Business Associations Exam No.______
Prof. James C. Spindler
Friday, December 9, 2005
This is a three-hour, open book examination.
The examination is in two parts, weighted approximately equally. The first part is the
short answer section, and consists of two short scenarios with multiple questions about
those scenarios. These questions are designed to be objective; however, you should be
careful to explain your reasoning. The second part is a single situation issue spotter,
which is designed to test your ability to spot and analyze legal issues, and to present a
balanced argument examining the relative strengths of each side of the issue.
You should be careful to divide your time appropriately among the questions in order to
adequately address each of them.
Where complex organizational relationships are involved, I would suggest that
diagramming the relationships may aid your analysis.
Make sure to state any assumptions or additional information you feel necessary to
resolve the problems or issues.
Unless stated otherwise, assume that the applicable organizational law is the Uniform
Partnership Act of 1997 (UPA) and the Delaware General Corporate Law.
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PART I – Short Answer
Reservoir Construction Co. is a Delaware corporation engaged in the business of
designing, constructing, and repairing dams and reservoirs in Southern California. Its
founders are Mr. Brown, Mr. Pink, and Mr. Orange, who comprise the three-member
board of directors and who also serve as officers of the company.
The shares of Reservoir Construction Co. are held 20% by Mr. Pink, 50.1% by Ramblers
Partners Ltd. (a UPA partnership), and 29.9% by Pink1 Co. (a Delaware corporation).
Pink1 is owned 49.9% by investors in the general public, and 50.1% by Pink2, Inc., a
Delaware corporation. Pink2 is owned 49.9% by investors in the general public, and
50.1% by Pink3, Inc., a Delaware corporation. Pink3 is owned 50.1% by Mr. Pink, and
49.9% by investors in the general public.
Ramblers Partners is owned half by Mr. Pink, and half by Orange-Brown Partners, a
UPA partnership. A partnership agreement among Mr. Pink, Orange-Brown Partners,
and Ramblers Partners (the “Ramblers Partnership Agreement”) provides that Mr. Pink
has one vote in the affairs of the partnership, while Orange-Brown has two votes. There
are no other provisions in the Ramblers Partnership Agreement. Orange-Brown Partners
is owned half by Mr. Orange, and half by Mr. Brown. An agreement among Mr. Orange,
Mr. Brown, and Orange-Brown Partners (the “Orange-Brown Partnership Agreement”)
provides that any voting or other rights arising under any shares, partnership interests, or
other securities or such instruments owned by Orange-Brown Partners will be divided
among the Orange-Brown partners according to their level of ownership in Orange
Brown Partners (rounding to whole numbers as needed in the case of indivisible votes or
Lately, Mr. Brown, Mr. Orange, and Mr. Pink have had something of a falling out; in
particular, Mr. Orange and Mr. Brown have expressed a desire to expel Mr. Pink from the
business. Your law firm, Dewey Cheatham & Howe, represents Mr. Pink. Your boss,
Dewey, has asked you to answer (and explain, as necessary) the following questions:
a. Is the Ramblers Partnership Agreement valid under the UPA? Why or why not?
b. What are the economic stakes of Mr. Pink, Mr. Brown, and Mr. Orange in
Reservoir Construction Co.? (Note: an approximate answer is fine; you can
round all numbers to the nearest whole percentage point.)
c. The annual meeting of the shareholders of Reservoir Construction Co. is coming
up next week, where the shareholders will elect the board of directors. Explain
how the voting is likely to go.
d. What actions, if any, can Mr. Pink take to protect his interests in Reservoir
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Dr. Benway, Dr. Thompson, and Dr. Gonzo own and operate two businesses: the Naked
Lunch Counter, a rather risqué cafeteria, and Fear and Clothing, Inc., an edgy designer
boutique. The Naked Lunch Counter is a partnership under the UPA, and Fear and
Clothing is a Delaware corporation.
Starting at the bottom, Fear and Clothing, Inc., which operates the designer boutique
assets, is 100% owned by FC Holdco, a Delaware corporation with no other assets. FC
Holdco is 100% owned by the Naked Lunch Counter partnership, which also operates the
cafeteria assets. There are two equal partners in The Naked Lunch Counter partnership:
Burroughs Holdco, a Delaware Corporation, and The Junk Partners, a UPA partnership,
neither of which have any other assets. Burroughs Holdco is 100% owned by Dr.
