BIZ ORG OUTLINEAGENCYWHO IS AN AGENT A. Agency is the fiduciary
relation which results from i. Consent a. Consent by the principle
for the agent to act, must manifest that the agent will act for him
ii. Acceptance a. Agent must accept the undertaking, act on behalf
of the principle (& both parties intend this) iii. Control 1.
Understanding that the agent is subject to control by the
principle. (a) Control only over the goal, not the means of
accomplishing it (lawyers). B. Formation & termination of an
agency relationship i. Unlike a contract (which is negotiated etc.)
an agency agreement is created very easily. Once A agrees to do
something for P, and A is acting on Ps behalf & is subject to
Ps control the agency relationship is created. a. Gorton v. Doty,
69 P.2d 136 (1937) woman tells the football coach who needs to
transport students to a game to use her car (but only he can drive
it). She volunteered the use of her car, no compensation. Accident
happens & suit against the woman, as the principle. Agency
relationship existed here between woman & coach. Woman
consented that coach act in her behalf in driving her car by
volunteering her car & her condition that only he drive it
shows the control she had. 1. How you describe it makes the diff on
whether or not its agency: (a) Gave permission this is a loan, not
agency (b) Directed - telling him what to do this is agency. 2.
This is a little extreme b/c it almost looks like it was only a
loan. But fact is that insurance is covering the woman, and the boy
injured has no insurance. So looks like court just wanted to cover
the boy. 3. Solution: if she had specified she is loaning the car
to him, then that would have settled it. b. It is not essential
that there be a contract between the principle and agent or that
the agent promise to act as such, nor is it essential to the
relationship of principle and agent that they, or either, receive
compensation. ii. Agency can be terminated at the will of either
party (notion that involuntary servitude is bad). Different from
contract relationship which you cannot just breach & court will
enforce. C. Creditor-debtor relationship vs. agent-principal
relationship i. A creditor who assumes control of his debtor's
business may become liable as principal for the acts of the debtor
in connection with the business ii. Gay Jenson Farms Co. v.
Cargill, Inc., P. 7 Court found agency relationship due to the
amount of control exerted by Cargill on Warren 1
1. Consent by principle C consented by directing W to implement
certain procedures 2. Agent acting on behalf of principle W acted
on Cs behalf in procuring grain for C, as part of its normal
operation which were totally financed by C. 3. Principle exercise
control over agent - C had a lot of influence and control over Ws
financial situation. b. An agreement may result in the creation of
an agency even though parties didnt call it an agency and did not
intend the legal consequences of the relation to follow. c. Someone
who contracts to acquire something from a 3rd person and convey it
to another is an agent only if it is agreed that he is to act
primarily for the benefit of the other. AGENCY POWER TO BIND -
LIABILITY OF PRINCIPLE TO THIRD PARTIES IN CONTRACT y y Actual
Authority - principle gave the agent the authority explicitly;
completely clear Implied Authority - Implied authority is actual
authority circumstantially proven which the principal actually
intended the agent to possess and includes such powers as are
practically necessary to carry out the duties actually delegated. o
To determine whether implied authority exists, it must be
determined whether the agent reasonably believes because of present
or past conduct of the principal that principal wishes him to act
in a certain way or have certain authority. Sometimes may be
necessary to implement express authority Prior similar conduct o
i.e. Have authority because its something that normally goes along
with the actual authority given. Mill Street Church of Christ v.
Hogan, 785 S.W.2d 263 (1990) Church has hired y Bill to paint. B
hires S to help, S is hurt and wants workers comp, but only for
employees. Did B have authority to hire S? a. Bill is an agent of
the Church (an employee Church hires Bill & has control over
Bill) b. Bill didnt have actual authority to hire Sam, but had
implied authority. 1. past conduct - Bill had been allowed to hire
Sam for previous work. 2. necessary to implement the express
authority - in order to finish the work, Bill had to hire a helper.
3. agent reasonably believed he had the authority - practice in the
past; Bill never told otherwise; Church even paid Sam for hours
worked. D. Apparent Authority when a principle acts in such a
manner as to give the impression to a third party that the agent
has certain powers which he may or may not actually possess. It is
a matter of appearances on which third parties come to rely. i. 3rd
parties have the right to believe the agent has the authority it is
reasonable to believe they have. ii. Three-Seventy Leasing
Corporation v. Ampex Corporation, 528 F.2d 993 (1976) Joyce, the
only employee of 370 corp, is in negotiations to buy HW from Ampex
& 2
is speaking to Ampexs employee, Kays (salesperson). Kays sends
Joyce an offer at the direction of Kays superior. a. An agent has
apparent authority sufficient to bind the principal when the
principal acts in such a manner as would lead a reasonably prudent
person to suppose that the agent had the authority he purports to
exercise. b. Absent knowledge on the part of 3rd parties to the
contrary, an agent has the apparent authority to do those things
which are usual and proper to the conduct of the business which he
is employed to conduct. c. Kays was employed by Ampex as a
salesman; it is reasonable for 3rd parties to presume that a
salesman has the authority to bind the employer to sell. d. Ampex's
actions furthered this belief; Document was given to Joyce at the
direction of Mueller, Kay's superior, and also Mueller agreed that
all communication with 370 would be through Kays. Doesnt matter if,
internally, Kays really didnt have this power. E. Inherent Agency
Power authority that comes from the role/status that comes with
being an agent. The agent (in the role/status) ordinarily possesses
certain powers. i. A servant acting within the scope of his
employment has inherent authority to commit torts - basically same
thing as respondeat superior. ii. Watteau v. Fenwick, Queen's Bench
(1892) - Humble sold business to Fenwick, but Humble still manager,
and Humble name on the door. Humble buys a bunch of stuff, no
payment a. Rest (2nd) Agency 194 - an undisclosed principle is
liable for acts of an agent done on his account, if usual or
necessary in such transactions, although forbidden by the
principle. b. Rest (2nd) Agency 195 - an undisclosed principal who
entrusts an agent with the management of his business is subject to
liability to third person with whom the agent enters into
transactions usual in such business and on the principals account,
although contrary to the directions of the principal. c. J. Learned
Hand - "It makes no difference that the agent may be disregarding
his principal's direction, secret or otherwise, so long as he
continues in that larger field measured by the general scope of the
business entrusted to his case." d. Rest (2nd) Agency 161. A
general agent for a disclosed or partially disclosed principal
subjects his principal to liability for acts done on [the
principles behalf] which usually accompany or are incidental to
transactions which the agent is authorized to conduct if, although
they are forbidden by the principal, the other party reasonably
believes that the agent is authorized to do them and has no notice
that he is not so authorized.
LIABILITY OF PRINCIPAL TO THIRD PARTIES IN TORT I. Roseburg says
three factors: A. Time/place B. Hired to do C. Scope of employment
(see below)3
II. Servant v. Independent ContractorA. A master is subject to
liability for the torts of his servants committed while acting in
the scope of their employment. As a general rule, a principle is
not liable for the torts of his non-servant agents - i.e.,
independent contractors. i. Servant-Master Relationship respondeat
superior; master liable for torts of his servants a. Master/servant
relationship exists where the servant has agreed to work on behalf
of the master and to be subject to the master's control or right to
control the "physical conduct" of the servant (the manner in which
the job is performed as opposed to the result alone). ii.
Independent contractors a. Agent-type independent contractor - one
who has agreed to act on behalf of another, the principal, but not
subject to the principal's control over how the result is
accomplished (over the physical conduct of the task). b. Non-agent
independent contractor - one who operates independently and simply
enters into arm's length transactions with others B. Whether the
relationship between the parties is an agency relationship does not
depend on what the parties call it, but what it actually is. The
parties cannot effectively disclaim it by formal consent. i. Humble
Oil & Refining Co. v. Martin, 222 S.W.2d 995 (1949) Love gives
her car to gas station owned by Humble for servicing. Negligence by
gas station & Martin injured by the car. Humble liable for
negligence? Humble says no b/c gas station operated as an
independent contractor, Schneider. Neither Humble nor Schneider
considered Humble the employer. a. Court says its a servant-master
relationship, so Humble is liable. Humble had strict financial
control & supervision over the gas station. 1. Humble furnished
the station location, equipment, advertising, and a substantial
part of the operating cost (they gave a 75% commission on
Schneider's payment of utilities, so Humble was effectively paying
75% of the utilities). Hours of operation controlled by Humble.
Humble could terminate at will Schneider's occupation of the
premises. Schneider had to do whatever Humble told them to do. The
only thing Schneider had the discretion to do was hiring, firing,
payment and supervision of the few employees. So looks more like
Schneider is an employee just being paid based on commission. C.
Control is an essential element of an agency relationship, whether
a servant or an independent contractor. To determine whether the
relationship is master-servant, the court will look at whether the
principle had control over the day-to-day operations. i. Hoover v.
