1 Business Associations Outline (1)Small firms first question - differences between modern RUPA, UPA and partnershipsand LLCs(probably planning questionsabout OAs suggestwhatshould be in it) or alitigation question (badly puttogether small business you figure outwho getssued) a.Default rules:whytheyshould modifythemand which ofthe small entitieswe should use (2)Large firms second question a.Exam distinguish civil, criminaland derivative actions; getthrough proxy fightsTERM DEFINITIONAffiliate Someone who is controlling the company or under common control ofsome other companyAgency An agreement by one person ( an agent) to act for a principalatthe principals direction and controlAgent Someone who isauthorized to act on behalf ofthe principalBeneficial title Own Stock: Buystock in IBM and get it fromMerrill Lynch you are owner ofthe beneficialtitle, while legaltitle i sstill owned by Merrill LynchBona fide purchaser Someone who gives consideration, acts in good faith, and who is not on notice ofan adverse claimC Corporation Any corporation thathasn't elected the status ofan S corporation Callable Can be redeemed atthe option ofthe issuer Capital Productive capacity:tangible assets (equipmentand buildings), intangible assets (intellectualproper tyand human capital), moneyCommon stock Residual interest in a corporation: including the rightto elect directorsand receive dividendsand distributionsConvertible Affiliate Someone who i s controlling the companyor under common control ofsome other companyCorporation by estoppel Doctrine that prevents personalliability for an obligation entered into in the name ofa non-
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(1) Small firms first question - differences between modern RUPA, UPA and partnerships and LLCs
(probably planning questions about OAs suggest what should be in it) or a litigation question
(badly put together small business you figure out who gets sued)a. Def ault rules: why they should modif y them and which of the small entities we should use
(2) Large firms second question
a. Exam distinguish civil, criminal and derivative actions; get through proxy fights
TERM DEFINITION
AffiliateSomeone who is controlling the company or under
common control of some other company
Agency
An agreement by one person (an agent) to act for
a principal at the principals direction and control
AgentSomeone who is authorized to act on behalf of the
principal
Beneficial title
Own Stock: Buy stock in IBM and get it from
Merrill Lynch you are owner of the beneficial
title, while legal title is still owned by Merrill Lynch
Bona fide purchaserSomeone who gives consideration, acts in good
f aith, and who is not on notice of an adverse claim
C CorporationAny corporation that hasn't elected the status of
an S corporation
Callable Can be redeemed at the option of the issuer
Capital
Productive capacity: tangible assets (equipment
and buildings), intangible assets (intellectual
property and human capital), money
Common stock
Residual interest in a corporation: including the
right to elect directors and receive dividends anddistributions
ConvertibleAffiliate Someone who is controlling the company
or under common control of some other company
Corporation by estoppel Doctrine that prevents personal liability for an
PERSON to believe the principal consents to have the
act done on his behalf by the person purporting to act for him
Agents Power: Source to Subject Principal to Torts1. Consensual Agency Relationship
a. Distinguish gratuitous bailee
b. Distinguish independent contractor
2. Within Scope: Agency must acts with scope of employment to create injury
3. Actual: Ex Ante or Ex Post
a. Can be express OR
b. Implied in f act (Jenson Farms)
4. In Equity: Implied in Law or Constructive Agency Court over looks lack of actual authority
a. Apparent Authority (Nogales Service Center)
b. Agency by Estoppel
c. Hybrid: Inherent Authority (by title)
Gorton v. Doty: agency arising from use of car
1. Facts: G was coach driving team to play in other city and offers car to use to help take plays to
game. G was in accident in s car and players f ather () sues on behalf of sons injuries. Jury
awards $5,000 to .
2. Issue: Was G an agent of while driving her car?
3. Held: Yes. Evidence showed that the relationship of principal and agent existed between and
G. was an independent contractor not a gratuitous baliee.
4. Reasoning: An agency relationship results when one person allows another to act on her behalf
and subject to her control.
a. Control consented to G acting on her behalf because she volunteered the car with express condition that G drive it; didnt say anything about G LOANING the car and did
not say anything about BORROWING it
b. Precedent ownership of a car alone, regardless of presence, establishes a prima f acie
case against the owner because there is presumption that driver is owners agent
c. In order to establish an agency relationship benefit is not specifically required
5. Incentive to Insure: Know your hit by lawsuit for letting someone borrow your car, shif t liability
onto insurance company.
Agency: Analysis of Question
1. Key: Necessary to determine when an agent can bind the principal, when the principal is liablefor the wrongful acts of the agent and what duties obligations of agents are to their principals
and vice versa.
2. Analysis: Determine three types
a. (1) Is the problem between the agency and principal?
b. (2) Does it involve a 3rd
party trying to hold the principal to an agreement based on the
c. (3) Does it involve a third party trying to hold a principal liable for the agents tort?
3. Proving Agency
a. Burden: Person claiming there was principal-agent relationship has burden
b. Intent: Whether an agency relationship has been created is not dependent on intent of
parties involved; can arise even if the parties do not intent to be in relationship and may
not arise even if the parties do intend to be in it if certain conditions arise
c. Formation: Factual elements are key, must be an agreement between parties that the
agent will undertake some act on behalf of the principal, with the understanding that
the principal is to remain in control of the undertaking
4. Fiduciary Relationship: Every agent is a fiduciary and owes a high standard of care to her
principal. Must avoid conf licts of interest, self-dealing, disloyal acts and so on; similar to duty a
trustee owes her trustor and beneficiaries.
5. Gratuitous Agents: Agents who perform their services without gain and cannot be compelled to
perform the duty they have undertaken; the principal still may be liable for the torts of
gratuitous agents
6. Principals Duty to Agent: Under duty to compensate agent, including paying back for
expenses, unless contract out of it also has duty to cooperate with agent and aid in performing
duties assigned
Who is an Agent?
1. Relationship Defined: Fiduciary relationship that results from the manifestation of consent that
one person (agent) shall act on behalf of subject to control of another person (principal)
2. Manifestation of Consent: Objective
a. Does not matter what intentions of principal may be depends on what the agent
believed the principal intended
b. May arise even where the principal subjectively intended no relationship and without
true mutual consent
3. Creation of Relationship: Several different ways
a. (1) By agreement
b. (2) By ratification: occurs where principal accepts benefits or affirms the conduct of
someone purporting to act for the principal, even though no actual agency agreement
exists
c. (3) Agency by estoppels: principal acts in such a way that a 3rd
party reasonably believes
that someone is the principals agent
Gay Jenson Farms v. Cargill: creditor control over debtor 1. Facts: Jenson, , large global grain dealer, has K with Warren in MN (grain elevator, small
business). loans money to W and W appointed grain agent with CCC. has right to 1st
refusal. W gets money and paid back from draf ts drawn on through MN banks. Imprinted
with both s and W names and money went to . W gives yearly reports, keep books. W has
problems says reports were f ake. W f ails and 86 f arming s sue to get $2M in payments for
M ill Street Church of Christ v. Hogan: Implied In Fact Authority from Past Conduct
1. Facts: Elders of Church, , hire BH to paint church. BH done many jobs for church in past and
had hired his brother, the , for them of ten. Painted most portion was high, spoke to elder
and asked for help. says hire G, but said it may be hard and never said MUST hire him. BH
hired brother instead and he worked for a while until fell and hurt arm. BH reported accident
and paid them both for hours worked. says was not an employee and that BH had no
implied or actual authority to hire him.
2. Issue: Did BH have authority to hire as an assistant?
3. Held: Yes, BH reasonably believed that the principal wished him to act in the scope of the way
he had acted.
a. Must determine whether the agent reasonably believed that principle wished him to act
in a certain way or to have certain authority Hogan reasonably believed he had
authority to hire to help him finish even though asked to hire GP but didnt require it
b. Prior dealings between principal and agent and nature of the task are f actors to consider
did it before, church even paid for the short time he had worked before the accident
Dweck v. Nasser: Apparent Authority
1. Facts: N, CEO, fired D, President, and members of board for operating competing businesses out
of their officers. Af ter cannot settle suit D hired Wachtel to help, although N had Heyman on
record, Shib. (another attorney for N for 20 years) executed settle onNs behalf requiring D to
pay 52.5% of profits and another $1.05M to N. N was to pay D for 30% interest in Corp. N says
not bound since Heyman didnt execute it.
2. Issue: Did Shiboleth have authority to bind Nasser into a settlement Agreement?
3. Held: Yes. Court says attorney had actual authority, implied authority and apparent authority.
a. Actual: because of 20 year relationship; N told him to do what he wants with K and both
S and H testified N granted authority to S to settle.
b. Implied: course of dealings over 20 year period of time including S settling many cases
for N before and N allowing S to speak on his behalf and directing to him to settle action
c. Apparent: because N knew S was working with H on settlement and S thought he had
the authority to act on Ns behalf
T hree-Seventy Leasing Corp. v. Ampex Corp.: Apparent Authority to Accept Contract
1. Facts: sues Ampex for breach connecting to sale of computers. J owns and was only
employee. K was salesmen of and fired of J. J meets with K and M, K boss, to talk sale of six
computers from to . M tells J could sell computers if could pass s credit
requirements. Negotiations continue K submits documents outlining sale to J for $100,000each with $150K down and rest in 5-years. Two signature lines, one for and . s line was
blank when J saw it K sent J letter confirming delivery. claimed no contract but only an offer
which required acceptance and.
2. Issue: Did , through conduct of agent K, show acceptance of the contract?
a. On f ace, document doesnt show that had intent necessary to form a contract in that
the signature line was blank for s. In order to have valid contract, must find some act
of acceptance on part of , which comes in form of Ks letter for delivery dates.
b. says only supervisors have authority to contract for company non-issue because this
f act was never conveyed to , nor were any other f acts giving any reason to believe
that K did not have the authority to speak for and contract for . K was salesmen.
c. Apparent Authority Scope: An agent has apparent authority to do those things that are
usually and proper in the conduct of the business he is employee to conduct; in this case
it is reasonable for a third party to believe a salesmen has the authority to bind his
employer to sell
W atteau v. Fenwick: Inherent Authority
1. Facts: H owned bar called Victoria Hotel and sells to but still managed bar liquor license was
always in H name and had H name painted on door. Under contract with , H only had authority
to buy bottled ales and water for bar. Over years delivers cigars and other supplies, which H
orders, sues to get payment for these. was liable. 2. Issue: Is an undisclosed principal liable for the acts of an agent taken in the ordinary course of
business even if the principal did not authorize the agent to act, nor held the agent out as his
agent?
