1 Busn Organizations Outline

CHAPTER TWO: AGENCY The Creation of an Agency Relationship Three requirements for an agency relationship to exist o Must be a mutual agreement o The agent must be acting on behalf of the principal o The agent must act subject to the principals control As long as the requisite elements are present, it is irrelevant whether the parties understood that they were creating an agency relationship or desired to create such a relationship [2nd restate 1 cmt b or 3rd restate 1.02] Marital status cannot in and of itself prove the agency relationship Agency vs Gratuitous Bailment o 2nd restate 1, 13-14, 16, 30 o 3rd restate 1.01-1.04 Not essential to the existence of authority that there ve a contract btwn principal and agent or that the agent promise to act as such, nor is it essential to the relationship of principal and agent that they or either receive compensation A principal may be liable for the torts of his agent A Gratuitous Bailment is the transfer of possession or use of property without compensation Agency vs Creditor Debtor Relationship o 2nd restate 14K, 14O Court concludes that Cargill, by its control and influence over Warren, became a principal with liability for the transactions entered into by its agent Warren The existence of the agency may be proved by circumstantial evidence which shows a course of dealings btwn the two parties o When an agency relationship is to be proven by circumstantial evidence, the principal must be shown to have consented to the agency since one cannot be the agent of another except by consent of the latter A creditor who assumes control of his debtors busn may become liable as principal for the acts of the debtor in connection with the busn [2nd restate 14O] o Veto power is not enough o Must take over management in person or through an agent and directs what may be done in the normal course of busn (de facto control of agent) Factors must be viewed in light of all the circumstances of the busn arrangements 2nd Restate 14K requires that the supplier has an independent busn before it can be concluded that he is not an agent Agency vs Contract Relationship o 2nd restate 2, 14N, 391 o 3rd restate 8.03 1

2 Three characteristics having particular relevance to the determination of the existence of a principal agent relationship [2nd restate 12-14] o Agents power to alter the legal relations of the principal o The agents duty to act primarily for the benefit of the principal o The principals right to control the agent An Agent renders services but retains control over the manner of doing it An independent contractor, as distinguished from a servant, is a person who contracts with another to do something for him but is not controlled by the other nor subject to the others right to control with respect to his physical conduct in the performance of the undertaking. He may or may not be an agent [2nd restate 2(3)] o The 3rd restatement drops the distinction btwn independent contractors and servants. It provides a general definition of agency [3rd restate 1.10]

Express Actual Authority o 2nd restate 26, 32-34, 37 o 3rd restate 2.01, 3.01 Express Actual Authority a principal has expressly communicated to an agent the power to perform some act on the principals behalf. However the scope of an express grant of authority may well be an issue. The ultimate test is whether a reasonable person in the agents position would interpret the principals communication to encompass a particular act The power to borrow money or to execute and deliver promissory notes must be granted by express terms or flow as a necessary and inevitable consequence from the nature of the agency actually created Implied Actual Authority and Apparent Authority o 2nd restate 26-27, 35, 49 o 3rd restate 2.01-2.03, 3.01, 3.03 Implied Actual Authority an agent has implied actual authority when the principal does not expressly confer authority but the principals words or conduct, reasonably interpreted, causes the agent to believe that he has authority Apparent Authority an agent has apparent authority in dealing with a third person when the principals words or conduct, reasonably interpreted, causes the third person to believe that the agent has authority o apparent authority is created by the conduct of the principal which causes a third person reasonably to believe that the purported agent has the authority to act for the principal and to reasonably and in good faith rely on the authority held out by the principal An agent may have apparent authority to act even though as between himself and the principal, such authority has not been granted. Apparent authority does not arise from the acts of the agent o Three ways to establish apparent authority Principal expressly and directly telling a third person that a second person has authority to act on the principals behalf Prior acts By position 2

3 o If a principal allows an agent to occupy a position which, according to the ordinary habits of people in the locality, trade or profession, carries a particular kind of authority, then anyone dealing with the agent is justified in inferring that the agent has such an authority. The principal may also create the appearance of authority by prior acts. By allowing an agent to carry out prior similar transactions, a principal creates the appearance that the agent is authorized to carry out such acts subsequently Inherent Authority o 2nd restate 3-4, 8A, 9C, 161-161A, 194-195A, 219 Inherent Authority a principal may be liable in contract for the acts of a general agent even if the agent lacks actual and apparent authority. A general agent is said to have inherent authority to bind the principal o A principal is disclosed if the third party is aware that a principal exists and knows the principals identity. A principal is partially disclosed if the third party knows that a principal exists but is unaware of the principals identity. A principal is undisclosed if the third party is unaware that a principal exists and believes that he is doing busn with the agent [2nd restate 4; 3rd restate 1.04(2)] o A general agent is an agent authorized to conduct a series of transactions involving a continuity of service [2nd restate 3(1) A general agent has inherent authority to act ofr a disclosed or partially disclosed principal regarding acts done on the principals account which usually accompany or are incidental to transactions which the agent is authorized to conduct I, although they are forbidden by the principal, the other party reasonably believes that the agent is authorized to do them and has no notice that he is not so authorized [2nd restate 161] o 3rd restatement declines to adopt the concept inherent agency power [2.01 cmt b] Well established that an agent for an undisclosed principal subject the principal to liability for acts done on his account if they are usual or necessary in such transactions [2nd restate 194]. This is true even if the principal has previously forbidden the agent to incur such debts so long as the transaction is in the usual course of busn engaged in by the agent [2nd restate 195; 3rd restate 2.06] o Secret instructions or limitations placed upon the authority of an agent must be known to the party dealing with the agent, or the principal is bound as if the limitations had not been made. o A principal may be held liable for the unauthorized acts of his agent if the principal ratifies the transaction after acquiring knowledge of the material facts concerning the transaction Ratification o 2nd restate 82-83, 91-92, 94-96, 98-100A o 3rd restate 4.01-4.08 Ratification a principal may ratify the conduct of an agent who acted without authority. A principal may do so unless allowing ratification would be unfair to the 3rd party as a consequence of changed circumstances [3rd restate 4.05] 3

4 o Ratification is defined as the affirmance by a person of a prior act which did not bind him but which was done or professedly done on his account [2nd restate 82] Ratification requires acceptance of the results of the act with an intent to ratify and with full knowledge of all the material circumstances o If the original transaction was not purported to be done on account of the principal, the fact that the principal receives its proceeds does not make him a party to it [2nd restate 98 cmt f] Ratification, like actual authority, may be express or implied as long as there is an affirmance of the contract by the principal. The most common basis of implied ratification exists when a principal has knowledge of a transaction, accepts its benefits, and fails to repudiate it [2nd restate 94, 98-99; 3rd restate 4.01] A principals ratification must be complete to be valid. He cannot ratify part of a contract or transaction [2nd restate 96, 3rd restate 4.07] o Once a principal manifests affirmance, the contract is ratified. It is not necessary that the principal communicate the affirmance to the agent, the third party or any other person [2nd restate 95; 3rd restate 4.02(1)] o If a principal ratifies a contract, the effect is to validate the contract from the moment of its original formation. It is as if the ratification travels back in time to create the agents authority [2nd restate 82, 100-100A; 3rd restate 4.02(1)] o Consideration is not required to validate a ratification. Ratification may also operate in the absence of unjust enrichment or estoppels [2nd restate 82 cmt c, 92(e); 3rd restate 4.01 cmt b] o 2nd restate 8B o 3rd restate 2.05 Estoppel a principal who misleads a third party into believing that an agent has authority to effect a particular transaction is liable with respect to that transaction [2nd restate 8B; 3rd restate 2.05] o However the courts often require that the third party justifiably rely on the agents purported authority Must Show o Express or real authority o Implied authority OR o Apparent authority Where a proprietor of a place of busn by his dereliction of duty enables one who is not his agent conspicuously to act as such and ostensibly to transact the proprietors busn with a patron in the establishment, the appearances being of such a character as to lead a person of ordinary prudence and circumspection to believe that the imposter was in truth the proprietors agent, in such circumstances the law will not permit the proprietor defensively to avail himself of the impostors lack of authority and thus escape liability for the consequential loss thereby sustained by the customer [gross negligence]

Estoppel

Liability in Contract Agents Liability to Third Parties 2nd restate 9, 210-210A, 320-322, 329-330, 336-337 4

