BusOrgsOutline-ForstFall2012

Bus Orgs Outline – AG 2012

Overview o Business organizations are everywhere and especially important to the study of law

o The law of business organization is very pro-business in order to promote business, wealth and private

property The fundamental tenets of democracy are closely tied to the fundamental tenets of capitalism

Democracy: Individual rights, equal opportunity [the ability to rise/fall on merit], private property/ownership, a representative system of governing ourselves

Capitalism: Individuals, competition for the best to succeed, private property, the right to contract, the right to amass capital and access and put capital to work, governance

o Public Policy - intended to shape behaviors [we will look at this a bit when relevant]

o Why do people own business?

Business Objective - to make money, to provide an ongoing living, to create wealth, endgame To provide a service; better society Control of work life

o Business Facts

Avg number of employees = 20 83% of businesses have revenues less than 1B Only 6,000 companies are public - millions of small businesses

o Roosevelt and The New Deal

Passage of two business laws: Securities Exchange Act of 1933 Securities Exchange Act of 1934

Similar to fact pattern of 2008 - same laws were supposed to protect at this time During this entire time, no rules, laws, statutes, or regulations were violated. Laws of the New Deal were old and could not get a handle of the technological

advances!!! Dodd Frank Act - was a Wall Street Reform and Consumer Protection Act. Attempt to

bring ideas of 1933 and 1934 to the present Types of Business Structures

o The decision regarding a business structure is driven chiefly by the objectives of the business's founder

and the firm's investors , in terms of tax status, exposure to legal liabilities, and flexibility in the operation and financing of the business

o What choices are available? Two most important differences are [1] tax treatment of profits and [2]

liability exposure Sole proprietorship

Oldest and simplest form of organizations Person undertakes a business without any of the formalities associated with other forms

of organization o Individual and business are one and the same for tax and legal liability

Taxes: are not paid as a separate entity; individual reports all income and deductible expenses for the business on personal income tax returns

o No vehicle for "sheltering" income from tax

Liability: individual and business are one and the same; legal claimants can pursue all assets of the owner

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Partnership General Partnership

o Businesses that consist of two or more owners

o Treated like a sole proprietorship for tax and liability purposes

o Earnings are distributed according to the partnership agreement

o "Pass-through" Taxation: paid only at the personal level on the partner's share

of the income o Liability: partners are jointly and severally liable

Injured party may pursue one or more of the partners; need not be proportional to invested capital of distributed earnings

Limited Partnership o Hybrid form of an org

o Tax: like a partnership or sole proprietorship

o Liability: has both limited and general partners

Limited: has little voice in management and is not individually liable for the company's debts [looks and acts like a shareholder in a corporation]

General: assumes the management responsibility and unlimited liability for the business

Corporation Most common legal structure for large businesses Liability: A corporation's owners are generally protected from personal liability Tax: The corporation is considered a tax paying entity. Income is basically taxed twice

o The corporation must pay taxes on the income

Max rate is at 35% o If the corporation pays out dividends, the receivers are taxed on the dividends are

personal income Max rate can be close to 40%

o After both sets of taxes $1.00 can be reduced to $0.39

Limited Liability Company [LLC] Tax: The LLC is not a tax paying entity

o Income taxes are only paid once - by the owners of the LLC when a part of the

company's earnings are distributed to them Liability: Owners are not individually liable for the company's debts The existence of an LLC depends on compliance with state laws which differ from state

to state The S Corporation and Not-For-Profit Corporations

S Corporation: afforded the tax status of a partnership, but the protection from legal liability of a corporation

o To qualify, the business must meet a number of rather restrictive conditions in

the IRS code: Domestic corp.

Owned wholly by human citizens of the US 100 or fewer stockholders

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Not-for-profit: operate for a public benefit - IRS 501(c)(3) o Need not pay corporate income tax

o Individuals can deduct gifts to nonprofits from their tax returns

o Ex: Churches and Universities

o How do you choose?

Balance the factors of each option Who will own the business? Who will manage it? Who will reap any profit? Who will bear the risk of loss? Who will pay income tax on profit?

o Questions lawyers should ask

Five key Inquiries Ownership Management? Liabilities/Risks Taxes Exit and transferability

Other questions to ask Investors? Status of investors? Real people? Other businesses? Do you know them? How

many are there? Who is going to own the company? How many owners? Will there be additional owners

in the future? Shareholders? Will there be active or passive owners? Capital? How much capital do you need? Where will the capital come from? Will it be

borrowed? When do you need the capital? Is the capital debt or equity? Risk? Financial Risks/Risk of lawsuits Liabilities? Liability for borrowed money? Employee liability Product liability What is the business? What product or service will you be providing? Taxes - Who will be responsible for paying the taxes? Tax Rate? Location? Some types of bus orgs will be governed mostly by state law Forum shopping.

Internet of Bricks and Mortar? Management? Who will manage the company? Will management be a part of the

ownership? How involved will you, Mr. Client, be involved in the day-to-day running of the business? Do you have the skills to run the company? Will you need to bring others into the management of the business

Strategy? Exit/Transferability - what is your plan at the end of the business? Employees? How many? Will there be a union? What kind of employees? Hourly?

Salary? Wages? Confidentiality issues? Non-compete Issues? IP? Has it been defined or protected? Tangible or intangible IP? Suppliers? Vendors? Who are they? Trustworthy? Quality Product? Customers? Will you extend credit? High-end/Low-End Regulated industry? Maturity of Product/Industry? State of the Market/Industry? Competitors? Size, where do they get their money? What have their strategies been?

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Nature of expenses/cost? Overhead?

Sole Proprietors General Partnership

Corporation Limited Partnership

Limited Liability Company

Ownership One person owns and operates the bus.

2 or more persons

1 or more owners

1 or more GP; 1 or LP

1 o r more

Management Proprietor is the management

Partners Centralized Management [invested in a mgmt. group] - [Perpetual existence of Corp.]

General Partners Can be managed by members [general partners] or elect to be have a manger

Liabilities Owner is personally liable for any debt of the business

Partners are jointly and severally liable

Limited - Owners have no personal obligation for the liabilities, debt, lawsuits of the Corp. - the Corp. is responsible.

General - complete liability [J and S] Limited - Limited Liability

Limited Liability

Tax Owner pays business/ "pass-through"

Pass-Through Double taxation S-Corps: May pass-through

Pass-Through Pass-Through [may elect to be taxed as a corporation]

Exit/transferability

Assets are indistinguishable from owner; makes it difficult to sell

Difficult - ownership is a percentage

Easy - easy to sell and trade stock

Medium Difficult

Understanding Financial Statementso How does the owner of a business [and the lawyers] know how much money the business has made

and how much money the business is worth? Need to understand the business's accounting records and financial statements Entities are required to keep "appropriate accounting records" and to make those records

available to owners and shareholders o Financial reports measure the company's financial health

Prepared according to GAAP (Generally Accepted Accounting Principles)

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Matching : costs or expenses should be "booked" in the same period as the revenues those expenditures helped generate

Conservatism : data should be conservative o Should present the firm's financial date in an accurate way, but err on the side of

understanding its revenues and the value of its assets, and on overestimating its costs and liabilities.

"Off-balance sheet" financing [Enron] Certain activities of the firm may be carried out in other legal entities [subsidiaries, joint

ventures] that the firm may not need to show the obligations of those entities on its balance sheet as long as there is no chance that the parent company could be forced to make good on those obligations.

o Non-recourse debt: parent company cannot be held liable for the debt of subs

and joint ventures o Recourse debt: parent company can be held liable for the debt of subs and joint

ventures o Income statement : computes profit during a given period based on date about revenues and costs

Profit before taxes equals Revenue minus Costs: PBT = R - C Things to include:

o Revenue from sales, Cost of Good Sold [COGS], Salaries, General and

Administrative Costs [G & A] o Depreciations

Straight line depreciation : the value of the equipment decreases by the same amount each year in a straight line

take the value of the equipment and divide by the number of years of useful life and then deduct this much each year from the income statement as depreciation.

Others : Accelerated methods: deduct proportionally more of the cost of the equipment in the earlier years and less later on

NI = PBT - T : All of the above plus taxes at the appropriate rate Looking at the income statement over several years allows us to see how a business's

performance changes Cannot see how much cash a business is generating or using in a given year Some entries in the IS, like depreciation, do not represent actual changes in cash flow.

o Cash flow Statement : measure the cash made available to a business from its operations during a given

period Two components create a difference between IS and CFS

Depreciation Investments: represents that money spent to purchase equipment

o Company's cash declines because it exchanges money for equipment

o When a company buys something that will be used for more than a year it is an

investment Shows up on the IS as depreciation

o If the purchase will be used within the year it is considered an expense

Total amount appears on the IS

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Cash flow equals Profit after Tax plus Depreciation minus Investment: CF = PaT + D - I o Balance Sheet : shows the company's assets, liabilities, and the owner's equity in the business

A snapshot of a particular moment Three main sections

Assets: things that the company owns that have value o Cash, land, building, accounts receivable, and machinery and equipment

o Equipment is depreciated and the dollar amount of the depreciation charge is

deducted as an expense on the IS The same amount is deducted from the value of the asset on the balance

sheet o Cash, etc. are not depreciated because they don’t "get used up"

o Accts. Rec. are not depreciated but can be "written off"

Customer files bankruptcy, etc. Ensures accts rec are an accurate reflection of bus. Expectations of

getting paid. Liabilities: what the company owes

o Accounts payable, wages that it owes to employees, debts

Owner's Equity: what is left over after you subtract the liabilities from the assets. o Insolvency: When liabilities total more than assets, OE will be negative

When you put the assets on the left-hand side of the balance sheet and the liabilities and owner's equity on the right-hand side, then the balance sheet will balance.

CF and BS An increase in a BS asset account other than cash results in a decrease in cash flow.

o The business now owns the other asset instead of cash

An increase in a BS liability account can result in an increase in the cash account on the BS and an increase in CF.

Not only do the balance sheet totals balance, but every transaction has a balancing effect; an increase in bank borrowings [liability] also creates an increase in cash [asset] when the borrowed money is deposited in the bank.

Double Entry System: every transaction has two effects, which always serves to balance Sole Proprietorships

o A Sole Proprietorship is a business structure without a legal structure. The business is indistinguishable

from it proprietor. o The sole proprietorship is the "default" structure for business with one owner.

Unless the owner files papers to create some other structure his business is automatically a sole proprietorship.

o One person owns the enterprise. Is responsible for management decisions, receives all profit and bears all

loss. Business income is part of the proprietor's taxable income for federal and state personal income tax purposes.

Overview of Agency and the Restatement of Agencyo Employees and Introduction to principles of Agency

A sole proprietorship can have thousands of employees - it remains a sole proprietorship so long as one person owns the business

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The Law of Agency Agency law involves delegations - Someone (the principal) has a task to perform or an

agreement to make. Instead of doing it herself, she engages someone else (the agent) to do it on her behalf.

Restatement (Second) of Agency (R-2) § 1 o 1. Agency is a "fiduciary relation - the agents owed the duties to the principal in

discharging the act o 2. There must be some "manifestation of consent by one person [the principal] to

another [the agent] that the other [the agent] shall act on his [the principal's] behalf and subject to his [the principal's] control"

o 3. There also must be consent by the other [the agent] to act

Agency is a result of conduct, and not of the words used. The conduct manifests that one will do something for another, who is in charge.

Authority - the power of the agent to affect the legal relations of the principal by acts done in accordance with the principal's manifestations of consent to him.

o Actual Authority

Created by manifestations from the principal [P] to the agent [A] that the agent reasonably believes create authority.

Actual Express Authority - P expressly gives power to A to undertake an act on his behalf.

Actual Implied Authority - An agent has the authority to do what is reasonably necessary to get the assigned job done, even if P did not spell it out in detail

Interstitial authority for the agent to do what needs to be done to accomplish the task assigned.

R-2 § 35 - an agent's authority "includes authority to do acts which are incidental to it, usually accompany it, or are reasonably necessary to accomplish it. "

R-3 § 2.02(1) - the agent may take action "necessary or incidental to achieving the principal's objectives."

o Apparent Authority

Created by manifestations by P to a third party [TP]. The manifestation (1) must be attributable to P, (2) must get to TP, and (3) must lead TP reasonably to conclude that A is an agent for P [does not require detrimental reliance by TP]

o Inherent Agency Power

Power of A to bind P to deals with TP The only substantive distinction between R-2 and R-3

R-2 recognizes the concept of inherent agency power R-3 purports to abolish it

o Expands the notion of what constitutes a "manifestation"

by P to TP, and hence broadens the scope of apparent authority.

o Tort Liability

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Respondeat Superior - P can be liable even though P is not personally negligent P's liability is "vicarious" or "secondary" and does not depend on P's being negligent. Does not apply in all cases of agency Applies only to a subset of principal-and-agent relationships traditionally referred to as

"master-and-servant" o Master [employer] has the right to control the details of how the servant

[employee] does the job. The master had control over the day-to-day performance of a servant's task - "control" over the details of the job.

o A servant [employee] is to be distinguished from an independent contractor, who

is hired to do a job, but is not told specifically how to do it. Dividing line between a servant and an independent contractor is often

hazy, and is always fact specific. o The master is liable for the torts of a servant only if the tort was committed

within the scope of employment. Torts committed during periods of frolic are not a basis from vicarious

liability.

Employer/Employee Agency Ind. Contractor

Control YesActual

InherentApparent

No

Torts Yes No

Contracts Yes/No Yes/No

o Other agency relationships in Business

Attorney - Client Hayes v. National Service Industry

o Issue: Whether the nature of the underlying action, i.e., the employment

discrimination claim, requires a departure from our general reliance on state law principles on determining whether to enforce a settlement agreement.

o Holding: An attorney has the apparent authority to enter into a binding

agreement on behalf of a client and such agreement is enforceable against the client. The agreement is enforceable against Hayes.

o Gorton v. Doty

Facts: Teacher volunteered her car to transport football players to their game on the condition that the football coach drive the car. There was an accident and one of the players was injured

Issue: Was the coach acting as an agent of the teacher by driving her car? Holding: An agency relationship of principal and agency existed between the teacher and the

coach Reasoning:

No formal agency relationship, no contract, no employee/employer relationship, no compensation on either side

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o It is not essential to the existence of authority that there be a contract between

principal and agent of that the agent promise to act as such, nos is it essential to the relationship of principal and agent that they, or either, receive compensation.

Not a relationship built on an explicit understanding, not contingent on employee relationship or on compensation.

Law of Agency can be used as a strategy Allows us to identify a principal and agency, make out an agency relationship to collect

from a principal. Agency is the relationship which results from the manifestation of consent by one person

to another that the other shall act on his behalf and subject to his control, and consent by the other so to act.

Principals and Agentso Questions to ask

What is the relationship in which the party stands to the business? Is there agency? What theory of agency is this party and agent? Was this conduct within the scope of authority?

o Atlantic Salmon v. Curran

Facts: D bought salmon for A/S under Boston Seafood Exchange and owed them money. Issue: Personal liability of an agent who at the relevant times was acting on behalf of a partially

disclosed or unidentified principal. Holding: Judgment entered against the defendant and he is held personally liable. Reasoning:

In contract law, the principal is bound by the actions of the agent. Except if the

o 1. Principal is undisclosed

o 2. Principal is only partially disclosed

It is the duty of the agent, if he would avoid personal liability on a contract entered into by him on behalf of his principal, to disclose not only that he is acting in a representative capacity, but also identify the principal.

It is not the plaintiff's duty to seek out the identity of the principal; it is the agents responsibility to fully to reveal it. Actual knowledge is the test

If the agent does not disclose, it may well be presumed that he intended to make himself personally responsible.

o Hoover v. Sun Oil Company - Actual Express Authority

Facts: Injuries were received at a service station operated by James F. Barone. The fire started at the rear of Ps car where it was being filled with gasoline and was allegedly caused by the negligence of John Smilyk an employee of Barone. P brought suit against Smilyk, Barone, and Sun which owned the service station. Sun alleges that Barone was an IC and the alleged negligence could not be a liability to Sun.

Sun Oil Company is using the Law of Agency as a defense Barone is not our agent, you cannot sue us, we are not liable Sun did not control the day to day operations of the franchise If we do not control, then we cannot be held liable and they are not our agent

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Holding: No agency relationship Reasoning:

Rule -Test to be applied is whether the oil company has retained the right to control the details of the day-to-day operation of the service station; control or influence over results alone being viewed as insufficient.

The lease contract and dealer’s agreement fail to establish any relationship other than landlord-tenant, and independent contractor. There was nothing in the conduct of the individuals which is inconsistent with that relationship so as to indicate that the contracts were mere subterfuge or sham.

o Miller v. McDonald's Corporation - Apparent Authority

Facts: Miller eats a hamburger and sues Issue: Whether there is evidence that would permit a jury to find defendant vicariously liable for

injuries because of the relationship with 3k [agent] Holding: There is sufficient evidence for both issues to go to the jury. Rule: If, in practical effect, the franchise agreement goes beyond the stage of setting standards,

and allocates to the franchisor the right to exercise control over the daily operations of the franchise, and agency relationship exists.

The difference is the extent to which the franchisor retained control over the details of the franchisee's performance.

o Arguello v. Conoco

Facts: Plaintiff's are a group of consumers who claim to have been racially discriminated against at gas stations. The gas stations were branded with Conoco signage. Some of the stations were actually franchises and Conoco was the franchisors; other stations were company owned.

Agency relationship Issue: Where the franchises agents of Conoco? Holding: There is no agency relationship between Conoco, Inc. and the branded stores

in question, and that Conoco, Inc. as a matter of law cannot be held liable for the unfortunate incidents which happened to the plaintiffs at the Conoco-branded stores.

Reasoning: The language of the PMA, while offering guidelines to the Conoco-branded stores, does not establish that Conoco. Inc. has any participation in the daily operations of the branded stores no that Conoco, Inc. participates in making personnel decisions

o The franchises made the day to day decisions of the operations

Scope of Employment Issue2: An employer can be held liable for the tort action of an employee if the activity

was within the scope of the employment. Whether the acts of the employee within the scope of the employment?

Holding2: The employee was acting within the scope of employment. Reasoning: Under general agency principles a master is subject to liability for the torts

of his servants while acting in the scope of their employmento Factors:

1. Time, place, and purpose of the act 2. Its similarity to acts which the servant is authorized to perform 3. Whether the act is commonly performed by servants 4. The extent of departure from normal methods

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5. Whether a master could reasonably expect such act would be performed.

o Patterson v. Dominoes - Vicarious Liability in an Employment Context: A Franchisor’s Actions Speak

Louder Than Words Facts: Patterson alleged that she was assaulted by Miranda, the assistant manager at the

Domino’s franchise. Franchise agreement stated that the franchisor was responsible for supervising and paying the persons who work in the Store.

Holding: The court held that sufficient evidence existed to hold Domino's vicariously liable for the torts committed by the franchisor's assistant manager.