Sun Oil Company, 212 A.2d 214 (1965) gas station employee
negligently caused a fire at a service station owned by Barone. s
brought suit against Sun Oil, Barone & the employee. Barone
leased the gas station from Sun, & had a dealers agreement that
dictated the K between them. Barone not obligated to do what Sun
would recommend, & determined the day-to-day operations. Barone
could sell whatever he wanted, although there were rules on what he
used Suns products for. 4
a. Held independent contractor - the close contact between the
two show merely that they have a mutual interest in the sale of Sun
products and in the success of Barone's business. Sun did not have
control over the day-to-day operations. 1. Control or influence
over the results alone is insufficient. D. Franchise agreement -
the franchisee will agree to operate its business in certain ways,
as required by the franchisor, in exchange for the use of the
license. The purpose of this is to create standardization in all
the franchises nationwide (to achieve the "brand"). However, a
franchise could still be a servant-master relationship if there is
sufficient control by the franchisor. i. Murphy v. Holiday Inns,
Inc., 219 S.E.2d 874 (1975) - Betsey-Len Motor Hotel Corporation
had a licensing agreement (franchise) with Holiday Inns, to use
their name/logo. Architecture of Betsey must be approved by
Holidays Inn, Betsey not allowed to sell stock w/o approval, Betsey
must operate under Holidays rules of operation & make quarterly
reports & submit to periodic inspections by Holiday. A customer
had a slip & fall and sues Holiday Inn for the negligence. a.
Not servant-master, this is a typical franchise agreement. Holiday
Inn does not have the control or right to control the methods or
details of doing the work. The purpose of the provisions was to
"achieve a system-wide standardization of business identity,
uniformity of commercial services . for the benefit of both
contracting parties." Betsey still had the control over the
day-to-day operations, and most other powers customarily exercised
by an owner. ii. Rationale for allowing a certain level of control
in franchising agreements: a. The problem of free-riding:
franchisee would take advantage of other peoples investments
(establishment of the brand name) and exploit it. If the franchisee
could do whatever they wanted, it would ruin the brand name.
III. Tort Liability and Apparent AgencyA. Advantages of setting
up a business as a franchise: i. Establish a brand name ppl can
walk in any location and know what to expect ii. Less liability for
the national company than having branches a. But national wants
some control since theyre promising something iii. Owners will work
harder than managers, even though same money & same job B.
Policy Issue for franchises should we allow businesses to insist
that they present themselves as one enterprise for purpose of
advertising, but then turn around for tort purposes and say were 2
enterprises? On its face it looks like consumer fraud. Although its
ok for contract purposes, not clear if its ok for tort purposes. C.
Miller v. McDonald's Corp., 945 P.2d 1107 (1997) - sues McDonalds
for injuries b/c she bit into a stone while eating a burger.
McDonalds was a franchise, owned by 3K, & had an operating
agreement that required 3K to operate in a manner consistent with
the McDonalds system, and described how it should be operated in a
lot of detail. K also explicitly stated 3K not an agent for any
purposes. i. Liability under Actual Agency: The Control Test If the
franchise agreement goes beyond the stage of setting standards, and
gives the franchisor the right to exercise control over the daily
operations of the franchise, an agency relationship exists. a. If
McDonalds retained sufficient control over 3K's daily operations,
then an actual agency relationship would exist (jury question).
Agreement didnt just set 5
standards - it required 3K to use the precise methods that
McDonalds established. McDonalds enforced the use of those methods
by regular inspections & retained power to cancel the
Agreement. ii. Apparent Agency - One who represents that another is
his servant or other agent and thereby causes a third person
justifiably to rely upon the care or skill of such apparent agent
is subject to liability to the third person for hard caused by the
lack of care or skill of the one appearing to be a servant or other
agent as if he were such. a. Question for jury whether McDonalds
held 3K out to be its agent & whether justifiably relied on
that representation 1. (Representation) Everything about the
appearance of the restaurant identified it with McDonald's - this
image the McDonalds had worked to create reputation, etc. 2.
(Reliance) General public not expected to understand how franchise
works. McDonalds cannot ignore its own efforts to lead the public
to believe that all McDonald's are the same.
IV. Scope of EmploymentA. Conduct of a servant is within the
scope of employment if it is actuated, at least in part, by a
purpose to serve the master (this is the minority, majority, must
be in furtherance of masters objective.) see below i. Ira S. Bushey
& Sons, Inc. v. United States, 398 F.2d 167 (1968) - Sailor
(works for U.S.) arrived back at his ship drunk, and negligently
caused damaged to the ship & drydock (owned by ). U.S. argues
its not liable b/c sailor acting outside scope of employment. a.
The sailor's conduct was not so unforeseeable as to make it unfair
to hold the government liable. The employer should be held to
expect risks, to the public also, which arise 'out of and in the
course of' his employment of labor. It is foreseeable that a
drunken sailor might cause damage while crossing a drydock on the
way back to his ship. B. Rosenberg: Three ways to determine scope
of employment i. Motive, why did the person do what they did? ii.
Public policy approach iii. Bushey standard (above, no requirement
of purpose to serve the master as the restatement does, just
foreseeablility) C. A servant's acts may be within the scope of
employment although consciously criminal or tortious (except
serious crimes). A servant's use of force against another is within
the scope of employment if the use of force is may be expected by
the master. i. Ex: the owner of a nightclub probably would be held
liable for injuries inflicted by a bouncer in ejecting someone from
the bar. The owner presumably hired the bounder for the very
purpose of using force to eject drunken or otherwise undesirable
patrons. ii. Manning v. Grimsley, 643 F.2d 20 (1981) professional
baseball game, pitcher threw a ball at & injured him ( heckling
him, and evidence that pitcher did it intentionally). Court found
employer liable for pitchers action b/c he was acting within the
scope of his employment. 6
a. To recover damages from an employer for injuries resulting
from an employee's assault, it must be shown that the assault was
in response to the 's conduct which was presently interfering with
the employee's ability to perform his duties successfully. 1. The
heckling was conduct that had affirmative purpose to interfere with
employees performing his duties successfully, and the pitcher's
assault was not a mere retaliation for past annoyance, but a
response to continuing conduct which was presently interfering with
his ability to pitch in the game.
V. Liability for Torts of Independent ContractorsA. Ordinarily
when a person engages an independent contractor (who conducts an
independent business by means of his own employees), he is not
liable for the negligent acts of the contractor in the performance
of the contract, but there are three exceptions: i. When landowner
retains control of the manner & means of the work contracted
for ii. Where he engages an incompetent contractor iii. Where the
activity contracted for constitutes a nuisance per se. a. Liability
imposed upon a landowner who engages an independent contractor to
do work which is inherently dangerous (a nuisance per se). 1.
Inherently dangerous - an activity which can be carried on safely
only by the exercise of special skill and care, and which involves
grave risk of danger to persons or property is negligently done. 2.
Ultra-hazardous - an activity which necessarily involves a serious
risk of harm to the person, land or chattels of others which cannot
be eliminated by the exercise of the utmost care, and is not a
matter of common usage. Liability is absolute where the work is
ultra-hazardous. b. Majestic Realty Associates, Inc. v. Toti
Contracting Co., 153 A.2d 321 (1959) Authority hires Toti to
demolish a building which was adjacent to 's. In the process, there
was damage to 's building. Evidence showed that it was hazardous
work. Authority held liable b/c the work was inherently
dangerous.
FIDUCIARY OBLIGATIONS OF AGENTS VI. Duties during AgencyA.
Reading v. Regem, 2 KB 268 (1948) - sergeant in the British army
paid a lot of money by escorting a smuggler's trucks. Crown gets
the money i. Servant is liable to his master if he takes advantage
of his service and violates his duty of honesty & good faith to
make a profit for himself, and the position he occupies is the
cause of obtaining the money, rather than providing the opportunity
for him to get it. Doesnt matter if master hasnt lost any profit or
sustained any damage, or that master couldnt have done the act
himself. ii. Examples: a. Money goes to master - Police officer
accepts bribes to direct traffic away from crime scene. The only
reason he had any authority to be able to direct traffic away &
the only reason he got paid, was b/c of his position as a police
officer & his uniform.
7
b. Servant keeps the money - Employee during time he's supposed
to work, gambles. Employer can sue him for breach of K, but the
money he makes from the gambling is his. B. Agent has the fiduciary
duty to act solely for the benefit of the principle. An employee
violates this duty by failing to disclose all facts relating to his
work and by receiving secret profits from it. i. General Automotive
Manufacturing Co. v. Singer, 120 N.W.2d 659 (1963) Singer worked
for General. Employment K says Singer would devote his entire time,
skill, labor and attention to said employment and not to engage in
any other business. Singer doesnt think General can fill some
orders & gets them filled somewhere else, making himself a
profit. a. Singer violated his fiduciary duty to act solely for the
benefit of General, so he is liable for the amount of the profits
he earned in his side business. He had a good faith duty to
disclose the fact that he didnt think General could fill the
orders; then General could decide what to do. VII. Duties during
and after termination of Agency (see below for more grabbing and
leaving) A. Post-termination competition with a former principle is
permitted, but the former agent is barred from disclosure of trade
secrets or other confidential information obtained during his
employment. B. Soliciting former employers clients i. Town &
Country House & Home Service, Inc. v. Newbery, 3 N.Y.2d 554
(1958) was an employee of , a house cleaning service. leaves
employment, then sets up a competitive business. had breached the
confidential relationship (b/c it stole the plan, which was unique)
and also solicited customers (which it had built over the years).
a. A former employee may not solicit his former employers customers
if those customers cannot be readily ascertained by means other
than knowledge b/c of the employment. Where the customer list was
secured by years of business effort & advertising, and the
expenditure of time & money, constituting a part of the good
will of a business. C. General Rules i. While an employee you can't
compete with employer b/c you have a fiduciary duty ii. You can
terminate the agency at will, however, so once you quit, you no
longer owe a fiduciary duty & you can compete. a. Knowledge
received by employment, reputation, etc. you can take this with
you. What you can't do is walk away with a client list on paper. b.
