BA _7_

1 The Hip, Cool and Groovy Outline to Business Associations (cough…..cough) Chapter One- Agency 1) Creation a) How is an agency created? i) Agency is a fiduciary relationship where the A has duties to act exclusively for the benefit of the P.- Restatement 2nd §39. ii) Created by manifestation and consent- Restatement 2nd §1& §15 (1) P has to ask for it. (2) A has to consent. (3) A must act on P‟s behalf (4) P must have control. iii) A & P does not need to acknowledge legal status of their relationship so long as the criteria is met. iv) 2 different kinds of agents. Restatement 2nd §3 (1) General (a) Authorized to do a series of transactions involving the same matter. (2) Special (a) Authorized to conduct a single transaction. Morris Oil v. Rainbow Facts: Defendant (P) thought they had explicitly said that Rainbow (A) was NOT their agent. Plaintiff, Morris, thought that there was an agency relationship. Issue: Whether or not a written contract that says there is no agency relationship is enough for courts to make determination that no agency relationship existed. Holding: Express contractual language will not be taken at face value if there is an indication of an agency. Courts examine actions pf parties to see if agency exists. They do not just rely on express language. Reasoning: The contract actually said that the P would be held responsible for the bad acts of A in the normal course of business. A was using P‟s license. The P was collecting A‟s money and refunding them the extra. The court said that this was an undisclosed agency. You can‟t try to fuck over 3rd parties just by writing in a contract that they are not A‟s. Plus, P told Morris that they would pay for A‟s fuck up. Allender Facts: Stock guy starts screwing widows. Buys $10 stocks and charges women $40. SEC reviews agency issue and says that if stock guy was widows‟ agents, then he owed them a fiduciary duty. Stock guy tried to make his transactions seem very sales-like by writing “bill of sale” at end of stock certificates. Direct words saying this is an independent sales K with the women (denying any form of agency). Ct doesn‟t care about express words that are in the K but rather the implicit manifestation of intent by the broker. Issue: Was an agency relationship created? Holding: Yes. They were in an independent relationship. He had superior knowledge/sophistication. He was buying and selling their stocks without asking them. The widows relied on him. LEVI FOCUS: Some courts won‟t care about the different levels of sophistication. What makes them care in this case? 2) Authority a) Introduction i) Definition: Restatement 2nd §7- Authority 2 (1) The power of the agent to affect the legal relations of the P by acts done in accordance with the P‟s manifestations of consent to him. Restatement 2nd §26 Creation of Authority: General Rule Authority can be created by written or spoken word or other conduct of the P which reasonably causes A to believe that the P wants him to act on his behalf. ii) When is P going to be liable for something A does? (1) Actual (a) P does not have to lay down entire blueprint for everything that he wants A to do. (b) Types (i) Express 1. “I authorize you to buy X” (ii) Implied/Implicit 1. A can do everything that he needs to do to accomplish what he expressly was given permission to do. a. Ex. P directs A to run a hat store. A reasonably believes he has authority to buy hats to stock the shelves. (iii) Incidental- Restatement 2nd §35 1. A has authority to do incidental acts to do things usually associated with a transaction of the type he has express authority to do. a. Ex. P tells A to go to the auction and try to bid on X. Only an auctioneer can bid. A has incidental authority to hire an auctioneer. (c) What happens when circumstances change between time when P gives A instructions and when A has to act? (i) Both Restatement 2nd §33 and 3rd of Agency focus on what the reasonable agent would believe was the actual intent of the P. If courts think that what A did was reasonable within the scope of their actual authority, then the P will be liable for A‟s actions. (d) How much authority can P give A? VanVadel Facts: German married American and moved back to Germany. He gave his lawyer power of attorney. The lawyer gave the German‟s wife his money. The government took the money because they said that it was property of an enemy alien. The lawyers says no because he gave the money to German‟s wife before the German was an enemy alien. Holding: The Court said that the German could not give that much actual power/authority to an agent. (e) Ratification Restatement 2nd §82 “Delayed actual authority”- Even though whatever act A engaged in was not authorized at the time, P approves of it later. (i) Express (ii) Implied 1. Where the P kept the benefit of the bargain and doesn‟t say anything about A‟s act being unauthorized at the time A did it. It has to be objectively manifested, but doesn‟t have to be communicated to a third party. Retention is enough to accomplish objective manifestation. 3 Morris LEVI FOCUS: The court said that there was ratification. The corporation was represented by an employee who told Morris that there was an escrow account. LEVI PONDER: Was the person of the authority to speak for the corporation? Should Morris have checked it out? Did Morris have a duty to check it out? How reasonable is a party‟s reliance on a representation to bind a corporate principle? LEVI ANSWER: Did corporation in fact admit to their own liability? No. They just admitted that there was an escrow account and that it was A‟s money. How does this extend to corporation ratifying the A relationship? The Court says that it is because the corporation was keeping A‟s money. LEVI thinks this is shitty. (f) Acquiescence- Restatement 2nd §43 (i) Even softer category than implied ratification. 1. Ex. A consistently does something that is unauthorized and P never says anything. Court will say that P has ratified the conduct through acquiescence if it is similar enough to the prior conduct he did nothing about. (g) Estoppel- Restatement 2nd 8(b) (i) You use this to get damages in tort when you are a 3 rd that cannot really prove an agency relationship. (2) Apparent- Restatement 2nd §8 (a) Manifestation of P to 3rd that A has authority.- Restatement 2nd §49 (b) If you do not tell 3rd the limitations of you‟re A‟s authority, then 3rd can hold P to acts of A that the reasonable 3rd would think A has authority to do. (c) Notions of apparent authority that hinge on what P says to 3rd can be interpreted narrowly or widely. The trend has been for the courts to interpret them widely. (d) If 3rd establishes apparent authority 3rd gets the benefit of the bargained damages. (e) Obviously you cannot establish apparent authority if there is an undisclosed P Restatement 2nd §27 Creation of Apparent Authority Authority can be created by written or spoken word or other conduct of the P which reasonably causes 3rd to reasonably believe that the P consents to have the act done on his behalf by the person purporting to act for him. (3) Inherent Restatement 2nd §8(a) Power to bind P that does not come from actual or apparent authority → comes from the inherent nature of agency relationship (this is undefined) (a) If you can‟t prove get apparent authority or estoppel you can still hold P responsible for unauthorized acts of A using inherent authority. Watteau v. Fenwick (1st way to look at it- must be customary) Restatement 2nd §195 Facts: A took care of all bars needs. A orders cigars and Bovril from 3 rd on credit. P never told A that he could order the cigars. P was an undisclosed principle. Issue: Was P liable for A‟s order? Holding: Yes because P will be liable for things that are customary for A to do. LEVI FOCUS: If you could never make undisclosed P liable then there would be a huge incentive to be an undisclosed P. Court is trying not to give undue incentive to be undisclosed P. LEVI PONDER: Why shouldn‟t there be strict liability? What happens if bar manager buys extraordinarily expensive things that are not related to business. LEVI says that courts seem to be limiting it to “customary” things. BUT, what is customary? LEVI says 4 that if activity seems a little bit unusual then there is a burden of inquiry on the 3 rd party. LEVI says that there was a Kidd case where there was no apparent authority, actual authority or agency by estoppel and they still made P liable. Where do you find the middle ground between too much liability on P and too much of a burden on the 3 rd to inquire? If you make burden high for 3rd then they will always go directly to P and there would no reason to have an A. LEVI says middle ground should be to look at what is customary in the industry as far as inquiry. Restatement says that customary are things that usually accommodate things in question. Kidd v. Edison (customary in the business) Facts: Kidd was making records for P. P‟s employee contracted with Kidd. Kidd said contract was for a singing tour. P said that employee only had authority to contract for possible concerts. Issue: Whether or not Kidd could reasonably believe that employee had authority to contract her for the concerts. Arguments: Defendant said that this type of contract has never been done before so it couldn‟t be customary. But can you ever have a custom in a changing industry. It‟s a new concept, but you can use analogies. Holding: Hand finds that it is custom and that employee had inherent authority. LEVI FOCUS: This vagueness is why inherent authority causes so many problems. Restatement 2nd §161 (2nd way to look at it- what third party reasonably believes) A disclosed or partially disclosed P is liable for an act done on his behalf by a general agent, even if the principal had forbidden the agent to do the act, if (i) the act usually accompanies or is incidental to transactions that the agent is authorized to conduct, and (ii) the third party reasonably believes the agent is authorized to do the act. LEVI FOCUS: Should 3rd reasonableness standard be objective or subjective? Restatement is 3rd centered. Eisenberg Approach (3rd way to look at it- P centered) The test should be whether the thing that A did was foreseeable to P. Restatement 3rd (4th way to look at it- get rid of it) Eliminates inherent agency power. It puts a foreseeability element into apparent and actual authority. b) Agency costs i) What can P do if A does not do what is beneficial to P? (1) P can monitor A. (2) P can hire other A‟s to monitor A. (a) The moment the monitoring costs are higher than the benefit of the A it is no longer beneficial. ii) Other Agency Costs (1) Lack of expertise (2) Mistakes by the A c) Note on the Restatement of Agency i) Restatement 2nd was completed in 1958. The ALI had been working on the Restatement 3 rd since the late 1990‟s. It hasn‟t been ratified yet. You need to always look to 2 nd because there isn‟t case law on the 3rd yet. d) Restatement (2nd) of Agency i) §4 Disclosed, Partially Disclosed and Undisclosed Ps (1) Disclosed: If at the time of a transaction conducted by an A the other party has notice that the A is acting on behalf of a P. 5 (2) Partially disclosed: If the other party has notice that the A is or may be acting for a P but has no notice of the P‟s identity. (3) Undisclosed: Other part has no notice that A is acting for P. ii) §14 Control by P (1) P has right to control conduct of the A with respect to the matters entrusted in him. iii) §23 A Having Interests Adverse to P (1) Even if As interests are adverse to P‟s they can be authorized to act on their behalf, but it is a breach of duty to do so if A does not reveal the existence and extent of her adverse interests. iv) §160 Violation of Secret Instruction (1) A disclosed or partially disclosed P authorizing an A to perform a K, but imposing upon him limitations as to the terms intended not to be revealed is subject to liability even if the A violates the limitations when the 3rd had no notice of them. (Ex. You tell A he can buy for $1 million but not to tell seller. A ends up buying for $1.5 million, too bad) v) §161A Unauthorized acts of Special As (1) Special A for disclosed or partially disclosed P has no power to bind your P to stuff he didn‟t authorize or apparently authorize you to do unless (a) the P is estopped, (b) the As only departure from his authority is: naming or disclosing the P, having an improper motive, being negligent in determining the facts by which his authority is based, or in making misrepresentations, (c) the A is given possession of good or commercial documents with authority to deal with them. vi) §194 Creation of Liability by Unauthorized Acts (of a general A) (1) A general A for an undisclosed P authorized to conduct transactions subjects his P to liability for acts done on his account if usual or necessary in such transactions although forbidden by the P to do them. Note on Authority i) Liability to 3rds- Restatement 2nd §140 &144 &159 (1) P is bound (a) If the A had the authority or a disclosed P ratified the act then A will not be liable to 3rd. (b) If the P is undisclosed, the A is bound even though the P is bound too. But, if a 3 rd gets a judgment against a P, then A is released and vice-versa. (c) If there is a partially disclosed or unidentified P, then the A and P are bound. (d) If A has actual or apparent authority and P is disclosed or partially disclosed liability will be created by A‟s acts. Restatement 2nd § 383 & Restatement 3rd § 8.09- If an agent takes an action that they had no actual authority to perform, but the P is bound because they had apparent authority then the A is liable to the P for any resulting damages to the P. (2) P is not bound (a) Where the P is not bound at all because the agent didn‟t have actual, apparent or inherent authority, then the A is bound to the 3 rd. 3) The Agent‟s Duty of Loyalty Restatement 2nd §13 Agent as a Fiduciary An agent is a fiduciary with respect to matters in the scope of his agency. Tarnowski v. Resop Facts: P asked A to negotiate for purchases of machines. A told P that he had investigated the machines. He really had not. A colluded with the seller. P bought the machines. P sued sellers to get his money back and won. Then the P sues the A for the secret commission and damages. Issue: Whether P can recover the commissions and damages from the A. Holding: A cannot take secret profits. They have to turn over all profits to P, even if the P was not hurt by the profits. e) 6 Reasoning: This rule is punitive and it is used to deter As from breaching fiduciary duties. Reading v. Attorney-General Facts: Guy in military uniform was ferrying alcohol Reasoning/Rule: A cannot take advantage of his service to the P (wearing the uniform) and make a profit. Even if it does not hurt the Queen, he has to turn over the profits. Restatement 2nd- §388 Duty to Account for Profits Arising out of Employment Unless otherwise agreed, an A who makes a profit in connection with transactions conducted by him on behalf of the P is under a duty to give such profit to the P. a) Restatement (2nd ) of Agency i) §387 General Principal of Duty of Loyalty (1) Unless otherwise agreed an A is subject to a duty to his P to act solely for the benefit of the P in all matters connected with is A ii) §389 Acting as an Adverse Party without Ps consent (1) Unless otherwise agreed, an A is subject to a duty not to deal with his p as an adverse party in a transaction connected wit his agency without the Ps knowledge. iii) §390 Acting as an Adverse Party with Ps consent (1) An A who to the knowledge of the P acts on his own account in a transaction in which he is employed has a duty to deal fairly with the P and to disclose to him all facts which the A knows or should know would reasonably affect the Ps judgment unless the P has manifested that he knows such facts or that he doesn‟t care to know them. iv) §391 Acting for Adverse Party Without Ps Consent (1) A is subject to a duty not to act on behalf of an adverse party that is in connection with his agency without the Ps knowledge. v) §392 Acting for Adverse Party with Ps Consent (1) An A who to the knowledge of two Ps acts for both of them in a transaction between them has a duty to act with fairness to each and to disclose to each all facts that he knows or should know would reasonably affect the judgment of each in permitting such dual agency unless the P has manifested that he knows such facts or that he doesn‟t care to know them. vi) §393 Competition as to Subject Matter of Agency (1) Unless otherwise agreed an A is subject to a duty not to compete with the P concerning the subject matter of his agency. vii) §394 Acting for One with Conflicting Interests (1) Unless otherwise agreed, an A is subject to a duty not to act or agree to act during the period of his agency for persons whose interest‟s conflict with those of the P in matters in which the A is employed. viii) §395 Using or Disclosing Confidential Info. (1) Unless otherwise agreed, any confidential information obtained during your role as an A, whether the P gave it to you or not must remain confidential unless it is general knowledge. ix) §396 Using Confidential Info After Termination of Agency (1) Unless you agree after you terminate the agency you have a duty (a) not to compete with the P, (b) duty not to use or disclose to other people in competition with them, trade secrets, written lists of names, or other confidential matters acquired by the A in violation of your duty to the P. The A is entitled to use general info regarding general info obtained during agency or any names you can remember by memory. (c) you have a duty to account for profits made by the sale or use of trade secrets even if it is not in competition with P. (d) can‟t take advantage. x) §401 Liability for Loss Caused (1) An A is subject to liability to loss caused to P for any breach of duty. xi) §403 Liability for things Received in Violation of Duty of Loyalty (1) If an A receives anything in result of a violation of a duty of loyalty to the P he is subject to a liability to deliver it, its value, or its proceeds to the P. 7 xii) §404 Liability for Use of Ps Assets (1) An A who, in violation of his duty to the P, uses for his own purposes or those of a 3 rd person assets of the Ps business is subject to liability to the P for the value of the use. If A uses the business and makes a profit, he has to turn it over. But if you just use the Ps time, then you do not have to hand over profit. xiii) §407 Ps Choice of Remedies (1) If an A received a benefit from violating his duty of loyalty, the P is entitled to recover what he has received, its value or its proceeds and the amount of damage caused except that if the violation consists of the wrongful disposal of the Ps property the P cannot recover its value and what the A received in exchange therefore. 4) An Introduction to Financial Statements a) One of the ways you monitor As is to show clear financial statements of liability and profits to see if As are doing what they say they are doing. An Introduction to Financial Statement This is to have transparent information to monitor your agents. Fundamental Equation Assets = Liabilities + Owners‟ Equity Double Entry Bookkeeping Rights and claims an entity holds against others (its assets) = rights and claims others hold against it (its creditors with respect to its liabilities and the owners as residual claims with respect to equity). Double-entry – two entries for every transaction to be accounted for Debits and Credits Debit = left-side entry Credit = right-side entry The Balance Sheet How well a business is doing; Parallel listing of assets and their sources. Speaks as of a particular date. Assets – Stuff he has in his office (like furniture, cash) Cost – Measure of these Assets Source – How you paid for your assets  Outside source – money owed by the business to outsiders; liabilities  If money owed on an open account, called an accounts payable  If money advanced on a note, called a note payable  Inside source – what the owner put into his business  Stake – what equity the owner has put into the business; Proprietorship  Entries on balance sheets don‟t necessarily reflect real or market values.  Book Value – the amount at which various assets and liabilities are recorded or “booked” on the financial statements, under GAAP (Generally Accepted Accounting Principles)  Examples of GAAP  Building Value = original cost of asset minus depreciation  Depreciation = formula like straight-line instead of actual loss in value. Income Statement Statement for a period of time, giving a summary of earnings between balance sheet dates. 5) Termination a) P has the power/control to terminate A at any time. But he may have to pay damages. 8 Chapter Two- Partnership 1) Partnership Formation a) Overview i) Partnership issues will be governed by partnership agreements entered into by the parties. If there is no agreement, then UPA and RUPA will govern. (1) Is there an explicit agreement? (2) Is there an implicit partnership agreement created through course of dealing? (3) If no to both, then UPA and RUPA govern. ii) Partners are personally liable for debts of partnership, so the person with the “deepest” pocket will claim not to be a partner. b) Background on UPA and RUPA i) UPA was drafted in 1914. In 1994 the uniform drafters revised it, and out came RUPA. 2/3 of the states have adopted RUPA. Some states have made significant changes before adoption by state legislatures. c) UPA & RUPA i) Big issue with UPA was whether partnerships should be looked at as one entity or an aggregate of the individuals that make it up. (1) UPA adopted the aggregate theory but uses the entity in some provisions. UPA tweaked the aggregate theory in a way where it turns out to be interpreted as an entity. (a) Under UPA you can‟t treat partnership property as individual property, so he came up with the idea of tenancy in partnership. (i) This way the partnership could own property without being an “it”. (2) RUPA was created to clarify these issues and make the partnership an “entity”. (a) But even though RUPA says that a partnership is an entity RUPA §201, it still hints of aggregation theory (like with issues of fiduciary duty). UPA §6- Partnership Defined Two or more people carrying on a business for profit. LEVI FOCUS- You do not have to file anything for a partnership to be formed. Therefore, there needs not be subjective intent to create a partnership. Holding something for appreciation is not a business. LEVI PONDER: UPA §16 - Partnership by Estoppel (Smith v. Kelly) - In this case, the accounting held out the plaintiff as a partner. The plaintiff said that if the firm hold him out as a partner, then he should have a part of the profit. He had made no contribution, he had no control, but he gets bonuses (which is kind of like sharing of profits). LEVI says that a normal UPA §6 analysis would not make him a partner. But the plaintiff says, under §16, he was held out as a partner and should be deemed one because §16 says that he would be liable for losses if he consented to the firm holding him out as a partner. The court said, sorry dude, you are not a partner - no profits for you. RUPA § 308 deals with this issue the same way. Hilco v. U.S- You have to be trying to earn profit in order for it to be deemed a business. You focus on the parties‟ actions. The key factor is not he subjective intent of the parties to form a partnership … It is immaterial that the parties do not call their relationship, or believe it to be, a partnership, especially where the rights of third parties are concerned. RUPA §202 &101(6) - Formation of a Partnership Same formation elements as UPA. Except under RUPA §301 allows you to file record to put third party on notice, but it is unclear where you file and how you look it up. But you do not HAVE to file anything. FRUPA §620.8202(2) Formation of Partnership The association of two or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership. 