5 3rd restate 5.01, 6.01-6.03, 6.10 o If an agent with a third party on behalf of a disclosed principal, the agent is not liable on the contract absent a contrary agreement (2nd restate 320; 3rd restate 6.01(2)) Courts typically require clear proof of intent to bind the agent Conversely, when an agent contracts on behalf of a partially disclosed or undisclosed principal, the agent is normally liable on the contract unless the contract states otherwise (2nd restate 321-322; 3rd restate 6.02(2), 6.03(2)) o If the agent lacks the power to bind the principal, the third party may sue the agent for breach of warranty of authority or misrepresentation of authority (2nd restate 329-330; 3rd restate 6.10) Well settled that where one enters into a contract as agent for an undisclosed principal, he may be held individually liable on the contract In order for an agent to avoid personal liability on a contract negotiated in his principals behalf, the agent must disclose not only that he is an agent but also the identity of his principal, regardless of whether the third person might have knowth that the agent was acting in a representative capacity. o the disclosure of an agency is not complete for the purpose of relieving the agent from personal liability unless it embraces the name of the principal, without that, the party dealing with the agent may understand that he intended to pledge his personal liability and responsibility in support of the contract and for its performance. o Furthermore, the use of a trade name is not necessarily a sufficient disclosure of the identity of the principal and the fact of agency so as to protect the agent against personal liability nd 321 2 Restate liability of agent under circumstances where identify of principal is unknown/partially disclosed to other party o Agent is a party to the contract unless the agent gives such complete info concerning his principals identity that he can be readily distinguished. If the other party has no reasonable means of ascertaining the principal, the inference is almost irresistible and prevails in the absence of an agreement to the contrary The Third Partys Liability to the Principal 2nd restate 292, 302-304 3rd restate 6.01-6.03 o When the principal is undisclosed 2nd restate 302, 304 = the third party is bound to a contract if principal undisclosed and agent had authority unless (a) the principals existence is fraudulently concealed, or (b) the third party is induced to enter into the contract by a representation that the agent was acting for himself and the

6 agent or the principal has notice that the third party would not have dealt with the principal 3rd restate 6.03(2) = the third party is simply bound to a contract with an undisclosed principal who agent had actual authority [commenters believe that if agent coming in to trick 3rd party into doing busn with undisclosed principal then the contract could still be rescindable] o An undisclosed principal cannot require that a third party accept the principals performance instead of the agents if this substitution changes the performance contemplated by the contract (2nd restate 309; 3rd restate 6.03 cmt d) [vice versa] Not fraud or deceit either 2nd restate 304 = a person with whom an agent contracts on account of an undisclosed principal can rescind the contract if he was induced to enter into it by a representation that the agent was not acting for a principal and if, as the agent or principal had notice, he would not have dealt with the principal o No evidence that the appellants would not have dealt with the Crosses had their existence been known [need evidence in course of dealings] The Agents Duties to the Principal o 2nd restate 13, 376-396, 398-401, 403-404, 407 o 3rd restate 8.01-8.12 An agent has an obligation to act in the principals best interests rather than his own (2nd restate 13; 3rd restate 8.01) The law places three major duties on the agent: loyalty, care and obedience o Loyalty account to the principal for all profits from the transaction that have not been promised to the agent by contract (2nd restate 388, 3rd restate 8.02), refrain from acting as or on behalf of an adverse party (2nd restate 389, 391, 393; 3rd restate 8.03), refrain from competing with the principal (2nd restate 393; 3rd restate 8.04), refrain from using the principals property or confidential info for personal purposes or for a third party (2nd restate 395, 404; 3rd restate 8.05), disclose relevant info to the principal (2nd restate 381, 3rd restate 8.11), segregate the principals property and keep and render accounts (2nd restate 382, 398; 3rd restate 8.12) and act in accordance with a general duty of good conduct (2nd restate 380; 3rd restate 8.10) o Care flows from the parties implicit assumption that the agent will carry out his duties with reasonable care (2nd restate 379; 3rd restate 8.08) o Obedience flows form the nature of the agency definition, which specifies that the agent must be subject ot the principals control. As a consequence, the agent must act only as authorized by the principal and must obey the principals instructions (2nd restate 383, 385; 3rd restate 8.09). must perform any contractual duties owned to the principal (2nd restate 376-377; 3rd restate 8.07) Violations void a contract restate 407(1) if an agent has received a benefit as a result of violating his duty of loyalty, the principal is entitled to recover from him what he has so received, its value, or its proceeds, and also the amount of damage thereby caused, except that if the violation 6

7 consists of the wrongful disposal of the principals property, the principal cannot recover its value and also what the agent received in the exchange therefore principal is entitled to be indemnified by the agent for any loss which has been caused to his interests by the improper transaction

Principals Duty to the Agent o 2nd restate 432, 435, 437-438, 441, 470 o 3rd restate 8.13-8.15 The principal and agent may specify their mutual obligations by contract, and the principal is, of course, required to comply with such contractual obligations [2nd restate 432; 3rd restate 8.13] In addition, b/c the agent is acting on the principals behalf, the law will often imply certain duties that the principal has to the agent, including duties to: (a) compensate the agent for services [2nd restate 441; 3rd restate 8.13 cmt d] (b) indemnify the agent for expenses [2nd restate 438; 3rd restate 8.14] (c) provide the agent with information concerning the risks of physical hamr or pecuniary loss attendant to his agency [2nd restate 435; 3rd restate8.15] (d) refrain from injuring the agents busn reputation or self respect [2nd restate 437; 3rd restate 8.15 cmt d] and (e) provide a safe working environment for agents who are servants [ 2nd restate 470]. The 3rd restate also includes a duty to deal with the agent fairly and in good faith [8.15] Under all evidence, were the circumstances such that the plaintiff could reasonably assume he was to be paid and that the defendant should have reasonably expected to pay for such services Imputing an Agents Knowledge to the Principal o 2nd restate 268, 272-273, 277, 282 o 3rd restate 5.02-5.04 Notification given to an agent is effective as notification ot the principal when the agent has actual or apparent authority to receive notification, unless the 3rd party knows or has reason to know that the agent is acting adversely to the principal [2nd restate 268(1); 3rd restate 5.02(1)] o A similar rule applies to notification given by an agent [2nd restate 268(2); 3rd restate 5.02(2)] An agents knowledge is imputed to the principal when the agent acquired the knowledge acting within the scope of his actual authority, but not when acting within the scope of his apparent authority (unless a third party relied on the appearance of an agency relationship) [2nd restate 272-3; 3rd restate 5.03 (providing that knowledge that is material to the agents duties to the principal may be imputed)] When an agents knowledge is imputed to the principal, the principal is charged not only with the agents actual knowledge, but also with information that the agent has reason to know [2nd restate 272 cmt b; 3rd restate 5.03] o Nevertheless, the 2nd restate provides that unless a principal has a duty to use care in obtaining info, the principal is not responsible for info that the agent should have acquired but did not acquire in the performance of the agents duties [2nd restate 277; 3rd restate does not contain this exception]

8 2nd restate provides that when an agent is acting adversely to the principal, the agents knowledge is not imputed to the principal unless: (a) the agents failure to reveal or act on the information results in the violation of a duty owed by the principal to a third party (b) the agent negotiates with a third party who reasonably believes tha thte agent is acting within the scope of his authority (c) the principal, before changing his position, knowingly retains a benefit through the act of the agent that he would not otherwise have received [2nd restate 288] o 3rd restate provides more generally that when an agent is acting adversely to the principal, the agents knowledge is not imputed to the principal unless such imputation is necessary to protect het rights of a third party acting in good faith, or when the principal has ratified or knowingly retained a benefit from the agents action [3rd restate 5.04] (note differences)

Termination of Agency Relationship o 2nd restate 105-125, 138-139 o 3rd restate 3.06-3.13 With respect to principal sand agents who are individuals, the death of either the principal or the agent terminates the agency relationship [2nd restate 120(1), 121; 3rd restate 3.07(1),(2)] o With respect to principals and agents that are not individuals, the 3rd restate also provides that the agency relationship is terminated when the principal or agent ceases to exist, commences a process that will lead to cessation of existence, or has its powers of operation suspended [3rd restate 3.07(3), (4)] 2nd restatement provides a laundry list of changed circumstances that may cause an agency relationship to terminate o 105 lapse of time o 106 accomplishment of authorized act o 107 happening of specified events o 108 happening of unspecified events or changes o 109-change in value of busn conditions o 110 loss or destruction of subject matter o 111 loss of qualification of principal or agent o 112 disloyalty of agent o 113 bankruptcy agent o 114 bankruptcy of principal o 115 war o 116 change of law o 124 impossibility 3rd restatement takes a more general approach o Actual authority exists when at the time of taking the action that has legal consequences for the principal, the agent reasonably believes, in accordance with the principals manifestations to the agent, that the principal wishes the agent so to act [3rd restate 2.01] The principal and agent may, of course, simply terminate the agency relationship by mutual agreement [2nd restate 117; 3rd restate 3.09]