3. Held: Yes, even without apparent authority.
a. Generally when person carries out business through manager, he holds out his own
credit and is liable for goods supplied even if manager exceeds authority (need proof of
agency in f act in order to make the principal liable)
b. Distinguished here there was not holding out by the principal and the business was
carried out in agents name and supplied on agents credit
c. Complications of Undisclosed Principal: indicated that he gave credit to H alone andhad never heard of (had only heard of Humble) so actual authority is not workable
4. Rule: Principal is liable for all acts of the agent that are within the authority usually confided to
an agent of that character regardless of limitations put on that authority by the principal.
a. 2nd
Restatement of Agency: undisclosed principal is liable for acts of an agent done on
his account if usual or necessary in such transactions, even if they are forbidden by the
principal. An undisclosed principal who entrusts his agent with management of his
business is liable to 3rd
parties with whom the agent enters into deals in the usual course
of business even if the agents actions are against the principals directives
Practical Issue: Lack of Express Authorityy Attorney of Record Confusion
y Actual/Implied Confusion
y Implied/Apparent Confusion
s Lawyer: Principle is Bound If:
1. General Direction Only: Specific power implied in f act. Actual authority
2. Explicit Reservation of Authority Disregarded (No Implied Authority): Must show apparent or
inherent authority
a. Inherent Authority = Undisclosed principal (Watteau)
3. Contractual Formalities Fail (Authorized Agent doesnt sign): Cannot use actual authority
a. Must show apparent or authority of employee (Ampex)
Transaction Lawyer: Recommendations - What should a lawyer tell a client to do to control oral
promises by employees?
1. Develop customer forms for use by employees that contain limits
2. Develop info packets for customers that disclose limits and disclaim oral agreements
3. Develop procedures to monitor employee contracts
Litigators Problem: When do I have the authority to settle? Good Practice:
1. Rarely, if ever, sign or agree, on behalf of client; time pressure or availability?
2. Normally I will present whatever we negotiate to my client for a final approval. Lawyer
represent he has authority to pass on bargaining positions (notif y other side if client is fickle?) 3. Can lawyer promise to recommend it to my client to judge or opposing counsel?
Distinguish Actual from Apparent AuthorityActual Authority Apparent Authority
How Conferred? By Contract In Equity
Point of ReferenceDistinguish reasonable view of
agent
Distinguish Reasonable View of
Third Party
Situations
y Actual or real contract y May be oral or written
y May be express of implied in
f act
y Apparent authority y Estoppel
y Ratification
y Close Call: Distinguish Implied in Fact Actual Authority from Apparent Authority
y Key is Point of Reference: Reasonable view of who?
o Agent: Contract
o Third Party: Equity
Ex Post Authority: Ratification
1. Ratification: Principal affirms and agrees to be bound by past acts of otherwise unauthorized
agent professed to be done on principals behalf .
a. May be express or implied in f act
2. Situations: A person may affirm or ratif y a prior act supposedly done on his behalf by another
that was not authorized at the time it was performed.
3. Effect: Causes the agents act to be treated as if the principal had authorized it at the outset
a. Express: if agent of corporation makes a deal outside scope of employment and
corporation still takes the money from the deal, the corporation has expressly ratified
the agents authority in the deal and are liable
b. Implied in Fact: did the principle impliedly agree to ratif y the deal?
Botticello v. Stefanvicz: Apparent Authority by Ratification
1. Facts: Husband and Wife, s, own f arm as tenants in common and makes $75K offer to buy.
Wife tells should couldnt sell for less than $85K and then and husband agree to $85K for
lease with option to buy. Agreement prepped by husbands lawyer and signed by and
Husband. s attorney didnt perform search on property and was unaware of wifes interest.
Husband never indicated to or attorneys that he was acting as wifes agent. took possession
and improved it. Attempted to use option to buy and s refuse to honor. sues for special
performance. Court finds for .
2. Issues:
a. (1) Do the f acts and law support a finding that husband acted as an agent for his wife?b. (2) Did wife ratif y the contract by her subsequent conduct?
3. Held: (1) No, not an agent. (2) No, judgment reversed no ratification.
4. Rule: Existence of an agency relationship is a question of f act and cannot be proved merely by
marital status, nor by joint ownership. For agency, must be shown that
a. (1) the principal consented to the agent acting for her
b. (2) that the agent accepted the undertaking
c. (3) that the parties understand that the principal would be in control of the undertaking.
5. Agency Applied: s admit to sale, wifes statement of selling for no less than $85K is not the
equivalent of an agreement to sell for that amount. Even if husband handled business matters
for f amily, he never signed any document before as agent for wife because wife had ALSOconsistently signed any deed, mortgage or note in connection with the property they held
jointly.
6. Ratification Applied: Ratification requires acceptance of the results of a prior act with an intent
to ratif y and with full knowledge of ALL the material circumstances.
a. Here f acts do not establish that wife had intent required to ratif y or full knowledge of
terms in contract. Even though wife saw using property and improving it and got
payments from , it is not enough to show she had full knowledge of all the material
terms of the agreement
b. No Ratification by Inaction: Because husband had power to lease undivided ½ interest
in property and nothing to show that wife had any reason to believe was for anything
more than that. may proceed against husband for specific performance damages but
not wife.
Implied in Law Authority: Estoppel1. Distinguished from Apparent Authority by Detrimental Reliance AND
c. Apparent authority makes the principal a contracting party with the 3rd
party with the
rights and liability on BOTH sides
d. Estoppel only compensates the 3rd
party for losses arising from the 3rd
parties reliance
and creates NO enforcement rights in the principal against the 3rd
party
2. Elements: A principal is estopped from denying the agents authority, when he
a. (1) negligently or intentionally
b. (2) causation: causes a 3rd
party to think his agent has authority to do an act that is
actually beyond his authority AND
c. (3) detrimental reliance: the 3rd
party detrimentally relies on the principals conduct
Hoddeson v. Koos: Estoppel by storeowners negligent surveillance
1. Facts: shopped at furniture store. Approached by man assumed was salesmen and placed
order for $168 without receipt, the goods were never delivered and when called store they
had no record. Store claims that man was not agent but imposter salesman operating without
knowledge or . 2. Issue: Circumstantially, can be liable for acts of imposter even if the imposter was not s
agent?
3. Held: Yes, wins.
a. Burden: when a party seeks to impose liability on a principal for a contract made with
an alleged agent, the burden is on the to prove the agency relationship.
b. Apparent Authority: imposter obviously didnt have express or implied authority to sell
and couldnt prove that appearance of authority was created by the manifestations of
the alleged principal.
c. Appearance of Authority: created by the manifestations of the imposter salesperson
alone and f ailure to prove this element of agency requires a reversal of the judgment. d. Duty of Care for Store: store has duty of care for safety and security of customer which
extends to reasonable care and vigilance to protect the customer from loss by deception
of imposter operating on premises. Tortious dereliction of duty to an invited customer.
e. Fact-Based Analysis: Sale took 30-40 minutes, through s lack of reasonable
surveillance and supervision, imposter operated as f ake for lengthy time.
Agents Liability on Contract 1. General Rule: An agent is not liable on contract executed on behalf of principal but is ultimately
depends upon the status of his principal
2. Status - Disclosed Principal: An agent who purports to contract for disclosed principal is not
personally liable on the contract.
a. Example agent negotiates the contract in the name of the principal and agent is not a
party to the contract.
b. Intent - Parties intent is that the principal be bound.
3. Status Undisclosed Principal: An agent acting on behalf of an undisclosed principal is
a. Agent must not compete with his principal anything that an agent obtains as result of
his employment belongs to that principal, barring the retention of secret profits,
advantages and benefits without the principals consent
3. Duty of Candor: Restatement Section 381
a. Duty to give information, keep and render accounts
Reading v. Regem: Secret Profits and Duty of Loyalty
1. Facts: was UK sergeant in Egypt would board truck with unknown contents each week and
escort them through Cairo in uniform. Passes civilian police without inspection and paid large
sums for work. Military finds activities and take money from for crown. Sues to get back.
2. Issue: Is entitled to recover money he made outside the scope of his employment?
3. Held: No, crown justifiably took money.
4. Reasoning: If a servant unjustly enriches himself by virtue of his service without his masters
sanction, the law says he should not be allowed to keep the money and it should be given to his master.
a. Because got the money SOLELY by reason of position he occupied as servant of the
crown uniform and position as servant to Crown were only reasons he was able to
obtain this money which is sufficient to cause him to forfeit it
General Automotive M anufacturing v. Singer: Duty to Disclose Information
1. Facts: was employed by as general manager with contract requiring he not engage in any
other business during his employment and that he not use or disclose any info concerning for
own benefit or to s detriment. Duty as GM was to get work for machine shop he was
successful. Then, took on orders he didnt feel had capacity for and didnt inform that hewould hire another shop to do the work at a lower price than he quoted and would keep the
difference.
2. Issue: Did breach his fiduciary duty to by f ailing to inform of the existence of orders
may not have been able to fill?
3. Held: Yes. Breach.
4. Reasoning: was acting as broker for his own profit in a field where he had contractual duty to
work only for . had fiduciary duty as an agent of to exercise good f aith and loyalty BUT
instead acted in self-interest and adversely to .
a. Failure to Disclose by f ailing to disclose the existence of the secret orders, he was in
violation of fiduciary duty to act solely for benefit of and liable for profits earned
Termination of Agency and Grabbing and Leaving1. General Default Terms:
a. Terminable at will of either party
b. Otherwise end of reasonable term or when specific act is performed
a. Partnership: in creditor pool claiming share of lef t-over assets v. paying all unpaid
creditors as well as losing investment contribution
b. Limited Liability Entities: Asset distribution priority creditor pool v. residual equity pool
Southex Exhibitions v. Rhode Island Builders: Service Contract or Partnership? 1. Facts: s entered into agreement with SEM, predecessor-in-interest to s regarding future of
s shows in RI arena. Agreement stated that wishes to participate in shows as sponsors and
partners and have 5 year fixed terms, renewable by mutuality. agrees to sponsor and endorse
only SEM, to persuade members to have exhibits at SEM shows and to allow SEM to use name
for promos. SEM agreed to obtain licenses, leases, permits, etc., indemnif y for show related
losses; could accept/reject any potential exhibits, audit show income and advance necessary
capital to finance shows. Mutually determine show dates, prices, bank.
2. Issue: Does a partnership exist between the parties?
3. Held: No. Not a partner, totality of the circumstances test and lack of dissolution rights (renewal
obligation) showed non-partnership. a. Producer absorbed all losses; management rights uneven
b. Also no public self-identification (e.g. no partnership tax return; no partnership
contracts with third parties)
4. Reasoning: Evidence of profit sharing is prima f acie evidence of partnership, and f ailed to
show any enumerated exceptions, BUT without any intent to form a partnership a finding of one
is not compelled.
Lawyers: Renewal Rights
1. Normal Situation: This is a more normal situation than Fenwick
2. Good Litigator: suggests to client af ter-the-f act that a partnership structure is possible and has litigation advantages
a. Client thats good, we were partners, then.
b. Contemporaneous self-declaration is think because no partnership tax returns, no name
or title sharing. Court sees through it.
