissociation wrongful?

o RUPA 602(a): A partner has the power to dissociate at any time, rightfully or
wrongfully, by express will pursuant to Section 601(1).

Are there any negative consequences to a wrongfully dissociating partner?

o Breaching a contract provision and youre liable for damages that caused as a
result of the breach If partnership goes into dissolution, the wrongfully dissociated
partner has no right to participate in the winding up of the partnership If
partnership is not dissolved, there is a buy out of the dissociated partner but the
buy is off set by damages and if it was for a definite term or undertaking the buy
out will not occur until the term or undertaking has expired unless you can show
that the payment would not cause an undue hardship to the partnership.

Article 8 Dissolution
Does a partners dissociation always result in dissolution? See RUPA
603(a).
o If a partner's dissociation results in a dissolution and winding up of the
partnership business, Article 8 applies; otherwise, Article 7 applies.

What events cause dissolution? See RUPA 801.

o In the case of an at-will partnership, the express will of any partner to dissolve
(so, its not a good idea to have an at-will partnership).
o In the case of a partnership with a definite term or undertaking, the dissolution
can happen if:
There is the express will (vote) of at least half the remaining partners to
dissolve within 90 days of the partners dissociation.

Upon the express will of all the partners.

At the expiration of the term or undertaking or
Under a judicial order to dissolve

Article 7 Buyout
What happens if a partner dissociates, but the partnership does not
dissolve? See RUPA 701(a).
o The buyout price is the greater of liquidation value or the value based on a sale of
the entire business as a going concern with the dissociated partner and the
partnership were wound up as of that date

If a partner is bought out, how is the buy out price set? See RUPA 701(b).
o Going Concern: the partnership is of value, but has no value in terms of hard
assets their value is in their reputation

Can the dissociated partner and the partnership agree to set a buy out
price? See RUPA 701(e).
o If the parties can agree on a value, that is binding

What happens if they cannot agree on a price? See RUPA 701(e), (i).
o If they cant agree, the dissociated partner can make a demand for payment.
o Within 120 days, the partnership can pay out what it estimates it owes.
o If the dissociated partner is not satisfied, he has 120 days to go to court.

Wrongful Dissociation Buyout

When a wrongfully dissociating partner is bought out, how is the price set?
See RUPA 701(c).
o Buyout price will be offset for damages

When does a wrongfully dissociating partner receive the buy out? See
RUPA 701(h).
o If there is a term or undertaking of the partnership, the buyout will not happen to
the end of the term.
o Exception: the dissociated partner must go to court and show that there is no
undue hardship in making the partnership pay before the end of the term (not
likely).

Liability of Bought Out Partner

Does a bought out partner remain liable for partnership debts? See RUPA
703.
o The third-party creditor can still look to the dissociated partner for a liability that
was incurred BEFORE the dissociation

Does it matter if the liability was incurred before or after dissociation?

o Generally, the dissociated partner is not liable for liabilities incurred AFTER the
dissociation

o RUPA 703(b): Exception

If, within 2 years of the dissociation, the third-party creditor reasonably
believed that the dissociated partner was still a partner and is not deemed to
have received notice of that dissociation.

If a partner has to pay a partnership debt after he is bought out, does the
partner have any recourse against the partnership? See RUPA 701(d).
o If that dissociated partner has to pay that post-dissociation liability, he can get
indemnity from the partnership

Settlement of accounts:
Once the partnership is dissolved and its business wound up, how are
partnership assets applied and distributed? See RUPA 807(a) & (b).
o RUPA 807(a): In winding up a partnership's business, the assets of the
partnership, including the contributions of the partners required by this section,
must be applied to discharge its obligations to creditors, including, to the extent
permitted by law, partners who are creditors. Any surplus must be applied to pay
in cash the net amount distributable to partners in accordance with their right to
distributions under subsection (b).
o RUPA 807(b): Each partner is entitled to a settlement of all partnership
accounts upon winding up the partnership business. In settling accounts among
the partners, profits and losses that result from the liquidation of the partnership
assets must be credited and charged to the partners' accounts. The partnership
shall make a distribution to a partner in an amount equal to any excess of the
credits over the charges in the partner's account. A partner shall contribute to the
partnership an amount equal to any excess of the charges over the credits in the
partner's account but excluding from the calculation charges attributable to an
obligation for which the partner is not personally liable under Section 306.

Who is paid first? Creditors? Partners? What about creditors who are also
partners?
o Creditors are paid first.
o Next settle accounts.
o If there is anything left over, pay the rest equally.
o Partners are liable for their debts.
o Shareholders may lose investment if a creditor cant be paid- thats why theyre
paid first.

Introduction to Corporations

What is a corporation?
o A separate legal entity formed under the authority of a state statute.
o Existence depends on filing with state.

Who are the players?

o Shareholders
Owners.
Elect the board of directors
Vote on major corporate actions or fundamental changes.
o Directors
Manage the business
Set business policy
Select officers
o Officers and other employees
Act as agents of the board
Execute boards decision
Manage day-to-day operations

What are shares (a.k.a. stock)?

o Intangible property that represents ownership in a corporation.

Who are shareholders (a.k.a. stockholders)?

o Collectively own the corporation.
o As a shareholder, you do not have any right to male business decisions for the
corporation, nor are you an agent of the corporation.

Are shareholders personally liable for the corporations debts?

o No they are not due to limited liability.

Is stock generally freely transferable?

o Common stock is almost always freely transferable.

Do corporations have perpetual existence?

o Yes.

Does the withdrawal of a shareholder cause dissolution?

o No.

Corporate Structure
Shareholders
o Shareholders are the owners of the corporation. They do not directly manage the
business and affairs of the corporation. The Board of Directors does. The
responsibility of the shareholders is to elect the board of directors. They also have
the right to vote on certain fundamental changes, one of which is a merger.

The Board of Directors

o The Board of Directors is the body that has the authority to manage the business
and affairs of the corporation. But the Board does NOT deal with the corporation
on a day-to-day basis.

Officers
o Officers manage business and affairs on a day-to-day business. Traditionally,
these were the President, VP, Secretary, and Treasurer. The modern terms are
Chief Executive Officer (CEO), Chief Financial Officer (CFO), Chief Operating
Officer (COO), etc.

This structure works well in the context of very large, publicly traded companies.

The Model Business Corporation Act applies regardless of the size of the company
(although there are some provisions that apply only to the small corporations), but
many of the rules contemplate large companies.

Can an individual be a shareholder, director, and officer simultaneously?

o YES.
o Ex. Tim Cook, is the CEO of Apple. He is also on the Board of Directors, and likely
owns some shares of Apple.

When a company is small, it is possible that there can be one individual who makes
up the entire Corporate Structure (One shareholder, who is also the Director and the
Officer).

What Is Corporate Law?

State Statutes:
o Model Business Corporation Act is our primary statutory authority
o FL is based on the MBCA
o Sometimes, we will look to Delaware law, because that is the most important
state when it comes to corporate law.

Articles of Incorporation & Bylaws

o Generally, Articles of Incorporation and Bylaws govern the internal affairs of a
corporation (Similar to a Partnership Agreement can be used to amend provision
in the MBCA)

Case Law
o Case law is important when we talk about the fiduciary duties of directors and
officers. Directors may have conflicts of interest.

Federal statutes
o Federal Securities Laws: Securities Act of 1933 and the Securities Exchange Act of
1934 concerned with the issuance of securities (which are broader than just
stocks)

State of Incorporation
May a corporation incorporate in any state?
o Yes. A corporation may incorporate in any of the 50 States, D.C., or even
overseas.
o If you are going to represent a mom-and-pop business that will only operate in FL,
it wouldnt make sense to look to another state to incorporate in. (Small business,
or closed corporations form the corporation in the state where the corporation is
located)

In what state should you incorporate your corporation? Is your answer

influenced by whether the corporations stock will be publicly traded or
not?
o For your small business, if you form the corporation, usually, you form within the
state you plan on doing business in.
o If it is a publicly traded corporation Delaware is usually the place of incorporation.
o Public companies (i.e. stock is publicly traded) have a preference for Delaware.
Historically, Delaware was trying to attract business to its state, so it was
aggressive in being on the leading edge of developing corporate law, and it was
perceived to be management friendly.

Why is Delaware a popular state to incorporate for public corporations?

o Friendly in allowing companies to come in
o No minimum capital requirements
o The need for only one incorporator (a corporation may be the incorporator)
o Favorable franchise tax in comparison to other states.
o Delaware, unlike most other states, has a separate court system that hears
corporate cases. This is very unusual. The judges are allegedly very experienced
in corporate matters.