9 o The agent, may, however, continue to have apparent authority with respect to third parties who lack notices of the termination [2nd restate 125; 3rd restate 311(2) (providing that apparent authority terminates when it is no longer reasonable for the third party to believe that the agent continues to act with actual authority)] The principal or agent may terminate the agency relationship at will, even when such termination constitutes a breach of contract [2nd restate 118-119; 3rd restate 3.10] o One major exception to revocability at will: the agents authority may not be revoked if it involves a power given as security If a power be coupled with an interest it survives the person giving it and may be executed after his death o The breaching party will be liable under contract law for any damages caused to the other party o 2nd restate 5, 77-80, 137, 142, 283, 406, 428, 458 o 3rd restate 3.15 According to the 2nd restatement, an agent may appoint a subagent, who is subject to the control of the agent as well as the principal, and may delegate tasks to the subagent if the agent has actual, apparent or inherent authority to make such an appointment [2nd restate 5 cmt. (a), 77] The 3rd restatement has a similar provision but does not include the power to appoint a subagent pursuant to inherent authority b/c the third restatement does not recognize the concept of inherent authority [3rd restate 3.15] A principal may also empower an agent to appoint another agent to act directly on the principals behalf. In this circumstance, the newly appointed agent is called a co-agent or simply an agent rather than subagent [2nd restate 5 cmt. (a); 3rd restate 3.15 cmt. (b)] o Subagents may be appointed in series If an agent has express actual authority to appoint a subagent, there is generally no difficulty in finding that a subagency relationship has been created o Implied actual authority in this context depends on what a reasonable person in the agents position would infer from the principals manifestations in light of all of the relevant circumstances [2nd restate 77; 3rd restate 3.15 cmt (c)] If the principal is aware that the agent has employees, there is usually implied consent for the agent to delegate tasks to his employees. When the agent is a corporation or other entity rather than an indiv, the agent has no choice but to act through subagents [2nd restate 80(b)(c)(d); 3rd restate 3.15 cmt (c)] A subagency relationship may also be created through apparent authority. Even if secretly forbidden to appoint subagents, if appointed, the subagent will bind the principal with respect to third parties who were unaware of the sever restrictions [2nd restate 5 cmt. (a), 142; 3rd restate 3.15 cmt (c)] o Of course the agent will be liable to the principal for disobeying the principals instructions According to the 2nd restate, a general agent may have inherent authority to appoint subagents when such appointments are a normal incident of the agents position without regard to whether the principal forbids the exercise of such power [2nd restate 5 cmt. (a)]

Subagency

10 In the event of conflicting instructions, the subagent should obey the principal [2nd restate 428 & cmt (b); 3rd restate 3.15 cmt (d)] The principal and the appointing agent both owe the duties of a principal to the subagent, except that the principal is not subject to duties created by agreements btwn the appointing agnet and the subagent (including compensation agreements) [2nd restate 458; 3rd restate 3.15 cmt (d)] Any knowledge acquired by the subagent will be imputed to the principal if such knowledge would have been imputed if acquired by the appointing agent [2nd restate 283; 3rd restate 3.15 cmt (d)] The appointing agent is responsible to the principal for the subagents actions. o Thus if a subagents misconduct exposes the principal to liability, the principal has a right of indemnity against both the appointing agent and the subagent. o If the subagent acts without authority, only the principal may ratify the subagents conduct (unless the appointing agent has authority to ratify) [2nd restate 406 & cmt (b); 3rd restate 3.15 cmt (d)] A principal may terminate the subagency relationship by communicating his intentions to either the appointing agent or the subagent o 2nd restate 137 cmt (b) a communication to the appointing agent terminates the subagency relationship, but termination does not become operative as to the subagent until the appointing agent has had time to communicate with him o 3rd restate 3.15 cmt (e) a communication to the appointing agent terminating the subagency relationship is not effective relative to the subagent until the subagent receives notice of termination

CHAPTER THREE: THE PARTNERSHIP General choice of law principles suggest that a court will apply the law of the state with the most significant relationship to the partnership and transaction at issue o May vary this by agreement o A choice of law provision will be invalidated only if: (a) there is no substantial relationship btwn the state whose law is chosen and the parties or the transaction at issue, and there is no other reasonable basis for the parties choice; or (b) the state whose law would otherwise have applied has a materially greater interest in the controversy and has a fundamental policy interest that would be contravened by application fo the chosen states law Formation o Uniform Partnership Act 6-7 [UPA] o Revised Uniform Partnership Act 101(6), 202 [RUPA ~ Texas] May be created informally o No written agreement is required to form a partnership o May be created without filing any organizational documents with the state Most Important Partnership Rules o Every partner has the right to perform the partnerships busn and to participate in the management of the partnership. Partners have equal voting power o Partners share equally in the profits and losses of the partnership 10

11 o The partnership is liable for contracts entered into by partners acting with actual or apparent authority. (this cannot be varied by agreement) The partnership is also liable for torts committed by partners acting with authority or in the ordinary course of the partnership busn Partners are personally liable to third parties for the obligations of the partnership o It takes unanimous agreement to admit new partners o Partners owe fiduciary duties to each other o Every partner may dissolve an at will partnership A partnership is an association of two or more persons to carry on as co-owners a busn for profit [UPA 6(1); RUPA 202(a)] Partnerships are established in common law by four factors o An agreement to share profits o An agreement to share losses o A mutual right of control or management of the enterprise o A community of interest in the venture However, the partnership definition in UPA and RUPA are more general o What matters is whether the parties have created the kind of association defined by statute to be a partnership o An agreement to share profits is by far the most important indicator of partnership status [UPA 7(4); RUPA 202(c)(3)) However both UPA and RUPA make exceptions if profits are distributed as (a) payment of a debt (b) wages to an employee or rent to a landlord (c) an annuity to a widow or representative of a deceased partner (d) interest on a loan (e) consideration for the sale of the goodwill of a busn or other property [UPA 7(4); RUPA 202(c)(3)] o Whether a partnership exists is by applying the definition of a partnership to the totality of the circumstances on a case by case basis Partnership by Estoppel o UPA 16 o RUPA 308 Partner by estoppel [UPA 16] when a person, by words spoken or writted or by conduct, represents himself, or consents to another representing him or anyone, as a partner in an existing partnership or with one or more persons not actual partners, he is liable to any such person to whom such representation has been made, who has, on the faith of such representation, given credit to the actual or apparent partnership, and if he has made such representation or consented to its being made in a public manner he is liable to such person, whether the representation has or has not been made or communicated to such person so giving credit by or with the knowledge of the apparent partner making representation or consenting to its being made Aggregate vs Entity Status o UPA 6, 10, 18(g), 24, 26-27, 29, 31-32, 41 11

12 As soon as a partner leaves the partnership dissolves Aggregate theory Partnership not separate from the partners o RUPA 201, 307, 801-802 A partnership is an entity distinct from its partners Entity theory Partnership different from the partners Federal Tax Consequences o A partnership is taxed on a pass through basis o A partnership is required to file a separate tax return reflecting the receipts and expenditures of the busn However no tax is paid with this return The net income or loss from the partnership operations is allocated among the partners and then carried over to each partners indiv return