Benway, and The Junk Partners is owned half by Dr. Thompson, and half by Dr. Gonzo.
a. On which loan (and why) would the interest rate be higher?
i. A loan taken out by Burroughs Holdco or an otherwise identical loan
taken out by The Junk Partners?
ii. A loan taken out by FC Holdco or an otherwise identical loan taken out by
Fear and Clothing, Inc?
b. If the Naked Lunch Counter borrows $100 from the Bank of Tangiers and then
defaults, which entities and persons could be liable on the debt?
c. Is there any reason for…
i. …Dr. Thompson to worry if Dr. Gonzo takes out a large loan from the
bank to buy cafeteria equipment for The Naked Lunch Counter?
ii. …Dr. Thompson to worry if Dr. Gonzo takes out a large loan from the
bank to buy a racehorse?
iii. …Dr. Benway to worry if Dr. Gonzo takes out a large loan from the bank
to buy a racehorse?
iv. Between ii and iii, is there more worry in one than the other?
d. The Bank of Las Vegas is considering making a loan to the Naked Lunch
Counter. The business assets consist of cooking equipment, secret recipes, and
the real estate on which the cafe is located. Explain how each of the following
impacts the willingness of the Bank of Las Vegas to make the loan.
i. At the time of formation of the Naked Lunch Counter in 2002, Dr.
Benway had Burroughs Holdco contribute $1MM in cash in return for
partnership equity. The Naked Lunch Counter used the cash to purchase
the kitchen equipment which it currently operates, which, because of its
collectible and vintage nature, is now worth approximately $3MM on the
ii. In 2003, Dr. Benway purchased the secret recipes that the Naked Lunch
Counter currently uses from a Moroccan chef, with a check written from
his personal bank account for $250k. The recipes have proven quite
popular in the market and are now estimated to be worth $3MM.
iii. In 2004, Dr. Benway wrote a check to the Naked Lunch Counter for
$1MM in order to fund a working capital shortfall. The Naked Lunch
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Counter, which prior to receiving the check had a negative balance in its
bank account, bought the real estate on which it currently operates for
$850k in cash immediately after receiving the check. The building is now
worth approximately $4MM.
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Your phone rings, and you pick it up to hear Jack Burton, CEO and Chairman of Big
Trouble Chinese Imports, Inc. (“Big Trouble”) (a Delaware publicly-traded corporation
with a market capitalization of about $150MM) on the other end of the line. Burton
informs you that Big Trouble is about to embark on a new business venture, and would
like your advice on any legal issues that may arise.
Big Trouble, which imports materials and goods from East Asia, believes that they can
profitably enter the “fluffy pillow” market due to their access to a long term supply of
very competitively-priced “pillow-grade fluff” from China. The fluff importation and
domestic processing is handled by a fully-owned subsidiary, Porkchop Express, Inc.
(“Porkchop”), a Delaware corporation. A confidential Goldman Sachs investment
banking report estimates Porkchop’s market value (were it to be sold as a going concern)
at approximately $4MM. However, while Big Trouble can obtain the requisite fluff, it
does not have the ability to independently produce, process, or obtain pillow shells to
contain the fluff.
Fortunately, though, Burton has identified a strategic partner for the fluffy pillow
enterprise in Shaolin Shadowboxers Corporation (“Shaolin”), a privately-held Delaware
corporation, which produces men’s underwear. Shaolin can retool the machinery of its
checkered boxer short division, Chessboxers, Inc. (Chessboxers), a wholly owned
subsidiary Delaware corporation, to produce fluffy pillow covers. Shaolin’s CEO, the
rather mercurial Rae Kwon, has wholeheartedly endorsed the deal, and in fact has already
executed a contract agreeing, on Shaolin’s behalf, to enter into a “strategic alliance” with
Big Trouble. The terms of the signed contract include (a) that Chessboxers and Porkchop
will merge to create a new jointly-owned subsidiary, to be set up as a Delaware
corporation and named Fists of Fury Fluffy Pillow Company (“Fists of Fury”), (b) a
division of revenues and preferred dividend plan that Burton tells you is very favorable to
Big Trouble, (c) that Big Trouble will have 3 of the 5 directorships on the Fists of Fury
board, and (d) that Rae Kwon will be guaranteed employment as Chief Fluffy Pillow
Testing Officer, and paid a salary of $1MM per year.