What is the internal affairs doctrine?

o The state where it is incorporated in will govern the corporations internal affairs.
o When there is a dispute over the governance of a corporation (ex. What notice will
go out to shareholders for a meeting), the state of incorporation governs the
internal affairs, even if its headquarters are in another state or it is doing business
somewhere else.
So, a Tampa company incorporated in Delaware will have its internal affairs
governed by Delaware law.

Formation of a Corporation
1. The Incorporator(s) file the Articles of Incorporation.
o Legal Name
o Number of authorized shares-shares you are entitled to issue at any time

o Outstanding shares-subset of authorized shares that are actually issued and

outstanding
o Name of Registered Agent
o Address
o Will be an authority on the internal affairs.
2. Organizational Meeting [MBCA 2.05(a)(2)]
o Incorporator(s) elect initial board of directors
3. After Incorporation; Hold First Meeting
o Appoint officers
o Adopt bylaws: can be any provisions for managing the business and regulating the
affairs of the corporation as long as it is not inconsistent with law or the articles of
incorporation.
o Issue Shares To Shareholders (subscription agreement)
Articles of Incorporation
What are articles of incorporation (a.k.a. certificate of incorporation)?
o Mandatory Terms (MBCA 2.02(a))
Name & Address of Incorporators (must have 1 or more)
Incorporator signs and files the articles
Can be a person OR an entity (Majority View), but in NY it must be a person
Often a lawyer
Agent for Service of Process
Registered Agents Address
Name of Corporation
Nature of the business or purposes to be conducted or promoted
Must have at least 1 class of common voting stock (the number of shares the corporation is
authorized to issue but remember, they dont necessarily need to issue them all)
Must include corporation suffix: ie. Corp., co., inc. (MCBA 4.01)
o Optional Terms MCBA 2.02(b) dont necessarily need to be in the Articles
Names and addresses of initial directors
o Must File the charter with the Secretary of State and Pay Required Fee
Under MCBA 2.03, Filing with the SOS starts the corporations life:
Proof of valid formation of business
You are a corporation in the eyes of the law (de jure corp)

Do articles of incorporation become a public document?

o Yes.

What word or words must the name of a corporation contain? See MBCA
4.01. Why do you suppose the name must contain one of these words?
o Must include corporation suffix: ie. Corp., co., inc. (MCBA 4.01)
o This is so the third party understands that they are dealing with a LLC.

Could you choose Apple Computer, Inc. as the name of your new
corporation? See MBCA 4.01(b).

o No, Apple is registered in every state.

Bylaws
What are bylaws? See MBCA 2.06(b).
o The bylaws of a corporation may contain any provision for managing the business
and regulating the affairs of the corporation that is not inconsistent with law or
the articles of incorporation.

Are bylaws public record?

o No

Must a corporation adopt bylaws under the MBCA? See MBCA 2.06(a).
o The incorporators or board of directors of a corporation shall adopt initial bylaws
for the corporation.

Promoters
Promoter: Someone who purports to act as an agent of the business prior to its
incorporation
o He is acting on behalf of the corporation that hasnt yet been formed
o Gets the corporation up and running (advance team)
o He is an organizer, acting as an agent, but isnt really an agent (cannot be an
agent of something that does not yet existremember he is a promoter preincorporation)
o Promoter retains liability on pre-incorporation contracts unless and until promoter
gets a novation
o Pay promoter either with stock or money
o EXAM: Whenever have promoter, look for liability he might enter contract on
behalf of the corporation, but the corp has not yet been formed

Example: Promoter would like to get a deal for office space for a 3 year
period
o Corporation he is working for has yet to be incorporated
o Promoter signs as an agent for yet to be formed corporation but he has not been
authorized [because corporation does not yet exist]
o Promoter believes that the corporation will ratify his contract [before this point
promoter is an unauthorized agent and liable for all of this debt]

Pre-Incorporation Contracts: contracts BEFORE there exists a legal corp.

o Need promoter to enter into them before corp. is officially formed

Liability on Pre-Incorporation Contracts

o Three Possible outcomes for pre-incorporation contracts signed by a promoter:
Promoter retains liability, corporation has none
No novation & Corp did not explicitly or implicitly agree to be bound by
contract

Promoter and corporation both have liability

No novation & Corp agreed to be bound either explicitly (through words) or
implicitly (conduct)
o Implicit agreement to be bound- Conduct:
Moving Into Office Space
Accepts Benefits of Contract
o As a matter of law, actions taking advantage of the K is the same as
explicitly agreeing to be bound.

Promoter has no liability, corporation has liability requires

NOVATION
Only way for promoter to be relieved of liability for pre-incorporation
contracts is novation (agreement between Promoter, Corp & 3d Party).
o Promoter retains liability on pre-incorporation contracts unless and until
he gets a novation
o For novation, need Corp to agree to release him from the contract, that
only Corp is bound, and the Third Party consents and agrees. (i.e.
Landlord of Office Space)

Why wont ratification work for pre-incorporation agreements?

o Ratification only works when there is an unauthorized act that occurred act
couldve been authorized at time entered into but wasnt and principal agrees to
be bound later.

Why ratification wont work now?

o Cant ratify because the day the promoter entered into the pre-incorporation
contract, there was no corporation in existence.
o The corporation didnt exist at time of contract, so couldnt have authorized at
time contract as made into.
o Principal wasnt in existence when unauthorized act occurred
There was no agent because there was no actual principal (only purported
agent)
o Rule: can never ratify pre-incorporation contract b/c corporation didnt exist at
time contract entered into.
Principal must be in existence when unauthorized acts occurred
Need novation, not ratification

Financing The Corporation

What are the two primary ways to finance a corporation with sufficient
money so that it can operate? Whats the difference between equity and
debt?
o Equity: Buying shares
Shares/stock represent an ownership interest.

o Debts: Borrowing money or issue debt instruments (bonds)

The bondholders are creditors of the corporation- the corporation will pay back
with interest over a period of time.

What is an issuance?
o Issuance of shares requires approval at a meeting at which a quorum exists if its
issue for something other than cash AND if the stock offering is more than 20% of
the stocks currently outstanding (voting shares). I.e. Merger, typically not needed

Whats the difference between authorized shares and issued and

outstanding shares? See MBCA 6.01 & 6.03.
o Authorized shares: shares you are entitled to issue at any time
o Outstanding shares: subset of authorized shares that are actually issued and
outstanding

Stock
May a corporation have more than one class of stock with different
dividend and liquidation preferences, voting rights, and so on? See MBCA
6.01.
o Yes

What is common stock?

o A type of stock that represents the RESIDUAL value of the corporation; common
stock has no special contract rights or preferences; so creditors and preferred
shareholders must receive their required interest and dividend payments before
common stockholders get ANYTHING.
o Common stock has no fixed maturity date (date when the debt is done/due); if the
corporation is liquidated, the creditors and preferred stockholders are paid the
value of their interests first, and common stockholders are paid the value of their
interests, if any, last.
o Hierarchy of Payment:
Creditors,
Preferred Stockholders,

Common Stockholders

o Ordinarily, common stockholders have the exclusive right to elect the board of
directors who manage the corporation
o They may also get to vote on mergers and other important matters.
o In return for their investment, common stockholders receive DIVIDENDS declared
by the board of directors
o Common stock is frequently the only class of stock outstanding;
o It generally represents the greatest proportion of the corporations capital
structure and bears the greatest risk of loss should the enterprise fail
But in return for this position of subordination, the common stockholders have
an exclusive claim to the corporate earnings and assets that exceed the claims
of creditors and other shareholders
Therefore, the common stockholders bear the major risks of the corporate
venture, yet stand to profit the most if it is successful.
They can benefit either from appreciation or cast/stock/property dividends.

What is preferred stock?

o An equity security that is given certain preferences and rights with regard to
assets or dividends over common stock. They have contractual rights superior to
those of common stock; it is preferred to common stock it takes priority over
the common stock in some way, usually either in terms of dividends or liquidation
preferences or both.
o Preferences:
Liquidation Preference: The right to be paid before the common
stockholders if the corporation is dissolved and liquidated. The liquidation
preference is usually stated in a dollar amount.
Example: a corporation issues a stock that has a liquidation preference of
$200. This means that if the corporation is dissolved and liquidated, the
holder of each preferred share will receive at least $200 before the common
stockholders will receive anything. Note that since the corporation must
pay its creditors first, there may be insufficient funds to pay even this
preference.

Remember Order of Payment (Liquidation):

o Outside Creditors -> Inside Creditors -> Preferred Stockholders ->
Common Stockholders

Dividend Preference: The right to receive a fixed dividend at set periods

during the year, like every quarter. The dividend rate is usually a set
percentage of the initial offering price.
Example: If a stockholder purchases $10,000 of a preferred stock that pays
an 8 % annual dividend. The stockholder has the right to receive $800 each
year as a dividend on the preferred stock.