Reason: Otherwise, it would be like slavery either you stay with
the same company forever, change careers, or pay royalties to
previous employer. 1. Exception information thats confidential like
patents. But this is addressed by non-competes (contract), so
unnecessary to address in agency law. D. *This is different for
lawyers soliciting clients, because the courts are concerned with
preserving the clients right to chose their own lawyer. Not to
protect lawyers right to solicit (although this is the practical
effect) but rather the clients right the choose. (SEE P. 13 for
more on grabbing and leaving) 8
PARTNERSHIPSI. Elements of a PartnershipA. 5 Elements of a
Partnership UPA (Uniform Partnership Act) 6. Partnership is an
association of "two or more persons to carry on, as co-owners, a
business for profit." i. Association of two or more a. agreement
necessary, but no written contract. Agreement is to associate, not
to form a partnership. b. no formal partnership agreement required
c. no governmental registration required d. If you fit the elements
of a partnership, youre a partnership. ii. Persons a. Person can be
a corporation (or any other business entity) or a natural person.
Some "people" are not "persons" under definition of law - minors,
etc. b. can't form a partnership with yourself, but you could with
a corporation of which you were the sole shareholder. iii. As
co-owners a. not employee/employer. iv. In a business a. Not a
church, not a share of stocks b. co-ownership of a rental property
as joint tenants is not enough v. For profit. a. Not-for-profits
don't count b. Just b/c no profit made won't mean its not a
partnership, as long as they intended to make profit B. UPA 7:
Rules for determining existence of a partnership i. Joint
tenancy/joint property/part ownership doesnt of itself establish
partnership ii. Sharing of gross returns doesnt of itself establish
a partnership iii. UPA 7(4) Receipt of a share of profits of a
business is prima facie evidence of partnership, but no such
inference shall be drawn if (exceptions): a. Wages or rent (even if
calculated based on profit) - store may pay landlord rent based on
profits of the store w/o landlord becoming its partner. b. Debt
repayment - if business owes ex-partners money, this doesnt make
them a partner, it makes them a creditor. c. Annuity to deceased
partner - if you want to retire, your payments should not be based
on profits; but they may be if you are dead. d. Interest - If you
lend money to the partnership & take as interest a share of
profits, you are not a partner. But if you invest money in the
partnership & take a share of the profits, you are. 1. So what
becomes important is the level of control. e. As consideration for
sale - the distinction between allowing in a new investor and
selling the business is going to be tough to make if the seller
still receives a share of profits. C. Liability Rules of a
partnership
9
i. Profit Sharing Default Rule profits are split per
person/partner, w/o regard to money or labor contribution. But you
can change the default rule by agreeing to something else in the
partnership agreement. ii. Splitting losses default rule - losses
follow profits. So if you make agreement on profits, losses also
split that way. a. 3rd party breach of K or torts - Sue the
partnership & collect. But if partnership is insolvent? 1.
Partners held jointly and severally liable for the obligations of
the partnership (UPA 15). Each partner is a guarantor of the
partnerships full debts. b. Partnership agreement can say how
losses (debts) will be split. If agreement says Partner A is liable
for 90% of debts, B 10% of debts, you can still sue B for full debt
and collect. But then B can sue/collect from A the 90%. 1.
Reasoning: 3rd parties entitled to rely on the entity, plus that
each individual partner puts their individual credit behind the
partnership. iii. UPA 9: Every partner is agent of the partnership
for purpose of its business. The act of every partner for carrying
on the usual way of business binds the partnership, unless he has
no authority to act in particular manner and 3rd party knows. iv.
UPA 13: Partnership liable for any wrongful act or omission of any
partner acting in the ordinary course of the business or
partnership or w/ authority of co-partners v. UPA 17: Person
admitted into existing partnership liable for all obligations of
the partnership arising before his admission vi. Federal Income tax
purposes income and losses of the partnership are attributed to the
individual partner; the partnership itself does not pay taxes.
II. Partners Compared with EmployeesA. UPA 42: The sharing of
profits is prima facie evidence of partnership, but no such
inference shall be drawn if such profits were received in payment
as wages of an employee. B. Fenwick v. Unemployment Compensation
Commission, - Chesire works for Fenwick & asks for a raise.
Fenwick agrees only if hes making enough money, so he gets a lawyer
to write an agreement, which said Chesire is a partner (so Chesire
gets share of profits). Chesire leaves employment, & Fenwick
refuses to pay into the unemployment fund b/c she wasnt an employee
within the meaning of the statute. said the agreement was not a
partnership agreement, but just an agreement fixing the
compensation of the employee. Court held that no partnership
created, the K was nothing more than a method to provide for
compensation. Just b/c the agreement says they are a partnership,
doesnt make it so. i. Court looks at the characteristics of a
partnership: a. The intention of the parties just b/c K said
partnership, doesnt make it so. The real reason for the K was to
provide calculation for an increase in compensation, but to protect
Fenwick in case he couldnt afford it. b. The right to share profits
not every agreement that gives a right to shares profits is a
partnership, so not conclusive. c. The obligation to share losses
only Fenwick liable for debts of partnership. d. The ownership and
control of the partnership property & business - Fenwick
contributed all the capital & Chesire had no right to share
capital upon dissolution. Fenwick also retained all control. 10
e. Community of power in administration - Fenwick had exclusive
control of mgmt of the business. f. Language in the agreement K
called it a partnership, but also excluded Chesire from most of the
ordinary rights of a partner. g. Conduct of the parties towards
third persons didnt hold themselves out as partners, she was still
working as the receptionist. h. The rights of the parties on
dissolution- No diff for Chesire than if she quit i. Co-ownership
agreement only to share profits, Fenwick had ownership.
III. Partners compared with LendersA. The determination of
whether a business organization constitutes a partnership is done
on a case-by-case analysis of all factors to determine whether they
reveal the intent to do business as co-owners; no single factor is
dispositive. Thus, an explicit partnership agreement may be deemed
not to create a partnership, and an agreement specifically denying
a partnership exists may be found void. B. The sharing of profits
is not conclusive evidence of a partnership. i. ***Martin v.
Peyton, 246 N.Y. 213 (1927) - KNK, a partnership, was in financial
difficulty, and Hall, a partner there, arranged for the s (Peyton +
others) to loan them some securities, to be used as collateral for
a bank loan to KNK. KNK creditors sued to get their money, and
argued that the loan to KNK by s was actually a partnership
agreement, so s would also be liable for KNK's debts b/c they were
partners. Although the agreement said no partnership, the rule is
to look at what actually is the case. Court looked at
circumstantial evidence, & decided no partnership formed. a.
Although profit sharing (which happened here) is considered an
element of a partnership, not all profit-sharing arrangements
indicate the existence of a partnership relationship. All of the
features of the agreement are consistent with a loan agreement, so
no partnership has been formed. b. Note: If KNK had been organized
as a corporation, LLC, or LLP, s here would have avoided any risk
of liability. Under those forms of business organization, as equity
investors, s could not have been held personally liable for the
firm's debts. c. ***While evidence of profit sharing is prima facie
evidence of the existence of a partnership, it is not dispositve,
and other factors may indicate no partnership was intended.
IV. Partnership by EstoppelA. General Rule: Persons who are not
actual partners as to each other are not partners as to third
persons. i. Exception: A person who represents, or who expressly or
impliedly consents to such a representation, that she is a partner,
is liable to any third person who extends credit in good-faith
reliance on such representations. (UPA 16) B. Young v. Jones, 816
F.Supp 1070 (1992) Price Waterhouse Bahamas (PW-Bahamas) is
Bahamian partnership, and price Waterhouse United States (PW-US) is
a NY partnership. invests money in a company, based on an audit
letter from PW-Bahamas, and later the money disappears. sues
PW-Bahamas for negligence, and saying that b/c the 2 are partners
by estoppel, PW-US is also liable. say b/c PW-Bahamas
letterhead
11
only identified it as Price Waterhouse & used that logo, and
also b/c Price Waterhouse advertised that it had offices all over
the world. i. Since the 2 firms are organized separately, there is
no partnership in fact. ii. Also, there is no partnership by
estoppel. doesnt contend that he relied on the advertising or
letterhead in investing. Plus, the exception in UPA 16 only applies
to reps made to 3rd person who give credit to the partnership. No
credit was extended here, this is a case of liability for
negligence. Also, didnt show that they relied on any conduct by
PW-US that they had a partnership with PW-Bahamas.