9 UPA §7 Rules for Determining the Existence of a Partnership The receipt by a person of a share of the profits of a business is a prima facie evidence that he is a partner in the business, but not if the profits were received in payment: 1. As a debt by installment or otherwise 2. As wages of an employee or rent to a landlord 3. As an annuity to a widow or representative to a deceased partner. 4. As an interest on a loan though the amount of payment varies with the profits of the business. 5. As a consideration of the sale of a good will of a business or other property by installments or otherwise. Martin v. Peyton Facts: Partners were loaning securities and making 40% on their loan. They went bankrupt. Lenders came in to help keep them afloat. In the agreement with the lenders they explicitly said that the lenders and the original partnership were not partners. Behind the lenders back, the original partners did a really risky deal and went completely under. Then the creditors showed up and tried to call the lenders partners. The lenders were like “oh no, we are just lenders- no partners here.” Lenders were making a lot of money. Issue: Were the lenders partners? Holding: No. They were under the UPA exception §7(4) (d) - you will not be a partner if you are getting interest on a loan. Reasoning: The court said that although the lenders were making profit and had some type of supervision, those types of negative controls are reasonable when you are loaning money out. Policy: No one will give loans to banks or businesses if they can‟t be protected from creditors if the business went wrong. Levi FOCUS: This is a close case. Lupien v. Malsbenden Facts: Plaintiff is the purchaser of a car and Defendant is the supposed partner of the shop where he bought. The Defendant gave the shop owner money. The shop guy skipped town and could not be served. Issue: Whether Defendant was a partner to shop guy and therefore liable to the plaintiff. Holding: Defendant was a partner and not a lender because he had control of the business. Reasoning: Defendant‟s loan is more like an investment, there was no interest or payback date and he also had management authority. A partnership can be implied. His total involvement in the operation was that of a partner – his financial interest and involvement in the day-to-day business. The loan carried no interest. His loan was not made in the form of a fixed payment or payments, but was made to the business, at least in substantial part, in the form of day-to-day purchases of kits and other equipment. He had the right to participate in the control of the business. LEVI FOCUS: You must watch out for being deemed a partner if you have profit sharing and controls that are more than just watching out for your money. Some of the controls in this case were not just negative controls for the protection of his money. He was actually looking out for the day-to-day operations. About the money - you may have a loose repayment option and still have it be considered a loan, but if you are not getting interest from it, then it is not going to be considered a loan and you will be deemed a partner. Miller v. Citibank Facts: It was a husband and wife business. Wife gave up a lucrative job to come work with her hubby. His business takes off because she is the bomb and makes it successful. She made no capital contributions, but she kept the books, hired and fired employees, ran household expenses out of money from the business. Wife thought she was a partner. Issue: Whether wife was a partner or an employee. Holding: Wife was not a partner, she was just an employee. Reasoning: There was no profit sharing. Her monthly wages were simply a salary. Everything the wife did isn‟t more control than you would give a trusted employee 10 LEVI FOCUS: Apparently the business had been listed as a partnership previously. The court just glosses over that and says that it was only deemed that way for tax purposes. LEVI FOCUS regarding partnership formation 1. At a minimum the courts what the courts will choose to focus on are not in the UPA itself. 2. The UPA is vague in itself. 3. The courts need to really look at the facts to categorize what they think Of as a “real relationship” for partnership formation. In Martin it was all a policy issue, even though there is UPA §6&7, the courts wanted to make sure that people would not stop lending to help others. And in the Miller case, social policy issues (she was a woman) dictated how that case came out. d) Note on the Formation of Partnerships i) There are two rebuttable presumptions for partnership: profit sharing and control of the business. ii) No filings are required by the UPA or RUPA but permits them. iii) There is also a 4 element test for partnership: (1) Agreement to share profits. (2) Agreement to share losses. (3) Mutual right of control or management of business. (4) Community of interest in the venture. (5) LEVI says- that the absence of one of these will not necessarily mean that there is no partnership. So LEVI PONDER - what happened when you don‟t have all four. 2) The Ongoing Operation of Partnerships a) Management i) Overview (1) Having a managing partner is okay. Management is not one of the things in UPA, RUPA and FRUPA that is non-waiveable. If there is no written agreement as to control, does UPA come in? Yes. But only after the courts get into the facts and conduct (oral or implied) with regard to management. If there is no specific facts to help court figure out who had control, then they will say that there was equality of management. ii) UPA and RUPA provisions (1) UPA §19 Partnership Books (a) The partnership books shall be kept, subject to any agreement by the partners, at the principal place of business of the partnership and all partners shall at any time have access to them. (2) RUPA § 403 Partner‟s Rights and Duties with Respect to Information (a) Same as UPA §19 &§20 except allows former partners access to information. Gives express right to copy information. You have to give them everything unless it is unreasonable. (3) UPA §20 Duty of Partners to Render Information (a) Partners shall render on demand true and full information of all things affecting the partnership to any partner or the legal representative of any deceased partner. (4) UPA §21 Partner Accountable as a Fiduciary (a) If you are a partner you have to tell the partnership if get any money or hold any money that is the partnership, you have to tell the partnership. This applies to representatives of deceased partners. (5) RUPA §404 General standards of Partner Conduct (a) Partner owes a duty of loyalty and duty of care. The duty of loyalty is: (i) To account to the partnership and hold as a trustee for it any property, profit, or benefit derived by the partner in the conduct of winding up the partnership business or any benefit they get from the use of partnership property. 11 (ii) While winding up, a partner must refrain from dealing with an adverse party to the partnership. (iii) You have to refrain from competing with the partnership before the dissolution. (b) The duty of care is to refrain from engaging in: (i) Grossly negligent or reckless conduct (ii) Intentional misconduct (iii) Or a knowing violation of the law. (c) You do not violate either duty by simply furthering your own interests. (6) UPA §18(g) Rules determining rights and Rules of Partners & RUPA § 401(i) Partners Rights and Duties (a) No person can become a member of the partnership without consent of all the partners (7) RUPA §103 Effect of Partnership Agreement; Non-waiveable Provisions (a) The partnership agreement can‟t: (i) unreasonably restrict right of access to books and records or (ii) eliminate the duty of loyalty 1. but it can identify specific things that do not violate the duty of loyalty if those things are not unreasonable and it can make it so all of the partners may authorize after full disclosure of all material facts a specific act that would violate the duty of loyalty (iii) unreasonably reduce the duty of care (iv) eliminate the obligation of good faith and fair dealing 1. But it can prescribe standards by which this obligation is to be measured as long as they are not unreasonable. (v) It can‟t vary the power to dissociate as a partner. (vi) It can‟t vary the right of the court to dispel a partner (vii) It can‟t vary the requirement to wind up a partnership as specified in other sections of RUPA (viii) It can‟t vary the law applicable to a LLP. (ix) It cannot restrict rights of third parties. UPA §18(e) Rules determining rights and Rules of Partners All partners have equal rights in the management and conduct of the partnership business. You have to let all partners vote even if you know that you will have majority over them (have to consult all partners). LEVI FOCUS/PONDER- How can it be equal, if there is majority vote in (h). Only unequal if there is a split where partners do not have the same number of shares. If you are the small partner then you can have something in your partnership agreement that says you have same voting power as big partner (remember UPA and RUPA are only default). RUPA §401(F) Is the same thing as UPA §18(e) - all partners must be consulted. UPA §18(h) Rules determining rights and Rules of Partners Any difference arising as to ordinary matters connected with the partnership business may be decided by the majority of the partners, but no act in contravention of any agreement between the partners may be done rightfully without the consent of all of the partners. LEVI FOCUS: If you have majority, for ordinary matters- you are fine. LEVI PONDER: But what happens when something is not ordinary and not in the contravention of an agreement? RUPA clarifies this. RUPA §401(j) Partners Rights and Duties (clarifies above, UPA §18(h)) Anything beyond ordinary matters, you need unanimity. LEVI FOCUS: Beyond ordinary matters is anything that changes how a partnership is going to be run. 12 LEVI PONDER: What do you do when there is a two person partnership (how do you get majority)? Is the majority approach a favorable one? What are the ordinary business decisions of a partnership? Summers v. Dooley (what do you do when there is a two person partnership) Facts: The garbage case. Partnership was a garbage company. One of the employees got sick, so they had to hire a replacement. Dooley and Summers are the partners. Dooley hires a replacement. Summers wants the new employee to stay on full time. Dooley said no. Summers goes ahead and does it anyway. Now Summers wants money from Dooley to pay the dude. Holding: The new employee was Summers‟ personal expense and not a business benefit, so the partnership doesn‟t have to pay him. Reasoning: Court says that regard to 18(h) there was no majority. Because one of two partners is 50%. Court was clear in saying that veto party would always win. LEVI FOCUS: Dooley did get the benefit of the employee working, because the employee was helping out the company. This is not fair. Sanchez v. Saylor (what do you do when there is a two person partnership) Facts: One of the partners does not provide his personal credit report to the second partner. Second partner sues and say that it is a breach of fiduciary duty. Holding: There was no breach. If you are having this problem then dissolution is the best remedy. Absent an enforceable contractual duty to agree, and you can‟t agree, then you should dissolve. LEVI FOCUS: Partner knew he could not sue under 18(h) because under Summers reading of 18(h) second partner would never win. LEVI SPOUT: Covalt v. High- Facts: Plaintiff wanted to increase rent of tenant because it would create more money for his partnership. The other partner owned 75% of the stock and he refused to increase the rent. Court says that absent an enforceable agreement covering such circumstances of disagreement, if you both disagree, then you just have to dissolve. LEVI says is this right here? In this case maybe they could have sued under breach of fiduciary duty because the 75% partner knew people in the building. National Biscuit v. Straud (what do you do when there is a two person partnership) - goes opposite of all other cases Facts: Two guys own a grocery store (Straud and Friedman). Straud sends a letter to Nabisco and says that Freedman no longer has authority to buy bread from them. Freedman buys it anyways. Holding: Nabisco didn‟t have to pay attention to the Straud letter because at the time of the letter the partnership was not dissolved. Plus, Straud cannot stop Freedman from buying bread. UPA §18(e) & 18(f) say Freedman can go along with the ordinary course of business. In this case, the veto partner wins. LEVI FOCUS: How can Straud protect himself then? At the start of the contract you put in a clause that says: (i) a unanimous agreement is needed, (ii) a buy-out provision, (iii) binding arbitration, (iv) a lawyer will be the tie breaker, (v) or write into the contract that one of the two parties control. UPA applies to mom and pop stores too. LEVI FOCUS regarding two partner partnerships In Summers the veto partner loses and in National Biscuit the veto partner wins. Maybe in Nabisco they won because there was a third party involved and because in Summers by hiring someone new you are changing the business (status quo vs. non-status quo). LEVI says that there is an analytical problem that does not get solved- Under the UPA a partnership is unstable. If anything happens to it, it must be dissolved. So if the whole basis of the partnership is instability, why would we have to decide one way or the other based on the fact that we want to maintain the status quo? iii) Note on Management of Partnerships (1) Voting (a) Cases and authorities are divided (Summers & Covalt and National Biscuit Co.). The rule of UPA §18(h) that any difference arising as to ordinary matters may be 13 decided by the majority of the partners is subject to any agreement between them. Even if it is not explicit in an agreement, then there can be an implied agreement inferred from course of business. Such an implied agreement can block nonmanaging partners from objecting to decisions made by managing partners regarding ordinary business matters. iv) Note on What Governs the Internal Affairs of Partnerships (1) The UPA does not say what the choice of law for internal affairs should be. (2) But RUPA §106 says that a general partnership‟s internal affairs are governed by the laws of the state where the partnership has its principal office/place of business. b) Indemnification and Contribution i) Note on Indemnification and Contribution (1) As between the partners each party is liable only for his share of the partnership obligations even though they are individually liable for the entire partnership obligation. So if one person pays more than his share he is entitled to indemnification from the partnership, but he is entitled to contribution from one or more partners. c) Distributions, Remunerations and Capital Contributions UPA §18(f) & RUPA § 401(h) - does not allow one partner to get extra money over the other unless the partnership is winding up (then you are entitled to reasonable compensation for your service. d) Capital Accounts and Draws i) The contribution each partner makes minus losses/gains = capital account. UPA § 18(a) Rules Determining Rights and Duties of Partners Each partner gets to be repaid his contributions either by way of capital or advances to the partnership property and share equally in the profits and surpluses remaining after all liabilities. He must also contribute to wards the losses of capital or otherwise sustained by the partnership according to his share of the profits. LEVI FOCUS: Suppose A, B & C form a partnership. A contributes 90% of the capital and B &C each contribute 5%. They all work full time in the partnership with roughly equal responsibilities. The partnership agreement is silent regarding how profits will be divided. If the partnership makes a profit in a year, how is it to be divided? LEVI- says that the profits are divided equally under UPA §18(a). Losses will flow like the profits are divided. However you can contract out of this through your partnership agreement. You can contract to divide losses equally and profits unequally and vice-versa. LEVI (SERVICE partners)- If you‟re a service partner you have to share in the loss the same as a capital partner even if you were not compensated for your services. UPA comes up with this result because it does not value services. BUT, some courts have said that the services are actually worth the amount of the capital contribution because at the time of the deal they were considered equal. LEVI- If you think that you are not getting a fair share of the profit you either have to dissolve or renegotiate your profit sharing. 3) The Authority of a Partner a) When can the partnership avoid getting bound due to one partner‟s actions? UPA §9 Partner Agent of Partnership as to Partnership Business If there is actual authority, then the partnership is bound. If there is apparent authority the partnership is bound unless: (i) the partner has no authority to act for the partnership in the particular matter, (ii) the third party had knowledge that the partner was not authorized to conduct that business (it could be actual or if the circumstances should have shown them/constructive knowledge- UPA §3). 9(3) (d) says that one partner cannot bind a partnership to an unauthorized settlement agreement because it is not in the ordinary course of business. 14 RUPA §301 Partner Agent of Partnership (more third party protective) Same as above, except that the third party has to have actual knowledge that the partner did not have the authority. The partnership can put a third party on notice of who has what authority by putting it in the partnership agreement or making a statement of authority. RNR v. Peoples Facts: The partnership agreement limits the general partner to certain activities; the general partner violates all of these provisions. The partnership defaults on the loan; the bank goes after the partnership for the money; and partnership claims that the bank was negligent in not checking out the loan agreement before making the loan. Holding: Court said that even though RUPA says that partnership can file a statement of partnership authority or send it to the bank, partnership must actually notify the bank of limiting authority. Partners are in the best position to notify others of the restrictions (inquiry notice). Partnerships also better risk bearers so that third parties doesn‟t have to look. LEVI FOCUS: If you are dealing with a partnership in real estate shit then constructive notice will be enough because it will come up in title searches and stuff. Northmon v. Milford (difference between liability between partners- inward 18(h) and third partyexternal liability) Rule: UPA is silent as to whether you have to tell third parties whether you are running your partnership in an unusual manner but RUPA §301 says that if you are running your partnership in an unusual manner you have to tell third parties. RUPA §301- A partnership is going to be held liable if a partner acts in a way that is in the “usual way” of the partnership business or the usual way for that kind of business. (Because third party has no way of being on notice). FRUPA has same test as RUPA except they say the usual way in the same geographic locality. 4) Liability for Partnership Obligations a) UPA & RUPA Provisions i) UPA §10 Conveyance of Real Property of the Partnership (1) Any partner can convey partnership in the partnership‟s name. However the partnership can recover the property if the partner did not have authority to do it. (2) Any partner can convey partnership property in his own name as long as it is within his authority. (3) If property title is in name of one or more partners, but not all partners, those partners can convey the property unless they didn‟t have the authority to do so or the third party didn‟t know that those partners had the right to do. (4) If property title is in name of one or more or all partners or under trustee, a conveyance executed by a partner in his own name or partnership name passes as long as he had authority. (5) Where title of the property is in name of all partners and the conveyance is executed by all of the partners, all of their rights are conveyed. ii) RUPA §302-Transfer of Partnership Property (1) Partnership Property may be transferred as follows: (a) As long as it is in the statement of partnership authority, if it is partnership property held in the name of the partnership it can be transferred by a partner who is acting in the partnership name. (b) Partnership property where the title is in the name of one or more partners, but it doesn‟t say the name of the partnership then they can transfer that property in the name of the partnership. (c) Partnership property held in the name of one or more persons other than the partnership can be transferred by those people in whose name the property is held. 15 (2) The partnership may recover partnership property only if it proves the initial transfer didn‟t bind the partnership and : (a) If the person who bought it knew that the person who sold it lacked authority to sell it- or (b) If the partnership proves the buyer knew or received notification that the property was partnership property and the person who sold it lacked authority. (3) A partnership cannot recover partnership property from a subsequent buyer if the partnership could not get the property back from the first buyer as listed above. (4) If a person holds all of the partners‟ interests in the partnership all of the partnership property vests in that person. UPA §11 Partnership bound by Admission of Partner (1) An admission or representation made by any partner concerning partnership affairs within the scope of his authority as conferred by this act is evidence against the partnership. UPA§12 Partnership Charged with Knowledge of or Notice to Partner (1) Notice to any partner of knowledge it means the partnership has notice as long as there is no fraud involved. UPA §13 Partnership Bound By Partner‟s Wrongful Act (1) If partner acts wrongfully in ordinary course of business and it causes loss or injury to third party, the partnership is liable to same extent as partner who did the act. RUPA §305- Partnership Liable for Partner‟s Actionable Conduct (1) A partnership is liable for loss or injury caused to a person or any penalty incurred as a result of a wrongful act or omission of a partner when acting in ordinary course of business or with authority of the partnership (like apparent authority) (2) If in the course of the partnership‟s business or while acting in authority of partnership, a partner receives or causes the partnership to receive money or property of a person not a partner and that money or property is misapplied the partnership is liable for the loss. UPA §14- Partnership Bound by Partner‟s Breach of Trust (1) The partnership is bound to make good the loss: (a) Where one partner acting within the scope of his apparent authority receives money or property of a third person and misapplies it and where the partnership in the course of its business receives money or property of a third persona and the money or property received is misapplied by any partner while it is in the custody of the partnership. iii) iv) v) vi) vii) viii) UPA §17 Liability of Incoming Partner (1) As a person admitted as a partner into an existing partnership, he is liable for obligations of partnership arising before his admission as though he had been a partner when obligations were incurred except that this liability shall be satisfied only out of partnership property. ix) UPA §36 Effect of Dissolution on Partner‟s Existing Liability (1) The dissolution does not itself discharge the existing liability of any partner. A partner is discharged from any existing liability upon dissolution by an agreement between himself, the creditor and the person or partnership continuing the business. Such an agreement can be inferred from the course of dealing by the creditor having knowledge of the dissolving business and the person continuing the business (2) Where a person agrees to assume the existing obligations of a dissolved partnership, the partners whose obligations have been assumed shall be discharged from any liability to any creditor of the partnership who knowing of the agreement consents to a material alteration in the nature or time of payment of such obligations. (3) Dead partner is obligated to debts of partnership that happened while he was part of partnership. 