BUSINESS ASSOCIATIONS OUTLINE

Answers to Heminways Questions

Table of Contents
I.

Agency..............................................................................................................................................................3
A.

II.

Agency Analysis Summary.......................................................................................................................6

Unincorporated Business Associations.........................................................................................................8

A.

General Partnership...................................................................................................................................8

B.

Limited Liability Partnership (LLP).......................................................................................................14

C.

Limited Partnerships (LPs)..................................................................................................................15

D.

Limited Liability Companies (LLCs)..................................................................................................18

III.

Corporations...............................................................................................................................................22

A.

Formation and Other Issues Relating to Corporate Formalities.............................................................22

B.

Limited Liability.....................................................................................................................................27

C.

Management and Control........................................................................................................................29

D.

The Role of Shareholders........................................................................................................................31

E.

Fiduciary Duty........................................................................................................................................33

F.

The Duty of Loyalty...............................................................................................................................34

G.

Exculpation, Indemnification, and Insurance.........................................................................................39

H.

Special Rules for Closely Held Corporations.........................................................................................40

I.

Oppression, Deadlock, and Dissolution.................................................................................................43

J.

4 Questions for Stock Transfer Restriction............................................................................................47

K.

Business Entity Finance..........................................................................................................................49

I.

AGENCY

What are the two primary types of legally recognized authority in agency relationships?
o Agency RST 1.01: Elements of agency:
Fiduciary
Assent,
Control,
On behalf (RST 1.03; Thayer).
o Actual Authority RST 2.01: it is an internal relationship b/w agent and principal. Agent has
actual authority when (elements):
At the time of action;
Agent reasonably believes based on principals actions (RST 3.01. Creation of Agency);
That the principal wishes agent to act.
o Apparent Authority RST 2.03: it is an external relationship where the agent represents to a
third-party that the agent has the authority to act on behalf of the principal. There is apparent
authority when (elements):
Third party reasonably believes agent has authority, and
Traceable to principal manifestations.
What is the difference?
o The difference is that actual authority is internal between the principal and the agent, while
apparent authority pertains to the agents actions with a third-party.
In what ways might these types of authority be made manifest?
o Manifestation of assent between principal and agent must be conveyed b/w the two parties. RST
1.01.
o Actual Authority
Look to RST 1.01, the agent manifests assent or otherwise consents so to act. RST
1.03. Manifestation, A person manifests assent or intention through written or spoken
words or other conduct. RST 3.01 created by principals manifestation to an agent
that expresses the principals assent (that the agent may take action on principals behalf).
i.e., Thayer, the defendant (agent) manifested assent by noting on the freight bill
that the P intended to claim damages because of the condition of his machine.
And the Court based assent of the actions between the parties.
i.e., Cargill, an agreement may result in the creation of an agency relationship
although the parties did not call it an agency and did not intend the legal
consequences of the relation to follow the existence of the agency may be
proved by circumstantial evidence which shows a course of dealing between the
two parties.
o Apparent Authority
Same RST rules govern however we are analyzing the agents power to affect principals
legal relations with a third party.
RST 2.03: The third party must:
Reasonably believe the agent has authority to act on behalf of the principal, and
That belief (by the third party) is traceable to the principals manifestations.
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i.e., Smith v. Hansen, Hansen, & Johnson, Inc., actual and apparent authority depend
upon objective manifestations of the principal (apparent authority) agents actions
made to a third person must have two effects:
must cause the one claiming apparent authority to actually believe that the agent
has authority to act for the principal, and
must be such that the claimants actual, subjective belief is objectively reasonable.
(thus, compare his subjective belief to what a reasonable person might think. If
reasonable apparent authority exists; if not reasonable no apparent
authority).
NOTE: an agent cannot, simply by his own words, invest himself with apparent authority.

What are the related rules for liability to third parties? What parts of the Restatement (Third) of Agency are
relevant to the each type of authority and to the related liability to third parties?
o Misrepresentation agent is liable to the third party exception: cannot be used in ratification
4.02(2)(a).
Estoppel: principal may be held liable to a third party if the principal is responsible for a
misunderstanding that the third party has as to the agents authority. RST 2.05.
o i.e., Cargill RST (2d) 14O a creditor who assumes control of his debtors business may
become liable as principal as principal for the acts of the debtor in connection with the business.
What duties does a principal owe an agent?
o Only duties a principal owes to an agent are that of (1) compensation, and (2) indemnification.
RST 8.13-8.15
Compensation: must be made in good faith and must comply with agreements between
the principal and agent
Indemnification: principal owes a duty for expenses occurred and claims that are in the
principals ordinary course of business exception: no duty of indemnification if the
agent is negligent.
What duties does an agent owe a principal?
o General Fiduciary Duty: RST 1.01 (manifestation of assent b/w the parties) Agent has a
fiduciary duty to act loyally for the principals benefit in all matters connected with the agency
relationship. RST 8.01.
o Duty of Care
Agents have a duty to conduct affairs of the principal with a certain level of diligence,
skill, and competence. RST 8.08; Carrier v. McLlarky.
Remedy if agent breaches principal may recover from agent any damages
caused by agents negligence.
o Duty of Disclosure:
Agents owe a duty to their principals to provide information that is material to the
principals decision-making process BUT it cannot violate a superior duty owed to
another person. RST 8.11
Definition of material (from Heminway): it is material if it something a
reasonable person would find important.

Remedy: Olsen v. Vail Associates Real Estate, Inc.: principal must seek remedy
against the agent when there is a breach because of the agents failure to disclose
information principal cannot seek remedy against third party
o Duty of Loyalty:
(Look to Chapter 8 of RST)
Agent owes a duty of loyalty to always put the interests of the principal before his own
(RST 8.01) standard of trust and confidence (Gelfand v. Horizin Corp.) cannot
place ones own interest before those of the principal (Gelfand v. Horizin Corp.)
Agency Opportunity Doctrine: agent has a duty not to acquire a material benefit from a
third party in connection with transactions conducted or other actions taken on behalf of
the principal or otherwise through the agents use of the agents position. RST 8.02;
Gelfand.
Remedies principal recovers agents gains, atty fees, expenses, and loss of time
courts split on recovering during time of disloyalty third party can be held
liable if aided the agent in the breach of the fiduciary duty
Common law does not stand in the way of competition after termination of the agent, so
long as it is fair. RST 8.04
o Contracting around the common law fiduciary duties? RST 8.06
An agent can get out of fiduciary duties if the principal consents and the agents
conduct in obtaining that consent must be:
In good faith, disclose all material facts, otherwise deal fairly, and consent can be
specific or general.
o i.e., if agent gives full information and obtains consent and acts fairly in
doing so, then the principals consent becomes part of the agency
relationship.
Dual Agency Rule: states that an agent cannot act on behalf of the adverse party to a
transaction connected with the agency without permission (consent or assent) of the
principal. RST 8.06(2); Aww Nviera Despina, Inc.
Remedies:
o If the two principals are unaware of the double employment, then the
transaction between them is voidable
o If one principal is unaware, while the other is aware of the double agency,
then the unaware principal has the right to either affirm the transaction or
rescind the transaction
What are fiduciary duties?
o General Fiduciary Duty: RST 1.01 (manifestation of assent b/w the parties) Agent has a
fiduciary duty to act loyally for the principals benefit in all matters connected with the agency
relationship. RST 8.01.
o The fiduciary duties are the duty of loyalty and the duty of care. (think of the bubble/square
example Heminway gave us including good faith, etc.)
When is a principal liable for the actionable conduct of his, her, or its agent?
o (Agent liable to third parties for agents own tortious conduct. RST 7.01)
o Direct Liability
RST 7.01(1): principal is subject to direct liability to a third party harmed by the agents
conduct when:
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The agent is acting with actual authority AND the agents conduct is tortious,
The agents conduct, if that of the principal, would subject the principal to tort
liability, OR
Principal is negligent in controlling the agent.
o Vicarious Liability for Negligent Act
To determine, apply the Control Test. (RST (2d) 220; Kane Furniture Corp. v. Miranda:
in determining whether one acting for another is a servant or an independent contract, the
following factors are considered:
Extent of control master exercises over the details of the work
Is the one employed in a distinct occupation or business?
Is the work, in the locality, typically done under the supervision of the master or
by as specialist without supervision?
The skill required in the particular occupation
Does the employer/employee supply the instrumentalities, tools, and the place of
work for the person doing the work?
The length of time for which the person is employed
Method of payment time or by job?
Is it the regular business of the employer?
Do the parties believe they are creating a master and servant relationship?
Is the principal in business?
o Respondeat Superior
Employers are held liable for the torts their employees commit when the employees are
acting within the scope of their employment. Clover v. Snowbird Ski Resort.
Criteria:
Employees conduct must be of the general kind the employee is employed to
perform;
Employees conduct must occur substantially within the hours and ordinary
spatial boundaries of the employment; AND
Employees conduct must be motivated by the purpose of serving the employers
interest.
o Vicarious Liability for Intentional Misconduct
To determine, apply the Foreseeability Test. Ira S. Bushey & Sons v. US (drunken sailor)
The employer should be held to expect risks, to the public also, which arise out
of and in the course of his employment labor. Further, a business cannot justly
disclaim responsibility for accidents, which may fairly be said to be
characteristics of its activities (foreseeable).
Does it matter what the agent is doing when the conduct occurs? Why, or why not?
o Yes, it does matter. See summary analysis below

A.

AGENCY ANALYSIS SUMMARY

AND/OR CONTRACT:

FOR

PRINCIPALS LIABILITY

Is there a principal-agent relationship? If so, does the issue involve a tort or a contract?

Tort:
6

IN

TORT

If the issue involves a tort, then in order to determine whether the principal is liable, you have to evaluate the
following questions:
1) Is there an Employee Employer relationship?
a. Did the principal have the right to exert control over the means and manner in which the agent
performed the task(s)?
2) If the Agent is an Employee, did the Tort occur within the scope of employment or was it clearly
outside the scope (frolic or detour)?
a. If the tort was intentional, with no purpose to serve the Employer, was it foreseeable
(characteristic of the risks that arise from the employment)?
3) Even if there is not an Employee/Employer relationship, is there sufficient control to create a nonemployee agent, and if so, did the tort occur within the scope of that control?
4) Even if there is no control exercised over the Agent, does the event fall into an exception such as
inherently dangerous activity, or non-delegable duty or negligent hiring?
5) Even if there is no liability for the Principal under a control analysis, is there a claim for Apparent
Agency because the 3P reasonably relied on the appearance of agency and was harmed as a result of that
reliance?
Contract:
If the issue involves a contract, then in order to determine whether the Principal is bound, one should evaluate
the following questions:
1)
2)
3)
4)

Did the Principal give Acutal Authority to the Agent (express or implied)?
Did the principal make some manifestation to the 3P creating Apparent Authority?
Was the Principal undisclosed, creating liability of an undisclosed principal (Inherent Agency)
Did the Principal ratify the contract?
a. Do any exceptions apply (didnt know all the facts, partial ratification, unfair to 3P)?
5) Is Estoppel an issue?
a. Did the Principal do something wrong, or fail to do something, that created an impression with
the 3P?
b. Did the 3P rely and alter his or her position to his or her detriment?
Duties in Agency
Duties of the Agent to the Principal:
Duty of Care, Competence, and Diligence: 3rd Rest. 8.08
Duty of Loyalty: 3rd Rest. 8.01 Must act loyally for the principals benefit.
Duty not to acquire material benefits arising out of the Agency: 8.02 The agent may not acquire a
material benefit from a 3P in connection with the transactions or actions taken on behalf of the principal
or otherwise through the Agents position.
Duty not to act as (or on behalf of) an adverse Party: 8.03
Duty Not to Compete: 8.04
Duty not to use Principals Property: 8.05(1) An agent may not use the property of the principal for
the agents own purposes or the purposes of a 3P.
Duty not to use Confidential Information: 8.05(2)
Duty of Good Conduct: 8.10
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Duty to Provide information: 8.11

Duties of the Principal to the Agent:
Duty to Indemnify: 8.14
Duty of Good Faith and Fair Dealing: 8.15

II. UNINCORPORATED BUSINESS ASSOCIATIONS

A.

GENERAL PARTNERSHIP

What is a partnership? (I.e., how is it defined?) How is it formed and maintained?

o A partnership if two or more individuals join together to operate a business, they have formed
(wittingly or unwittingly) a general partnership. RUPA 202 factors to help us determine if
we have a partnership RUPA 202(c):
Ownership (bundle of financial rights and governance rights vote or consent on
what is happening in the entity (Serapion v. Martinez);
Compensation;
Management/responsibilities; and
Does not require subjective intent.
Stated differently: if two or more persons associate together to carry on as co-owners of a
business for profit, they have formed a partnership. Byker v. Mannes; RUPA 101(6)
Also, a partnership is a separate legal entity from its partners. RUPA 201(a).
o Each partner will be jointly and severally liable for all of the debts, including tort liability, of the
business and each will be an agent of the other, with full agency authority to bind one another on
obligation of the business.
These are default rules which may be altered.
o Partners will recognize a pro rata share of the businesss income or loss on their personal income
tax returns. (Pass-through taxation).
What is a partnership agreement? What is its relationship of a partnership agreement to the statutory rules
governing partnerships and their partners?
o A partnership agreement means the agreement, whether written, oral, or implied, among the
partners concerning the partnership, including amendments to the partnership. RUPA 101(7)
RUPA 103(b): The partnership agreement may not:
Vary the rights and duties under 105 except the duty to provide copies of
statements to all other partners
Unreasonably restrict the right of access to books and records under 403(b)
Eliminate the duty of loyalty under 404(b) or 603(b)(3), BUT
o the agreement may identify specific types or categories of activities that
do not violate the duty of loyalty, if not manifestly unreasonable
o may authorize or ratify, after full disclosure of all material facts, a specific
act or transaction that otherwise would violate the duty of loyalty
8

Unreasonably reduce the duty of care under 404(c)

Eliminate the obligation of good faith under 404(c), but the agreement may
prescribe the standards by which the performance of the obligation is to be
measured, if the standards are not manifestly unreasonable
Vary the power to disassociate as a partner under 602(a), except to require the
notice under 601(1) to be in writing
Vary the right of a court to expel a partner in the events specified in 601(5)
Vary the requirement to wind up the partnership business
Vary the law applicable to a limited liability partnership under 106(b)
Restrict the rights of third parties under the RUPA
o Note: this is why the LLP still has obligations to third parties!