Rule: If the franchisor has substantial control over the local operations of the franchisee, it may potentially face liability for the actions of the franchisee's employees

Reasoning: Domino's sets the qualifications for employees, sets the required demeanor for employees, employee identities must be disclosed, and sets training guidelines.

Totality of the Circumstances Approach - appropriate when analyzing the franchisor/franchisee relationship for purposes of vicarious liability determinations regarding all tort causes of action.

Partners and Partnershipso A partnership is a business with more than one owner

An association of two or more persons to carry on as co-owners a business for profit.o The obligations of a business operated as a partnership are also obligations of its owners

RUPA : A partnership is an entity distinct from its partners UPA : aggregate theory - considers a partnership not as a separate legal person but rather as

merely the aggregate of its partnerso Partnership Law

Deals with the rights and obligations of partnerships and the rights and obligations of partners Primary source of partnership law will be the partnership agreement

The general rule is that relations among the partners and between the partners and the partnership are governed by the partnership agreement.

UPA and RUPA are fall-back provisions - they apply only if the partners have not agreed to the contrary.

o Starting a business as a partnership requires no formal legal steps

If two or more people own a business and they do not take any action to qualify it as a corporation or some other particular form of business structure, it will be a partnership.

Partnership law does not require that there be a written partnership agreement. A partnership agreement is a contract and is enforceable to the same extent as contract generally.

o In Re State of Fenimore

Facts: PL - Villabona [creditors] and D - Mrs. Serge (fka Watt). Villabona entered a claim against Fenimore [ judgment debtor] because they did not receive payment for him. Villabona cannot collect from Fenimore [insolvent] so they attempt to collect from Serge [Fenimore’s sister]. Serge claims that she is also a creditor and references a signed agreement. Villabona claims the bro and sis had a partnership and also references the signed agreement between Fenimore and Serge. If they are partners then they are jointly and severally liable.

Issue: Whether the relationship between Serge and Fenimore was a partnership. Holding: A partnership existed in fact between Serge and Fenimore.

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This holding could have been avoided by explicitly stating that the money was a loan, in the terms of the agreement, or with a promissory note.

Reasoning: It is not essential to the existence of a partnership that all partners have the right to make decision and a duty to share liabilities on dissolution, but at least one of these factors must be present, and there must also be an intent to share profits.

There was a written declaration of the intent of the parties and it specifically calls for the sharing of profits and the allocation of expenses. The balance of the agreement was concerned with securing Serge’s interest in the case of the death of Fenimore and stated terms of dissolution.

o National Biscuit Company v. Stroud

Facts: Partners; one partner doesn't want to sell bread to another company, other partner sells the bread to the company. Plaintiff is a creditor; there was a partnership agreement in place but did not speak to the issue so the gap-filler of UPA controlled.

Issue: Whether one partner could bind the other partner, even if he did not consent. Holding: Yes, all partners are created equal under UPA, they could agree to different terms

through a partnership agreement [would not be relevant to third parties but if the agreement was violated - partners would have claims against each other].

Reasoning: Rule: "All persons have equal rights in the management and conduct of the partnership

business." § 401(f): Each partner has equal rights in the management and conduct of the partnership

business. § 301: Each partner is an agent of the a partnership for the purpose of the business.

o Agency exists in a partnership on all three level of agency theory

o Actual, Inherent, and Apparent

o Meinhard v. Salmon

Facts: Two partners, Meinhard and Salmon, Salmon had the experience and Minehard had the cash for the venture. The lease was for 20 years and they would share the profit for that length of time. Nineteen years later, Salmon is approached by the building owner with a new venture, Salmon does not inform Minehard of the proposition and proceeds without him.

Holding: A fiduciary Reasoning: Partners have a fiduciary relationship with each other

Joint adventurers, like copartners, owe to one another, while the enterprise continues, the duty of the finest loyalty.

Whether a fiduciary duty exists is very fact dependent In this case, the subject-matter of the new lease was an extension and enlargement of the

subject-matter of the old lease. o No duty would have been imposed if it had been a completely separate venture

o If a 3rd party brings a deal to one partner, we must look at the capacity in which

the 3rd party approached the partner. Fiduciary Duty to not put your own interest over the interest of a partner: The trouble

with the conduct of Salmon is that he excluded his coadventurer from any chance to compete, from any chance to enjoy the opportunity for benefit that had come to him alone by virtue of his agency.

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Fiduciary Dutieso 1. Duty of loyalty [partner cannot compete with the partnership or the partner;

avoid a conflict of interest]o 2. Duty of Confidentiality

o 3. Duty to Account [disclose and allocate losses and profits]

o 4. Duty of Diligence.

o Bohatch v. Butler and Binion

Facts: Partner [Bohatch] at a firm reported overbilling by another partner. The other partners retaliated by expelling Bohatch from the partnership.

Issue: Whether the fiduciary relationship between and among partners creates an exception to the at-will nature of partnerships - whether it gives rise to a duty not to expel a partner who reports suspected overbilling by another partner.

Holding: The firm did not owe Bohatch a duty not to expel her for reporting suspected overbilling by another partner.

There was still a breach of contract Reasoning: The relationship between partners is fiduciary in character, and imposes upon all the

participants the obligation of loyalty to the joint concern and of the utmost good faith, fairness, and honesty in their dealings with each other. Yet partners have no obligation to remain partners.

o Two types of Partnerships

At Will Partnership: no time limit on the partnership. No duty to remain partners. For Term Partnership: Partnership Agreement states an expiration of the partnership at a certain

time or after the purpose of the partnership is achieved. o Dissolving Partnerships

The departure of a partner from a partnership will not dissolve the partnership Revised Uniform Partnership Act (RUPA)

o § 202: "The association of two or more persons to carry on as co-owners a business for profit forms a

partnership, whether or not the persons intend to form a partnership. " The important thing to notice from this section is that the "partners" do not have to intend to enter

into a partnership. o § 103: The partnership agreement will govern between partners

What is the big deal? If the state has partnership law and there is a statute - then it is ok to not have a

partnership agreement [but the statute may lead us to a conclusion about a partnership that is not congruent with the facts.]

Why do lawyers encourage agreements if there is a statute? RUPA gives law about general partnerships which could lead to very different legal

results that what the parties intended. Small business - partners are actively engaged in day-to-day business and share in

management, profits, and losses of the business.o § 301 Relations to TPs - Agency and Partnerships

Each partner is an agent of the partnership - actual, inherent, and apparent authorityo § 401

(b) Profits: each partner is entitled to an equal share of the partnership profits and is chargeable with a share of the partnership losses in proportions to the partner’s share of the profits.

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(f) Management: Each partner has equal management and conduct of the business. (j) Decisions: A difference arising as to a matter in the ordinary course of business of a

partnership may be decided by a majority of the partnerso Liability

§ 305: (a) A partnership is liable for loss or injury caused to a person, or for a penalty incurred, as a result of a wrongful act or omission, or other actionable conduct, of a partner acting in the ordinary course of business of the partnership or with authority of the partnership.

§ 306: (a) Except as otherwise provided in subsections (b) and (c), all partners are liable jointly and severally for all obligations of the partnership unless otherwise agreed by the claimant or provided by law. (b) A person admitted as a partner into an existing partnership is not personally liable for any partnership obligation incurred before the person’s admission as a partner

307(a): A partnership may sue and be sued in the name of the partnership (d): Have to go after the partnerships assets first and then if the judgment is unsatisfied can they go against the partners personal assets.

o Transfer of Partnership interests

§ 502: Partner's Transferable Interest in Partnership The only transferable interest of a partner in the partnership is the partner's share of the

profits and losses of the partnership and the partner's right to receive distribution. The interest is personal property.

Cannot transfer actual partnership Our notion of partnerships is that it is genuinely people who know each other and being

able to transfer partnership right's goes against that The only thing that can be transferred is the economics of the partnership - profits, losses,

assets, liabilities § 401(i): a person may become a partner only with the consent of all the partners. § 503: Transfer of Partner’s Transferable Interest § 504: Creditors can take over the partners economic portions/distribution but cannot take over

the partnership roleo 601: Events Causing Partner’s Dissociation

o 602: Partner’s Power to Dissociate; Wrongful dissociation

o 603: Effect of a Partner’s Dissociation

“Looking for Lenders’ Little Helpers” - Article discussing the collapse of the housing economy.o What do we have?

Individuals who want to buy home; they go to mortgage lenders who allow them to take out a mortgage

What happens when the mortgage company lends out all the money it has?o The mortgage company decided to sell the mortgages to WS so they could have

more money to lend out. Then the big WS Banks ran out of money so they took thousands of the

mortgages, put them in a big pool, went out to the investment public and sold little slivers of the pool [collateralized mortgage operations - bonds].

People started defaulting on their loans as the banks were asking the mortgage companies for more mortgages and in turn the mortgage companies lowered their qualifications for borrowing.

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This was not sustainable…obviously. What does this have to do with Partnership Law?

Mortgage companies and Investment Banks…Partners??o Allows the consumer to sue both the Mortgage Company and the banks [joint

and severally liable]. Bad for the banks because most of the mortgage companies are gone!

Case Study 1 Introduction to Corporations

o A corporation is an artificial being, invisible, intangible, and existing only in contemplation of law. Being

a mere creature of the law, it possesses only those properties which the charter of its existence confers upon it.

o They have the legal rights as a person - they stand separate and apart from the people who own them.

They also are protected by Constitution - right to free speech, due process, equal protection They are creatures of state law.

o Most popular form of business organization.

o Most corporations are not big; many are owned and run by one person

o Most statutes concerning the formation and running of corporations do not distinguish between large and

small businesseso Small Corporations are called "close" or "closely-held"

They have relatively few shareholders; there is no public market for buying or selling interests in them. The shareholders usually know each other and have an agreement on what is to be done with the business; there are restrictions on what you can do with your shares.

Also Private corporationso Large Corporations are often called "public"

They have many shareholders; interests in them are publicly traded All information regarding company are public

o What is a corporation and what is corporation law?

The primary authority over the creation of business organizations has resided with the individual states

A corporation has always required formal recognition by a sovereign person or government A corporation is not only the business structure used by most large businesses with thousand of

owners but it is also the business structure used by most small businesses, some with just one owner.

Accounts for approximately 90% of business receiptso A corporation is …

Creation of state legislatures Every state's corporation statute provides that [i] a corporation is a separate, legal entity

and [ii] its owners, usually called shareholders are generally not personally liable [the most the owner risks is the amount that the owner paid for the shares of stock - concept of Limited Liability]

The elemental purpose of corporation law is the facilitation of cooperative activity that produces wealth

o A net increase in total wealth is an "absolute good"

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o With a net increase in total wealth there comes a greater ability to relieve human

suffering and enhancement of life - an "unqualified good" Corporation law facilitates wealth creation principally by creating a legal structure that makes it

substantially cheaper for investors to commit their capital to risky ventures. Economics and Business/Corporations

1. Economists view the corporation as a way to reduce "transaction costs" 2. View the corporation not as an entity but as a set of contractual relationships among

the suppliers of all of the corporation's inputs - "nexus of contracts" 3. Agency Costs - Much of corporate law and lawyering attempts to control agency costs

o Corporate Law is . . .

Four primary sources of corporate law 1. State Statutes

o Some states have modeled corporate statutes after the MBCA.(Including AZ)

MBCA is not a default law (like RUPA), but instead they are rules you have to follow and there are penalties for not complying with the statutes.

o Some state statutory provisions are mandatory; others are default rules that apply

only if the articles of incorporation or bylaws do not speak to the issues 2. Articles of Incorporation, bylaws, and other agreements

o Can be an important source of corporate law

3. Case lawo Two separate functions

1. Cases interpret and apply the provisions in corporate statutes and in a corporation's articles and bylaws

2. Fill in gaps in the law 4. Federal statutes

o Govern certain corporate activities

When look at what governs the corporation, first look to the articles of incorporation (these are the only legal documents required to be filed with the state), the corporation bylaws (set of internal rules, guidelines inside the corporation - these can be changed at any time and aren’t filed with anyone), MBCA (or the state statutes), and case law (all law is state law, there is no federal corporation law).

o Characteristics of a Corporation:

Ownership = one or more person/entity, memorialized by shareholders or stockholders Management = centralized (management is separate and apart from ownership of the business).

The owners appoint a board of directors, who in turn select officers to manage business. Corporations are perpetually in existence because the separation of management and

ownership. Liability = limited, shareholders are not responsible for liabilities of a corporation (usually...) Taxes = Double Tax

Revenue – profit – pay taxes at end of fiscal year – taxes paid at corporate rate If corporation passes profits onto shareholders or owners, individual must show it on

personal income tax Exit = very easy.

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MBCA Sections:o 2.01-one or more persons may act as the incorporator(s) of a corporation by delivering articles of

incorporation to the secretary of state for filling. AZ has a special corporation commissiono 2.02- Articles of incorporation must set forth:

corporate name number of shares the Corp is authorized to issue street address of Corp Name and address of each incorporator Names and address of individuals who are to serve as the initial directors. Purpose for which corporation is organized [can be as vague as "all lawful business for which

corporations can be incorporated" o 3.01 - must have purpose of engaging in lawful business

o 4.01- Name MUST contain word "corporation" "incorporated" "company" or "limited" [why? So you

know how you are doing business with and communicating with an entity whose owners have limited liability.

o 2.03 - Corporation comes into existence on date of filing

o 5.01 - Each corporation must continuously maintain in this state:

A registered office that may be the same as any of its places of business; and A registered agent, who may be: an individual, a domestic corporation, a foreign corporation

authorized to transact business in this state. These are very loose rules for where your business is incorporated - it does not have to be

the same place as owners, where bank accounts are, or even where principal business is. You can forum shop (We don’t see this much anymore because laws have become much more uniform, although Delaware is often chosen).

What state is often chosen? Delaware.o Why Delaware? Corporation law is attractive to corporations because it is

beneficial and favorable to the Corporations.o When all these Corps started going to Delaware, every state then tried to make

their law as favorable to businesses as well -- this is called "the race to the bottom". - so now many states have law favorable to business.

o BUT Delaware still is winning this race. Why? There is a ton of case law there,

and a lot of people teach and learn about Delaware case law.o Nevada is trying to be more pro-business than Delaware.

Issuance of Stocko Shares of stock are the units of ownership in a corporation

6.21 - The Board of Directors can authorize shares in exchange for consideration. consideration can be cash, notes, property, services

o "A corporation may issue the number of shares of each class or series authorized by the articles of

incorporation" A corporation sells its own stock A corporation's sale of its own stock is called an "issuance" The articles of incorporation determine the number of shares a corporation may issue

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This number is the number of "authorized shares" - the TOTAL number of shares your company is authorized to sell to buyers (this is a much higher number than you will actually issue)

A corporation is not required to issue all of its authorized shares Shares that the corporation actually does issue are called "issued shares"

number of shares sold/transferred/issue to the public for consideration. Once shares are issues, they are always issued, just maybe no longer outstanding.

"Outstanding shares" consist of issued shares that the corporation has not reacquired A corporation can have more than one type of stock

MBCAo 6.01 - articles of incorporation must set forth classes of shares, number of shares

of each class and number of authorized shares. (c) - may authorize different types of shares

o 6.02 - "the blank check" - board of directors are allowed to create new classes

and series of stock, so long as there was a number of authorized shares in letters of incorporation

o 6.03 - ALL corporations have common stock. A corporation cannot exists

without shares of common stock.o 6.22 - corporation no longer has any right at any time to ask for more money

after you have paid consideration to the corporation. Shareholders DON’T have liability for corporate obligations and debts, except to pay for their shares. Claims will be satisfied from assets of corporation. Also, when you buy the stock it is yours.

Preferred Stock - a creature of articles of incorporation o A class of stock that is treated more favorably that the other class of stock

Dividend rights Voting rights Liquidation rights - preferred payouts, first dibs before common

stockholders get anything even when company is dissolved Redemption rights - right to get money back from corporation, have

corporation buy their stock back at a date certain or at an event (required to buy back shares for money they paid

o Preferred stock allows corporation to attract a lot more capital because they can

have assurances. These are usually sophisticated traders - they want to have preference over common shareholders because they are taking a risk greater than common stockholders because they put a lot of money and want ability to get money back

Common Stock - does not enjoy special treatment (pro-rate ownership based on percentage of shares owned). All corporations must issue common stock.

o Par Value - is the minimum price for which a corporation can issue its shares

[minimum issuance price, not a fixed price][usually fractions of a penny because it requires a shareholder vote to lower par value]

o Stated Capital - includes the aggregate par value of all issued shares of par value

stock

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Cannot be distributed to shareholders A cushion to protect creditors, to ensure that the company retains at least

some money to pay billso Capital Surplus - funds received in excess of par

May be redistributed to shareholders in the form of dividendso Limiting the practical impact of par value, stated capital, and capital surplus

1. Requirement of stating a par value in the articles of incorporation has been eliminated

2. Even if a state requires it, corporations have diminished it by setting the par value at a penny or even a fraction of a penny.

A corporation can have different series of stocks Inside a Class – Class A shares have certain rights, subset Series 1 has additional rights.

Forming Corporationo What are legal problems in starting a business as a corporation?

Preparing the necessary papers Necessary papers - A corporation does not exist until the articles of incorporation are

properly executed with the appropriate state agent or agencyo Articles of corporation may be the only document that a corporation makes

publico Can be seen as a contract between the corporation and shareholders

o Shareholders must approve any amendments to the Articles of Incorporation

Adoption of bylaws is not a condition precedent to forming a corporation although almost every corporation does have bylaws

o No state requires filing of bylaws - usually a completely internal document

o Contracting before incorporating

Promoter - is someone acting on behalf of a corporation that is not yet formed. When is the promoter liable and when is the "corporation" liable?

A corporation may not be liable for actions taken by the promoter until some action is taken to adopt the actions of the promoter.

o The corporation must expressly adopt the contracts/action/etc.

o The corporation can impliedly adopt the contract/action/etc/

o When the contract/action/etc. is adopted, the corporation has ratified what its

"agent" did Ratification - affirmance by a person of a prior act which did not bind

him but which was done or professedly done on his account. It is the ex post facto adoption of something an "agent" purportedly did for a "principal"

o To free the promoted from personal responsibility , the contract would have to be

"novated" - old party is released and new party is responsibleo De Facto Corporation and Corporation by Estoppel

De facto corporation - if proprietors are acting in good faith and came very close to forming a de jure corporation [usually said to have reached "colorable compliance with the formation requirements], there was a de facto corporation and the proprietors would not be personally liable

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Is an equitable doctrine , so one seeking to use it must act in good faith means that she must be unaware of the failure to form a de jure corporation

Many state have done away with de facto corporations because it is so easy to form a de jure corporation

o If you fail to form a de jure corporation, the proprietors are liable for whatever

they purported to do on the "corporation's" behalf Corporation by estoppel - generally applies only in contract cases, not tort

It is basically just estoppelo Choosing the state of incorporation and qualifying as a "foreign corporation"

Corporations are free to incorporate in any state of their choosing Reason we do not see much forum shopping now is because of the MBCA which is

adopted in most states Eliminated the need for the "race to the bottom" between states.