Common stockholders have NO RIGHT to a dividend; Contract right to a

dividend for preferred stockholders.

Cumulative dividend right: corporations must pay a preferred dividend if

they have the earnings to do so. Cumulative preferred stock provides that
any missed dividend payments must be paid in the future to the preferred
stockholders before the common stockholders can receive any dividends.

Non-Cumulative preferred: dividends do not cumulate; the corporation

does not have to pay any missed dividends. For these shares, only the
current years dividends must be paid to preferred shareholders prior to the
payment of dividends to common shareholders.

Preferred stockholders would choose to have cumulative dividends;

common stockholders would choose to have preferred stockholders get
noncumulative dividends

o Participation Preference: Allows the stockholder to participate in the profits of

the corporation, along with the common stockholders. Participation is in addition
to the fixed dividend paid on preferred stock. The terms of the participation can
vary widely. Usually, the common stockholders must be paid a certain amount of
dividends before participation kicks in.
Preferred stockholders share in common stockholder profits
Common stockholders HATE this stipulation)
o Conversion Right: Permits the stockholders to convert their shares into another
security, typically, common stock. The terms and exchange rate of the
conversion are established when the shares are first issued. The holders of the
convertible preferred stock usually exercise this option if the corporations stock
increases significantly in value.
A conversion ratio must be built in for these options (wont convert if common
stock is at or below the price of the preferred stock)
Source of discontent among common stockholders because this right has a
dilution effect on stocks
A 1-Time Conversion
o Redemption Right: Permits the corporation to redeem/buy back the preferred
stock at some future date. The terms of the redemption are established when the

shares are first issued. Corporations usually redeem shares when the current
interest rate falls below the dividend rate on the preferred stock.
As soon as the corporation has the contractual right to redeem stock it will
*Only thing that makes preferred stock less valuable

What is par value? Must stock have a par value under the MBCA? See
MBCA 2.02(b)(iv).
o Minimum amount you can issue a share for (ex. $1/share)

Problem 5-19: ABC Corp. has two classes of stock: (1) common stock, of which
there are 10,000 shares outstanding, and (2) preferred stock, of which there are
5,000 shares outstanding. The preferred stock has a $10 per share liquidation
preference. ABC Corp. has dissolved. After liquidating its assets, it had $200,000 in
cash. However, it owes creditors $50,000. How will this money be divided among
(1) creditors, (2) holders of preferred stock, and (3) holders of common stock, if the
preferred stock's liquidation preference is non-participating? How does your answer
change if the preferred stock's liquidation preference is participating?
$200,000
x 50,000
Creditors
150,000
x 50,000_____ Preferred (5000 PS x $10/share =50,000)
100,000
Common Shares (100k 10k common shares = $10/share)
Outside Creditors -> Inside Creditors -> Preferred Stockholders -> Common
Stockholders
Dividends & Distributions
Dividends: when you receive a percentage of the stock that you own after a year. i.e.
if you are a preferred stockholder, and you put in $1,000, and the shares are 3$
apiece, youd get $3,000 at the end of the year
o This decision is always within the discretion of Board
o Never open to SH discussion

Appreciation: only realized after you sell your stock (which has become more
valuable)

Should a board declare a dividend? Its ALWAYS a BJR for the BOARD to
decide!!
o Decided on a case by case basis by some companies
o Dividends are always paid by some companies, never paid by others
o Is the decision of a board to pay or not to pay dividends open to shareholder
debate?
o NO this would be a usurpation of the Boards authority (Always within the
discretion of the board to declare a dividend)
*DEFINITION OF BUSINESS JUDGMENT
Problem 5-22: The only outstanding shares of Grape Corp. stock are 2,000 shares
of common stock. Grape's most recent balance sheet shows that it has $100,000 of
assets, $70,000 of liabilities, and shareholders' equity of $30,000. What is the
maximum amount of dividends that Grape Corp. could pay on its common stock and
pass the balance sheet test of MBCA 6.40(c)(2)? What is the per-share amount of
that dividend?

o Assets Liabilities = Shareholder Equities

o 100k -70k = 30k
$15 per-share amount.

Problem 5-23: Same facts as Problem 5-22, except that Grape Corp. also has 1,000
shares of preferred stock outstanding, which have a $5 per share liquidation
preference. What is the maximum amount of dividends that Grape Corp. could pay
on its common stock and pass the balance sheet test of MBCA 6.40(c)(2)?
o Assets Liabilities = Shareholder Equities
o 100k -70k = 30k Shareholder Equities
30k Shareholder Equities
5k Pref. Shareholder Shares
25k Common Shares

Problem 5-24: The only outstanding shares of Orange Corp. stock are 7,000 shares
of common stock. Orange's most recent balance sheet shows that it has $160,000 of
assets and $70,000 of liabilities. What is the maximum amount of dividends that
Orange Corp. could pay on its common stock and pass the balance sheet test of
MBCA 6.40(c)(2)?
o $160k - $70k = $90k Shareholder Equity

Problem 5-25: Same facts as Problem 5-24, except that Orange Corp. also has
3,000 shares of preferred stock outstanding, which has a $7 per share liquidation
preference. What is the maximum amount of dividends that Orange Corp. could pay
on its common stock and pass the balance sheet test of MBCA 6.40(c)(2)?
o 3,000 x 7/share = $21k
o $69k common

Problem 5-27: The board of directors of Strawberry Corp. was advised by the
company's accountants and lawyers that the maximum amount of dividends that the
corporation could pay was $10,000. Nonetheless, the board declared total dividends
of $15,000 and the corporation paid this amount to its shareholders. What is the
board's liability, if any? If the board members are liable, to whom are they liable?
Will any of the shareholders who received the dividend be liable to repay it?
o There is an illegal distribution of $5K
o The directors who voted or assented to the illegal distribution are jointly and
severally liable to have to repay the amount to the corporation
o The shareholders who received the dividend will not be liable to repay it (unless
there is a shareholder who was also director, in which case his liability is based on
his being a director, not a shareholder)

In General
Because a corporation is a legal entity distinct from its shareholders, the rights and
obligations of a corporation are normally separate from those of the shareholders.

Under the corporate statutes, a shareholder normally has no liability for corporate
debts or other obligations. Instead, her liability-more accurately, her risk-is limited to
the loss of her investment.

Under certain circumstances, shareholders can be found liable to corporate creditors.

o In such cases, it is said, the courts "pierce the corporate veil."
o The tests for whether the corporate veil will be pierced are generally vague.
Often, courts put the issue in terms of whether the corporation was the alter
ego/instrumentality of its shareholders.

One common formulation is that a corporate entity will be disregarded, and the veil
of limited liability pierced, when two requirements are met.
o First, there must be such unity of interest and ownership that the separate
personalities of the corporation and its shareholder or shareholders no longer
exist.
o Second, circumstances must be such that adherence to the fiction of separate
corporate existence would sanction a fraud or promote injustice.
In determining whether a corporation is so controlled by another to justify
disregarding their separate identities, the cases focus on four factors:
1. The commingling of funds or assets,
o A commingling of the corporation's assets and the shareholders' personal
as- sets occurs when the shareholders have dealt with the assets of the
corporation as if those assets were their own, e.g., by using corporate
funds to pay private debts, or by using corporate assets for other private
purposes.
2. The failure to maintain adequate corporate formalities,
o Also relevant to piercing the corporate veil is whether basic corporate
formalities were followed (e.g., whether stock was issued, corporate
records maintained, directors or officers elected, and regular meetings of
directors and shareholders held).
3. Undercapitalization, and
o An extremely important factor in deciding whether the corporate veil
should be pierced is whether the corporation was organized with
sufficient resources, by way of capital, liability insurance, or both, to
meet the obligations that reason-ably could be expected to arise in its
business.
The issue here is not whether the shareholders have respected and
maintained the corporation as a separate entity; rather, the issue is
whether the shareholders should reasonably have anticipated that the
corporation would be unable to pay the debts it would be likely to
incur.
The rationale of piercing the veil on the basis of undercapitalization is
that the legislature, in conferring limited liability, assumed that
shareholders would in good faith put up unencumbered capital (or
insurance) reasonably adequate for its prospective liabilities.

4. Domination and control

o Courts will often pierce the corporate veil of one corporation, C, when a
share- holder who owns most or all of C's stock so completely dominates
C's policy and business practices that C can be said to have no separate
mind, will, or existence of its own. The prime example occurs when a
parent corporation directly deter- mines the business policy of a
subsidiary, rather than allowing that policy to be determined by the
subsidiary's board. In contrast, the court is less likely to pierce a
subsidiary's veil if the subsidiary's business policies are determined by its
own board, even though the directors are elected by the parent, and
even though they are also officers or employees of the parent.