What conduct does a partnership agreement govern?

o To the extent the partnership agreement does not otherwise provide (or comply), RUPA defaults
as the law. RUPA 103(a)
What is partnership property? (I.e., how is it defined?)
o RUPA 203. Property acquired by a partnership is property of the partnership and not of the
partners individually RUPA 204: factors for when property is partnership property:
When the property is acquired in the name of the partnership
By one or more partners with an indication of the persons capacity as partner or the
existence of a partnership
By a transfer of the property to the partnership governed by RUPA 302
By a transfer of the property to one or more partners in their capacity as partners in the
partnership with the name of the partnership indicated on the transfer
Property is presumed to be partnership property is purchased with partnership assets
Presumptions are rebuttable
Property purchased without partnership assets and without indication of the partners
capacity as partner in the partnership or the partnership itself is presumed to be separate
property
o RUPA 501 A partner is not a co-owner of partnership property and has no interest in
transferrable partnership property
o RUPA establishes two presumptions:
Property purchased with partnership funds is partnership property, and
Property acquired in the name of one or more of the partners w/o an indication of their
status as partners and without use of partnership funds is presumed to be the partners'
separate property, even if used for partnership purposes.
(McCormick v. Brevig)
What are the basic principles of partnership accounting? Where are the rules in the RUPA that help us to
answer these questions?
o Partners are not entitled to salary. RUPA 401(h) they receive partner distributions at the end
of the year, if there is enough to give to determine how much, look to capital accounts
(below)
o Financial condition of a partnership customarily is described by two distinct documents: (1)
income statement, and (2) balance sheet.
9

Income statement (profit and loss statement): covers a defined period. Sets forth the
revenues and expenses of a business during an accounting period.
Balance sheet: shows the financial condition of a partnership at one particular point in
time. statement of assets, liabilities, and owners' equities at a given point in time.
o Capital Account: shows the equity of the partner in the business. At formation shows only
capital contribution. Accounting: adds undistributed net profits to the capital accounts of the
partners at the end of each accounting period and deducts from capital any withdrawals made
during the accounting period.
RUPA 401(a). "Each partner is deemed to have an account" . . .
RUPA 401(b). If you do not provide anything to the income, then you still can be liable
for losses.
If you agree on profits, losses follow profits
If you agree on losses, but not profits, then the default is 50/50 for profits even if
the agreed loss percentage is 90/10.
Profits do not follow losses!!!

How does authority work in a partnership? (I.e., who has authority to act for or on behalf of a partnership?)
o To determine who has authority, you would look to RUPA 301. Partner Agent of Partnership
RUPA 303. Statement of Partnership Authority
o RUPA 301. Partner Agent of Partnership
Each partner is an agent of the partnership for the purposes of its business.
Rule 1: Default rule is that a partners actions when acting within the ordinary course of
the partnership business makes him an agent. RUPA 301(1) EXCEPTION: unless,
the partner had no actual or apparent authority AND the third party knew the partner
lacked that authority. RUPA 301(1).
Rule 2: partner acting outside the ordinary course of business only binds the partnership
if the act was authorized by the other partners. RUPA 301(2).
o RUPA 303. Statement of Partnership Authority.
o Equal Authority of Management:
RUPA 401(f): each partner has equal rights in the management and conduct of the
partnership business.
RUPA 401(j): a difference arising as to a matter in the ordinary course of business of a
partnership may be decided by a majority of the partners. An act outside the ordinary
course of business of a partnership and an amendment to the partnership agreement may
be undertaken only with the consent of all the partners.
What are the rules regarding the liability of a partnership and its partners to third parties?
o If you do not have partnership liability under RUPA 305, then no need to go on to RUPA 306.
o RUPA 305. Partnership Liable for Partners Actionable Conduct.
A partner is liable to third parties in tort for his or her own actionable conduct. (See tort
law, generally.)
The partnership is liable to third parties for a partners actionable conduct, if the partner
acted in the ordinary course of business of the partnership or with authority. (305(a)).
The partnership is liable when the money or property received by the partnership is
misapplied by a partner.
o RUPA 306. Partners Liability.
Each partner (including, but not limited to, a partner whose actionable conduct has been
charged to the partnership under RUPA 305(a)) is jointly and severally liable to third
10

parties for the partnerships obligations. (306(a)).

A partner is not jointly and severally liable for obligations of the partnership incurred
before the persons admission as a partner.
An obligation of a limited liability partnership arising in tort is solely the obligation of
the partnership. Accordingly, a partner is not personally liable to third parties for the
obligations of a limited liability partnership solely by reason of being or so acting as a
partner. (306(c)).
A partners liability to third parties for his or her own actionable conduct is not an
obligation arising solely by reason of being or so acting as a partner; rather, the liability
arises out of his or her own actionable conduct.
Therefore, in a limited liability partnership, a partner remains liable to third parties for his
or her own actionable conduct (and the partnership also may be liable, as applicable)
even though co-partners of the wrongful actor are not personally liable for the wrongful
actors conduct.

What rule(s) govern a partners fraud or other tortious conduct? How does the Rouse case help us to
understand this aspect of partnership law?
o Rouse: It is not a characteristic function of the practice of law to accept clients money for
deposit and future investment in unspecified securities at the discretion of the attorney.
Rouse fails on apparent authority because the Firm did nothing to indicate that
Fitzsimmons had any authority to act in their behalf outside the practice of law.
He was acting outside of his role as a law partner.

What duties and obligations do partners owe to the partnership and to each other? What rules in the RUPA
govern that question, and how do the assigned cases illustrate these rules and the resultant liability, if any, of
the partnership and its partners?
o ***REFER TO FIDUCIARY DUTY CHART***
o A partners 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 the law.
The drafters assumed that most partners would agree to share losses equally, reasoning
that negligence is inevitable and likely to occur at random among partners.
o 404(c): Has a fairly high threshold to violate it.
Limited to grossly negligent or reckless conduct, intentional misconduct, or a knowing
violation of the law.
Pure negligence is not covered by 404(c) nor was it covered by other
partnership principles as seen in Duffy. In a partnership, negligence is just not
enough.
o Three Duties within the Duty of Loyalty:
The duty to account for partnership property
The duty to refrain from dealing with the partnership as or on behalf of an adverse party.
The duty to refrain from competing with the partnership.
o Cases
Duty of Loyalty
Meinhard v. Salmon: Partnership Opportunity (RUPA 401(b)(1)).
11

o Not honesty alone, but the punctilio of an honor the most sensitive, is then
the standard of behavior
J & J Celcom v. AT&T: Conflict of Interest (RUPA 404(b)(2)).
Duty of Care
Duffy v. Piazza Construction, Inc.: Standard (RUPA 404(c)).
Moren v. Jax Restaurant: Indemnification (RUPA 401(c)).

What is partnership dissolution? When does dissolution occur? What happens next? Can the effects of
dissolution be waived?
o Dissolution is a threshold/gateway event that catapults the partnership toward its windup &
termination. Its an event relating to the partnership. In between the event and the termination is
the wind-up. (801 and 802 together).
RUPA 801 The series of events RUPA 802(a) The partnership continues after
dissolution during windup and that the partnership is terminated after windup is
completed.
Decision by all of the partners, including dissociated partners, but not
wrongfully dissociated partners, to continue the business as if the dissolution
did not occur. RUPA 802(b).
RUPA 101(8) defines a partnership at will helpful for 801(1).
Partnership at will: Mere notice from a partner dissolves the partnership (thats the
old rule, like in UPA)
o Article 8
Dissociation that does cause dissolution Article 8
Any partner that has wrongfully dissociated may NOT participate in the winding up of
the partnerships business
Partnership only bound in wind up
By acts that are appropriate for winding up
Would have bound the partnership before dissociation under 301, if the third party did not
have notice of the dissolution
o Summary of RUPA 801 807
801 Events causing dissolution and winding up
Partnership at will when a partner decides to leave.
o NOT 601.2- .10
Partnership for a definite term/particular undertaking
o Majority of partners vote to wind up within 90 days of
Partners dissociation by death,
Dissociation by 601.6 10
Wrongful dissociation under 602 (b)
o Unanimous vote to wind up
o Expiration of the term/completion of the undertaking
o Event agreed to result in wind up
802 partnership continues after dissolution
Only to wind up
Between dissolution and wind up any partner can waive right to wind up and
carry on as if the decision was never made
803 right to wind up partnership
12

Anybody can wind up except wrongfully dissociated partners last man

standing officially ends it
It can continue until all loose ends are tied up
(c) List of appropriate actions in wind up
804 partners power to bind after dissolution
During dissolution, partnership is bound by the act of any partnership
if appropriate to wind up the firm (actual authority)OR
any act that would bind the partnership if done prior to dissociation under 301
analysis (lingering apparent authority problem)
3rd party cannot have notice (102 b) of dissolution
805 statement of dissolution
Partnership can file a statement of dissolution (new to RUPA), with the secretary
of state. Apparent authority then cut off 90 days after filing
Prior to this, you would have to try to give the best notice you could, to try to
head off any potential lingering apparent authority. Actual and constructive notice
in newspaper.
Like section 303
806 partners liability to other partners after dissolution
807 settlement of accounts between partners
Capital accounts keep track of all this
Estate of a deceased partner is liable to partners obligation to contribute to the
partnership

How does dissolution relate to partner dissociation? When does dissociation occur? What are the potential
effects of dissociation?
o Article 6 & 8
Article 6 = Events relating to a partner (dissociation) separation of a partner from a
partnership.
Article 8 = events relating to a partnership (dissolution) the event that propels a
partnership to its termination
You can have dissolution without having a dissociation of a partner (the court can
determine it, for example).
A dissociation either results in a dissolution, or if there is not dissolution, then it results in
a buy-out at a fair-price.
o Article 6 Defining Dissociation: the separation of partners from a partnership; an event
relating to the partners
o 601 events causing partners dissociation
Partnership has notice of partners express will to withdraw
2 10:
Event agreed to causing partner dissociation occurs
Expulsion due to partnership agreement
Expulsion by unanimous vote of the other partners if
o Unlawful to carry on partnership business with that partner
o Transfer of all or substantially all of partners transferable interest in the
partnership
o Within 90 days after corporate partner has been notified because the
corporate partner is being dissolved/charter revoked etc.
13

o Partnership that is a partner has been dissolved

Wrongful conduct on behalf of partner that = material breach
Partner in bankruptcy
o 602 partners power to dissociate; wrongful dissociation
Partner can dissociate at any time
Wrongful only if:
Breach of partnership agreement
Before definite term expires if
o Partner withdraws by express will, unless within 90 days after another
partners dissociation rightful or wrongful
o Partner is expelled by judicial determination, bankruptcy
o Non-individual it is dissolved willfully
Liability: Partner who wrongfully dissociates is liable to partnership for damages in
addition to any other obligations of partner to partnership
o 603 effect of partners disassociation
If dissociation results in winding up Article 8.
If partners decide not to wind up (under 802(b)) Article 7
His rights and duties terminate basically no more fiduciary duties to the partnership
o Article 7 Partners Dissociation when Business Not Wound Up
701 Purchase of Dissociated Partners Interest
Buyout price
o Basically capital account based on either liquidation value of the entire
business or the sale of the entire business without the dissociated partner.
Plus interest for the time it takes to calculate that
o Damages for wrongful dissociation offset against the buyout
o Partnership must indemnify for anything other than what the partner
actually did, either before or after dissociation
o Partner who wrongfully dissociates before the expiration of a definite term
not entitled to buyout until the term is complete
702 Dissociated partners power to bind partnership
For 2 years after dissociation, partnership bound by dissociated partners acts in
the ordinary course of business due to apparent agency (own summation, check
with class notes)
Other party must reasonably believe dissociated was still a partner, and not have
actual knowledge that he was no longer a partner
Partnership can go after dissociated for such purchases
703 Dissociated partners liability to other persons
Still liable for what happened before dissociation
Dissociated still liable for partnership agreements entered within 2 years after
dissociation if other party reasonably believed the partner was still associated, and
did not have actual knowledge of the dissociation
704 Statement of dissociation
Must file a statement of dissociation
705 Continued use of partnership name
Such continued use of partners name, or partnerships name does not
automatically make the non-participating party liable
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B.

LIMITED LIABILITY PARTNERSHIP (LLP)

What is a LLP?

It is a general partnership with an important modification (to liability):

o The partners are not personally liable for the debts and obligations of the business except to the
extent they have agreed to be (for contractual obligations) or bear personal fault (tort
obligations).

How is a LLP different from a partnership (e.g., definition, formation, maintenance, other attributes)? How do
you know? Where are the relevant legal rules found?

Definition:
Formation (MUST be filed, called formalities) & Maintenance
o RUPA 101(5) Limited liability partnership Article 10. Limited Liability Partnership
RUPA 1001. Statement of Qualification:
(a) a partnership may become a LLP pursuant to this section
Note: RUPA 401(j) if you are already a partnership, you have to seek approval
from your partners and would require the consent of all the partners because it is
not in the ordinary course of business However RUPA 1001(b) states that the
vote to change the partnership to a LLP must be approved by the vote necessary
to amend the partnership agreement. (So, if can amend by a majority vote can
change to an LLP with a majority vote).
o RUPA 1001(2): must end with one of the specified formulations or acronyms. (i.e., LLP, L.L.P.,
etc.)
o RUPA 1001(3). Annual Report
An annual report must be filed with the Secretary of State and there is a fee that is
involved. Some states the fee is small, others it is large.
Secretary of State may revoke the statement LLP (or partnership filing for LLP status)
has 60 days written notice to revoke the statement.
Revocation only affects status as an LLP and does not result in dissolution
LLP statement of qualification that has been revoked may apply for reinstatement
within 2 years after the effective date of the revocation.
If successfully revoked, the reinstatement relates back to the effective date as if
the revocation never occurred.
Liability
o 306(c) Limited Liability Partnership Formed under RUPA: See above.
An obligation of a partnership incurred while the partnership is a LLP, whether arising in
contract, tort, or otherwise, is solely the obligation of the partnership. A partner is not
personally liable, directly or indirectly, by way of contribution or otherwise, for such an
obligation solely by reason of being or so acting as a partner. This subsection applies
notwithstanding anything inconsistent in the partnership agreement that existed
immediately before the vote required to become a LLP under 1001(b).
Its a partnership that requires filing and you get limited liability in return.
Partners have limited personal liability of the partnership. Their obligations are
still there.
Liability for the obligations of the partnership are at issue here. Partners in the
LLP are still liable for their own actions.
Partners are not personally liable for the obligations of the partnership.
15

C.