Incorporation state - the laws of that state will become the default rules that govern the internal affairs of a corporations

Internal affairs include procedures for corporate actions and that rights and duties of directors, shareholders and officers with respect to each other

Would NOT include the rights of third parties with respect to the corporation Most Fortune 500 corporations are incorporated in Delaware

At this point, Delaware's laws are not significantly different from other states Most publicly traded corporations are Delaware corporations

In corporate law, "foreign" does not refer to another country - it applies to another state Every state requires foreign corporations transacting business there to "qualify"

o Obtaining authorization for the appropriate state agency

o Appointing a registered agent in the state

o Filing annual statements in the state

o Paying fees and franchise taxes to the state

Limited Liability - Piercing the Corporate Veilo A corporation can be held liable to third parties for contracts, torts, violations of statutes, etc.

o There are contractual and judicial exceptions to the rule that shareholders are not personally liable for the

acts or debts of the corporation Contractual Exceptions - a shareholder will personally guarantee a loan Piercing the Corporate Veil

Concept of disregarding limited liability and holding shareholders personally liable. Law will be different based on jurisdiction; very fact-driven cases; most commonly

litigated issue in corporate laws Doctrine is directed exclusively at close corporations and corporate groups. Courts are less likely to pierce the veil in cases involving torts claims as opposed to those

involving contractual or statutory claims. In a contract, there are certain expectations and bargaining [you know what you are doing, who you will be involved with, and the terms of the agreement, this is not the case with a tort].

Undercapitalization and corporate formalities often lead to piercing Three theories under which to pierce the corporate veil

o Alter Ego

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o Undercapitalization

o Disregarding corporate formalities

o Roman Catholic Archbishop of San Francisco v. Sheffield

Facts: Sheffield went to Switzerland and entered into a contract to purchase a Saint Bernard from the monk. Sheffield was to pay certain fees and the monk would send the dog. The dog was never sent. Sheffield sued everyone!! Pope, Vatican, Archbishop of San Francisco, etc. He sued in San Francisco, California because it was prohibited in Italy. He served the Archbishop of San Francisco claiming that all defendants were "alter egos" of each other.

Alter Ego Factors:

o Commingling of funds

o Holding out by one entity as liable for the debts of the other

o Identical equitable ownership

o Same offices and employees,

o Use of one as a mere shell or conduit for the affairs of the other.

The theory makes a "parent" liable for the actions of a subsidiary which it controls, but it does not mean that where a "parent" controls several subsidiaries each subsidiary then become liable for the actions of all other subsidiaries. There is no respondeat superior between the subagents

In almost every instance where a plaintiff has attempted to invoke the doctrine he is an unsatisfied creditor. the purpose of the doctrine is not to protect every unsatisfied creditor, but rather to afford him protection, where some conduct amounting to bad faith makes it inequitable for the equitable owner of a corp to hide behind its corporate veil.

o Dewitt Truck Brokers, Inc. v. Ray Flemming Fruit Company

Facts: Dewitt, trucking company, is suing Flemming, fruit company, for not receiving payment. W. Ray Flemming, the corporation’s principal shareholder, orally assured plaintiff that he would personally pay for the fruit transportation if the corporation did not [this was not enforceable under contract law because of Statute of Frauds].

Issue: Whether Flemming, the principal shareholder, be held personally liable for the debt of the corporation?

Holding: Flemming is personally liable for the debt of the corporation under the theory of “piercing the corporate veil.”

Reasoning: In an appropriate case and in furtherance of the ends of justice, the corporate veil will be

pierced and the corporation and its stockholders will be treated as identical. o Burden of Proof belongs to the Claimant

o Is applied reluctantly and cautiously

o Proof of plain fraud is not a necessary element

Instrumentality or Alter Ego Theoryo Factors: [totality of the circumstances]

Grossly undercapitalized Failure to observe corporate formalities Non-payment of dividends

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Insolvency of the debtor corporation at the time Siphoning of fund by dominant stockholder Non-functioning of other officers or directors Absence of corporate records Corporation is a façade PLUS injustice or fundamental unfairness

o Subsidiaries - a corporation whose stock is owned by another corporation

A parent corporation is not liable for the contracts, torts, and other obligations of its subsidiary corporation unless there is a contractual or judicial exception to the rule that a shareholder is not liable for the acts or debts of the corporation

o In Re Silicone Gel Breast Implants Liability Litigation

Facts: Bristol was the sole shareholder of MEC, major supplier of breast implants. Reasoning:

The potential for abuse of the corporate form is greatest when, as here, the corporation is owned by a single shareholder

A parent corporation is expected to exert some control over its subsidiary When a corporation is so controlled as to be the alter ego or mere instrumentality of its

stockholder, the corporate form may be disregarded in the interest of justice. Totality of Circumstances

o All jurisdictions require a showing of substantial domination

o Common directors/officers

o Common business departments

o File consolidated financial statements and tax returns

o Parent finances Subsidiary

o Parent caused the incorporation of the Sub

o Sub operates with grossly inadequate capital

o Parent pays the salaries and other expenses of the sub

o Sub receives no business except that give to it by the parent

o Parent uses the Sub’s property as its own

o Daily operations of the two corporations are not kept separate

o Sub does not observe the basic corporate formalities, such as keeping separate

books and records and holding shareholder and board meetings. o Enterprise Liability

Theory under which corporations that [although technically separate] are commonly-owned and engage in one enterprise should be treated as a single legal entity for purposes of liability.

Pierces the walls of one corporation not to go after the asset of a shareholder, but to go after the assets of related companies.

Corporate Governance - Shareholders, Directors, and Officerso Who gets to decide what?

Board of Directors - have a pretty broad mandate to govern the company but not a rigid set of legal rules dictating the way to govern. The BODs don't have to really have any qualifications to be there, but we seem to expect the most of them. Role of BOD has changed overtime. [timeline pg 68 supp].

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Practical constraints of BOD - they meet infrequently so they cannot get a grasp over business they are supposed to be making decisions for. Most presentation of information is from management- so there is an inherent bias.

o Is BOD truly skilled to be the oversight of a corporation?

Demographic issues - board is there to represent the interest of the shareholders, but traditionally they are not an actual representation of the shareholders. (the old boys club is created by CEOs knowing CEOs and asking them to be on each other boards - and setting their pay). There are better boards that set their own mandates to actively seek diversity and set term limits, age limits etc.

Legal constraints - it is an ever evolving story of what they are expected to do and what is there legal authority.

Officers - there is more a system of best practices than there are required statutory practices. Statutorily you have certain positions They are appointed by the BOD They are deemed the fiduciaries of the company - they are AGENTS of the corporation!

The BOD and Shareholders are not.o Since they are agents - what theory are they agents under? Actual, Inherent, and

Apparent Authority.o When company names someone president - this gives manifestation of agent

authority. Management - mostly tradition, not law

Shareholders - don't participate in management BOD- Income Statement: general oversight, decision to incur debt, strategic decisions Officers - Revenue Statement: day to day operations, manage employees, research

development, marketing etc There is a “pyramid of control” in a corporation

Officers have most power, Shareholders have least power, and Board of Directors are somewhere in the middle.

These are the competing interest within the corporation - those whose interest must be balanced.

o MCBA

o Shareholders:

7.01 - annual meeting 7.02 - special meeting usually for fundamental change 7.21 -outstanding shares get one vote per share 7.28 - allows for cumulative voting when contracted or by articles (cumuative voting is

mandatory in AZ)o Board of Directors:

8.01 - (a) Every Corporation must have a BOD (b)

8.02 - there are no prescribed duties, limits, education, status of ownership etc for BOD. 8.03 - must have 1 or more directors. Directors are elected at annual meeting by shareholders. 8.05-Terms of Directors expire at 1st annual meeting

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8.06 - Staggered terms for directors 8.20 - Liberal about how board does job - Meetings can be held outside state of business

(b) and may participate in special or regular meetings by phone/skype etc 8.21 - BOD may take any action without a meeting if they sign a consent to the action 8.11 - BOD may fix their own compensation 8.25 - BOD may create committees and appoint one or more director to the committee

o Officers:

8.40 - Board may elect individuals as officers and can assign responsibilities 8.41- Functions of Officers - statute gives little guidance, other than to do things delegated by the

Board.

o McQuade v. Stoneham

Facts: McQuade, McGraw, Stoneham [Shareholders/owners of the Giants] decided they would be directors and officers [with set compensation] and signed an agreement stating that no changes would be made to the agreement except if there was a mutual and unanimous consent of all the parties. Stoneham was the majority shareholder and president; McGraw was the VP; McQuade was the treasurer. The board of directors consisted of seven men and included the three above. The four outside of the parties hereto were selected by Stoneham and he had complete control over them. McQuade gets voted out because of a "falling out of friends" over money. (D alleges there was a normal vote to replace him as treasurer) McQuade wants to enforce the agreement between the three [pg. 154]

Issue: Whether the shareholder's agreement should be enforced? Holding: A contract is illegal and void so far as it precludes the Board, at the risk of incurring

legal liability, from changing officers, salaries, or policies or retaining individuals in office,except by consent of the contracting parties.

Directors may not, by agreements entered as stockholders, abrogate their independent judgment.

Their duty was to the corporation and its stockholders, to be exercised according to their unrestricted lawful judgment.

o The parties were under no legal duty obligation to deal righteously with

McQuade if it was against public policy to do so. As shareholders --> they could elect directors, NOT officers [as they did in this case]

o If this contract was done as Directors tha

o t it would be fine (because Directors pick Officers), but it was an agreement

made as shareholders picking officers and therefore void Note: There was a statute passed after McQuade that allows for shareholder agreements between

and among themselves, and the effect of that agreement will allow them to do this they normally couldn't do or couldn't do without the agreement. [McQuade no longer good law]

Villar v. Kernan o Facts: Villar and Kernan went into business with Villar having 49% share, Kernan had 51%, then

manager became 2% shareholder (1% from each). Parties orally agreed to no compensation/salaries for shareholders, only distribution. Kernan later enters into a consulting agreement with the corporation

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which pays him $2,000/week. This agreement was ratified at a shareholders’ and board of directors meeting at which Villar was not present. Villar wants to enforce the original oral agreement.

o Issues:

1. Does Maine law preclude an action for breach of an oral contract between two shareholders? 2. If Maine law doesn’t preclude, what are the factors that should be applied?

o Holding:

1. The agreement is precluded because it was an oral agreement. 2. Not considered

o Reasoning:

Maine law allows closely-held corporate shareholders to contract to be able to do things that shareholders would not normally be allowed to do [different than the law, at the time, of McQuade]

Shareholder Rightso What do Shareholders get to do? They get to vote! But really, Shareholders have a very limited voice in

corporate affairs - they elect and remove directors and they have to approve fundamental changes. It is one of the earmarks of a corporation - the separation of ownership from management.

MBCA § 8.03 (c ) One role of shareholders is to make decision about directors; Shareholders elect directors

In large, publicly held corporations, the role of shareholders in electing directors does not matter as much because most shareholders own too little shares to make a difference.

In small, closely held corporations, several shareholders can have the power to elect or remove directors.

For fundamental corporate changes Amendment of Articles of Incorporation Dissolution Mergers Sale of all/subset of all assets

Types of voting Straight voting [default] [MBCA § 7.28(a)]

o Separate election for each seat on the board

o Each shareholder gets to cast his/her number of shares in any way they choose

for each election Cumulative Voting [based on contractual agreement [MBCA § 7.289(b)]

One at-large election Shareholders get to "cumulate" votes

o # of shares times # of directors to be elected

Applies only to shareholders election of/removal of directors Gives minority shareholders more of a voice [empowers minority shareholders] It is mandatory in Arizona by the state constitution [different from most states]

§ 8.06 Staggered Terms for Directors Example: 9 Directors --> 3 Directors are elected each year Perpetuates the incumbenance

§ 7. 27 Super majority - Requires more than just a majority of decision making Can work to protect both minority or majority shareholders

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o Who, what, when, where, and why of voting

§ 7.01 Annual Meeting § 7.02 Special Meeting [usually for addressing issues of fundamental corporate change] Record Date: date on which you must be a shareholder in order to vote

Ex: Mtg. is on 07/01; must be a shareholder by 06/01 Record Owner: Name of Shareholder [will be the broker if bought through a broker] Proxy: Legal Document that creates an agency between shareholders and 3rd parties to vote the

shares Street Name: Owner of shares who buys shares through a broker.

o Who votes [and what are proxies]

A shareholder does not have to present at the annual or special meeting to vote her share The person who is entitled to vote authorizes another person to vote for her - form of agency: the

owner is the principal and authorizes the proxy-holder to be her agent for voting.o Lovenheim v. Iroquois Brands

Facts: Minority shareholder seeks to bar Iroquois from excluding from the proxy materials being sent to all shareholders in preparation for an upcoming shareholder meeting information concerning a proposed resolution [proposal about animal cruelty]. Iroquois has refused to allow information concerning the proposal by relying on an exception to the general requirement of Rule 14a-8 - provides that an issuer of securities may omit a proposal and any statement in support thereof from its proxy statement and form of proxy.

Proxy Process: at annual meetings, proxy materials are sent out [like a ballot] and shareholders can vote by sending that in [regulated by Federal Security Laws and the SEC]

Holding: In light of the ethical and social significance of plaintiff’s proposal and the fact that it implicates significant levels of sales, P has shown a likelihood of prevailing on the merits with regard to the issue of whether his proposal is otherwise significantly related to Iroquois’ business.

Reasoning: Five percent test of economic significance

o Proposals must meet this test to be put on a proxy material

o If the proposal relates to operations which account for less than 5% of the

issuer’s total assets at the end of its most recent fiscal year, and for less than 5% of its net earnings and gross sales for its most recent fiscal year . . .

Or…"…and is not otherwise significantly related to the issuer's business"o Plaintiff argued that ethical/social issues could affect consumers as much as

economical issues --> therefore significantly related to the businesso Shareholder Activist Proposals

Most common is "say in pay" of CEOs Result of vote is not binding on the Board of Directors [can differ based on the Articles of

Incorporation] - Vote is only advisory Why? Because it is not the role of shareholders to make decision on business practices

Shareholder doesn’t like this?o Elect different directors

o Sell your shares!

Duties of Boards of Directors and Officerso It is management’s job to create value for the owners.

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o Managers of privately held companies are little worried about the short-term implication of their actions,

or about the way in which outsiders perceive those decisions but public companies have to disclose financial statements, there are a lot of “owners”, and federal security laws and rules of stock exchanges require disclosure and transparency.

o Duty of Care

Shlensky v. Wrigley [Breach of Duty of Care by Board Action] Parties: D = directors of Cubs, Philip K. Wrigley; P = minority stockholders Facts: The action was a stockholder’s derivative suit against the directors for

negligence and mismanagement. The Defendants are the directors of the Cubs and Wrigley is also the president of the corporation and owner of approx. 80% of the stock. Plaintiff alleges that every member of the MLB, except the Cubs, had night games. P is alleging mismanagement and negligence because of inadequate attendance at Cubs’ home games - because of the lack of night games. He charges that the directors are acting for a reason or reasons contrary and wholly unrelated to the business interests of the corp. Cubs had operating losses from 1961-1965

Holding: The decision is one properly before directors and the motives alleged in the amended complaint showed no fraud, illegality, or conflict of interest in their making of that decision

o What did the court actually say? Did not decide the case, no judgment rendered

on the merits. Just looked at the decision and decided if it was made in good faith.

Reasoning: The judgment of the directors of corporations enjoy the benefit of a presumption that it was formed in good faith and was designed to promote the best interests of the corporation they serve.

o There is no such thing as a claim for "mismanagement". In corporate law,

negligence as a claim is rareo Courts may not decided these questions in the absence of a clear showing of

dereliction of duty on the part of the specific directors and mere failure to “follow the crowd” is not such dereliction.

Barnes v. Andrews [Breach of Duty of Care by Board Inaction] Parties: D = Andrews [director - corp. manufactured starters for Ford Motors]; P =

Barnes [standing in the shoes of a shareholder]. The complaint by the P is that the D had failed to give adequate attention to the affairs of the company [breached duty of care]. While he was a director there had been only two meetings of directors [only one of which he attended] and his only attention to the affairs of the company consisted of talks with the president as they met from time to time [they were friends].

Holding: There is no evidence that the D's neglect cause any losses to the company and that, if the actions did lead to losses, the loss cannot be ascertained.

Reasoning: o Directors can act individually only by counsel and advice to the yet they have an

individual duty to keep themselves informed in some detail, and it is this duty which the defendant failed to adequately perform.

o The director made no effort to keep advised of the actual conduct of the corporate

affairs.

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o The P has the burden of showing that the performance of the Ds duties would

have avoided loss, and what loss it would have avoided [Majority View: The P must show not only that the D breached the duty of care, but that this breach caused a loss to the corporation; Delaware courts: Do not make the P show causation - it is an affirmative defense for the D which requires him to show that the process used to approve the deal was fair and that the terms of the deal were fair]. The D is not subject to the burden of proving that the loss would have happened, whether he had done his duty or not.

o The Business Judgment Rule

Joy v. North Facts: Parties: D = North, CityTrust; P = Shareholder (derivative Suit). Lawsuit against

the officers and directors of a Connecticut bank alleged that they had breached the duty of care in making a series of loans to a real estate developer [Katz]. CityTrust made a series of loans to a real estate developer [Katz]. The Loans resulted in losses to shareholders. The corp. board of directors appointed a special litigation committee which issued a report that recommended that the suit be dismissed as to the outside directors. According to the report, the management of the corp. was completely dominated by North and North also exercised strong control over the activities of the BoD.

Business Judgment Rule: Liability is rarely imposed upon corporate directors/officers simply for bad judgment --> the reluctance to impose liability for unsuccessful business decision. Rule reflects the oft-stated judicial policy that courts will not interfere with business decisions by corporate directors [not officers?] as long as the directors are acting with disinterest, good faith, and due diligence.

o Policy Reasons

Recognizes a certain voluntariness in undertaking the risk of bad business decision

After-the-fact litigation is a most imperfect device to evaluate corporate business decisions

Potential profit corresponds to the potential risk Interest of the shareholders for the law to NOT create incentives

for overly cautious corporate decisionso Limitations

Doesn’t apply in cases in which the corporate decision lacks a business purpose, is tainted by a conflict of interest, is so egregious as to amount to a no-win decision, or results from an obvious and prolonged failure to exercise oversight/supervision

Shareholder Derivative Actionso A derivative action is the common law’s inventive solution to the problem of

actions to protect shareholder’s interests. A derivative suit involves two actions brought by an individual shareholder:

An action against the corporation for failing to bring a specified suit and An action on behalf of the corporation for harm to it identical to the one

which the corporation failed to bring. Termination of Derivative Suits by Special Litigation Committees

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o A decision to bring a lawsuit is a corporate economic decisions subject to the

business judgment rule. o A shareholder must first make a demand on the board to bring a demand before

bringing her own. If the directors refuse, and the shareholder brings an action, the courts will apply the business judgment rule to the action of the directors.

o Court: The situation in which there is a conflict of interest in the directors’

decision not to sue and because the directors themselves are named defendants should be treated differently.

o Business judgment rule does not apply to the recommendation by a special

litigation committee. Holding:

o As to the liability, we find that the Ps chances of success are rather high. The

loss to CityTrust resulted from decisions which put the bank in a classic “no win” situation.

o Directors who willingly allow others to make major decisions affecting the future

of the corporation wholly without supervision or oversight may not defend on their lack of knowledge, for that ignorance itself is a breach of fiduciary duty.