Management and Control UPA 18(h) [RUPA 401(j)] any difference arising as to ordinary matters connected with the partnership busn may be decided by a majority of the partners [mandatory] o If no differences, partners can make ordinary decisions in the course of busn What is ordinary is not specified and is determined as a question of fact o If it is an extraordinary decision not in the course of busn, then you need the majority of partners consenting UPA 18(e) [RUPA 401(f)] bestows equal rights in the management and conduct of the partnership busn upon all the partners o It is manifestly unjust to permit recovery of an expense which was incurred individually and not for the benefit of the partnership but rather for the benefit of one partner acts in contravention of the partnership agreement require unanimous consent [RUPA 401 cmt 11] o amendments to the partnership agreements requires unanimous consent Financial Rights and Obligations Partnership Accounting o Capital Accounts The capital investment held by each party is simply a reflection the relative claims of the partners to the assets of the partnerships o Draw Term used to decided cash distributions to partners The amount of the draw of each partner is determined by majority vote of the partners (absence another express agreement) and may be more or less than the profit The draw would reduce their capital investment in the firm o Capital Accounts and Value of a Partners Interest Profit or loss of the busn is distributed evenly across the partners capital investment in the firm (unless agreed otherwise) Sharing Profits and Losses 12

13 UPA 18(a), (b), (f) RUPA 401(b), (c), (h) o General rule is that in the absence of an agreement to such effect, a partner contributing only personal services is ordinarily not entitled to any share of partnership capital pursuant to dissolution Personal services may qualify as capital contributions to a partnership where an express or implied agreement to such effect exists o To be distinguished from non cash capital contributions to a partnership, an agreement is usually needed Liabilities to Third Parties UPA 4(3), 9, 13-15, 17 RUPA 104(a), 201, 301, 305-307 o Under the UPA, the partnership is liable for contracts entered into by partners acting with actual or apparent authority [UPA 9] The partnership is liable to third parties in tort for wrongful acts or omissions of partners acting with authority or in the ordinary course of the partnership [UPA 13] The partnership is also liable for certain breaches of trust committed by partners [UPA 14] Although UPA establishes partnership liability, it does not state that the partnership may be sued directly because, the UPA does not recognize the partnership as an entity. Partners are jointly and severally liable for partnership obligations pursuant to UPA 13-14 [UPA 15(a)] When liability is joint and several, a plaintiff may sue the partners together or individually. However, when liability is merely joint, a plaintiff must sue all of the partners in a single action Thus UPA makes it substantially easier to sue partners in tort than in contract o Under RUPA, a partnership is an entity distinct from its partners and that a partnership may sue and be sued [RUPA 201(a), 307(a)] Also, partners are jointly and severally liable for all obligations of the partnership [RUPA 306(a)] RUPA creates a hurdle for partnership creditors that is not present in UPA. Under RUPA, although a creditor may sue the partnership and the partners in a single action, a creditor may not collect his judgment against a partner unless he ahs a separate judgment against the partner and (a) he has attempted unsuccessfully to enforce judgment against the partnership (exhaustion requirement); (b) the partnership is in bankruptcy; (c) the partner has waived the exhaustion requirement by contract; (d) a court waives the exhaustion requirement; or (e) the partners is independently liable to the plaintiff [RUPA 307(c), (d)] o Liability in Contract UPA (9) every partners is an agent of the partnership for the purpose of its busn and the act of every partner, including the execution in the 13

14 partnership name of any instrument, for apparently carrying on in the usual way the busn of the partnership of which he is a member binds the partnership, unless the partners so acting ahs in fact no authority to act for the partnership in the particular matter, and the person with whom he is dealing has knowledge of the fact that he has no such authority The act of a partner binds the firm, absent an express limitation of authority know to the party dealing with such partner o Liability in Tort Liability is imposed on a partner for the tortious acts of his partner only where (1) the act occurred in the ordinary course of the partnerships busn or (2) the tortfeasor partner acts with the authority of his partner or partners Generally, authority to manage a busn includes authority to (1) make contracts which are incidental to such busn, are usually made in it or are reasonable necessary in conducting it; (2) to procure equipment and supplies and to make repairs reasonably necessary for the proper conduct of the busn; (3) to employ, supervise or discharge employees as the course of busn may reasonable require; (4) to sell or otherwise dispose of goods or other things in accordance with the purposes for which the busn is operated; (5) to receive payment of sums due the principal and to pay debts from the principal arising out of the busn enterprise and (6) to direct the ordinary operations of the busn [2nd restate agency 73] Under RUPA a partnership is a separate and distinct entity from the partner members. Thus to recover against the partners individually, one must prove a contract against each partner of the partnership Two ways to establish the indiv liability of a partner o Prove a separate contract o Prove that partnership assets have been exhausted Once partnership assets have been exhausted, a partnership creditor becomes a creditor of the indiv partner with the same rights and upon the same level as the partners other indiv creditors Under joint liability, once all the debtors are named in the suit and judgment is entered against them, the creditor may force any one of the debtors to pay all of the judgment o Each debtor is responsible for the entire sum Indemnity and Contribution UPA 18(a), (b), 40(b), (d) RUPA 401(b), (c), 807(a), (b) o If a partner pays a partnership obligation, he is entitled to be indemnified by the partnership [UPA 18(b); RUPA 401(c)] o If the partnership is unable to pay, the other partners must contribute and pay according to their loss shares [UPA 18(a); RUPA 401(b)] o The partners may also be required to contribute to satisfy creditors, including partner creditors, on dissolution [UPA 40(b)(I), (b)(II), (d); RUPA 807(a)(b)] 14

15 o Thus as btwn partners and the outside world, every partner is liable for partnership obligations Any third party may collect the entirety of a partnership obligation from any partner under UPA and from any partner under RUPA if a judgment against the partnership goes unsatisfied Ownership Interests and Transferability Partnership Property UPA 8, 25 RUPA 201(a), 203-204, 501 o UPA 8(1) provides that all property originally brought into the partnership stock or subsequently acquired by purchase or otherwise, on account of the partnership, is partnership property UPA 8(2) presumption that property bought with partnership funds is partnership property o Although the UPA takes the aggregate theory of partnership, UPA 25 replicates a situation where the partnership, rather than the partners, owns partnership property o RUPA with its separate entity theory views that the partnership, rather than the indiv partners, owns partnership property [201(a), 203] o RUPA provides consistently that a partner is not a co-owner of partnership property and has no interest in partnership property which can be transferred, either voluntarily or involuntarily [501] o RUPA provides that property is deemed to be partnership property when acquired: (a) in the partnerships name or (b) in the name of one or more partners if the document transferring titlte to the property references the acquiring partners status as a partner or the existence of a partnership Presumption that property bought with partnership funds is property of the partnership otherwise property is presumed to be a partners indiv property [RUPA 204(c),(d)] Admitting New Partners vs. Assigning Partnership Interests UPA 18(g), 24, 26-28 RUPA 401(i), 502-504 o Consent needed by all the partners in order to admit new members into the partnership An assignee of an interest in the partnership is not entitled to interfere in the management or administration of the partnership busn but is merely entitled to receive the profits to which the assigning partner would otherwise be entitled The Rights of a Partners Creditors UPA 28, 31(5), 32(2), 40(h) RUPA 504, 601(6), 701, 801 o A partners judgment creditor may obtain a charging order against the partners interest in the partnership [UPA 28(1); RUPA 504(a)] This order permits the creditor to receive any partnership distributions to which the partner would otherwise be entitled. However, the partner 15

16 retains full rights to participate in the management of the partnership and the creditor receives no such rights The creditor may obtain foreclosure of the partners interest in the partnership, which the creditor or a third party may purchase [UPA 28(2); RUPA 504(b)] The foreclosure purchaser may cause a judicial dissolution of the partnership if the partnerships term has expired or if the partnership was at will at the time the charging order was obtained [UPA 32(2); RUPA 801(6)] On dissolution, the foreclosure purchaser receives the debtorpartners share o Under UPA, a judgement creditor may also cause a dissolution fo the partnership by putting the debtor-partner into bankruptcy [UPA 31(5)]. By contrast, under RUPA, a debtor-partners bankruptcy merely dissociates the partner from the partnership [RUPA 601(6)(i)]. The other partners may choose to dissolve the partnership as a consequence [RUPA 801(1), (2)(i)] If the other partners choose to continue the partnership, the dissociated partners has the right to be bought out by the partnership [701(a), (b)] o What if the partnership and the debtor-partner both end up in bankruptcy? UPA 40(h) partnership creditors have priority with respect to partnership assets, and the partners separate creditors have priority with respect ot the partners indiv assets Bankruptcy code allows partnership creditors who go unsatisfied with partnership assets, to take on par with the partners separate creditors with respect to the partners indiv assets o Hellman v. Anderson (Ca ct app 1991) Court holds that a judgment debtors interest in a partnership may be foreclosed upon and sold, even though other partners do not consent to the sale, provided the foreclosure does not unduly interfere with the partnership busn A partners right in specific partnership property is different from his interest in the partnership The property rights of a partner are (1) his rights in specific partnership property, (2) his interest in the partnership and (3) his right to participate in the management Judicial authority to order foreclosure and sale of the charged interest b/c the interest charged may be redeemed at any time before foreclosure, or in case of a sale being directed by the court may be purchased by nondebtor partners without causing a dissolution of the partnership In some cases, foreclosure might cause a partner with essential managerial skills to abandon the partnership. In other cases, foreclosure would appear to have no appreciable effect on the conduct of partnership busn