LIMITED PARTNERSHIPS (LPS)

What is a LP?

Source of authority is the Re-Revised Uniform Limited Partnership Act of 2001 (RULPA)
RULPA 101(11) LP means an entity, having one or more general partners and one or more limited
partners, which is formed under this act by two or more persons
RULPA 104(b): LP may be organized for any lawful purpose.
LPs have two different structures within. There is a separation of ownership and control. Here, we
separate our Managers who run the day to day from the investors (financial).
General Partners manage more risk related to the management of the business.
Limited Partners limited in liability and in management the difference is more than just liability,
their fiduciary duties are limited as well.
LPs are distinct from LLPs in which all partners have limited liability.
o Like SHs in a corporation, LPs have limited liability, meaning they are only liable on debts
incurred by the firm to the extent of their registered investment and have no management
authority. The GPs pay the limited partners a return on their investment (similar to a dividend),
the nature and extent of which is usually defined in the PA. GPs thus carry more liability, and in
cases of financial loss, the GPs will be personally liable.

How is it formed?

RULPA 201. Formation of LP; Certificate of LP

o RULPA requires the organizes of a LP to make a filing with the state. (Formalities).
If the proper filing is made, the LPs do not control the business, the limited partners will
not be vicariously liable for the debts or obligations of the LP, but the general partners
will.
If a filing is not made, the limited partners run the risk of being treated as a general
partner.
o Subsection (d) if there is a provision inconsistent as between the partnership agreement and
the certificate of limited partnership
the partnership agreement prevails as to partners
the filed certificate prevails as to persons, other than partners and transferees, that
reasonably rely on the filed record to their detriment. (SI Management LP v. Winiger).

How is it different from a partnership in terms of structure, authority, duties among the constituents, and related
questions of liability?

Structure: Has two classes of partners: General and Limited

o General Partners: (management) Like general partners in a conventional partnership personal
liability for the debts of the business.
o Limited Partners: (investors and can manage as well)
For federal income tax purposes, limited and general partners are treated as partners in a
general partnership.
Limited partners are not personally liable for the debts of the business will only
lose their investments in the business
Do not have agency authority, although they can contract otherwise.
Be mindful of dealing with Limited Partners in a LP. They may not have the
authority to do what they are doing.
16

Authority
o General Partner (RULPA 402) Same as a partner in a general partnership (RUPA 301).
Duties
o The GP of a limited partnership owes fiduciary duties of good faith, due care, and loyalty to the
limited partnership. This is because the LPs are dependent on the GP if they are to realize a
return on their investment.
o Courts have generally protected LPs (as shown in Appletree); however, like in a general
partnership, a limited partnership is contractual in nature, and, inevitable, the general partner will
seek to limit its fiduciary duties (as in Brickell).
o General Partner (RULPA 408)
Stated above
Duty of Loyalty ( 408) is limited to three instances
LP Opportunity/Disclosure: disclosure survives because it is attended to the
required obligation of good faith and fair dealing RULPA 304 and 305(b)
limited partners have the right upon reasonable demand to obtain information
from the general partners.
Conflicts of Interest: dealing with the LP as or on behalf of an adverse party
(Brickell).
Competition: general partner must refrain from competing with the LP in the
conduct or winding up of the LPs activities.
Duty of Care: limited to grossly negligent or reckless conduct, intentional misconduct, or
a knowing violation of the law.
A general partner does not violate a duty or obligation under the RULPA or the
partnership agreement merely because the general partners conduct furthers the general
partners own interest. RULPA 408(e).
o Limited Partner
RULPA 305 limited partner only owes a duty of good faith and fair dealing (no
fiduciary duty) and does not violate if conduct further the limited partners own interest.
Liability
o General Partner RULPA 403 (compare to RUPA 306):
Personally liable for the obligation of the limited partnership, unless limited in some way
in the partnership agreement
o Limited partner RULPA 303: a limited partner is not liable for any obligations of the
partnership even if the limited partner participates in the management and control of the
LP. (Gateway Potato Sales v. G.B. Investment Co. (1991) followed the old RULPA where a
limited partner could may become liable if taken control).

What law governs its existence, maintenance, and operations?

RULPA
Maintenance and Operations
o RULPA 406: management rights of the general partner exclusively by the general partner or
if multiple, by a majority of the general partners.
o RULPA 303 (above): limited partner may participate in management and control of the LP with
no liability.
Partnership Agreement: RULPA 101(13): means the partners agreement, whether oral, implied, in a
record, or in any combination, concerning the LP, including amendments.
17

o RULPA 110. Effect of Partnership Agreement; Non-Waivable Provisions Subsection (b):

a partnership agreement may not:
Vary a limited partnerships power under RULPA 105 to sue, be sued, and defend its
own name
Eliminate the duty of loyalty under RULPA 408, but may modify as long as not
manifestly unreasonable
Unreasonably reduce the duty of care under RURLPA 408(c)
Eliminate the obligation of good faith and fair dealing under 305(b) and 408(d)
But may modify as long as not manifestly unreasonable

D.

LIMITED LIABILITY COMPANIES (LLCS)

What is a LLC? How is it formed? How is it structurally similar to or different from a partnerships or LP?
What law governs its existence, maintenance, and operations? Where are the rules relevant to the preceding
questions?

General: The LLC offers the benefits of limited liability, taxation as a partnership, and management
flexibility. Owners (members) are not liable for the debts of the business, like in a LLP. The LLC can
elect to be Manager Managed, in which case only those persons designated as managers have
agency authority. However, the LLC can elect to be Member Managed, in which all the members will
have agency authority and participate in the management of the LLC.
o Typically, the organizes of an LLC will enter into an Operating Agreement (OA) that delinates
the obligations of the parties and any other provisions that the parties desire. As in a general
partnership, a LLC is a contractual entity, with only a few mandatory, non-waivable provisions.
RULLCA 102(13).
Formation
o Formalities: RULLCA 102(1). Certificate of organization (called Articles of
Organization) must be filed RULLCA 201. Formation of LLC:
One or more person may file certificate
Certificate must state:

Name, address, and there are rules on if it will form in beginning with no
members.
o An LLC may have only one person. RULLCA 201(a).
Structure
o Member Managed vs. Manager Managed
o Member Managed: RULLCA 102(12). an LLC that is not a manager managed LLC under
RULLCA 407(a). RULLCA 407(b) (see below)
Elf Atochem North America, Inc. v. Jaffari
o Manager Managed: RULLCA 102(10) RULLCA 407(c) (see below)
Management and Control
o Member Managed
RULLCA 407(b): the following rules apply:
Management and conduct of the company are vested in the members;
Each member has equal rights in the management and conduct of the companys
activities;
18

A difference arising among members as to a matter in the ordinary course of the

activities of the company may be decided by a majority of the members;
An act outside the ordinary course of the activities of the company may be
undertaken only with the consent of all members; and
The operating agreement may be amended only with the consent of all members.
o Manager Managed
RULLCA 407(c): following rules apply (below is a summary of (c)-(f):
Managers decide the activities of the company;
Managers have equal rights in management;
Difference among managers for activity that is in ordinary course of business
needs consent of majority of managers;
Consent of all managers needed to:
o Sell company property outside course of business;
o Approve a merger;
o Acts outside ordinary course of business; and
o Amend the operating agreement;
Manager may be chosen by majority of members and may be removed by a
majority of members;
Manager does not have to be a member but dissociation of person that is
member/manager removes person as manager nevertheless, removal from
manager does not dissociate as a member;
Cessation of manager does not discharge any debt;
Manager is not entitled to a salary receives ?
What is an operating agreement? What is its relationship to the statutory rules governing LLCs and their
members? What conduct does an operating agreement govern? Where are these rules found?

RULLCA 102(13): may be written, oral, or implied RULLCA 108. Name of LLC RULLCA
110. Operating Agreement
RULLCA 110: subsection (a) covers what the OA governs, subsection (b) says if it is not in the OA,
this act governs, subsection (c) states what an OA may not govern (non-waivable provisions), and
subsection (d) states what the OA may govern.
o (a) OA governs relations among the members as members and between the members and the
LLC, the rights and duties under this act of a person in the capacity of a manager, and the
activities of the company and the conduct of those activities, and the means and conditions for
amending the OA.
o (c) An OA may not: (list of provisions) including, eliminate the duty of loyalty, duty of care, or
any other fiduciary duty (good faith and fair dealing).
HOWEVER, in subsection (d) can limit the duty of loyalty within the bounds of the
statute and manifestly reasonable, and (basically) eliminate the duty of care and good
faith/fair dealing.
o (e) a violation of duty of loyalty may later be ratified to not violate the duty after full disclosure
of the facts.
o (f) for a member managed LLC, the OA may eliminate or limit fiduciary duties of a member.
o (g) OA may alter or eliminate the indemnification for a member or manager

19

o (h) Court may determine any terms in the OA to be manifestly unreasonable considering the
circumstances existing at the time the term was added to the OA, and may invalidate the term if
found unreasonable.
What general wisdom can we take away from the Abrahim & Sons and Premier Van Schaack Realty cases about
the legal difference between entities and their owners? To answer this question, identify first the operative
legal rule and its source. Then, consider how the cases work with or around the rule.
Abrahim & Sons Enterprises v. Equilon Premier Van Shaack Realty, Inc. v. Sieg
Enterprises, LLC
- Court says separate entity; transfer to - The brokerage fee is at issue here
- The buyer and the seller form a LLC together
that new entity; looks like a transfer
- Court says that it is a separate entity, but there is
to a third party
not a purchase, sale or exchange here BECAUSE
- Texaco and Shell should have
there was no consideration AND Sieg continued to
offered the right of first refusal
have substantially the same ownership interest in
the property
- Equitable reason to deny the brokerage fee? They
did less than what the court thought they should
have done Maybe the court didnt really
understand what consideration is (obtaining an
interest in an entity is consideration)
How does authority work in a LLC? (I.e., who has authority to act for and on behalf of an LLC?) What about
related questions of liability to third parties? Where are the relevant rules in the RULLCA and how are they
illustrated in the assigned cases?

Look to Article 3 of RULLCA Agency Law

Authority
o A member cant bind the LLC solely by being a member. RULLCA 301(a).
But, it could be provided for in the OA and would be actual authority, transmitted by
the principal.
o RULLCA 301(b) throws us into Agency Law Leave it up to Agency Law to cover issues of
apparent authority.
Says it by the way of negative Liability still may be imposed by laws other than this act
imposing liability on a LLC because of the persons conduct.
The default rule is to look to the common law look to the law of Agency.
Third party beware!!! Puts third parties on notice that a member does NOT have
authority unless so expressed in the OA.
o Third parties should ask for a statement of authority (302).
o There could be actions of the members or managers that are covered.
That puts the transaction costs on the 3P. It shifts the burden for transaction cost
allocation significantly onto 3Ps to do this kind of searching / diligence.
Idea was to open this up to freedom of contract.
Agency can create 3P liability for obligations of the entity.
o RULLCA 302: Statement of Authority: may state who has authority
o RULLCA 303: Statement of Denial: may state who does not have authority
If youre given authority and you dont want it, you can deny it.
Liability
20

o RULLCA 304 Liability of Members and Managers:

Same kind of limited liability provisions in LLP and LPs.
The failure of an LLC to observe any particular formalities relating to the exercise of its
powers or management of its activities is not a ground for imposing liability on the
members or managers for the debts, obligations, or under liabilities of the company.
Court will look to see if someone is acting as a rogue.
Commingling your funds
What about lack of funds?
LLCs are meant to be quite serious and protect you from liability for what the
entity does, it does NOT protect you from your own mistakes see RULLCA
408
What duties and obligations exist among LLC constituents and between them and the LLC? Who among the
constituents in a LLC owes these duties and obligations to whom? Where are the relevant rules found and how
do the assigned cases illustrate those rules in operation? How do LLC derivative actions and the oppression
rule noted in the text relate to duties in the LLC context?

Duties: RULLCA 409. Standards of Conduct for Members and Managers

o The managers of an LLC in a manager-managed LLC owe the same fiduciary duties of CARE
and LOYALTY as a general partner owes to the limited partners in a limited partnership and
courts often draw on partnership precedents in LLC cases.
o Non-manager members do not have a fiduciary duty.
Katris v. Carroll Specifically set out which member were managers in the OA so court
held that a member excluded as a manager could not be held liable as a fiduciary even
with allegations of collusion with other non-manager members.
o Despite the similarities between partnerships and LLCs, some courts look to corporate law to
define the fiduciary duties of managers, perhaps because the management structure of LLCs is
often similar to corporations with boards of directors and officers (plus the law is established).
The Courts apply BJR to actions of such directors, meaning that the courts will generally
defer to the business judgment of the directors of an LLC unless the directors failed to act
in good faith, acted without care (i.e., were grossly negligent), or had some conflict of
interest.
o Can the fiduciary duty of members be limited in LLCs?
McConnel (NHL Franchise case) says that the fiduciary duty is owed, but a breach
should be viewed in the context of the members ability to compete with granted by the
OA (so basically, the OA can limit fiduciary duties in some regard). Also, in this case, the
competition was practicable given the failure of the general purpose of the LLCs
formation.
Oppression: Under RULLCA 701(a)(5), an LLC must be dissolved and wound on application by a
member that the members (in control) or managers (in a manager managed) have acted in a manner that
is oppressive. ((b) states it does not have to dissolve, if court so orders). This action by a member for
oppression may be brought under RULLCA 901 or 902.
o Pointer v. Castellani
o The oppression doctrine is established in corporate law in which a shareholder may maintain a
cause of action if their reasonable expectations have been disappointed by the unanticipated
actions of other shareholders.
RULLCA 901. Direct Action.
o Members may maintain a direct action against another member, a manager, or the LLC.
21

o The member would have to prove an actual or threatened injury that is not solely the result of an
injury suffered or threatened to be suffered by the LLC.
o Was the action taken appropriately?
First, make sure that the management is behaving in accordance with the statutes >
operating agreement (governing docs of the firm).
Second, in taking that action, even if they followed the rules, did the management
exercise appropriately their fiduciary duties.
Loyalty? Care? Arm's length? Bad faith?
Derivative Action: if the managers are the one that have to bring the lawsuit, owners have the right to
sue. (RULLCA 902).
o Members may bring a derivative action if bringing an action had been demanded of the LLC and
one was not brought within a reasonable time or such a demand would be futile.
McConnell v. Hunt Sports Enterprises (1999)
o Issue: whether an operating agreement of a LLC may, in essence, limit or define the scope of the
fiduciary duties imposed upon its members?
o Holding: Yes.
o Fiduciary: person having a duty, created by his or her undertaking, to act primarily for the benefit
of another in matters connected with such undertaking.
o Hunt was found he breached the operating agreement dissolution is the remedy.