Reasoning:o The Katz venture was risky and increasingly so but the issue of which Ds are

responsible is not clear. A lack of knowledge is not necessarily a defense, if it is a result of an abdication of directional responsibility [decision would depend on how and why the Ds were left in the dark].

Smith v. Van Gorkom [people have mixed feelings about this case but it is a big deal] Parties: D = Van Gorkom; P = Shareholders. Directors approved a merger that

shareholders did not like and they are seeking either a rescission of the merger or damages against the BoD.

Issue: Whether the directors informed themselves as to all the information that was available to them

Holding: The LC finding that the Board's conduct was not "reckless or imprudent" is contrary to the record and not the product of a logical and deductive reasoning process.

o The Board lacked valuation information adequate to reach an informed decision

[business judgment rule] as to the fairness of $55/share for the sale of the company

Court is not judging the quality of the decision but the quality of the decision making process

Reasoning: o Directors are charged with an unyielding fiduciary duty to the corporation and its

shareholders. The bus. judgment rule exists to protect and promote the full and free exercise of the managerial power granted to directors and is a presumption that the directors acted in an informed basis, in good faith, and in the honest belief that the action takes was in the best interest of the company.

o The determination of whether a bus. judgment is an informed one turns on

whether the directors have informed themselves prior to making a business decisions, of all material information reasonably available to them.

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Gross Negligence is the proper standard for determining whether a bus. judgment reached by a BoD was an informed one.

Dissento Directors were highly capable of making this decision and directors of this

caliber are not ordinarily taken in by a "fast shuffle" Fallout of Van Gorkom

Increase in lawsuits Directors and Officers Insurance increased

o Ds and Os are indemnified and corporations buy insurance to pay for the

indemnification More Involved Due Diligence Process- showing that Ds and Os went through a complete

decision-making process, pg 116 supplement Statute in Delaware: Delaware legislature decided to permit corporations to limit their

directors’ liability for money damages for breach of fiduciary duty - cannot protect directors from all liability, not to outside parties, not for violations of duty of loyalty or conduct that was in bad faith.

MBCA § 8.30(6): Can argue that it was unreasonable or not actually "experts"o There are only 2 claims you can make against directors

1. Breach of duty of care: There is a minimum standard of conduct we expect the directors to meet when in their

role. But courts do not want to take position that directors and officers are guarantors for a business' success. Also, hindsight is perfect and we don't want to give shareholders benefit of hindsight when making claims against directors. Also, courts don’t think judges and juries have enough expertise to make business decisions, and we are not going to substitute our judgment for theirs [business judgment rule - we are entitled to the presumption that we made good faith decisions].

How do we get there?o Fraud, gross negligence - needed to be found to overcome the business judgment

ruleo Breach of Duty of Care by Gross Negligence

Decision, if grossly negligent Inattentive, if grossly negligent Uninformed, if grossly negligent

BJR is the standard until Van Gorkom - says directors have a duty to make informed decisions. Allows you to make a case against decision making process. Opens up businesses to many more claims than under the BJR. This also started the growth of Directors and Officers Insurance. There was also an increase in due diligence - take the steps to show your process.

2. Breach of Duty of Loyaltyo We're Not the Boss of A.I.G.

Should directors of AIG have known or did they know the implications of these bad loans? Dodd Frank laws after bailout - set up a mechanism to determine risks to prevent banks from

getting too big.

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Problem - we now have fewer banks that are bigger (bc they consolidated to avoid going under). There is also a moral hazard of rescuing the big banks because they think they will. . .

o In Re Caremark Int'l Inc Derivative Litigation

Facts: Caremark is a healthcare provider. The settlement of various government and private claims of violations of Medicare/Medicaid rules cost the corp over $250,000,000. The complaint alleges the director Ds breached their duty of care in connection the on-going operation of corp business. Shareholders file derivative suit against directors for the costs for violations. They think directors did not do anything to prevent the fraud. [This is an inattention case like Barnes, and a failure to monitor/be informed. Shareholders think BJR is not applicable here because they say there was no decision made, no action was taken. Shareholders say there should have been some type of monitoring system in place to detect the overbilling/defraud of Medicare and that there was no good faith effort to be informed. Monitoring does NOT include espionage to spy on your own employees. (management is entitled to assume employees are not wrongdoing).]

Holding: Settlement approved - Ps have been given express assurances that Caremark will have a more centralized, active supervisory system in the future.

Reasoning: There are no grounds for director liability so long as the court determines that the process

employed was either rational or employed in a good faith effort to advance corporate interest.

Liability for failure to monitor: A loss eventuates not from a decision but, from unconsidered inaction.

A director’s obligation includes a duty to attempt in good faith to assure that a corporate information and reporting system, which the board concludes is adequate, exists, and that failure to do so under some circumstances, may, in theory at least, render a director liable for losses caused by non-compliance with applicable legal standard.

The directors utterly failed to implement any reporting or info system of controls or having implemented such a system or control, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.

What do you do to protect your directors? --> maybe have IT system to check billing, maybe have legal audits and codes of ethics. This might be sufficient. But more than just putting the system in is not sufficient - the directors must utilize the system.

Caremark claims are director oversight liabilityo In Re Citigroup Inc Shareholder Derivative Litigation

Facts: Citigroup is a very large investment bank - they were bailed out by US government. They essentially were a giant conglomerate of traditional bank and investment bank etc. Citybank shareholders allege that directors did not protect corporation from exposure to subprime markets. The directors failed to adequately oversee and manage Citigroup's exposure to the problems in subprime mortgage market (failure to monitor).--> Caremark Case.

What did they fail to monitor? Caremark doesn’t say you knew or should have known - just says there is a duty to

monitor and the systems are used.

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The claims are framed as Caremark claims but they essentially amount to a claim that the director defendants should be personally liable to the Company because they failed to fully recognize the risk posed by subprime securities.

Holding: Shareholders lose. Court says it is understandable that investors and others want to find someone to hold responsible for these losses, and it is often difficult to distinguish between a desire to blame someone and a desire to force those responsible to account for their wrongdoing. But our law does not hold them personally liable.

o McCall v. Scott

Facts: Remarkably similar to Caremark. Holding: taking allegations as a whole and drawing the reasonable inferences in Ps favor, the

court found that the particularized facts are sufficient to allege facts that presented a substantial likelihood of director liability for intentional or reckless breach of the duty of care. Caremark does not require a director to have intentionally acted to harm the corporation.

o In Re The Walt Disney Company Derivative Litigation

Facts: Disney's President died and CEO got sick. So they needed to get a new CEO - Eisner called Ovitz to be CEO. Ovitz owned another private company where he got $20-25m a year and was an important figure in Hollywood. Ovitz and Russell agreed on a salary of $30 million plus downside protection and upside opportunity. The employment agreement [OEA] included a golden parachute; this essentially is an employment contract that says if we fire you for any reason we will give you a bunch of money. In total, if Ovitz was fired in a non-fault termination [NFT] after the first year, he would be entitled to a severance package of $140m [$40m in cash and over $90m in stock]. He joined the company and 14 months later they fired him after realizing it was a horrible decision. Shareholders allege the directors should have known better than to offer such a ridiculous package to this guy. They are suing for bad faith - breach of duty of care. People were worried about how this could turn out (the new Gorkom).

Holding: Shareholders lose. The compensation committee members did not fail to exercise due care in approving the employment agreement or in the hiring of Ovitz as president of Disney

Reasoning: There was not a breach of duty of care. There was an extensive process that the directors went through to hire Ovitz.- There was a compensation committee put together to determine what to pay executives, Eisner was a proponent of Ovitz, they hired a compensation consultant to determine pay. Then the board approved the pay suggested by consultant to committee then to board. While the process employed by Disney fell below the industry’s best practices, it was higher than the minimum required for due care.

Court set a very high bar to be able to sue based on setting CEO pay. The shareholders would have to prove acts were not in good faith (must be subjective bad faith)in establishing pay.

Must show: The intentional dereliction of duty or conscious disregard of responsibility. Golden parachutes are very common (and something that shareholders often want to

eliminate in the say on pay propositions). Companies justify paying a lot for CEOs because the market sets the rate and you want to pull good talent, you have to offer a lot of money.

o Summary

Duty of Care:

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Requires that directors act in good faith, be informed, be attentive, reasonably supervise and monitor the business

Can be breached by action or inaction (don't forget proximate cause requirement) Duty not to be dumb and lazy

Duty of Loyalty Duty not to be greedy

The Duty of Loyaltyo Considers complaints that directors or officers were greedy and put their own financial interests ahead of

the interests of the corporation and its shareholders. o Duty of Loyalty is potentially more serious claim and potentially easier to make.

Have to identify and plead the act There is no business judgment rule in play Burden of proof is on defendant.

o DoL usually arises where the director:

competes with the company takes for himself a “corporate opportunity” has some personal pecuniary interest in a corporation’s decision.

Competition - Breach of Duty of Loyalty for Competing with a Corporation o Jones Co., Inc v. Frank Burke, Jr. -

Jones Co was suffering because its founder had behavioral lapses. Some of the officers of the company decided to create a competing company, SBW, they took employees and clients from Jones, and then the disloyal officers quit Jones and began working for the new Company. Jones sued officers.

Court Held: Officers had breached their fiduciary duty of loyalty but competing with their employers corporation.

Reasoning: defendants are prohibited from acting in a manner inconsistent with his agency or trust and is at all times bound to exercise the utmost duty of good faith and loyalty in the performance of his duties. The conduct resulted in benefit to themselves through destruction of P’s business.

This was a predetermined course of action, they informed P of their actions and originally attempted to buy him out (this failed). Court says that in the circumstances, the defendants would not be relieved of liability even if they were terminated and they still gained these opportunities through their employment at Jones.

Corporate Opportunities-Breach of Duty of Loyalty though “Usurping” a Corporate Opportunity- o Saw this in Meinhard v. Salmon - where managing coadventurer took the real estate development

opportunity for himself. o Northeast Harbor Golf Club, Inc v. Harris -

What is a corporate opportunity? What does a director have to do when she is offered a corporate opportunity? Facts: Harris was approached by listing broker for property right next to the golf course - the

listed property included an unused right of way where the Club’s parking lot and Clubhouse were located. Harris had often tried to get the Club Directors interested in developing around the course, but no others wanted too. The broker approached Harris first because she was the Prez of the Club and thought the Club might want to buy the property so there was no development on

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the land. Harris instead bought the land in her own name and did not disclose her plans to the Board before the purchase. After the purchase she told them she bought it and the Club would be protected. The Board took no action then. Harris then purchased more property surrounding 3 sides of the golf course, and again disclosed to the board after the purchase, saying she had no plans to develop the land. A few years later, Harris began developing the land.The Board sued for breach of fiduciary duty.

Lower Court held there was no breach of duty because the development was not the same “line of business” as the golf course. (Guth v. Loft)

Holding: Vacated and Remanded. Need factual determination under ALI standard to see if Harris breached her fiduciary duty as president of golf club by purchasing and developing property next to the golf course.

Reasoning: the Club had made the policy judgment that development of the surrounding land was detrimental to the best interests of the Club- but had considered reversing this policy and expanding the Club. Harris effectively foreclosed that option when she bought the land

Court used ALI 5.05- Corporate Opportunity Doctrine which defines what a corporate opportunity is (any opportunity in connection with company or that the executive becomes aware of through use of corp. resources etc - very broad),requires full disclosure, when a director can take advantage of a corporate opportunity (rejected by corporation), burden of proof, ability to cure a defective disclosure.

o Under ALI standard, once the Club shows that the opportunity is a corporate

opportunity to the Club, it must show that Harris did not offer the opportunity to the Club or that the Club did not reject it properly.

o Broz v. Cellular Information Systems-, Inc -

Defendant Broz was a Director of P (CIS)and was also the sole stockholder and President of RFBC, a competitor of CIS (both are cell phone service providers).

Facts: Mackinac approached Broz about RFBC possibly acquiring its license for a portion of Michigan adjacent to area served by RFBC. Mackinac did not contact CIS. CIS has recently gone through Ch 11 bankruptcy and not longer had any business operations in the Midwest. Broz bought the license for RFBC and did not formally t disclose or get approval from CIS board, though he did mention it to a few board members and the CEO of CIS, all who said CIS had no interest in the license. BUT at the same time, PriCelluar was engaged in acquiring CIS, and PriCellular had an interest in the Mackinac license.

Holding: There was no improper usurpation of a corporate opportunity. The director of the target company (CIS) has no fiduciary duty to present the opportunity to the target company if the interest and ability to entertain the acquisition is by another company (the acquiring company in this case).

Guth Factors - balancing test, no factors are dispositive: The corporate opportunity doctrine, holds that a corporate officer or director may not

take a business opportunity of its own if: o the corporation is financially able to exploit the opportunity

o the opportunity is within the corporation’s line of business

o the corporation has an interest or expectancy in the opportunity

o by taking the opportunity for his own, the corporate fiduciary will thereby be

placed in a position inimical to his duties to the corporation

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An officer or director may take a corporate opportunity if:o the opportunity is presented to the director or officer in his individual and not his

corporate capacity o the opportunity is not essential to the corporation

o the corporation holds no interest or expectancy in the opportunity

o the director or officer has not wrongfully employed the resources of the

corporation in pursuing or exploiting the opportunity. Conflicts of Interest- Being on Both Sides of a Deal with the Corporation (“Interested Director Transactions”

o HMG/Courtland Properties, Inc v. Gray -

Facts: Gray and Fieber were directors of HMG (bought and sold commercial real estate). Gray negotiated a sale of HMG real estate to NAF. Fieber owned interest in NAF and disclosed it to directors and abstained from voting in the proposed sale. Gray through relatives and related business entities also owned an interest in NAF, but did not disclose that interest to the board and voted to approve the sale. Fieber knew of Gray’s interests but did not disclose them either.

Holding: Fieber and Gray breached their fiduciary duties of loyalty and care and defrauded the company.

This case implicates the BJR and Section 144 of Delaware General Corporation Law (Gray’s interest has issue of fairness and implicates “self dealing” because of his undisclosed buy-side interest). Proof of such undisclosed self-dealing, in itself, is sufficient to rebut the presumption of the BJR and invoke entire fairness review.

Section 144 provides a self-dealing transaction will not be void or voidable solely for being self-dealing, if the transaction is ratified by a majority of teh disinterested directors or by a shareholder’s vote. To be valid though, material facts of director’s interest in deal must be disclosed. In the absence of disclosure, transactions can only be found non-voidable if they were fair [to HMG] at the time they were authorized.

o What is fair? Gray must prove (1) fair dealing and (2) fair price.[Court looks at

issue as a whole, not specific elements] Fair dealing - in the transaction includes how it was initiated, structured,

negotiated, disclosed to directors, and how director/shareholder approvals were obtained.

Fair Price - includes all financial considerations of the proposed merger, such as assets, market value, earnings, future prospects, and any other elements that affect the intrinsic stock value.

o Court thinks D failed to meet burden on both components.

Shareholder Litigation - Direct and Derivativeo Examples of Derivative Claims

Duty of Care Duty of Loyalty Overpaying executives

o Examples of Direct Suits

Damages to shareholders directly Proposed recapitalization that would unfairly benefit one group of holders over another Depriving shareholders of a property/monetary right [voting rights] Unpaid dividends

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o Shareholders can bring actions for and on behalf of the corporation against officers and directors to

redress the harm to the corporation - the corporation gets the damages from a derivative suito Eisenberg v. Flying Tiger Line, Inc. Pg. 276

Facts: Eisenberg owned stock in Flying tiger, Flying Tiger formed a wholly-owned subsidiary, FTC. FTC formed another wholly-owned subsidiary called FTL. Flying tiger merged into FTL. FTL took over running the airline. The shareholders of Flying Tiger got stock not in FTL, but in FTC. Eisenberg, who used to own stock in an airline, now owned stock in a holding company [FTC] which runs the airline [FTL]. Eisenberg argued that these machinations had deprived him of any vote or influence over the affairs of the corporation that now runs the airline.

Issue: Whether the suit was a derivative suit or a direct suit. If the suit was a derivative suit, Eisenberg would have been required to post security for costs as a condition to prosecuting his action.

Holding: The suit was a direct suit because the result of the action harmed the shareholder personally

Reasoning: Derivative Suit: If the gravamen of the complaint is injury to the corporation

o Suits are derivative only if brought in the right of a corporation to procure a

judgment in its favor. o Security for expenses - to help prevent against frivolous lawsuits

Direct Suit: If the injury is one to the plaintiff as a stockholder and to him individually and not to the corporation.

Strategy in this case:o Eisenberg: Direct suits are freer from procedural requirements and he wouldn’t

have to pay the security stock/bond thingo Flying Tiger: Derivative suit would be best if they could get the claim dismissed

without even having to get to the merits of the case. Test: Where the corporation has no right of action by reason of the transaction

complained of, the suit is not derivative. o Actions to compel the dissolution of a corporation have been held to be direct,

since the corporation could not possibly benefit. The reorganization deprived Eisenberg and other minority stockholders of any voice in

the affairs of their previously existing operating company. o Problems from pg. 276

5.1: Roberts sues the directors of Bubba’s Burritos because they failed to permit him to inspect corporate books and records. Direct

5.2: The articles of Bubba’s Burritos, Inc. provide that the corporation will operate restaurants featuring burritos and related food and beverage products. Shepherd learns that the directors plan to enter a contract with Chad and Associates to go into the voting machine business. He sues to enjoin the corporation for engaging in this ultra vires activity. Derivative

5.3: Roberts sues the directors of Bubba’s Burritos for wasting corporate assets by paying themselves huge bonuses. Why is this a derivative suit? A judgment will benefit the corporation.

5.4: Shepherd sues the directors of for usurping corporate opportunities. Will benefit the corp. so the suit would be a derivative suit.

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5.5: Epstein sues the directors of Bubba’s Burritos for failing to exercise due care because they purchased supplies at a price much higher than could have been negotiated. Duty of Care suits are derivative suits.