Limited Liability for Owners (when done correctly) owners are shareholders
o Owners liability for firm debts is capped by individual contributions (shares)
The most you can lose is what you put in and own
Creditors if run out of money before run out of creditors, creditors go away
o MBCA 6.22(b): Unless otherwise provided in the articles of incorporation, a
shareholder of a corporation is not personally liable for the acts or debts of the
corporation except that he may become personally liable by reason of his own
acts or conduct.
If you behave yourself as a shareholder the most you can lose is the value of
your shares [In sharp contract to a partnership]
Shareholders that behave properly are not personally liable for the acts or
conduct of the corporation (unless you become personally liable by reason
of your own acts or conduct then can pierce the corporate veil)

Piercing The Corporate Veil

General Rule of Shareholder Non-Liability:
o If the corporations debts exceed its assets then the corporations creditors may
not recover the unpaid amounts from the shareholders.
The most shareholders can lose is their investments.
o It protects shareholders from the corporations debts. If a court allows a creditor
to pierce the corporate veil, then what has happened is that one or more of the
shareholders will be personally liable for what is otherwise a corporate debt.

Factors When Determining If Corp. Veil Should Be Pierced:

o Whether the corporation was adequately capitalized.
o Whether the corporation observed corporate formalities
o Whether shareholders siphoned off corporate funds
o Whether the corporation acted as a facade for the shareholder.
o Whether fraud, lies, or misrepresentations were involved.

Bottom Line: Is it UNFAIR to allow the corporate shield to stand= this is the main
question
o When the corporate veil is pierced then the shareholder is personally
liable.

The doctrine of piercing the corporate veil only applies if the debtor corporation is
closely held.

Closely Held Corporations:

o Corporations that have a small number of shareholders.
Requirements:
Small number of stockholders (Less than 10)
No ready market of stock
Substantial majority stockholder participation in the management, direction,
operations of the corporation.
Stockholders run the day-to-day operations.
Hard to sell shares
Employment opportunity/investment =a lot like a partnership
Limited Liability of Shareholders

What if the shareholder of the debtor corporation isnt an individual, but is itself a
corporation?
o If a majority of a corporations stock is owned by another corporation, then the
first corporation is a subsidiary (child) and the second corporation is a parent.
o Parent/Child Corporation
Subsidiary= more than owned by the parent corporation.
Parent-Sub Piercing:
Whether subsidiary was adequately capitalized
Whether there are separate records being kept.
Whether subsidiary observed corporate formalities
Whether the parent siphoned off subsidiarys funds.
Whether the subsidiary acted as a faade for the parent.
Whether parent and subsidiary have common directors and officers
(common control).

Involuntary creditors (i.e., tort creditors) may be more likely to pierce the
corporate veil than voluntary creditors (i.e., contract creditors). Why do
you suppose this is the case?
o Because involuntary creditors do not willingly embrace unsecured status, and
creditors who contract for unsecured status voluntarily but in ignorance of
security's threat.

How can contract creditors protect themselves?

o Taking a security interest in real property

What factors go into piercing the corporate veil of a close corporation? Is

any one factor determinative?
o Dania Jai-Alai Palace Inc. v. Sykes:

Alter ego/ mere instrumentality

Improper conduct (Fraud, Illegality, Organized or used to mislead creditors)
Causation

Enterprise Liability
Enterprise liability only works when the companies that you have brought
into the corporation have other assets (Horizontal Veil Piercing)
o Looks at a unity of interest between corporations and allows you to sue each as a
single entity
o Enterprise liability allows you to scoop up assets horizontally (through corporation
to related corporation)
o PCV allows you to get at individual shareholders.

What does Enterprise Liability depend on?

o Here are some factors to consider in determining whether two or more
corporations have been operated as a single business enterprise:
Common employees;
Common record keeping;
Centralized accounting;
Payment of wages by one corporation to another corporations employees;
A common business name;
Services rendered by the employees of one corporation on behalf of another;
Undocumented transfers between corporations;
Unclear allocation of profits and losses between the corporations;
The same officers;
The same shareholders; and
The same telephone number.

Board of Directors
What is the board of directors?
o The board of directors is the ultimate source of decision-making authority in the
corporation.

MCBA 8.01. Requirement For And Duties Of Board Of Directors

o MCBA 8.01(a): Except as provided in 7.32, each corporation must have a board
of directors.
o MCBA 8.01(b): All corporate powers shall be exercised by or under the authority
of, and the business and affairs of the corporation managed by or under the
direction of, its board of directors, subject to any limitation set forth in the articles
of incorporation or in an agreement authorized under 7.32.

How does the board approve or ratify transactions?

o Consent Resolution: no meeting of the BOD they contact each other directly and a
document is prepared where they sign and approve without a meeting.

Meetings:
o Who has the power to call or convene the meeting?
The board of directors
o What kind of notice, if any, is required to be sent to directors informing them of
the forthcoming meeting, including:
How soon before the meeting must it be sent?
Two or more days notice required of date, time and place but not the
purpose of the meeting. MBCA 8.22
o Notice: must be in writing unless verbal notice is

What must the notice contain?

Date, Time, and Place BUT NOT PURPOSE

Does it make a difference if the board meeting is a special meeting or a

regular meeting? See MBCA 8.22.

Regular Meeting:
o Meetings that are fixed in the bylaws of the corp.
o No notice requirement because notice is in the bylaws already.

Special Meeting:
o Two or more days notice required of date, time and place but not the
purpose of the meeting. MBCA 8.22
o Notice: although formal notice is unnecessary for a regular meeting,
special meetings require notice to every director of the date, time,and
place of the meeting.

Can a director waive right to notice? If so, when? Before or after the meeting?
If a director attends a meeting, does he waive right to notice? See MBCA
8.23.
o Usually, notice can be waived in writing before or after a meeting.
Attendance waives notice unless the director attends only to protest the
meeting.

What is a quorum of the board of directors? See MBCA 8.24(a).

A majority of the total number of authorized directors

How many directors must be present at a meeting to constitute quorum?

MBCA 8.24(a). May the articles or bylaws fix a greater of lower number
quorum requirement? MBCA 8.24(b).
The certificate or bylaws may specify that any percentage greater or lesser
than a majority constitutes a quorum but they may not specify a percentage
less than one third of the total number of authorized directors.

What does it mean for a director to be present at a meeting? Must a director

be physically present at the meeting? See MBCA 8.20(b).
As long as everyone can simultaneously hear each other then they are
deemed present.

o Assuming quorum is present, how many directors must approve a particular

proposal for valid board action? See MBCA 8.24(c).
If quorum exists when vote taken, affirmative vote of Majority of directors
present = action of the board unless Articles/bylaws requires more. Directors
may abstain, vote yes/no. To abstain/dissent, must not vote in favor as noted in
minutes AND object at beginning of meeting /deliver written notice of
abstention to corporation during meeting/immediately thereafter.
o May the board act informally? In other words, may the board take action without
a meeting?
Yes, through a consent resolution.
Officers
Who are the officers of a corporation and what is their function?

o Model Act does not specifically say what officers are needed; some states will
require a President, Vice President, Secretary, and Treasurer. Now CEO, CFO, COO,
etc.
Look to corporations bylaws to see what officers it has, how they are
appointed, and what authority they have.

When do officers have actual authority to bind the corporation?

o Bylaws may have actual authority
o A resolution would give the actual authority to an officer to sign a contract on the
corp. behalf.
o Only authorized officers can bind the corporation.
o Authority may be:
Actual (expressed in bylaws or by valid board resolution), apparent
(corporationgives third parties reason to believe authority exists), or power of
position (inherent to position). If ratified by the board, even unauthorized acts
may bind the corporation.

When do officers have apparent authority to bind the corporation?

o Apparent Authority is something the principle has done which gives someone the
impression that they have the authority to act.
o The majority rule is that the president has power to bind the corporation in
transactions arising in the ordinary and regular course of business.

Scope of Shareholder Authority

Who can be a shareholder of a corporation? Must a shareholder be an
individual?
o A corp. may be a shareholder of another corp. (a parent/sub corp.)
o Any legal entity capable of owning property.

Do shareholders have management rights? On what matters is a

shareholder vote necessary?
o Shareholders have a very limited role:
They can select or remove the board of directors,
They can vote to approve fundamental changes in the corporate structure
They adopt, amend and repeal bylaws (with the board)
They have to approve certain mergers and acquisitions
They have to approve dissolutions

Do shareholders vote on day-to-day matters or do they generally only vote

on extraordinary matters?
o Shareholders are not voting on day-to-day operations of the corp.