What is a series LLC? How is one formed? Why do legislatures believe this form of entity is desirable? What
challenges do you perceive this type of entity may face based on what you now know about business
associations?

A LLC partitioned into distinct series with each having its own assets, debts, obligations, liabilities, and
rights separate from the other series. Another advantage is that the owner only has to pay one filing fee
for the Series LLC, rather than multiple.
o i.e., a real estate investor could form a Series LLC to own and manage various properties with
each property being a distinct series, and any loss or liability would only be enforceable against
that particular series.
Formation (in Delaware)
o Notice given in the certificate of formation and separate and distinct records must be maintained
for each series and its assets Failure to properly manage the distinct series as separate entities
may subject a series to the liabilities of another series
i.e., joint ownership of assets or cross-collateralization between series may lead to a court
being reluctant to enforce the liability limitation provided for in the various statutes.

What is an LLLC (or L3C)? How is one formed? Why do legislatures believe this form of entity is beneficial?
Why may this ostensible benefit be illusory?

L3C: Low-profit limited liability company

Takes advantage of federal tax regulations so that private foundations will invest in certain for-profit
companies.

III. CORPORATIONS- THE BASICS

22

A. FORMATION
FORMALITIES

AND

OTHER ISSUES RELATING

TO

CORPORATE

What is a corporation?

MBCA 1.40(4) defines corporation as a corporation for profit, which is not a foreign corporation,
incorporated or subject to provisions of the act.
Not expressly defined in Delaware general corporation law.

How is it formed?

MBCA 2.02 Articles of Incorporation

o Must set forth requirements in 2.02(a)(1-4)
Corporate name that includes certain word, number of shares authorized to issue, street
address of corporations initial registered office and name of registered agent, and the
name of each incorporator
o Permissive Provisions under 2.02(b)(1-5)
Names and addresses of individuals serving as initial directors,
provisions not inconsistent with law regarding (purpose; managing the business and
regulating affairs; defining powers of corporation, board and shareholders; par value for
authorized shares, classes of shares)
any provision required or permitted to be set forth in bylaws;
a provision alter liability of director to the corporation or its shareholders for money
damages for any action taken as director, except for
A) The amount of a financial benefit received by a director to which he is not
entitled
B) intentional infliction of harm on the corporation or the shareholders
C) violation of 8.33 (Directors liability for unlawful distributions)
D) Intentional violation of criminal law
Provision for indemnification of a director for liability, except liability for
A) The amount of a financial benefit received by a director to which he is not
entitled
B) intentional infliction of harm on the corporation or the shareholders
C) violation of 8.33 (Directors liability for unlawful distributions)
D) Intentional violation of criminal law
o Doesnt have to set forth powers in the Act
o File with Secretary of State, engage in very specific procedure
First meeting of Board of Directors, where bylaws are adopted after filing
Bylaws and process for setting up corporation are mandatory
MBCA 2.06 Bylaws: Incorporators or board adopt initial bylaws
DGCL 102 Certificate of Incorporation
o Required Provisions
1) Name
2) The address
3) The nature of the business or purpose to be conducted or promoted
4) Stock, has a mandatory par value
5) Name and mailing address of the incorporator
6) Who is on hook until first board is named
o Permissive
23

Any provision which is required or permitted by any section of this chapter to be stated in
the bylaws may instead by stated in the COI
Provision for the management of the business
Provisions creating, defining, limiting, and regulating the powers of the corporation,
directors, and stockholders
Preemptive rights
Larger voting requirement
Limiting the duration of the corporation
Provision imposing liability on stockholder to a certain extent
Provision eliminating or limiting personal liability of a director (Exculpation)
DGCL 109 Bylaws
o May contain any provision not inconsistent with law or the COI relating to the business of the
corporation, the conduct of its affairs and its rights or powers or the rights or powers of its
stockholders, directors, officers, or employees.
DGCL 101: tells how to file, later sections give exact steps that need to go through

Seven types of optional charter provisions which attorneys may use:

Naming the initial board of directors; including an article narrowing the purpose versus any lawful
purpose; capping or eliminating directors duty of care liability (exculpatory clauses); special
governance provisions such as eliminating the board of directors entirely; installing shareholders
preemptive rights; electing treatment as a close corporation if possible in jurisdiction with special
statutory schemes; implementing indemnification of directors

How is it structurally similar to or different from a partnerships or LP?

Partnership is set up with all partners as owner-operators at the same level. Limited Partnerships have
general partner (owner/operators), then limited partner (owner with limited rights to manage/operate).
Thus limited partnerships have two different roles/levels.
Corporations have a board of directors at the top, then officers. The Board of Directors and the officers
are operators/managers, then there is the shareholders (owners).
o Shareholders (stockholders in Delaware)(owners) Board of Directors (operators/managers)
Officers (operators/managers)

What law governs its existence, maintenance, and operations? What are the relevant rules for the preceding
questions?

State adoption of the Model Business Corporations Act

Delaware General Corporation Law
Corporations have express purposes and powers that are scripted out in the statute
o MBCA 3.01, 3.02: Every corporation can be organized to do everything lawful unless more
limited purpose is expressly written.
3.01(b): Exception for state bank and trust companies. Have to be organized under own
state law
o DGCL 121, 122: General Powers and Specific Powers, unlike purposes.
122: Gives specific powers of corporation as a separate legal person.
o DGCL 102(3): In the COI, the corporation must set out that the business purpose of the
corporation is to engage in any lawful act or activity.

24

What does a corporate charter look like? What do corporate bylaws look like?

There are examples in the Statutory Resource book.

MBCA
o Charter: Articles of Incorporation Page 529
o Bylaws: Page 533
DGCL
o Charter: Certificate of Incorporation no specific example, but assuming it is similar to the one
on Page 529
o Bylaws: Page 533

What types of private ordering are common in the corporate form? Why (on what basis) do business ventures
choose particular states (especially Delaware) in which to incorporate their business?

Important to look at relevant statute because not standardized, each state has different statute that give
expressed purposes and powers that are scripted out in the statute.
o i.e., MBCA 2.02(b) vs. DGCL 102(b) shows the difference between what may be included
in the charter document. Delaware here provides for more protection for directors/stockholders.
Delaware is very popular because of an expertized judiciary, state legislature, and favorable tax
structures, deemed to be pro-management but give shareholders several rights.
Internal affairs governed by state law under Internal Affairs Doctrine, as well as who is liable to third
party entities
MBCA: in 39 of the 50 states, allows attorneys and companies to stay home
Delaware
o Attorneys may incorporate in Delaware if the enterprise is quite large, or will be used in a
business combination with another large entity, or soon acquire many
Choice of Law rule: If DL is the state of incorporation, even if hq, directors, and officers are in another
state, Delaware law governs conflicts among shareholders and officers or directors, and other matters
internal to the corporation
o Problem though that under DGCL 114 Delaware deems every officer or director of a Delaware
corporation to have consented to suit there

How are corporations classified? What other ways of characterizing corporations have you heard or can you
think of?

Profit and Non-Profit

o Important Distinction that the MBCA is only for profit corporations, with the states adopting
separate non-profit law.
Public Corporations and Closely held corporations.
o Heminway says this distinction leaves out corporations in the middle. Arranged currently as
publicly held (securities) and Closely held (friends and family).
o She thinks better is
1) Publicly Held
2) Privately Held
Closely Held (Close Corps in Delaware)
o Subchapter XIV of DGCL specifically deals with close corporations
Other
Size-related taxonomy
o Small ten or fewer shareholders
25

o Quasi-Public 11-299 shareholders

o Public 300+ sharheolders
What are the perils of not organizing a corporation properly?

Being held liable

Defective Incorporation
o MBCA Thompson v. Music City MBCA 2.04.
The requirements in the statute are strict the filing of a chartering document is now an
immutable rule and not a default. Thus, it does not matter what the third party thought he
was dealing with a corporation. The COI provides a cutoff point:
Before it is issued individuals liable
After corporation
De jure (good against the world) is all that remains
o DGCL 329
Pre-incorporation Contracts
o MBCA 2.04. Liability for Pre-Incorporation Transactions
Involuntary Dissolution
o Once incorporated, a corporation has yearly responsibilities to maintain its corporate status.
A corporations failure to pay its annual fee or file its annual report are grounds for
administrative dissolution by the secretary of state MBCA 14.20.
Once a cause for dissolution arises, the corporation is notified and has 60 days to
correct.
Once the corporation is dissolved, it continues its corporate existence but may not carry
on any business except to appropriately wind-up and liquidate its business and affairs
14.05(a).
A Dissolved corporation can apply for reinstatement within 2 years of dissolution
(MBCA 14.22(a)).
Reinstatements relate back to the effective date of the original dissolution
14.22(c)
pp. 194-212

How does dissolution affect the liability of corporate participants for the obligations of the corporation? What
are the best practices for pre-incorporation contracts, based on assigned cases?

Equipto Division Aurora Equip. Co. v. Yarmouth: MBCA 2.04: all persons purporting to act as or on
behalf of a corporation, knowing there was no incorporation, are jointly and severally liable for
liabilities created while so acting, except for any liability to any person who alse knew there was no
corporation
o Applies to pre-incorporation and post-dissolution
Pre-incorporation contracts:
o Indicate non-existence of principal
o Sign in a representative capacity
o Provide that when it comes into existence, the corporation will be bound
o Affirmatively provide that, also in that instance, promotor will no longer be responsible
In cases of defective incorporation, a founder or promoter signs contracts, thinking that the corporation
exists, and will be bound when, in reality the corporation does not exists.
Best practices for pre-incorporation contracts:
o For a promoter work a novation in futuro, he should:
26

Indicated the non-existence of her principal;

Sign in a representative capacity;
Provide that when it comes into existence the corporation will be bound;
Affirmatively provide that, also in that instance, the promoter no longer will be
responsible.
Comes from RKO-Stanley Warner.
o For an attorney advising incorporators, you should:
At the organizational meeting, lay out all of the contracts to be decided upon, and
The corporations directors should then take action with regard to each contract.
This really applies to pre-incorporation contracts.

What is the ultra vires doctrine? What is its history and how does it operate today?

Tells us what happens if a corporation validly organized and existing, seems to be acting outside of its
purposes and powers
Legal term historically describing actions which are beyond the powers or purpose of the corporation.
Statutes today though grant corporations basically all the powers of a natural person. Charters also grant
powers
Decline because of judicial hostility, broad purpose clauses, ease of amendment, grand of implied
powers, statutes
MBCA 3.04 a corporations power to act may be challenged only by: a shareholder seeking to enjoin a
corporate act; by the corporation, directly or derivatively, against an incumbent or former director,
officer, employee, or agent; or by the Attorney General under 14.30.
o Thus, corporation cannot as a defendant in a contract action raise ultra vires as a defense for nonperformance
DGCL 124
Total Access v. Caddo: expression of one thing is the exclusion of another. MBCA 3.04 does not
permit competitors to bring an ultra vires suit

What is the nature and content of the organizational meeting in the corporate form? How is this practice rooted
or reflected, if at all, in corporate law statutes? What best practices for organizational meetings can you imply
from the text?

An organizational meeting is required to be held, but incorporators or directors may sign an instrument
which states the action with a meeting
o Usually the minutes are typed up in advance to not have to meet
o Election of first boards is usually done at an organizational meeting, many attorney believe a
formal meeting is desirable
o Directors appoint officers and fix salaries
o Directors Examine and adopt bylaws
o Corporation, at direction of the board, issues the shares
o List on 210-211
DGCL 108, MBCA 2.05

B.

LIMITED LIABILITY

Story out of a few sentences that summarizes this chapter:

27

A story on limited liability & veil piercing

In the United States of Corporate Law, state corporate laws typically provide for a shield of limited
liability that protects shareholders (or stockholders, as they are commonly known in the State of Delaware), as
owners of the corporation, from liability for the corporations obligations.1
Some corporate owners, however, use the corporate organizational form not merely to shield themselves
from the ordinary liabilities of business operations (which the law generally permits 2), but rather to
affirmatively do harm (through fraudulent, unjust, or inequitable conduct). Courts construing corporate law may
find this use of the corporate form offensive to an orderly society (and, frankly, public policy). As a result, they
may take exception to limited liability and remove the limited liability shield, exposing the corporations owners
to personal liability for the corporations obligations when to do otherwise would foster fraud or be unjust or
inequitable. (The shield of limited liability protecting members in the limited liability company context also
may be removed for the same reasons. 3) So, for example, in some states, a shareholder who participates in the
conduct of affairs for a corporation that is capitalized with insufficient funds to conduct its ordinary business
operations may be held personally liable for a personal injury claim against that business; 4 in some states,
comingling corporate payables and receivables with those of an owner may provides a basis for piercing the
veil;5 and in some states, a parent corporation that effectively dominates the conduct of the affairs of its
subsidiary corporation may be held personally liable for the obligations of that subsidiary corporation.6
Statutes outside corporate law also may confer personal liability on shareholders under rules that differ
from those imposed by the Courts of Corporate Law,7 overriding the limited liability shield. Finally, courts may
disregard the separateness between corporations and their shareholders and, for reasons of justice and fairness,
hold corporations responsible for individual owners obligationse.g., when it is more equitable for the
corporation to be responsible for an individual shareholders obligations 8and may disregard a controlling
shareholders position as a corporate creditor in bankruptcy, treating the shareholders loan as equity instead of
debt for purposes of the priority of payments.9

1 MBCA 6.22; DGCL 102(b)(6).

2 See Gardemal v. Westin Hotel Co., 186 F.3d 588 (5th Cir. 1999); Brunswick Corp. v. Waxman, 599 F.2d 34
(2d Cir. 1979).
3 See Text at 309-10.
4 See Minton v. Caveney, 364 P.2d 473 (1961); but see Baatz v. Arrow Bar, 452 N.W.2d 138 (1989); Walkovsky
v. Carlton, 18 N.Y.2d 414 (1966).
5 NLRB v. West Dixie Enterprises, 190 F.3d (11th Cir. 1999).
6 See OTR Associates v. IBC Services, Inc., 801 A.2d 407 (2002).
7 See U.S. v. Bestfoods, 524 U.S. 51 (1998).
8 See Text at 305-307.
9 See Text at 307-09.
28

29

C.