5.6: Roberts is the minority shareholder in Bubba’s Burritos which is a close corporation. He sues the controlling shareholders, alleging they have breached fiduciary duties by oppressing him. Specifically, he alleges that while they have had the corporation hire them and purchase their stock for cash, they have refused to allow the corporation to do such things for him. Direct Suit.

5.7: Suppose Freer is not the only CEO of Bubba’s Burrito, but also works as its bouncer. Shepherd, a shareholder, eats at Bubba’s, gets boisterous after too many beers, and is pummeled by Freer as Freer tosses him out of a window. Whom can Shepherd sue, and what kind of suit will it be? Freer, Bubba’s [respondeat superior]?, and a direct suit?

Procedural Requirements of Shareholder litigationo Standing - MBCA §7.41

o Security for Expenses - Eisenberg Case; The MBCA and most states do not have security-for-expenses

provisions. o Demand

Most states require the shareholders who wants to bring a derivative suit to make a written demand on the directors that they assert a claim allegedly existing in favor of the corporation. A procedural requirement [rules of civil procedure] that requires plaintiff shareholders to tender a demand on the Board of Directors of the Corp. asking them to bring the lawsuit.

Attorney would draft a demand letter which states the facts and what they want the Board of Directors to do

Why is there a demand requirement and why should it ever be excused? Does this make sense? Pros:

o Bringing a claim is a business decision - responsibility of the Directors

o Might be able to do it better/more efficiently

Cons:o Directors may act in self-interest when voting against bringing a claim.

o Demand may be futile

AZ has no provision for futility What happens if the plaintiff makes a demand?

1. The board can accept the recommendation and authorize the corporation to sue - the shareholder would bow out since the corp is bringing the suit.

2. The board can refuse the demand and not take the claimo Shareholder can

1. Forget the whole thing 2. P/S can still bring the derivative suit and state that they fulfilled the

demand requirement Lot of obstacles for P/S to bring the claim Under Delaware law: The fact that the plaintiff made the

demand constitutes an admission that the directors were disinterested [not violating the business judgment rule]. Making the demand was not futile - a competent lawyer in Delaware will

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never make a demand on the BoD or they would certainly lose the case.

Where would we look to find the law of the demand requirement? Civil Rules of Procedure

Bringing a suit without a demand? Futility

o Suing the board of directors

o Self-Interest by the board of directors

o Can make the demand requirement just a procedural impediment on shareholders

bringing derivative suits Special Litigation Committees

o Composed of Disinterested Directors with their own attorney [not general

counsel]o Will perform an investigation and then decide if they should take the suit.

Probably not the best way to deal with this - usually never come back with a decision to sue fellow directors.

Corporations do not like Shareholder Litigation Why do people bring derivative suits [considering that the corporations receive any

damages that are awarded]? Who makes money? Lawyers get 33% of Recovery

Direct Cases: Class Action Suits o Marx v. Akers - P filed shareholder derivative action against IBM and IBM's BOD without first

demanding the board initiate a lawsuit. The claim alleges the board wasted corporate assets by awarding excessive compensation to IBM’s executives and outside directors.

Issue: Whether the appellate court abused its discretion by dismissing P's complaint for failure to make a demand. Whether P's complaint fails to state a cause of action.

Holding: Affirm appellate court decision. The plaintiff was not excused from making a demand with respect to the executive compensation claim and that plaintiff has failed to state a cause of action for corporate waste in connection with the allegations concerning payments to IBM’s outside directors.

Various jurisdictions have tried to balance discretion of directors and shareholders right to bring derivatives claims.

Delaware Approach: Two Prong Test - P must allege particularized facts which create a reasonable doubt (subjective) that (1) directors and disinterested and independent and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.

Universal Demand: (11 states) Bright Line Rule - before commencing shareholder derivative suit you must demand the board brings it.

New York Approach to Demand Futility - Reasonable Doubt Standard; Court determined a demand would be futile if (1) majority of directors are interested in the transaction (2) the directors failed to inform themselves to a degree reasonably necessary about the transaction, or (3) directors failed to exercise business judgment in approving transaction.

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Rule in this State/Case: No demand is necessary if the complaint alleges acts for which a majority of the directors may be liable and plaintiff reasonably concluded that the board would not be responsive to a demand.

o Self-Interest, a loss of independence, uninformed, challenged transaction was so

egregious on its face that it could not have been the product of sound business judgment of the directors.

Reasoning: Only three directors are alleged to have received the benefit of executive compensation

scheme, plaintiff failed to allege that a majority of the board was interested in setting executive compensation.

A director who votes for a raise in directors’ compensation is always “interested” because that person will receive a personal financial benefit from the transaction not shared in by stockholders but many jurisdictions state that the BoD has the authority to fix director compensation unless the corporation charter or bylaws provides otherwise.

The courts will not undertake to review the fairness of official salaries, at the suit of a shareholder attacking them as excessive, unless wrongdoing and oppression or possible abuse of a fiduciary position are shown.

Case Study 2 Capitalization

o Proprietors can borrow money, sell interests in the corporation, or use company earnings.

Debt Hybrid - Preferred Stock Equity

Expectations of rights and resp.o Repayment

o Return on Investment [interest]

o Restrictions [covenants on taking

debt, assets, or comp./dividends]o No ownership

o Liquidation preference

o Lenders have > rights than SH

Expectation about rights and responsibilities.o Dividends

o Ownership

o Return - maybe

Expectation about rights and responsibilitieso No guarantee of Repayment

o No guarantee of Return

o No Restrictions

o Ownership

o Last in case of liquidation

o Greatest Risk ; Greatest Rewards

Dilution/Cost Only Source Leverage

Pre-emptive Rights MBCA 6.30 Dilution of Voting Rights [with the

issuance of new stock and not pre-emptive rights]o Anti-Dilution Agreements and

Rights - often found in Shareholder Agreements

Restrictions - Shareholder Agreements

Preferences

o Return on Capital: the rate of return that the business earns on financial capital

o Debt and Equity Financing

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Financial Capital may be debt, equity, or a combination of both depending on what will serve the needs of the company

Debt is money that must be paid back and is borrowed at a fixed interest rate Usually done through loan agreements of bond indentures

o Loan "covenants" force the borrowing company to keep its business within

certain parameters of financial health of be forced to pay the loan back immediately

o Assets may also be pledged as collateral.

Debt Analysiso Why finance using debt?

Debt may be preferred because of dilution - more costly to give up ownership than simply to borrow money.

Debt creates expenses for deductions [tax breaks] Increases Rate of Return - Leverage

Corporation Ao Capital: 100,000

o Earn: 20,000

o Return: 20%

Corporation Bo Debt: 50,000

o Equity: 50,000

o Capital: 100,000

o Earn: 20,000

o Interest: -5,000

o Net: 15,000

o Return: 30% [15,000/50,000]

o Where can a company borrow money?

Banks Any number of lenders

Venture Capitalist Investment Lenders

Bonds - Corporation selling, to a large number of investors - the public, a promissory note

Shareholders can loan money Will be able to impose restrictions Will have a return Will be a creditor and will get paid before other shareholders

o Deep Rock Doctrine

It stands for the principle that where a parent corporation has not only dominated but has mismanaged a subsidiary corporation, which is presently in bankruptcy or reorganization, and where the parent corporation has a claim which is due to the mismanagement, a court may refuse to permit the parent to assert the claim as a creditor except in

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subordination to the claims of the subsidiary's other creditors and preferred stockholders.

Deep Rock had thousands of gas stations across the country Each gas station was structured as its own corporation - cost 1.5

million - 1 million in debt [loaned by Deep Rock] and 500,000 in equity

Was done to protect deep rock if the gas station went under "Deep Rock your claim" - Shareholder Debt is subordinate to

Shareholder Equityo Loan Agreements

Reps and Warranties: A series of contractually negotiated provisions as to the nature and status of the business - lawyers go to wars over these

Affirmative Covenants: Things the borrower promises the lender they will do

Negative Covenants: What the borrower promises the lender they will not do.

Equity is the money that is invested so that, in exchange for their money, the investors become owners of the firm

Investor, unlike a creditor, has no legal right to recover the investment from the corporation

o Creditors will get paid first and shareholders will only have access to the capital

left over after payment Why invest: hope of superior returns

o Stocks of large, publicly traded corporations generally outperform the debt of

such companies. o Debt and Return on Equity Capital and the Financial Crisis

Ignoring the risk of debt leads to an increase in debt Investors is highly leveraged companies do great when the economy is thriving but when the

economy stops booming revenues and return on investment fallso The Best Capital Structure

Companies pay a lower price for debt than they do for equity Federal government subsidizes debt

Creates a powerful incentive for companies to load up its capital structure with debt Two forces that put the brakes on the inclination to rely solely on debt:

1. Lenders will only lend what they are sure will be paid back 2. Corporations fear bankruptcy

o Use of equity in the capital structure reduces the risk of bankruptcy by lowering

the amount of debt and the fixed costs associated with the debt. Important to weigh the risks of increased debt against larger returns to the equity holders that debt

leverage provideso Calibrating Risk

The riskier the company is, the higher the interest it will have to pay on its debt Risk may come from a fundamental risk in the business "Contingent Liabilities" - do not show up on financial statements but are real risks

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"Rating Agencies" help investors assess the riskiness of different companies' bonds S & P

o AAA - extremely strong capacity to meet financial obligations

o AA - very strong capacity to meet financial obligations

o A - strong capacity to meet financial obligations

o BBB - adequate capacity to meet financial obligations

o BB, B, CCC, and CC - Significant speculative characteristics

o BB - faces major ongoing uncertainties that might impair the capacity or

willingness to meet its financial commitmentso B - Can meet financial obligations but conditions will likely impair the

willingness/capacity to meet financial obligationso CCC - vulnerable and dependent on favorable conditions to be able to meet

financial obligationso CC - highly vulnerable.

Rating Yield [effective interest rate] Yield [effective interest rate]

11/28/08 06/30/09

AAA 5.96 4.22

AA 7.03 4.81

A 8.69 5.80

BBB 9.99 7.20

BB 15.95 10.47

B 20.59 12.26

Effective interest rate will increase on bonds to reflect and increase in risk if the rating changes for a company.

Effective interest rate always increases as the risk increases Interest rate on the bonds of a particular rating changes over time Spread between the bonds of various risks levels also varies

Reflects the market's appetite for - or aversion to - risk at any particular timeo The financial crisis revisited 315

o Banks and Wall Street investment firms are different from other businesses

The risk is not that a bank will experience a decrease in its sales revenues but rather that some of the financial assets the banks own as investments will decrease in value.

o This section talks all about the sub-prime mortgages and the effect of the economy. Listen to lecture - he

will explain what we need Raising Capital

o Lawyers draft loan documents

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o Problem - loan documents can be structured in many different ways

o Docs will spell out payment and repayment terms as well as the rights and responsibilities of the parties.

o Negotiating the loan

Who is going to make the loan? What covenant will the lender require?

Limits on large expenditures Restrictions on both distribution to owners and issuance of new debt

How is the corporation going to service the loan? What happens if the corporation defaults?

o Issuing More Stock

To whom? Preemptive Rights

o A shareholder with preemptive rights has the right to purchase that number of

shares of any new issuance of shares that will enable the shareholder to maintain her percentage of ownership.

o Preemptive rights depend on

What the state corporation code says about preemptive rights What the articles of incorporation say about preemptive rights What the purpose of the issuance is

Byelick v. Vivadelli Facts: Byelick owned 10% of the D Corporation. Vivadellis owned 90%. The Board of

Directors (Vivadelli - husband and wife) eliminated the shareholders' preemptive rights which were provided for in the company's by-laws. They then issued an additional 50,000 stock to themselves which reduced Byelick's ownership from 10% to 1%.

o Classic fact pattern

Issue: Did the Ds breach their fiduciary duty of loyalty [conflict of interest because they sat on both sides of the deal]

Holding: Possibly. Remanded for consideration. Summary judgment is denied Reasoning: Stockholders in close corporations own one another substantially the same

fiduciary duty in the operation of the enterprise that partners owe to one another.o A minority stockholders of a closely held corporation can sue a director/majority

shareholder for breach of fiduciary duty in respect of a transaction benefitting the inside director.

o Whether or not preemptive rights are elected, however, the director's fiduciary

duty extends to the issuance of shares. o Burden is on Ds to prove

The fairness of the issuance of the new stock The fairness of the actual sale itself

MBCA 6.30: Default Rule - preemptive rights do not exist unless the articles of incorporation provide for them.

o Venture Capital

Venture capital is a substantial equity investment in a non-public enterprise that does not involve active control of the firm.

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Entrepreneurs usually seek venture capital when they need capital but are unable to raise it elsewhere.

Most companies that seek venture capital are unstable and risky. 1/3 wind up in bankruptcy 1/3 end up in limbo - living dead 1/3 succeed

Venture capitalists demand high returns because the successful 1/3 must cover the losses of the other 2/3

Cannot reduce risk by diversifying. Illiquidity

Venture capitalists usually obtain a significant voice in the control of the firm and demand protective covenants

A venture capitalist is a shareholder but with special rights. Downside protection - liquidation preference Upside opportunities - right to acquire additional stock at a predetermined price Voting and veto rights Exit opportunities - redemption rights

Why is this topical? Bain Capital - Acted as VCs and bought interest in small companies

o Ex: Staples [was actually one of their shortest and least profitable ventures]

o Selling to a person [or a few people] or to the public

Any "public offering" of stock generally will require registration Federal and state securities laws tens to treat a corporation's offerings of a limited number of

investors differently than they do a corporation's offering of a substantial amount of its stocks to the public.

Going Publico Process:

Company (called issuer), sells stock to an underwriter to draft IPO registration documents to determine how much stock your company should sell and for how much.

Underwriter - transfer stocks to public Public - Exchanges : once in hands of public, shares can be traded anytime, anywhere, at

any priceo 2 big exchanges:

NYSE - brick and mortar, industrial, motor etc NASDAQ - times square: new, tech companies

o Why would a company go public?

To raise money Also, to allow owners to sell stock and enjoy benefits of starting company (liquidity!) The founders, venture capitalist, and private investors are all interested in liquidity.

The exit for VCs is through the IPO, they can sell their private company shares into the market and make a huge profit.

Easily value the company - trading on public market gives market price/value of shares Status with taking companies public

o How much money to raise?

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Depends on how much capital the firm needs to finance its growth. Companies tend to use an IPO to raise enough money to meet anticipated needs for at least 2 years. There is a balance between having enough money for a bad IPO and not giving up too much ownership if you have a good IPO.

o How many additional shares to sell?

First - Calculate what the company is currently worth Publicly traded company - Company's market value is the price per share at which the

shares trade times the number of shares outstanding Price per share is reflection of voting that takes place every day in the stock market on

the relative values Number of shares sold has to equal the number bought

o Company that is not publicly traded - firm will need to estimate its future earnings as best it can

In estimating future earnings, past earning are not irrelevant - most likely will be the best indication of future earnings

Use estimation of future earnings to calculate current value Look at comparable businesses that are publicly traded and determine the market value of

those companies Calculate how many additional shares How does a corporation make a public offering

o Public offering is part registration process and part sales process

o Path to an IPO

Selecting and underwriter - typically an investment bank Selection is usually driven by a company's sense of who can get it the best price for its

stock - who has the reputation and relationships to get it done? Underwriter manages the process of drawing up the offering memo that is filed with the

SEC Underwriter is responsible for advice on structuring the offering, pricing the securities,

and maintaining a market for the securities after the offering. Pricing

The price at which the public offering is sold at is set right before the offering. Underpricing: It is not uncommon for the stock price to rise quickly after the IPO when

they are resold on the secondary marketo Can also occur if there are unscrupulous underwriters that have an incentive to

underprice the share for their own selfish purposes. Where does the money come from?

o Underwriting activities are conducting either through "firm commitment" or a "best efforts" basis

Firm commitment - underwriter buys all of the shares in the IPO and then resells the shares to other investment bankers and the public

Underwriter bears all the risk but reduces the risk by ensuring that the offering price is not set until very late in the offering process

Best Efforts - the money comes from the public The underwriter uses best efforts to help the issuer to find buyers for the stock The corporation bears the risk that share cannot be sold at the offering price Most common method

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Where does the money go?o Answer depends on who is selling the shares

Company - then company gets the money Existing owners - then existing owners get the money

o Prospectus [doc an issuer provides to potential purchasers] will always have a table that describes in great

detail where the shares are coming from, so you will always know- at least for the offering as a wholeo If a share of stock represent a proportional claim of the company's value, does it matter whether you

bought it from an original owner of the company itself? First, if all the shares were shares that other shareholders already owned, then after the offering,

the company would have the same amount of money in the bank as it did before the offering- and all of the money goes to shareholders who owned the shares, not the company. If instead, the offering sold only new shares, then the company would have the entire amount sold in the bank.

Second, it depends on which shareholders are selling. If VCs are selling their shares, and had just backed company prior to IPO, the new shareholders need not worry.But, if the CEO is selling a large percentage of her shares, new shareholders would be warry. Many investors look unfavorably on a company’s prospects when an executive sells a significant fraction of his shares.

Consequences of taking company publico Transparency - both of financials and procedures (can take away competitive advantage)

o Cost to owners - must disclose money they make, have to stand for election every year

o Regulation - feds regulate public corporations

1933 SEC Act Says you need to file registration document and must describe certain things to allow

investors to make a decision. SEC process is NOT a merit process, it just gives ok if all necessary things are disclosed. But a company must be registered to sell securities

1934 SEC Act Regulates everything that happens after the company has gone public

o Companies must file a Form 10-K each year setting out the financials for the

year. It is essentially an updated registration statement.o 10-Q is a disclosure document prepared and filed showing the Quarterly

statements. Public Offerings and Private Exemptions:

o Federal Law 33 Act Section 5(a)-Unless a registration statement is in effect as to a security, it shall be

unlawful for any person or indirectly. [this applies to small businesses trying to raise money]o There are exceptions: for sales not involving a Public Offering

Factors to determine if you are exempt from filing under Regulation D: we will find you exempt from registration and will embrace your offering as a private offering, if you do it under the requirements of this regulation:

Give access to information - can show investors had the same information they would have had if company was registered

Limit you can sell to 35 purchasers/investors (can be natural persons or entities) Relationship of investors to you and sophistication There can be no general solicitation - (can't be an ad in paper, send out postcards to get

people to buy stock in company)

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No re-sales - 2 yearso 1 and 3 are a bit problematic, and the burden is on the company to prove they

meet the exception: sometimes there are questionnaires that can determine how much money and investing that can be done. 1 is still tough because you could maybe disclose certain things but not others and this can be a slippery slope.

o Doran v. Petroleum Management Corp -

Sophisticated Investor purchased a limited partnership interest in an oil drilling venture and is seeking to rescind. PMC (Defendant) organized a limited liability partnership for purposes of drilling in Wyoming. PMC contacts 4 persons to participate in partnership, all but Plaintiff declined. Doran was to contribute $125K toward the partnership. PMC periodically sent production information to Doran, though throughout the period the wells were deliberately overproduced in violation of Wyoming production allowances. As a consequence, the wells were sealed for about a year. During that time, Doran defaulted on a note and Doran, PMC were held liable to pay the note. Doran filed suit to seek damages for breach of contract, rescission of the contract based on violations of Sec Ex Act 33 and 34. PMC did not file a registration statement. So this court had to determine if they meet the Reg D exemption.