THE FIDUCIARY OBLIGATIONS OF PARTNERSI. The Fiduciary
Obligations of PartnersA. Each partner has a fiduciary duty to all
other partners. i. The only fiduciary duties a partner owes to the
partnership & the other partners are the duty of loyalty &
the duty of care. (UPA 404). a. A partners duty of loyalty is
limited to the following: 1. every partner must account to the
partnership for ANY benefit and hold in trust all profits derived
by or for the partnership 2. refrain from dealing with the
partnership in conduct or winding up as or on behalf of an party
with adverse interest to the partnership 3. refrain from competing
with the partnership before dissolution b. A partners duty of care
is limited to refraining from engaging in grossly negligent or
reckless conduct, intentional misconduct, or a knowing violation of
the law. c. Partner required to act in good faith and fair dealing
with regard to the partnership & other partners d. A partner
does not violate a duty or obligation merely because the partners
conduct furthers the partners own interest (partner CAN further his
own interests). e. A partner may lend money to and transact other
business with the partnership & with regard to these
transactions, the rights and obligations of the partner is the same
as if he was not a partner. ii. Unless otherwise agreed (default),
books of the partnership shall be placed at the principal place of
partnership's business & all partners shall have access to the
books at any time (UPA 19). iii. All partners shall render
information affecting the partnership to other partners (UPA 20) B.
Partners in a business have a fiduciary duty to inform one another
of business opportunities that arise. Joint venture partners owe
each other the highest obligation of loyalty as long as their
venture continues. i. ***Meinhard v. Salmon, Salmon leased a hotel
from Gerry for a term of 20 yrs; Salmon needs financing, &
enters into a joint venture (partnership, but never actually called
that) with Meinhard who would pay the money needed for this, and
would receive 40% of the profits for 5 yrs, and 50% after. Salmon
had the sole power to manage the property & no interest in the
lease ever assigned to Meinhard. Towards 12
the end of the lease, Gerry approaches Salmon with a new, bigger
opportunity, and Salmon enters this other lease w/o telling
Meinhard. Meinhard finds out and demands he be let in on the new
deal b/c the opportunity to renew the lease belonged to the joint
venture. a. Holding: Meinhard gets % of the shares of the new deal.
1. Salmon (managing partner) owed Meinhard (investing partner) a
fiduciary duty, and that this included a duty to inform Meinhard of
the new leasing opportunity. Joint venturers owe each other the
highest duty of loyalty, and the duty is even higher for a managing
co-adventurer, b/c Meinhard relied on him to manage the
partnership. 2. There was a close nexus between the original joint
venture and the new opportunity, since it was essentially an
extension & enlargement of the subject matter of the old one.
This would be diff if the new opportunity didnt involve the same
thing. 3. Salmon was also an agent of the joint venture, and this
new opportunity was only made available because he held that
position in the joint venture. Salmon would never have had this
opportunity were it not for Meinhards initial investment. 4. This
case extended the duties of partnership far beyond duties under
contract. b. Dissent: This isn't a partnership (where the majority
would be correct), its a joint venture, which is a partnership for
a very limited purpose & contemplated that it would end at a
certain time. Where the parties engage in a joint enterprise each
owes to the other the duty of good faith in all that relates to
their common venture. Their fiduciary relationship only exists
within that scope.
II. After DissolutionA. A partner who retires ceases to be a
partner, and his former partners no longer owe him a fiduciary
duty. a. Partners can't do anything that makes it impossible to
carry on the ordinary business of the partnership, unless
authorized by all the partners (UPA 9(3)(c)). Also, a partner is a
fiduciary of his partners, & owes this duty against negligence.
But neither apply here, b/c Bane was no longer a partner once he
retired. The only complaint he could have had was if there was
fraud or deliberate misconduct (where no fiduciary relationship is
necessary). 1. The business judgment rule protects the firm from
liability for mere negligent operation.
III. Withdrawing Partners Removing Clients from Firm (Grabbing
and Leaving)A. Fiduciaries may plan to compete with entity to which
they owe allegiance, provided that in the course of these
arrangements they dont otherwise act in violation of fiduciary
duties. i. Partners owe each other fiduciary duty of "utmost good
faith and loyalty," must consider other partners' welfare &
refrain from acting for purely private gain. ii. A partner has an
obligation to render on demand true and full information of all
things affecting the partnership to any partner iii. Meehan v.
Shaughnessy, 535 N.E.2d 1255 (1989) 2 partners in a law firm were
planning to leave & set up their own firm. They asked another
partner & some 13
associates to leave with them. They had a list of cases they
were going to take with them & sent out letters to the clients
to consent to removal of their files from the firm. As they were
preparing to leave, they denied that they were leaving when asked
by the partners. a. The fiduciary duty of a partner does not
prevent that partner from secretly preparing to start his own law
firm. But they breached their duty of loyalty by acting in secret
and obtaining an unfair advantage over the firm by (1) denying
(lying) they were leaving, (2) preparing notices to go out
immediately (before firm could compete) to the clients, and (3)
delaying to provide the firm with a list of clients they intended
to solicit until they had already obtained authorization from most
of them. The also gave less notice than required (30 days instead
of 90). Also, the letters to the clients were unfairly prejudicial
it did not indicate to the clients that they had a choice on
whether to remain with the firm, but only that they were leaving
and needed permission to remove the files from the firm.
IV.
Expulsion of a Partner
A. Dissolution is caused: (1) without violation of the agreement
between the partners, (d) by the expulsion of any partner from the
business bona fide in accordance with such power conferred by the
agreement between the partners. [UPA 31]. When a partner is
involuntarily expelled from a business, his expulsion must be bona
fide or in good faith, for a dissolution to occur without violation
of the partnership agreement. B. Lawlis v. Kightlinger & Gray,
562 N.E.2d 435 (1990) Lawlis was a senior partner in a law firm and
began using alcohol, so he didnt practice for several months b/c of
this, & b/c he was seeking treatment. He later informed his
partners of his problems, and they set forth some conditions with
no 2nd chance. When he relapsed, they did give him a 2nd chance,
where if he met certain conditions, they would return him to full
partnership status. He didnt consume alcohol after that. However,
Lawlis was then told they would recommend his expulsion & a few
days later the firms files were removed from his office. Lawliss
expulsion was voted on by a majority vote of the senior partners,
as per the partnership agreement. i. Lawlis claims that the
notification of the impending recommendation of expulsion &
removal of files was a dissolution of the partnership, and this was
wrongful b/c it wasnt authorized by the majority vote. a. Court
disagrees. Everyone still considered him a partner even after this,
and Lawlis still acted like a partner. The notification was merely
to say what they planned to do. The dissolution occurred when they
voted by majority for his expulsion, in accordance with the
partnership agreement. ii. Lawlis also claims that his expulsion
was a breach of the fiduciary duty between partners, which requires
each to exercise the duty of good faith and fair dealing b/c he was
expelled for the predatory purpose of increasing the firms
lawyer-to-partner ratio. a. Court disagrees. When the firm found
out about the alcoholism problem, it sought to help him, even
though he was taking substantial time off work. Even after he
violated the conditions set forth at first, the firm still gave him
a 2nd chance. And instead of recommending immediate expulsion, the
firm proposed to allow him to stay for a while so he could find
other employment & retain insurance coverage. 14
PARTNERSHIP PROPERTY, RAISING CAPITAL & RIGHTS OF PARTNERS
IN
MANAGEMENTI. Partnership PropertyA. What constitutes partnership
property? Issue is whether property is partnership property or the
individual property of the partner. All property originally brought
into the partnership or subsequently acquired, by purchase or
otherwise, for the partnership, is partnership property. [UPA 8(1)]
i. Where there is no clear intention expressed as to whether
property is partnership property, then courts consider all the
facts related to the acquisition and ownership of the asset. Some
of the factors considered are: a. How title to the property is held
b. Whether partnership funds were used in the purchase of the
property c. Whether partnership funds have been used to improve the
property d. How central the property is to the partnerships
purposes e. How frequent and extensive the partnerships use is of
the property f. Whether the property is accounted for on the
financial records of the partnership. B. Rights and Interests i.
The property rights of an individual partner in the partnership
property are (i) her rights in specific partnership property, (ii)
her interest in the partnership, and (iii) her right to participate
in the management of the partnership. [UPA 24] a. Each partner is a
tenant-in-partnership with her co-partners as to each asset of the
partnership [UPA 25(1)] (Each partner, collectively, owns the whole
partnership). 1. Each partner has an equal right to possession for
partnership purposes (but no right to partnership property for any
other purpose w/o consent of all other partners). 2. The right to
possession is not assignable, except when done by all the partners
individually or by the partnership as an entity 3. The right is not
subject to attachment or execution except on a claim against the
partnership 4. The right is not community property 5. On the death
of a partner, the right vests in the surviving partners. b. A
partners interest in the partnership is her share of the profits
and surplus, which is personal property. [UPA 26] 1. A partner may
assign her interest in the partnership and such assignment will not
dissolve the partnership (unless partnership agreement says
otherwise). [UPA 27(1)] (a) The assignee has no right to
participate in the management of the partnership. But the assignee
is liable for all partnership obligations. (b) C. Co-partners do
not own any asset of the partnership; the partnership owns the
asset and the partners own interest in the partnership. The
interest is an undivided interest.
II. Raising Additional CapitalA. Partnerships sometimes need to
raise additional capital to finance their activities. Sometimes the
issue is addressed in the partnership agreement itself. Examples:
i. Pro rata dilution provision permits a call to each partner for a
certain sum and provides for a reduction in partnership shares of
any partner who does not contribute the requested sum. ii.