16 (4) LEVI- Suppose you agree that you and your partners are going to split, have you dispelled liabilities or can creditor come get you individually? Is it reasonable to think that you would not be responsible for money owed to creditors? No. There is a difference between legal and financial ending to dissolution. This section says that if you can get creditors to agree to let the dissolving partner go, you end liability or the court can decide to create an implied agreement to let them go for policy reasons. x) RUPA §303- Statement of Partnership Authority (1) A partnership may file a statement partnership authority, which: (a) Must include: (i) Name of the partnership. (ii) Address of principal place of business. (iii) Names and addresses of all the partners. (iv) Names of partners authorized to execute an instrument transferring real property held in the name of the partnership. (b) May state the authority or limits on authority of some or all partners to enter into transactions on behalf of the partnership. (2) If the statement of partnership authority names an agent, the agent has to maintain a list of names and addresses of all of the partners and give that to anyone who asks for it. (3) If the statement is filed by anyone other than a partner and puts the partnership but doesn‟t put all the other info in (a), then the statement nevertheless operates with respect to a person, not a partner as provided in the next two sections (4) A filed statement of partnership authority supplements the authority of a partner to enter into transactions on behalf of the partnership as follows: (a) Except for transfers of real property, a grant of authority contained in filed statement of partnership authority is conclusive in favor of a person who buys as long as there is not another filed statement that says otherwise. (b) A grant of authority for real property that is in the name of the partnership will be in favor of person who buys it as long as you do not record a subsequent paper that says that you take the authority away. You can file again to revive authority. (5) A person who isn‟t a partner is deemed to know of a limitation on the authority of a partner to transfer real property if you file a certified copy. (6) THIS IS GOOD FOR FIVE YEARS FROM MOST RECENT AMENDMENT TO STATEMENT. xi) RUPA §304- Statement of Denial (1) If you are listed as a partner in the filed statement of partnership authority, you have the right to file a statement of denial saying that you are not a partner of that entity. Davis v. Loftus Facts: Law firm partnership arrangement w/ different kinds of partners. Some people were income partners others were equity partners. Income partners did not share in net profit and loss. Issue: Whether the income partners were really partners and therefore liable? Holding: Under the UPA the income partners were not actually partners because they did not share in the profits and losses therefore they were not liable. Rule: The substance and not the “form” of a business relationship determines whether the relationship qualifies as a partnership. UPA §15- Nature of Partner‟s Liability Under the UPA the partnership is not an entity, so the partners are liable, not the partnership. With contract actions there is joint liability. You have to sue all of the partners and there is no indemnification. With tort actions, the partners are joint and severally liable, so you can sue one partner and collect all of it and partners then have to sue each other for contribution. RUPA §306- Partner‟s Liability 17 Under RUPA the partnership is an entity in and of itself, so it can sue and be sued. There is no difference between contract and tort liability, so all the partners are jointly and severally liable. (This is very third party friendly). RUPA §307 Actions by and Against a Partnership and Partners To execute a judgment, a third party first has to go against the partnership‟s assets and then go for the partner‟s assets. This is called exhaustion. There are exceptions to this: (i)A judgment based on the same claim has been obtained against the partnership and a writ of execution on that judgment has been returned unsatisfied in whole or in part (ii) the partnership is a debtor in bankruptcy, (iii) the partner has agreed that the creditor need not exhaust partnership assets, (iv) a court grants permission to the creditor to go against the assets of the partner based on the finding that the partnership assets are clearly insufficient, (v) liability is imposed on the partner by law or contract independent of the existence of the partnership. *Plaintiff has to get same judgment against partner and partnership or else you can‟t go after partners individually. 5) Partnership Interest and Partnership Property UPA §8- Partnership Property (1) All property originally brought into the partnership or required by purchase later that is on the account of the partnership is partnership property (2) Unless a contrary intention appears, property bought with partnership funds is partnership property. (3) You can get real property in the partnership name and that title can only be conveyed in the partnership name. (4) A conveyance to a partnership in the partnership name, though without words of inheritance, passes the entire estate of the grantor unless a contrary intent appears. Balafas v. Balafas Facts: Greek brothers have many securities in their names, one of the brothers dies and the wife of this man wants part of the partnership funds. The other brother claims that all of the securities go to him because they are held between the bros as joint tenants with rights of survivorship, not as partnership funds. Issue: Whether the securities were partnership property or not (if it was, wife gets $) Holding: Court sees the intention of the brothers in the manner that they are held as joint tenants and say it is clear and trumps §8(2) giving the money to Mary. In Re Gerlach‟s Estate Facts: estate gives property to company and the rest of his money to his mother; however, the mother wants everything. Contributed his own funds and company funds to buy the property (§8.2 UPA says nothing of mixed funds). The property was carried on the books and used by the partnership; Issue Whether the intention was for partnership to have property. Opponent argument: Title was in his name and charged the company for the lease Holding: It was partnership property. Reasoning: Court focuses on certain evidence which makes the intention most plausible in the next case. RUPA §203- Partnership Property makes it clear that the partnership is an entity and can therefore hold property. RUPA §204- When Property is Partnership Property Lays out the test to determine whether the property is the partner‟s or the partnerships. Test: (a)Property is partnership property if it is acquired in the name of the partnership or acquired in 18 the name of one or more partners as long as the title says the person‟s capacity as a partner (even if it doesn‟t name the partnership), (b)Property is acquired/bought in the name of the partnership by a transfer to the partnership in its name or one or more of the partners in their capacity as a partner to the partnership if the partnership is indicated in the title. (c) it is presumed to partnership property if it is purchased with partnership assets even if it is not acquired in the name of the partnership or of one or more partners. (d) property that is acquired in the name of one or more of the partners where the title doesn‟t show that the person is doing it in the capacity of the partner is presumed to be separate property even if it is used for partnership property. RUPA §501- Partner not Co-owner of Partnership Property Partner is not a co-owner and had no interest in the property that can be transferred. LEVI FOCUS on intention of partnership property, etc. In UPA intention is key. She says the issue is why should we allow the courts to interpret the intention of the parties and why does UPA impose a default? LEVI says that because the courts are dealing with unsophisticated parties and usually no written documents. RUPA § 203 is a response to the difficulties that arise from the UPA ambiguities. RUPA §501 abolishes the idea that partners own any partnership property. UPA §25(1) which said partner owned the property. Rappaport v. Rappaport Facts: Two families. Best friends. Rappaport‟s want their kids to come in as partners (which would give them voting rights) The contract says that partners can assign their partnership interest to immediate family, but cannot make someone a partner (with voting rights) without the consent of all the partners. Under 18(g) of UPA you cannot sell your voting or managing powers, you can only sell your interest. Everyone has to be on board to make someone a partner. Issue: Whether the Rappaports can make their kids a partner. Holding: No. Because the contract was in line with UPA §18(g), they could only assign their interests. UPA §28- Partner‟s Interests Subject to Charging Order & RUPA §504- Partner‟s Transferrable Interest Subject to Charging Order This arises when one partner has a creditor and the creditor want s to go after the partner‟s individual assets as well as the partnership assets. It gives the creditor the opportunity to get a charging order on the partnership interest. LEVI FOCUS: This can pose problems because depending on how the partnership is structured that creditor can go to court and force a dissolution so that they can get paid. The UPA does say that all partners can decide to buy-out the creditor with partnership funds or individual funds, but if they don‟t buy out the debt then they have opened up challenges by that creditor that the business isn‟t being run properly and needs to be dissolved. UPA doesn‟t say what to do if there is not enough money between the partnerships or if you have more than one creditor how you deal with priority. b) UPA& RUPA Provisions i) UPA §24- Extent of Property Rights of a Partner (1) The property rights of a partner are: (a) His rights in specific partnership property. (b) His interests in the partnership (c) His right to participate in management. ii) UPA §26- Nature of Partner‟s Interest in the Partnership (1) A partner‟s interest in the partnership is his share of the profits and surplus and the same as his personal property. iii) RUPA §502- Partner‟s Transferable Interest in Partnership (1) The only transferable interest of a partner in the partnership is the partner‟s share of the profits and losses of the partnership and the partners‟ right to receive distributions. The interest is personal property. 19 iv) UPA §27- Assignment of Partnership Interest (1) If you convey your partnership interest it doesn‟t by itself dissolve the partnership and unless all the other partners agree, the assignee cannot interfere with the management with the partnership interest, they can‟t require information about the partnership transactions and they cannot inspect the partnership books. They only get the profits. v) RUPA §503- Transfer of Partner‟s Transferrable Interests (1) Same as above except it adds: A transferee has the right to receive distributions and upon dissolution get all the winding up of the business and they can seek a judicial determination that it is equitable to wind up the business. Upon transfer the partner (seller) retains the rights and duties of a partner except he doesn‟t get the money anymore (he sold it). If you get the partnership interest and you knew that you could not get it per the partnership interest then the transfer is void. c) Note on Partnership Property i) Under UPA property can be either partner or partnership property §25(1) tenancy in partnership. This makes a difference when you are dissolving or creditors are knocking at the door. RUPA §203 does away with that, they make it okay for partnership to own property, not partners individually. d) Note on Partnership Interest i) Two tiered ownership thing: You own your partnership and your interests in the partnership. You can‟t make someone a partner. Under the UPA if you assign your interest you remain a partner, but under RUPA you say that if you assign your interests the other partners can kick your ass out. UPA has priority shit in it with regard to creditors, but RUPA doesn‟t deal with that because the Bankruptcy Code handles all that. 6) The Partner‟s Duty of Loyalty a) Overview i) How does UPA deal with loyalty? (1) Nothing in the UPA explicitly announced the duty of loyalty, but it is embedded in 19, 20, 21 & 22. This is why when it comes to UPA the job of interpreting fiduciary duties has come from case law. ii) How does RUPA deal with fiduciary duty? (1) RUPA appears to have tried to define with greater specificity what the duty of loyalty is between partners and what actually constitutes a breach. Criticized by both those who want minimal fiduciary duties and those who want more extensive fiduciary duties. Meinhard v. Salmon UPA §21 Facts: Partnership was between Meinhard (Plaintiff) and Salmon (Defendant). They had a 20 year lease with Mrs. Gerry. As they were nearing the end of the lease, Mrs. Gerry died. Instead of renewing the lease her son wanted to tear down the hotel and redo it completely. So the son goes to Salmon and tells him the idea of the new hotel. Salmon goes for it and says he will be a part of it (on his own- not the partnership), but Meinhard knows nothing about the deal. Meinhard sues for breach of fiduciary duty. Rule: If you get information regarding the partnership business during your joint venture, you have an obligation to tell your partner so that they have the opportunity to compete for it too. You have a fiduciary duty to disclose. Holding: Court gives Meinhard 50% of the shares of the corporation since Salmon didn‟t give him a chance. LEVI FOCUS: Meinhard gets to be part of the deal because he gets 50% of what it is worth. Apparently many courts have found that this duty exists even when the parties are antagonistic and dissolving. LEVI says that there is a big difference between this case and the self-dealing cases. It all rides on whether it was a partnership opportunity taken for oneself. The question is whether it was a partnership opportunity. How do you know? Cardozo seems to look at the old business and see if the new opportunity is an extension or enlargement of that old business or a completely new business altogether. Partner that is left out has to make his claim right away. If he wits to see if the business is lucrative courts will say that it is too late. 20 RUPA §404- General Standard of Partner‟s Conduct (shift to compromise position) This can be changed by agreement, but you can‟t get rid of it totally because it would be unreasonable. 404(b) is the exclusive statement of duty of loyalty: (i) partners have to account for the partnership and hold as trustee for it any profit, property or benefit derived by the partner while he is conducting business of thee partnership or winding up the partnership, or any benefits you get from using partnership property, (ii) partners cannot represent adverse party to the partnership while the business is winding up, (iii) you have to refrain from competing with the partnership until it is dissolved. 404(d) says that good faith and fair dealing is implied in your duties. Courts interpret this as disclosure. 404(e) A partner doesn‟t necessarily violate this just because they do something in their own interests. LEVI says this seems to go against Meinhard and that it is controversial. And if you do something in your own interest you are still subject to good faith. LEVI PONDER: How would Meinhard have come out under RUPA? b) UPA & RUPA Provisions i) RUPA §104 Supplemental Principles of Law. (1) If it is not particularly covered in the act then law and equity supplant it. ii) RUPA §405- Actions by Partnership and Partners (1) A partnership can maintain an action against a partner for breach of the partnership agreement or for violation of a duty to the partnership that causes harm (2) A partner can maintain an action against the partnership or another partner for legal or equitable relief with or without an accounting as to partnership business to: (i) enforce the partner‟s rights under the partnership agreement, (ii) to enforce their rights under this act including: 401, 403, 404, this is included to have their rights ,to have their interests purchased pursuant to 701, pursuant to 801 their right to compel dissolution and wind up the partnership, (iii) enforce the rights and protect the interests of the partner, including their rights and interest that are independent of the partnership relationship. SOL is governed by other law. 7) Dissolution (I) Dissolution by Rightful Election a) Overview i) UPA Approach- BIG MESS- Three point process (1) Dissolution §29- Any change in relation between partners caused by one partner ceasing relationship in business. (dies, leaves, bankrupt). This doesn‟t mean business is dead. (a) Automatic Dissolution §31: Rightful: Termination of a definite term of agreement. By any partner that wants to terminate it. By express will of all the partners. By expulsion of any partner. Just happens: By death, bankruptcy or decree of court §32. Wrongful: In contravention of the agreement between the partners where the circumstances don‟t permit a dissolution. (b) If you don‟t completely terminate your liability is in §41. (2) Winding Up §30,37 (a) Process of terminating all existing contracts of the business, sell things off, tie up loose ends. Accounting evaluation. (b) Good thing is that you can contract out of all of this confusion. (3) Termination §30 (a) Just because there is dissolution doesn‟t mean that there has to be a termination. You can dissolve and come back. ii) RUPA Approach (1) UPA relies on the courts a lot. If there is any doubt as to whether the dissolution may have been wrongful then the partnership goes to court because UPA imposes very Draconian consequences for wrongful dissolution. (2) RUPA lessens the Draconian consequences. It takes a damages approach. If dissolvers move to dissolve and thereby cause the partnership any damages (including damages 21 to good will), then they are subtracted from his share. If there are no damages, then dissolver will not pay any damages. Creel v. Lilly (RUPA) Reasoning/Rule: Courts understand that unexpected dissolutions occur and it is imperative that partnerships draft provisions that save the partners from drastic economic loss. Ideas behind cases like Creel is that everyone will be left worse off if partnerships are sold piece by piece if put on the block. They allow the defendants to buy her out. Dreifuerst v. Dreifuerst (UPA) Facts: Two brothers in a three brother partnership want to dissolve the other partner - they file for dissolution and want to just split up the parcels. The other brother wanted a cash distribution because the mill that he was to receive probably would not have been adequate. Holding: Court says that under §38 – This guy has the right to demand a cash distribution – how can they argue that in-kind is acceptable. Bros say that the court have allowed in-kind distributions and that it is equivalent to cash but court doesn‟t accept the argument. Court goes opposite of Creel, do not let two brothers buy out third. They said that there was no way to get a fair valuation without putting it up for sale. Gerard Bank v. Haley Facts: So lady says she wants to get out of partnership in a letter. Then she dies. The other partners don‟t have the money to buy her out. So they want the dissolution trigger to be her death so they don‟t have to pay anyone her share. They say that the letter was defective because she didn‟t say why she wanted out. Issue: What triggered the dissolution? Holding: The letter. It was an at-will partnership. Dissolving partner does not have to offer justification to get out. Page v. Page Facts: Both brothers put in $43k to start the business and then it went down the crapper. So one brother put in an extra $47k from his own corporation on a demand note. Then he wanted to get out of the partnership. Partnership agreement did not say that they had to stay in partnership until it made a profit. Issue: Whether the partnership is at will? Holding: They are not going to imply a an agreement to stay in a partnership from the existence of a debt Reasoning: If you implied this then no one could get out of a business that is going down the shitter. Candice Focus: (1) Should a partnership be treated as an at will partnership? Can you imply that a partnership must remain until debts are covered? Can courts imply this? NO – the parties actually have to intent. Court adopts a strict fiduciary duty. (2) When should a court imply a term, when should it not? A terms that covers an obligation to repay a loan? In this case the court found that there was not agreement to repay because no partnership agreement that stated there was a term obligation. There was no evidence of a date certain for termination of a partnership. Just because there is a debt, that does not mean anything as long as they partner getting out is acting in good faith. They can‟t under-compensate the other partner. The fiduciary duty states that you can terminate the partnership as long as you don‟t freeze out the other partner or strategically terminate to screw them. Candice Ponder: Isn‟t this totally undermining the whole point of an at-will partnership, this fiduciary duty crap? Leff v. Gunter Rule: Broad interpretation/expansion of Page. You will have a perpetual non-compete agreement implied whether or not you drafted one in your agreement when partnership is dissolved. You can‟t screw your old partner. 