Burton tells you that, while this is an encouraging start, there have been some rough
spots. Most notably, Dirt McGirt, a board member and major shareholder of Shaolin, has
denied the validity of the agreement, insisting that the Shaolin board never authorized the
deal. Furthermore, it comes to light that Rae Kwon’s employment contract, while giving
Rae Kwon broad control over the affairs of the firm, explicitly forbids Rae Kwon from
selling capital assets of the company without getting approval of the board.
Subsequent to your initial conversation with Burton, plans get underway to merge
Porkchop and Chessboxers. Among the specifics (in addition to that described above):
• The merger will be set up as a statutory merger under DGCL § 251. Big Trouble
and Shaolin will each receive 50 shares of common stock in the new entity.
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• The charter states that the purpose of Fists of Fury is to produce, market, and sell
• The charter states that Fists of Fury may not issue additional securities (other than
ordinary course trade debt), may not borrow money, and may not purchase any
capital assets without majority shareholder approval.
• The charter states that Fists of Fury must pay dividends with any retained
earnings in excess of $1MM.
As soon as Big Trouble and Shaolin issue a press release announcing the deal, a
shareholder of Big Trouble attacks the merger in court, claiming violation of proxy rules
and a wrongful denial of appraisal rights.
Some time thereafter, about ten months after the merger is successfully accomplished,
Burton calls you again. Fists of Fury’s business is booming: profit in the first quarter of
operation was negative, but second quarter proved quite profitable – net earnings of
$350,000 – and expectations are for profits to grow rapidly. If things continue to go as
they’ve been going, profits will approach $2.5MM per year by the end of 2007.
Taking advantage of their good fortune and in order to free up some cash, both Big
Trouble and Shaolin agreed to sell 10 shares each of Fists of Fury to a newcomer, the
Pikachu Corporation, a Japanese firm, for a price of $300k per share. Subsequently,
however, Big Trouble finds itself again in a cash crunch, and Burton enters into
negotiations with Shaolin over the sale of 20 shares of Fists of Fury to Shaolin. Shaolin
agrees to buy, and terms hammered out in an agreement between Shaolin and Big
Trouble provide that:
• Big Trouble will sell 20 shares of Fists of Fury to Shaolin for the price of $1MM
• Shaolin will vote its shares so as to guarantee Big Trouble two seats on the board
of directors of Fists of Fury.
• Big Trouble will be the exclusive supplier of fluff to Fists of Fury.
Once that is ironed out, a new matter emerges. Gracie Law, a director and officer of both
Big Trouble and Fists of Fury, has brought to Burton’s attention a new, and potentially
lucrative, business opportunity: a possible takeover target for Big Trouble. The target is
Master Killer Cuddly Cushion Company (“Master Killer”), a small, publicly traded
Delaware corporation. Master Killer is in the business of designing and importing cuddly
cushions, an industry in which Big Trouble has some expertise, and Master Killer appears
to be operating well below its potential. Furthermore, Master Killer generates significant
cash, which Big Trouble is in need of. In short, both Burton and Law believe a strategic
acquisition and consolidation would add much value.
One wrinkle: Law learned of Master Killer while attending a meeting at an investment
bank in her capacity as a director of Fists of Fury (the subject of a meeting was a possible
public issuance of securities by Fists of Fury, an idea which has been since discarded).
The banker originally pitched Master Killer as a merger partner with Fists of Fury, but is
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even more optimistic regarding an acquisition by Big Trouble. While Law and Burton
insist that Fists of Fury “doesn’t do that kind of business,” both Law and Burton admit
that Shaolin (and, in particular, Rae Kwon) would likely be very interested in a Master
Killer acquisition as well.
END OF EXAM
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