Issue: whether the sale was part of a private offering, exempt by § 4(2) of the Sec. Ex. Act 33. Holding: Remand to determine if offerees know or have a realistic opportunity to learn facts

essential to an investment judgment. PMC met the last three factors of Reg D exemption (small number of units offered, modest financial stakes, and an offering characterized by personal contact between issuer and offerees free of public advertising or investment banker intermediates), but probably fails on the first (disclosure of information).

What is a security? o Anything that you do try to do to get money from people (investors)

Shares of stock in a corporation Promissory Notes Investment Contracts - any type of investment of money in a common enterprise with an

expectation of profit solely from the efforts of others. SEC v. Howey- Four Factors?

o Howey was a citrus farmer in Florida. Needed money to continue to run the

orchard, and talked to friends and family to collect money to devote to each section of the orchard, then they would share profits.

o Where the people who bought in doing this because they are citrus farmers? NO,

they were investors. SEC said this is an investment contract, and Howey is a promoter of

business, and he needs to follow SEC regulations. Making Money: Salaries - Dividends

o Oppression of the Closely-Held Corporation : A close corporation is a business entity typified by a small

number of stockholders, the absence of a market for the corporation’s stock, and substantial shareholder participation in the management of the corporation.

Investors typically look to salary rather than dividends for the principal return on investment Squeeze out or Freeze out techniques: A majority shareholder who has control of the board has

the ability to take various actions that threaten the minority shareholder.

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Termination of minority shareholder’s employment, refusal to declare dividends, removal from a position of management, siphoning of corporate earnings through high compensation to the majority shareholder.

In a large, public corp a minority shareholder could just sell their shares but that option is usually not available to the close corp minority shareholder because, by definition, there is no ready market for the stock of a close corporation

o Many state legislatures have amended their dissolution statutes to include “oppression” by the controlling

shareholder as a ground for involuntary dissolution of the corporation. Oppression has evolved from a ground for involuntary dissolution to a ground for a wide variety

of relief. Some courts have imposed an enhanced fiduciary duty between close corporation shareholders

and have allowed and oppressed shareholder to bring a direct cause of action for breach of this duty [Donahue v. Rodd Electrotype]

o How do owners of a business make money?

Small Companies where shareholders are also employees: compensation, salaries, bonus Distribution, typically in the form of dividends Sale of stock by shareholders

o Receiving Salaries from the Corporation

Hollis v. Hill Facts: Hollis is seeking a court-ordered buy-out of his 50% interest in a Nevada

Corporation. Hill and Hollis were both 50% owners of FFUSA. Hill was a director and served as its president, and operated the Houston Office. Hollis was a director and served as vice-president. The wives of both Hill and Hollis were directors as well. Hill began to complain that Hollis was not carrying an equal share of the firm's workload. Hill stopped paying Hollis' salary. Hollis proposed several ways to resolve the dispute but Hill rejected all of the proposals. Hill took FFUSA's annuity business and placed in it into a sole proprietorship in his own name. Hill stopped paying Hollis' lease payment, cut his salary first by 50% and then to zero, and cancelled the lease for Hollis' office.

Issue: Whether a duty of loyalty was breached by Hill and, if so, whether the district court erred in granting a retroactive buy-out remedy?

Holding: Fiduciary duty was breached and Hollis is entitled to the remedy he seeked but the calculations of the remedy made by the LC are incorrect.

Reasoning:o Why is this not protected by the Business Judgment Rule?

Shareholder Oppression A fiduciary duty existed between Hollis and Hill because they agreed to

begin a business together, they retained equal ownership, and a fiduciary relationship was created not unlike that in a partnership.

Duty existing between controlling and minority shareholders in close corporations is the same as the duty existing between partners.

o What law is being applied?

The case took place in Texas, Texas law says that they should apply the law of the state of incorporation, the state of incorporation was Nevada,

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Nevada did not have precedent/law for this type of case, Majority looks to Massachusetts, Dissent looks to Delaware.

Massachusetts has law about shareholder oppression Delaware - the concept of shareholder oppression does not exist.

o How could Hill have had a stronger case?

Provided evidence about Hollis performance and how it did not meet expectation

Provided evidence that the business was in distress and that his actions were to try and save the company

Applied cuts across the board and not just against Holliso Types of agreements that would have avoided this situation?

Shareholders Agreements - plan proactively about employment, compensation, terminations, reduction in compensation, and buy-outs.

Employment Contract - could have provided guide posts to how to handle the situation.

o Dividends

The MBCA and other state corporate codes do not set limits on the salaries that a corporation pays its officers or directors. Federal income tax law, however does limit the amount of salary payment that a corporation can deduct as an ordinary and necessary business expense.

MBCA § 1.40 (6): Distribution means a direct/indirect transfer of money/property…to shareholders in respect to their shares.

Who pays? Who receives? Why pay? Why not pay? From what source can dividends be paid? Must dividends be paid? Can a corporation be compelled to pay dividends?

Exacto Spring Corp. v. Internal Revenue Facts: Exacto, a closely held C corp. engaged in the manufacturing of precision springs,

paid its co founder, chief executive, and principal owner, Heitz, $1.3 and $1.0 million, respectively in salary. IRS thought this was excessive [you can only deduct "reasonable" salary for taxes]. IRS was involved because salaries can be deducted from taxes, reducing income, taxable income and the amount of taxes to be paid. Dividends are not deductible. The IRS thought that the corp. was trying to scam the system to pay lower taxes. Tax court agreed with the IRS by using seven factors.

o 1. the type and extent of the services rendered; 2. the scarcity of qualified

employees; 3. the qualifications and prior earning capacity of the employee; 4. the contributions of the employee to the business venture; 5. the net earnings of the employer; 6. the prevailing compensation paid to employees with comparable jobs; and 7. the peculiar characteristics of the employer’s business.

o Court thought the factors were insufficient for a ton of reasons [nondirective,

how should the factors be weighed, vague, etc.] and instead applies the indirect market test [the higher the rate of return, adjusted for risk, that a manager can generate, the greater the salary he can command.]

When, notwithstanding the CEO's "exorbitant" salary, the investors in a company are obtaining a far higher return than they had any reason to expect, his salary is presumptively reasonable.

Giannotti v. Hamway

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Facts: The corporation was engaged in the development and operation of nursing homes. The plaintiffs, minority shareholders, alleged that the defendants salaries are excessive and that they are, in bad faith, refusing to declare dividends. Plaintiffs are asking that they either stop paying themselves so much, declare dividends, or that the company be dissolved.

Holding: There is abundant, credible evidence to support the trial court's conclusion that defendants engage in oppressive conduct and that they misapplied and wasted corporate assets.

Reasoning:o Why is this not a duty case and why does the B.J.R. apply?

In this case, because of the closely held nature, there was not a disinterested board. The board elected themselves as officers and set their own salaries

This is a duty of loyalty case because of conflict of interest - directors are on both sides of the salary deal.

Burden shifts to the directors to prove that the transaction was fair and reasonable to the corporation

o The work that was performed was not of sufficient scope and complexity to

justify the salary, bonuses, fringe benefits, and other compensation which was paid to the individuals.

Dissent: Neither the corporation nor shareholders have suffered from oppressive actions by the defendants, only the usual and legal burdens borne by minority stockholders.

Zidell v. Zidell Facts: Arnold Zidell, minority shareholder of four related, closely held corporations,

seeking to compel the directors of those corporations to declare dividends. All three Zidells were employed by the corporation, in which they all owned stock. Arnold Zidell voluntary quit his position, because he wanted higher compensation, and then demanded that the corporation paid dividends [they did one year].

Holding: Court held that the plaintiff left his corporate employment voluntarily and was not forced out. The dividends one Zidell has received were not unreasonable in light of the corporations' projected financial needs. The court was not persuaded that the directors are employing starvation tactics to force the sale of plaintiff's stock at an unreasonably low price.

Reasoning: o Those in control of corporate affairs have fiduciary duties of good faith and fair

dealing toward the minority shareholder. Insofar as dividend policy is concerned, however, that duty is discharged if the decision is made in good faith and reflects legitimate business purposes rather than private interests of those in control.

o Plaintiff had the burden of proving bad faith on the part of the directors in

determining the amount of corporate dividends.o Facts that are relevant to the issue of bad faith and are admissible in evidence:

intense hostility, exclusion of the minority from employment, high salaries or bonuses or corporate loans made to the officers in control, the fact that the

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majority group may be subject to high personal income taxes if substantial dividends are paid, existence of a desire by the controlling directors to acquire the minority stock interests as cheaply as possible.

P left his corporate employment voluntarily, he was not forced out. Dodge v. Ford

Facts: Henry Ford was the majority shareholder and the Dodge Brothers were among the other shareholder. Dividends were paid out by Ford Motor Co. but the Company’s profits were far in excess of the amount of the dividends. In 1916, ford announced that no more special dividends would be paid; profits would be reinvested in the business. Dodge Brothers were upset with the announcement and went to go speak with Ford about it; they offered to sell their shares back to Ford for $35 Million. Ford denied their offer.

Court says they will not get involved in business decisions but will compel Ford to pay dividends

o Seemed to have issues with the fact that Ford was making more money than they

knew what to do with and Ford's philanthropic endeavors [not what businesses should do according to the court]

o Criticized as one of the worst business rulings

o Dividends

Pays: Corp. Receive: Shareholders When? When the company makes a profit, distributed based on number of shares and proportion

of shares owned. Companies, typically, do not pay dividends.

Why? Use the money to invest back in the business. Why issue dividends? Make shareholders happy. [especially if there is not an effective

way to use the money to grow the business]. Could be a tax-driven decision. Could be a liquidity reason [get the wealth of the business into the hands of the owners]. Could be used as a tool to attract investors.

Apple - Steve Jobs never paid dividends and was against doing so even though Apple had more money in the bank than US had money in the treasury. When Jobs died, the new CEO paid a dividend [10 billion = $2.75 per share]

Constraints on paying dividends MBCA 6.40(c ) spells out when a corporation cannot declare a dividend

o Insolvency Test: Distribution is proper so long as the corporation is not insolvent

and as long as the distribution does not render the corporation insolvent. o Balance Sheet Test: Liabilities exceed assets

o Director can be held personally liable to refund the corporation in accrued

amount of dividends distributed that would cause corporation to be insolvent or would not pass the balance sheet test

Cannot be waived in the articles of incorporationo DO NOT NEED TO KNOW

Redemption Repurchase - usually done to have fewer shares outstanding so that those

that are outstanding will be worth more.

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Traditional approach - requires references to different funds or accounts that the corporate codes require a corporation to keep.

o Earned Surplus [retained earnings] - consists of money generated by the business

itselfo Issuing stock

Stated Capital - consists of the par value of a par issuance plus the amount allocated to stated capital on a no=par issuance.

CANNOT BE USED FOR A DISTRIBUTION Capital Surplus - can be sued to pay a distribution

Summary of whether a corporation may pay a distribution: 1) Traditional view requires us to know earned surplus, stated capital, and capital surplus. 2). Modern approach simply imposes insolvency limitations, distribution cannot be paid if the corporation is insolvent or would be rendered insolvent by the distribution

Hypo: Three friends made beer in the basement and turned it into a business. ABC custom micro brew. They do limited distribution. A wants to sell some of her shares in the business.

o What is A going to face as a practical matter to sell shares?

She must find a buyer; this is not always an easy task Then this person will also buy an minority interest (bc there are 3 owners each with equal

interest) and there may be baggage with the other two owners She must be able to evaluate the shares and determining the value of the company

They will want to know what is your product, how good is it, want to look at financial statements (don't show future!) , pending lawsuits etc

o The buyer will have to get the information from the owner - they have to rely on

the person who wants to sell it to you. You have to rely on information that is only as good as the person giving it, which may not be that great.

What if B claims preemptive rights on the sale?? Doesn't matter, Preemptive rights are only to the ability to issuance of new shares, and

NOT transfer of shares.

Buying and Selling Stock at a Profito How does someone know what shares of a corporation's stock are worth?

Available Information: It is easy to know the basis on publicly traded shares and the gain you get off the basis is

taxed at capital gains rate. Buying and selling of shares that are not publicly traded on major stock exchanges are

much more difficult to determine what the value of the stock is. Smaller corporations are sometimes recorded on Pink Sheets - and are used as records by

stock brokers investing in OTC (over-the-counter) Securities. Available Information on value of company can include:

o SEC filings 10 K, 10 Q

o Guidance = Affirmative statements by company about their earnings

o Brokers -sell information on public companies based on

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o Analysts - work for investment banks, could create an issue because there is a

conflict of interest ; they may write a report for a company to buy that they own/underwrote for

o Independent Analysts - firms that aren't connected to companies they write about

Market Cap = issued and outstanding shares*price per shareo Gives you a sense of value, but doesn't necessarily match with which company is

the biggest (pg 209 sup) NYSE is largest Exchange in the US. Each stock exchange has certain requirements you

have to meet to be able to list [years is business, market cap, amount of profits etc] there is a tier of stock exchanges you want to get on.

o Then if you don't qualify for any stock exchange, then you are a pink sheet, OTC

security (PISD). Shanghai stock exchange is huge, but known for integrity issues - this is a huge

impediment to progress for Chinese companies. Debt Markets [supp 218]. - the biggest debt market is the US treasury (US borrows

through bonds). The US used to never have problems issuing bonds because they are considered almost riskless - the US would never default or fail to pay back people who lent them money. [this is still true today - and China buys A LOT of bonds - why? It is a safe place to put money, and it helps us buy their goods!

o But because there is so much money that is willing to go to the bonds, the return

is really low (.5%). In a securities action and you can find a defendant, in a private claim, you can get

damages. The SEC can levy penalties - biggest penalty was $.5 billion against Goldman Sachs.

Reliability of Information - Common Law and 10-b5 Protection From Fraud Corporations are governed by state law, but there are federal securities laws that regulate

corporations as well. The main provision that is regulated is 10(b)(5). - this is a mechanism that allows investors to sue for lost profits. This is federal, but every state enacts the securities regulation almost word for word as well.

10(b)(5) is the enforcement mechanism for giving true information about investments, Rule 10(b)(5) - antifraud provision of the sec laws pg 335 this is the most widely litigated rule

under the federal securities laws. "It shall be unlawful for any person, directly or indirectly, by the use of any means or

instrumentality of interstate commerce, or the mails or of any facility of any national securities exchange,

o (a) to employ any device, scheme, or artifice to defraud,

o (b) to make any untrue statement of a material fact or omit to state a material fact

necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

o (c) to engage in any act, practice, or course of business which operates or would

operate as a fraud or deceit upon any person in connection with the purchase or sale of any security. "

This can be any security - one you sell to neighbors as investors, stock exchange transactions, investment contracts, etc.

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10(b)(5) does not face the normal thresholds you must meet under a common law fraud claim (scienter, intent, causal connection from misrep to damages etc)

The whole point of the security laws is DISCLOSURE. Just need to even the playing field, then people can make their own decisions.

Efficient Market theory- if there is full information in the market, then all that information will be impounded in the price of the stock and the price that the stock is trading on the exchange is a perfect reflection of value based on ALL information

Basic Inc v. Levinson - Facts: Basic was public company that manufactured steel. Combustion was interested in

acquiring Basic. Basic Shareholders sold stock, not knowing about possible merger. Former shareholders of Basic are plaintiffs, suing saying they would not have sold their shares, but for the statements by Basic that there was not a merger. There were multiple public statements that Basic was not in talks of a merger. But soon after, they did merge and the stock price shot up.

Issue: What is the standard of materiality applicable to preliminary merger discussions? (1) Whether information regarding the possibility of a merger is significant to the reasonable investor’s trading decision.(2) Can “fraud on the market theory” create a rebuttable presumption that respondents relied on petitioner’s material misrepresentation?

A merger is one of the most important events that can occur in the life of a company, we think inside information can become material at an earlier stage than would be the case in smaller transactions - even if mergers don’t often go through.

o Materiality of merger discussions is fact specific. And depends on the

significance a reasonable investor would place on the withheld or misrepresented information. [to be actionable, a statement must be misleading. Silence, absent a duty to disclose, is not misleading under 10b-5]

o This court remanded to determine materiality.

Fraud on the Market- says reliance and causation is satisfied if information is put into the market, than everybody trading in that market is damaged by it. You don't even have to prove P received info and relied on it to their detriment. Only have to show it was out there, so there is fraud on the market.

o It is appropriate to apply a presumption of reliance supported by fraud on the

market theory, but this is a rebuttable presumption. What do you have to prove under 10(b)(5)?

o Jurisdiction - Dupuy v. Dupuy - brothers owned and operated Lori Corp that owned building in New

Orleans. One brother gets sick and sells his shares to the other brother. The sick brother then claims he was victim of securities fraud because his brother misrepresented how much shares were valued at. The brothers lived in New Orleans and in the same apartment complex. BUT the brother says this court does not have jurisdiction for this violation.

Federal court says they held intrastate telephone conversations using an instrumentality of interstate commerce, because they could have called across state lines, Federal court has jurisdiction.

So essentially everything is within Federal jurisdiction for securities and 10b-5 purposes. o Standing

o Fraud or act which is the misrepresentation or omission

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o The misrepresentation must be Material

o With scienter (intent - previous knowledge) you may not intend for statement to harm a person, but rather

you made a statement that had a propensity to mislead. (no need for bad faith- so can probably be satisfied with recklessness, but not negligence)

o Reliance/causation - there is no record the P's in Basic even read the information about the denial of

merger. ---> fraud on the marketo Reliance was proximate cause of injury

o Damages - there must be some injury

EP Medsystems, Inc. v. Echocath, Inc- o Echocath CEO said that they had imminent contracts with some big companies. EP Med then invests $1.4

million in Echocath on the belief that the other companies were going to contract. EP bought preferred stock.

o MedSystems must prove elements of 10b-5: Under the legal principles governing actions alleging

securities fraud, MedSystems must prove that EchoCath (1) made misstatements or omissions of material fact (2) with scienter (3) in connection with the purchase or sale of securities (4) upon which Medsystems relied; (5) that Medsystems reliance was the proximate cause of its injury.

o Defense - the Prospectus already said investment in our company could be risky; buyer beware. Also that

there was forward looking information in the 10-K and 10-Q. Also, in contract Medsystem signed saying they had all the info they wanted.