Provision might allow partners to invest in the firm at a reduced
price or require partners to make loans that will bear interest at
a higher rate. iii. May provide for the sale of new partnership
assets to people outside the partnership, similar to a corporations
placing new shares on the stock market. 15
III.
The Rights of Partners in Management
A. UPA 18 sets out basic rights and duties, but these are
default rules which can be changed by agreeing otherwise (in
partnership agreement). i. 18(a) Equal shares of profits per
person. Losses follows profits. ii. 18(b) if a partner advances
money on behalf of partnership, the partnership needs to indemnify
(b/c its the partnerships expense, and partnerships liabity). iii.
18 (c, d): a. The distinction between contributions and loans. b.
No interest on capital contributions. iv. 18(e): All partners have
equal rights in management equal votes (even if sharing of profits
is unequal). Meaning a voice, a right to information, and a right
to vote. v. 18 (f): No partner entitled to salary for acting in
partnership business vi. 18(g): black ball rule need unanimous vote
of all existing partners to become a partner. vii. 18(h): Any
difference arising as to ordinary matters connected with the
partnership business may be decided by a majority of the partners.
viii. 18(i): Distinction between legislative and constitutional
matters a. Constitutional matters - things that require change in
partnership agreement requires unanimous consent (this rule can't
be changed) b. Legislative matters (ordinary matters) - decided by
majority vote (this is a default rule, it can be changed in the
partnership agreement). B. The acts of a partner within the scope
of the partnership business bind all partners; all partners are
severally and jointly liable for the acts and obligations of the
partnership (unless no authority to act & 3rd party knows the
restriction). Partner who is sued con then sue for percentage of
contribution from other partner. A majority of partners can make a
decision and inform creditors and will thereafter not be bound by
acts of minority partners in contravention of the majority
decision. i. National Biscuit Company v. Stroud, P.140 (1959)
Stroud and Freeman enter into a partnership to sell groceries.
There were no restrictions in the partnership agreement on the
management functions or authority of either partner. Stroud
notifies Biscuit ( ) that he would not be responsible for
additional bread delivered. But Freeman orders bread, Biscuit
delivers it. Partnership is dissolved, Stroud responsible for
winding up partnerships affairs, and refuses to pay Biscuit. a.
Court holds that Freemans purchases of bread bound the partnership.
The purchase was an ordinary matter connected with the partnership
business within the scope of the business and Stroud could not be a
majority (b/c only 2) of the partners to make a decision otherwise.
C. Where equal partners exists, differences on business matters
must be decided by a majority of the partners. i. Summers v.
Dooley, 481 P.2d 318 (1971) Summers & Dooley form partnership
to operate trash collection business. Summers wants to hire a 3rd
person to help, but Dooley says no. Summers hires someone anyway
& paid him from his own funds. Dooley finds out & objects.
Summers then sues Dooley for reimbursement from partnership funds
for money paid to the 3rd person. a. Dooley refused consent to hire
the 3rd person & objected when he found out Summers still did.
A partner who has actively opposed expense incurred 16
individually and for the benefit of one partner rather than
partnership as a whole is not liable for the cost D. Partnerships
are distinct entities from their partners. A partnership must
indemnify a partner for injuries that occurred in the ordinary
course of the partnership business. There is no corresponding right
of indemnity for the partnership against the partner. E. The
essence of a breach of fiduciary duty between partners is that one
partner has advantaged himself at the expense of the firm. i. The
basic fiduciary duties are: a. a partner must account for any
profit acquired in a manner injurious to the interests of the
partnership, such as commissions or purchases on the sale of
partnership property; b. a partner cannot without the consent of
the other partners, acquire for himself a partnership asset, nor
may he divert to his own use a partnership opportunity; and c. he
must not compete with the partnership within the scope of the
business ii. Day v. Sidley & Austin, 548 F.2d 1018 (1976) Day
was a senior partner & chairman at Sidley, and signed an
agreement for the firm to merge with another firm. Then they set up
a new location, despite Days objection. Day then resigned, saying
the relocation & appointment of a new co-chairman made his
continued service with the firm intolerable. a. Day alleges
misrepresentation by Sidley that no partner would be worse off
because of the merger, & he was worse off b/c no longer sole
chairman. But Day had no legal right for Day to remain chairman of
the DC office. Also, even if he did know this to begin with, &
he changed his vote, it would have no effect, b/c all that was
needed was majority vote (not unanimous). b. Day also alleges
breach of Sidleys fiduciary duty b/c they began the merger
negotiations w/o informing all partners & didnt reveal changes
that might occur b/c of the merger. But the only breach would be if
one partner has advantaged himself at the expense of the firm, and
this wasnt the case here. Concealing merger plans didnt produce
profit for the other partners or financial loss for partnership as
a whole.
PARTNERSHIP DISSOLUTIONI. DissolutionA. Dissolution of a
partnership does not immediately terminate the partnership. The
partnership continues until all of its affairs are wound up. [UPA
30] B. Causes of Dissolution: Unless otherwise provided in the
partnership agreement, the following may result in dissolution: i.
Expiration of the partnership term a. Even if partnership is for a
fixed term, partners can still terminate at will. But since this
will be breach the other partners can sue for damages. ii. Any
partner can terminate the partnership at will (b/c a partnership is
a personal relationship which no one can be forced to maintain).
Where the partnership is for a 17
term or where it is a partnership at will but the dissolution is
motivated by bad faith, it may be a breach of the agreement. iii.
Assignment. Although an assignment of a partners interest is not an
automatic dissolution, an assignee can get a dissolution decree
upon expiration of the partnership term or at any time in a
partnership at will [UPA 30-32]. iv. Death of a partner. On the
death of a partner, the surviving partners are entitled to
possession of the partnership assets and are charged with winding
up the partnership affairs without delay [UPA 37]. The surviving
partners are also charged with a fiduciary duty in liquidating the
partnership and must account to the decedents estate for the value
of the decedents interest. v. Withdrawal or admission of a partner.
Partnerships only exist if same partners. a. This only works if
very few partners, where one person makes a difference. But in a
large partnership, it doesnt work every time one partner leaves the
partnership changes. This is a default rule, which you can change.
b. Most partnership agreements provide that losing or admitting a
new partner will not result in dissolution. New partners may become
parties to the preexisting agreement by signing it at the time of
admission to the partnership [UPA 13(7)]. When an old partner
leaves, there are usually provisions for continuing the partnership
and buying out the partner who is leaving. vi. Illegality.
Dissolution results from any event making it unlawful for the
partnership to continue in business. vii. Death or Bankruptcy.
(Default rule) The partnership is dissolved on the death or
bankruptcy of any partner [UPA 31(4), (5)] viii. Dissolution by
court decree. Court may do this in its discretion. Some
circumstances may be insanity of a partner, incapacity, improper
conduct, inevitable loss, or whenever it is equitable [32].
II. The Right to DissolveA. Dissolution by court decree
Significant disagreement between partners that undermines the
business of the partnership, makes it impossible to continue i. On
application by or for a partner the court shall decree a
dissolution whenever (c) A partner has been guilty of such conduct
as tends to affect prejudicially the carrying on of business, or
(d) A partner willfully or persistently commits a breach of the
partnership agreement or otherwise so conducts himself in matters
relating to the partnership business that it is not reasonably
practicable to carry on the business in partnership with him. [UPA
32]. a. Owen v. Cohen, 119 P.2d 713 (1941) and were partners in a
bowling alley, with no duration time set. loans the partnership
$6,986 to be paid back to him from prospective profits. Bowling
alley running at a profit, but then the partners started having
disagreement over how the business should be run, and these
conflicts affected the profitability. sues for dissolution. 1.
Court found that s actions severely undermined the success of the
partnership. There were bitter, antagonistic feelings between the
parties while the arrangement required cooperation, coordination
& harmony. The partners were no longer able to carry on the
business of their mutual partnership. B. There is no such thing as
an indissoluble partnership only in the sense that there always
exists the power, as oppose to the right, of dissolution. But
without a legal 18
right to dissolution, there will be damages because it is a
breach of the partnership agreement. i. Collins v. Lewis, 283
S.W.2d 258 (1955) and entered into partnership to operate a
cafeteria. was to finance the project & was to supervise
development & manage it. would be paid back from the profits,
and the rest of the profits would be split equally. When they
opened, they were not making a profit. said it was because refused
to pay additional development costs, so that money was coming out
of the revenue. sued for dissolution. a. has the power to dissolve
the partnership, but not the right to do so without damages since
his conduct is the source of the partnership problems and amounts
to a breach of the partnership agreement. C. A partner at will is
not bound to remain in a partnership, regardless of whether the
business is profitable or unprofitable. Exercising the power to
dissolve, however, must be exercised pursuant to the fiduciary duty
of good faith.
III.
The Sharing of Losses
A. In the absence of an agreement to the contrary, it is
presumed that partners and joint venturers intended to share
equally in profits and losses. However, where one partner or joint
venturer contributes the capital while the other contributes skill
and labor, neither party is liable to the other for losses. (The
reason behind this rule is that in the event of loss, each party
loses the value of his own capital or contribution). B. RUPA (1997)
401(b) expressly cites and rejects Kovacik: Each partner is
entitled to an equal share of the partnerships profits and is
chargeable with a share of partnership losses in proportion to the
partners share of the profits. [losses follow profits]
IV.
Buyout Agreementsi.