16

17 Effect of foreclosure on a partnership should be evaluated on a case by case basis by the trial court in connection with its equitable power to order a foreclosure

Fiduciary Duties Codification of Fiduciary Duty and Contractual Waiver UPA 21-22 RUPA 103, 404 o UPA 21 every partner must account ot the partnership for any benefit, and hold as trustee for it any profits derived by him without the consent of the other partners, from any transaction connected with the formation, conduct or liquidation of the partnership or from any use by him of its property If UPA 21 is violated, any aggrieved partner has the right to an accounting [UPA 22(c)] o RUPA 404(a) the only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care set forth in (b) and (c) (b) (1)to account to the partnership and hold as trustee for it any property, profit or benefit derived by the partner in the conduct and winding up of the partnership busn or derived from a use by the partner of partnership property, including the appropriation of a partnership opportunity; (2) to refrain from dealing with the partnership in the conduct or winding up of the partnership busn as or on behalf of a party having an interest adverse to the partnership; and (3) to refrain from competing with the partnership in the conduct of the partnership busn before the dissolution of the partnership (d) - imposes on partners an obligation of good faith and fair dealing when discharging any duties owed to the partnership and the other partners or when exercising any rights (e) - a partner does not violate any duty or obligation merely b/c the partners conduct furthers the partners own interest Unlike a true fiduciary, every partner has legitimate, selfish interests (f) permits a partner to lend money to and transact other busn with the partnership and as to each loan or transaction the rights and obligations of the partner are the same as those of a person who is not a partner, subject to other applicalbe law o Whereas UPA 21(a) applies to the formation, conduct or liquidation of the partnership, RUPA 404(b)(1) and (2) applies only to the conduct and winding up of the partnership busn o Most of RUPAs rules may be altered by agreement. Among the few exceptions are the rules governing a partners duties. Partners may not eliminate the duty of loyalty by contract [103(b)(3)] However, they may identify specific types or categories of activities that do not violate the duty of loyalty, if not manifestly unreasonable [103(b)(3)(i)]

17

18 Similarly, partners may not unreasonably reduce the duty of care [103(b)(4)] Partners also may not eliminate the obligation of good faith and fair dealing but they may prescribe the standards by which such obligation is measured if the standards are not manifestly unreasonable [103(b)(5)]

Duty of Disclosure o UPA 19-20 o RUPA 103(b), 403 Under UPA, a partnership is required to keep books and to make them available to partners for inspection and copying [19] o Beyond this, UPA contains a narrow version of a partners duty of disclosure: partners shall render on demand true and full information of all things affecting the partnership to any partner [20] RUPA also requires that a partnership give every partner access to the partnerships books and records [403(b)] o However, RUPA contains an affirmative obligation to make certain disclosures It requires that each partner and the partnership furnish without demand any info concerning the partnerships busn and affairs reasonably required for the proper exercise of the partners rights and duites under the partnership agreement or RUPA [403(c)(1)] Requires each partner and the partnership to furnish on demand any other info concerning the partnerships busn and affairs, except to the extent the demand or the info demanded is unreasonable or otherwise improper under the circumstances [403(c)(2)] RUPA 404(a) limits a partners fiduciary duties to the duties of loyalty and care described in 404(b) and 404(c) o The duty of disclosure is contained in 403. o Moreover, RUPA places few restriction on the ability to waive disclosure obligations 103 contains a list of the rules that may not be varied by agreement, provides that the partners may not unreasonably restrict the right of access to books and records under 403(b) [103(b)(2)] Does not address the duty to make disclosures pursuant to RUPA 403(c). therefore the 403(c) duties may be varied or eliminated by agreement [403 cmt (c)] Duty of Care RUPA 404(c) o Provides that a partner must be guilty of more than negligent mismanagement before he is liable o A partners duty of care to the partnership and the other partners in the conduct and winding up of the partnership busn is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct or a knowing violation of law. The partners may not unreasonably reduce the duty of car by contract [103(b)(4)] 18

19 Under UPA it is not clear that a partner has standing to bring suit for mismanagement or other torts. o Other than the right to seek an accounting pursuant to UPA 22 the only available statutory remedy appeasrs to be dissolution [31] o UPA 13 governs liability based on any wrongful act or omission by any partner acting in the ordinary course of the busn of the partnership applies only to injuires to any person, not being a partner in the partnership Language appears to preclude one partner form suing the partnership or the other partners for mismanagement or other torts RUPA 305(a)s intent is to allow partners to sue the partnership based on wrongful acts or omission committed in the ordinary course of the partnerships busn RUPA 405(b) permits a partner to maintain certain actions against the partnership or the other partners including actions for breach of fiduciary duty o UPA 21-22 o RUPA 405 UPA 22 a partner may assert a breach of fiduciary duty claim against a co partner as part of an accounting action o An accounting action involves an all encompassing review of the partnerships affairs and the partners obligation to each other. At common law an accounting action had to be preceded by dissolution o UPA 22 makes clear that dissolution is no longer required to obtain an accounting o The difficult question under UPA is whether an accounting action is the exclusive means by which a partner can seek recourse for breach of fiduciary duty or for violation of other legal duties Usual and normal remedy for a breach of fiduciary duty or other legal conflict among partners is an accounting o A party seeking an accounting must introduce sufficient evidence to enable the court to make a definitive accounting that states the true condition of the affairs btwn the partners

Remedies

Dissolution o UPA 29-33, 37-38, 40 Events Causing Dissolution UPA 29 the dissolution of a partnership is the change in the relation of the partners caused by any partner ceasing to be associated in the carrying on as distinguished from the winding up of the busn Rule reflects UPAs aggregate theory of partnership The separation of any partner from the partnership causes dissolution as a different aggregate of the partners would remain The partnership still remains to wind up its affairs, pay off creditors, and distribute what is left to the partners [UPA 30,37] 19

20 UPA 31(1)(b) default rule that a partnership is terminable at will by any partner The partners may agree, formally or informally, that the partnership will continue for a definite term or particular undertaking o In any event, the partnership terminates when the term expires or the undertaking is completed [31(1)(a)] The partnership can be dissolved prior to the expiration of the term or the completion of the undertaking by the unanimous consent of all partners who have neither assigned their interests nor had them subjected to a charging order [31(1)(c)] The partnership can also be dissolved by the bona fide expulsion of any partner pursuant to the partnership agreement [31(1)(d)] The partnership can also be dissolved by (a) any event that makes it unlawful to carry on the partnership; (b) death of a partner; or (c) the bankruptcy of any partner or the partnership [31(3), (4), (5)] The partnership may also be dissolved by judicial decree [31(6), 32] o Under UPA 31(1)(d) and 38(1), the expulsion of a partner pursuant to a partnership agreement must be bona fide Consequences of Dissolution o Unless the exceptions discussed below apply, a partnerships dissolution commences the winding up of the partnerships affairs and leads to the partnerships ultimate termination [UPA 30] The partnership will need to complete transactions that have begun and sell its assets. Once the partnership assets are sold, the proceeds are distributed in the following order Nonpartner creditors are paid Partner creditors are paid Partners receive a return of their capital contributions Partners receive any remaining profits according to their relative profit shares [40(d)] If the partnership assets are insufficient to satisfy the partnerships liabilities, the partners must contribute according to their loss shares [40(d)] o After dissolution, a partner may bind the partnership when acting to wind up the busn or to complete unfinished transactions [33] o In addition a partner retains apparent authority to bind the partnership in transactions with third parties A partner may bind the partnership in a transaction with a third party if the partners acts would have bound the partnership before dissolution, unless the third party receive knowledge or notice of the dissolution or the partnership publishes a notice of dissolution in a newspaper of general circulation in every place where the partnership regularly does busn o Among the partners, a partners authority to act for the partnership, other than in connection with winding up the busn and completing unfinished transactions, terminates: (a) upon dissolution when dissolution occurs other than by act, bankruptcy or death of a partner; (b) upon knowledge of dissolution when dissolution 20