Generally we want to encourage companies to make statements regarding what may happen to companies in the future and we want to protect these (safe harbor for forward looking statements).

o Court held - that the statements were not forward looking and not protected by a safe harbor.

Insider Trading o You have to buy or sell stock connected to the misrepresentation to have a 10b5 claim - its not enough to

simply be a shareholder. o Can a corporation say, we are not going to disclose any information?

Even if the information is important to trade. Can they say, "loose lips, sink ships". There is nothing in 10b5 that requires disclosure . BUT if you decide to make a disclosure, you cannot omit

part that makes the statement misleading. Disclose Something?

o If you have a proper purpose not to disclose something.

o This can be patents, trade secrets, finding minerals on land etc

What happens if the information leaks out?o Even if there is information you don't have to disclose but there is a huge impact in stock price because

there was a leak etc - often the stock exchange will look at a huge trend upwards, call the company and ask what is going on, may suspend trading and let the company figure out what kind of statement to make.

Securities and Exchange Commission v. Texas Gulf Sulphur Co - TGS was looking for mineral sites in Canada, and were drilling various test holes. They found one good site, kept

the mineral sources secret, bought the land up around it for cheap, then announced the discovery.- there were no statements or misrepresentations, just silence.

o Proper business purpose? The want to buy the land cheaply. This is legit. There were other issues though.

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o Directors and some insiders were buying shares on the open market for $18, and then when the discovery

was announced, shares jumped $37.If you are in possession of material, non-public information, you must either disclose it or abstain from trading that security.

The SEC does not like this. Notice, the SEC is always the plaintiff, there is NOT a private right of action for this fact scenario.

o SEC claims a 10b5 violation. If was unlawful for directors to buy stock without public disclosure. SEC

says rule 10b5 deals with insider trading because the Congressional purpose of the act is to give everyone identical market risks and make capital market fair.

o There was no statement of misleading facts or omissions with the intent to mislead - they did not disclose

Anything. “Material non -public information"= inside information You may not trade in the securities of your company if you have this inside information. You

have to disclose this. There is no where in 10b5 that says this, but regulators have decided that if you posses

this inside info, you MUST disclose it or abstain from trading on that information. "thus, anyone in possession of material inside information must either disclose it to the investing

public, or, if he is disabled from disclosing must abstain from trading" - pg 409 was very broad and cause a lot of problems. This was solved in Chiarella.

o What if a geologist follow this company and bought up a lot of shares?

This is ok.o To solve this problem of officers and directors (who always have material nonpublic information) being

looked at by the SEC, they have to publicly announce they are planning on selling shares at a certain time every month or something.

How does this compare to real estate speculation? We have different rules for the securities market than we do for other markets. We don't care if the real estate person makes money off buying up certain lands like we do if a person makes money off inside info in securities.

o Criticism: Insider trading is unique to the US, we do it for fairness, but it is really selectively enforced.

Pg 412 - Julie Freese, was an associate in a San Fran firm and was doing her own deals. Then she accidentally gave information about an acquisition when talking to a stock trader. This guy made almost half a million off this information. She was dismissed from the firm, not for insider training but for breach of confidentiality.

Chiarella v. US- o There was a printing company where Mr. Chiarella worked. Chiarella noticed that he could see the

announcements of company mergers. He bought stock in these companies and made $30,000 after the mergers were announced. The SEC then investigated his trading activities. These mergers were material, non-public information that Chiarella was privy to.

o Lower courts convicted him of violating 10b5. The supreme court looks at this because they don't think

he had a duty to disclose - deal with the "anyone in possession" issue from Texas Gulf Sulphur case.o SCOTUS reversed.

o Issue: was are the legal effects of the petitioners silence? Whether a person who learns from the

confidential documents of one corporation that it is planning an attempt to secure control of a second corporation violates 10b-5, if he fails to disclose the impending takeover before trading in the target company's’ securities.

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o Held: Chiarella did not have a fiduciary duty to the company in which who's shares he is trading. He may

have had material non -public information, but he was in no way connected to this company - so there is no 10b5 issue.

What if he had bought in the buyer company and not the target company? I t would have been different - because he would have a fiduciary relationship with that

company - the company he worked for had business relations with the buyer company, there is a duty. BUT not with the target company.

o Burger Dissent -He stole information that wasn’t his and used it for his own personal benefit.

Though, as the majority holds, the law allowed this, until O'Hagan. US v. O'Hagan -

o O'Hagan worked at a law firm that was working on a merger for GrandMet and Pillsbury. He did not

specifically work on the merger, but his company represented GrandMet. He made $4.3million on the stock, he bought the target company (Pillsbury).

The court applies the misappropriation theory - this is basically the Burger dissent in Chiarella. He took information and used it to his own advantage (it was stolen basically and

misappropriated to benefit you). Is Chiarella still good law?

They still require the person have a fiduciary nexus to insider trading.Two types: Classic fiduciary nexus = Chiarella Misappropriation Theory = If you come into information that you know is confidential,

and you know (or should have known) the confidentiality of this information ,you cannot use it to your own benefit.

o This would have made Chiarella guilty if misappropriation was the law during

that case. o Because it is a lawyer, this seems too easy. But if this was a drug company and a chemist that works in

the lab of the drug company. If chemist in course of work is working on samples brought in by company and recognizes the importance of the drug discovery, she cannot use this information to buy stock (use info for her own benefit).

Dirks v. SEC -o Court uses this to get to a rule about "tipper" and "tipee" liability, but stretches the facts to get there.

o Dirks is a stock broker and received insider information for a corporation that he had no connection to,

relied on it in trading shares of the corp.He was told (got a tip) there was fraud going on in a life insurance company, and was told to verify the fraud and disclose it publicly.Through the investigation, he told several newspapers, people in the industry, regulators, and clients. Telling clients was the big issue. They probably sold because it had these issues.

Is this insider trading? NO. He had no fiduciary nexus to the company. This nexus is established if 1. he is an insider or 2. he misappropriated it.

o We know he wasn’t a company employee

o He did not misappropriate it - he was tipped by someone (who was NOT a

fiduciary) but found out based on his own investigations. He also did not do it for his benefit - he tried to make it public.

o If insider tells someone that someone is tippee, if that person tells someone else..etc. Where does this

end??

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Tippee/Tipper Liability - how do you brake the chain? Tippee is liable if: You must have to establish Tipper was an insider If they tip it to another party, did they do it with the expectation of getting something

down the line IF the Tippee turns around and tells boss, and boss buys on the information. If the tippee

is going to get something in return this is the point you need to make.o But what getting something in return is very muddy. - it can be cash, gifts,

reputation or familial (if your brother buys on your tip).o Hypos:

o Chemist works for drug company, and has material non public info.

She is in fiduciary relationship with co and can be liable for insider trading. She goes to the bar and tells a friend. Friend goes and buys.

This is a tough case. Was it tipped with the expectation that you get something in return? If it was to her brother, that is easier. But at a bar maybe a familial connection.

o You overhear a CEO discussing info.

There is no chance of being convicted of insider trading - because there was no relationship. What about a tip from your crazy neighbor?

Depends on if they are an insider. Tipper/Tippee - if insider (either fiduciary or misappropriate) tips tippee and there is an expectation of the return,

there is insider trading. ONLY first tipper has to be insider!o Does the tippee need to know the tipper was an insider? If you give something in return, there is a logical

conclusion that there was inside information.o Both tippee and tipper are liable.

Case Study 3 Duty owed by Shareholders to Other Shareholders

o Shareholders rights against shareholders is not statutory, very fact driven and varies a lot from state to

state. The cases are very tortured to get a 'just outcome'. Primarily issues that you see in a small private company.

Redemption and the "Equal Access" Rule - Donahue v. Rodd Electrotype Company -

o Donahue is a minority shareholder in a close corporation, Defendants are directors and majority

shareholders. She is unhappy that the head of the company retired and wanted to sell shares of stock he owned back to the company. His kids are on the board and approve the sale. Then Donahue wants to sell her shares and the board said no.

o This is not an unusual set of circumstances - often people start up companies then get older and need

some money when they retire. They cannot sell them to strangers because there is not a market.o Plaintiff is arguing Equal Access Rule - if you are offering to buy back shares of a majority shareholder,

the controlling stockholders must cause the corporation to offer each stockholder an equal opportunity to sell a ratable number of his shares to the corporation at an identical price.

This is NOT a common rule, but this is Massachusetts so there are strong shareholder rights. The court likens this to a partnership and says there are fiduciary duties (very much like

Mienhard case).o Lower court said - we applied the test of good faith and inherent fairness. Case that was tried was a

breach of loyalty, which gives burden to defendant.

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o The high court reversed this and instead treated this as a partnership.

Flipside of the equal access rule - may limit or eliminate any chance for majority shareholder to sell stock if the company cannot afford to liquidate a ton of shares.

o What could he have done?

He could have sold his shares to another shareholders. (no preemptive rights on transfer, only on issuance of stock).

He could have contracted through stockholder agreements that they will buy back from certain people in a certain order at a certain price. [buy-sell agreements: allow you to do what you want to that you otherwise couldn’t under this law].

He could have sold preferred stock to founders, which would have different rights. Common Law Duty of Selling Shareholder Perlman v. Feldman -

o Majority shareholder Feldman sold his shares in the steel company to Wilport, a company that was a big

consumer of steel and wanted to acquire a supplier. The shares sold at a premium and came with ability to control the board of directors. The value of the shares was $10, but Wilport paid Feldman $20 per share basically because they were buying control of the company. A majority shareholder can sell his shares whenever they want, for whatever price they want (even way over market price) and it is often that you pay a control premium when you buy a majority interest.

o Soooo what happened here??

The minority shareholders are objecting because they think he is selling an asset of the business and they should share in the profit.

(This is a really result driven case.)o Indiana court decided we are going to recognize the majority shareholder has a fiduciary duty to minority

shareholders and articulate this duty as putting obligations of corporation first. The court says his official conduct swayed by private interest, and his private interest should yield to official duty. Courts say he was selling not just control shares but instead the sold the "power of the corporation" and this is a breach of duty to minority.

o What asset or power was sold? The voting power, ability to replace board.

Court said when the sale necessarily results in a sacrifice of this element of corporate good will and consequent unusual profit to the fiduciary who has caused the sacrifice, he should account for his gains.

o The reason this is in court is mainly because of who the buyer is. The shareholders are upset because

Wilport is attempting to funnel all steel to themselves (not sell on open market) and not to benefit the company.

After this the minority shareholders stock shot way up - so here they complain about something that didn't even harm them.

DeBaun v. First Western Bank and Trust Co-o Closed corporation with 3 shareholders, with a successful photography business. The majority

shareholder dies and the executor of the estate (Defendant Bank) sold the shares to a really crappy Mattison.

The bank has a right to sell the shares to anyone they want and at a premium BUT they breached a duty to the company because they were negligent. They knew the new party was a schemer and wanted to loot company.

o Why should we have a remedy for shareholders that don’t like the new majority shareholder?

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o Why not sue Mattison?

He doesn’t have money, they want deep pockets. But they do this under breach of fiduciary duty that you have to know who you are selling do. The bank knew this guy, they knew he had lots of bad history and STILL sold him the shares.

o When is someone actually a looter and when are they restructuring?? T

his is a tough call and why this is not law in majority of jurisdictions. o What the F is wrong with the damages?

Damages were paid to corporation, where this guy is still the majority shareholder.Forst thinks the case book forgot to include something here.

Berreman v. West Publishing Company -o Berreman worked at West and when he decided to retire he sold his shares back to the company for

$2,088.90 a share. H claims that West had a duty to disclose to him before he retired and sold his stock back that 3 directors had begun to consider the sale of West and had engaged an investment-banking firm to explore West's options. Company was speaking with lawyers to see if they should sell, merge, acquire, joint venture etc. They eventually decide to merge with Thomson and Thomson paid $10,445 per share to acquire West.

o Court granted and affirmed SJ for West.

o Berreman uses legal theory, "duty to disclose material facts" which is embedded in fiduciary duty (in

Minn.)o Court held: this was not a material fact, because materiality will depend at any time upon a balancing of

both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity.

Maybe if they had agreed to a merger before he retired but hadn't yet announced it this could be a breach. But at the time of the retirement, they were just looking at potential options for the future. - this is too attenuated to connect retirement with potential value of shares in future.

Mergers and Acquisitionso What are the various "endgames/exits" for the Corporation, Its shareholders, its managers?

Voluntary dissolution - unusual, and usually just occurs to clean up legalities of a business that never took off

Judicial Dissolution - there is a deadlock and no avenues to overcome the deadlock. You can apply to have the courts dissolute the company, they don’t like to do it

Company fails - can file for bankruptcy protection to try and reorganize the business or can choose to be liquidated and use assets to pay creditors.

Restructuring - bring in new management, recapitalize, streamline products/equipment. Sell it - Why would you sell a company? Want to make money, retire and take cash. We brought

the business as far as we could, we need to pass it off to let it grow. We need substantial capital to move forward and you can’t raise the capital, it is better to sell.

o 2 ways companies are bought and sold

Merger- two or more business entities combine into one business entity. One company is the "surviving corporation" and the other is a "disappearing corporation

Acquisition - an Asset Purchaseo Why would you buy a company?

Want to expand - can buy a competitor to get market share advantage. HMO- W Inc v. SSM Health Care System

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o SSM and Neillsville are a minority shareholders in HMO-W. HMO-W is attempting to merger with

United (United surviving, HMO disappearing) Before shareholder approval of the merger, HMO-W retained a valuation company that valued HMO's assets at $16.5-$18 million. Then the board of directors voted to approve the proposed merger with United and submitted the merger to a shareholder vote. The Valuation report was sent to shareholders and informed them of their statutory right to dissent to the merger. At shareholder meeting, SSM and Neillsville voted against the proposed merger. BUT merger was ultimately approved. Then SSM and Neillsville perfected a demand report for the payment of their dissenting shares.

o Then HMO hired another valuation company that valued HMO-W's assets at approx $7.4 million. Based

on this valuation HMO paid SSM $1.5 million. SSM thinks this was not a fair consideration paid based on valuation upon which the decision to

not merge was based. o At trial there were several experts that testified to the value of HMO-W. The court accepted HMO's

valuation. Then upon observing the dissenters; minority status, the lower court applied a minority discount

of 30%.o Holding: This court allowed the HMO valuation to stand, but said minority discounts are not allowed.

Dissenters Appraisal Rights o 13.02 - Right to Appraisal, There are specific steps you must follow to get paid for dissenting shares.

13.02(b) - there are no appraisal rights for publicly traded companies (because value is obvious by market price).

Mergers are highly statutory o 11.02 - one or more domestic corporation may merge with one or more domestic or foreign corporations.

There is a legal contract that sets out the terms of the merger Main term of the contract = what is the value to be paid for the shares

o Straight Merger - once we determine value, we pay per share.

Consideration (cash, property, shares) is then paid to shareholders o Triangle Merger -When P creates a subsidiary solely for the intent of merging a

lower level business. Done to Protect the parent company from liabilities (known and

unknown) of target company. Now, the subsidiary has to stand for liabilities, NOT the parent company.

o 11.04 - Procedures

Plan of merger must be adopted by BOD, then Board must submit to shareholders for approval. Plan of merger requires majority.

Early days of mergers required unanimous vote by shareholders. But we don't want to allow one minority shareholder to hold back a transaction that would otherwise be good.

But because they are giving up this veto right, they are getting minority dissenters rights (can get paid for shares).

Then you must file Articles of Merger - this is a legal public filing. (g)- When merging, approval is NOT needed by shareholders of surviving corporation (because

there is no fundamental change to them - rather it is only to benefit those shareholders).o 11.07 - the legal effect of the merger is that the target company disappears! All liabilities are vested in

surviving company (lawyers don’t like this).

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All Assets go to survivor - includes property, plant, equipment, IP, employees, capital, inventory, receivables, contracts, customers, leases. Strange part is that they transfer under operation of law and no actual transfer or title changes or recertification.

Liabilities - loans, debt, payables, lease AND there are unknown liabilities (environmental) AND contingent liabilities such as lawsuits.

Mergers are operations of law - no creditor consent needed. Do you have to ask lender to go into merger? No. Landlords don't have to consent to merger. This might not make them happy, because

they don’t know the new party. Weinberger v. UOP, INC-

o This was a direct class action suit. UOP is a publicly traded oil corporation. Signal is another oil

company, and they had previously made purchases in UOP and at the time held 50.5% of stock. The other shares were held by all the other Public Shareholders. Then Signal wanted to acquire the rest of UOP. Plaintiff is unhappy that they were not paid as much for shares as they could have. He was paid a price upon merger that he thinks was not enough. Files duty of loyalty claim because conflict of interest, the directors are on both sides.Signal had 6 of 11 directors on the UOP board. These directors have a fiduciary duty to BOTH Signal and UOP public shareholders.

In Duty of Loyalty case - Burden of proof is on directors to prove entire fairness - both terms (fair dealing) and price are fair.

P's prevail! There was a conflict of interest and a breach of duty of loyalty, and were paid. Why didn’t they assert appraisal rights? They don't have any! This is a publicly traded company.

Example:NEWCO - Nick owns 55%, Eliz and William own 45% (minority)o Nick is unhappy with corporation and shareholders. Comes to a clever lawyer and creates NICKCO,

which Nick is 100% shareholder. Have NICKCO propose merger with NEWCO, and NEWCO will merger into NICKCO for consideration. There is a vote in NEWCO, and Nick wins (bc Nick owns majority). Now we have eliminated the minority shareholders.

o Minority shareholders can bring duty of loyalty claim? Maybe not if there is a fair consideration paid and

fair terms. You are allowed to freeze out to eliminate minority to advantage corporation. BUT if Nick did the freeze out to benefit himself (sell at a higher cost once in NICKCO to another corporation) - there could be duty of loyalty and Duty of minority shareholder to minority

Rights and Remedies of Shareholders of The Target Corporation:o Opportunity to Vote - if passes by majority, merger will occur and you will be paid (even if you vote no,

unless you dissent)o Dissenter’s Right/ Appraisal Rights-

o Lawsuit against Board - Can be a duty of loyalty or duty of care claim, but loyalty is easier because no

BJR. Tender Offer/ Takeover -->alternative to Merger

o You could choose to structure transaction to go after buying shareholders, and bypass the board. If there

is an incumbent board or manager that don't want to discuss a merger. You can also bypass the merger agreement and the process where shareholders vote (and can dissent and meet appraisal rights).

o This is hostile, because A's interests don’t match interest of board of T.

o Once you buy majority of shares, you can control the board, and eventually merge

o This is very fast and avoids negotiation - valuation of company. Go to shareholders with a take-it-or leave

it offer.

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o This is not often done. Because shareholders often pause when the board doesn’t like A (acquiring

corporation). Purchase or Sale of Assets - Acquisition

o Franklin v. USX Corp

o Franklin on behalf of wife’s estate, filed action for personal injury, premises liability and loss of

consortium against USX. Franklin claims his wife contracted mesothelioma (asbestos cause cancer) as a result of childhood exposure to asbestos carried home by her parents who worked at WPS. Sued USX as successor in interest to WPS.