22 Rosenfeld v. Cohen Rule: You can‟t terminate at-will in bad faith. Implements a fiduciary duty to everyone. b) UPA & RUPA Provisions i) UPA §40- Rules for Distribution (1) In settling accounts between the partners after dissolution, the following rules shall be observed unless you contract out: (a) The assets of the partnership are: (i) The partnership property (ii) The contributions of the partners necessary for the payment of all the liabilities specified in clause (b) (b) The liabilities of the partnership shall rank in order of payment as follows: (i) Those owing to creditors other than partners. (ii) Those owing to partners other than for capital and profits. (iii) Those owing to partners in respect of capital. (iv) Those owing to partners in respect to profits. (c) The partners have to contribute their part to satisfy the liabilities, but if any of them are insolvent or refuse to contribute then the other partners have to cover his/her share. (d) Individual property of a deceased partner should be liable for contributions listed in (c). (e) If the court seizes partnership property or the individual property of the partners, the partnership creditors have priority over it. (f) When a partner has become bankrupt or his estate is insolvent, this is the rank for the claims against his personal property: (i) Those owing to separate creditors. (ii) Those owing to partnership creditors. (iii) Those owing to partners by way of contribution. ii) RUPA §601- Events Causing Partner Dissociation (1) A partner is dissociated from a partnership upon the occurrence of any of the following: (a) A partner basically telling the partnership that he is going to leave. (b) If anything happens that is specifically stated in partnership agreement that would cause someone to dissociate. (c) If the partner gets expelled pursuant to the agreement. (d) The partners expulsion by unanimous vote by other partners, if: (i) If it would make it unlawful to carry on partnership business with that partner. (ii) There has been a transfer of all that partners transferable interests in the partnership. (iii) If a partner is a corporation then you can kick them out with 90 days notice if their charter has been revoked. (iv) The partner is itself another partnership that is being dissolved. (e) Expulsion by judicial determination because: (i) The partner engaged in wrongful conduct. (ii) The partner willfully committed a material breach of the agreement or a duty owed. (iii) The partner did something that made it unreasonable for them to carry on as a part of the partnership. (f) The partner‟s: (i) Filing for bankruptcy. (ii) Executing an assignment for the benefit of creditors. (iii) Hiring someone to liquidate all of their property. (iv) If the court imposes a liquidator and you do not file a motion to stop it within 90 days. 23 (g) In the case of a partner that is an individual: (i) The partner‟s death. (ii) The appointment of a guardian of the partner. (iii) A judicial determination that they have become incapable of performing the partner‟s duties under the partnership agreement. (h) If the partner is a trust and the trust gets sold. (i) In the case of a partner that is an estate, if the entire estate‟s interest gets distributed. (j) Termination of a partner who is not an individual, partnership, corporation, trust, or estate. iii) RUPA §602- Partners Power to Dissociate/Wrongful Dissociation (1) A partner can dissociate at any time, rightfully or wrongfully, pursuant to 601(1) (2) Dissociation is wrongful only if: (a) It is in breach of an express provision of the partnership agreement (b) If the partnership is for a definite term or for a particular undertaking or project, if you try to disassociate before that. (i) Except, you can dissociate under express will within 90 days of another partner dissociating or dying. (ii) if you are expelled by judicial determination. (iii) if you become dissociated because you file for bankruptcy. (iv) if you are a corporation and are dissolved. (c) If you wrongfully dissociate you are responsible for any damages you cause by your dissociation in addition to your obligations to the partnership. iv) RUPA §603- Effect of Partner‟s Dissociation (1) If a partner‟s dissociation results in a dissolution and winding up of the partnership business, Article 8 applies, otherwise, Article 7 applies. (2) Upon a partner‟s dissociation: (a) The partner‟s right to participate in the management of the business terminates. (b) The partner‟s duty of loyalty to the partnership terminates. (c) But their duty of loyalty and duty of care continue for matters that occurred before they disassociated. v) RUPA §701-Purchase of Dissociated Partner‟s Interest (1) If a partner dissociated from a partnership and the partnership is not winding up, his interests can be purchased. (2) The buy-out price is the amount that would have been given to the partner as of the date of his disassociation if the assets of the partnership were sold at a price equal to the greater of the liquidation value or the value based on the sale of the entire business. (3) Damages from wrongful disassociation have to be off-set from the buy-out price. (4) A partnership shall indemnify a dissociated partner whose interests are being purchased against all partnership liabilities. (5) If no agreement is reached for the purchase of disassociated partner‟s interest within 120 days, the partnership shall pay, in cash, to the dissociated partner, the amount that they estimated to be the buy-out price reduced by any off-set. (6) The partnership can defer payment to dissociated partner as long as you have written notice of schedule of payments. (7) The payment to tender required by (5)&(6) HAVE TO INCLUDE THE FOLLOWING: (a) A statement of the partnership assets and liabilities as of the date of dissociation. (b) The latest available balance sheet and income statement (c) An explanation of how the estimated amount was calculated. (d) Written notice that the payment is in full satisfaction f the obligation to purchase, unless within 120 days the dissociated partner files an action to determine the buy-out price. (8) A partner who wrongfully dissociates is not entitled to his money before the 120 days are up. 24 (9) The dissociated partner can maintain an action against the partnership to determine his buy-out price. The action must be commenced within 120 days after the partnership has tendered payment or an offer to pay the partner or within 1 year after a written demand for payment if no payment or offer to pay is tendered. Then the court determines the buy-out price vi) RUPA §801-Events Causing Dissolution and Winding Up of Partnership Business (1) The partnership is dissolved and has to be wound up only if any of these things happen: (a) In an at will partnership, the partnership has notice from a partner of that partners express will to withdraw as a partner (b) In a partnership for a definite term or project, (i) within 90 days after a partner‟s wrongful dissociation or by death, half of the partners want to wind up the business. (ii) The express will of all of the partners to wind up (iii) The expiration of the term or the completion of the project (c) An event agreed to in the partnership agreement causes winding up (d) An event that makes it unlawful for partnership to continue (e) On application by a partner, a judicial determination that (i) The economic purpose of the partnership is likely to be unreasonably frustrated (ii) It is not reasonably practical to carry on the partnership (iii) Not practical to carry on partnership in conformance with agreement (f) On application by a transferee of a partner‟s interest, a judicial determination that it is equitable to wind up the partnership business (i) After the expiration of the term or completion of the project (ii) At any time, if the partnership is a partnership at will vii) RUPA §802- Partnership Continues After Dissolution (1) Subject to (2) a partnership continues after dissolution only for the purpose of winding up the business. It is terminated when winding up occurs. (2) At any time after the dissolution but before winding up is finished, all of the partners may waive the right the partnership to be wound up and terminated (consent of wrongfully dissociated partners is not required). In that event; (a) The partnership resumes carrying on business as if dissolution has never occurred (b) The rights of a third party in reliance on the dissolution may not be affected viii) RUPA §803- Right to Wind-Up Partnership Business (1) After dissolution a partner who has not wrongfully dissociated may participate in winding up the partnership business, but any partner can apply to the court to have judicial supervision of the winding up (2) The legal rep of the last surviving partner may wind up the business. (3) A person who is winding up the partnership can take a reasonable amount of time to clear up any criminal, civil, admin issues that the partnership has ix) RUPA §804- Partner‟s Power to Bind Partnership After Dissolution & UPA §35- Same Name. (1) Subject to §805, a partnership is bound by a partners act after dissolution that: (i) is appropriate for winding-up the business, or (ii) would have bound the partnership under §301 before dissolution if the other party to the transaction did not have notice of the dissolution. x) RUPA §805- Statement of Dissolution (1) After dissolution any partner who has not been wrongfully dissociated may file a statement of dissolution stating that the partnership is dissolved and winding up. (2) A statement of dissolution cancels a field statement of partnership authority (3) A person who is not a partner has notice of the dissolution 90 days after the statement has been file (4) After filing statement of dissolution, the partnership can file a statement of authority for any person who is not a partner with respect to winding up and other activities. 25 xi) RUPA §806- Partner‟s Liability to Other Partners After Dissolution (1) Except as otherwise provided in subsection (b) and §306, after dissolution, a partner is liable to the other partners for their share of any partnership liability incurred under §804. (2) A partner who , with the knowledge of dissolution incurs a partnership liability under §804(2) by an act that is not appropriate for winding-up the partnership is liable to the partnership for any damage caused to the partnership xii) RUPA §807- Settlement of Accounts and Contributions Among Partners (1) When you are winding up a partnership, the assets including the contributions of the partners must be applied to pay off the creditors, including partnership creditors, any surplus will be distributed in cash to the partners in accordance to their right of distribution. (2) Each partner is entitled to a settlement of all partnership accounts upon winding up. Gotta calculate what each partner has done (credits/debits) so that you know how much to give each person (3) If a partner fails to contribute, then all the other partners have to kick in to cover for that person. Go for contributions. (4) After settlement of accounts, if there are any partnership obligations that were not know at the time of settlement, then partners have to pay proportionate share. (5) The estate of dead partner is liable for their obligations to the partnership (6) Any assignee of a creditor can file for their $. c) Note on Distributions in Dissolution and on “Services Partners” i) There are priorities in paying off people when the partnership dissolves. You first have to pay off non-partner creditors. They want it to be an at-will dissolution so they can‟t get paid. Litigation occurs to determine if it is at-will or not. Gerard. 8) Dissolution (II) Dissolution by Judicial Decree and Wrongful Dissolution Drashner v. Sorenson Facts: 2 capital partners and one service partner Rule/Reasoning: Court says this was a partnership for a term and the service partner terminated the partnership in bad faith (because he went to jail), so he is not entitled to the good will of the business. Court can say you wrongfully dissolved under the UPA if you did bad things outside of the scope of the business. LEVI FOCUS: Should a term have been implied in this case? Court says that there‟s a loan and therefore a term is implied. LEVI- they don‟t even think that this may have been a capital contribution. What is the rationale that says the wrongful dissolver does not get good will? UPA gives severe sanctions as an attempt to approximate the damages to the partnership, due to wrongful dissolution. Under RUPA, the wrongful dissolver ONLY pays for damages to partnership. He does not lose everything, like you do in UPA. BIG CHANGE FROM UPA to RUPA. Crutcher v. Smith Facts: Partner stole $110 and wrote a check that bounced. Other partners wanted to expel him under UPA §32. Issue: Whether it was they had the right to kick his ass out. Holding: In this case what the partner did was not enough. LEVI FOCUS: You will not necessarily have a court agree with you that the categories under UPA §32 have been met. BIG RULE: You can expel any partner, but you just have to use good faith when you pay him. a) UPA and RUPA above b) Note on Wrongful Dissolution i) Drashner illustrates the drastic consequences that can happen to a wrongfully dissolving partner under the UPA in the form of (i) damages, (ii) evaluation of his interests that does not reflect the real value of the interests because good will is not taken into account and (iii) a continuation of the business without him. c) Note on Expulsion of a Partner 26 The expulsion of a partner prior to the end of the partnership term without good cause is ordinarily a wrongful violation of the partnership agreement and the wrongfully expelled partner ordinarily has a right to have the partnership dissolved and liquidated. UPA §31(1)(d), UPA §32(1)(d), UPA §38(1) ii) In contrast, UPA §38(1) provides that if dissolution is caused by the expulsion of a partner bona fide under the partnership agreement and if the expelled partner is discharged from all partnership liabilities either by payment or agreement he shall receive in cash only the net amount due him from the partnership. iii) What does the bona fide portion of 31(1) (d) mean? – whether it‟s in “good faith” or not? What the hell does good faith mean? Lawlis - good faith has nothing to do with the reason for the expulsion but rather that you don‟t withhold money or property from the expelled partner that is rightfully his. LEVI – policy agreements are not bad faith, the expelled partner must show the P tried to take business or property advantage. Crutcher – the partners pick some small things to expel the partner – maybe the court underplays these deficiencies of the partner but the fact is that he stole some money (bad checks and misuse of partnership funds). Court characterizes these as small acts and this was a pre-textual expulsion. There is no discussion of the right to partnership funds (doesn‟t he have the right to access them – no he does not)  he has a right to other things, what he really has is an undivided interest in the partnership. UPA really kicks your ass for wrongful dissolution. d) Note on Partnership Breakup Under RUPA i) RUPA §801 tell you which road you have to take between these two: (1) Termination and Liquidation. Chapter 6&8 of RUPA. (2) Continuation and Buy-Out. Chapter 7 of RUPA. (a) RUPA §701 (b) &(c) give you a default buy-out formula in case you don‟t have one in your agreement. You either get liquidation value/asset worth or going concern value (whichever is worth more is what dissociated partner should get. Buy-out formula is beneficial to the dissociated partner. i) Chapter 7- Alternative Forms of Business Organization 1) Limited Partnerships a) Limited Partnerships popped up because general partnerships were an instable form and gave unlimited liability of partners. b) Hybrid form of corporation and partnership. i) This is a way that you can get money from investors without ceding control to venture capitalists. General partners will be liable, but limited partners will only have at stake what they put into the business, UNLESS they take control. c) ULPA- 1916-1976: Only a couple of states are still using it. d) RULPA- 1976 and was revised again in 1985 and revised again in 2001. Most of the states use the 1976 and 1985 versions. i) The shift between 1976 and 1985 is that 1985 version is making LPs more corporate forms. ii) Under the 1976 act if a limited partner acted like a general partner in everything, who would he be liable to? Everyone. If he wasn‟t acting like a general partner he would only be liable to those that relied on him. iii) Under 1985 revision the limited partner, no matter how much control they exert will only be liable to those who relied on them. There is a burden of investigation on the third party and the third party has to show that: (i) he relied and (ii) reliance was reasonable based on the action of the LP. 27 Uniform Limited Partnership Acts Formation of a Limited Partnership i) RULPA (1) 101 RULPA §201- Certificate of Limited Partnership Tells you what has to be in the certificate to form a LP. LEVI says it is odd that you only have to list name and addresses of GPs and not of limited partners. Maybe it is because limited partners change often. g) Liability of Limited Partners Gateway Potato Sales v. G.B. Investment (using 1976) Facts: Gateway has creditors. Creditor sued GB saying that he was a general partner. GB says that he should get summary judgment because he is only a limited partner and cannot be liable. Issue: Whether GB is a general or limited partner. Holding: Court says that the trial court has to determine whether he was substantially acting like a general partner. Reasoning: Even though the third party creditor didn‟t know of you being a general partner based on your own representation, there is contested evidence that GB acted like a general partner. You don‟t need reliance. LEVI FOCUS: Court made a list of RULPA §303 (b) that will not be deemed as taking part in the business (safe harbors). Between 1976 and 1985 the list gets bigger. If your name is with the LP then there is an essential notice that you are a GP even if you are not acting like one. i) RULPA (1) 302 RULPA §303(b) These are all the things that you are not going to be controlling in the business: being a contractor for or an agent or an employee of the LP or of a GP or being an officer, director or shareholder of a GP that is a corporation. (ii) consulting with an advising a GP with respect to the business of the LP. (iii) acting as a surety of the LP. (iv) taking any action permitted by law to bring a derivative action for the LP. (v) requesting or attending a meeting of partners, (vi) proposing, approving or disapproving by voting or otherwise any of the following things: dissolution and winding up, the sale/exchange/etc of assets of LP, by incurring debt for the LP, changing the nature of the business, the admission or removal of GP or LP, transaction to stop conflict of interest between GP and LP, amend partnership agreement and (vii) catch-all. h) Corporate General Partners In Re USA Cafes Fact: LP suing other LPs because they got kickbacks for merging co. with other co. rather than having a public auction where company would have made more money. Plaintiffs say that this is a classic case of breach of fiduciary duty. Defendants say that they are the BOD of the GP, not the GP, so they don‟t owe a duty of fiduciary duty to the LPs. Issue: Whether LPs have fiduciary duty. Holding: Yes. Court says that there is a fiduciary duty and this fiduciary duty runs to LPs. i) Note on Corporate General Partners (1) LEVI- What happens when the only GP is a corporation? Corporate shareholders have limited liability. Is anyone left to be liable to the third party? No because LP is not liable and if corporation goes bankrupt, you can‟t go after the corp. shareholders. Can the sole GP be a corp? Yes. ii) Note on Taxation of Unincorporated Business Organizations (1) Because corporation is an entity then they are double taxed- they tax the entity and the shareholder. No one likes this because they are essentially being taxed twice. This is why people are turning toward alternative business forms. Fiduciary Obligations e) f) i) 28 Gotham Partners v. Hallwood (narrower than Café) Facts: LP owned commercial real estate. Corporation owned General Partner and went through with three transactions of question: reverse split, unit option plan, odd lot resale. Odd lot resale was not an issuance and therefore was subject to the P K and a fiduciary duty of entire fairness. Issue: Whether the fiduciary duty was broken by General Partner. Holding/Reasoning: Duty broken by General Partner by not going to Audit Committee and get a financial analysis of the correct value. can‟t just eliminate all fiduciary duties by contracting out of them – Del. Law  restrict F duties but can‟t get rid of them. Entire fairness – two prongs – fair process and fair price. The Limited Partner‟s choose to write this standard into the LP K and the General Partner should be held to this. Remedy wasn‟t enough – needed to add in a control premium – Gotham lost control of the company in the transaction and that is worth something more than the individual share price. What to remember? 1) waiver of duties to a point is ok in this case; 2) people can‟t waive all the duties. Main difference from Partnerships is that the Limited Partnerships are like corps and the RULPA recognize this. LEVI FOCUS- Court said you can‟t eliminate, but you can reduce fiduciary obligations. Then the DE legislature acme back and said that you can eliminate. 2) Limited Liability Companies a) Why do people choose LLCs? i) Small businesses like LLCs because the IRS treats them like a partnership (in 1998 the IRS said the LLCs got partnership tax status, but then changed it to check the box theory by which the IRS treats you the way you check the box). There is no double taxation. All LLP are liability. (kind of like corporate GP in LP) b) What is a LLC? i) A creature of statute. ii) Like a corporation, but no double tax. iii) Created in Wyoming. c) State tax issues i) In FL, the intangible tax (applies to stock, etc.) LLC units are equivalent, in FL, to stocks and they have to pay tax on it. d) Note on Limited Liability Companies i) Default rule for LLC- you can have member management. But, you can vary that in member agreement. There is EXTRAORDINARY amount of flexibility in operation as long as write it out in the agreement. ii) Two types of LLCs (1) Member managed (2) Manager managed (a) Managers may or may not be members. iii) Formation (1) Formed by filing articles of organization usually at the secretary of state. Has to include purpose of LLC, if it is going to be manager managed you have to have the names of the initial managers, member managed you need the names of the initial members. It has to have the duration or latest date of dissolution. iv) Operating Agreements (1) This is like the critical document. It is an agreement among everyone concerning their affairs. It usually has the governance, way to admit members and distributions. v) Management (1) The most common default rule concerning management is that it is going to be managed by its members. Statutes can require that this can only be varied by the operating agreement. vi) Voting by Members (1) Voting can be per capita/one vote per member or pro rata, by financial interest. vii) Agency Powers (1) Member-managed LLCs (a) Like apparent authority of a partner. Each member has the power to bind the LLC for any act that is for apparently carrying on the business of the LLC in the usual way or 29 ordinary course. Even if something isn‟t in usual course all other members can confer authority on someone to do that act? (2) Manager managed LLCs (a) Typically only managers will have apparent authority to bind. (3) The Delaware statute (a) §18-402 gives wide authority- gives each member and manager authority to bind. Says you can change this in operation agreement. viii) Inspection of books and records (a) Most statutes provide explicit provision that inspection must be for a proper purpose. ix) Fiduciary Duties (1) It is not in LLC statutes specifically. Most statutes have elements of duty of care, but there is nothing explicit. LEVI says it is still up in the air. Statutes pretty much say you can waive everything but good faith. x) Derivative Actions (1) Either statutes allow or courts allow derivative actions by the members. xi) Distributions (1) Default is that distributions are made pro rata according to member contribution. (partnership default is per capita- difference) xii) Members‟ Interests (1) Most statutes define a member‟s interest to consist of the member‟s financial rights, but some define the financial interests to also include governance rights and just like a partnership, you can transfer your financial interest but not your governance interest. Not clear that if you give up financial rights that you preserve your governance right. xiii) Liability (1) All of the statutes provide members and managers are not liable for LLCs debts, obligations and other liabilities. However the members may become liable if conditions for piercing the LLC veil are met. xiv) Dissociation (1) Statutes vary on this issue. Dissociation does not trigger liquidation and it is unclear whether there can be a buy-out. Kaycee Land and Livestock v. Flahive Issue: Should LLC be treated as a corporation for piercing the corporate veil? Should LLC members get total perpetual limited liability or should the equitable principles that apply to piercing the corporate veil apply to LLCs? Holding: Yes they should apply. But they are not going to give a finite principles. It is fact intensive for LLCs Reasoning: Court say that LLCs may have alter ego too. But it is not like a corporation because they are less formal. LEVI PONDER: Can courts take corporate principles and transpose them on to LLCs? Solar Cells v. Trust North Partners Facts: Operating agreement says that they waived conflicts of interest and that it is okay. Rule/Reasoning: Sorry no can do. You cannot waive a fiduciary duty like this. LEVI: Practically tell your client to put in agreement specific situations where they are willing to waive fiduciary duties because it seems like after Solar Cells a broad statement will not work. 3) Limited Liability Partnership a) They are only available in half the states unlike the LLC that are available in all the states. It‟s like a GP with some sort of liability shields. It doesn‟t shield a partner from their own misconduct, conduct they can deemed to have participated in or the misconduct of people they oversee. Megadyne v. Rosner Facts: There were partners that were misbehaving/talking about things that were illegal. They called in other expert partner to ask about the illegal thing. 