Because partnerships result from contract, the partners rights
and liabilities are subject to the agreement made among them. The
agreement here provided for a buyout if one of the partners died.
Although the exact provision in the agreement calculated the value
of the interest as less than the fair market value, court says that
parties must be bound by the contracts into which they enter,
absent a showing of fraud or duress in the inducement. a. Buyout
provision here if the remaining partners choose to continue the
business, it must purchase the interest of the departed partner
(interest that belongs to the estate). Here, the buyout formula is
the capital account of the deceased partner plus the average of the
prior 3 yrs earnings. (Capital acct = partners capital contribution
to partnership minus losses and reduced by any distributions
already made). B. Four main aspects of the buyout agreement: a.
Trigger Events 1. Death 2. Disability 3. Will of any partner b.
Obligation to buy versus option 1. Firm 2. Other investors 19
c.
d.
e. f.
3. Consequences of refusal to buy (a) If there is an obligation
(b) If there is no obligation Price 1. Book value
(assets-liability/ number of shares) 2. Appraisal (but who does the
appraising?) 3. Formula (e.g. five time earnings) 4. Set price each
year 5. Relation to duration (e.g. lower price in first five years)
Method of payment 1. Cash 2. Installments (with interest?)
Protection against the debts of partnership Procedure for offering
either to buy or sell 1. First mover sets prices to buy or sell 2.
First mover forces others to set price
C. Other ways to create a system for determining the price of
the buyout i. If both parties solvent, set it up where one party
names the price, and the other decides whether to buyer. This is
the most fair outcome. (think about 2 little children sharing a
piece of cake one cuts it in half, the other gets to choose which
half. This way the one cutting will try to be as fair as possible
cutting it equally). ii. Appraisal - but must determine what kind
of appraisal a. Each side picks an appraiser, and the 2 appraiser
pick a 3rd appraiser (that's if they have money) iii. Base the
amount on gross revenues a. Small business, less money - most
common formula is book value 1. Book value - something you need to
generate anyway. But problem is that the book value can easily be
manipulated - must trust the accountant. iv. Buy life insurance on
the dead partner to ensure the dead partner is solvent D. Limited
partnerships i. Holzman v. De Escamilla a. Limited partner took
control in business by controlling the funds and planting, thus
became exposed for the liability of the general partners. b. Rule
of Law: A limited partner will be held liable as a general partner
if the limited partner acts to take part in the control of the
business 1. So what do you do if you want to control and
protection? They should for an LLC or an S type corporation.
NATURE OF THE CORPORATION20
I. Promoters and the Corporate EntityA. Southern-Gulf Marin Co.
No. 9. Inc. v. Camcraft, Inc. i. Basically you have to treat
corporations fairly even before true incorporation. Even if the
papers are filed improperly. What is important is what the other
party thought, e.g. the other party was a corporation by estoppel.
ii. Rule of Law: A party can not justify the nonperformance of a
contractual obligation by the other partys lack of corporate
capacity or the lack of stated corporate capacity a. Minority
interest in a privately held company is one of the worst positions
you can have. Way to protect interest is that Ill make the
investment, but need to make sure that under certain circumstances
that the company need to buy out my shares at a fair price Firm
obligation to buy back b. Hypo: Represent large corporation that is
trying to purchase large tract of land. Framers would charge more
is they knew who the buyer is. However, it is set up so he will not
know. He has no right to know, and will not be told so.
II. The Corporate Entity and Limited LiabilityA. Characteristics
of the Corporation i. Separate Legal Entity. A corporation is a
separate legal entity (created by the law of a specific state),
apart from the individuals that may own it (shareholders) or manage
it (directors, officers, etc.). Thus, the corporation has legal
rights and duties as a separate legal entity. ii. Limited
Liability. The owners (shareholders) have limited liability; debts
and liabilities incurred by the corporation belong to the
corporation and not to the shareholders, since they are separate
legal entities. (Also vice versa, corporation not responsible for
debts of shareholders.) iii. Continuity of existence. The death of
the owners (shareholders) does not terminate the entity, since
shares can be transferred. iv. Management and control. Management
is centralized with the officers and directors. Each is charged by
law with specific duties to the corporation and its shareholders.
v. Corporate powers. As a legal entity, a corporation can sue or be
sued, contract, own property, etc. B. Exceptions to the Limited
Liability Rule In some circumstances, the court may pierce the
corporate veil and dissolve the distinction between the corporate
entity and its shareholders so that the shareholders may be held
liable as individuals despite the existence of the corporation. i.
Fraud or Injustice. Where the maintenance of the corporation as a
separate entity results in fraud or injustice to outside parties
(i.e. creditors). ii. Disregard of corporate requirements. Where
the shareholders do not maintain the corporation as a separate
entity but use it for personal purposes. The rationale is that if
the shareholders have disregarded the corporate form, then the
entity is really the alter ego of the individuals and decisions
made are for their benefit and not the entitys. This is most likely
to occur with close corporations. 21
iii. Undercapitalization. Where the corporation is
undercapitalized given the liabilities, debts, and risk it
reasonably could be expected to incur. iv. Fairness. The veil may
also be pierced in any other situation where it is only fair that
the corporate form be disregarded.
III.
Piercing the Corporate Veil
A. Piercing the corporate veil is allowed whenever necessary to
prevent fraud or to achieve equity. Whenever anyone uses control of
the corporation to further his own, rather than the corporations
business, he will be liable for the corporations acts. i. Walkovsky
v. Carlton, 18 N.Y.2d 414 (1966) was severely injured in a taxicab
accident, and sues the cab driver, the corporation owning the cab,
and the . owned that corporation and 9 others, each corporation had
2 cabs each with the min $10k liability insurance coverage required
by state law. alleged that the corporations operated as a single
entity & constituted a fraud to the public. a. Court says no
reason to pierce the corporate veil. 1. (1) Nothing wrong with one
corporation being part of a larger corporate enterprise (i.e.
subsidiary). The only issue would be whether there was a disregard
of the corporate form, but did not allege this. (2)
(Undercapitalization) The state has set minimum insurance
requirements & all other cab corporations have taken out the
min insurance. If insurance protection is inadequate, the remedy is
the legislature. b. Dissent: Corps were intentionally
undercapitalized to avoid responsibility for accidents, which were
likely to happen. All income was continuously drained for this
purpose. B. Alter Ego theory Two requirements must be met before
the corporate veil can be pierced: (1) such a unity of interest and
ownership that the corporation and the individual are not separate
personalities, and (2) circumstances are such that not piercing the
veil would sanction a fraud or promote injustice. i. To determine
whether a corporation is so controlled by an individual or another
corporation that the court would be justified in disregarding their
separate identities, courts looks to four factors: a. The failure
to comply with corporate formalities or to keep sufficient business
records b. A commingling of corporate assets c.
Undercapitalization; and d. One corporations treatment of another
corporations assets as its own. ii. Sea-Land Services, Inc. v.
Pepper Source, 941 F.2d 519 received a judgment from Sea-Land for
breach of contract, but when attempted to collect, Sea-Land was
dissolved. sues Sea-Lands sole shareholder ( ) and s other business
entities. wanted to pierce Sea-Lands corporate veil so that could
be held personally liable, then reverse pierce s other corporations
(to get the money the other corporations have). Court held that the
corporate veil could be pierced. a. Unity of interest and ownership
- There was no differentiation/separation between the corporation
and the owner. used same office, same phone line, & expense
acct to run most of the corporations. None of the corporations ever
held a meeting. borrowed funds from corporation for personal
expenses, and the 22
corporations would borrow money from each other. didnt even have
a personal bank acct. b. Separate corporate existences would
sanction a fraud or promote injustice - must be something more than
just a creditor not being able to recover. 1. Comment: On remand,
court found in s favor, b/c by receiving countless benefits at the
expense of and other creditors, insured that his corporations had
insufficient funds with which to pay their debts. iii. When a
parent corporation controls several subsidiaries, a subsidiary is
not liable for the actions of the other subsidiaries. a. Roman
Catholic Archbishop of San Francisco v. Sheffield, 15 Cal.App.3d
405 (1971) goes t Switzerland and contracts to buy a dog for $175
from a Catholic monastery, to be paid in $20 installments. makes 2
payments. Monastery refuses to ship the dog until all payments
made, plus additional fees, and refuses to refund the money. sues
the Roman Catholic Church (parent), the Roman Catholic Archbishop
of San Francisco (subsidiary) & others. 1. Unity of interest
and ownership - was a distinct legal entity from the monastery had
no knowledge of the contract, and no dealings with the monastery.
did not allege that was involved in the transaction. Although the
monastery may have been an alter ego of the Catholic Church, thats
not the case here. There is no respondeat superior between
subagents. 2. Non-piercing would sanction fraud or promote
injustice Not enough that won't be able to collect if not permitted
to sue . iv. A parent corporation is expected to exert some control
over its subsidiary. When, however, a corporation is controlled to
such an extent that it is merely the alter ego or instrumentality
of its shareholder, the corporate veil should be pierced in the
interest of justice. a. In Re Silicone Gel Breast Implants Products
Liability Litigation, 887 F.Supp. 1447 (1995) is the sole
shareholder of MEC (they have a parent-subsidiary relationship).
highly involved in MECs daily operations. MEC sued in tort & s
want to pierce the veil & hold parent liable. 1. There is
sufficient evidence here that MEC is s alter ego. 2. To determine
if a subsidiary is merely the alter ego of the parent, the court
must evaluate the totality of the circumstances, considering
factors above (see sea-land) [first five in this case always
happen: (1) same directors or officers, (2) they file consolidated
taxes, (3) the subsidiary is undercapitalized, (4) the subsidiary
gets all its business from the parent, (5) the parent uses the
subsidiarys property for its own, (6) the parent pays expenses or
wages for the subsidiary, (7) their daily operations are
commingled.] b. To determine whether to pierce the veil in a
parent-subsidiary situation, no showing of fraud is required under
DE law. Most states that require fraud only do so in contracts
cases, not torts. 1. Even if fraud required MECs funds may be
insufficient to satisfy s claims. Also, may have induced ppl to
believe it was vouching for MEC, so allowing to escape liabily
would be unjust.