21 is caused by the act of a partner; (c) upon knowledge or notice of dissolution when dissolution is caused by the death or bankruptcy of a partner [UPA 33-34] If a partner acts without authority under UPA 34, he may not call on his copartners to contribute to any liability that his actions have created o UPA aggregate theory of partnership requires that dissolution occurs whenever a partner leaves the partnership [29] However, dissolution does not always lead to liquidation of the partnership busn Upon a dissolution that is not wrongful, the busn must be liquidated unless otherwise agreed [38(1)]. Agreement must be unanimous and must include the consent of any departing partners. Partners may also agree in advance that a partners expulsion will not lead to liquidation. o The prevailing view under UPA is that dissolution cannot be prevented by agreement Instead, an agreement purporting to avoid dissolution will be construed as an agreement providing for the creation of a new partnership with the ability to continue the busn How to allocate liabilities btwn the old and new partnerships??? o After dissolution, the partners in the old partnership remain responsible for predissolution liabilities [36(1)] o The successor partnership succeds to the liabilities of its predecessor [41(1)] o A new partners liability for partnership obligatiosn incurred before his admission may be satisfied only out of partnership property [17] Wrongful Dissolution o The penalty for wrongfully dissolving a partnership can be severe Includes (1) expulsion from the partnership busn; (2) damages for breach of contract pursuant to UPA 38(2)(a)(II) and (3) a distributive share that does not reflect the goodwill of the busn

RUPA 201(a), 601-602, 701, 801-803, 807 Partnership Dissociation o Due to RUPAs entity view of partnership, RUPA is able to distinguish btwn partner dissociation and partnership dissolution o RUPA 601 provides the circumstances under which a partner becomes dissociated from a partnership Partnership has notice of the partners express will to withdraw An event agreed to in the partnership agreement as causing the partners dissociation occurs The partner is expelled pursuant to the partnership agreement The partner is expelled for misconduct by court order The partner becomes a debtor in bankruptcy The partner dies o RUPA 602(a) continues the rule that a partner may dissociate form a parnership at any time, whether such dissociation is rightful or wrongful.

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22 In a partnership for a definite term or particular undertaking, a partners dissociation is wrongful when, prior to the expriation of the term or completion of the undertaking The partner withdraws by express will The partner is expelled by court order for misconduct The partner becomes a debtor in bankruptcy A partner is not a natural person is expelled or otherwise dissociated b/c it willfully dissolve or terminates [602(b)] o Pursuant to RUPA 601(5), a court may expel a partner for misconduct on the following grounds The partner has engaged in wrongful conduct that adversely and materially affects the partnership The partner commits a willful and persistent breach of the partnership agreement or a duty owed to the partners or partnership under RUPA 404 The partner engages in conduct relating to the partnership busn that makes it not reasonably practicable to carry on the busn in partnership with him o A partner who wrongfully dissociates form the partnership is liable to the partnership and the other partners for any damages caused by his wrongful conduct [602(c)] o A partners dissociation from a partnership pdoes not discharge his liability for partnership obligations incurred prior to his dissociation [703(a)] A partner who dissociates form a continuing partnership is generally not liable for partnership obligations incurred after his dissociation. However if the partnership transacts busn with a third party who lacks notice of the partners dissociation and reasonably believes that the dissociated partner is still a partner, the dissociated partner is laible o This potential liability continues for two years after the partners dissociation [703(b)] To protect himself against such liability, a dissociating partner may file a statement of dissociation o Non partners are deemed to have notice of such a statement 90 days after it is filed [704] o A new partner is not personally liable for partnership obligations incurred before his admission as a partner [306(b)] Partnership Dissolution o RUPA 801(1) continues the rule that a partner may dissolve an at will partnership at any time Tex Rev Civ State art 6132b, 7.01(a), 8.01(a) providing that partners have the right to a majority of the profits may decide to continue an at will partnership subject to a duty to buy out the withdrawing partner at fair value o A partnership for a definite term or particular undertaking is dissolved At the expiration for a definite term or on completion of the undertaking By unanimous agreement of the partners

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23 Within 90 days of dissociation, by express will of at least half of the remaining partners when a partner has wrongfully dissociated himself from the partnership ursuant to RUPA 602(b) or become dissociated pursuant to RUPA 601(6-10) [RUPA 801(2)] o A partnership is also dissolved when An event specified in the partnership agreement as dissolving the partnership occurs An event that makes it unlawful to carry on the partnership busn occurs A court decrees dissolution because The econ purpose of the partnership is likely to be unreasonably frustrated A partner has engaged in conduct so that it is not reasonably practicable to carry on the partnership busn It is not reasonably practicable to carry on the partnership busn in conformity with the partnership agreement A transferee of a partners interest seeks dissolution [801(3-6) o Under RUPA partner creditors stand on the same footing as outside creditors [807(a)] o all profits and losses resulting from selling the partnerships assets are charged to the partners accounts in accordance with their profit and loss shares if positive than cash is received; if negative cash must be paid [807(b)] o a partnership is bound by a partners act after dissolution if the act is appropriate for winding up the busn the act would have bound the partnership before dissolution and the third party does not have notice of dissolution [804] o a partner who incurs partnership liability is liable to his co-partners for acts taken after he acquired knowledge of the partnerships dissolution [806] o a partner may file a statement of dissolution on behalf of the partnership [805(c)] third parties are deemed to have notice of such a statement 90 days after it is filed o even when RUPA provides that partner dissociation leads to dissolution, the partners may vary this outcome by agreement to the extent permitted by RUPA 103 unless dissolution occurs pursuant to RUPA 801(4), (5) or (6) the partners may agree that partner dissociation does not dissolve the partnership [103(b)(8)] in this circumstance, the partnership simply continues in existence despite the change in membership o the agreement must be unanimous and must include any partners dissociating from the partnership. In this event, the partnership is treated as if dissolution never occurred [802(b)] Buying Out Dissociated Partners o If a partnerships dissociation does nto result in dissolution of the partnership, the partnership continues in existence and a buyout of the dissociated partners interest occurs [701] 23

24 The buyout price is the amount the dissociated partner would have received upon dissolution, assuming that the partnership assets were sold at the greater of liquidation or going concern value [701(b)] Provision does not permit minority or marketability discounts in arriving at the buy out price If a partner wrongfully dissociates from the partnership, the buyout price is reduced by any damages caused by his wrongful conduct [701(c)] o No other penalty for wrongful dissociation o Contrary to UPA, there is no loss of goodwill value as a consequence of wrongful dissociation A prartner who wrongfully dissociates from a partnership for a term or undertaking does not receive his buyout share until the term expires or the undertaking is completed, unless a court finds that earlier payment will not cause undue hardship to the partnership [701(h)]

CHAPTER FOUR: THE CORPORATION Introduction Comparing the Partnership and the Corporation o A corporation can only be created by filing a certificate of incorporation with the state in accordance with statutory criteria. [partnership can be created informally] o A corporation is a distinct entity [UPA not distinct; RUPA distinct] o A corporation has a perpetual existence until and unless it is dissolved [partnership are easy to dissolve] Corporation dissolution requires approval by the corporations board of directors and shareholders o A corporation is governed by a board of directors chosen by the shareholders [partners govern the partnership] Shareholders otherwise vote only on fundamental transactions (mergers/dissolutions) o Shareholders of a corporation have limited liability [partnership partners personally liable] limited to the value of their investment o Corporation shares are freely transferable [not happening in partnership] o A corporation is taxed as a separate legal person [partnership taxed on a pass through basis] Choosing a State of Incorporation o The internal affairs of a corporation are normally governed by the jurisdiction of incorporation FORMATION Incorporation and its Aftermath Delaware General Corp Law 102-103, 107-109, 141, 151, 165, 211 Model Busn Code Annotated 2.01-2.07, 6.01-6.02, 6.20, 7.03, 8.06