Shareholders Meetings
Must shareholders hold an annual meeting? See MBCA 7.01. What
typically take place at an annual meeting?
o Annual Meeting Requirement
Elect directors during this meeting
Conduct other business as necessary
Can elect directors annually or staggered.
o Special Meeting
Remove a director
The board can, for cause or no cause, fire a director subject to approval of the
shareholder approval.
o The failure to hold an annual meeting on the date in the bylaws does not affect
the validity of the corporate action.

Can shareholders hold a special meeting? Why would the shareholders

need to hold a special meeting?
o To approve a director or approve a fundamental change

Who can call a special meeting of the shareholders? See MBCA 7.02(a).
o Holders of 10% of the shares of the corp.
o CEO
o President

Must shareholders receive notice of a meeting? If so, when and what must
the notice contain? Are the requirements different for an annual meeting
and a special meeting? See MBCA 7.05. May a shareholder waive right to
notice? See MBCA 7.06.
o Not less than 10, no more than 60 days before the meeting date for both annual
and special meetings
o Right to notice can be waived.
o They can act by written consent without a meeting.
o Board has to set a record date, 70 days, to figure out who gets mailed the notice.
Record Date: the day the board elects to see who owns the shares for voting
purposes.
Record Holder: the person holding the shares on the record date.
o Notice needs to contain
Time of the meeting

Place of meeting
Date
Purpose for SPECIAL meeting, NOT ANNUAL

Shareholders of a publicly traded corporation change on a daily basis. In

this case, how do we know which shareholder is entitled to receive notice
and to vote? MBCA 7.07(a) & (b).
o The BOD sets a record date, which states that who ever owns the shares by that
date are entitled to notice.
o Record Date: the day the board elects to see who owns the shares for voting
purposes.

How is the quorum requirement met for a shareholders meeting? MBCA

7.25(a).
o Quorum a majority of the shares that are qualified to vote on the issue.
o It may just be one person if they hold enough shares (51% owner)
o If you dont have a quorum- anything you vote on has no valid legal effect.
o Everything is unless stated differently in the articles or the bylaws- can agree to
lower quorum requirement.

If all of the shareholders are in agreement on a particular matter, do they

even have to hold a meeting to act? MBCA 7.04(a).
o Yes via a unanimous vote resolution.
o Only will work with a closed corporation

Election of Directors
As a general rule, how do shareholders elect directors? What is straight
(plurality) voting and how does it work? MBCA 7.28(a).
o Plurality Voting: G/R
You can vote up to your number of shares for each candidate.
Ex: If you had 100, you could vote 100 for each candidate or no votes for
any candidate or any combination thereof.
You may NOT accumulate your votes you cant vote 200 on a candidate.
o Cumulative voting: Special if in Articles
With Cumulative voting each shareholder can accumulate all votes and cast
them for any one or more candidates.

FORMULA: The number of votes = Number of shares x Number of vacancies

Ex: But cumulative you can vote 400 all on one, where you could only put a
max of 100 in plurality.

o Must a shareholder actually appear at a meeting to vote? See MBCA

7.22(a) & (b).
May be met by shares represented either in person or by proxy.
Plurality
Simple Majority
Absolute Majority
Super Majority

Default
DELAWARE

More yes than no votes

More than present say yes
Majority of the outstanding shares
Any agreement

o Proxy: Appointing someone else as your agent to your shares.

Once your proxy has been delivered youre there for the whole thing even if
you leave.

Requirements:
Appointment must be in writing and signed.

Proxys can be made irrevocable if:

In writing
Say its irrevocable
Give it to a person in interest.

Absent an irrevocable proxy they can revoke it at any time for any reason or no
reason at all.
A proxy is normally revocable by the shareholder at any time, althoughit
may be made irrevocable if expressly stated and coupled with aninterest in
the shares themselves (or in some states, an interest in the corporation).
Absent written notice to the corporation, the death or incapacity of a
shareholder does not revoke a proxy. A shareholder may revoke a proxy by
notifying the proxy holder, giving a new proxy to some- one else, or by
personally attending the meeting and voting.

Cumulative Voting
What is Cumulative Voting?
o Formula: PUT THIS ON CHEAT SHEAT
[(N x S) (D+1)] + 1 = X
N = number of directors the shareholder wants to elect
S = total number of shares voting
D = total number of directors to be chosen at the election

X = the number of shares needed to elect

Is cumulative voting the default rule?

o No.
o MBCA 7.28(b): Shareholders do not have a right to cumulate their votes for
directors unless the articles of incorporation so provide.

If not, where must cumulative voting be authorized, i.e., articles of

incorporation, bylaws, or either one? See MBCA 7.28(c).
o A statement included in the articles of incorporation that all a designated
voting group of shareholders are entitled to cumulate their votes for directors
means that the shareholders designated are entitled to multiply the number of
votes they are entitled to cast by the number of directors for whom they are
entitled to vote and cast the product for a single candidate or distribute the
product among two or more candidates.

If cumulative voting is in place, do shareholders vote cumulatively on all

matters or just for election of directors?
o Only applies to shareholder votes for the election or removal of directors
o Directors not elected seat by seat but, instead, one at-large election

If minority shareholders vote intelligently, cumulative voting will enable them to

elect at least some directors between them (see example on next slide)

Some states require cumulative voting, others leave it up to the corp.

Example:
o Britney owns 80 voting common shares of ABC, Inc. At its next shareholders'
meeting, the common shareholders will vote to fill the eight spots on the board of
directors. What is the total number of votes that Britney will have?
80 x 8 Directors up for election = 640 votes
o Which of the following is acceptable voting by Britney under MBCA 7.28?
Britney casts all 640 votes for John Smith, the candidate she likes best.
Yes
Britney casts 80 votes each for eight different candidates
Yes.
Britney casts 1 vote each for 640 different candidates.
Yes
Britney casts 640 votes each for eight different candidates.
No

Removal of Directors
May the shareholders remove a director without cause? See MBCA
8.08(a)

o Yes, the shareholders may remove one or more directors with or without cause
unless the articles of incorporation provide that directors may be removed only for
cause.

How does MBCA 8.08(c) protect cumulative voting?

o If cumulative voting is authorized, a director may not be removed if the number of
votes sufficient to elect him under cumulative voting is voted against his removal.
If cumulative voting is not authorized, a director may be removed only if the
number of votes cast to remove him exceeds the number of votes cast not to
remove him.

Might a for cause provision for removal of directors be desirable in some

cases?
o If the corporation only wants directors to be removed for cause it has to set it up
in the articles of incorporation.

Shareholder Voting (on matters other than election of directors)

General Rule: Each share is entitled to one vote.

What is Plurality (Straight) Voting?

o DEFAULT
o A plurality vote has more yes than no.
o Plurality/Straight voting allows one vote for each share held and applies to all
matters other than the election of directors, which may be subject to cumulative
voting. Anything over 50% of the votes cast generally controls. However, certain
fundamental changes (e.g., merger) frequently require higher shareholder
approval.
Ex: If you had 100, you could vote 100 for each candidate or no votes for any
candidate or any combination thereof.

What is a simple majority vote?

o Once you have quorum, more than half of the present shareholders vote yes.
o An abstention is essentially a no vote because we are only counting the no votes.

What is an absolute majority vote?

o Majority of the outstanding shares.
o Delaware rule.

Under the MBCA, once quorum exists, how many votes are necessary to
pass a measure? See MBCA 7.25(c).
o MBCA 7.25(c): If a quorum exists, action on a matter (other than the election of
directors) by a voting group is approved if the votes cast within the voting group
favoring the action exceed the votes cast opposing the action, unless the articles
of incorporation or this Act require a greater number of affirmative votes.

Does the MBCA provide for a plurality, simple majority, or absolute majority
vote?

o MBCA 7.28(a): Unless otherwise provided in the articles of incorporation,

directors are elected by a plurality of the votes cast by the shares entitled to vote
in the election at a meeting at which a quorum is present.
Plurality is the default rule
Shareholder Voting Agreements
May shareholders of a close corporation agree to vote their shares a
certain way on specified issues, e.g., to vote for each other to the board of
directors? Must the agreement be unanimous? Must it be in writing? See
MBCA 7.31(a).
o Yes, two or more shareholders may provide for the manner in which they will vote
their shares by signing an agreement for that purpose. A voting agreement
created under this section is not subject to the provisions of section 7.30.
Does not have to be unanimous, only binding to the shareholders who agree to
it in writing.
o For a voting agreement to be enforceable, two things must occur
1. It must be in writing
2. Must be signed by the parties

Whats the remedy if a voting agreement is breached? MBCA 7.31(b).

o A voting agreement created under this section is specifically enforceable.