3. How could Southex better protect renewal rights?
a. Contract language on good f aith
b. Renewal expectations in agreement leave little open to interpretation
Partnership by Estoppel
1. Liability of Alleged Partner: One who holds self out to be partner, or who expressly or impliedly consents to representations that they are partner, is liable to any 3
rdperson who extends credit
in good f aith reliance on such representations (UPA § 16)
a. Example A represents to C that she has wealthy partner in B in order to get credit; B
knows of the representations and does nothing to tell C she is not partner; C makes loan
for purposes of the loan, B will be held to be a partner with A but has no other rights
2. Liability of Partners who Represent Others to be Partners: If in above example A were part of
actual partnership, then she would make B an agent of the partnership by her representation
that B was also a partner in this case, B could bind A as though they were f actually partners
but only those other partners of A who made or consented to As representations would be
bound
Y oung v. Jones: Liability of Affiliated Company (DSC, 1992)
1. Facts: PW-B is Bahamian general partnership and PW-US is NY GP. s invested $550K in SAFIG
based on unqualified audit letter on SAFIG by PW-B. Af ter funds disappeared and s learned
that SAFIG f aked statements s allege that two are partners by estoppel because of
letterheads and signatures and similar names.
2. Issue: Do a US firm and its foreign affiliate operate as partners by estoppel when the foreign
affiliate uses the firm name and trademark, and the US firm makes no distinction in its
advertising between itself and foreign affiliates?
3. Held: No, case dismissed.
4. Reasoning: Two firms are organized separately, there is no partnership in f act. a. UPA § 16 says that a person who represents himself or allows another to represent him
to anyone as partner in an existing partnership or with others who are not actual
partners are liable to anyone whom relies on this representation in good f aith
b. An exception to the rule that persons who are not actual partners as to each other are
not partners as to 3rd
parties
c. This case s do not contend they saw the PW-US brochure or that they relied on it in
investing nor does it say that affiliated entities are liable for each others action. Must
a. Not wrongful: at will partnership RUPA § 601(1) no term or task Death, Bankruptcy,
Court Order
b. Wrongful: breach of partnership agreement (even if partnership is at will) OR short of
agreed term of task
4. Effects of Wrongful or Not Wrongful Distinction: Can remaining partners continue partnership
or may partnership dissolve? RUPA § 801.
a. At Will Partnership Dissociation: Liquidation unless wrongful or plus, kicking out on
proper grounds by unanimous vote or on more general grounds by court order,
bankruptcy of partner, death or incapacity must liquidate
b. Term or Task Partnership: special rules
c. Damages?
M einhard v. Salmon: Duties with Regard to Outside Opportunities
1. Facts: G leased hotel to for 20 years; with agreement, had to spend $2M in improvements
shortly af ter, entered joint venture with to pay1/2 of money needed to alter and manage
property receiving 40% of net profits for 5 years and 50% af ter. had sole power to manage,interest in lease never assigned to . End of deal tried to put deal together to level all property
to put up large building but f ailed and asked to enter new lease for 80 year renewal period.
found out about it and demanded it be held in trust as asset of their joint venture.
2. Issue: Does the new lease come within s fiduciary duty to his joint venture partner as a joint
venture opportunity?
3. Held: Yes. was entitled to ½ interest in the new lease and must assume responsibility for ½ of
obligations.
4. Reasoning: Joint venture partners have highest obligation of loyalty to partners including and
obligation not to usurp opportunities that are incidents of the joint ventures
a. Close Nexus: there was a close nexus between joint venture and opportunity that was brought to manager of JV as it was essentially extension of subject matter
b. controlled gets 51% and should get 49%
5. Punctilio Paragraph: Not honestly alone, but the punctilio of an honor the most sensitive, is
then the standard of behavior.
a. If a court cites this case, the will lose, if the court uses the term punctilio, the will
lose big.
6. Correct Decision:
a. Yes Salmon is greedy and secretive, this is just a renewal when they had the
expectation of sharing.
b. No Would parties have negotiated to the holding ex ante probably not, this is a huge
change in operations and 50/50 split with a passive investor doesnt make sense;
Meinhard had right of first refusal in financing better approximation
7. Rebuttal and Penalty Default: Rules force the party with the information about future
opportunity (Salmon) to disclose that information to the other party (Meinhard) to avoid an
undesirable result. It is not the rule that the parties would have contracted for ex ante.
a. Problem: af ter Salmon disclosure, they do not agree and M sues, who wins?
Partners Fiduciary Duties: Defaults1. RUPA § 404: Only (without RUPA § 403) on old Duty of Candor (information) lef t out
a. Duty of Care: Business Judgment Rule (gross negligence rate of agreement, grossly
means that 9 of 10 people would agree)
b. Duty of Loyalty: account, conf lict of interest, non-compete (may be waived in § 103)c. Duty of Good Faith and Fair Dealing: added to RUPA
2. RUPA § 103: Agreement May NOT
a. Unreasonably restrict § 403(b) information
b. Elimination duty of loyalty except for (1) categories of acts if not manifestly
unreasonable or (2) cleansing vote
c. Unreasonably reduce duty of care
d. Eliminate Duty of Good Faith/Fair Dealing but may prescribe standards if not manifestly
unreasonable
Duties after Dissolution of a Law Firm1. Duty of Care: Bane v. Ferguson terminates on end of partnership ex-partners as creditors
BJN introduced - RUPA § 404(c)
2. Duty of Loyalty: Meehan v. Shaughnessy procedure for soliciting firm clients
a. Held: breach on the facts no candor; client notice and other communications not
proper
b. Duty to Account for Fees from partnership clients serviced by Ex-Partnerships (later in
Chapt.)
Lawyer Leaving Firm: What Actions to Take
1. What should do: sit down with the firm and tell them you are leaving jointly negotiate a letter signed by both firm and you; then cut a deal on how the clients will get approached
a. Clients have the choice on who to go to cannot just say that will not give them the file
2. Reality - Firm will kick you out in reality write your letter af ter you already are packed and give
it to them
Perretta v. Prometheus: Opting out of Fiduciary Duties
1. Facts: Prometheus PIP and PDC were partnership to manage two apartment complexes PDC is
100% owned by DNS. Peretta was limited partner in partnership between POP and PDC, PD
notified limited partners that it would merge into PIP Partners-General, which was owned by
DNS and daughter of DNS. Proxy statement sent to LPs with terms and asking to approve it said PIP would vote neutrally. Peretta alleges merger was self-dealing transaction in violation of
PDCs duty of loyalty by setting an unf airly low price
2. Issue: Can we count votes?
3. Held: The partnership agreement controls. Partners werent harmed at expense of partnership;
a. was fired to improve our lawyer to partner ratio and f acts showed that was less
productive when an alcoholic and initially concealed problem
b. There was no real issue the firm acted in good f aith to kick him out
Partnership Property1. What is it: Issue is whether property is partnership property of the individual property of a
partner; all property originally brought into the partnership or subsequently acquired, by
purchase or otherwise, for the partnership is partnership property UPA § 81(1)
a. RUPA § 203: partnership holds property as an entity separate from partners
2. Intent: Where there is no clear intention expressed courts consider all f acts related to the
acquisition and ownership of asset
a. Factors: (1) How title is held; (2) partnership funds used in purchase; (3) used to
improve; (4) central to partnerships purpose; (5) frequent and extensive is partnerships
use; (6) accounted for in financial records of partnership
3. Partners Property Rights in RUPA § 501: a. (1) Right to use specific partnership property RUPA § 401(g) tenancy in partnership
b. (2) Owns a partnership interest RUPA § 501, personal property
c. (3) Right to participate in management
Putnam v. Shoaf: Conveyance of Partnership Interest
1. Facts: FJ Gin Co. originally operated as equal partnership between EC, LC, LP, and CP in
agreement, CP succeeded her husband LP af ter death. CP decided to sever relationship and
relief from debt liability owed by gin to Bank. Shoaf s agree to take over position and assume
personal liability for all debts if CP and Cs each paid $21,000. FJ Gin has negative $90K
agreement. All Gin assets and land held in partnerships name and CP conveyed her interest toShoaf by quitclaim deed. In 1977 bookkeeper leaves and find out he embezzled money banks
pay $68,000 into court. ½ sum paid to C and other to dispute to S and CP
2. Issue: When a partner conveys her partnership interest to another, can she later claim an
interest in a recovery resulting from a chose in action unknown to the parties at the time of
conveyance of the interest?
3. Held: No, partner can only convey interest, legal claim of the partnership asset. There was no
existing interest by the exiting partner.
4. Mistake: Right result but wrong reasoning
a. Court treats agreement as partnership assignment under UPA § 27 but assignment
doesnt dissolve partnership itself ; need court decree under UPA § 32(2) and interest can be conveyed, pledged, subject to execution
b. Interest portion of profit and surplus minus cash f low
c. Agreements were in f act a voluntary dissolution under UPA § 31(1)(c) because Putnam
held ½ assets as tenant in common and conveyed all title to S secured release from
ma jor credit and assumption from S; still secondary liable on some debts if creditor
2. Issue: Without restrictions in the PA as to authority, can an equal partner escape responsibility
for obligations by notif ying a creditor that he will not be responsible for partnership debts
incurred with that creditor?
3. Held: No, third party knowledge of disagreement does not affect actual authority to sign bread
delivery contract.
a. Acts of partner within the scope of partnership business bind all partners.
b. A ma jority of partners can make a decision to inform creditors and then will not be
bound but acts of minority in contravention but there is no ma jority here.
4. Dissolution: Had dissolved the partnership and given notification prior to order by F,
would not have been personally liable for the partnership debt to .
5. Why not allow Stroud to opt out by notification? RUPA allows it, but it protects partnership
from hold-up power of minority partners.
6. How can Stroud protect himself?
a. Ex ante partnership agreement
b. Ex post dissolve partnership and notif y 3rd
parties that he is not liable; Fs agency
survives in the winding up period, however
Summer v. Dooley:M ajority Resolutions
1. Facts: and entered into partnership, operating trash business. Both worked, each providing
and paying for sub when couldnt. asked to hire a 3rd
person and refused, hired one
anyway and paid him with own funds. When found out, he objected. sues for
reimbursement.
2. Issue: In a two-person partnership, can one partner, over the objection of the other partner,
take action that will bind the partnership?
3. Held: No, no actually authority to hire employee. Either not ordinary or not reimbursable
between partners under UPA § 18(b) distinguish third-party cases. a. When one of two partners refuse to consent to hiring a third person and objects upon
finding out hiring there is no sitting idly by and acquiescence in the actions and it
would be unjust to allow to recover
Partnership Tort Liability1. Rule: partnership liable for partners wrongful act in ordinary course of business or with
authority of co-partners RUPA § 305
2. Indemnification: There is no indemnification against partner causing injury (def ault)
M oren ex Rel v. JAX: Indemnification1. Facts: M, partner in JAX, one day M brings in son, , to restaurant while she worked; sat and
rolled dough while pressed hand in roller.