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25 o The first step in forming a corporation involves filing a certificate of incorporation with a state official, usually the Secretary of State Under the MBCA this document is called the articles of incorporation The corporation existence commences upon the filing of the certificate [DGCL 106; MBCA 2.03] There is a statutory list of items that the certificate must include [DGCL 102(a); MBCA 2.02(a)] Number of shares that the corp is authorized to issue and share classes o Cannot issue stock that is not authorized o May include statement that the board may fix the terms at the time of issuance [DGCL 102(a)(4), 151(a); MBCA 2.02(a)(2), 6.01(a), 6.02] May include any provision concerning the management of the corps busn or the conduct of the corps affairs that is not otherwise contrary to law [DGCL 102(b)(1); MBCA 2.02(b)(2)] After the certificate of incorporation is filed, the incorporators, or the initial directors if they are named in the certificate, call an organizational meeting [DGCL 108; MBCA 2.05] o If the incorporators call the meeting, they elect the initial board of directors o At the organizational meeting, the initial directors typically approve the following: (1) the certificate of incorporation; (2) the corporations minute book; (3) the form of stock certificate that will represent ownership of the corps shares; (4) the corporate seal The initial directors usually adopt bylaws at the corps organizational meeting o The bylaws may contain any provision not inconsistent with the certificate of incorporation or the law generally [DGCL 109(b); MBCA 2.06] the first annual meeting of shareholders is often held directly after the organizational meeting o the primary purpose of this meeting is to elect directors to replace the initial directors o the directors elected at this meeting hold office for one year or longer if the corp has a staggered board [DGCL 141(d), 211(c); MBCA 8.03, 8.06]

Financing the Corporation The only statutory requirement for the issuance of shares is that their authorized number and terms appear in the certificate of incorporation Corp may borrow money from a bank or directly from investors o May be secured by corps assets [bond] or stock [debenture] Preemptive Rights o DGCL 102(b)(3) o MBCA 6.30 Preemptive rights give existing shareholders the ability to subscribe proportionately to any new issuance of shares

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26 o Preemptive rights enable shareholder to preserve their proportional stake in the corps assets, earnings and voting power o In most states preemptive rights do not exist unless they are granted by the certificate of incorporation [DGCL 102(b)(3); MBCA 6.30(a)] In closely held corps, protection against dilution is often important and preemptive rights may serve a real purpose o In order to preserve a shareholders relative position through the exercise of preemptive rights, the shareholder must make a further cash contribution to the corp

Promoters Contracts A promoter is someone who helps to found and organize a corp o A promoter will often make contracts for the corps benefit with the intention of causing the corp to adopt the contracts once it is formed o Question whether the corp comes to be liable on the contracts and if so, whether the promoter remains liable A corp which is incapable of authorizing an agreement made on its behalf prior to its existence may nevertheless adopt the agreement after its incorp Adoption may be manifested by the corps receipt of the contracts benefits with knowledge of its terms o A corp is therefore liable for the breach of an agreement executed on its behalf by its promoters where the corp expressly adopts the agreement or benefits from it with knowledge of its terms o It is axiomatic that the promoters of a corp are at least initially liable on any contracts they execute in furtherance of the corp entity prior to its formation The promoters are released from liability only where (1) the contact provides that performance is to be the obligation of the corp, (2) the corp is ultimately formed, and (3) the corp then formally adopts the contract A newly formed corp does not have the capacity to ratify pre-incorporation contracts made on its behalf b/c ratification requires the principal to exist at the time the contract was made [2nd restate 84(1), 86(1); 3rd restate 4.04] o However the corp may adopt pre-incorporation contracts according to rules that are similar to the rules governing ratification Ratification retroactively validates a contract from the time the contract was made Adoption makes a corp a party to a contract only form the movement of adoption Defective Incorporation o DGCL 105-106, 329 o MBCA 2.03-2.04 Considered in light that the plaintiffs knew they were dealing with a corp entity and not the indiv himself the de facto status of the corp suffices to absolve the person from indiv liability De facto status allows the shareholder to retain their limited liability in suits by third parties 26

27 o Three elements of de facto corp A statute that permits incorporation A bona fide attempt to incorp Some actual use or exercise of corporate privileges Corporations by Estoppel o A corp may not avoid a contract based on defective incorporation nor may it deny its corp status at a later time o A third party may not avoid a contract with a corp based on defective incorporation o Allows shareholders of a defective corp to retain their limited liability when a third party understands his contract to be with the purported corp o Robertson v. Levy (DC ct app 1964) Whether the president of an association which filed its articles of incorp, which were first rejected but later accepted, can be held personally liable on an obligation entered into by the association before the certificate of incorp has been issued or whether the creditor is stopped from denying the existence of the corp b/c after the certificate of incorp was issued, he accepted the first installment payment on the note Indiv is subjected to personal liability b/c before the date of contract, he assumed to act as a corp without any authority to do so An indiv who incurs statutory liability on an obligation b/c he has acted w/out authority is not relieved of that liability where at a later time, the corp does come into existence by complying with the contract o Subsequent partial payment by the corp does not remove this liability

The Ultra Vires Doctrine o DGCL 102, 122, 124 o MBCA 2.02, 3.02, 3.04 Under modern law, statutes permit a corp to state that it is created to perform any lawful act [DGCL 102(a)(3)] or make a declaration of purposes option [MBCA 2.02(b)(2)(i), 3.01(a)] o The ultra vires doctrine tends to be an issue only when conduct does not benefit the corp in any manner Court may set aside and enjoin the performance of the ultra vires contract if it deems such a course equitable MANAGEMENT AND OPERATION Allocation of Power o DGCL 109, 141-142, 211, 220, 223, 228, 242 o MBCA 7.02-7.04, 8.01, 8.06, 8.08-8.10, 8.40, 10.03, 10.20, 16.05 According to the traditional model of corporate governance, the board of directors appoints the officers and supervises the management of the corporations busn o The officers run the corps day to day affairs. 27

28 o The shareholders elect the board and vote on extraordinary matters Otherwise shareholders have little role in running the corps busn Directors are true fiduciaries in that they have a duty to act solely in the best interests of the corp. Although they manage corporate property on behalf of shareholders, directors are not agents of the shareholders Directors have greater informational rights than shareholders o Right to inspect the corps books and records as long as they do not have a purpose detrimental to the corp [DGCL 220(d); MBCA 16.05(a)]

Removal of Directors Unless the certificate or bylaws provide to the contrary, any director, or the entire board may be removed by the shareholders with or without cause [DGCL 141(k); MBCA 8.08(a) Three important restrictions on the shareholders ability to remove directors without cause o First, if a corp has a classified or staggered board, directors may be removed only for cause A classified board is usually divided into three groups with one group of directors standing for election each year. Each director is elected to a three year term [DGCL 141(d); MBCA 8.06] o In a corp that permits cumulative voting, if less than the entire board is to be removed, no single director may be removed if the votes cast against the removal would be sufficient to elect him o Whenever a particular class or series of stock has the right to elect one or more directors, only the shareholders eligible to vote for such directors are permitted to vote on the removal of such directors A director threatened with removal for cause is entitled to notice of the charges against him, an opportunity to be heard and a hearing o In the absence of a statute authorizing judicial removal of directors [MBCA 8.09] there is a split of authority on whether a court has the power to remove a director for cause It is generally settled that the board itself lacks the power to remove a director Interference with the Shareholder Franchise o DGCL 102, 109, 141, 212, 228, 242 o MBCA 2.02, 7.21, 8.02, 10.03, 10.20 Stroud v. Grace (De SC 1992) o Allegation that board of directors breached its fiduciary duties by recommending certain charter amendments to its shareholders o Board of directors did not act out of threat of lost control No improper corp purpose is crucial to analysis Must show abuse o Delaware corps have broad authority to adopt charter provisions

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29 DGCL 102(b)(1) authorizes the inclusion in the certificate of incorp of any provision creating, defining, limiting and regulating the powers of the directors as long as they are not contrary to the laws of this state DGCL 141(b) permits the certificate of incrop or the bylaws to prescribe other qualifications for directors DGCL 242(b) no such charter amendment can be effected without stockholder approval Delaware law permits weighted voting [DGCL 212(a)]