MANAGEMENT

AND

CONTROL

What is the actual and desired role of the corporation in society? How does corporate law (judicial opinions,
statutes relating to corporate purposes and powers, etc.) shape this role?

The key role of a corporation is for the profit of its stockholders. The powers of the directors are to be
employed to that end, within the discretion of the board of directors, but cannot have primary purpose of
benefitting others. Judges will not evaluate business decisions in that context usually. Dodge v. Ford
MBCA 3.02(13); DGCL 122(9): a corporation has the power to make donations for the public welfare
or for charitable; scientific; or educational purposes
o Modern view that provide indirect benefits, reasonable promote corporate objectives. Donation
must be voluntarily made, within reasonable limits, in the reasonable belief that it would aid the
public welfare and advance the interests of the corporation and community in which it operates.
AP Smith v. Barlow
Other states have statutes which enhance boards power to make charitable contributions, such as other
constituency statutes.
o Challenge on grounds of conflicted
Also, consider that there are new B corporations that uses the power of business to solve social and
environmental problems. They have a double bottom line certified by an outside corporation.
o Different then a For Benefit corporation.

What is corporate governance?

Heminway: Relationship as among shareholders, directors, and the board in relation to the management.
Looking at the role of officers, can manipulate he board/exercise control over board.
o Generally, the board is in control, while the shareholders have ownership.
Book: allocation of power (ownership and control) between the board and the shareholders
Stockholders have the right to vote on specific matters, mainly election of directors
o Corporate charter can allocate greater power to the shareholders, such as approving particular
transactions, or the exclusive power to amend the bylaws, etc.
Elected board representatives have power to manage
Officers play a key role as well may somewhat control the Board through manipulation.

What types of voting rights does corporate law permit shareholders to have? How do they work? How do
proxies, voting (pooling) agreements, and voting trusts impact corporate governance?

Shareholder Voting
o Can vote to: elect directors, amend charter/bylaws; and basic changes.
Shareholder Voting for Election of Directors
o Straight Voting: one vote per share per director. MBCA 7.21(a); DGCL 212(a).
o Cumulative Voting: SHs accumulate their votes. Only for the election of directors. MBCA
7.28; DGCL 212.
o Weighted Voting: corporations can issue non-voting stock which limits or eliminates the rights
of SHs owning such shares to vote on various matters that are usually voted on by SHs. MBCA
6.01; DGCL 151.
Can also increase a stocks weight, such as 10 votes per share. MBCA 6.01; DGCL
151.
Tenure Voting: when stock that holds more than one vote is trades, then it drops down to
one-vote per share. Used to keep control in original/certain shareholders.
30

o Pooling Agreements: SHs enter into agreements to assure that minority shareholders have board
representation and to achieve objectives.
Voting trusts
Voting agreements
Ringling Bros
Mountain Manor Realty, Inc. v. Buccheri

Under what circumstances and how is corporate action taken by the shareholders and directors? What is the
shareholders role in the corporation under state law? What is the directors role in the corporation under state
law?

Shareholders meeting, required annually. (MBCA 7.01; DGCL 211). Shareholders have the power to
elect directors, amend the articles of incorporation, adopt or amend bylaws, approve agreements of
merger or consolidation, dissolve the corporation, and consent to sell all assets of the corporation.
Meeting must have a quorum (majority) of shares present to have meeting. (MBCA 7.25(b); DGCL
216).
o Directors have power to manage the business and affairs of the corporation and refer to
shareholders those matters on which the shareholders may vote
Directors Meetings
o MBCA Article 8
o DGCL 141(f) kind of more about actions taken without a meeting.
Directors Role in a Corporation:
o Board of directors is responsible for managing the business and affairs of the corporation.
Individual directors making up the board are not mere employees, but a part of an elected body
of officers constituting the executive agents of the corporation. Generally, stockholders cannot
act in relation to the ordinary business of the corporation, nor can they control the directors in the
exercise of the judgment vested in them by virtue of their office.
o Board of directors has control and it is its job to manage the firm. (MBCA 8.01(b); DGCL
141(a)). Article 8.
If it is not in the statute, it is likely the job of the Board.
Common law is consistent with the statute. (MBCA 8.01(b)).
Directors of a corporation are not agents of the corporation; unless specifically authorized
by the board of directors, individual directors have no authority to bind the corp to
contracts or otherwise commit the corporation to a course of action. (Principles of Corp
Governance 3.02).
31

Manson v. Curtis (1918): "duty to act for the corporation according to their best judgment
. . ."
CEO should not be the Chairman of the Board.

How is the boards work structured to enable it to serve in that role and achieve its aims?

Board of directors is responsible for managing the business and affairs of the corporation
o All corporate powers under authority of board (administration of internal affairs and
management and use of its assets). MBCA 8.01(b); DGCL 141(a)
Independent Directors: hope is that it will place the firm first before the needs of others.
o NASDAQ Rule 4350(c) tells us a board member is not independent if:
7 factors listed on Page 344 of Text
Staggered Board: Can be set up in a staggered board (MBCA 8.06, DGCL 141(a)) to ensure
continuity.
Board has exclusive authority to issue stock and regulate a corporations corporate structure. Grimes
Action taken by the board is effective and binding on corporation if a quorum of board is present and the
action is approved by the affirmative vote of a majority of directors present. MBCA 7.25; DGCL
141(b).
Often run by Committees: MBCA 8.25(e) and DGCL 141 limit what can do
Grimes: board has exclusive authority to issue stock and regulate a corporations corporate structure.
DGCL 151-153, 157, 161, 166

How and why is board authority/autonomy to take action limited?

Increasing trend for independent directors- focus on impartiality and objectivity

Removal of Directors: Can be removed with or without cause, element of control that shareholders have
o DGCL 141(k); MBCA 8.08
o Superwire: elements for for-cause removal
Equitable Restraints on board action, especially prevalent in Delaware
o Inequitable action does not become permissible simply because it is legally possible. Blasius
Industries, Inc. v. Atlas Corp.; See also Schnell
Together with Schnell, Blasius showed the importance of courts respecting shareholders key right of
election of board members
o Blasius: The Board must have a compelling justification for action that interferes with
shareholder franchise/ right to elect new directors

What is the officers role in the corporation?

Corporate officers who manage the day-to-day business of the corporation

o Like agents, have duty to act with diligence, in good faith, and with loyalty (includes duty of
candor)
Authority of officer can be found in corporate code, bylaws, employment contract, board resolutions,
directions of superior officer, common law of agency
MBCA 8.40-8.42; DGCL 142
Grimes: CEO could not issue stock and regulate corporate structure. Statutory framework is key

D.

THE ROLE

OF

SHAREHOLDERS

How is shareholder voting conducting and what role does state corporate law play in that process?
32

See above

How is the shareholders statutory authority and power to approve and adopt corporate bylaws limited through
judicial review?

International Brotherhood of Teamsters General Fund v. Fleming Companies, Inc.

o Court found there is no authority to support the contention that a certificate of incorporation
which is silent with regard to shareholder rights plans precludes shareholder enacted bylaws
regarding the implementation of rights plans Thus, holding that shareholders may propose
bylaws which restrict board implementation of shareholder rights plans, assuming the certificate
of incorporation does not provide otherwise.

What role does federal proxy regulation play in shareholder voting and shareholder proposals at a meeting?
What types of corporations are subject to federal proxy regulation?

First, only publically held companies are subject to federal proxy regulation.
The Securities Act of 1933 governs the offer and sales of securities.
o Commandment: thou shall not offer or sell securities without registration absent an
exemption.
o 14a: governs trading transaction and securities; have to comply with the proxy regulations
o Regulation 14a-9: prohibits solicitation containing any statements which is false or misleading
with respect to any material fact, or which omits to state any material fact necessary in order to
make the statement therein not false or misleading. (Mills v. Electric Auto-Lite Co.).
A SH may maintain both a direct and derivative action for violations of this rule.
Materiality Standard:
Where there is a substantial likelihood that the reasonable investor would find the
fact missing or misstated to be important in whatever context applicable
Where there is a substantial likelihood that the fact at issue would significantly
alter the total mix of information from the standpoint of the reasonable investor
o Regulation 14a-8
Enables shareholders, subject to certain limitations, to propose resolutions for
consideration by the shareholders at any annual or special meeting of shareholders and
requires a registered company to include those proposal in its proxy statement and on its
proxy card.
Lovenheim v. Iroquois

What are shareholder inspection rights? How and under what circumstances do they operate? How might
shareholders use these rights in corporate governance?

MBCA 16.01(e) and 16.02(c): recognize two categories of records which a shareholder may inspect.
o (1) Easily assembled information such as AoI, bylaws, BOD resolutions, names and addresses
of directors.
o (2) Hard to assemble information such as directors minutes, accounting records, lists of
shareholders:
o Test:
A demand must be made in good faith AND for a proper purpose
Must describe with reasonable particularity his purpose and the records he desires to
inspect.
The records must be directly connected with a proper purpose
33

o When does a shareholder have a proper purpose? A SH has a proper purpose to inspect the SH
list if the SH seeks to:
Communicate with other SHs about joining a suit against the corporation (either as a
direct action or derivative action)
Solicit proxies from fellow SHs in an election of directors
However, this purpose must be based on an economic interest, not a personal
interest.
DGCL 220
A shareholder cannot gain access to records if the sole purpose is a political motive instead of an
economic gain (for the corporation). Must have a proper purpose. State ex rel. Pillsbury v. Honeywell,
Inc.
The plaintiff (shareholder) has to bring forth some evidence of wrongdoing before gaining access to the
records preponderance of the evidence credible basis.
o In Seinfeld v. Verizon, the plaintiff believed the company was mismanaged but was unable to
show any credible basis that there was anything wrong, thus, not meeting the standard of
preponderance of the evidence.

E.

FIDUCIARY DUTY

Who owes whom fiduciary duties in the corporation?

Five fiduciaries: LLC managers, corporate directors, corporate officers, and controlling stockholders
o Duty of Care: the amount of care exercised by a like person in similar circumstances
o Duty of Loyalty: duty to place the best interests of the company over others
o Duty to act lawfully
In a corporation, an officer or director owes her duties to the entity (the corporation), and not any one
person within it.
o Shareholders cannot bring an action directly against officers or directors because those persons
owe no duties to shareholders. Instead, they bring a derivative action to be able to step into the
shoes of the corporation, to whom the duties are owed.

What are the attributes of the fiduciary duty of care in the corporate form? Label them. How do they compare
with what we saw in unincorporated entities?

Directors have a duty to inform themselves of all material information reasonable available to make a
decision (oversight function). Brane
MBCA 8.01(c): In a public corporation, the boards oversight responsibilities include attention to
o Business performance and plans, major risks the corporation is or may become exposed to,
performance and compensation of senior officers, policies and practices that foster compliance
with law and ethical conduct, preparation of financial statements, effectiveness of internal
controls, arrangements for providing adequate and timely information to directors, the
composition of the board
Disclosure, candor, good faith and fair dealing
Directors charged with basic knowledge and supervision. This includes making a reasonable attempt to
detect and prevent illegal conduct of other officers and directs. Francis
Proximate Cause and Damages. Francis

Does a corporate director ever owe a fiduciary duty to creditors? If so, in what context might fiduciary duties
be owed and why?
34

Creditors of a Delaware Corporation that is either insolvent or in the zone of insolvency have no right,
as a matter of law, to assert direct claims for breach of fiduciary duty against the corporations directors.
Gheewalla
o Creditors are afforded protection through contractual agreements, fraud and fraudulent
conveyance law, implied covenants of good faith and fair dealing, bankruptcy law, general
commercial law, and other sources of creditors rights. Leads to general rule that directors do not
owe creditors duties beyond the relevant contractual terms.
Directors owe fiduciary duties to the corporation. However, when corporation is insolvent, its creditors
take the place of the shareholders as the residual beneficiaries of any increase in value. Therefore, the
creditors of an insolvent corporation have standing to maintain derivative claims against directors on
behalf of the corporation for breaches of fiduciary duties.

What is a Caremark duty? Is it a fiduciary duty? Why or why not?

As a part of the duty of care in a corporation, directors must insure that corporations and their senior
managers have in place a preventive law system (information and reporting system) which insures that
all the corporations businesses comply with the law and which gives off early warning signals where
danger of noncompliance might exist.

Is a directors failure to act actionable as a breach of fiduciary duty under corporate law?

See below

What is the business judgment rule and why does it exist? How and when does it operate under corporate law?

See below

F.

THE DUTY

OF

LOYALTY

What are the attributes of the fiduciary duty of loyalty in the corporate form?

Duty of Disclosure: Hayes Oyster

Usurpation of a Corporate Opportunity: Today Homes Inc. v. Williams
o Objective Standard: A corporate opportunity exists when a proposed activity is reasonably
incidental to the corporations present or prospective business, and is one in which the
corporation has the capacity to engage. Brandt v. Somervile
Compensation, Bad Faith, Disclosure Ryan v. Gifford
Tyson Foods: Fairness of Transaction

How do they compare with what we saw in unincorporated entities?

What fiduciary duties are implicated by management compensation decisions?