23
C. Limited partners do not incur general liability for the
limited partnerships obligations simply because they are officers,
directors, or shareholders of the corporate general partner.
Undercapitalization is no reason to open liability to limited
partners who control the general partner, but theres the remedy of
piercing the corporations veil. i. Frigidaire Sales Corporation v.
Union Properties, Inc., 88 Wash.2d 400 (1977) Commercial is a
limited partnership. s were limited partners of Commercial, and the
only general partner was Union, a corporation. s were also Unions
officers, directors, and shareholders. Commercial breached contract
with ; and wants to pierce Unions veil to make s liable. a. Just
b/c undercapitalized, can't go after the partners in Commercial.
Need to pierce the corporations veil. But here, no reason to pierce
Unions veil. entered into K with Commercial, and s signed the
contract only through their capacities as officers of Union
(Commercials general partner). Court refused to pierce veil, and
found that s scrupulously separated their actions on behalf of
Union from their personal actions, and never had cause to believe s
were general partners in Commercial. ii. Contract vs Tort Courts
are more willing to pierce the veil b/c of undercapitalization in
tort cases than in contract cases. This is b/c in K cases, the had
an opportunity to investigate the financial resources of the
corporation & had chosen to do business with it. Almost like
assumption of the risk.
24
SHAREHOLDER DERIVATIVE ACTIONI. Shareholder Derivative &
Direct ActionA. Two Types: i. 145(a) Personal claims covers
expenses, judgment, and settlement ii. 145(b) derivative claims
covers only expenses (maybe, only if settlement, not a judgment) B.
Derivative Suits. A shareholder may sue to enforce mgmts duties. If
the claim is that mgmts breach reduced the residual value of the
business, the shareholder must due derivatively in the name of the
corporation. i. Problem - A person with a relatively small stake in
the residual value of a business might want to bring derivative
suit just to be bought off. Requiring the s to make payment to the
corporation reduces this temptation for the complaining
shareholder. The real party in interest here though, is the
shareholders attorney, b/c he may legitimately demand payment from
the corporation in connection with a settlement. C. Limiting
Derivative Strike Suits i. In order to limit strike suits and
otherwise protect against over-deterrence, most statutes limit
shareholders who may bring derivative suits, and many states have
enacted statutes requiring the -shareholder in a derivative suit,
under certain circumstances, to post a bond or other security to
indemnify the corporation against certain litigation expenses if
loses the suit. a. When security must be posted. Depends on the
statute; some say when owns less than a specified % of stock;
others say it is at the courts discretion (& demanded only when
there is no reasonable possibility that the action could benefit
the corporation). b. Who is entitled to security. In most states,
only the corporation may demand security & only its expenses
may be paid. Some states allow directors/officers to demand it
& receive reimbursement. c. Covered Expenses. Usually all
expenses, including attorneys fees. Also expenses of
officers/directors that the corporation has obligated to pay b/c it
has indemnified them may be covered (indemnification doesnt usually
apply for fraudulent actions, only for actions taken in good
faith). ii. Cohen v. Beneficial Industrial Loan Corp., 337 U.S. 541
(1949) brings derivative action in federal court in NJ against
Beneficial & some of its mgrs/directors ( s), alleging that s
engaged in conspiracy to enrich themselves at the corporations
expense. owned only .0125% of the total stock. NJ statute required
less than 5% shareholders who bring a derivative action to post a
security bond; the lower court here required the bond and appealed.
a. A stockholder who brings a derivative action assumes a position
of a fiduciary nature. He sues as a representative of a class that
did not elect him as a representative as they elected the corporate
director or manager. The state has plenary power to impose
standards promoting accountability, responsibility, and liability
upon such representation. b. Constitutionality 1. Doesnt violate
due process clause since it only imposes liability & requires
security only for reasonable expenses. 25
D.
E.
F.
G.
2. Doesnt violate the equal protection clause by making a
classification based on the financial interest the representative
has in a corporation; the classification serves only to insure some
measure of good faith and responsibility. c. Erie Doctrine using
state law in federal court under diversity jurisdiction. The
statute is substantive, so federal court will apply NJ statute.
Direct Suits - If the claim is that mgmts breach deprived the
shareholder of some other right (like right to inspect shareholder
list), the shareholder must sue directly in her own name. i. If the
-shareholder brings suit alleging that management is interfering
with the rights and privileges of stockholders and is not
challenging managements acts on behalf of the corporation, it is a
personal suit. Since this is not a derivative action, posting of a
security bond is not required. a. Eisenberg v. Flying Tiger Line,
Inc., 451 F.2d 267 (1971) shareholder brings suit to prevent merger
& reorganization, alleging that the purpose of the plan was to
dilute his voting rights. Lower court demanded that the post a
security bond & appeals. 1. is not challenging mgmt of the
company on behalf of the corporation; claims that he has been
deprived of any voice in the operation of their company. Therefore,
the Court held that the action was personal, and not a shareholder
derivative action, so no bond is required. The statute only applies
to derivative actions. Note on Settlements and attorney fees i.
When derivative suits reach settlement rather than proceeding to
judgment, the company can pay the parties attorneys fees. When a
judgment is rendered against the s, however, except as covered by
insurance, the s generally will be responsible for attorneys fees
and possibly costs. Often, the real beneficiary on the s side is
his attorney, who may accept a generous fee from the corporation to
settle the lawsuit while the corporate managers who brought harm on
the corporation are relieved of the risk of personal loss. Note on
Individual Recovery in a Derivative Action i. In Lynch v. Patterson
(1985), the , one of 3 shareholders, brought a derivative suit
against the other shareholders who, in managing the corporation,
had increased their own salaries, ultimately paying themselves an
extra $266k. The court awarded the damages in his individual
capacity, reasoning that allowing a corporate recovery would merely
put the funds back in the hands of the wrongdoers. The Demand
Requirement. In order to deter frivolous suits, a complaining
shareholder is required to exhaust internal remedies before
bringing suit. So before a shareholder may bring a derivative suit,
he must request that the directors bring the suit, and they must
refuse. Now the Business Judgment Rule comes into play if the
directors refuse on the basis of a good faith business judgment,
the ct will dismiss the derivative suit. However, directors may
sometimes refuse in bad faith. i. Purpose of the demand
requirement: a. Creates a form of alternative dispute resolution by
providing corporation directors with opportunities to correct
alleged abuses,
26
b. Helps insulate directors from harassment by litigations on
matters clearly within the discretion of directors, and c.