30 Issue: Whether expert partner is shielded under the LLP for the other partners‟ conduct. Holding: He has no shield because of his broad involvement. They showed evidence that the lawyers had discussions among each other. Level of involvement is key. b) Note on LLPs. i) They are like general partnerships with one core difference: the liability of a general partner in a LLP is less extensive than a general partner in a partnership. And LLP need to be registered with the state office. A variation on the LLP is the LLLP in which the liability of the general partners in a limited partnership is limited. c) FL LLP statute i) Until 1999 FL had a separate LLP statute that was not in general business law. Under the statute you have to advise the public that you have become a LLP (register the name), you have to file a statement of qualification, pay an annual registration fee, you have to include LLP in the name of your company, but there is no requirement of insurance and your status of a LLP remains effective until it is cancelled or revoked. Chapter 3- The Corporate Form 1) Introduction a) The BOD have the apparent authority to bind the corporation. The SH have no apparent authority. They only get to vote on the BOD and they have no right to have corporate profits because only the BOD can pass out dividends. This is a huge separation between ownership and control. b) Limited Liability i) Some people said that there was no reason to have a corporation because you can shield yourself in a partnership by getting insurance. BUT insurance doesn‟t cover everything, sometimes you can‟t afford it, plus they can drop you. 31 ii) For big deals, shareholders may be asked by contracting party to provide personal liability. 2) History a) Corporations weren‟t private at first. There were very few of them because they were only for construction. They were instruments to get he economy out of war-mode (like to make roads). Up until the 1830‟s states started giving charters to private corps and states started buying shares. 1830- states started specially chartering them to do more than public works. It led to huge corruption because people were paying off the states to get charters. In 1870‟s all states adopted corporation acts to stop the corruption. b) In the 1950‟s the private corporation was looked at as working against communism. In the 1980‟s and 1990‟s it was like THE capitalist machine. Then Enron happened and people started worrying about executive compensation, info to shareholders that is not getting disbursed. c) Then in 2002-2003 Sarbanes Oxley was passed which gave whistleblower protection, created auditing committees and made disclosure requirements re: executive compensation, financial bookkeeping, and prohibited loans to directors. d) LEVI- Enron/Sarbanes –Oxley is extremely regulatory. e) Now in 2004-2005 there is backlash and people are saying that SOX can be too expensive for small corps and is holding the market back. Push back towards deregulation. 3) Selecting a State of Incorporation a) Because corporations are creatures of state statute they have to pick a state to incorporate in. Most small businesses go to the state where they do most of their businesses, but for large corporations, most go to DE. b) States will have incentives to have corporations incorporate there so that they can make the money. i) Race to the bottom- DE will have money incentives; promote management friendly/antishareholder laws. (DE is afraid to be looked at as bad, so may put in some management restrictive laws) ii) Race to the top- SH will not buy stocks in corps that do not promote SH interest. iii) LEVI PONDER: Are capital markets really that efficient? iv) Is this something the average SH knows and cares about? 4) Organizing a Corporation a) Three steps to incorporation i) Select state ii) File certificate of incorporation aka charter (1) DE §103(c)- Filing Initial Docs (2) FL §607.0202- “ (3) You have to your name, the office, a registers agent for service of process, etc. DE §102 iii) First organizational meeting. (1) Adopt bylaws (2) Elect directors (3) Elect officers (4) FL §607.205- what happens @meeting DE §106- Characteristics of a Corporation There is limited liability and it has an entity status. There is a tax status. Continuity of existence. There is free transferability of shares and they are publicly held enterprises. LEVI- closely held corporations do not really fit into this model. DE law focuses on large corps. b) Note on Authorized and Issued Stock and Preemptive Rights i) Certificate of incorporation must outline stock options and the number of shares the corporation is allowed to issue. Power to sell unissued, but authorized stock is up to the board. The board may not issue stock for the purpose of reallocating or perpetuating control. And under basic fiduciary principles, the board cannot issue stock to directors at an unfairly low price. c) Note on Initial Directors i) Corporation has no shareholders until stock is issued. 32 ii) Circular problem- Board gets elected by shareholders- but no shareholders until board issues stock. (1) Corporation‟s incorporators have power of shareholders until stock is issued. (2) Initial directors can be named in the corporations charter d) Note on Subscriptions for Shares i) Subscription agreement is when a shareholder agrees to purchase a shareholders stock when it is issued to him at some future date. Usually happens when the corp has not been formed yet = pre-incorporation subscription agreements (1) Old rule- a subscriber could revoke the agreement until moment of incorporation or until corporation issued the stock to the subscriber (a) Exception- if there was a mutual promise with consideration you can‟t revoke (2) New Rule- they are irrevocable. e) DE i) 101 – Corporations; how corporation is formed (1) Anyone can file a corp charter at Sec of State; can do any lawful business; corp can do the shares however they want ii) 102 – Certificate of Corporation iii) 103- Charter Execution and Effective Date (1) Fee; formal requirements to make it effective; effective upon filing date; has to be signed iv) 107- Powers of Incorporation (1) If the persons who are to serve as director until 1st annual meeting of stockholder have not been named in charter the incorporator shall manage the affairs of the corporation, and may do what is necessary and proper to perfect eh organization of the corp including (a) Adoption of bylaws (b) Election of directors v) 108- Organization Meeting (1) After filing of the charter, have to hold a meeting to adopt by laws, elect directors, officers, etc. (2) Have to provide 2 days written notice to other incorporators/directors that says time, place, purpose of meeting (3) Can do all of this w/o an actual meeting as long as everyone signs off on it. vi) 109 –By-Laws (1) Before the corp sells any stock, the incorporators/directors can make by-laws, but after the corp has sold stock, the power to make by-laws are in the stockholders. But a corp can put in the charter that the BOD have the power to amend by-laws. (2) By-laws have to be consistent with law and charter f) MBCAi) 10.20- Amendment by BOD or Shareholders (1) BOD have power to amend unless the charter says that the power is only for the shareholders or the shareholders do a by-law that says that they can‟t. ii) 10.21- By-law increasing quorum or Voting Requirement for shareholders (1) Shareholders can adopt by-laws to change the voting requirements. (2) By-laws that do this can‟t be amended or appealed by the BOD. g) RMBCA i) 2.01 – Incorporators (1) One or more persons can act as the incorporator or (s) of a corp by delivering a charter to the Sec of State for filing ii) 2.02 – Articles of incorporation (1) Same as DE iii) 2.03 – Incorporation (1) Same as DE iv) 2.05 – Organization of Corporation (1) Same as DE v) 2.06 – By-laws (1) Same as DE 5) Pre-incorporation Transactions by Promoters (1st way directors/shareholders can be personally liable) 33 a) Promoter is a person who facilitates the incorporation of the business. They assume high liability by entering into contracts. i) Three ways problems can arise (1) Promoter enters into a K, and once the corp is formed the corp kicks out the promoter and says will not adopt K (2) Corp can say “we like the K, but we can‟t pay it all” (3) The corp never gets formed ii) Circumstances when the promoter can/can‟t get off the hook (1) If corp meets and executes a novation that nulls all promoters K with third parties (a) Ratification/Adoption will not excuse the promoter. It will just make the corporation liable as well. (2) When the parties did not intend to hold the promoter liable and they only intended to hold the corp liable. (a) How do you decide if the third party intended to not hold the promoter liable? Goodman v. Darden (Washington) Facts: Guy was a promoter; he signed as the Pres of the company, not in his own name as an individual. The third party knew the corp was not formed yet. Issue: Whether the promoter is liable individually? Holding: Promoter is on the hook Reasoning: Just because the contracting party knows that the corp was not formed yet, does not mean that they are agreeing to release the promoter. Company Stores v. Pottery Warehouse (Tenn.) Facts: Again the 3rd party knew that the corp was not formed yet…Promoter signed the lease. Issue: Whether the promoter is liable individually? Holding: Promoter is off the hook Reasoning: She made is clear that she was acting in her capacity as President. Stipulations of fact establish that the 3rd party intended to look solely to Potter Warehouse Inc. for satisfaction of the obligation. The 3rd party knew that there was not a corp and did not require the promoter to sign in individual capacity. LEVI PONDER: What should the burden be for the 3rd party v. the promoter? Should it include the sophistication of the 3rd party? When should the corp be liable for the promoter‟s actions? (When it has reaped the benefits of the K that that promoter entered into). Why should a corp have the ability to say no the K‟s? (because the incoming board & shareholders had no say. But if the BOD and the promoter are the same person, this theory does not work). b) Restatement (2nd) of Agency i) 326- Principle known to be non-existent or incompetent (1) Unless otherwise agreed a person who in dealing with another purports to act as an A for a P whom both know to be non-existent or wholly incompetent becomes a party to such a K. 6) Consequences of Defective Incorporation (2nd way directors/shareholders can be personally liable) a) DEL i) 106 ii) 329 b) Note on Defective Incorporation i) Problem arises most commonly when a 3rd party seeks to hold the would be shareholders personally liable on the ground that corporate status was not attained, and therefore was limited liability. (1) De Jure Corporation (a) Substantial compliance with the statutory requirements for incorporation. Determined on a case by case basis. (b) Litigation over substantial compliance. 34 (2) De Facto Corporation (a) Compliance is not enough to = de jure but the steps taken to the formation of a corp are sufficient to treat the enterprise as a corp with respect to third parties. (b) Requires a colorable attempt to incorporate and some actual use or exercise of corporate privileges. (c) Did they act like a corp, did they negotiate K‟s, did they attempt to comply? (d) Some courts say (i) that there should not be de facto because the burden of incorporation should be on the parties that are trying to incorporate because the process is so damn simple (ii) Others say 3rd parties should not be able to capitalize on a mistake, so they give de facto and corp by estoppel. Cantor v. Sunshine Greenery Facts: Mailed charter before they signed the lease. Broke the lease. Lessor sued. Issues: What is enough to be de facto? Holding: If the 3rd party treats the business as a corp, the it will be de facto and no personal liability. (3) Corp by Estoppel (a) Less than what = de facto. Courts won‟t use this for tort. (4) Who may be held liable? (a) A party who has dealt with an enterprise on the basis that it is a corp, can‟t say it‟s not a corp and sue for personal liability. (b) RMBCA § 2.04 & FL Stat § 607.0204 (i) All persons purporting to act as or on behalf of a corp, knowing that there was no incorporation under this act, are jointly and severally liable for all liabilities created while so acting. (ii) But FL Stat § 607.0204 says that if promoter has actual knowledge that there is no corp, and the 3rd parties has actual knowledge that there is no corp, the promoter won‟t be liable. 7) The Classical Ultra Vires Doctrine (3rd way directors/shareholders can be personally liable) a) Introductory Note i) Back in the day corp charters said exactly what a corp can do, and anything outside of that was considered ultra vires (or outside the corp powers) and that meant that anything that went on UV could not be enforced against the corp. ii) Underlying question is what is the purpose of the corp? (1) Intra v. Ultra vires means what encompasses the powers of the corp? To answer this you look at the bylaws and charter of corp. iii) Demise of UV Doctrine (1) It really started going downhill when the charters became more prominent so you could just look at them to see what was inside or out. Goodman v. Ladd Estates Facts: BOD member took out a personal loan and had it guaranteed by the corporation. The BOD member‟s defaults and the corporation ends up paying. P bought all the shares of the corp, and tries to get the corp‟s $ back by saying that it was UV. At the time they bought the corp, they knew about the guarantee. Issue: Is it UV, is it enforceable against corp? Holding: It is UV, and will be enforceable nonetheless Reasoning: It adopts what the shareholder intended, they intended to guarantee the loan, so that‟s what will happen. 35 Levi Focus: Much more shareholder intent centered than UV centered. But we still talk about UV doctrine because old case law talks about the purposes of a corporation and what should be allowed. Intercontinental v. Moody Facts: Corp gave its president a guarantee on a personal note. Issue: Is it UV, is it enforceable against corp? Holding: UV can‟t be used as a defense by the corp as an entity, even if other party knew it was outside of scope. But the shareholder can use it as long as they are not acting as an agent of the corp (by enjoining). Kings Highway Facts: KH leased a movie theatre to another company for 15 years. Before the 15 years was up, they wanted to invalidate the lease, because it was a marine repair shop that they leased it to. Issue: Is it UV, is it enforceable against corp? Holding: Not UV. It is not one of the things in the state statute that DE § 124- Lack of corporate capacity or power; effect; UV No act of a corp shall be invalid by reason of the fact that the corp was w/o capacity or power to do such act, but such lack of capacity or power may be asserted (1) in a proceeding by a stockholder against the corp to enjoin the doing of any act (2) in a proceeding by the corp against an incumbent or former officer or director of corp for loss or damage due to such former officers unauthorized act (3) in a proceeding by the Attorney General to dissolve the corp or to enjoin the corp from the transaction of unauthorized business. FL Stat §678.0201 – UV UV is gone in FL. Not even a stockholder exception LEVI FOCUS The end of the UV Doctrine shows a shift in what the perception of the corporation is. It is a shift to a more private look, and it looks at the goal and purpose of each individual corp is. b) DEL i) §121- General Powers (1) In addition to the powers in §122, every corp shall posses and can exercise all powers and privileges granted by this chapter or any other law, or by the charter together with any powers incidental thereto so far as such powers and privileges are necessary and convenient to the conduct, promotion, or attainment of the business or purposes set forth in the charter. ii) §122- Specific Powers (1) Every corp created under this chapter has power to: (a) Continue its corporate name unless limited in the charter (b) Sue and be sued in any kind of proceeding (c) Have a corporate shield (d) Have and sell property (e) Appoint officers and pay them (f) Adopt, amend, and repeal by-laws (g) Wind up and dissolve itself (h) Conduct its business within or outside the state (i) Make donations for public welfare (j) Be an incorporator, promoter, or manager of other corporations (k) Participate with others in any other kind of business entity 36 (l) Transact any lawful business which the corp‟s BOD shall find to be an aid of governmental authority (m) Make K, incur liability, issue notes (n) Lend $ for its corp purposes, invest and re-invest (o) Pay pensions and establish profit sharing and stock options (p) Provide insurance on the life of any directors or stockholders (q) Renounce in the charter any actions it BOD cannot make 8) The Objective and Conduct of a Corporation a) LEVI FOCUS: The big thing is striking a balance between shareholder wealth maximization vs. corp long term earnings. They are not always jiving. So what should the model be and what are we leaning towards? b) The Shareholder‟s Interests, the Present Value Rule and Diversification i) Some people say that managers should seize all investment opportunities that have a positive net present value regardless of risk because shareholders can diversify their risks (have stock in more than one co). So if corp makes a big mistake its not really a mistake for the shareholders. c) Interests Other than Maximization of Shareholder‟s Economic Wealth LEVI FOCUS: Deterioration of the Dodge Theory (1) Dodge- Private court is there to make shareholders $! No philanthropy (2) AP Smith- Well, can give $ sometimes, it just can‟t be the pet charity. Has to be a modest amount. No longer just looking at the bottom line. (3) Unocol- Gives bondholders and employees some say for takeovers (4) State Statutes- Now allow charitable giving but with limits. So the obligation is there. Some states say a reasonable amount, but some give a $ limit. DE § 122.9 says that you can make these donations (reasonable/ but has to show some type of corp interest, but can be very broadly interpreted). (5) Presumption is that charitable giving is OK. So Dodge has been effectively overruled. (a) Some states have a presumption that considering other constituencies is OK, and if what you are doing is not the BEST for the shareholders, but is still good for them, and good for other constituencies, then you can do it. DE does not say this. Dodge v. Ford Facts: Ford was not going to give the dividends back to the stockholders he wanted to put it back into the business, to make cars cheaper, and then everyone would have a car, and he could employ more people. Issue: Is this for the corp? Holding: No. Corp is there to make $ for the shareholders. Levi Focus: If he would have just said that he was doing this to lower the price to screw competition, the court would have looked at it like a business decision and allowed it. AP Smith v. Barlow Facts: Corp gave a donation to Princeton. Shareholders wanted a declaratory judgment to say that this was outside the authority of corp. Issue: Is it for the corp? Holding: Court says donation is fine. Reasoning: The legislature gave express authority for the corp to do that as long as it was a reasonable sum. Levi Focus: Big question as to whether this came out right. There was an ideological slant (protect from commies by having universities) when this case came out. Levi Ponder: Also, pet charity issue. Who makes the decision of where the $ goes? What if shareholder doesn‟t like it? But maybe it does not matter if shareholder likes it, they can just sell their stocks. When is the line crossed? Maybe if the charity has nothing to do with the corp. ii) Note on Other Constituencies Under DE law. 37 (1) DE does not have an other constituency‟s stat. But the court has made some pronouncements on the obligations of management. Most of them have been in takeover cases. Unocal v. Mesa (1985) Overview: Corp directors have a fiduciary duty to shareholders but can take into account other constituencies (creditors, customers, employees, perhaps community generally) when dealing with hostile takeovers. Revlon (1985) Overview: Principle that you can take into account other constituencies is limited by the requirements that there be some rationally related benefit accruing to the stockholders. Katz (1986) Overview: You have to maximize the long run interests of the corporation‟s stockholders even if it is at the expense of others. Go to the legislature to get a statute passed if you don‟t like it! Paramount (1989) Overview: BOD can take into account the corporate culture. Dicta- But the case also talked about threat to shareholders. Levi: Went way forward from Unocol. Credit Lyonnais (1991) Overview: Court did not wait for legislature. At least when corp is operating close to insolvency, you can‟t prefer any other constituency. You have to save the corp‟s ass. ALI‟s Exceptions to when Shareholders should be #1 (1) Corp has to obey the law regardless if the shareholders will get screwed. (2) Principles say that corps can make decisions based on ethical principles recognized in business even if they don‟t enhance profits (3) can make donations even if it is non-corporate business reasons. Chapter Four- Corporate Structure 1) Shareholdership in Publicly Held Corporations a) Pre- 1930‟s- Traditional corp structure. Shareholder was at the top of the pyramid, then the board, then the officers. b) 1932- Book came out by Berele & Means that said that control had to be separate from ownership in order for the corp to flourish. i) Costs? Monitoring agents/managers. Expensive, and the transactions costs of getting shareholders together in publicly held corps would be huge. Feeling