Bad faith by the corporate management, and therefore a breach of the duty of loyalty
o Sufficient to rebut the business judgment rule

35

o DL Business Judgment Rule: presumption that in making a business decision the directors of a
corporation acted on an informed basis, in good faith, and in the honest belief that the actions
were taken in the best interest of the corporation
Encompasses propriety of type of executive compensation, requisite disclosures that must accompany
such compensation, and legal implications of intentional-noncompliance with shareholder approved
plans. Ryan v. Gifford
Stone: Supreme Court of Delaware held that acts taken in bad faith breach the duty of loyalty.
o Bad faith may be shown where the fiduciary intentionally acts with a purpose other than that of
advancing the best interests of the corporation, where the fiduciary acts with the intent to violate
applicable positive law, or where the fiduciary intentionally fails to act in the face of known duty
to act, demonstrating a conscious disregard for his duties
Any action that indicates a lack of faithlessness or lack of true devotion to interests of
corporation and its shareholders
Duty of Loyalty: Director and officers duty to place the best interests of the corporation before those of
themselves, family, friends, or other entities in which the corporation had an interest

What types of compensation arrangements raise fiduciary duty questions? Why do these arrangements raise
these questions?

Ryan v Gifford: Backdating (company issuing stock options to an executive on one date while providing
fraudulent documentation saying were issued earlier)
o Alleged breached duty of loyalty by offering/accepting
o Lying to shareholders (violations of shareholder approved plan)
Violation of shareholder approved plan, fraudulent disclosures regarded purported
compliance with that plan
o Bad faith to the corporation
Tyson Foods: Spring Loading Options (grants them to executives before the release of material
information reasonably expected to drive the shares of such options higher)
o Bullet Dodging (granting options to employees after release of materially damaging
information)
o Have to show granting of options not within Compensation Committees business judgment
o Directors approve an option lie as to the date which grant was actually made
Deception=bad faith
Granting spring-loaded options without explicit authorization from shareholders involves
indirect deception
A directors duty of loyalty includes the duty to deal fairly and honestly with shareholders
Walt Disney
o Disney shareholders (plaintiffs) brought derivative suits against Disneys
directors for failure to exercise due care and good faith in approving the
contract and in hiring Ovitz, and, even if the contract was valid, for breaching
their fiduciary duties by actually making the exorbitant severance payout
to Ovitz.
o Directors did not breach their duty of due care in approving the contract or
hiring Ovitz because the directors were fully informed of all information
available, including the total possible severance payout to Ovitz.
Directors actions, although not in line with corporate best practices,
did not violate a duty to act in good faith.
36

Directors did not violate any fiduciary duties by actually making the
severance payout to Ovitz because the directors were entitled, under
the business judgment rule, to rely on advice from Disneys CEO and
attorneys that there were no grounds for Ovitz to be fired for cause.
o In terms of the bad faith claim, there are at least three categories of fiduciary
bad faith.
Subjective bad faith, meaning intent to harm
Lack of due care, meaning gross negligence.
Intentional dereliction of duty and a conscious disregard for ones
responsibilities.

How does the Dodd-Frank Act contribute regulate executive compensation?

Requires that corporations conduct an advisory shareholder vote on executive compensation no less than
every six years
Have to have a Compensation Committee, independence
Companies must include in their annual filings clear expositions of the relationship between executive
compensation and firm financial performance
If a corporation has to restate its financials, and the restatement is found due to misconduct, the CEO
and CFO must forfeit all incentive-based compensation have received within past 12 months
Shareholder Proxy Access for Board
Sarbanes Oxley requires public corporations top officers to attest that they have detected and are
unaware of any material weaknesses in the corporations internal accounting controls.

What do these final few sections of the chapter add to our knowledge of fiduciary duties under corporate law?

Aiding and Abetting Breaches of Fiduciary Duty- Koken v. Steinberg

o Alleging that Deloitte propped up Reliances reported financial position and other failures when
Deloitte knew or shouldve known that Reliance was seriously financially troubled and would
soon be insolvent
o New Tort of Aiding and Abetting Fiduciary Duty
Wrong (Breach of Fiduciary Duty), the wrongdoer (Reliance), party that acted in concert
with the wrongdoer (Deloitte)
Based on Tort Principles
Critical element of knowing participation
o No authority in federal securities law
Three Additional (Inchoate) Fiduciary Duties
o 1) Duty of Candor- Turner v. Bernstein
The Fiduciary duty of disclosure flows from the broader duties of care and loyalty
Disclosure duty is triggered where directors present to stockholders for their
consideration a transaction that requires them to cast a vote and/or make an investment
decision, such as whether or not to accept a merger or demand appraisal
Stockholders confronted with that choice are entitled to disclosure of the available
material facts needed to make an informed decision.
In a merger context, directors have a fiduciary duty to disclose to shareholders the
available material facts that would enable them to make an informed decision
Here, didnt even receive the most recent financial results or any projections of
future company performance, or explanation why good for company
37

Directors who knowingly disseminate false information that results in corporate injury or
damage to an individual violate their fiduciary duty
When a director seeks board approval for a transaction, directors duty of candor operates
as a matter of Delaware law, and requires full disclosure
Effect of Exculpatory Provisions
Delaware court has held that if a corporation has adopted exculpatory provisions,
a trial court is to dismiss all duty of care damage allegations against corporate
directors
Whether qualifies as duty of care or loyalty
o 2) The Duty of Good Faith
Disney used the lack of good faith to rebut the presumption of the business judgment rule,
but also the 102(7) Exculpatory Provisions
Permitted a claim of bad faith to survive a motion to dismiss and go forward in
trial against Disney directors
o Supreme Court drew distinction between duty of care and good faith
102(b)(7) allows exculpatory provisions to exculpate directors
from monetary damage liability for a breach of duty of care
Several exceptions, including acts not in good faith
DGCL 145, a director or officer can be indemnified for liability incurred by a
violation of the duty of care, but not for a violation of duty to act in good faith
Disney gave three examples of a failure to act in good faith
o Fiduciary intentionally acts with a purpose other than that of advancing
the best interests of the corporation
o The fiduciary acts with the intent to violate applicable positive law
o The Fiduciary intentionally fails to act in the fact of known duty to act,
conscious disregard of duties
Loyalty and Good Faith- Stone v. Ritter
Caremark articulates the two necessary conditions for asserting director oversight
liability
o 1) The directors utterly failed to implement any reporting or information
systems or controls OR
o 2) Having implemented such a system or controls, the directors
consciously failed to monitor or oversee its operations, thus disabling
themselves from being informed of risks
Where directors fail to act in the face of a known duty to act, they breach their
duty of loyalty by failing to discharge obligation in good faith
Failure to act in good faith may result in liability because the requirement to act in
good faith is a subsidiary element, i.e. a condition of fundamental duty of loyalty
Therefore, obligation to act in good faith does not establish an independent
fiduciary duty
Fiduciary duty of loyalty not limited to cases involving a financial or other
cognizable fiduciary conflict of interest as also includes cases where fiduciary
fails to act in good faith
Therefore, duty of loyalty includes disloyalty (preferring the adverse-self-interest of the
fiduciary of a related person to the interests of the corporation) and bad faith (intentional
dereliction of duty or conscious disregard of ones responsibilities/ or fiduciary conduct
motivated by actual intent to do harm

38

o Business judgment rule ensures that courts will respect the business decisions of the directors
unless the directors
Were interested in the decision, lacked independence to objectively evaluate the merits of
the decision, failed to act in good faith in making the decision, or otherwise acted in a
manner not attributable to any rational business purpose or constituted gross negligence
o Most corporations have a charter provision under DGCL 102(b)(7) that eliminates or limits
directors personal liability to the corporation and its stockholders for money damages for a
breach of fiduciary duty of care
Plaintiffs must allege and prove a breach of fiduciary duty of loyalty, which includes
obligation of good faith, in order for court to hold the directors personally liable
Stockholder plaintiffs must bring an action on the theory that the director defendants
breached their duty of loyalty by engaging in intentional, bad faith, or self-interested
conduct that is not immunized by exculpatory charter provision of 102(b)(7)
o Citigroup: Caremark articulates standard for liability for failures of oversight that requires a
showing that the directors breached their duty of loyalty by failing to attend to duties in good
faith
o Business judgment rule too has an umbrella requirement of good faith
o 3) The Duty to Act Lawfully
Some commenters pose the need to establish a duty to act lawfully, in addition to the
duties of care and loyalty
Duty of Controlling Shareholders
o Fiduciary in character
o Changing view that majority shareholders owe a fiduciary responsibility to the minority and to
the corporation to use their power to control in a fair, just, and equitable manner
o Sinclair Oil
Parent Corporation must pass the intrinsic fairness test only when its transactions with its
subsidiary constitute self-dealing in that the parent is on both sides of the transaction with
its subsidiary and the parent receives a benefit to the exclusion and at the expense of the
subsidiary. Otherwise, the business judgment rule will apply.
Dividends
There was no benefit to Sinclair that came at the expense of
Sinvens minority shareholders and so the payments do not
constitute self-dealing. Accordingly, the business judgment rule
applies to the payments and under the business judgment rule,
the court can find no evidence that the decision to cause Sinven
to pay dividends was fraudulent or made in bad faith. Sinclair,
therefore, did not violate its fiduciary duty to Sinven by causing
the dividends to be paid
Contract with International
Sinclair was engaged in self-dealing, as Sinclair is the parent of
both parties to the contract.
o Moreover, when the contract was breached by late
payment, Sinclair was able to reap the benefits of the
crude oil to the detriment of Sinvens minority
shareholders.
As a result, the Delaware Court of Chancery was correct in
applying the intrinsic fairness standard to Sinclairs involvement
39

in the contract, and the court determines that the Delaware

Court of Chancery was also correct in finding that Sinclair did not
meet its burden of showing objective fairness under that
standard.

G.

EXCULPATION, INDEMNIFICATION,

AND

INSURANCE

Exculpation: Affirmative defense for directors (generally not officers) against claims for monetary
damages (but not equitable relief) based on a breach of the duty of care (but typically not loyalty or good
faith)
o Further protection through business judgment rule (burdens plaintiff with proof)
Indemnification: available as a means of reimbursing directors or officers for litigation
expenses and either settlement payments or monetary liability if found personally liable
for damages for alleged breach of fiduciary duty
D&O (Director and Officer Liability) Insurance: Fill gaps not covered by
exculpation and indemnification

40

-What is exculpation in the context of

corporate governance? How is it authorized
and how does it operate under corporate
law?

DGCL 102(b)(7) permits a

corporation to include in its charter a
provision that exculpates directors
for monetary liability for breaches of
the duty of care
(MBCA 2.02(b)
(4))
o enacted largely due to
decision in Smith v. Van
Gorkom (finding board liable
for violating fiduciary duty
of care in spite of business
judgment
rule),
rising
insurance costs
Expressly provide that liability may
not be eliminated or limited for
breach of duty of loyalty, a failure to
act in good faith, intentional
misconduct, a knowing violation of a
law, the attainment of an improper
personal benefit, or the unlawful
authorization of a dividend or
approval of stock repurchase
Not automatic, must be enabled my

express provision in corporations charter

A defense based on an exculpation provision is an affirmative defense
Whether disclosure violations are duty of care or loyalty?
Only bars duty of care cases based monetary damages, plaintiff could still bring suit for injunction or
other equitable remedy

What is indemnification in the process of corporate governance? How is it authorized and how does it operate
under corporate law?

Corporate reimbursement for costs and damages suffered by directors in fiduciary duty litigation
o Also includes advancement
DGCL 145 and MBCA 202(5), 8.50-8.56
Directors entitlement to indemnification in Delaware case-by-case basis
When a successful action is brought against a director or officer by the corporation or on its behalf by a
shareholder in a derivative action, a liable director or officer cant be indemnified
o Corporation can indemnify a director who settles a suit. Court may order indemnification of legal
expenses, if fair and reasonable, even though director is found liable.
o MBCA permits court to order indemnification of settlement amounts in a derivative suit, if fair
and reasonable

41

What is director and officer liability insurance? How is it authorized and how does it operate under corporate
law?

D&O Insurance may be purchased by a corporation to cover the risks associated with potential director
and officer malfeasance, regardless of any applicable indemnification
o Require that the insurer control litigation that may require coverage under terms of the policy
Extends to agreements to settle the litigation
o Usually cover both liabilities and defense costs arising from directors or officers actions for the
corporation
Policies usually exclude coverage for potential or actual liability regarding self-dealing,
actions taken in bad faith, illegal compensation, libel or slander, knowing violations of
law, and other willful misconduct.
Sphinx International, Inc. v. National Union Fire Insurance Company of Pittsburgh
o Makes argument that the words of the insurance contract trump the rationale for policy exclusion
Many statutes authorize the purchase of insurance even if it covers expenses and liability for which the
corporation may not provide indemnification
o DGCL 145(g); MBCA 8.57
o Insurance premiums considered to be nature of compensation to directors or officers

H.

SPECIAL RULES

FOR

CLOSELY HELD CORPORATIONS

What is a closely held (sometimes a.k.a. a close corporation, if under Delaware law)? Where does one find the
appropriate definition?

Close Corporation: Under Statute, DGCL subchapter 14. People dont do this though
o 342: not exceeding 30 shareholders, transfer of shares restricted, no public offering
Closely held corporations are corporations having a small number of shareholders who normally expect
to be involved in the day-to-day management and operations of the corporations business, and who
have shares that are not registered with the SEC, listed on a stock exchange, or otherwise regularly
traded on a security market
Donahue: Closely held corporation is one with
o 1) Small number of shareholders, 2) No ready market for its stock, and 3) Substantial majority
shareholder participation in the management, direction, and operation of the business

Why do shareholders in closely held corporations owe each other fiduciary duties under Massachusetts law?
What is the nature of these duties? Summarize the holdings of the Massachusetts cases.