2. Issue: Does have indemnity right against Nicole Moren?
3. Held: No, there is no right to indemnification against partners.
3. Assignment: Not an automatic dissolution, nor is the levy of a creditors charging order against a
persons interest but an assignee or the credit can get a decree to dissolve on the expiration of
the partnership term or at any time in a partnership at will
4. Withdrawal or admission of a partner: Most Pas provide that losing a partner or getting one will
not result in dissolution
a. New Partners: may become parties to preexisting PA by signing it at the time of
admission to the partnership § 13(7)
b. Old Leaving: usually provisions for continuing partnership and buying out the partner
who is leaving
5. Dissolution by Court Decree: A court may use discretion in certain situation to dissolve a
partnership
a. Examples insanity of partner, incapacity, improper conduct, inevitable loss and or
whatever is equitable § 32
Consequences of Dissolution and the UPA
1. Distribution of Assets: Partnership[ debts must first be paida. Capital Account: Amount are applied to pay the partners their capital account (capital
contributions plus accumulated earnings MINUS accumulated losses)
b. Current Earnings: If there is anything lef tover, receive their agreed share of current
partnership earnings § 40
c. Distributions in Kind: Where there are no debts, or where debts can be handled from
cash account, assets may not be sold but they may be distributed in kind to the partners
d. Losses: where liabilities exceed assets, partners must contribute their agreed shares to
make up the difference § 18(a)
2. Rights of Partners: Violation v. No Violation
a. No Violation of PA: assets are distributed as set forth above and no partner has any
cause of action against another
b. Violation of PA: innocent partners have a right in addition to those listed
i. Right to damages: innocent partners have right to lost profits due to
dissolution, etc. against the offender § 38(2)
ii. Right to continue business: right to not sell off and distribute assets, etc. by
buying the offenders interest in the partnership § 38(2)(b) posting bond and
begin court proceedings Alternatively, innocents may simply dissolve and wind
up, paying the offender her share, MINUS damages
3. Effects of Dissolution: Parties are liable until debts are discharged
a. New partnership remains liable for old debts when there has been death, withdrawal
or admission or new partner and business is continued, new partnership remains liable
for old debts incurred by old partnership (§ 41)
b. Retiring partners liability for debts incurred by partners continuing the business ends
power of a partner to bind the partnership except to the extent necessary to wind up his
aff airs § 33; if 3rd
parties do not know of the dissolution, contracts entered into with
partner bind the partnership thus, retiring partner must make sure that prescribed
procedures are following to terminate any chance of liability for partnership obligations
UPA provides notice of withdrawal or dissolution may be in newspaper or generally
circulated
Judicial Help in Dissolution: Decrees of Breachy Significant disagreements
y Incompetence
y Implied terms
Owen v. Chen: Significant Disagreements
1. Facts: and had oral agreement to become partners in bowling alley didnt state duration.
advances $7K to partnership to buy equipment knowing he was taking out loan repaid out of
profits of partnership. Disputes cause negative profits.
2. Issue: Was a decree of dissolution warranted? Proper for s loan to be paid from proceeds of
the sale of assets when the PA provided the loan would be repaid through profits?
3. Held: Yes to both, in CA the Court may order dissolution if disagreements between partners make it so they cannot act in confidence and harmony, or if one partner, by his misdeeds,
materially hinders carrying on the business.
a. Although a party to a contract may limit his right to receive payments to a specific
sources - Where the other partys conduct rendered it impossible for the partners to
carry on the business from which the payments would be made, it would be inequitable
to enforce that part of the agreement
Collins v. Lewis: Breach of Agreement
1. Facts: and have PA where puts up money to build and equip big café and would
supervise and manage it. Lease. would be paid back from net income and then they wouldprofit share. Estimate $300K and eventually costs $600K with delays. Agreement provided that
would repay $30K of s investment 1st year and $60K each year af ter. indicated that there
were costs that were being paid out of the operating revenue rather than by as promised.
2. Issue: Does have the right to dissolve the partnership?
3. Held: No, the money partner f ailed to contribute the final $60K.
a. had the right to dissolve the partnership but not the right to do so without damages
since his conduct is the course of the partnership problems and amounts to a breach of
the PA
b. can either continue to the partnership and perform on the agreement OR dissolve and
subject himself to possible damages for breaching agreement 4. Collins Declares Dissolution: Breach Agreement and becomes Wrongful Withdrawer
a. Victim (Lewis) has Options: Can continue business for term by paying Collins (value
excluding good will minus damages or posting bond to pay at end of term § 38(2) OR
can liquidate (cannot afford bond); Collins pays substantial damages (f ailure of business)
out of his share and continues to put in funds per agreement
b. RUPA does not deduct good will and no payout or bond until end of term unless
undue hardship
Page v. Page: At W ill Partnership
1. Facts: and partners in linen supply. supplies essentials and PTS owes him $47K
also was managing partner each
contributed $43K in capital; no written
agreement; 8 year losing money then starts
to make profit sues to dissolve for
implied term partnership saying would end
when money was paid back.
2. Issue: Was the partnership for a term
rather than at will?
3. Held: No term, but fiduciary duty to not appropriate new prosperity
a. said there were no
understandings about continuation
for a term or until money was paid back some cases do hold that PTS shall continue for
necessary term to repay debut but only if there is evidence showing this intention
b. No evidence of intention here instead it reveals at will partnership; had power to
dissolve the partnership upon express notice to
c. If dissolves in bad f aith he may be violating fiduciary duty as partner and would have
to pay damages in a separate action but a partner is not bound at will to remain in a
partnership just because it is profitable
Prentiss v. Sheffel: W inding-Up Problem of Bidding for Assets
1. Facts: s and s were three partners to buy Center s filed suit to dissolve saying was
derelict in duties and f ailed to pay balance of his share of operating losses. Seek permission to
continue business and request value be placed on s interest. counterclaims seeking winding
up as well as appointment of receiver and said he was wrongfully excluded from PTS in violation
of rights. Court appointed a receiver to protect the partnership property until it could be sold, a
partition made and assets distributed. At auction, s buy assets from court.
2. Issue: Should two ma jority partners in 3-man PTS, who have excluded the 3rd
from management
and aff airs, be allowed to buy the PTS assets at a judicially supervised dissolution sale?3. Held: Yes, his exclusion was not done for the wrongful purpose of buying the PTS asset in bad
f aith but rather was result of f ailure to relate in harmony for benefit of
Pav-Saver v. Vasso: W ind-Up Problems and PA
1. Facts: owned PST and patents. Ma jority SH, Dale, invests SLP. M owner and sole SH of .
Dale and formed PSMC for sale of PSM. Sale agreed to contribute his service to venture
patents and trademarks are contributed and M agrees to financing. Draf ts PA approved by s
Page v. Page
Can plaint i
d i¡ ¡ ¢
lv£
partnership?
Held: Yes, at will; could be liable for breach of f iduciary duhowever. Effect? ³Implied´ term, long enough time torecover capital investment; or ³Generous´
president. Dissolved and replaced with identical one between and eliminating individual
partners.
2. Issue: What is the effect of the wrongful dissolution?
3. Held: The business can survive, the innocent may keep his patents and receive the agree upon
penalty in the PA that was poorly draf ted.
Kovacik v. Reed: Sharing of Losses in the UPA
1. Facts: asks to be his superintendent and estimator for kitchen job in SF. said would invest
$50k and share profits on 50-50 if would do it. Never talked about loss obtained jobs and
was super with giving all financing. told venture lost $ and that had to pay portion.
refused sought account and recovery.
2. Issue: Is a party who has contributed only his services and not capital to a joint venture liable
for a portion of the ventures losses?
3. Held: No, generally it is presumed that partners and joint venturers intended to share equally
in profits and losses BUT
a. Capital v. Work: Exception is that when one partner contributes the capital when theother contributes skill and labor neither is liable to the other for losses
b. Rationale: where one party gives money and other services, in event of loss each party
loses the value of his own capital or contribution
Distribution Problems: Default Rules (RUPA)1. Marshall Cash: pay cash in order, UPA § 807 to (1) creditors; (2) partners and loans and (3)
partners for capital contributions
2. RUPA § 401(b): Partners equally split for profits; expressly rejects Kovacik and states that losses
are shared even when one or more partners do not contribute any capital 3. Deficiency in 1, 2 or 3? UPA § 401, 807 (c) and (d) each partner pays suffers losses in same
proportion as split of profits (def ault equal payments)
4. Surprises: Capital Contribution Gross Up
a. Capital contribution proportion not ref lected in def ault split rule (50/50)
b. E.g. A gives $1,000 and B gives $5,000 split on profits and losses 50-50; absent an
agreement otherwise
c. E.g. MB contributes $1,000 in capital; worker contributes labor; 50-50 on profits; If
business insolvent must worker give MB $500; NO in Kovacik and YES in others.
Law Firm Dissolutions1. What is the effect on fees collected after dissolution from old clients?
2. UPA § 21 Default: New fees, net of expenses, allocated under old agreement as partner assets.
3. WrongfulWithdrawal: New fees received by leaving partners subject to off set for damages in
breach of duty case
a. If clients would have lef t with proper conduct pay f air charge
b. Pay fees net of overhead and f air charged (double charge)
c. Note that breaching partners lost claim on new fees obtained by continuing firm from
old clients who stayed with the firm
Jewel v. Boxer: Law Partnership Dissolutions without Agreement
1. Facts: s and s dissolved law firm 2 and 2 split. No written agreement as to fees from active
cases allocate. Former went to new firms and hired 3 associated who had been employed by
older firm. s had many cases and s handled most of rest. Sent letter to each af ter
dissolution. Clients executed and return the forms and new firms represented the clients under
fee agreements of old firm. filed complaint for accounting of fees.
2. Issue: Upon dissolution of a law partnership, are attorneys fees received on open cases upon
dissolution to be shared according to the former partners rights under the former partnership
agreement regardless of which former partner provides the legal services?3. Held: Yes. UPA says dissolved partnership continued until unfinished PTS business is wound up.
Without agreement to contract, those are def ault
a. Unfinished business is allocated among partners according to their respected interests
in the former PTS.
b. Unless partner is the surviving partner, UPA expressly stops receipt of extra
compensation and no partner can get more than value of interest regardless of level of
participation in winding up.
M eehan v. Shaugnessy: Enforcement of Agreement
1. Facts: Same f acts as above. 2. Issue: Do a partnership agreements provisions regarding dissolution supersede the applicable
UPA provisions?