Discourages strike suits commenced by shareholders for personal
gain rather then for the benefit of the corporation. ii. When a
claim of harm belongs to the corporation, it is the corporation,
through the Board, that must decide whether or not to pursue the
claim. Shareholder derivative actions impinge on the Boards
managerial freedom; therefore, when a shareholder files a
derivative action, he/she must show either Board rejection of
his/her pre-suit demand, or justification why demand wasnt made
(Futility Exception). a. Grimes v. Donald, 673 A.2d 1207 (1996)
-shareholder claimed that the Bd of Directors failed to use due
care, committed waste, approved excessive compensation, and
unlawfully delegated its duties & responsibilities by entering
into an agreement with the CEO which provided that the CEO could
make decision w/o interference from the Bd, & if Bd did
interfered, CEO could get damages. 1. An abdication claim can be
stated by a stockholder as a direct claim, as distinct from a
derivative claim, but here the complaint fails to state a claim
upon which relief can be granted. When a stockholder demands that
the board of directors take action on a claim allegedly belonging
to a corporation and demand is refused, the stockholder may not
thereafter assert that the demand is excused with respect to other
legal theories in support of the same claim, although the
stockholder may have a remedy for wrongful refusal or may submit
further demands which are not repetitious. iii. Futility Exception
to the demand requirement: no demand necessary when it is evident
that directors will wrongfully refuse to bring such claims. a. To
qualify for the futility exception, a shareholder must allege with
particularity that: 1. Self-Interest. A majority of the bd of
directors is interested in the challenged transaction, by virtue of
self-interest in the transaction or control by a selfinterested
director 2. Incapacity. that the bd of directors did not fully
inform themselves about the challenged transaction to the extent
reasonably appropriate under the circumstances, or 3. Lack of sound
business judgment. that the challenged transaction was so egregious
on its face that it could not have been the product of sound
business judgment of the directors. b. Marx v. Akers, (Not Done In
Class) Without making a demand on Bd of IBM ( ), filed a
shareholder derivative suit alleging that the Bd had wasted
corporate assets by awarding excessive compensation to IBMs exec
officers & to its outside directors. 1. Excessive compensation
paid to exec officers - no futility. Less than a majority of the
directors recd such compensation, indicating that the bd was not
interested. 2. Excessive outside director compensation futility
(yes). The outside directors comprised a majority of the Bd
indicated that a majority of the Bd was self27
interested. So demand here is excused, but ct dismissed the
complaint b/c there was no wrong to the corporation. (a) No cause
of action did not allege compensation rates excessive on their
faces or other facts that would have questioned whether the
compensation was fair to the corporation when approved, the good
faith of the directors setting those rates, or that the decision to
set the compensation could not have been a product of valid
business judgment. H. The Role of Special Committees Bd of
Directors may create a special independent committee composed of
disinterested directors to decide on whether to bring the
derivative action. i. A Board may legally delegate authority to a
committee of disinterested directors when the Board finds that it
is tainted by the self-interest of a majority of directors. The Bd
is not abdicating b/c the decision to create a committee is
revocable. ii. An action must be dismissed if a committee of
independent and disinterested directors conducted a proper review,
considered a variety of factors and reached a good-faith business
judgment that the action was not in the best interest of the
corporation. iii. A committee must show that (i) its members are
disinterested and used proper methodology, (ii) the committee is
independent, (iii) it proceeded in good faith, and that (iv) it
reasonably investigated the claim (procedural due process). a. If
it recommends no lawsuit then usually loses (see Zapata case) b. In
Re Oracle Corp. Derivative Litigation, 824 A.2d 917 (2003)
-shareholders file derivative suit alleging insider trading by 4
members of the Bd. Bd forms special litigation committee to
investigate. The 2 Bd members who were named on the committee
joined the Bd after the events alleged took place & were both
Stanford professors. The committee also got expert advisors to help
investigate. After the committee conducted an extensive
investigation, they concluded that the corporation should not
pursue the derivative suit. Issue is whether this was an
Independent & Disinterested Committee. (a) Facts revealed
during discovery: (i) one of the -director was prof to one of the
committee members & they have remained in contact with each
other & both served on a Stanford committee, (ii) another
-director wellknow alumnus of Stanford & generous contributor,
(iii) yet another director had made major charitable contributions
to Stanford. (b) Although none of the s could deprive the committee
members of their prof positions at Stanford b/c they have tenure,
ct notes that its not the only motivating factor of human behavior.
Social influence may also direct behavior. The committee has not
met its burden of showing their independence. The ties here are
substantial enough to raise a reasonable doubt about the committees
ability to impartially decide whether the derivative suit against
the s should proceed.
28
CORPORATE ROLE & PROFIT MAXIMIZATIONI. The Role and Purpose
of the CorporationA. Corporate Purpose and Power i. Corporations
must have a purpose or goal. So the question is What purposes are
within the bounds set by the articles of incorporation and
statutory law under which the corporation was formed? ii. State law
often sets forth the acts that a corporation may legally perform.
These acts should be in the aid of a proper corporate purpose. iii.
If the corporation engages in an improper purpose or uses an
improper power, that purpose or act is said to be ultra vires
(beyond the corporations powers). iv. Powers of a Corporation a. A
corporation has express power to perform any act authorized by the
general corporation laws of the state & those acts authorized
by the articles of incorporation. b. In most states, corporations
also have implied power to do whatever is reasonably necessary for
the purpose of promoting their express purposes and in aid of their
express powers, unless such acts are expressly prohibited by common
or statutory law. B. Corporate Social Responsibility i. Debate
about the responsibility of corporations: a. A corporations
objective should be to produce the best possible goods and
services, that no other legal standard is enforceable, and that any
other standard allows an unhealthy divorce between management
(making decisions) and ownership; VS b. Corporations have a social
responsibility and that they must balance the interests of
stockholders, employees, customers, and the public at large. C.
Charitable Contributions i. Charitable contributions tend
reasonably to promote corporative objectives, and is a lawful
exercise of implied corporate power. a. ***A.P. Smith Mfg. Co. v.
Barlow, 346 U.S. 861 (1953) Corporation gave a gift of $1500 to
Princeton University; the gift was challenged by a shareholder.
Corporations president & other execs say the gift was an
investment (qualified graduates would work for them), that it
created a favorable environment for the company, and that the
public had a reasonable expectation of such socially oriented
contributions by the corporation. Its more like advertising; theyre
furthering their corporate image. 1. A corporation may participate
in the creation and maintenance of community, charitable, and
philanthropic funds as the directors deem appropriate and will, in
their judgment, contribute to the protection of corporate
interests. 2. Del C. 122: Ever corp created under this chapter
shall have the power to...(9) Make donation for public welfare or
for charitable, scientific or educational purposes D. Business
Judgment Rule i. A corporation is organized primarily for profit of
the stockholders, and the powers of the directors are to be used
for that end. However, directors have 29
reasonable discretion, to be exercised in good faith, to act for
this end. Directors also have the power to declare dividends and
their amounts. Their discretion will not be interfered with unless
they are guilty of fraud, misappropriation or bad faith (when there
are sufficient funds to do so w/o detriment to the business). a.
***Dodge v. Ford Motor Co., 204 Mich. 459 (1919) - Shareholders of
Ford brought suit to prevent expansion of a new plant and to compel
the director to pay addl special dividends. Corporation had surplus
and Ford wanted to use it to increase production and cut prices of
cars to benefit the public (reinvestment). 1. Here, Fords
discretion to expand the business and cut car prices is upheld.
Past experience shows Ford mgmt has been capable & acted for
the benefit of its shareholders, & it doesnt look like any
detriment to shareholders interests. Fords expansion plans can
still be carried out & there would still be surplus available
for dividends. So court says the surplus dividends after that
should be distributed. ii. It is not the function of the courts to
resolve a corporations questions of policy and management, and the
judgment of directors will be accepted by the courts unless those
decisions are shown to be tainted by fraud, illegality or a
conflict of interest. a. Shlensky v. Wrigley, 95 Ill.App.2d 173
(1968) minority shareholder of corporation that owns Wrigley field
& the Chicago Cubs brought a derivative suits against directors
for refusing to install light on the field & to schedule night
games for the Cubs as other teams had done to increase revenues.
Motivation in refusing to do this was the view of the majority
shareholders that it wanted to preserve the surrounding
neighborhood & believed baseball was a daytime sport. 1.
Business judgment rule presumption of good faith. No evidence that
installing lights and scheduling night games will bring extra
revenue, and theres a detrimental effect on the neighborhood (if it
brings neighborhood down, fans may not want to see games in poor
areas; property value might go down). No evidence that the motives
of directors are contrary to the best interests of the corporation
and stockholders. 2. Corporations are not obliged to follow the
direction taken by other, similar corporations. Directors are
elected for their own business capabilities and not for their
abilities to follow others.
30
THE LLC LLCS AND PIERCING THE VEILI. The Operating AgreementA.
Although LLCs are governed by statute, LLC statutes generally
provide that the members can adopt an operating agreement with
provisions different from the LLC statute. Generally, the operating
agreement will control. B. Operating Agreement controls if there is
no conflict with mandatory statutory provisions.
II. Piercing the "LLC" VeilA. It is unlcear whether corporate
principals of law, like piercing the veil, applies to LLCs. B.
Uniform LLC Act 303(b) The failure of a limited liability company
to observe the usual company formalities or requirements relating
to the exercise of its company powers or management of its business
is not a ground for imposing personal liability on the members or
managers for liabilities of the company. C. Sometimes, though, the
court will hold that the LLC veil may be pierced in a manner
similar to piercing the corporate veil. i. Kaycee Land and
Livestock v. Flahive, 46 P.3d 323 (2002) entered into a K with FOG,
which allowed FOG to use s real property. alleges that during its
use of the property, FOG caused environmental contamination of the
property. FOG has no assets, and wants to pierce the veil to hold ,
FOGs managing member, liable. a. Every state that has enacted LLC
piercing legislation has chosen to follow corporate law standards.
There is no reason to treat LLCs differently than corporations. If
members of an LLC fail to treat the LLC in the manner contemplated
by statute, they should not be free from individual liability.
31
DUTIES (OFFICERS, DIRECTORS AND OTHER INSIDERS)II.
IntroductionA. Directors are normally held to have the duty of mgmt
of the corporation. These duties are normally delegated to the
officers; so, the directors must supervise the officers. The legal
duties of the directos and officers are owed to the corporation, so
the performance of these duties is usually enforced by an action on
behalf of the corporation brought by an individual shareholder
(derivative action). B. Fiduciary Relationship of directors to the
corporation. Directors have fiduciary duty to corporation and the
mgmt of its affairs, since they manage on behalf of shareholders.
i. Duty of Loyalty. Directors are bound by the rules of fairness,
loyalty, honesty and good faith in their relationship, dealings and
mgmt of the corporation, as are officers. ii. Duty of reasonable
care. Directors must exercise reasonable care, prudence, and
diligence in the mgmt of the corporation. iii. Business Judgment.
When a matter of business judgment is involved, the directos meet
their responsibility of reasonable care and diligence if they
exercise an honest, good-faith, unbia