that shareholder interests would not be protected. Why we need corporate law rules. c) 80‟s & 90‟s- Those that did not believe that the Berele theory would work put in inside constraints. No collective action, no rational apathy, indexing strategies, ERISA. But still not effective because of the “Wall Street Club” d) Today- We have turned to law. Behind the scenes the institutional shareholder has become the consultant. i) But the question is what should they be consulted on.? (1) Corporate governance structure (because of conflicts of interest that managers have) (2) Proposed structural changes (mergers/acquisitions/takeovers) (3) Overall management performance monitoring (4) Corporate business and policy concerning dismissal of CEO‟s ii) How can Institutional shareholders exercise power? (1) Vote on shareholder proposals (2) Making own shareholder proposals 38 (3) Electing own individuals to represent you (not really used in the US because of insider trading) (4) Consultation iii) 6 types of shareholders (1) Private pension plans (created by private employers to provide retirement for employees. Usually employer hires banks to manage these plans- but in large corps this stays with the managers) (2) Public Pension Plans (government employers- decision making power can be retained or delegated to fiduciaries. Portfolio decisions are delegated, but voting decisions are retained) (3) Banks (often manage the funds of pension plans and often serve as trustees) (4) Investment Companies (usually manage money on behalf of individuals or other entities. Most common is the mutual fund where investors can withdraw their money at any time. Closed end companies are another type that raise funds for investment, but owners can‟t withdraw $, they can only sell shares to other people) (5) Insurance Companies (get $ from premiums, and invest in portfolios to make $) (6) Foundations (Usually have endowments which they invest through outside managers or on their own behalf) iv) What‟s the deal with all these laws yo? Can‟t we just rely on constraints? LEVI FOCUS: We have to find the messy middle. What are the three avenues that shareholders can take if they are dissatisfied? i) Vote (1) What can you vote to do? Can you sue for interference of right to vote? ii) Sue iii) Sell Legal Mechanisms that should protect shareholders i) Removal rights ii) Limit on election of directors iii) Statutory obligations for director iv) Dissemination of information to the shareholder v) Right to wage a derivative suit (1) Stockholders sue on behalf of the corp against management vi) Meeting rights vii) Appraisal remedy viii) State and Federal Fraud Actions ix) Fiduciary Duty Actions e) f) 2) The Allocation of Legal Power Between management and Shareholders DEL §141(a) & FL Stat §607.0801 The business and affairs of every corp organized under this chapter shall be managed by or under the direction of the BOD, except as may be otherwise provided in this chapter or in the charter. If any such provision is made in the charter, the powers and duties conferred or imposed upon the BOD by this chapter shall be exercised or performed to such extent and by such person as shall be provided in the charter. CHARTER RULES, but statute gives the BOD the central power. LEVI PONDER: Maybe this undoes Charlestown and Manice, or maybe this is a tip of the hat to the close corp. RMBCA §8.01(b) All corporate powers shall be exercised by or under the authority of, and the business and affairs of the corp managed by or under the direction of the BOD, subject to any limitation set forth in the charter. Charlestown Boot v. Dunsmore 39 Overview: Can‟t have the shareholders elect someone to wind up the corp, even when the board members were the ones who fucked everything up in the first place. Statute does not say that directors have to interact with someone who is not a director, because then they would be controlling their acts. Holding: When a statute provides that powers granted to a corp shall be exercised by any set of officers or any particular agents, such powers can be exercised only by such officers or agents although they are required to be chosen by the whole corp, and if the whole corp attempts to exercise powers which by the charter are lodged elsewhere (like the BOD) the action is void) Manice v. Powell Overview: Powers of the corporation are original and un-delegated. Holding: Shareholders cannot act in relation to the ordinary business of the corporation, nor can they control the BOD in the exercise of the judgment vested in them by virtue of their office. The BOD is charged with the duty to act for the corp according to their best judgment, and in so doing they cannot be controlled in the reasonable exercise and performance of such duty. DEL §141(k) a) Note on Removal of Directors i) To remove, have to call a meeting and have a vote. If you can‟t call a meeting, you cannot exercise your removal right. Voting by proxy is a cluster, so this is really hard to coordinate. ii) Shareholders can elect a director, but can they remove in the elected term with or without cause? iii) Removal by the Shareholders (1) Can do it for cause, even in absence of a stat that says so. (2) Cannot remove a director w/o cause in the absence of a specific authority to do so under a statute, the charter, or the bylaws (a) FL § 607.0808 – Atypical says that you can remove all directors with or without cause unless the charter says differently. (3) LEVI PONDER: Why is this w/o cause thing a big issue? (a) Bad to have w/o cause: Shareholders can blackmail, or just give the BOD time to do their thing, Due Process is pain in the ass (b) Good to have w/o cause: Makes BOD listen to shareholders, and sometimes it is hard to show cause iv) Removal by the Board (1) In the absence of statue the board cannot remove a director with or without cause. Whether the charter can change this rule is uncertain. But some state statues allow this. v) Removal by the Court (1) The cases are split on whether a court can remove a director for cause. However some statues permit the courts to remove a director for specified reasons such as fraudulent or dishonest acts. b) Interfering with shareholder voting rights Schnell v. Chris-Craft (Direct attempt to stop shareholder vote) Facts: Shareholders wanted to have a proxy vote toe kick BOD out. BOD moves up the date of the meeting so that the shareholders could not meet the deadlines to procedurally kick them out (proxy deadline of 30 b/f meeting). DE does not have a law that says can‟t change the date of the annual meeting. Issue: Can the BOD change the date of annual meeting to stop shareholders from voting/kicking them out? Holding: Can‟t do this shit. Reasoning: Inequitable actions (changing the date) does not become permissible simply because it is legally possible. Focus is not on the time issue, it‟s about the BOD screwing with the voting rights themselves. Despite the fact that the corp law allowed the board to do what it did, court said 40 that if board power disenfranchised stockholder vote it will not be allowed. The intent was board entrenchment. LEVI FOCUS: This is ridiculous! The court should have just said that this was a breach of a fiduciary duty and make it illegal that way. Balsius v. Atlas (Direct attempt to stop shareholder vote) Facts: BOD tries to stop shareholder voting because they are genuinely worried about the proposal on the table screwing up the company. They are not just trying to save their ass. Blasius (a shareholder) wanted to take over the board with a majority and give $ to shareholders. Issue: Can BOD try to stop a shareholder vote because it is a bad proposal that will hurt the company? Holding: In this instance need a compelling justification to act. Board did not have one. Reasoning: Court finds that the proposal was a bad deal and they agreed with the BOD. They find no bad faith on the part of the board. Usually the Business Judgment Rule applies to BOD decisions, but in this case the court said you need a compelling justification to make a business decision (stop the vote). LEVI PONDER: Why didn‟t the court just make a per se rule saying that the BOD can never interfere with shareholder voting instead in creating this whole new freaking category? So what the hell is a compelling justification anyway? Maybe if the BOD did not have time or $ to engage in a information campaign. Condec Corp. v. Lunkenheimer (Indirect attempt to stop shareholder vote) Facts: D‟s moved stock around (issued new stock) to prevent the Plaintiff shareholder from gaining a majority. Issue: Is this a denial of voting rights? Holding: Court must look at the objective of the board. What is the primary purpose of issuing the stock? If it is to retain control, the BOD has interfered. If it is to help the corp, the BOD is within their business judgment. Reasoning: Shares cannot be issued for an improper purpose such as take-over of voting control form others. c) Note on the Business Judgment Rule i) What BOD is usually held to. Was the decision rational. ii) Most lenient standard (like a rational basis) (1) But don‟t review interference with shareholder voting rights under the BJR, you use the compelling justification rule (somewhere between intermediate and SS) d) Note on Takeovers i) Three Ways You Can Take Over a Company (1) Mergers and Sale of Assets (a) Negotiation (i) Directed to and negotiated by the BOD. Cannot be initiated by the shareholders 1. Usually these talks are done in secret. But under Securities law the BOD has to come clean with the terms at some point, but there is a lot of leeway. a. Shareholders can sue the board for breach of fiduciary duty for nondisclosure. (ii) Shareholders simply vote up and down. (b) Shareholder approval (i) At CL they had to be approved unanimously by shareholders (ii) Statutes change this but some still require a supermajority 2/3. (iii) DE §271(a) You need to have a majority of outstanding voting shares to get something passed (iv) MBA – You only need a majority of those shareholders present at the meeting that are voting. (2) Proxy Contests 41 (a) Corp A buys shares in corp B and then they vote out the BOD and put their own people in that will approve the merger. (3) Hostile Takeovers/Tender Offers (a) Pro‟s and Con‟s (i) Pro- Hostile takeovers are prefect market mechanism to control managerial misconduct (rules are not needed to control misconduct) (ii) Con- Takeover will create coercive pressure on shareholders who do not want to tender, they are harmful o other constituencies because creates confusion, fear of takeover can fudge up management decision making. (b) Pre-1960‟s it was really difficult to oust management of publicly held corporations. Could only do it by proxy fights, and these were impossible. (c) Mid-1960‟s they took hold. (i) A makes a public offer called a bid or tender offer to purchase stock in B (the tender offer is made to B‟s shareholders directly and the price is way above market price). BECAUSE shareholders are buying it, you never need board‟s approval for takeover. 1. Federal Securities law heavily regulates this. (ii) This is why the BOD‟s try to do defensive tactics (poison pill, etc) 1. Legislatures have adopted specific statues that permit BOD to erect hurdles for wild takeover activities. a. Shark Repellant - To put in amendments to the charter or bylaws to deter potential raiders. Either: i. Requirement of staggered board where BOD members have staggered multi-year terms (rather than everyone is up on same year). So the whole board cannot be replaced at one time. It causes delay until the BOD can be replaced. If they acquire a co. they will need to pay off loans and this will prevent them from being able to do so. ii. Provisions for supermajority on certain types of transactions. This will make it costly for a potential raider because they will need to tender more than 50% of the shares to takeover. iii. DE §102(b)(4) gives BOD and shareholders power to establish supermajorities. In order to amend the shareholders would need a supermajority to do it. b. Crown Jewel i. BOD sells off the “crown jewel” of the company to make it less attractive to raiders. Very radical approach. c. Taking on more debt i. So raider will not want to take over the corp. d. Splitting corp i. Split corp up so that they would have to acquire more than one portion e. Self-Tender i. Corp buys shares from own shareholders to solidify BOD control f. Pension Plan Manipulation i. Make employee‟s pension vest upon hostile takeover. Once the takeover happens the employees leave. This hurts in technology corporations especially. g. Poison Pills- Shareholder rights plans Upon occurrence of a triggering event something will happen to the stock (a bidder gets a certain % of stock which means that they will have more voting rights). This makes it more expensive to take over and dilute voting power of the takeover co. i. Flip Over- The shareholder gets the right to get shares of acquiring corp at ½ price. 42 ii. Flip In- Once the triggering event happens the shareholder will get the option to buy stock in their own corp or the acquiring corp usually at a very low price. How can the pills be redeemed? (1) Dead Hand- Rights plan can only be redeemed by directors on the board who were there when the plan was adopted. (2) Slow Hand- Before you can redeem the pill you have to wait a period of time (usually 6 months). (3) No Hand- can‟t be redeemed at all. DE court has struck these all down. But not because they are inconsistent with shareholder voting rights, but because they interfere with the business judgment of the current board (DE § 141). Con‟s- Some says that they are BOD entrenchment mechanisms that undermine powers of the owners of corp. Pro‟s- They may entrench management. But there is no way that shareholders will ever get the best deal if the BOD cannot negotiate. Shareholders will get screwed if all they are given is a hostile bid with no negotiation. 2. The most fundamental rule when it comes to this is the Unocal Test: If the board wants to take defensive action against takeovers it must satisfy the enhanced business judgment rule or intermediate standard of review (Somewhere in between the regular BJR and the duty of loyalty –very fact intensive). a. PRONG 1- The board has to show it had reasonable grounds for believing that the tender offer presented a danger to corporate policy and effectiveness i. The burden is met by showing good faith and reasonable investigation (little deeper investigation that what is required for regular business decisions) b. PRONG 2 -The board must then satisfy a proportionality test. The defensive action must be reasonable in relation to the threat posed. i. Unitrin – When doing this prong there is 2 things to look at: ii. (1) the court will see if the boards defensive action was Draconian because it was either preclusive or coercive iii. (2) even if the defensive action was not preclusive or coercive, it must be within a range of reasonable responses to the threat. LEVI PONDER: At first people thought this was at ends with Blasius because the Unocol standard is intermediate and Blaisus is like SS. Why is the rule that when the BOD does something to effect shareholder voting rights so much more stringent, than when the BOD does something to effect another shareholder right? Most board use more than one defensive tactic. Their cumulative effect makes them effective. Courts will balance the stringency of the antitakeover device with whether it is too formidable. a. Courts will scrutinize tactics that are employed once a takeover is already in the works, but ones that are in place before hand will be looked upon more favorably. 3. 4. 43 MM Companies v. Liquid Audio Facts: Shareholders wanted an injunction against the BOD from trying to expand the BOD to impede the shareholder vote. Holding: The incumbent BOD has the burden of demonstrating a compelling justification Balsius for that action to withstand enhanced judicial scrutiny within the Unocal standard of reasonableness and proportionality. Rule: When the primary purpose of a BOD defensive measure is to interfere with or impede shareholder voting the board must 1st demonstrate a CJ (Blasius) as a condition precedent to any judicial consideration of reasonableness and proportionality (Unocal‟s) Reasoning: This case presents an example of when the compelling justification standard of Balsius must be applied within Unocal‟s requirement that any defensive measure be proportionate and reasonable in relation to the threat posed LEVI FOCUS: To invoke the Blasius CJ within an application of the Unocal standard of review, the defensive actions of the BOD only need to be taken for the primary purpose of interfering with or impeding the effectiveness of the stockholder vote in a contested election for directors. International Teamsters v. Fleming (Oklahoma) Issue: Is it up to the board to adopt a poison pill? What about when to redeem it? When or do shareholders have the right to force the BOD to redeem their pill and/or force the BOD to get shareholder approval next time they want to adopt a poison pill? Holding: (1) Shareholders can‟t restrict the board‟s authority to adopt a poison pill (2) But they can pass binding shareholder resolution that will require the board to get approval next time they want to adopt a pill. It is not the exclusive authority of the BOD to implement poison pills. Reasoning: Court analogizes the poison pill with a stock option plan. You need shareholder ratification of these. LEVI FOCUS #1: But this is different from a stock option plan because there was nothing that needed to be ratified, the BOD already has this right. LEVI FOCUS #2: This has to do with shareholder v. BOD primacy. What you have to worry about with shareholder primacy is that each individual shareholder will have strategic economic interests of their own that may not jive with the interests of the other shareholders or of the corp on a whole. DE § 109 & DE §141 DE has not spoken on this on this issue yet. DE §109 Gives the power to adopt, amend, repeal to the stockholders, but if in the charter the directors are given the right as well, it will not take that right away from the shareholders (so the recursive loop can take place). The charter will be illegal if it states that shareholders do not have the right to appeal, amend, and repeal by-laws. But then DE §141 says that BOD is in charge of the “business affairs of the corp except as otherwise said by the chapter” LEVI FOCUS: How would Fleming have come out in DE? Most likely opposite. But DE § 109 & DE §141 are at odds. So the whole thing turns on whether the poison pills are the “business affairs” or not. LEVI PONDER: Case in DE may help us to figure out what will occur once the courts address this. Quickturn: The DE SC stuck down Qutickturn‟s slow hand poison pill. Why? BECAUSE the old BOD cannot exercise significant restraints on the new BOD because it is a §141 violation. Although the case did not touch on shareholder issue, Levi thinks that their logic could undermine shareholders because how can you argue that shareholders can monitor if the old BOD can‟t even do so? If you are on the shareholder‟s side, argue that §109 needs meaning and shareholders overseeing governance decision is not the same as actual decision making (what the old BOD was doing in Quickturn). 44 LEVI LOOP QUESTION: Argument for shareholders is that if the BOD can remove bylaws at their whim, then what power does §109 have? BOD says the very fact that §141 exists, shows that there are limits to §109. Levi thinks that DE courts will say that it “depends on the circumstances.” Other States In some states the directors get the power exclusively unless the charter says it goes to the shareholders. Opposite of DE. RMBCA §10.20 & FL as well (1) Shareholder has the fundamental right to repeal by-laws. (2) BOD also has that power unless (a) the charter says that they can‟t because the charter will beat the statute (b) the charter limits the exact by-laws that the BOD can change. (c) BOD can‟t change by-law that shareholders pass if the by-law itself says that it can‟t be repealed (closes the loop). 3) The Legal Structure of Management a) Things that Keep Managers “True” i) Outside Directors/Independent Board (1) Outside of the BOD, but they know the norms of the business community and will keep the BOD in check. Structural unity of interest. ii) Committees (1) People within the corp given delegated governance issues and usually demonstrate expertise. iii) Corporate Raters (1) Consumer report type systems that give corp‟s ratings on several things. Useful pressure point, but it is subjective, so not everyone takes it seriously. iv) Search Firms (1) To steer away from “good „ol boys club” more and more corps are using search firms to find directors and managers. v) Director School (1) Some elite business schools have classes on how to direct corps. These may have an impact over time because it could help standardize the norms across the board re: corp governance vi) Pubic Eye (1) Media has made corp scandals “sexy” and corps are fearful of negative publicity. b) Note on the Architecture of Corporate Law i) Corp law consists of 4 major things: (1) State statutory law (2) State judge made law (3) Federal law (SOX, SEC Acts) (4) Soft law, such as NY Stock Exchange rules c) Note on the Director‟s Informational Rights i) Some courts say that the Director has to have unqualified access to the information to do his duties. ii) DE courts say that if it can be established that the director‟s motives are improper to the interest of the corp then his right to inspect ceases to exist. 4) Formalities Required for Action by the Board a) Note on the Formalities Required for Action by the Board i) Meetings (1) A single director cannot act by himself, so you have to have a convened meeting where quorum is present. (can do by phone, video phone DE § 141(i)) 45 (2) Can take action w/o a meeting if everyone agrees DE § 141(f) ii) Notice (1) Formal notice is not required for regular BOD meeting. But for special meetings have to give notice to every director (reasonable) unless the statute or charter sets out a specific amount of days. iii) Quorum (1) Majority of States say you need a majority of the full board in order to change by-laws, etc. (2) Minority of states including (DE §141(b), FL, MBCA) allow the charter or by-laws to raise or lower the number of directors required for quorum. (a) Difference b/w DE and MBCA (i) DE: Abstentions counts as a “nay” (ii) MBCA: Abstentions don‟t count as all. iv) Close corporations- courts don‟t really have stringent requirements for these. But LEVI PONDERS: if we should have more requirements because they are apt to have the most problems. b) Note on Committees- Most statutes contain a short list of matters than cannot be delegated to committees, but generally speaking there is very little that cannot be delegated. (DE §141(c) & MBCA §8.25) 5) Authority of Corporate Officers a) Note on Authority i) They manage the day to day operations of the corp ii) President/CEO/Chairman of the Board (1) Can bind into K in ordinary course of business, not extraordinary. (a) Decisions that would make a significant change in the structure of the business enterprise or in the structure of control over the enterprise are extraordinary and normally outside the president‟s apparent authority. (i) Look to the economic magnitude of the action, the extent of risk involved, the time span of the action‟s effect, and the cost of reversing the action. (2) Two times when these authority issues will come up: (a) If the Pres or CEO entered into a bad deal (b) If Pres or CEO fails to enter into a good deal iii) VP‟s (1) VP has little or no apparent authority under prior case law, but if VP seems to be close to the top of hierarchy, they may get some apparent authority. iv) Secretary/COO (1) Apparent authority to certify the records of the corp including resolutions of the board. A secretary‟s certificate that a given resolution was adopted by the board is therefore conclusive in favor a third party relying on the certificate. v) Treasurer/CFO (1) No case law vi) Closely held corporations (1) If President handles all the business and BOD never says anything, then the courts will say that they have wide actual and apparent authority. vii) Ratification (1) Even if an officer did not have the actual or apparent authority to do an act, if the BOD ratifies, they will be bound. 