3. Held: Yes. s partnership agreement provided specific means for handling dissolution of firm
when partners lef t and they overrule UPA def aults.
a. Burden of proof on s to show that the clients who lef t would have consented to leave
even if there had not been a breach of fiduciary duty; if cannot reach burden must
account to the firm for any profits received from these cases plus must pay firm the f air
charge called for by agreement
b. Damages allowed are only those CAUSED by s actions share of current income and
a. Three types of Corporate Distributions: (1) Dividends; (2) Liquidating Dividends and (3)redemption
b. Class A and B: common for a few selected areas of industry
3. Authorized/Issued/Outstanding: Like treasury shares
4. Primary Secondary market sales
Fi i r t f
Pr t r Y Form
Corp C,
CEO
! C Corp.
" ll
C
tock
to X, # $ t ! " # Y imm " $ iat " ly t ! " r " af t " r " ll p " r o # ally ! " l$ land to C, acc " pting a CEO, atp " r onal profit. Y m% t di gorg " profit on land r " al "
% nl " Y di clo " d to X p" r onal profit (and Xr atifie ??).Y Form
C Corp, take
C tock in exc
! ange f or land,immediately ell per onally- ! eld C tock to X at a profit. No di clo % r e of per onal profit. Violation? (Split: US no; Ma . ye ) Di
a. Executives as agents bind firm on contracts; agents are not personally parties (or
personally liable) unless agreed upon
b. Liable for PERSONAL wrongful acts not liable for wrongful acts of other agents (absent
some form of participation)
Shareholder Personal Exposure and Piercing the V eil1. Equitable Subordination: If SH is an (1) officer and (2) a creditor of firm and misbehaves debts
subordinated to those of all other creditors
a. Disregard the registered legal entity becomes a General Partnership or Sole
Proprietorship
2. Disregard the Entity: SH (1) Dominates firm and (2) Acts unjustly towards creditors
a. Evidence of Domination: commingling of corporate and personal funds, lack of
observance of necessary entity formalities (board and SH meetings) note that OH lack
of meetings is not f actors
b. Courts Vary what is unf air or unjust?
Exceptions to Limited Liability1. Compare by Contract: execute a personal guarantee with
2. Compare by Law: Disregard the entity or pierce the veil forms
a. Vertical SHs liable on firm obligations
b. Horizontal - sister corporations liable on firm obligation (enterprise liability)
c. Reverse piercing corp. liable to personal creditors of SH
3. Contract v. Tort: Ma jor difference between tort and contract cases is that in contract cases, the
had chance in advance to investigate the financial resources of the corporation and had then
chosen to do business with it. THUS, in contract cases, the intention of the parties and
knowledge of the risks assumed in entering into a contract are f actors to be assessed in making
a determination as to whether the corporate veil should be pierced.
W alkovszky v. Carlton: Liability Insurance as Evidence
1. Facts: was hurt in taxi and sues driver, corp. owning
cab and who owned corp. and 9 others, each with
minimum of $10K of liability insurance coverage
required. Complaint said corporations operated as single
entity and constituted on fraud on public.
2. Issue: Does complaint state a cause of action becausethe companies were underinsured and undercapitalized?
3. Held: No. Dismissed. Courts will pierce the veil when
necessary to stop fraud or achieve equity.
a. Nothing wrong with one corp. being part of
larger enterprise (like subsidiary);
Wal vszky v arlt
Marchese
Employee
Seon Cab: 2 cabs(min. required insurance)
Carlton
O0 ner
Walkovszky
9 other Cab
Companies
Tort
Shares
Shares
Jud1 ment?
Jud1 ment
Can Walkovszky br in1 suit a1 ainst Carlton? A1 ainst the nine
other cab companies? Held: Motion to Dismiss Granted
2. Issue: When a parent corporation controls several subsidiaries, is each subsidiary liable for the
actions of all other subsidiaries?
3. Held: No, not domination, no injustice. No alter ego theory.
4. Rule: must show that not only is inf luenced and governed by the other entity but also that
there is such a unity of interest and ownership that the individuality or separateness of each has
ceased and the f acts are such that an adherence to fiction of separation would promote
injustice and allow fraud.
a. No respondent superior between subagents. Even though RC is an alter ego of the
Church doesnt show that the RC is an alter ego of ; had no dealings with the church.
In re Silicone Gel Breasts: Liability of Parent to Subsidiary
1. Facts: is sole SH of breast implant MEC, had 3 directors
on board. Two were s execs and MEC president
evidence revealed MEC prepped reports for and had
MEC submit 5 year plan MEC submits budgets, kept
monitoring of . MEC was highly involved in personnel,
auditing, review, name and logo were with sale and
communications. s exec VP suspended MEC sales and
MEC stopped ops later that year selling with s
approval and turning proceeds over to . s bring
products liability.
2. Issue: Is the parent corporation liable for product torts of a subsidiary?
3. Held: Yes. They had control, the subsidiary was underfunded and undercapitalized.
a. Control: A parent corp. is expected to exert SOME control over its subsidiary BUT
when a corp. is controlled to such an extent that it is merely the ALTER EGO orINSTRUMENTALITY of its SH, the corporate veil should be pierced in interest of justice
b. DE can pierce without finding fraud or misconduct if a subsidiary is found to be an
alter ego or mere instrumentality; many states that do require fraud do only in contract
cases not torts
c. Vouched: since MEC funds may be insufficient to pay for damages, and may have
induced people to think was vouching through actions in support allow finding
Frigidaire Sales v. Union Properties: No Improper Actions
1. Facts: contracts with CI, an LP. s were LPs of CI, as well
as officers, directors and SHs of CIs only partner, Union. s
controlled U and through control had day-to-day
management and control of CI. CI breaches and sues.
2. Issue: Do LPs incur general liability for the limited
partnerships obligations because they are directors,
officers, or SHs of the corporations general partner?
3. Held: No, LPs are not personally liable as GPs.
4. Rule: In WA, parties may form an LPship with one corp. as
In r e Silicone Gel r ea tImplant
Held: No S.J. for Bristol. Distinguish Bristols situation fromDow Chemicals.
3. Held: Having a ma jority of a board of outside director, does not excuse from making a demand
in connection with claims of excessive compensation to execs.
a. With ma jority outside directors on board, futility excuse excuses from making a demand in connection with claims of excessive compensation to outsiders.
b. Demand Requirement: (1) Creates a form of alternative dispute resolution to allow corp.
directors with chance to correct abuses; (2) helps insulate directors from harassment by
litigation on matters within discretion; (3) discourages strike suits began by SHs for
personal gain not benefit of corp.
c. Exception: permits SHs to bring claims on behalf of the corp. when it is evident that the
directors will wrongfully refuse to bring the claims
d. Q ualif y for Exception: (1) ma jority of board are interested by self-interest or control by
self-interest director; (2) board didnt fully inform themselves about deal to the extent
reasonably appropriate under the circumstances; OR (3) deal was so bad on its f acecouldnt have been product of sound business judgment of board
Auerbach v. Bennett: Special Litigation Committees
1. Facts: GTE management looks into chance that co. or subsidiaries made improper payments
board determines that $11m had been bribed and that 4 of 15 s had been personally involved.
SH brings derivative suit on behalf of corp. against bribes. Board creates SLC of 3 disinterested
directors who had joined the board af ter bad deal happened. SLC found that it was not in the
best interest of the corp. for the action to proceed.
2. Issue: Does BJR stop inquiry into the disinterested impendence of SLC? Is SLC allowed to
determine whether suit may go on?3. Held: Courts may inquire into the disinterested independence of the members of the board
who are chosen to pass on whether the derivative suit should be dismissed or not. To require
the people outside the board to investigation would require that board abdicate its fiduciary to
the corp. to manage aff airs. Good f aith inquiry.
a. Decision of SLC: substantive decision may not be looked into by court; only the
composition of the Committee (Substantive is within BJR)
b. Statutory: MI ongoing business relationship may disqualif y OH § 1701.59 clear and
convincing evidence needed that director salary concerns defeat good f aith
c. NYSE: listing requirements similar to MI
d. DE: common law test evolving
In re Oracle Corp. Derivative Litigation:Burden on SLC 1. Facts: SHs of Oracle bring derivative on insider trading by 4 of board Ellison, H, L and B; Forms
SLC to look into and determine best course 2 board Ms G and G were named to SLC joined
af ter events and both were Stanford prof s. Hourly wage paid but agreed to waive compensation
if a court deemed it necessary to maintain impartiality.
2. Issue: Has the SLC met its burden of persuasion and shown there is no material issue of f act
calling into doubt its independence?
3. Held: No. Did not disclose Boskin was also Stanford professor that L had made donations to
Stanford and that one donations was used by G for personal research. Failed to disclose that B
taught G when PHD, two are good friends in Stanford Committees. L is well known Stanford
alum. Third E was Stanford contributor and wanted to make it best. a. Social Inf luences: may also inf luence and be motivating f actors can use them to show
SLC did not meet burden to show absence of material f actual question about
independence
Questions: s Suits against Corporations1. DE Supreme Court: views in Martha Stewart
a. Burden: directors in Oracle had the burden of demonstrating their independence for
purposes of their motion to dismiss the derivative action. In contrast,
b. In Beam ex rel Martha Stewart Living Omnimedia, Inc v Stewart, which was also a
shareholder derivative action, the PTF had the burden of alleging sufficient f acts to raisereasonable doubts about the independence of directors.
2. Distinguish: should we look at structural bias v. social circle bias personally beholden
3. Oracle: personal and f amilial, collegial as well as economic interests count
4. Standard: too substantial and guided by a general sense of human nature
a. Higher than standard for demand excuse: Martha Stewart (implied)
Plaintiff·s Lawyer: Derivative Strike Suits
1. File and Plead with Particularity:
a. First choice: A class (direct) action securities law; vote or dividend related
b. Second Choice: Derivative Action, plead that demand is excused first choice: breach of duty of loyalty, second choice bready of duty of care (hopeless)
2. Under both actions, expect and defeat
a. Motion based on the named s f ailure to adequately represent SHs
b. Motion on f ailure to plead with particularity
3. IF Class Action, Expect and Defeat Summary Motions: Motions to dismiss and a motion for
summary judgment on the merits; if lose, settle for peanuts; if win, settle for millions
a. Expect and beat motion based on f ailure to make a demand; if lose, make demand and
start second suit for wrongful dismissal (hopeless?)
b. Expect and beat a second summary motion filed by an SLC
c. Expect and beat a third summary motion on the merits defense just a duty of care
case then BJR applies
d. If lose, file appeal and settle for peanuts or take risk of appeal
Settle for Millions: take 20-30% of the cash and collude with lawyers and sell the settlement to the
judge; who must approve. If successful buy naming rights to a law school.