Donahue v. Rodd Electrotype Co. of New England, Inc.

o All Stockholders in close corporations owe one another strict duties
of care and loyalty, similar to the duties owed among partners in a
partnership. (directly to each other)
Equal opportunity rule applicable to controlling shareholders
o Alleged breach of fiduciary duty that controlling stockholders owed to her, a minority
stockholder, because the Rodds failed to accord her an equal opportunity to sell her shares to the
corporation => Equal opportunity with respect to stockholders (only in close corporations)
o Just as in a partnership, relationship among stockholders must be one of trust, confidence, and
absolute loyalty if enterprise is to succeed
Corporate form provides opportunity for majority stockholders to oppress or
disadvantage minority shareholders (freeze-out)
42

o Why stockholders in the close corporation owe one another substantially the same fiduciary duty
that partners owe to one another
Partners: utmost good faith and loyalty. Corporations: strict good faith standard.
Controlling shareholders may not use their authority to obtain special advantages from
the corporation at the expense of the minority shareholders
o The rule of equal opportunity in stock purchases by close corporations provides equal access to
these benefits for all stockholders. In any case where the controlling stockholders have exercised
their power over the corporation to deny the minority such equal opportunity, the minority shall
be entitled to appropriate relief
Wilks v. Springside Nursing Home, Inc.
o Majority shareholders in a close corporation owe minority
shareholders a strict duty of the utmost good faith and loyalty,
unless a legitimate business purpose can be demonstrated to justify
a breach of that duty.
Majority breached their fiduciary duty to minority when terminated
employment and refused to re-elect as salaried officer and director
o the defendants voted to pay out salaries to themselves, but did not include Wilkes in the group to
whom salary would be paid. Wilkes then not elected as director, told wasnt wanted as
management
In this case, no misconduct or poor performance in Wilkess role as director
The defendants actions constitute an unlawful corporate freeze out
and because they did not show any legitimate business purpose for the
freezing out of Wilkes, they are liable for breach of their fiduciary duty
to him
o Defendants would have to prove legitimate business interest. If couldve
proved that, then burden shifts to minority group to show same legitimate
objective couldve been achieved by alternative, less offensive course
Smith: breaching shareholder was minority shareholder, although found to have been an ad hoc
controlling shareholder due to corporations supermajority voting provision
o A minority stockholder in a close corporation that requires a
unanimous vote for corporate action may not repeatedly vote
against an action for personal reasons if the action would be in the
best interest of the corporation.
o Atlantic accumulated so much profit that they were in excess of the IRS
limits, which provided that at a certain point of profit, corporations must
declare dividends but defendant still voted against declaring dividends
Merola
o Termination of the employment of a minority shareholder in a close
corporation does not automatically give rise to a claim for breach of
fiduciary duty owed to the minority shareholder.
o Whether salary was contingent on stock purposes
Courts may conclude that terminating a minority shareholders
employment constitutes a freeze-out, but close corporations retain
some discretion to hire and fire shareholders for proper business
purposes.

43

Where the vast majority of a corporations earnings are paid out

to shareholders as salaries, a termination of a shareholder
without cause is suspect.

How does the law governing fiduciary duties in closely held corporations in Delaware, Montana, Maine, and
Illinois compare with that in Massachusetts based on the Riblet Products, Sletteland, Rosenthal, and Hagshenas
cases?

Riblet (Delaware)
o Fiduciary duties go to stockholder analysis. Distinguish firms contract with someone from
shareholder action
o Issue of whether majority stockholders of a DL corporation may be held liable for violation of
fiduciary duty to a minority stockholder who is an employee of the corporation under an
employment contract w/ respect to issue involving that employment
o Majority stockholders have fiduciary duties to minority stockholders (in their role as
stockholders), those duties are not implicated when the issue involves the rights of the minority
stockholder (As an employee) under an employment contract
Duties of corporation to the CEO are contractual
o Cf: Goes against Wilkes, which was not adopted by Delaware law
Governed by employment contract. Stockholder here doesnt claim that termination
amounted to wrongful freeze out of stock interest, or harmed as stockholder
Delaware saying claim would be breach of contract, not breach of fid. duty
o Merola also reflects tension between fiduciary law and employment law
Sletteland v. Roberts (Montana)
o The fiduciary duty between stockholders of a close corporation is one of the utmost good faith of
loyalty
Duty of good faith cannot be limited where a minority shareholder has the power to do
damage to the corporation
o C.f. with Donahue, Smith
Rosenthal v. Rosenthal (Maine)
o Complex of Family business, claim that one family member wrongfully froze other out
o 4 Specific fiduciary duties owed by the business associates to each other
Care (to act with degree of diligence, care, and skill which ordinarily prudent persons
would exercise under similar circumstances in like positions)
Good faith: to each other and the firm (to discharge the duties affecting their relationship
in good faith with a view to furthering the interests of one another as to the matters within
the scope of the relationship
Duty to disclose and not withhold (from one another relevant information affecting the
status and affairs of the relationship)
To not use their position, influence, or knowledge respecting the affairs and organization
that are subject to the relationship to gain any special privilege or advantage over the
other person involved in the relationship
Hagshenas v. Gaylord (Illinois)
o Was a breach of fiduciary duty, more closely knit family. Inconsistent with the duty that partners
owe each other to do things in the best interest of the firm
o 50% shareholder sought to dissolve the corporation because of deadlock with other 50%
shareholder

44

Hagshenas resigned as officer and director, felt owed no duty to the corporation. But
Gaylord said standing as 50% shareholder imposed fiduciary duty
o Found fiduciary duty, implicit that people who enter into a small business enterprise, place their
trust and confidence in each other. Fiduciary Relationship exists in all cases which a confidential
relationship has been acquired.

I.

OPPRESSION, DEADLOCK,

AND

DISSOLUTION

What are the special statutory and case law rules relating to dissolution that commonly apply to closely held
corporations? Where are they found? How do they work?

In most jurisdictions, the minority shareholder can bring a direct against the majority shareholders for
breach of their common law fiduciary duties, as established by the case law
Alternatively, can bring statutory action against the corporation for involuntary dissolution on the
grounds of oppression- MBCA 14.30(a)(2)(ii)- No equivalent in DGCL
o Often leads to negotiation
o Plaintiff must prove that oppression has occurred: course of misconduct intended to harm the
interests of the minority shareholder or to otherwise frustrate his expectation.
o If the court finds that the plaintiff has shown oppression, court may dissolve the corporation
(extinguish legal existence)
Winding up of the corporations affairs, including liquidation of assets, satisfaction of
creditor claims, and distribution of remaining assets to shareholders based on ownership
percentage
o Given extreme nature, courts increasable condition order of dissolution on the majoritys
purchase of the minoritys shares at a fair price.
MBCA 14.34 permits majority shareholders in closely held corporations to avoid
dissolution by electing to buy minority shares out at fair value
MBCA 14.30(a)(2): Involuntary Dissolution of Corporations in Shareholder Proceedings when
o 1) directors are deadlocked, shareholders unable to break deadlock, irreparable injury threat
o 2) Shareholders are deadlocked in voting, have failed to elect successor directors in two or more
annual meetings
o 3) Directors/those in control have engaged in conduct that is illegal, oppressive, or fraudulent
o 4) Corporate assets are being misapplied or wasted
Meiselman: Disappoints reasonable expectations
o Part of shareholders rights and interests in a closely held firm
Kemp & Beatley
o the company began to make its annual distributions on the basis of service
rendered to the corporation, rather than stock ownership. As a result,
plaintiffs no longer received distributions.
o If majority shareholders take actions that substantially defeat the
reasonable expectations of minority shareholders, they have
engaged in oppressive conduct and the court may order forced
dissolution of the corporation.
o Conduct is oppressive if it substantially defeats the expectations of minority
shareholders, provided those expectations were reasonable and were an
important factor behind the minority shareholders decision to invest in the
company.
Determining whether or not conduct was oppressive is a fact-specific
inquiry.
45

Dissolution should not be granted if there is an adequate, alternative

remedy, or if majority shareholders are willing to buy out the
complaining shareholders at fair value.
Gimpel v. Bolstein
o Oppression as violating reasonable expectations of minority
Gimpel case did not use the reasonable expectations test because the shareholders in the
case were not original shareholders,
instead applied the "secondary definition" of "burdensome, harsh and wrongful
conduct, a lack of probity and fair dealing in the fears of a company to the
prejudice of some of its members, were visible departure from the standards of
fair dealing, and a violation of fair play on which every shareholder who entrust
his money to a company is entitled to rely."
o Gimpel was embezzling money, froze out essentially because of that by family business
Oppressive Conduct: excluded from corporate participation, no dividends declared,
excluded from examination of corporate books and records
Under secondary definition, discharge and subsequent exclusion from management was
not oppressive
Freezing out may have been improper, but not oppressive. Dont have to allow
back in management, but have to give some share of profit

What is a shareholder agreement as that term is used in corporate law? Under what circumstances might
they be useful, especially in closely held corporations? When is a shareholder agreement valid or invalid under
corporate law?

Contract between the shareholders of a corporation. Usually addresses Operation of Close-held

o Shareholder rights and responsibilities; share ownership and valuation; management of finances,
business, assets, capital, and shares; Rules for issuing new shares and restrictions on share
transfers; actions to be taken upon the death or incapacitation of a shareholder; conflict of
interest rules (such as a non-compete clause)
Restrictions on the transfer of shares in a closely held corporation may be set forth in a corporations
articles of incorporation, bylaws, or in a shareholders agreement among all or certain shareholders or
among the corporation and all or certain of its shareholders
o If you dont have pre-emptive rights in a closely held firm, can have shares diluted when new
owners/investors come in (The Social Network)
MBCA 7.32: Shareholders Agreements
o Ceases to be effective when the corporation becomes a public corporation (Therefore only
dealing with closely held corporations
o Shifts around powers that would normally be exercised by the Board of Directors. Provides
specifically for in MBCA to make clear that shareholders can do. 8.01(b), sends to 7.32 to say
power to manage corporation is under board authority, except as set forth in the articles or as
provided in a shareholder agreement
DGCL 350 (eliminate board of directors), 351, 354 similar to MBCA7.32
MBCA 7.32(a)(7); DGCL 355: Dissolution required upon request or specific event
MBCA 7.32: tells what requirements are for a good shareholder agreement
o Location: Set forth in articles of incorporation, bylaws, specifically bylaws approved by all
persons who are shareholders at the time. If not there, then in written agreement signed by all
persons
who
are
shareholders
at
46

o
o
o
o

time of the agreement, and corporation made known (although corporation doesnt have to be a
party)
If board members arent shareholders, then need copy
Subject to amendment only by unanimous shareholders who are at the time of the amendment
unless agreement says otherwise
Have to have legends on certificate of shares, saying that they are subject to a shareholder
agreement
7.32(h) if have shareholder agreement under old rules, valid only for 10 year period
Comments give good inside

What voting and financial rights are common in closely held corporations?

Reasonable expectations of shareholders in closely held corporations: membership in the board of

directors, voting rights proportionate to investment that cant be diluted, right to veto material changes to
structure/purpose, right to approve new owner-shareholders, employment as an officer (with reasonable
salary), liquidity rights of shares upon certain triggering events (loss of employment through discharge
or retirement, deadlock), equal opportunity to participate in corporate benefits
Preemptive Rights: MBCA 6.30(b)- Preemptive rights to purchase their pro rata share of any additional
shares offered by the corporation that would otherwise dilute the shareholders voting power
Supermajority Voting and Quorum Provisions: MBCA 7.27, 8.24
o Good review on amendments/quorum (453)
o Example of 4 shareholders, each with 25%
o Giving each shareholder veto power over proposed amendment by including provision in the
articles requiring approval of any amendments by at least 80% of Shares
Quorum: precluding any action being taken where one shareholder isnt there
Classification of Stock
o MBCA 6.01: Minority shareholders preference for veto power can be done through classified
stock
Multiple classes of stock and classified board of directors to ensure board representation
Lehrman v. Cohen
o Separate groups of shares issued to different shareholder families, with each class entitled to
elect one or more directors, can ensure voting rights
o Tried to say was voting trust, court ruled wasnt here
A voting trust is not created with the addition of new voting stock if the remaining
stockholders still retain their voting rights. Delawares Voting Trust Statute requires that
any voting trust be limited to a period of ten years
o A voting trust exists where: (1) the stocks voting rights are
separated from other attributes of stock ownership; (2) the voting
rights are irrevocable for a definite period of time; and (3) the
principle purpose of granting voting rights is to acquire voting
control in the corporation.

How do proxies, voting (pooling) agreements, and voting trusts impact corporate governance in closely held
corporations?

Pooling Agreements: to gain voting control, shareholders of like minds enter into agreement where they
pool their shares as a voting block
o MBCA 7.3; DGCL 218(C)
Irrevocable Proxies
47

o MBCA 7.22: some agreements provide for the appointment of an irrevocable proxy for the life
of the agreement, authorizing a third party to vote the shares in accordance with agreement
o Commonly used, irrevocable if appoint express states that it is irrevocable and the appointment is
coupled with an interest; DGCL 212(e)
Interest: pledgees, persons who have purchased or agreed to purchase shares, creditors
who have required proxy appointments in loan agreements, employees with employment
contracts that require the appointment, and parties to voting agreements
Once interest is extinguished, proxy becomes revocable
Voting Trusts: shareholders transfer legal title to their shares to the trustee who they designate. Trustee
will have exclusive power to vote the shares.
o MBCA 7.30; DGCL 218(a)(b)
o Unless extended, not valid for more than ten years

Under what circumstances are agreements between and among shareholders that attempt to vary corporate law
norms found to be valid or unenforceable?

Restricting Board Discretion: go around rules in 8.01, shareholders tying the hands of the board that
they elect
o Many expectations of shareholders in closely held corporations conflict with board authority
MBCA 8.01 gives core principle of corporate governance, that all corporate powers
exercised by the board, subject to any limitation set forth in the articles of incorporation
or agreement authorized under 7.32
o MBCA 7.32 provides that if authorizez in the articles or bylaws by unanimous vote or in a
written agreement signed by all the shareholders at the time, an agreement is effective even if:
Eliminates the board or restricts its discretion or powers,
governs corporate distributions, establishes who shall be directors and officers,
governs the exercise of voting power by shareholders and directors,
establishes terms of transfers of property or the provision of services between the
corporation and its shareholders, directors, officers, or employees
Transfers to one or more shareholders the authority to manage the corporation, including
the power to resolve deadlocks,
Requires dissolution at the request of shareholders upon certain events,
Otherwise governs the exercise of corporate powers or the management of the
corporation or the relationships among the shareholders, the directors, and the
corporation, so long as not contrary to public policy
McQuade v. Stoneham
o A contract is void if it requires directors of a corporation to refrain from changing officers,
salaries, or policies or retaining individuals in office without consent of the contracting parties.
o Agreement between two of the stockholders, not all of them. Which is the factual distinction in
this case. Shareholders at issue forming the agreement were not the only constituents in the
corporation.
Clark v. Dodge
o If the enforcement of a contract between directors that are the sole
stockholders in a corporation damages no one, not even the public,
it is not illegal.
o contract between directors that are the sole stockholders in a corporation to
vote for certain people as officers not illegal

48

In this case, the contract between Clark and Dodge harms no one and
does not interfere with the directors ability to manage the
corporations with their best interest in mind.
Galler v. Galler
o In a close corporation, an agreement as to the management of the corporation agreed to by
the directors must be valid where there is no complaining minority interest, no fraud or
apparent injury to the public or creditors, and no violation of clearly prohibitory statutory
language.