6) Formalities Required for Shareholder Action a) Even if the shareholder has the substantive right to do an action, they have to follow all of the formalities to exercise them. b) Meetings and Notice i) Notice of place, time and date is required for annual meeting of shareholders. But if there is a special meeting an agenda with the purpose of the meeting has to be sent. ii) Who can call a special meeting? 46 (1) DE § 211 - Unless the charter says otherwise, only directors can call special meetings. (2) FL §607.0702 & MBCA §7.02- Either the BOD, holders of at least 10% of the shares, or anyone listed on the charter, can call a special meeting. If a shareholder calls a meeting, they have to pay for it unless the charter or by-law says otherwise. (3) LEVI FOCUS: Shareholders own the freaking stock, they should be able to call the meeting. (a) DE §228 & FL §607.0703 – In lieu of a meeting, as long as you have written consent, you don‟t have to have a meeting. c) Quorum i) Under most statutes, a majority is necessary for quorum, unless the charter sets a higher or lower figure. d) Voting i) Ordinary Matters (1) DE §216 (a) An abstention counts as a “no” because the statute requires the majority of those present at the meeting. (2) RMBCA §7.25(c) & FL§ 607.0725(c) (a) An abstention does not count as a “no” because you only need a majority of people at the meeting. ii) Fundamental Changes (1) Change to charter, sale, merger, etc. Most statutes require an approval by a majority of EVERYONE not just those that show up at the meeting (a) But the MBCA only requires a majority of the shares voting, providing that you have quorum. iii) Election of Directors (1) Only need a plurality vote. (2) Cumulative voting is required by some states. iv) Written Consent (1) Statutes typically permit a shareholder to act by written consent in lieu of a meeting. 7) Cumulative Voting a) Can only be used for voting on directors i) Mechanism for minority shareholder representation vis-à-vis election of directors. b) Why do you need this? i) Let‟s say you have a 51% stockholder and you have to vote for each seat separately, then whomever that 51% person votes for, will win. (1) However, with cumulative voting, you can mush all your votes together (for all of the seats) and put all of the votes for one director. ii) People don‟t really need to do this anymore because there are smaller BOD‟s. Also, in order to get around this the BOD‟s implemented staggered boards. (1) Staggered Board- Policy tradeoff = trade off your commitment to have minority representation so that you can allow the BOD to manage anti-takeover devices. 8) Limited Liability a) Introduction i) Under modern statues a shareholders risk is ordinarily limited to her investment. That is, the most a shareholder stands to lose even if the corp fails, is the amount she paid for her shares. (1) DE § 102(b)(6) & RMBCA 6.22(b) ii) What does LL promote? (1) LL promotes people to diversify their stock. Investors put their $ in many different corp‟s because they know they will only be liable for their investment. (2) Liquid Securities Markets. (3) Less Agency and Monitoring costs (4) Incentive for efficient management because management not scared (5) Managers not afraid to take risks because stockholders can‟t lose too much iii) Problems with LL? 47 (1) It will create a moral hazard because managers will not be scared & they will do whatever they want iv) Are there times when LL will be disregarded? (1) Piercing the corp veil and imposing liability in instances of fraud. v) LEVI FOCUS: for this section (1) Are there any other situations other than fraud where piercing is OK? (2) Are there circumstances where it makes less or more sense to pierce the veil ands what are some ways that it can be done (3) Difference b/w piercing in the parent/sub situation v. Individual shareholders. (4) Difference b/w piercing in tort and K actions (5) Are there situations where the rationales for LL don‟t fit? (6) Are there any limiting principles that should be applied to LL? vi) Doctrinally why do courts pierce the veil? (1) Fraud- False representation or omission. Intent to induce the plaintiff to act or not to act, reliance, damage. (2) Alter/Ego Instrumentality approach- when the individual shareholder is using the corp as a shell. You can prove this if they don‟t follow formalities, co-mingling funds, undercapitalization, Moving fast and loose with corp funds, diminishing assets. (a) Undercapitalization- Question is, what happens if a corp has done everything else right, but is extremely undercapitalized? (i) Minton (CA) case says that undercapitalization alone is enough to pierce. But Cal courts have gotten away from this. (ii) But if legislature does not say what undercapitalization is, then how will a corp ever know that they are undercapitalized? (b) Close Corporations- Courts will just look at what the creditors would expect (because formalities not really present). Fletcher v. Atex (Using the alter ego theory) Facts: Kodak is the parent corp and they have a sub named Atex. Fletched field suit against Kodak and the sub to recover from stress injuries from the use of a computer. P tried to argue that it was a separate entity because the sub was wholly owned by Kodak and there was co-mingling. Issue: Whether the two corps operated a single economic entity such that it would be inequitable to not pierce the parent too? Holding: Not a single economic entity. TEST: Have to show they acted as a (1) single economic entity and that an (2) overall element of injustice and fairness is present. 5 Factors to determine if the parent/sub are a Single Economic Entity: (a) Whether the sub was adequately capitalized for its business (b) whether it was solvent (c) whether formalities were observed (records, meetings, dividends) (d) whether parent of the sub siphoned corp funds for the parent (e) in general, if the sub simply functioned as a façade for the parent. Reasoning: No mingling because there was separate records and there was a paper trail. Injustice is different then fraud, but no injustice because no fraud! LEVI FOCUS: So why have a test for fraud OR alter ego if in alter ego you have to prove fraud? LEVI PONDER #1: Should there be easy piercing for parents and subs? Case book author thinks so if it is a wholly owned sub because it is economically efficient. It is economically efficient because (a) when you pierce you don‟t go into the pockets of individuals, but a corp that the sub should have been a division of anyway. LEVI PONDER #2-Some people think that you should not have to show unfairness if you can prove a single economic entity. But Levi says that if you did not have to show this, then all close corps would be screwed because they always look like a single economic deli. Walkovszky v. Carlton Facts: Taxi fleet that divided up the corp into a bunch of subs so that they would be able to dodge big insurance coverage. P wants to get after the parent and all of the subs because they are really one entity (he got hit by a cab). 48 Holding: P pled wrong. He pled fraud. He should have just sued the parent and pled single economic entity. LEVI FOCUS: Bad use of corp law? Seminole Boat Yard -FL Very hard to pierce in FL. Have to show by a preponderance that (1) the shareholder dominated and controlled so there was only really one entity (2) shareholders were the alter-ego (3) corp did this for an improper purpose or committed fraud (4) the fraud or improper purpose caused an injury. Arnold v. Browne Undercapitalization Overview: Undercapitalization is only one factor. It alone does not seem to be enough to pierce. Slottow Fidelity v. American Casualty Undercapitalization Overview: Under CA law, undercapitalization may alone be enough. But in this case the capitalization was really inadequate. Truckweld v. Olsen Undercapitalization Overview: Although there may be situations in which a corp is so undercapitalized it may = fraud, it did not happen here. Stockholders don‟t have to throw in own private funds to make sure that it gets back on its feet. Radaszewski v. Telecom Undercapitalization Overview: At what point to do you look to determine if the corp was undercapitalized? Sea-Land v. Pepper Source Undercapitalization Overview: Guy was taking $ in and out of all the corps so that he could avoid creditors. Court says that you should only pierce when there is a fraudulent conveyance. LEVI FOCUS: Some academics say that piercing should be used in situations where you can‟t prove fraud conveyance, but there are elements of fraud. b) Should piercing be limited to cases where you can show fraud conveyance rather than just an alter ego? i) But what would happen in Minton, Walkovszky, and Fletcher? ii) Some jurisdictions requirement fraud and alter egoness, others just require alter egoness. (1) What about a wholly owned parent/sub problem? If it doesn‟t fit the Uniform Fraudulent Transfer Act then you don‟t get piercing? Or do you anyway (what some academics have argued) c) Should there be piercing differences between Tort v. K creditors? i) Courts are more likely to pierce in K cases than in tort cases. This does not make sense because in K cases they could bargain for protections. ii) Much more piercing in close corps rather than in public corps. Maybe this is because the close corps make operational decisions. d) Direct Liability i) Federal legislature comes up with separate federal state which has nothing to do with corp law, and it says that if a parent owns and operates, the operator can be held liable, not just the owner. (1) If sub is bankrupt can you go after the parent? Not always under piercing law, but maybe you can through other statutes. Chapter 5- Shareholder Informational Rights and Proxy Voting 49 1) Shareholder Informational Rights Under State Law a) Overview: Shareholders may want to get access to 2 types of information: i) Contact info. for other shareholders (1) If corporation says no, then they have to show that the request was for an improper purpose. ii) Access to books of the corporation DE §220 & FL§607.1602 (Florida has limitations on the kinds of documents shareholders can ask for) (1) In this case shareholders has the burden to show that she has a proper purpose. (a) You have to do this because courts do not want shareholders to do fishing expeditions or to exploit trade secrets b) Inspection of Books and Record Saito v. McKesson Facts: Merger. 3 months later the company says that the other company was supposed to sell software as contingent to the merger. But they never did. The SH start suits on both sides saying 1 side didn‟t investigate and the other side misrepresented. But they need the info. for the lawsuit so they ask for it under DE§220. Issue: (i)Whether the plaintiff was asking for the info under a proper purpose.(ii) The defendants say that the SH have a standing problem under DE§327- it says you can‟t start a derivative action unless you were a SH at the time of the problem, so the defendants say, if you can‟t sue then we are not giving you the info. Rule: (i)If you have one proper purpose (reasonably related to his rights as shareholders) the rest of your purposes, no matter how improper, are looked over and do not defeat the first proper purpose. (ii) No. Under DE §220 you cannot prevent them from getting the info. because it can be a continuing activity that can still harm them and they still may want the info. to nag the board, not just sue them. Corporation can have a penalty imposed if they do not provide a list of names of all Sh and make it available for peeps to inspect. DE §219 & RMBCA §7.20 Additionally: Just because SH can get info. does not mean that he can go on a fishing expedition. The Court says that SH can only get docs. That are “essential for their particular purpose” (narrowing the scope of discovery). LEVI: How do you suggest to the court that you as a SH should be able to see a lot of documents? You have to show credible evidence of wrongdoing. There is a lot of litigation with regard to these issues. Stock prices going down is not sufficient under DE §220 argument. Pillsbury v. Honeywell (Minnesota Court applying DE law)- WRONG Facts: Honeywell made fragmentation bombs for the Vietnam War. Pillsbury was a do-gooder organization that was trying to get them to stop making them. So Pillsbury bought shares of stock from Honeywell and then asked for a list of the SH so that they could levy a proxy contest. Pillsbury admitted that he did not have a business purpose. Holding: Court interpreted DE law to mean that a proper purpose has a motive requirement. They wouldn‟t allow him to do this because there was no business interest, but a political one. Rule (WRONG): Proper purpose has to be business. (They were wrong) Credit Bureau Rule: When this issue came up in DE they said that proper purpose does not look at motive at all. If SH wants to start proxy contest it is perfectly within their right. Give them the freaking list. It is not up to the courts to decide the substantive desirability. (1) RMBCA §16.01- Corporate Records (a) Corporations shall keep all minutes of meetings and accounting records, list of shareholders. In principal office you have to have the charter, the bylaws, resolutions, and all written communications to SH, most recent annual report and the list of names and businesses of current directors and officers. (2) RMBCA §16.02- Inspection of Records by SH (a) SH entitled to inspect and copy all records above. You have to give 5 days business notice. Demand has to be in good faith and for proper purpose. 50 (3) RMBCA §16.03- Scope of Inspection Right (a) SH agent or attorney has same rights of inspection as they do. If your right to copy is reasonable you can get them through email by request. Expense for the list of SH is the corporations, the copies are at expense of SH. (4) RMBCA §16.04- Court ordered inspection (a) If the corporation doesn‟t allow or doesn‟t allow in reasonable time a SH that meets requirements of 16.02, then the court can give them an order. If court has to order this, then the corporation has to pay for the SH costs, including counsel fees. ii) Note on Record Ownership and Record Date/Owner Identification Problems (1) SH are called record owners. For a variety of reasons, the people who actually own share often differ from the record owners. For example the stock of an individual may be in the name of the bank or institution, so they are the record owners, though the individual is the beneficial owner. (2) The beneficial owners are the ones that are supposed to vote but there is a problem identifying them because a lot of times their stocks are recorded under banks, etc. (3) To solve the problem for record owners who become of record after notice of vote is given, the corporation will create a record date and if you weren‟t a record owner by that date, you weren‟t entitled to vote. c) Reporting Under State Law (1) Differences between states: (a) FL and RMBCA 16.20 (i) Corps must provide annual financial statements to the SHs. (ii) Have state disclosure requirements. (b) DE §220 (i) Corps do NOT have to provide anything to the SHs. SHs have to beg under §220. (ii) This is important because SH have to spend a lot of money on §220 requests and they really don‟t know what to ask for. At least if you get an annual report SH have a better idea of what particular documents they need to do a further investigation. 2) Shareholder Informational Rights Under Federal Law and Stock Exchange Rules a) An Overview of the Stock Markets i) Depression Era legislation- there was a feeling of need for reliable market with transparent info. b) An Overview of the SEC and the Securities Exchange Act i) SEC Act of 1934 §12(g) (1) An eligibility requirement. Only companies that meet this will have federal law apply to them. You have to have 500 SHs. You had to have a security requirement of $1 million. ii) SEC amendment (1) Upped the 12(g) requirement to $10 million. iii) SEC 1934 (1) Delegates an immense amount of power to the SEC. (2) SEC §14-Proxy (a) Says it is unlawful for any person to solicit proxies in contradiction of SEC rules, but it doesn‟t say what those rules are. c) Periodic Disclosures (3 enforcement mechanisms) i) State Disclosure Rules. ii) Federal Disclosure mechanisms/rules (1) SOX (a) Disclosure is more important under SOX §404- the compliance mechanism. (b) Now CEOs have to certify accuracy of disclosure. (i) They have to put in systems to ensure that information is reported accurately. (ii) In-house counsel have a lot of control over §404 compliance. (2) SEC (a) Says that you have to file annual reports when certain triggering events happen. (i) Complaints of cost of reporting and not timely. 51 iii) Exchange Rules (1) American and NY Stock Exchange have their own disclosure rules. They keep up with this shit because they know the SEC can go after them and shut them down. They provide discretion to management but require disclosure of merger negotiations. Corps do not want to get booted from the exchanges. 3) The Proxy Rules (I): Introduction a) Note on Terminology i) A proxy holder is a person authorized to vote shares on SHs behalf. ii) A proxy, a form of proxy or proxy form is the written instrument in which the authorization is embodied. iii) Proxy solicitation is when SHs are asked to give their proxies. iv) A proxy statement is the written statement sent to SHs to solicit the proxies. b) Note on Overview of the Proxy rules i) 1935 SEC Act 12(g)- tells you what has to go into a proxy. The whole idea is that SHs should be informed so that they know hat they are voting for and they can have a chance to solicit proxies themselves. ii) Two types of proxies (need different disclosures for each) (1) Mergers and Acquisitions (business actions) (2) Election of BOD c) Note on Annual Report to shareholders i) When proxies for the election of directors are solicited on behalf of a corp that is subject to the Proxy Rules, they have to send a annual report to shareholders before or with the proxy statement. d) Most Litigated Proxy Rules i) In 1992 SEC Act shareholder communication was made easier ii) SEC § 14(a)(9); SEC § 14(a)(7); SEC § 14(a)(8) 4) The Proxy Rules (II): Private Actions under the Proxy Rules SEC § 14(a)(9) Anti-fraud regulation. No proxy solicitation can have a statements that is false or misleading as to a material fact, or omission, or ½ truth. LEVI FOCUS: But none of this stuff is defined! Mills v. Electric Audio Facts: P‟s are the shareholders. BOD sent a proxy that says that they were recommending a merger with another corp, but they did not say that the current BOD‟s people owned 50% of the merger corp. Self-interested. P said that was against §14(a)(9) because material omission of self-interest. Issue: What casual relationship must be shown between such a proxy statement and the merger to establish a COA based on the violation of §14(a)(9)? Holding: Violation of §14(a)(9). Rule: If the misstatement or omission is material then causation will be presumed in §14(a)(9). If the proxy was an essential link in accomplishing the transaction than material. Material = would the reasonable shareholder have wanted this info in deciding how to vote? Reasoning: Because they 2/3 to get the merger through. TSC Industries v. Northway Overview: Changes the Mills Standard. The standard was too broad because shareholders might be interested in anything. Rule: “Might” is replaced with “substantial likelihood” that a reasonable shareholder would consider it important in deciding how to vote. LEVI FOCUS: Don‟t have to prove that the material fact would have changed the vote, but just that it would be a substantial factor in deliberation. LEVI PONDER: In one case, the court said that a BOD member having a criminal past was not material. But how do you determine if a reasonable shareholder would think this was important? Marijuana v. money laundering? 52 Virginia Bankshares v. Sandberg Facts: Corp told the shareholders that their shares were going to be rated higher than they were (and they did not think that they were anyway- they lied). Shareholder who did not vote in support of merger claimed a §14(a)(9) violation because the value was screwed up. D says that §14(a)(9) should not apply here because the “misleading” element was an opinion and not a fact. Issue: (1) Materiality – (a) Is an option a fact (b) Is it enough that the statement is false to their belief, or do the underlying facts have to be false? (2) Causation Holding/Reasoning: (1) (a) Conclusory beliefs are actionable under §14(a)(9) because it is a fact that the BOD is recommending. (b) Both the statement and the underlying facts have to be false to win (2) She lost on causation because she did not vote, so no reliance. Also the BOD never needed shareholder approval for the action. LEVI FOCUS: Test = was the statement material? Was there causation? a) Note on State Law Wilson v. Great American Overview: Allows shareholders who have exhausted their state remedies to seek relief for a §14 (a)(9) violation. 5) Proxy Rules (III): Shareholder Proposals a) SEC §14(a)(7) i) If management is going to solicit proxies & SH wants SH list, management can either (i) give SH the list or (ii) it can mail it out to them. Management pays the costs and it has control over when it is sent. (SHs don‟t like this) b) SEC §14(a)(8) i) SHs who want to communicate with other SH. In plain English. Q&A format. Allows SH to make proposals so other SHs can vote for them. Management has to send it out and pay for it. There are limitations: 500 word limit, someone representing your interest has to be present at the meeting. There are also exclusions issues: The management can say that they won‟t send it out because (i) it is about the ordinary course of business of the company, (ii) it is about something that is worth less than 5% of the business, (iii) if it is about something that is illegal for SHs to do under state law. What makes it problematic is that even if it violates (i) or (ii) the SEC will allow it if it addresses important social issues. (This is where the litigation happens). Roosevelt v. Dupont Facts: DuPont complains to the SEC about proposed SH proposal. The SH asked for reports about the ordinary course of business so that they could create a SH report regarding this. They say that it is under the ordinary course of business. Issue: Whether or not the proposal that the SH is trying to send out is in the ordinary course of business or if it is a policy issue. Holding: The Court says that this is not a policy issue because DuPont is actually trying to get this work done. They are not being slackers. They are not slacking. LEVI PONDER: How come asking for a report about ordinary business isn‟t a presumptive “no” under this statute? c) Note on no-action Letters Interpreting Rule SEC §14(a)-8 i) The management must solicit the SEC if they feel that a SH cannot send out certain proxy statements. If the SEC agrees with the management then they will send them a no-action letter that says that they do not have to send out the SH proposals. If they disagree they send a letter saying why the proposal should be included (these are called no-action letters too, makes no sense). In such cases the management can still omit the SH proposal, but they risk action by the SEC. The SEC rarely actualizes that option. 