Is a proxy issued in connection with a voting agreement irrevocable? See

MBCA 7.22(d)(5).
o Yes. MBCA 7.22(d): An appointment of a proxy is revocable unless the
appointment form or electronic transmission states that it is irrevocable and the
appointment is coupled with an interest. Appointments coupled with an interest
include the appointment of:
5) A party to a voting agreement created under section 7.31.

Fiduciary Duties
What is the duty of care?
o MBCA 8. 30(a): Each member of the board of directors, when discharging the
duties of the directors, shall act:
In good faith, and
In a manner the director reasonably believes to be in the best interests of
the corporation

What is the duty of loyalty?

o Directors and officers have a fiduciary duty to put the interests of the corporation
ahead of their own.

Breaches of DOC & DOL are procedural prerequisites to uphold

presumption and be entitled to defense, need to show neither was
breached and thus entitled to BJR presumption and protection

Duty of Care
What is a directors duty of care? See MBCA 8.30(a) & (b).
o MBCA 8.30(a): Each member of the board of directors, when discharging the
duties of a director, shall act:
In good faith, and
In a manner the director reasonably believes to be in the best interests of
the corporation.
o MBCA 8.30(b): The members of the board of directors or a committee of the
board, when becoming informed in connection with their decision-making function
or devoting attention to their oversight function, shall discharge their duties with
the care that a person in a like position would reasonably believe
appropriate under similar circumstances.

What is the duty?

o Fiduciaries must perform their functions with the care that an ordinarily prudent
person would reasonably be expected to exercise in a like position and under
similar circumstances

To whom do the board of directors owe their duty of care?

o A corporations directors and officers owe a duty of care to the corporation
o Those who manage the corporation owe fiduciary duties

When does the duty apply?

o The duty of care applies to directors when becoming informed with their decisionmaking function or devoting attention to their oversight function.

Causation
o Plaintiff must show that defendants failure to meet the duty of resulted in harm
to the corporation
Majority/MBCA: plaintiff must show proximate causation
Delaware: once the plaintiff shows that the defendant breached his duty of
care, the burden shifts to the defendant to show that his actions were fair to
the corporation

What happens if a director violates his or her duty of care?

o If director or officer violates the duty of due care, and the corp. loses money, the
director/officer will be personally liable to pay money damages to the corporation.
It is very rare for directors and officers to be found liable for breach of the duty
of due care. It is usually because there is some amount of self-dealing but not
enough for the court to find a formal violation of duty of loyalty.

Best Judgment Rule

What is the business judgment rule (BJR)?
o Presumption: that Director acted honestly and in good faith and reasonably in the
interest of the Corporation when making an informed decision. (Shlensky v
Wrigley)
o The business judgment rule is a presumption that in making a business decision,
managers acted on an informed basis, in good faith, and in the honest belief that
the action was in the best interest of the company
o Applies when there is no allegation of conflict of interest (i.e. duty of loyalty not
implicated)
o As long as business decisions are based upon reasonable information and are not
irrational, managers making them are not liable
o Behavior that is not grossly negligent or reckless, or decisions with any rational
business purpose satisfy the business judgment rule

Is the BJR mentioned in the MBCA or is it a judicially created doctrine?

o Judicially Created

Is the BJR a presumption or a substantive rule of law (or both)?

o Both

What is the rationale for the BJR?

o Shareholders voluntarily undertake the risk of bad business judgment

o After-the-fact litigation is a poor device to evaluate business decisions
o Potential profit often corresponds to potential risk, so it is in the shareholders
interest that law not create incentives for overly cautious corporate decisions

If the directors completely fail to act (or are oblivious), are they entitled to
use the BJR as a defense?
o BJR only applies when managers have made conscious decisions.
o BJR may not apply to managers who are interested in the decision.
o BJR does not apply if the decision itself constitutes illegal conduct.

If the directors act illegally, fraudulently, or with a conflict of interest, does

the BJR apply?
o The BJR CAN BE REBUTTED by a demonstration of:
Gross negligence or
Illegality or fraud or
Conflict of interest

If the plaintiff is successful in rebutting the BJR presumption, are the

directors automatically liable? In other words, is there anything else the
plaintiff must show?
o No, if the plaintiff overcomes that presumption, they still must show harm and
causation.

May directors rely upon advice from experts and still receive the
protections of the BJR? See MBCA 8.30(d)-(f).
o The individual directors dont have to be experts.
o They are entitled to rely upon experts inside or outside the corporation so long as
they believe they are reliable and competent.
o The directors can appoint a committee and if the committee does their homework
the directors can rely on them.

Upon whose advise can the directors rely? See MBCA 8.30(f).
o A director is entitled to rely, in accordance with subsection (d) or (e), on:
One or more officers or employees of the corporation whom the director
reasonably believes to be reliable and competent in the functions performed or
the information, opinions, reports or statements provided;
Legal counsel, public accountants, or other persons retained by the corporation
as to matters involving skills or expertise the director reasonably believes are
matters (i) within the particular persons professional or expert competence or
(ii) as to which the particular person merits confidence; or
A committee of the board of directors of which the director is not a member if
the director reasonably believes the committee merits confidence.

Which Directors Are Liable

o MBCA 8.30: conduct of entire board & deficient performance by single director
may be overcome by acceptable conduct on part of other directors

o MBCA 8.24(d): director liable if assents to challenged conduct. BUT, if

abstains/votes against with vote recorded in minutes, may escape liability.
o MBCA 8.31(a)(2)(iv): duty of care includes devotion of sufficient oversight to
corporation and its business.
Duty of Loyalty
What is the duty of loyalty?
o Involves conflicts of interest where issue is one of fairness

Applies to:
o Directors
o Officers- agents of the corporation
o Does not apply to shareholders generally

Violate By:
o Competing with the corporation,
o Self-dealing/conflicting interest,
o Usurping a corporate opportunity (stealing an opportunity)

When theres a conflict of loyalty, the transaction is presumed to be

invalid, unless certain procedural requirements are met or the conflicted
director(s) can show the transaction was entirely fair to the corporation
(substantive fairnessfair price and in best interest of Corp)
o They can show its procedurally fair- the process for approving the transaction was
fair.
o They can show its substantively fair- the substance of the transaction is entirely
fair to the corp.
Fair Price AND
In the best interest of the corporation

Self- Dealing Transactions

What is a self-dealing transaction (a directors conflicting interest
transaction)
o MBCA 8.60(1): Direct
Director is a party to a transaction with the corporation

Must the self-dealing transaction be direct? In other words, may a director

engage in self-dealing indirectly through a related person?
o MBCA 8.60(1): Directors conflicting interest transaction means a trans- action
effected or proposed to be effected by the corporation (or by an entity controlled
by the corporation)
To which, at the relevant time, the director is a party; or
Respecting which, at the relevant time, the director had knowledge and a
material financial interest known to the director; or
Respecting which, at the relevant time, the director knew that a related person
was a party or had a material financial interest.

o MBCA 8.60(5): Related person means:

The directors spouse;
A child, stepchild, grandchild, parent, step parent, grandparent, sibling, step
sibling, half sibling, aunt, uncle, niece or nephew (or spouse of any thereof) of
the director or of the directors spouse;
An individual living in the same home as the director;
An entity (other than the corporation or an entity controlled by the corporation)
controlled by the director or any person specified above in this subdivision (5);
A domestic or foreign:
Business or nonprofit corporation (other than the corporation or an entity
controlled by the corporation) of which the director is a director,
Unincorporated entity of which the director is a general partner or a
member of the governing body, or
Individual, trust or estate for whom or of which the director is a trustee,
guardian, personal representative or like fiduciary; or
A person that is, or an entity that is controlled by, an employer of the
director.

Are director self-dealing transactions void or voidable under the MBCA?

See MBCA 8.61(b).
o Self-dealing transactions are not per se void, because there may be instances
where a related person is providing services that are in the best interest of the
corporation.

If a self-dealing transaction is not automatically void or voidable, under

what circumstances is a self-dealing transaction permissible? See MBCA
8.61(b).
o Not automatically void or voidable the self-dealing transaction is permissible in
two ways:
o Procedural fairness
o Substantive fairness

Sanitizing Statute
Under MBCA 8.61(b), a directors self-dealing transaction will be permissible if:
o Procedural fairness (the process for approving the transaction was fair)
Directors action respecting the transaction was at any time taken in
compliance with section 8.62 [qualified director approval]; or
Shareholders action respecting the transaction was at any time taken in
compliance with section 8.63 [qualified shareholder approval]; or
Substantive fairness (i.e., the substance of the transaction is fair)
o The transaction, judged to the circumstances at the relevant time, is established
to have been fair to the corporation.
DCIT: (DIRECTORS CONFLICT OF INTEREST TRANSACTION)
Unlike decisions of neutral, fair, and impartial directors, once a conflict of interest
exists, the BJR does not automatically apply.