Demand Excused: Aronson v. Lewis (DEL) and Barr v. W ackman (N Y )
1. Aronson v. Lewis: Test
a. Specifically plead one of two claims: reasonable doubt or belief that directors are (1)
ma jority interested or dominated by interested party OR (2) otherwise unable to
exercise independent judgment in evaluating SH demand (procedural/substantive tests of due care)
2. Barr v.Wackman (NY): Marx in NY
a. Ma jority of board interested pecuniary interest or controlled by someone who has
pecuniary interest
b. Directors not informed OR
c. Decision egregious on its f act; directors didnt exercise sound business judgment
PrimaryDuties: Board of Directors (and AppointedOfficers)
1. Duty to Whom: To the firm collectively, to maintain firm health not to individual SHs or
individual constituencies
2. Measuring FirmHealth Legally:
a. SH Value maximize residual profits long/short term; stock market price inaccuracies
b. Total firm capital value SHs returns PLUS bondholder returns
c. Total firm value return to investors plus income value to workers
d. Total social value firm is better off in the long run if society is healthy??
3. Corporate Powers: Express Powers
a. Generally: Most states have provisions to allow corporations to sue, be sued, own
property, make gif ts to charity, borrow money, get stock and redeem or purchase stockb. Limitations: most have limits e.g. transfer of substantially all of corporations assets
normally require approval of ma jority of voting power of the SHs
4. Corporate Powers: Implied Powers
a. Reasonably Necessary: most corporations have power to reasonably do what it is
necessary for the purpose of promoting their purposes (firm health) and help express
powers unless they are expressly prohibited by common or statutory law.
b. Pro-labor run company until broke and until all the cash is gone (like NYTIMES, GM
and CHRYSLER)
5. Opponents of Rule: CEOs in OH have duty to all accountable to none; insulated board from
Court Review
a. Asset redistribution social engineers want say over others assets and money for
greater good of society
b. Opportunistic renegotiation contracts agree to terms (labor money) and ask court to
change it because of circumstances (big profits, no profits)
c. Promoters of idea that consensual, inclusive decision making dialogue is a universal
good and will lead to peace and
happiness
6. Bottom Line on Principle: one of the most
significant structural assets
a. Combination: Economic f lexibility and
accountability of those who control
pools of investor money
b. Constant attack from politicians,
academics, journalists, clergy, etc. and
survives because competition among
nations, states and companies; core
respect for individual initiative and
common sense
What st rl i t ay
Republican � r�
paganda: �
�
(I�
ish), t he Republic�
E�
s do not like
y views eit her. They do not wanbe held account able in shareholder law suits; t hey li
dividend ret ention and t he power t o
ake charit ablegifts (and political contributions t o � ixon).
Profits�
ver Environment : � o, t he met hod of prot ecting t he environment is t o pass general legislawit h prohibitions; do not give t he board a fiduciary dt o be green.
Do � ot Invest in (or buy Products from) only Et hical�
1. Facts: KC, , and FOG contracted to use s real property and Roger, , is managing member of
FOG says that during use, FOG fucked up property. FOG has no assets and seeks to pierce
LCC and hold ROGER individually liable for the fucking up.
2. Issue: Without fraud, may a court pierce the LLC veil in the same manner as the court would
pierce a corporate veil?
3. Held: Yes. Every state that has enacted LCC piercing laws hasnt developed a different LLC
standard but has chosen to follow corp. law standards; no reason to treaty LLCs differently than
corps
a. Some f actors justif ying corp. piercing like f ailure of formalities obviously will not apply
b. OH §.48 says no language on formalities
M cConnel v. Hunt Sports: M ember-M anaged LLC with OA
1. Facts: CHL in 1996 was formed; Member managed LLC with an OA; LLC OA allowed members to
compete with LLC; restricted liability of members of willful misconduct; required ma jority to file
suit. Member of LLC formed new LP to take sports franchise in competition with LLC2. Issue: Can an OA of an LLC limit of define the scope of fiduciary duties imposed on its members?
3. Held: Yes, § 3.3 of the OA said that members may compete and shall not in any way be stopped
from engaging or owning any competing interest. Language is clear and unambiguous
o By very clear terms OA allowed competition and voided duty of loyalty for the LLC
members involved; no duty not to compete
o OA obligations only apply to conduct in carrying out their duties of the OA: Breach of LLC
OA was by member for filing an unauthorized suit against LP
4. Waiver of fiduciary duties: in partnerships harder to do this because of common law duty; cannot
be engaging in any other business in joint venture industry (so preserve the right to pursue other
businesses)
o Members may waive: all duty of care claims other than willful acts and some types of
duty of loyalty claims (duty not to compete)
o Court Refusals to Respect Waiver: basic contract theory strict construction of language
mistake, fraud, contract of adhesion, non-waivable fiduciary rights?
o Homer Opinion: in this case, OA doesnt specifically say that cannot TAKE THIS BUSINESS
only says cannot take others (ridiculous)
5. Cannot waive in RUPA § 103: generally any unless manifestly unreasonable
Formalities of LLCs1. Many Without Formalities: Operate with one-page Articles of Associations
a. Many oral implied agreements custom, course of practice evidence
b. Usually member-managed but can be manager-managed in mutual unwritten
understanding that only B runs business, not A.
2. Effect on Integrity of Entity: Court interprets implied agreement and other applies def ault rules
than lessor); BOT v. Benihanna (board member bought convertible preferred stock); has
independently paid (bribed) the director/officer or CS (Agency)
2. Standard of Review: Entire Fairness Test is current version
a. Test: It makes little difference whether the board is disinterested or not, the issue is
whether the transaction is f air.
b. Requirements: Directors interest must be fully disclosed if the board is not
disinterested, the contract will be given very close scrutiny; many states have this.
c. Burden: On the conf licted board with careful scrutiny met in Bayer and BOT
3. Two Types of Duty of Loyalty
a. (1) Sweetheart deal: CEO who owns both
corporation, one corp. is 2% and other is 100%
- has them deal with each other with 2% share
and sell goods for too little money to the 100%
(Singapore asset stripping); CEOs Mom buys
$100 hat for $10 puts asset value out
b. (2) Bribery: CEO approaches CEO and wants
deal says will bribe CEO for decision-making
in company, outside the deal (a lot of problems
here e.g. takeover artist with one CEO
blocking it pays that guy bribe and he stops
blocking it)
Bayer v. Beran: Relatives
1. Facts: Wife choose advertising campaign even though
she is singer. She chose herself to sing in ads and paid
normal price. SHs sue who was ma jority owner. 2. Breach? No. Burden to show good f aith of deal and
inherent unf airness. No disloyalty. Just because the
participation of wife may have helped her singing
career is not a sole ground for subjected s to liability
for breach because there wasnt excessive pay to her
and directors free to chose campaign.
Lewis v. SL: Fairness Burdens
1. Facts: SR owns SLE and LGT and real property used by LGT owned by SLE. Transfers stock to 6
children in LGT but not SLE, who leases from LGT. Sell stock to LGT at low price and refused tosell saying rental was greater than what lease was for and so was book value.
2. Burden: Overcome by s, made no effort to determine f air rental value at any time. Must show
3. Fairness Test Applies: Transactions between corporation and controlling SH with burden shif ted
(Wheelabrator)
Transaction Lawyer: Special Committee of Independent Directors
1. Composition: independent directors
2. Authority: full powers to decide, delegated by resolution of full board3. Charge: negotiate best price
4. Powers: may hire outside lawyers, banks and accountants
5. Effect on Standard of Review: Only shif ts burden to to show unf airness in controlled SH
transactions
The Duty of Loyalty1. Distinguish from Duty of Care:
a. (1) Sloth, inattention or stupidity
b. (2) Disloyalty, betrayal, personal benefit at firm expense selfishness c. (3) Care: s lose; Loyalty: s win.
2. Alternative Terms: Bad f aith, self-interested, self-dealing, conf licted, interested or related party
transactions; conf licts of interest
Corporate Opportunities1. Prevents: Corporate officers and directors from taking opportunities for themselves that should
belong to the corporation
a. Example of Property: May not use corp. property to develop own personal business
2. Distinguish: FROM related party transactions like In re Ebay (bribes not Cos)
3. Standard: interest or expectancy test; stronger line of business test (Guth)4. Expectancies: May not assume for herself property or interests in which the corp. is interested
or which the corp. could be said to have a tangible expectancy or which are important to corp.
business purposes
a. Corp. leases land cannot buy the land for self
b. If reasonably foreseeable corp. would be interested in property necessary expectancy
and if opportunities relate very closely to the business of the corp. necessary
expectancy
5. Defenses: Must be in good f aith
a. (1) Individual Capacity: s may claim opportunities were presented to them as
individuals and not through role in corp. b. (2) Corp. Unable to Take Advantage: if disclosed to corp. first, and cannot use, then
officer and director may use. Need heavy justification to show no finances.
c. (3) Corp. refuses: May take advantage of
6. Remedies: (1) Damages or (2) constructive trust
7. Competition with Corporation: May not use assets, property, materials, secrets to form
a. A fiduciary may leave corporation and form a business in competition occasionally the
conduct of the fiduciary while still with the corp. prior to leaving may be examined
Broz v. Cellular Info Systems: Financially Unable
1. Facts: hears of chance to buy company; wants to sell and tells in personal capacity because
Corp. was not seen as viable to purchase. 2. Issue: did usurp corporate opportunity?
3. Held: No, they were financially incapable of exploiting the chance to buy the land and was; not
clear that had a cognizable interest or expectancy in the license because their business plan
didnt involve any new acquisitions.
a. Emphasis that did not formally present the matter to the board of directors but
these are not required under circumstances where there is no interest, expectancy or
financial ability to pursue the opportunity
b. Came to Broz in capacity as individual not CIS director and CIS had no expectancy or
financial capacity
c. Same line of business; CIS CEO says that expectancy not there f ailure to act oninformal disclosure would be impeaching evidence
In re E B AY : Delaware
1. Facts: 1995 O and S found Ebay as sole proprietorship and in 1998 retained underwriters for
IPO, GS was lead and GS recommends to rewarded clients including directors of Ebay by
allocating 1000s of IPO shares at IPO price for HUGE profits.