What types of share transfer restrictions are authorized under state corporate law? How do they operate?

MBCA 6.27(a): Restrictions on the transfer of shares in a closely held corporation may be set forth in a
corporations articles of incorporation, bylaws, or in a shareholders agreement among all or certain
shareholders or among the corporation and all or certain of its shareholders
MBCA 6.27(c) share transfer restrictions are authorized 1) to maintain the corporations status, when it
is dependent on the number or identity of its shareholders (S Corporations); 2) To preserve exemptions
under federal or state securities law; and 3) for any reasonable purpose
o 1) Right of First Offer
o 2) Mandatory buy out
o 3) Consent restrictions that require the corporation or other persons to approved any proposed
transfer of shares, if not manifestly unreasonable
o 4) Marketability restrictions that prohibit the transfer of the shares to designated persons or
classes of persons, if not manifestly unreasonable. 6.27(d)
Transfer restrictions do not effect shareholders who purchased the shares before the restriction was
adopted, unless such shareholders voted in favor of the restriction or are parties to the shareholder
agreement. 6.27(a)
o Valid against shareholders who purchased shares after the restriction was adopted if restriction is
conspicuously noted on the certificate
o

Why might they be useful in closely held corporations? How must these restrictions be authorized and
documented in order to be valid under state corporate law?

Limit transfers to third parties, control entry of new participants in the enterprise. Useful in closely held
corporations because shareholders are unlikely to desire new co-owners with different business
perspectives (as corporation grows)
o Dont want corporations shares to fall into competitors hands, or if want shares to remain in the
family
o Provide liquidity for shareholders- specially designated provisions

J.

4 QUESTIONS

FOR

STOCK TRANSFER RESTRICTION

To answer these questions, we look to MBCA 6.27 (Parallel Provision: DGCL 202)
1. Where do need to put stock transfer restriction?

Location: 6.27(a)
o The articles of incorporation, bylaws, shareholder agreement, or an agreement between
shareholders and the corporation
49

2. How does it get memorialized so people understand that a stock transfer agreement exists (legending)

MBCA 6.27(b)
Legend
Note conspicuously the transfer restriction on the front or back of the stock certificate
o In statute
o Sometimes, have to get stock certificate back to get legend put on
May have to have stock certificate re-issued
o Unless restriction is put on stock certificate, restriction not valid against person who didnt know
Notice requirement

3. What is the rationale for the stock transfer restriction?

MBCA 6.27(c)
Any reasonable purpose
o Investor who wants to buy stock, but wants opportunity to tagalong with owners sale to someone
else
Drag along rights
Maintain the corporations status when it is dependent on the number or identity of its shareholders
o S-corporation for tax purposes (can have limited number of shareholders, cant be foreign
nationals)
Preserve exemptions under federal or state securities law

4. What kind of stock transfer restriction is it?

MBCA 6.27(d)
o 1) Right of First Offer
o 2) Buy back shares when employment is terminated
o 3) Require to approve if not manifestly unreasonable
Come and ask for consent before sell
Mother May I Provision
o 4) Prohibit transfer to designated person or class of person
If not manifestly unreasonable (keep class of corporation)

-Mather : First Option and Refusals

Whether provision, a first option to purchase the stock at the price at which it originally received for it
was unreasonable restraint Right of first offer at ridiculous price
Court says parties freely agreed to it, knew what it was
If under MBCA, obligation of shareholder to first offer is not modified by unless manifestly
unreasonable provision
o Enforceable even if unfair price

-Lash: These two cases relate to right of first offer provision

Right of first Offer

Fiduciary Duties in Closely held corporations
Ralph breaches fiduciary duty by arbitrarily refusing to accept option so he himself could purchase the
shares
Unlawful not because stock transfer restriction is invalid but because breach of fiduciary duty, selfinterest
50

-Look to validity of under statute. Then see if breach of fiduciary duty under it.
-Gallagher

Fiduciary duties in implementing restrictions on transfer

o Close corporations may enforce stock buy-back agreements to the
detriment of minority shareholders without breaching the fiduciary
duty owed to minority shareholders.
o Stock buy-back agreements are commonly used by close corporations as
employment incentives. Where the language is clear and no procedural
irregularities exist, courts should not intervene to change the terms of the
agreement
If employed at a current date, would be able to sell shares at market rate. IF fired before that date, sell at
a lower rate
o Fired on eve of date, company was able to make a lot of money
o Company said wasnt unlawful, as employee should have understood the opportunism involved
in this
Did have continued expectation of continued employment?
o No fiduciary duty here
Employer had unfettered discretion to fire at any time.
Dissent: More of a duty to a minority shareholder
o Not a validity issue, put a fiduciary duty

FOR EXAMS: VALIDITY UNDER STATUTE, THEN LOOK AT BREACH OF FIDUCIARY DUTY
-Pedro v. Pedro

Shareholders in a close corporation owe each other a strict duty of the

utmost good faith and loyalty, including a duty to deal openly, honestly
and fairly with each other.
o Breach even though corporations value doesnt decrease as a result
of actions
Attacking validity and breach of fiduciary duty, and getting damages for both
Closely held firm, nature of family resulted in almost lifelong contract
3 brothers owed firm, one found big accounting discrepancy and the others forced him out essentially.
Fired him and said had nervous breakdown. Said expectation of lifelong employment
o Based on his fathers lifetime employment, his brothers apparent
expectation of lifetime employment, and his 45 year tenure with the
company, it was reasonable for Alfred to expect that he would be employed
by the company for life

-Jensen

Jensen squeezed out so would have to pay lower stock prices

Wrongfully terminated, wanted to use rebound time for stock price to go up, when stock buyback
triggered
Wrongful discharge, and breached fiduciary duty
Court agrees. Defendants breached their fiduciary duty as minority shareholders
o Failed to deal fairly when was a conflict of interest
51

Affirm dismissal of trial court though for failure to state a claim for which relief can be granted on
wrongful discharge. Reverse dismissal of breach of fiduciary duty
Shows can assert both validity and breach of fiduciary duty, but not always succeed on both.

K.

BUSINESS ENTITY FINANCE

Glossary of Terms: p. 58 of outline (**Note: contains a lot of information necessary for these questions**)
Equity, debt and distributions (ie., dividends and repurchases)
What is equity? What is debt?

Equity and Debt are types of corporate securities that are issued by the corporation in exchange for
capital.
Equity is the issuance of a class of equity securities and is mandatory under corporate structures. MBCA
6.03, 6.21; DGCL 151(b). Two types that we covered: (1) Common stock, and (2) Preferred stock.
o The article/certificate of incorporation sets forth the number of shares the Board is authorized to
issue, the class or types of shares (common/preferred), and the preferences, rights, and
limitations relative to each class.
o (1) Common stock represents the residual ownership interests in the corporation after the senior
financial claims of general and secured creditors, and of preferred shareholders have been
satisfied. DGCL 170.
Attributes:
Voting rights MBCA 6.01 7.21(a) (See above)
Liquidation Rights
Dividends. MBCA 6.40.
Conversion Rights
o (2) Preferred stock means stock that has preference over the common stock, largely in terms of
dividend payments and fixed payments upon the corporations liquidation.
Attributes:
All of the common stock attributes, plus
Redemption Rights
Preemptive Rights. MBCA 6.30(b)(4)
Debt is fixed claims against the corporation for principal and interest. Additional capital is frequently
obtained through bank loans, usually collateralized by corporate assets and personally guaranteed by the
initial shareholders. Also, the extension of credit by suppliers and other trade creditors.
o Primary types of corporate debt: (1) trade debt, recorded on the balance sheet as accounts
payable; (2) bank debt, recorded as loans payable; and (3) bonds, debentures, and notes

What are the different kinds of financial statements? What do they record?

Balance Sheets: Balance Sheet is a basic accounting statement that provides a financial photograph of a
business at a particular point of time. captures a static viewpoint of the company based on assets and
liabilities.
o Assets (A): includes cash & other property; set on the left-hand side of the balance sheet
o Liabilities (L): includes bank loans, trade debts, & other liabilities; set on the top right-hand side
of the balance sheet
52

o Shareholders Equity (E): includes the amounts the shareholders have invested in a corporations
equity securities
Equation: A = L + SE
o Net Worth or SE = A L
o Refer to DGCL 154
Income Statements: Income Statement is a basic accounting statement that provides a view of the
Corporations financial documentary over a period of time, generally a quarter or year, rather than at
one particular point of time.
o Revenues (R): assets, cash or in-kind, received by the corporation in exchange for its goods or
services
o Expenses (E): the costs or assets that the corporation has used in producing the revenues
o Net Income (Net Loss) (NI): states the difference between the corporations revenues and its
expenses
o Equation: R E = NI
Statements of Cash Flow: shows you in this period of time here is what our money in/money out was at
all times.

How does a dividend work? How are dividends authorized? Whose approval is needed, and when? What MBCA
and DGCL provisions govern these matters?

A dividend is a type of distribution involving the pro rata payment or transfer of cash, common and
preferred stock, debt, or other property to equity shareholders based on corporate earnings.
o Dividends are subject to statutory restraints on distribution (See below).

Dividends and Other Distributions to Shareholders

o Corporations through actions of their BOD can distribute money or other assets in kind to SHs.
o Dividends:
Dividends: Distribution of past or current earnings, but the term is frequently used in a
more general sense to include all selective or pro rata distribution of corporate assets to
SHs.
Dividends can also be made to SHs disguised in forms such as payments of
exorbitant salaries, consulting fees, and other non-arms length contractual
payments. Courts usually re-characterize them as dividends.
Refer to DGCL 170, 160; MBCA 1.40, 6.40
o Fiduciary Duty:
Duty of Loyalty When a person is shut out from making a salary, the court will likely
force the payment of dividends. The court doesnt want the company to shut out one of
the directors. Close corporations have the capacity to do this.
o The BODs Discretion:
The declaration of dividends and other distributions of corporate assets are within the
BODs discretion (subject to statutory or contractual restrictions).
This discretion is sacred when it comes to publically held companies.
However, courts are less deferential to BODs that do not declare dividends in
closely held corporations.
o They are increasingly according credence to the reasonable expectations
of SHs, often through the application of the fiduciary duty of loyalty or
good faith.
o Gottfried v. Gottfried pg 256
53

Rule: Its ok for the BOD to withhold payments of dividends it not made in bad faith. Be
careful of bad faith in closely held corporations.
Issuance of Shares
o MBCA
WHO - 6.21 The BOD may authorize shares to be issued for consideration consisting
of any intangible or tangible property or benefit to the corporation, including cash,
promissory note, services performed, contracts for services to be performed, or other
securities of the corporation.
HOW - 6.21(c) According to the authorization in the Articles (6.03) Determination
by the BOD is conclusive as to adequacy of consideration. That means that the BOD may
determine what is valid consideration.
Fully paid = adequate consideration. You cant go back to the SHs and assess
liability.
o DGCL
152 Issuance of Stock; Lawful consideration; Fully Paid Stock
BOD can authorize capital stock
Consideration to be determined by the BOD may be a little more broad. The
BOD may authorize capital stock to be issued for consideration consisting of
cash, any tangible or intangible property, or any benefit to the corporation, or any
combination thereof.
153 Consideration for Stock
BOD determination is conclusive; however, there is an express statutory
exception when there is actual fraud.
Cannot offer shares below par value.
151 and 161:
How does the BOD know its issued shares without par value for adequate
consideration: The BOD gets to determine, or the stockholders if the Charter
delegates that to the stockholders.
BOD has the power and they consider the consideration, they have to live within
the statutory constraints for consideration, and what happens to those shares is
that they are outstanding, fully paid, and non-accessible, if they follow all the
rules in the statute.
154
BOD will specify what capital is an its amounts constraints on their power to
determine the amount are for par value shares in particular that shall be in excess
of the aggregate par value of the shares issued for such consideration having a par
value, unless all the shares issued shall be shares having a par value, in which
case the amount of the part of such consideration so determined to be capital need
be only equal to the aggregate par value of such shares.
100 shares at 1 par value
$10 aggregate for Capital under DGCL
$90 capital increase of par in Shareholder Equity

Must put $100 in Assets.

What restrictions does state corporate law place on corporate boards relating to declaration and payment of
dividends? What MBCA and DGCL provisions govern these matters?
Policies Supporting Limitations:
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o Distributions by corporations to its SHs create concerns for creditors After SHs have made
back their initial investment; they may have less incentive to manage the business efficiently.
Balance Sheet or Capital impairment Restrictions:
o DGCL 160 and 170(a) address share repurchase and dividends:
o Distributions generally cannot exceed the amount of the corporations surplus.
o DGCL 154 states that the surplus available for distribution is the excess of net assets
(shareholders equity) of the corporation over the amount so determined to be (stated)
capital.
Earned Surplus Restrictions:
o A corporation may make distributions out of its earned surplus, which refers to the sum of its net
profits and gains over the years, less its losses and prior distributions to SHs.
Solvency Restrictions:
o The MBCA does not use the Balance Sheet or Earned Surplus method. It uses a double solvency
test that prohibits distributions to its SHs if their payment would render the corporation insolvent
under the equity or bankruptcy definitions.
o MBCA 6.40(c) states that a corporation may not make a distribution to its SHs if, after giving it
effect, the corporation would not be able to pay its debts in the usual course of business or the
corporations total assets would be less than the sum of its liabilities (as well as any liquidation
preferences).

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