Only four ways:

1. Director is a party on opposite side of transaction

2. Director has a material financial interest (but not party)

3. Related person is a party on opp. Side of transaction
4. Related person has material financial int. (but not a party)

Procedural Fairness
Qualified Director Approval
At least 2 directors voting in favor
Making up an affirmative vote of a majority of the qualified directors
o Who is a qualified director?
Is not engaged in self-dealing (i.e., a directors conflicting interest
transaction).
Does not have a material relationship with another director who is engaged in
the self-dealing transaction. MBCA 1.43(a)(3).
After required disclosure. Must Disclose:
o The existence and nature of the directors conflicting interest, and
o All facts known to the director respecting the subject matter of the transaction
that a director free of such conflicting interest would reasonably believe to be
material in deciding whether to proceed with the transaction. MBCA 8.60(7).
Qualified directors must deliberate and vote outside presence of other directors.
MBCA 8.62(a)(1)
IF WE HAVE APPROVAL=BJR APPLIES

IF NOT- SEE IF SHAREHOLDERS WILL APPROVE

A self-dealing transaction (DCIT) is permissible if the transaction:

o Has been authorized by the affirmative vote of a majority (but no fewer than two)
of the qualified directors who voted on the transaction,
o After required disclosure by the conflicted director of information not already
known by such qualified directors. . . . MBCA 8.62(a).

A majority of the qualified directors qualifies as quorum for this particular vote.

Qualified Shareholder Approval

A self-dealing transaction (DCIT) is permissible if:
o A majority of votes cast by the holders of all qualified shares are in favor of the
transaction; and
No conflicting interest = qualified
Need a majority of the qualified shares to be present or represented by proxy
at this meeting to satisfy the quorum requirement.
o Shareholders receive prior notice containing
Description of the action to be taken;
Disclosure from the director with the conflicting interest the number of shares
the director knows are not qualified and the identity of the holders of those
shares; and
Information that is the subject of required disclosure. MBCA 8.63(a).

Substantive Fairness:

IF NO PROCEDURAL FAIRNESS-BURDEN SHIFTS The self-dealing transaction is only

sanitized if the conflicted director(s) can show its fair to the corporation.

Fair to the Corporation if:

o Fair Price= Substance
o In the best interest of the corporation=Procedure

Effect of Procedural Fairness

If the qualified directors ( 8.62) or qualified shareholders ( 8.63) properly approve a

conflicting interest transaction, does that mean that the case is closed and there is
no judicial review?
o No this just becomes a normal duty of care case from this.
o Qualified Shareholders

USURPING A CORPORATE OPPORTUNITY:

GUTH-LINE OF BUSINESS TEST: DELAWARE (Broz v Cellular: DELAWARE CASE)
o ELEMENTS:
1. Whether the corporation could afford to financially exploit the opportunity.
2. In their line of the business
3. Is there any interest or expectancy on behalf of the corporation that they
would have this opportunity?
4. Whether the interest is adverse to the corporate interest.
o Fiduciary is placed in a position inimical to his duties to the corporation.
UNDER THE GUTH TEST YOU NEED ALL FOUR!

Corporate Opportunity Doctrine (ALI Test)

When is a business opportunity a corporate opportunity under the ALI
Principles? See 5.05(b) ALI Principles.
o Definition of a Corporate Opportunity: For purposes of this Section, a corporate
opportunity means:
Any opportunity to engage in a business activity of which a director or senior
executive becomes aware, either:
In connection with the performance of functions as a director or senior
executive, or under circumstances that should reasonably lead the director

or senior executive to believe that the person offering the opportunity

expects it to be offered to the corporation; or
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; or
Any opportunity to engage in a business activity of which a senior executive
becomes aware and knows is closely related to a business in which the
corporation is engaged or expects to engage.

Under what circumstances may a corporate fiduciary take a corporate

opportunity for himself? See 5.05(a) ALI Principles.
o GR: A director or senior executive may not take advantage of a corporate
opportunity unless:
The director or senior executive first offers the corporate opportunity to the
corporation and makes disclosure concerning the conflict of interest and the
corporate opportunity;
The corporate opportunity is rejected by the corporation; and
Either:
The rejection of the opportunity is fair to the corporation;
The opportunity is rejected in advance, following such disclosure, by
disinterested directors, or, in the case of a senior executive who is not a
director, by a disinterested superior, in a manner that satisfies the
standards of the business judgment rule; or
The rejection is authorized in advance or ratified, following such disclosure,
by disinterested shareholders, and the rejection is not equivalent to a waste
of corporate assets.

Under the ALI Principles, what happens if the corporate fiduciary never
gave the corporation the right of first refusal to take the corporate
opportunity? See 5.05(a)(1) & (e) ALI Principles.
o ALI 5.05(a)(1): General Rule
A director or senior executive may not take advantage of a corporate
opportunity unless:
The director or senior executive first offers the corporate opportunity to the
corporation and makes disclosure concerning the conflict of interest and the
corporate opportunity.
o ALI 5.05(e): Special Rule Concerning Delayed Offering of Corporate
Opportunities
Relief based solely on failure to first offer an opportunity to the corporation
under 505(a)(1) is not available if:
Such failure resulted from a good faith belief that the business activity did
not constitute a corporate opportunity, and
Not later than a reasonable time after suit is filed challenging the taking of
the corporate opportunity, the corporate opportunity is to the extent
possible offered to the corporation and rejected in a manner that satisfies
the standards of Subsection (a).

Under the ALI Principles, who bears the burden of proof? What must that
party show?
o ALI 5.05(c): Burden of Proof
A party who challenges the taking of a corporate opportunity has the burden of
proof, except that if such party establishes that the requirements of Subsection
(a)(3)(B) or (C) are not met, the director or the senior executive has the burden
of proving that the rejection and the taking of the opportunity were fair to the
corporation.

Competition With The Corporation

Officers and employees:
o Must refrain from competing under general agency laws, but duty ends on
termination of agency. Restatement (3d) Agency 8.04.
Covenant not to compete (reasonable as to duration and geographic scope).
Officers are agents of the corporation, and in agency relations, agents have a
duty to not compete with the principal during the relationship.
That duty to refrain from competing ends when the agency relationship
terminates.
A covenant not to compete is very common because the duty of loyalty
ends at termination if the covenant is violated after the termination of the
relationship, there is a remedy for breach of contract

Directors (ALI Principles):

o Very similar to corporate opportunity. Competition may be sanitized by
disinterested director or shareholder approval with full disclosure. See 5.06 ALI
Principles.
Directors often serve on the board of various corporations that compete with
each other.
You need disclosure and the relationship needs to be sanitized

Derivative Suits:
What is a derivative suit?
o One brought by a shareholder (plaintiff) on behalf of the corporation, to remedy
harm that the corporation has suffered.
MCBA 7.40(1): a civil suit in the right of a domestic corporation.
Forces the action that BOD doesn't want to take.
Shares are indirectly affected
We care because there are procedural hurdles.

Why is a derivative suit necessary? HINT: Who makes the decision whether a
corporation sues its directors for breach of duty of care or duty of loyalty?
o It's the way we keep directors honest.
o Can be used against a corporation because the Board, for instance, refuses to sue
a third party
o Most likely situation is where you have conflicts of interest or any other breach of
fiduciary duty

o If directors have ripped the corporation off, the corporation (through its
shareholders) have a cause of action, because they stole from the corporation
(shareholders are indirectly impacted)
o Its an action to force the corporation to go after themselves or after a specific
director

Derivative Suit Requirements:

o Wrong to Corporation Itself
Things can be wrong to the shareholder but not corporation.
Derivative v. Direct Suit

Shareholder with Standing

o MBCA 7.41 Contemporaneous Shareholder Rule
Shareholder has to be a shareholder at the time of act complained or from
transfer by operation of law. AND
Fairly and adequately represent the corporation.
If the shareholder ceases to satisfy either one of them- then they dont have
standing and another shareholder can be substituted in, or
If they want personal gain then its dismissed.
o May bondholders be derivative plaintiffs? What if the bonds are convertible into
common stock? May holders of stock options be derivative plaintiffs?
Bondholders are creditors they are not derivative plaintiffs. If the bonds are
converted into stock, they only have standing if the conversion happened
before the alleged harm. Options are merely contracts you dont own shares
until you exercise the option to buy shares. No standing.
o Can a director who is not a shareholder but believes that that the other board
members have breached their duty of loyalty to the corporation become a
derivative plaintiff?
No. Someone who does not own shares at the time of the alleged harm has no
standing. Being a director is not enough to have standing.
o What if the shareholder-plaintiff sells all of her shares during the lawsuit?
A shareholder may not commence or maintain a derivative proceeding unless
they are a contemporaneous owner who fairly and adequately represents the
interests of the corporation. So no standing if the shares are sold.