2. Issue: Were allocations a corporate opportunity?
3. Held: Yes. Ebay was financially able to exploit the opportunity; was in the business of investing
in securities and had been their cash management strategy
a. Unique, Below Market Price: offered as a direct reward for their dealings with Goldmanb. Agent is under a duty to account for profits obtained personally in connection with
transactions related to the company; reasonable to infer that s accepted a commission
or gratuity from GS that rightfully belonged to eBay
Controlling or Dominant Shareholder Transactions 1. Situations: (1) Parent-Subsidiary and (2) Dominant individual SH founder, raider
2. Can SH favor interested while running firm: Yes, but must be done within NARROW bounds
a. Cannot be unf air to the minority
b. Cannot be due to bribe
3. Example: if a dominant SH deals with the corp. (contract) the deal will be closely scrutinized tosee that minority SHs are treaty f airly
a. Corp. loans a ma jority SH money scrutinize
b. Deals where ma jority had effect to make deal check to see good f aith and NOT to
3. Index Funds: mimic the movements of the ma jor industries tell us where the markets are and
we decide where they are going
4. Closed-end funds v. open-end funds no redemption value
Jones v. Harris: Advisor Fees for M utual Funds
1. Advisor Fees In Mutual Fees: especially not in index funds the fees can get crazy big andridiculous; consumer advocates say investors get cheated by the fees
2. Investment Company Act of 1940: one of five acts passed to regulate securities af ter the Great
Depression (fees regulated in companies act)
a. Hedge Funds: not under the act because the number of investors is small less than 30
and go to very rich guys in small groups and are not considered investment companies
b. Mutual Funds: public investment funds
c. Structural Protections: 40% of trustees must be independent of the sponsors, that
4. Supreme Court rules against Trustees by vacating and remandinga. Vacating is odd because District Court at first did exactly what should have been and
could have reinstituted that original opinion without remand
5. Gartenberg Standard: balancing test and just shill for judicial discretion
a. Look to process and amount if process progress
b. Less rigorous look at amount and vice versa
6. Circuit Court SHOULD have considered but threw out one of the KEY f actors the f actor that
the advisor and sponsor were affiliated with other funds and charged different fees for those
other funds they worked together with
a. Other fees were much lower than the ones they charged the s who brought suit
b. Evidence of fees in and out brings suit 7. Easterbrook-Posner argument based on bargaining power, if they didnt like them they could
have gone to another fund because they have to disclose all the fees to the investors and they
are not hidden
a. Easterbrook they can leave, can drive down themselves since there is full disclosure
shouldnt be allowed to sue
b. Posner I used to be market-guy, market now sucks because investors are not
protected; shocking to law-economics community; market is imperfect and these
investors must be protected from these affiliated and non-affiliated fees
8. Supreme Court consider all f actors, dont go down to the nitty gritty of Easterbrook dispute,
dispute from Posner-Easterbrook is one for Congress to decide
a. Punted on central issue to declare an imperfect or perfect market
b. Protection in the market is up to Congress
c. Preserve small procedural area for judicial review still look at a bit but defer to
trustees, almost like BJR (gross negligence standard?); maybe put BJR in but didnt
2. 1993 Act: Defines security very broadly as most passive instruments; if you sell the security to
the public, must go through a full registration process at a federal level involving the SECa. If didnt sell them to public find exemption to federal registration system and had
procedural and merit based exemption issues
b. Criminal and civil penalties criminal if sell a security which is not registered properly,
you can go to jail (if selling big security, not small listen for broadness and schemes to
get around it)
3. Once in broad net: (1) Register or (2) find exemption
4. Look to state laws on top of federal laws
5. Technical side of the side deal securities
Securities:Defined1. 1933 and 1934 Acts: do not agree; a technical difference
2. Ohio title interest only state that adds to federal definition, and doesnt just take it in
whole; title interests, which is real estate titles are added (split up real estate title among small
amount of people may have a security)
a. In Rem Property Interest: generally, outside of OH, is never a security
3. Specific Instruments: stock, notes, bonds
4. Catchalls: Evidence of indebtedness, investment contracts and any instrument commonly
known as a security
a. Trying to catch: passive investors (want peoples manage, who are not going to manage
the company who get investment back and return)
b. Partnerships active investors not securities
c. Surprises: worm f arming, condos, strips of orange grove, oil drilling rights, pyramid sales
schemes and scams
Sources of Corporate Capital1. Retained earnings how much capital of obtained in growth
a. By f ar the biggest way to capitalize a company
b. Tax incentives to retain earnings double tax phenomenon very strong tax incentive
to grow by retained earnings
2. BorrowMoney: cash for promises to repay plus interest
a. Bonds real estate, secured, earnings
b. Debentures unsecured, middle length
c. Notes unsecured, shortest term (security itself is only helpful if there is a def ault you
dont want it, youd rather the IOU)
d. Lines of credit and commercial paper house and business;
a. (1) Any interest of instrument commonly known as security: stocks, bonds debentures,
warrants, etc.
b. (2) Types mentioned specifically in the Act: preorganization subscriptions and fractional
interests of oil, gas or minerals
c. (3) Investment contracts and certificates of participation: broad and catchall (Howey
Test)
Four Part Howey Test 1. Critical Test: everywhere except in OH (where we have our own test from HI)
2. Facts: orange grove, didnt want to sell securities, so sold strips of the grove and could buy the
strips; problem oranges on those trees were not yours, the profits came from selling juice to
the public; had option to get into the processing deal, which would take slice of the profits
based on % of strips of land owned
3. Held: this is a security you dont have a % of ownership in property, you have a security 4. Ask: An investment contract is any K or scheme whereby a person invests his money in a
common enterprise and expects to make a profit solely on the efforts of the promoter or a third
party responsible for management.
a. (1) is it a profit-making venture?
b. (2) is the investor passive in management?
5. Howey Test:
a. (1) Investment of value to get money back
b. (2) In a common enterprise selling orange juice together, pooling requirement
c. (3) With an expectative of profits - return
d. (4) Solely (not largely) from the efforts of others picking, selling, marketing andprofiting from the efforts of the f arm
6. Glynn: is he a passive or active investor?
a. Application (1) Member-managed or manager-managed?
b. Member: Presumption to Member is not a security;
c. Manager: Presumption to Manager it is a security and must overcome on the f acts
d. Glynn: overcomes presumption even though it was manager-managed; it was not a
security
7. Trend Towards Expansion in Decisions: Expansion of the word security now covers situations
where investors do participate in management and the form of benefit derived by the investor
may be something other than cash profits
a. Mentioned: (1) Is the property interest one that is specifically mentioned in the Act?
b. Commonly Thought: (2) Is the type of interest commonly thought to be a security?
c. Profit-Making: (3) Is it an investment contract or a participation in a profit-making
venture? Benefit of substance to investor? Third party management?
d. Need: (4) Is there a need for the protection of the Act? Is there an investment so that
1. Initially required: purchasers must perform some minor management duties like filing reports but investors dont assume the ma jor duties normally required of a person buying a franchise
2. BUT Substantial Control: even these plans have been held to involve securities and now the test
no longer requires total management passivity but only substantial control
3. Not Only Cash Benefit: may be any economic benefit as property interest
Registration1. Registration: prior to IPO must file.
2. Purpose: to disclose all info possible to decide if sound investment
3. Prospectus: most important info is in shorter document given to a purchaser prior to buyingor at some time delivered
4. MaterialRequired:
a. SEC exercises broad discretion over what is put in the statement
b. Financial info about issuer is a very big part and must be disclosed
Private Placement Exemption to Registration1. 1933 Act Allows: certain exemptions from registration in § 5 (e.g. issues by banks or guaranteed
by the US); certain deals are also exempt (e.g. deals without an IPO private offerings are
exempted from registration under § 4(2)
2. Private offerings under § 4(2) 3. Fact Q uestion: to decide if private or public offering
a. (1) need for protection;
b. (2) Access to investment info sophistication of offerees
i. for private must show that offerees were given or had access to the same kind
of info that would have been contained in a registration statement
ii. Must be allied with or have CLOSE RELATIONSHIP with issuer and management
c. (3) Distribution of Material info: implied that the mere access to material info is not
enough may have to actually distribute to the offerees the same type of material in
registration and may even have to give additional info if requested by private firm
d. (4) Number of offerees: fewer in number generally not ma jor f actor but RULE OFTHUMB is > 25 = IPO but now it is more like > People = > Chance of Public;
e. (5) Dollar amount of offering
f . (6) Marketability of securities smaller denominations greater public
g. (7) Diverse group rule more unrelated to each other, the more chance of public
h. (8) Manner of offering manner in which the offering is made (advertising?)
4. New Regulations: (1) Integration; (2) Info Requirements; (3) Manner; (4) Resale limits
b. (2) Info Requirements: 505 or 506 then specific disclosure to ALL purchasers is required;
Type of info depends on nature and size of offering. Must also give investors the chance
to ask questions and get any info the issuer can get without unreasonable effort Only
under 504 or sells under credited investor then Reg. D doesnt mandate specific
disclosure.
c. (3) Manner of Offering: Use of general ads or solicitation in connection with Reg. D is
prohibited unless in certain 504 cases see 502(c)
d. (4) Limitations on Resale: With exceptions of certain 504 offerings, have status of
securities acquired in a transaction under 4(2) of the 1933 Act 502(c) issuers must
use reasonable care to assure that buyers of these securities are not UWs and to make
reasonable inquiry as to an investors investment purpose; legend restricting transfer
must be placed on the share
certificates.
4. Form D: Uniform notice of sales
form for use in 4(6) and Reg. D
offerings give info on Form D with
checklist within 15 days af ter first
sale in Reg. D; then every 6 months
af ter first sale and 30 days af ter last
sale.
Exemptions on Lower Priced
Sales1. Rule 504 Sales Less than $1M:
Section 3(b) of 19
33 allows sales >$1M during any 12-month period
(SA 504); not available to investment companies or to 1934 Act reporting companies
commissions or similar remuneration MAY be paid to those selling the offering in a rule 504
offering
a. Rule 504: Does not mandate specific disclosure BUT issuer is subject to antifraud and
civil liability provisions of the fed. Sec. laws and MUST comply with any applicable STATE
requirements
b. If whole offering is in states with registration requirement: and the offering is in
compliance then the general rule of 502(c) (manner) and (d) (restrictions) do not apply
2. Rule 505 Sales Less than $5M: Under 3(b) of 1933 Act allows any number of ACCREDITED investors and to no more than 34 NONACCREDITED investors for sale of $5M or less available
to any issuer that is not an investment company
V enture Capital1. Goal: get income f low to begin selling debt; must have some type of equity to begin selling debt
and stop selling equity then final goal to sell equity into the public market
d. (4) Any expert who gives certification that part of the registration statement was
prepped by him (accountants, etc.);
e. (5) Every UW involved
f . (6) Controlled persons people who control any other person listed above SA § 15
4. Key Practical Issue: Law firm should be very interested in what partners are doing because the
law firm itself and board of directors may be liable for it; can get malpractice insurance but
there are of ten rider for securities to not insure you for it
a. Why dont insure it? Cant assess the premium, cannot assess the liability so of ten
exclude environmental and securities liability because cannot predict what judges will
do
Private Securities Litigation
Reform Act 1. 1994 Contract of America Legislation put
in to reign in Clinton2. Key: to try to reign in strike suits
3. How: if you are on the private side and bring 10(b)5 lawsuit,
you must plead scienter (particularity) with particularity, must show
in the pleadings why there was scienter so that means that you can
throw a lot of these out for Rule 12(b)(6)
4. Key Provisions apply to Section 11 but not Rule 10(b)5 on slide
Elements in Section 11 Action
1. Privity of Contract not Required: Anyone buying a security that was subject of a defectiveregistration may sue under § 11 but there is a tracing requirement so that the must be able
to trace the securities bought back to the defective registration statement
2. Reliance: need not prove relied on misstatement or omission in order to recover BUT if the
issuer sends out an earnings statement covering period of 1 year af ter the effective date of the
registration statement then a person buying it af ter that must prove reliance to recover
Section 11: Defenses1. Issue Defenses:
a. (1) Show were true
b. (2) Show immateriality c. (3) Show knew of them and bought the securities anyway
2. Distinctions: Non-issuers can get due diligence excuse but issuers cannot
Non-experts in Section 11
1. Standard of Diligence: Must meet test and (1) actually believe statements were true and that
2. SEC can prosecute can be in Fed. Ct. or in Agency Actions
3. Private Actions by Investors implied under 10b-5 and express in § 16 (34Act)
Elements of Rule 10b-5
1. When is f ailure to disclose actionable must be under a duty to speak: SEC Filings, mandatory duty to disclosure; voluntary statements, duty to be accurate; insider trading
o (1)Materiality
probability X
magnitude test to
determine if material
o (2) Scienter Ernst and
Ernst
o (3) Reliance or
Causation
o (4) Standing 2. Rule 10b-5 Elements Change if SEC is
o No scienter
o No standing problems
o Enhanced remedies
Materiality1. Puffery: vague statements of optimism by company officials are immaterial
2. Bespeaks Caution: read in context
3. Zero Price Change: price of security doesnt drop when truth revealed
4. Trivial: only effect small % of total firm sales/revenues (exceptions for lies of the CEO presumedto effect and not be trivial)