Chain of companies: WPS -> Con Cal -> Con Del -> USX Injury in 1996 WPS is no longer in business. Assets of WPS were purchased by Con Cal for $6.2

million ( and liabilities were assumed) Then Con Cal assets were transferred to Con Del for consideration of $17 million (but

did not assume liabilities). Con Cal then merged with USX for consideration. BUT only took on liabilities of Con

Del. o Lower ct held USX liable, verdict of $5 million.

o This court holds USX is not liable as the successor in interest to WPS.

Comparison of Merger and Acquisition -o In an asset purchase, the buyer acquires the assets of the T, and consideration is paid to T corp, and

shareholders own T company (which is now just cash). Consideration goes to T corporation who decides what to do with the money - shareholders have

no decision or control over assets. Shareholders of T still have same shares of T. (even though T is not an active company, they have

money).o What do we do now that we have sold our assets, have cash, and shareholders?

Invest! Or pay out to shareholders and dissolve company. 12.01- Shareholders don’t have the right to vote on asset purchases 12.02 -requires approval of shareholders if disposition would leave corporation without any significant continuing

business activity 13.02(a)(3) - In a sale of all or substantially all assets, shareholders have right to vote, appraisal and dissenters

rights. Result is the same as the merger, A owns T as a going company.

o Differences - there is no comparable to 11.07 for acquisitions. So parties can negotiate and agree which

liabilities will transfer. o What is the difference between a merger and acquisition?

Successor Liability. - you don’t usually have it in an asset purchase. o If you are a lawyer for the seller, you want a merger. If you are a lawyer for the buyer, you want an asset

purchase.o Creditors prefer asset sale, because person has to get consent to transfer and you may get something to

give the approval.o Merger is easier to accomplish!

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o The most hard fought parts of asset purchase agreements are the liabilities.

o One of the hardest parts of asset purchase is indemnification for any claims during time business is in

your hands. You can have a basket of indemnification - we can indemnify for up to a certain amount $500,000 for a certain

period of time. Can have a hold back/escrow to have for potential claims for a period of time. [pay $50 million in assets, put $5million in escrow in case there is a claim, then in certain time 5 years, T gets that escrow].

Hypo: If they had all been mergers than liabilities (known and unknown) would have transferred in law. o Is it fair that we can transfer assets and not give them liabilities?? Why do we have this?

o To promote business and certainty for business. There are limits though, to ensure this process doesn’t

happen just to avoid liability. Hypo: Straight asset purchase -

o What assets do you buy? Includes property, plant, equipment, IP, employees, capital, inventory,

receivables, contracts (future sales, supplier contracts), customers, leases. You have to enumerate assets you are going to buy. You file and assign patents and copyrights. You will have to read contracts to make sure you can sell it to someone else, or you will have to formally assign it to A. Land - give deed, and record it. UCC filing security has to be released by creditor. You can sell your name of your corporation (brand recognition) - T has to amend your articles of incorporation to change name. You can also transfer employees - by firing and hiring them in A the next day, you have to do all the paperwork. .

You don’t have to do any of this in merger - it all transfers by operation of the law. With Assets you have to do each enumerated transfer.

o Liabilities? - If you don't want liabilities, then you contract. But usually you want to assume some

liabilities (leases, bank debt, accounts payable). Post Asset Sale

A Corp has: o New Assets

o Only assumed liabilities

o You can issue a stock to the seller of the asset for the purchase of the asset,

o Can have a new shareholder (T corp)

T Corp has: o Has retained liabilities

o Negotiated assets

o Cash, stock

o No more creditors because they will get paid

Hypo: Until 6 months ago Nokia was largest cell phone (computer and camera), Apple wants to acquire Nokia. How would this work?

o Apple would want a merger. Because size and complexity of business, and nature of assets. There would

be consideration paid (maybe cash to shareholders, maybe apple stock)o Nokia shareholders would have to approve merger. Special shareholders meeting would be called to vote

on this sale.o If we go to shareholders to get this meeting, we give shareholders a proxy that is likely to say to

shareholders that we are proposing that you approve merger and we think you should know these things (acquisition cost, pay out per share) We have to show them all about Apple, all about us etc. because we

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don't want to be sued(if there were misstatement or omissions/ misrepresentation there will be a shareholder derivative 10(b)(5) suit, because it was in connection on the sale and purchase of a security.

Stock Purchase S- Corporations

o Pass through entity for tax purposes.

o You are not likely to form an S-corp because there are two other formations to get to the same place with

more flexibility (LLCs). They were more popular in the past, and sometimes they are used as an estate planning tool or accounting driven transaction purposes.

o You don’t go out and create an "s-corp" because there are losses in the first tax year. S-corps give you

limited liability.o Limitations:

Have to have 100 or fewer shareholders Have only 1 class of stock Shareholders must be natural persons All of the natural persons have to be US citizens.

Limited Partnershipso No longer formed because like S-Corp, there are better forms of business that give more advantages and

more flexibility (LLCs). You will see them in estate planning or hedge funds sometimes. You may see them more in AZ than other places, because they were a good way to invest in real estate development. There is a promoter that identifies a piece of property, put it in escrow, get partners to invest for a limited partnership, and then sell property, distribute funds to partners (and this dissolves partnership) [create business to accomplish a single purpose and then don’t need it for anything else].

o Characteristics:

Ownership - you have to have at least one general partner and at least 1 limited partner. Limited partners are just there to get a return on investment - and don't have any of the liabilities of the company, just liabilities of the investment you have made in the company.

Management - in power of general partner. General partner is active day to day participant in the business.

Liability - limited only for limited partners Taxation - pass through Transferability /Formality- there has to be legally formed with documents (don't just happen like

normal partnerships), this is a creature of statute. o Limited Partnerships are governed by the Uniform Limited Partnership Act

Zeiger v. Wilf -o P, Zeiger, sold property to D , and was supposed to collect consultant fees of $27K per year for 16 years,

but the payments stopped after 2 years. Wilf got tagged by lawyers mainly because he was the last guy standing. Shareholders (Midnov and CPA- family partnership) form Trenton as a corporation to prevent liability. The limited partnership, which was formed by General Partner (Trenton Inc) and Limited partners (CPA/Wilf, Trenton Inc, Midnov, Albanses, Zeigler). Why form a limited partnership? To get money.

o Why is Trenton Inc both a general and limited partner in the Limited Partnership?

The GP has no interest in the economics of the business, but the investment and returns on the investment comes from buy in by the limited partners - so Trenton wants to invest in its own business.

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o The limited partnership project fails, and the partnership files for bankruptcy.

o When Zeiger looks to get money, why didn't he sue partnership? They were bankrupt.

Why not sue Trenton Inc? They also filed bankruptcy.o What was Wilf's role in the partnership? He was a limited partner (though he was a director, he still

wouldn’t have liability as a director). So why could he get sued? How does a limited partner lose his libited liability? --> you have to

act like a limited partner (passive, not interact in day to day business), BUT Wilf moved to acting as an active manager so the Plaintiff thought Wilf became a General Partner.

o What makes you active?!

You can go to limited partner meetings or read the books of your company. Tipping point - voting on objective strategy of business or were votes for day to day

business. It is common to make your general partner a corporation. [this is to circumvent the potential

liability for the general partner]. Court gave Wilf a pass - said somebody had to run the business because everyone else bailed. We

want to protect him from liability.o What legal theories could atty have used?

Sue Wilf as an agent of Trenton? No- this doesn't get you anywhere, because there is no liability for agents!

Pierce the corporate veil? Yes! Pg 588, para 4. This was a fake shield of a corporation, there needed to be formalities to be corporation.

Limited Liability Companies (LLC)o What is an LLC and what is LLC Law/?

An LLC offers all of its owners, generally referred to as members, both [1] protections from liabilitycorp. and [2] gives benefits of pass-through taxes

Origins trace to a statute in Wyoming in 1978 but has become increasingly popular.o Even though each state has an LLC statute, the law of LLC is primarily contract law

Members of an LLC enter into an operating agreement which sets out the rules that govern the firm.

ULLCA 103: Operating Agreements – where most of the work gets done for lawyers Lawyers address the risks and statutory discrepancies Can become very complex and expensive – counterintuitive to the idea that it should be

easy to do business Can be oral

o Took all the things we regard as advantageous in each structure and combine them and threw away the

disadvantagesLLC

Ownership 1 or moreControl Member Managed LLC – Similar to General Partnership

Manager Managed LLC – Similar to Corporation [default]You get to pick

Liabilities Limited for Members and Managers

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Taxes Pass-thru taxation [Tax code says that an LLC may elect to pass as a corporation or as an LLC – for this class we will regard it as a pass-thru]

Transfer/Formality ??You own a percentage ownership interest [can be called a variety of thing – interest, stock, percentage, etc.]

o The owners of an LLC can elect the form of management

Member Managed Company or Manager Managed Company The decision-making authority of the members of a member-managed company is much like that

of the partners in a general partnership. Of a Manger managed – like a corporation with a board of directors, professional

managers, and separation of ownership and management. o Water, Waste, and Land [supp pg. 346] (this class is really about agency law)

Facts: Westec was a land development and engineering company. Lanham and Clark were managers and also members of the LLC. In March, Clark contacted Westec about the possibility of hiring Westec to perform engineering work in connection with a development project. Clark gave his business card to Westec, there was no indication that Clark was representing an LLC. After an oral agreement, Clark instructed Westec to send a written contract to Lanham which Lanham was to execute and return [gave Westec the perception that Lanham was the principal and Clark was the agent]. Westec completed the work and sent a $9,000 bill – no payments were made. Westec filed a claim against the LLC and Lanham and Clark.

Issue: Whether the members or managers of a LLC are excused from personal liability of a contract where the other party to the contract did not have notice that the members or managers were negotiating on behalf of a LLC at the time the contract was made

Holding: Lanham was responsible and liable as the principal Reasoning:

Undisclosed Principal Disclosed Principal Agency Law – what the court decided on – Clark was an agent, Lanham was the principal

so Lanham is responsibleo Members liability to third-parties

An LLC is an entity ULLCA 201: It can carry any lawful business purpose or activity LLC statutes protect the owners form personal liability for these claims against the

company [ULLCA 303]o Protection from liability extends to all members

o Members are protected from liability only for the company’s debt – a member is

personally liable for her own conduct, even when she is acting for the company Webber v. US Sterling Securities

Facts: Michelle Master Orr and Shawn Orr are members of an LLC [Retail Relief]. The Orrs sent an unsolicited fax to the P on behalf of Retail Relief [in violation of federal law]. The Orrs claimed that they were acting on behalf of the corporation and so they should not be held personally liable.

Holding: Members can be held liable for their own tortuous act.

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o Shows that the LLC protection from liability is not as strong as it is in a

Corporation Reasoning:

o The Delaware LLC Code 18-303 states that “no member or manager of a LLC

shall be obligated personally for any such debt, obligation or liability of the LLC solely by reason of being a member or manager of the LLC.

o “Solely” – A member must do more than just be a member in order to be held

liable but does not preclude individual liabilities for members of a LLC if that liability is not based simply on the member’s affiliation with the company.

o Piercing the Limited Liability Corporate Veil?

In Re Suhadolnik Issue: Whether the veil of a LLC may be pierced [under Illinois law]?

o Holding: Veil piercing is available with respect to members and managers under

traditional veil piercing theories such as alter ego, fraud, or undercapitalization. Kaycee Land and Livestock v. Flahive

Issue: In the absence of fraud, is a claim to pierce the LLC entity veil or disregard the LLC entity in the same manner as a court would pierce a corporate veil

Holding: We can discern no reason, in either law or policy, to treat LLCs differently than we treat corporations.

o The ULLCA does not say, “In the event the act is unclear, refer to corporate law

or state law – there is no savings clause. Courts are left to construct their own doctrine.

o Cases of first impressions – most states are looking at their corporate law statutes

o ULLCA

201 202 203 105 101 112 301; Each Member is an agent of the company and an act by any member will bind the business

[similar to a partnership [b] Manager managed Company – member is not an agent of the business [similar to a

corporation – shareholders are not agents] 103: All members of an LLC may enter into and Operating Agreement [need not be in writing].

The OA will govern the relations amongst members; ULLCA will be a gap-filler. Members have the opportunity to contract in any way that they want and the law will

back them up [very pro-business] Combination of AI, By-Laws, and SA [prospective]

404: Similar to Corporate Law 405: Similar to Corporate Law 406: Similar to Corporate Law 303: Limited Liability of Managers

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(b) No requirement of corporate formalities [takes away one of the grounds that is available for piercing the corporate veil – why? Supposed to be flexible, easy, lets not expose them to this liability. Is silent of the ability to pierce the corporate veil on the theories of Alter Ego or Undercapitalization]

o Members and Managers Liability to the Company

A member acquires her ownership interest in a LLC by making or agreeing to make a payment or other contribution to the company.

The OA usually lists the amount of each member’s initial contribution. In addition to contractual obligations:

Members of LLCs that are member-managed and managers of a LLC that are manager-managed also owe the company fiduciary duties.

Members of a manager-managed LLC generally owe no fiduciary duty. Lynch Multimedia Corporation v. Carson Communications, LLC

Facts: Lynch is suing Carson alleging that they breached the OA and various fiduciary duties when they independently acquired other cable franchises, rather than securing them for CLR. Under the OA, CLR [an LLC] has three owners – Lynch Multimedia, Rainbow Comm. and Electronics, and the Robert C. Carson Trust. CLR has a Board of Managers which manages its business: under the OA Lynch names three of the managers, and Rainbow and the Carson Trust each name one. Carson was the pres. of CLR. The OA gives the pres “general and active management” of CLRs business and carries out orders and resolutions of the Board.

Holding: There was no violation of the operating agreement/fiduciary duties Reasoning: Carson informed the other members of CLR of certain opportunities to

purchase cable companies. Only after the passes of several months or years, and at one point after the rejection of the proposal, did Carson independently acquire the companies. The P has demonstrated neither a breach of the OA or the fiduciary duties.

McConnell v. Hunt Sports Entertainment Facts: CHL, LLC was formed by McConnell and Hunt in order to seek a NHL franchise

for Columbus, Ohio. To secure a franchise, CHL needed an arena and sought out public financing through an increase in sales tax increase [rejected by voters]. Hunt was then approached By Nationwide to build an arena and lease if to the franchise. Hunt rejected the proposal, McConnell accepted the proposal [without CHL on the signature line – purposely eliminated].

Issue: Whether an operating agreement of an LLC may,, in essence, limit or define the scope of the fiduciary duties imposed upon its members.

Holding: Court concludes that the Operating Agreement [which diminished the fiduciary duties] applies and is appropriate.

o General Partnership: Look at Meinhard v. Salmon

o Corporate Law: Duty of Loyalty – not allowed to divert corporate opportunities

for oneself, not allowed to compete against the corp.o How do the Owners of a Business Structured as an LLC Make Money?

Usually, the OA provides how and when a LLC’s earnings are to be distributed to its members. ULLCA 405 creates a simple default rule

Abilities for a member to sell interest may be limited by statute or by the OA or by both

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ULLCA 502, 503 Lieberman v. Wyoming.Com LLC

Issues:o 1. Whether Lieberman’s withdrawal triggered dissolution of Wyoming.com

o 2. The propriety of the return of contributions to capital

o 3. Whether Lieberman can demand dissolution of the LLC

o 4. What becomes of Lieberman’s interest in the LLC

Holdings:o 1. There was no dissolution and Lieberman is not entitled to distribution of

assets.o 2. Lieberman is entitled to the return of his capital contribution but only the

initial or stated capital contribution of a member [not the fair market value of the contribution]

o 3. Lieberman cannot compel dissolution.

o 4. Remanded?

Reasoningo 1. Wyo stat – upon withdrawal of a member, the LLC must dissolve unless all

the remaining members of the company consent to continue under a right to do so stated in the articles of organization. The minutes of s pecial meeting of Wyoming.com reflect that the remaining members of Wyoming.com elected to continue the LLC after Lieberman’s departure.

o 2. Nothing in 17-15-120 indicates that fair market value of a member’s interest

is to be included in the amount to be paid to a member upon withdrawal of that member’s capital contribution. Also, 17-15-129(b)(i) requires an amendment to an LLCs OA when the amount or character of contribution changes.

o 3. To compel dissolution Lieberman’s demand for the return of his capital must

have been unsuccessful and it was not. o 4. ????

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Last Class

LLCo Based primarily on contracts [OA]

o Lawyers see the OA as an opportunity to predict what may occur and being preemptive about solutions

Same with risks and adversitieso What does an LLC signal?

Small business – but does not have to be [ex: Chrysler is an LLC] One person businesses [OA is not complicated – can be run off the internet – until new

members are admitted Flexibility Informality Problems

Tries to free people from the structure of a corporation but leads to irregularities on how the business is run

o LLCs are relatively new

No case law Statutory based – ULLCA and OAs

ULLCAo 404

o 409 Fiduciary Duties – Duty of Loyalty and Duty of Care

(b) Duty of Loyalty Conflict of Interest Competing

(c) Duty of Care Negligence

o 103 Effect of OA

(b) OA may not eliminate the Duty of Loyalty but you can modify it as long as it is not manifestly unreasonable or unreasonably eliminate duty of care but may determine the standards of how it should be measured

In AZ?? Nothing in the statute about Duty of Care/Duty of Loyalty Possibilities:

o 1. Statute is silent [on purpose] so the OA may establish fiduciary duties

o 2. No fiduciary duties in AZ

o 3. All fiduciary duties apply – reference corporate and partnership law

o 502

(a) (b) (c)

o 504

o 805

o 902 Converting a Partnership into an LLC

o 903 Effect of Conversion

o 904 Merger of Entities

o 905 Articles of Merger

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o 906 Effect of Merger

Nothing about dissenter rightso 1101 Derivative Actions in LLC

o 1103 Pleading [looks like a demand requirement in Corp. Law]

Do not know specifics – like excusal with futility Investors Interest

o Is it an Investment Contract?

If it is – must be registered because it would be considered a security Member Managed – not a security Manager Managed - security

Pros of creating an LLCo Easy to form

o Limited liability for both managers and members

o Able to contract for desired outcome

Cons of creating an LLCo Uncertainty in the law

o Hard to go public

o No preferred stock

General Partnerships Corporations Lim. Liability CorporationOwnership 2 or more general partners 1 or more shareholders 1 or more managers/1 or

more membersControlLiabilityTaxFiduciary DutiesFilingAgreement

Hypo – 2 young entrepreuners that have created a source of solar energy which is dangerous. No business experience; wil probably lose money. Think they will bring in more investors over time [mainly friends]

5 wealthy business men – software. Want an investment and will probably have VCs and then take the company public

Mentioned in class – fair game

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