53 d) Note on Corporate – Governance Shareholder Proposals i) Mainly you either have policy resolutions or corporate government resolutions. A number of governance proposals meet a majority, all other proposals don‟t usually win. Full blown proxy contests declined in 2004. One of the two most prominent battles were Walt Disney. e) Note on Shareholder Social-Policy Proposals i) 300 were filed. 145 came to vote. They concerned environmental issues, global labor issues, and equal employment, tobacco and health issues. Most of them resulted in the corporation and the proposal proponents coming to some kind of resolution. 6) Proxy Contests Rosenfeld v. Fairchild Facts: $250,000 in proxy solicitations was spent by the management. Insurgents win anyway. The former management still owes $28,000 on their proxy balance. The insurgents decide that the corporation will pay off the former management debt. They also turn in their own receipts for the proxy fight. Apparently they get majority SH approval to do this. Rule: In a proxy contest, the incumbent BOD can take on reasonable expenses incurred through proxy solicitations. LEVI FOCUS: Are there limitations? There are policy proxies vs. personal power struggles. Is it easy to distinguish between the two? In this case, each side contended that the other side was trying to take over the corporation. There will always be a policy question that you can coct behind a proxy solicitation. LEVI FOCUS: How do you know if the expenses are reasonable? The court doesn‟t address this issue. You ought to be able to spend money to inform the SHs, but not to persuade them. In no jurisdiction do they actually tell you that you CANNOT persuade. In fact DE says that you can persuade them if you want to. Realism has won the day. LEVI PONDER: Can insurgents vote to pay the losers‟ debt? Corporations paying off debt encourage real democracy. Should winner and losers both be paid for by the corporation? Heineman v. Datapoint Rule: Says that if you use your newly acquired position to reimburse yourself for the costs of waging a proxy contest, then you have a prima facie case of director self-dealing. LEVI FOCUS- This does not overturn Rosenfeld because in Rosenfeld they had SH approval. Either way losers of proxies usually sue to get their money back. They are made whole either by settlement or other forms of compensation. Chapter 8 – The Duty of Care and the Duty to Act in Good Faith 1) The Duty of Care a) Overview: How can SHs discipline management other than insurgence and voting/proxy contests. They can sue for breach of duty of care/duty to act in good faith. b) Standards for Violation of Duty of Care i) Under Smith the standard is gross negligence, which is a violation of the BJR ii) Caremark added to the BJR the duty to monitor c) The Basic Standard of Care i) All states require the BOD to use a duty of care. What is the standard? (1) What a reasonably prudent person would use under similar circumstances. MBCA §8.30/DE/FL Francis v. United Jersey Bank Facts: Ms. Pritchard was inattentive to her business. The SHs were embezzlers and the creditors are suing the SHs. 54 Issue: Whether a corporate director is personally liable in negligence for the failure to prevent the misappropriation of trust funds by other directors who were also officers and SHs of the corporation. Who is the duty of care supposed to protect. Holding: Find that the duty of care runs to the creditors. Reasoning: Ms. Pritchard should have gone to a lawyer or resigned. The court found causation. LEVI FOCUS: If the duty of care is only supposed to run to the SHs, then how do you explain this case? One theory, when the corporation is getting close to bankruptcy, the duty of care extends to creditors. LEVI PONDER: If Ms. Pritchard would have gone to a lawyer, would it have been enough? But I mean the other SHs were Ms. Pritchard‟s kids. Is she supposed to send them to jail. If she didn‟t then she would have breached her duty. Aronson (Majority) Overview: Process vs. Substantive- If you get yourself informed then you will only be tested against a standard of gross negligence. Quillen (Minority) Overview: Says that gross negligence should not be the standard at all. Instead on the threshold duty of care issue, the standard should be “reasonable care under the circumstances”. In re Emerging Communications Facts: There was an expert on the BOD. He knew that the valuation was low but he didn‟t say anything. Issue: Is an expert on the BOD held to a higher standard of duty? Does it make sense that he should be? LEVI: Where do you draw the threshold when someone know s that they are an expert and should be? ii) Note on Causation (1) Two difficult causation issues raised in duty-of-care: (a) If the violation of the duty-of-care consists of an omission by a director, would the loss have occurred even if the director had not violated his duty? (b) If the whole board or a substantial majority of directors violate the duty of care can an individual director be excused on the ground that the result would have been the same had she reacted differently. LEVI FOCUS/PONDER/RANT: Should we be looking at the duty of care as a static requirement that is generally applied to corporations or should we see them as contextual and evolutionary (Quillen)? There are lots of duties and there can be some ideal notion of what a director should be, but reality isn‟t so ideal, so we have to look at, in a particular context, whether the BOD acted okay in their situation. Plus society evolves and what we look for and want from director‟s changes. LEVI AGAIN: Has there been an evolutionary change in what courts expect CEOs to do? Has there been a sea change? Are there countervailing factors to this sea change. Effectively, what is the evolution? Is it going to evolve further? In what direction? Is it a good thing or a bad thing? LEVI: If there is this whole evolution thing going on, what is the standard that CEOs will be judged by? The BJR .There is a presumption that the BOD has been acting in compliance with the duty of care and even if their decisions are moronic they will only be held liable if they were not informed and grossly negligent. d) The Business Judgment Rule i) LEVI Overview: (1) The BJR is based on a presumption that the BOD is acting in the best interest of the corporation. We want this presumption because we want business people to make decisions without always worrying about being in trouble. 55 (2) The reason that breach of care cases all have to do with inattentiveness is because if your decision is rational then you will not be liable. ii) Exceptions to the BJR/ If you are within the exceptions then you have to apply the entire fairness standard (which is much more stringent) (1) Complete inattention/Nonfeasance (Francis) (a) Minimum that is required of a BOD to show that they have complied with common law duty of care (i) BOD has rudimentary understanding of business (ii) Should be informed of state of affairs (iii) Attend board meetings regularly (iv) Review financial statements (v) Make inquiry about things that are not normal (vi) You raise objections to stuff that you don‟t understand (vii) (Though not in Francis) There is now a notion that the BOD needs to put internal monitoring functions in place. (2) You have your own interest at stake/breach of duty of loyalty (3) You make a no-win/irrational decision. (a) Things director did were not done for any rational business purpose or in bad faith. Even if in good faith- if you are so stupid like Joy v. North you are irrational. Joy v. North Facts: The bank gave money to the developer for an office building. The deal is a bomb. The bank keeps lending more money to the developer anyway. They lose everything. There is a duty of care lawsuit. Rule: The court says that this was an irrational decision because there was a low ceiling and a high floor. LEVI: But do business people really ever go into a deal thinking that they are doing something irrational? How do you define rational v. irrational? Is there ANY potential to an economic upside? (4) Fraud/Illegal behavior/Conflict of interest. (a) Not acting for corporation, you are acting for your own interests. ATT Case Facts: AT&T decided not to bill the democratic party for phone calls during the convention Holding: This is a violation of Federal Election Law, so it is a breach of duty of care Court: This is the same as a contribution, not a BJ. (b) Liability for subordinates- Can be held criminally liable for something that someone under you did even though you had no idea that they were doing something wrong. Only limitations are though agency law. (5) Gross negligenceKamin v. American Express Facts: BOD passed up an $8 million tax benefit to hide the fact that the corp had taken a loss that year. Rule: BJR protects the decision because it wasn‟t completely irrational to decide to pass up the tax break. They were informed of their options (reports, time, experts), and they made their choice. Smith v. Van Gorkom (BOD gets nailed for violation of BJR) Facts: Corp is sitting pretty for a hostile takeover (BOD wants it). Management pondered whether to put together a leveraged buyout (BOD came up with sell for $50-60/share). VG is facing mandatory retirement. He owns $85,000 in stocks and thinks the corp is 56 undervalued. He asks someone if they want to buy the corp for $55/share, buyer says yes with conditions (1. he will be able to buy “x” amount of stock for less 2. things have to be done quickly 3. the corp can‟t affirmatively solicit other bids 4. can consider unsolicited bids, but can‟t give them insider info) VG brings this up at a BOD meeting and lawyer says that they need to take this. Shareholders sue because no market test to value the shares. Below: TC says no problem, rational decision. Holding: Bo BJR here! Reasoning: Why gross negligence? BOD just took VG‟s word for it! No inquiry of fairness of deal, never did a valuation of the stock. Dissent: By saying you have to do a valuation, they are adding in a due process requirement into corp law, and that has never been there. It is common process to rely on subordinates. LEVI RESPONSE TO DISSENT: Can only make knee jerk decisions if you are an expert. Can listen to subordinates, but have to check to see what they relied on for their decisions. Have to look at reports DE § 141(e). If BOD would have asked questions of VG, then it would have been more like a report and court would have let him go. DE § 102 (b)(7) (Response to Smith, because no one wanted to be a BOD member) Opt- in provision- Can limit or prohibit personal liability of a director for $ damages (can still sue for an injunction) only for duty of care, as long as they still acted in good faith and be loyal. Shareholders have to give them the shield. Malpiede (Interpreting DE §102 (b)(7) liability shield) Facts: Company had a 102(b)(7) provision in its charter, so lawyers tried to get to directors by saying it was not just a duty of care claim, but also a duty of loyalty claim because they were intertwined. Holding: P‟s only really pleaded DOC, they did not show a breach of DOL. LEVI FOCUS: 2 views on how this case should be read (1) That §102(b)(7) is a huge shield (2) That is an erosion of §102(b)(7) because the court is telling you to flush out your claims. FL §607.0831 Opposite of DE. Directors are in better situation because it is opt-out, they already have a shield for $ damages. Can protect for duty of care and duty of loyalty breach. MBCA These jurisdictions provide for a shield for duty of care and duty of loyalty but they are opt in (like DE‟s opt in for duty of care) iii) BJR – Substantive v. Procedural Portion, Difference between Standards and Liability. (1) There is a difference in certain situations between the standards of conduct the BOD has to comply with and standards for the imposition of liability. But once you get into the lawsuit you have the BJR that imposes a much lower standard of liability than the standard owed. Decision making has procedural and substantive aspects. (a) Substantive portion of BJR: If when you are making the decision, your decision is reasonable, you do not have to ensure that it will come out fine. (b) Procedural portion of BJR: Some courts will take into consideration how you go about making your decision and how well you were informed. Plaintiff has to show that the BJR should not apply. If court does not apply the BJR then you either look at : (i) reasonableness or (ii) entire fairness standard, (a) fairness of dealing and (b) fairness of price) – Conflict in DE about which to apply. (2) LEVI FOCUS: Francis- Ms. Pritchard did nothing to inform herself of what was going on with the business, so you can‟t give her the presumption of the BJR. Complete ignorance is an exception to applying the BJR. 57 2) Duty of Care spawns a duty of Good Faith –Internal Controls a) Overview i) SOX will only apply to certain companies. But even though it doesn‟t apply to all corps it kind of becomes a background norm and puts pressure on how state courts will interpret things. It becomes an ethic that becomes incorporated into state law duty of care. b) Caremark – Court says you need some type of internal controls. At a minimum you will be in trouble if you do nothing. i) Question is how far will these internal controls have to go? ii) What is you obligation after you put in these types of controls? (1) So you need to check weekly, monthly iii) What if BOD was fully informed but decided to put in internal controls? (1) It depends on how broadly or narrowly Caremark will be read. 3) The Duty to Act in Good Faith a) Think of it as a continuum Duty of Care----------------Duty of Good Faith----------------Duty of Loyalty Designed to promote profit earnings. BOD May be protected with DE § 102(b)(7). Breach of D of GF is worse than Worst violation. Be violation of DOC, but does not faithful to your rise to breach of DOL. Comes up company in Caremark, but court does not give an definition. Disney Does. Courts created a duty of good faith because they were pissed that legislature put in DE § 102(b)(7) to get around the duty of care. By creating a D of GF, people who are harmed can still Standards for Violation of get damages. Faith Duty of Good (1) Disney says there is a (a) mens rea component (bad faith) or (b) “Intentional inattention” or (c) egregious (beyond gross) negligence. (2) Can‟t use the BJR as a defense to a breach of duty of good faith claim. i) Walt Disney Case I Overview: Plaintiff‟s made a duty of care complaint. But Disney has a 102(b)(7) provision, so the court sends it back. Walt Disney Case II Procedure: P‟s added that it was a violation of good faith. The court does not dismiss this. Court says that if P clearly pleads violation of good faith than §102(b)(7) won‟t bar the claim. 4) Overview: Five Developments in Fiduciary Duty Analysis (Duty of Care & Good Faith) a) Caremark i) Duty of care applies when talking about when BOD makes transactions (settled law). The question is does this extend to a duty to monitor? (1) Failure to monitor may become a breach of duty of care. ii) After SOX it seems to be written in stone that you need monitoring devices. b) Emerging Technology i) Shows how BJR can include a higher standard c) Disney & emergence of Duty of Good Faith i) Disney may have won, but reputation damage. Dicta was huge, so can‟t just rely on rule of Disney. Case said difference b/w standard of duty and standard of liability. Dicta was also pro BJR BUT there is language that the minimal norms that the BOD have to meet are different/higher than before. 58 d) Use of DE §220 (inspection of books and records for litigation) i) Disney case morphed form a duty of care case to a duty of loyalty case by using §220 to get as many records as they could and then once they had them they could make a stronger fiduciary duty claim (1) It can‟t be a fishing expedition- but that is exactly what it is. e) Reliance on Reports (Smith v. VG) Chapter 9- The Duty of Loyalty 1) Self- Interested Transactions a) Overview i) 19th Century- Historically there was an absolute prohibition ii) 20th Century-Then relaxed to OK if have shareholder approval iii) Then relaxed more with either (a) was it fair or (b) do you have shareholder approval? iv) Today- Is moving backwards, more constraints. b) Four types of Self-Dealing transaction i) When a director has self interest in a decision that he has the power to make (1) Ex. Director sells his own property to his the corp, or director who is chairman of a bank, loans the corp he is director of $ ii) Transaction between a corp and some other business entity that the director of the corp has direct or indirect (family tie) financial interest in iii) Transaction between parent and partially owned sub iv) Interlocking directors (Lewis v. SL) c) Standard of Review for D of Loyalty i) BJR? No. BECAUSE BJR only applies when the transaction is not tainted. You know that it is tainted when if the majority of the board has self-interest, if the D has influence over the rest of the board, or if the interested D manipulates the process. Lewis v. SL (New York) Facts: Family Corp was renting property to their own sub corp for much less than they would have gotten from a stranger. Holding: Court says that there has to be a finding that the deal is fair, and in this case there is no such finding. Rule: In cases with interlocking directors, the D has the burden to prove the fairness of the deal. If P claims breach of this duty, D has to prove it was fair. (Straight fairness standard). Reasoning: Not a fair deal because they did not know how much the property would have gone for otherwise LEVI FOCUS: If this is what the family has in mind when they created this arrangement why is the court imposing a stringent fairness test? BECAUSE the court is trying to tell you if you are going to create 2 different corp entities, then play by the rules and treat them like it. LEVI WHAT IS FAIRNESS: It is a range of possibilities, not necessarily the best or the worst price, but a reasonable price. But in this case the court seems to be implying that it has to market tested. So can no self-dealing transaction ever be fair unless it is tested against the market? Probably not! (Got to see if it is a good deal at the time for the particular company) 59 Cookies v. Lakes (Iowa) Rule: No obligation to disclose profit, but have to disclose identity along with fairness standard. Talbot v. James (South Carolina) Facts: James (a BOD member of corp A) contracts his own construction company to build condominiums for corp A. He did not tell the rest of the BOD members on corp A that he was getting good shit out of this. Shareholders sue. Holding: Shareholders of corp A win. Have to disclose identity of construction company, and the profits made along with the fairness standard. Rule: Even if a deal is fair, no disclosure will kill it. Reasoning: The deal in the case was fair because the price they were going to pay was less then other construction company‟s bids, BUT he did not disclose. d) Levi‟s Overview to get to Statutory Approaches of D of L i) Would disclosure have made a difference in Talbot? No because P‟s would have done the deal anyway. So why does he lose? ii) In Cookies, if D would have disclosed how much he was making, maybe it would have affected the outcome. How do you square the Talbot reasoning with the Cookies reasoning? iii) This moves us to the statutory approaches. DE §144(a) If you have a K that is self-dealing, the transaction is not voidable just because of that. You can cleanse such a transaction by (1) Disclosure plus approval by disinterested board members (Friendship or financial interests can‟t influence them, or court may look a little deeper if they think that there is a “taint” by a bully BOD member, etc.), or (2) Disclosure plus shareholder vote, or (3) Fairness test (comes in if (a)(1) or (a)(2) were not done, or the action failed under them. Courts will look to see if BOD or shareholders ever just ratified the act. Need to look at the particular business at this time in history). TYPE OF DISCLOSURE = fact of relationship and the K itself. LEVI FOCUS: Why is this important? BECAUSE you are putting the burden on the interested director rather than disinterested directors that would not know to even ask. LEVI PONDER: Why would you have DE §144(a)(1) &(2) if under (a)(3) the judges can just decide fairness? Big question is does the fact that there have been a vote by (a)(1) or (a)(2) deprive the court of looking at fairness? Unclear in DE. Marciano in dicta seems to say that the court cannot review under (a)(3) if there has been a vote. FL §607.0832(a) The fact of interest and relationship must be known. (Don‟t ask for a lot of disclosure because they think self-dealing is good. No need for telling how much profit you will get). LEVI FOCUS: Doesn‟t ask for as much info as DE §144 RMBCA § 8.60- Definition of Self Dealing (Same as DE) RMBCA § 8.61 – Judicial Action (Same as DE §144) Not a hard and fast rule, different states that use this will have different outcomes. CA § 310 If you get approval by directors, you still have to show fairness. But if you get approval by shareholders, you just have to show shareholders were disinterested and that you were not coercing them. 2) Use of Corporate Assets; Competition with the Corp; The Corporate Opportunity Doctrine a) Three Violations 60 i) Take a corporate opportunity (1) Four different ways to take a business opportunity (a) line of business (most common) (b) fairness (c) interest and expectancy (d) ALI Approach (i) SOR for disinterested directors saying No = BJR (ii) SOR for disinterested shareholders saying No = Waste Rule (iii) SOR for no rejection = fairness review. Northeast Harbor (Maine- ALI approach) Issue: What is a corporate opportunity? Holding: In this case they used the ALI approach. Different than line of business because of disclosure. In Maine, it is irrelevant if the opportunity is in the line of business if there has not been disclosure to the corporation. Corp gets right of 1 st refusal, and person who is using the assets can‟t make the decision for the corp. LEVI FOCUS: What happens if it was a corp opportunity but the corp can‟t take advantage of it? ALI says even if they would not have been able to take advantage of it, you still have to disclose. Broz v. Cellular Info Systems (DE) Overview: DE does not require disclosure. Instead they use a multi-factor test. Test: A corporate director or officer may not take an opportunity for his own if (1) the corp is financially able to use the opportunity (2) the opportunity is within the corp.‟s line of business (3) the corp has an interest or expectancy in the opportunity (4) by taking the opportunity for his own the BOD member will be placed in a position that won‟t allow him to do his duties to the corp. LEVI FOCUS: It seems to matter to DE courts if the opportunity came in professional or personal capacity. But especially in cases of outside officers, how can you tell if it was personal or business? ii) Use corporate assets, money, and info and your position for your personal gain Hawaiian v. Pablo Overview: Pablo was the president. He bought land for corp, and the people he bought from gave him a %. Rule: A director, while engaged in a transaction for a corp, can not retain an undisclosed profit. iii) You compete with the corporation (especially when corp does not know about it) b) Difference b/w corporate opportunity doctrine and self dealing i) Under self dealing ask (was it fair, disclosure, disinterested), but in corp opportunity doctrine, if you find a violation of corporate opportunity you are screwed (SL).