5. Truth in the market: if market already knows truth, then new lie isnt material
Materiality Problems
1. Internal Forecasts: Do I have to tell everyone internal ideas of what business will be like?
2. Sensitive Business Info: like merger dont want to tell the world you are negotiating, what to do.
Scienter1. E rnst & E rnst : intention to deceive
a. Only Private Actions b. Inference from Recklessness??
2. Pleading: Private Securities Litigation Reform Act of 1995. State with particularity f acts giving
rise to a strong inference of scienter.
a. Is pleading motive and opportunity enough??
3. Possession (Trading while in possession of) Versus Use (Trading on the Basis of) See Rule 10b5-1
b. Example- Widow SH asks director before a board if company would pay dividend and he
showed her financials and said didnt know; he then bought her stock for $1.25 and
declared $1 per share dividend three days later director was liable
4. Special Circumstances Rule: Number of courts took position that a duty of disclosure is owed
only if there are special f acts or circumstances making nondisclosure unf air
a. Example Strong v. Repide director and pres. And 75% SH use strawman to buy
minority interest knowing that government would buy company property had duty
of disclosure
5. State Law No Duty to Disclose unless special f acts in Goodwin v. Agassiz
SEC v. T exas Gulf: M ateriality and Probability
1. Facts: TGS conducted exploratory activities in eastern Canada. These operations resulted in the
detection of a significant amount of commercially mineable ore. Rumors of the ore strike began
circulating throughout Canada. TGS issued a press release denying having struck ore and stating
that the rumors were only speculation. Between the time of the press release (April 12) and the
dissemination of the TGS official announcement (April 16), two of the defendants purchasedTGS stock as the mining industry journal article was published, statement to Ont. Min of Mines
and US Finance Media released. . April 13 press release drilling inconclusive but stock goes to
30 because info was seeping out that they pulled some good stuff out
a. April 16 Release to media they found largest copper mine in all of North America
timeframe from 9:40-10:54 am.
2. Questions:
a. Coates: lef t TGS Presser and buys shares at 10:20 liable? Yes, because market must
have time to disseminate info which was done at 10:54 am when ran on ticket
b. Call Options: if client buys call options who usually doesnt buy them at all, he is doing
insider trading use them for leverage because for $1 in stock but if option on 10,000shares is $1 because for each share I buy I can get leverage on stock price
3. Held: Basic test of materiality is whether a reasonable person would attach importance to the
information in making decisions about the deal.
a. Need not be conservative one in sense of f acts solely by measuring effect knowledge
would have upon prudent and conservative investors (may be risky)
b. Test encompasses any f act that in reasonable and objective contemplation may affect
the value of the securities
Insider Trading: Duty to Disclosure and Questions to Ask
1. What was the injury to the people who sold their shares:
2. Who are the insiders? directors, Sr. employees and in some cases (like man who pulled out
sample of copper) can be an insider ONLY if there was a confidentiality agreement with employer
and anyone these people tells
3. Information is material? Must be was discovery of hole material YES.
4. Trades? Purchased stock and calls on stock.
5. Latent Issue: is possession alone enough or must it motivate the trade possession is enough.
lawyers, consultants who get info with an obligation of confidentiality
3. Tippees of Insiders or Quasi-Insiders: or other tippees
Tipper/Tippee Liability (Dirks)
1. Why was Dirks not liable as a Tippee of Secrist (insider officer of equity funding)?
o Dirks liability is derivative of Secrists liability problem with tippor and tippee becausehe gave him information without any motivation for PERSONAL GAIN
o In tippee and tippor relationship must know that Secrist is breaching (1) fiduciary duty
AND (2) doing it for personal gain directly or indirectly with a (3) personal gain
2. Personal Benefit:
o Secrist was just a whistleblower not doing it for personal gain doing it out of good
1. Derivative Suits: State statutes govern extent to which the corp. may properly indemnif y its
officers for expenses incurred in of suits for conduct in official capacity; apply to both derivative
and direct exclusive basis for indemnification
o Demand on SHs?o Right to jury trial?
2. Court approval of settlement (or voluntary dismissal): Ellison settlement in CA derivative litigation
3. Recovery of attorneys fees: Benefit to Corporation standard
o Non-monetary awards consent decrees with injunctions against future violations and/or
structural relief
Indemnification1. Mandatory v. Options: Discretionary
o
Statutory: mostly discretionary with the board but under some statutes
the corp. must indemnif y the Ds and
Os when he is successful on the
merits in of derivatives.
o Ex Post DE: right is subject to a
judicial finding that his conduct f airly
and equitably merits such indemnity
o Ex Post (optional board of directors
hires attorney and pays advances
that is unsecured)2. Mandatory: Successful defense § 145(c)
3. Contractual Option ex ante becomes
owed in ex post
o optional ex ante firm will indemnif y to the full extent allowed ex post; § 145(f) BUT requires
board to indemnif y if able to
o Good Faith: good f aith finding required to extend
Ex Post Indemnification1. Ex post good faith (DE); as long as the D or O wins on the merits, there is usually no problem;
o DSCC § 145(c) required indemnification expenses in connection with the of any action as towhich the indemnification is successful on the merits or otherwise
o When loses: varying statutes when lose distinguish 3rd
party suits and derivative suits
o Amounts paid DGCL § 145(a) and (b);
o Advances in (e) unsecured promised to repay reasonableness requirement
o Can argue good f aith test cannot be met on indemnification
3. Indemnification is harder best interest of the firm? on settlement; insurance coverage offend
not available
4. Insurance Companies will not insure CEO on OWN duty of care
Basics of SH V oting Proxy1. Combination of State and Federal Law
2. State Law: defines what a proxy is because an area of agency
3. Federal law: defining disclosure obligations for publicly traded company
o Not publicly traded no federal law at all with exception of anti-fraud statute
4. Record owner writer grants proxy to proxy holder to vote shares at a physical meeting
o Guys name on record books of a corporation
o Right to vote when shows up at SH meeting then vote your shares of which you are a
record owner
o If do not go may grant an agency power to someone else (proxy) who shows up at themeeting and votes your shares
o Proxy delegation of agency to vote on your behalf
5. Proxy is an AGENCY created by state law OH § .48 and DE § 212
6. NOT a written or absentee ballot:
o distinguish written consent procedure
7. Terms: revocable at will unless coupled with an interest (e.g. sale of stock af ter record date but
before meeting)
o Coupled problem with SH meetings is that you must close the record 30 days prior to the
meeting; what if buy stock in that period record holder does not change, so there may be a
guy who sold his stock and still has right to vote as record holder; SO when you buy stockfrom a record holder, you get stock PLUS proxy (that would be coupled with an interest) ex-
record stock
o Supplemented by federal law if IPO
Federal Proxy Rules1. Defined: required that you solicit proxies from all your SHs; if have annual meeting, must send out
firm proxy solicitation to all the record SHs and then firm will nominate proxy for SHs who do not
show up and votes all the shares in whichever way the firm wants
2. Why are they needed?
3. What law controls?
o State
o Federal: 34 § 14(a)-(c) AND has rules 14a to 14a- 15 and Schedule 14A
Overview: Regulation 14A1. Mandatory Disclosure Requirements: Full disclosure all material information to the SHs
2. SolicitationRegulation can only solicit them in certain way, regulation form no discretionary
voting; general anti-fraud prohibition; must be true(form and process)
3. SH Resolutions (Rule 14a-8): regulates when ordinary SHs can get access to the firm held property
normally board of directors controls what is on the firm
4. Fraud Prohibition (Rule 14a-9)
Proxy V oting: Terms1. Must be publicly traded company
2. Must be a proxy someone authorized to act on someones behalf
3. Solicitation is carefully defined
o Doesnt include: efforts at persuasion as opposed to requests for proxies Rule 14a-2
o 10 Person exception Rule 14a-2(c)
o Cannot just try to convince people to vote one way or another must try to get them to give
proxy votes to you before going in
Basic Requirements1. Proxy statements form 14A, items
2. Proxy Card: format requirements
o Limited discretionary grants
o Slates of directors yes and abstain (no NO or other)
3. Filing requirements: general rule for plain vanilla proxy statement and form file with the SEC on
first use
How is a Ballot Slate Selected?4. Only one candidate per seat decided by the board of directors with ONE choice (YES or abstain)
5. Opponents do not have access to Managements Proxy 6. Voting Oddities: All you need is plurality so when there is no vote it is very hard for anyone to
win
7. Must send out NEW FORM to get someone else on the form in there is a quorum requirement
but SOME do not have it in states that dont require it (usually 25% vote abstentions count
toward it)
8. New Rage: ma jority vote buy-ups, we will not seek a director unless he or she gets a ma jority of
all those voting (which means more yeses than abstentions)
o Stricter: ma jority of outstanding shares to vote YES
o If do not get: seated because you win but you offer letter to resign but Board has decision to
take it or not if there is an empty seat and they accept, Board fills empty seat
Proxy Contest 1. Insurgents: to defeat management slate MUST
o Create own proxy statement and card with an alternate slate
o File with the SEC AND
o Pay to have firm mail the material to all SH or if firm elects, mail material themselves