Demand
o MBCA:
Thou shalt make a demand ALWAYS
In writing
To the board
Board has up to 90 days to respond. Apply BJR.

EXCEPT the 90 days can be waived/lessened if there is going to be

irreparable injury.
MBCA- ALWAYS ALWAYS ALWAYS must make the demand

o Delaware:
If making a demand would be futile then demand is excused.
Futile if the plaintiff must allege particularize facts, which create a
reasonable doubt that the directors are disinterested and independent or
the challenged transaction was otherwise the product of a valid exercise of
BJ.

Dismissing Derivative Suits:

o If demand is made, then the corporation can take the lawsuit forward, or can try
to have the lawsuit dismissed.
o The board can appoint a SLC that can make the determination whether or not to
proceed with the litigation.
Special Litigation Committee Vote for Dismissal:
1. At least 2 directors voting in favor
2. Making up an affirmative vote of a majority of the qualified directors
o SLC can agree its a good claim, but if it costs too much it can still be not
in the best interest of the corporation.

MBCA DISMISSAL:
o A derivative proceeding shall be dismissed that is:
Within good faith and
After reasonable inquiry
o Burden of Proof:
If qualified majority, plaintiff must show either
Lack of good faith,
No reasonable inquiry,
SLC was grossly negligent

If majority of directors are disqualified, Corp must show

Good Faith
Reasonable Inquiry

DELAWARE DISMISSAL:
o Demand Required Cases- court defers to BJR
o Demand Excused cases- courts give a second look to SLC decisions:
Step 1: the corporation will have to show facts that the special litigation
committee was:
Really independent,
In good faith and

After thorough investigation.

Step 2: If the corporation meets Step 1 then the court will apply its own
independent judgment anyway.

Closely Held Corporations

Requirements:
o Small number of stockholders (Less than 10)
o No ready market of stock
o Substantial majority stockholder participation in the
management/direction/operations of the corporation.
Stockholders run the day-to-day operations.
Hard to sell shares
Employment opportunity/investment =a lot like a partnership
Limited Liability of Shareholders

Shareholder Agreement:
o Has to be in writing and signed before its enforceable.
o Have to put the world on notice of the shareholder agreement.
Have to conspicuously note on the shares the shareholder agreements
presence.
If they take without notice then they would be a bona fide purchaser for value
not bound by the provisions of the shareholder agreement.
o Agreement ceases when they become publicly traded.
o Its valid for 10 years unless the agreement provides otherwise.
o Board: Can eliminate the board altogether.
Another way is to guarantee a shareholder is elected as director.

Resolving These Special Problems

How do we protect the rights of minority shareholders of close corporation?
o Assuring their representation on the board directors through voting control
devices.
o Restrictions of stock transfers
o Providing a market for their shares in the event of death, disability, and
termination of employment

o Protecting minority shareholders from oppressive conduct of majority

shareholders.
o Resolution of deadlock
Restrictions on Transfer of Stock
Can shareholders of a close corporation prevent outsides from acquiring
shares? If so, how do they do so and what are the requirements? See
MBCA 6.27.
o Shareholders will worry about what will happen in case one of the shareholders
gets divorced, and their shares get transferred to the ex-spouse.
You may not want that person to have rights as a shareholder.
They may also worry about the children of their co-owners getting shareholder
interest
o Three ways we can protect against outsiders (must be in writing):
Bylaws
Shareholder Agreement
Articles of Incorporation

What type of agreement do shareholders typically enter to restrict transfer

of shares and to provide a market for shares upon withdrawal?
o In one of those three places, we can have a restriction on transfer of stock (right
of first refusal must first be given to the remaining shareholders).
o Typically done in bylaws or a separate agreement, because articles of
incorporation are public record, and owners of small corporations probably dont
want their internal affairs to be made public.

What has to be placed on stock certificate if theres a restriction?

o Conspicuous notice called a restrictive ledger (these shares are subject to a
shareholder agreement on X date).
o Buy-Sell Agreement: If someone dies, gets divorced, becomes disabled, there
must be a mechanism as to what will happen to the remaining shares.
In the case of death, can be funded by life insurance. In the case of disability,
can be funded by disability insurance.

Sterilizing The Board

As a general rule, who has the exclusive authority to manage the business
and affairs of the corporation? See MBCA 8.01.
o MBCA 8.01(b): All corporate powers shall be exercised by or under the authority
of, and the business and affairs of the corporation managed by or under the
direction of, its board of director.

If shareholders can agree among themselves how they will vote their
shares, can they also agree on how the corporation will be managed?
o Old cases say shareholders cant agree to make board of directors to act in a
certain way

MBCA 7.32: Shareholder Agreements

o What is the purpose of a shareholder agreement under MBCA 7.32? May the
shareholders restrict the discretion of the board of directors to manage the
business? May the shareholders completely eliminate the board all together?
The purpose of the shareholder agreement is to restrict/eliminate board of
directors discretion, it may dictate that X is to be employed and restrictions on
the transfer of stock.
MBCA 7.32 allows for these restrictions, but only if UNANIMOUSLY agreed to
by the shareholders.
o Can the shareholders of a public corporation enter into a shareholder
agreement? See MBCA 7.32(d).
Shareholders of a public corporation enter into a shareholder agreement,
because MBCA forbids it and, practically speaking, you cant get 1000+
shareholders to unanimously agree

Shareholder Fiduciary Duties

Minority Shareholder Protection:
o The Equal Opportunity Test: If you give an opportunity of the majority to sell their
shares you have to give the same percentage (ratable percent) to the minority to
let them sell their shares. Otherwise the majority to liquidate their shares while
the minority is left liquid. (Donahue)

Massachusetts Approach: Fiduciary Duties Among Shareholders

o Freeze Out: A minority shareholder is left with no opportunity to sell shares, is
removed from the board, is fired from their position or receives no benefits.
Good Faith
Utmost respect to other shareholders
o Partnership standard: Meinhard Utmost good faith and loyalty
o Strict Good Faith: Applies from minority shareholders to the majority shareholders
as well.

Steps:
o Step 1: Legitimate business purpose.

Once the plaintiff shows prima facie case of a freeze out the burden is on the
majority (corporation) to show a legitimate business purpose.
If there is no legitimate purpose the plaintiff (minority) prevails.

o Step 2: If they show a legitimate purpose

Then the burden shifts to the minority shareholder to show that the legitimate
business purpose for the decision could have been achieved through an less
intrusive way.
IF ON EXAM HE TALKS ABOUT MASSACHUSETTS, HE IS ASKING ABOUT THE
WILKES AND DONAHUE CASE
Judicial (Involuntary) Dissolution
On what grounds may a shareholder petition a court to order dissolution of
a corporation? See MBCA 14.30(2)?
o Deadlock
Includes situations where the directors are deadlocked or shareholders are
deadlock and it leads to irreparable injury.
Cant engage in deadlock on purpose/in bad faith.
o Illegal, fraudulent, or oppressive conduct
If the corporation is illegal and they want out but dont want to sell for pennies
on the dollar then they can make the judicial petition.
Oppression: Once a prima facie case of frustration of reasonable expectations
is established, the control group must show an adequate, alternative remedy
(buy out) to forestall dissolution in an oppression case
o Corporate assets being misapplied or wasted
o BUY OUT Option: If the court orders dissolution of a close corporation, the
corporation may elect or, if it fails to elect, one or more shareholders may elect to
purchase all of the petitioners shares.

Can deadlock be avoided by proper advance planning?

o Yes by putting it in your buy-sell agreement

MBCA Oppression
Oppression: Frustration of the reasonable expectations of the shareholder at the
time they became a shareholder (Kemp and Beatley)

Reasonable Expectations Test:

o High Expectation: Livelihood? Payroll rest of my life?
o Low Expectation: Silent partner not caring about operations maybe buy sell
agreement is all the protection they need.

Dissolution: Drastic Remedy: Terminates the legal entity of the corporation.

o Proceedings by the state- not meeting their corporate obligations the state can
shut you down.

o Proceeding by a shareholder- director deadlock in the management of the

corporation affairs and there is injury threatened or being suffered.