Formalities Required for Board Action o DGCL 141, 229 o MBCA 8.20-8.25, 14.30 The general rule is that a board of directors may exercise its power only as a body at a meeting duly assembled o Directors may act by unanimous written consent in lieu of having a meeting [DGCL 141(f); MBCA 8.21] o Directors may participate in a board meeting by any method that allows all of the participants to hear each other [DGCL 141(i); MBCA 8.20(b)] o The board may delegate most matters to committees comprised of one or more directors [DGCL 141(c); MBCA 8.25] Delaware does not have statutory provisions dealing with the required notice for board meetings. The question is usually addressed in the bylaws o The MBCA states that unless the articles or bylaws provide otherwise, regular meetings of the board may be held without notice of the date, time, place or purpose of the meeting Special meetings require at least two days notice of the date, time, and place but do not require notice of the purpose of the meeting [MBCA 8.22] o A director may waive any notice requirement in writing. He may also waive notice by attending the meeting without objection [DGCL 229; MBCA 8.23] A quorum of directors is a majority of the total number of authorized directors o The certificate or bylaws may specify that any percentage greater or lesser than a majority constitutes a quorum but they may not specify a percentage less than one third of the total number of authorized directors [DGCL 141(b); MBCA 8.24(a)(b)] If a quorum exists, it takes a majority vote of the directors present to approve a matter. The certificate or bylaws may specify that a supermajority board vote is required [DGCL 141(b); MBCA 8.24(c)] In closely held corps, unanimous assent or acquiescence by directors is normally viewed as the equivalent of formal board action o Moreover, the dissenting directors are entitled to be informed of the action before it is taken When all of the shareholders of a closely held corp approve a transaction, courts often ignore the fact that the board, rather than the shareholders, was the body required to make the decision

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30 The Authority of Officers o DGCL 142 o MBCA 8.40-8.44 A corp has such offices as are stated in its bylaws or in a board resolution that is not inconsistent with its bylaws Officers are chosen in a manner prescribed by the bylaws or the board of directors [DGCL 142; MBCA 8.40] o Usually the board of directors appoint officers The extent to which officers have authority to bind the corp is governed by the law of agency A president may have implied authority based upon the boards acquiescence to a course of conduct o The board can always ratify actions In jurisdictions that follow LEE, the president is normally thoguth to have at least apparent authority to bind the corp to ordinary but not extraordinary transactions Shareholder Action Formalities Required for Shareholder Action o DGCL 211, 213, 216, 219, 228-229 o MBCA 7.01-7.02, 7.04-7.07, 7.20, 7.25, 7.27-7.28 o The corp is required to hold an annual meeting of shareholders at which directors are elected [DGCL 211(b); MBCA 7.01(a)] In Delaware, unless otherwise provided in the certificate or bylaws, only the board of directors may call a special meeting of shareholders [DGCL 211(d)] Under the MBCA, owners of at least 10% of the shares entitled to vote may call a special meeting. The articles may alter this percentage bu may not raise it above 25% [MBCA 7.02] The shareholders must be sent notice of an annual or special meeting that specifies the date, time, and place of the meeting. The notice of meeting must be mailed at least ten days and not more than sixty days before the meeting [DGCL 222(b); MBCA 7.05] o Shareholders may waive defects in the notice in writing or by attending the meeting without objection [DGCL 229; MBCA 7.06] o In Delaware, to determine which shareholders are allowed to vote at a meeting, the board establishes a record date At least ten and not more than sixty days before the meeting Under the MBCA, unless otherwise provided in the bylaws, the board may set a record date that is not more than seventy days before the meeting [MBCA 7.07] If no date established then the record date is the day prior to the meeting [DGCL 213(a)]

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31 o In Delaware, the corp is required to make a shareholder list available for inspection beginning ten days prior to the meeting and continuing through the meeting itself [DGCL 219(a)] Under the MBCA, the corp is required to make the list avail beginning two busn days after the notice of meeting is given [MBCA 7.20(b)] o To constitute a quorum, a majority of shares entitled to vote on a matter must be represented in person or by proxy at the meeting [DGCL 216(1); MBCA 7.25(a)] In Delaware, the certificate or bylaws may prescribe any lower or higher percentage, but may not allow a percentage lower than one third of the shares entitled to vote [DGCL 216] Under the MBCA, the articles may provide that a percentage greater than a majority is required to constitute a quorum [MBCA 7.27(a)] o In Delaware, for ordinary matters other than the election of directors, it takes a majority of shares present at the meeting and entitled to vote to approve the matter [DGCL 216(2)] Present shareholders who abstain vote no Under the MBCA, for ordinary matter other than the election of directors, the matter is approved if the yes votes exceed the no votes [MBCA 7.25(c)] Abstentions are effectively ignored o Directors are elected by a plurality vote [DGCL 216(3); MBCA 7.28(a)] o In Delaware, supermajority voting requirements may be imposed by the certificate or bylaws [DGCL 216] Under the MBCA, such requirements must appear in the articles [MBCA 7.27(a)] o In Delaware, shareholder meetings have been permitted to be held by remote communication If the meeting is not held from a physical location then The corp must be able to verify that each person deemed present and desiring to vote is a shareholder or proxyholder Shareholders and proxyholders must have a reasonable opportunity to participate in the meeting, including the opportunity to read or hear the proceedings substantially as they occur The corp must maintain a record of actions taken at the meeting by shareholders or proxyholders [DGCL 211(a)(2)(B)] o In Delaware, those owning enough shares to approve a particular matter may act by written consent in lieu of a meeting. A telegram, cablegram or other electronic transmission counts as a writing so long as the corp can verify the identity of the sender and the date on which it was sent [DGCL 228(a), (d)(1)] Under the MBCA, it takes unanimous written consent to approve a matter without a meeting [MBCA 7.04(a)] Straight versus Cumulative Voting o DGCL 214 o MBCA7.28 31

32 o In a straight voting election of directors, every shareholder votes the entire number of shares that he owns for as many directors as there are seats up for election Thus in a straight election, anyone owning 51% of the shares elects 100% of the board Vote entire number of shares owned for as many directors as there are seats up for election o In a cumulative voting election of directors, every shareholder has a number of votes equal to the number of shares he owns multiplied by the number of board seats up for election. He may distribute these votes among the candidates in any manner that he chooses Number of votes equal to number of shares owned multiplied by the number of board seats up for election o Unless the entire board is removed, shareholders may not remove a director elected by cumulative voting without cause if the votes caset against removal would be insufficient to elect him o Most states have straight voting for the election of directors unless the certificates provide cumulative voting [DGCL 214; MBCA 7.28(b)] Some states have mandatory cumulative voting As a general matter, classifying or staggering the board reduces the number of directors that the minority can elect through cumulative voting Informational Rights o DGCL 220 o MBCA 16.02 DGCL 220 defines proper purpose as reasonably related to such persons interest as a stockholder and it is clearly proper for a stockholder to ask leave to examine corporate books and records to follow up his suspicions of corporate mismanagement, thereby acting not only on his own behalf but on that of the corp and its other stockholders Under 220(c) the burden of proving a proper purpose is on the stockholder, where the demand is for inspection of books and records rather than for a stock list A further qualification as to the right of inspection of books and records is that even if a proper purpose for a demand is demonstrated and such demand is shown to be reasonably related to a plaintiffs interest as a stockholder, nonetheless such demand must not be for a purpose adverse to the best interests of the corp Whether or not a plaintiff is entitled to inspection of corporate books and records depends on whether or not a clear indication of wrong doing on the part of corporate mismanagement has been established clearly as a result of a trial o In Delaware, when a shareholder seeks access to the corps shareholder list, the corp has the burden of proving that the shareholders purpose is improper When a shareholder seeks other books and records, he has the burden of demonstrating a proper purpose [DGCL 220(c)] The MBCA is silent on the burden of proof question [16.02] 32

33 If a corp has a NOBO list [non objection beneficiary owners list] it is required to produce it No corp is required to have a NOBO list o A shareholder in litigation may use discovery procedures to obtain corp books and records. Corp law places no limit on these litigation rights [MBCA 16.02(e)(1)] ALTERNATING CORPORATE NORMS BY CONTRACT Voting Agreements o DGCL 141, 151, 212, 218 o MBCA 6.01, 7.22, 7.30, 7.31, 8.08 Del SC holds that a voting agreement need not satisfy the requirements of a voting trust to be valid [see DGCL 218(d); MBCA 7.31(a)] For a voting agreement to be enforceable, two things must occur o It must be in writing o Must be signed by the parties o Common Law Restriction buying votes by giving the seller a purely personal benefit is illegal per se Note on Self Enforcing Voting Mechanisms o Irrevocable Proxies Involves an agency relationship. One person gives another the power to vote shares on his behalf [statutes want signed authorization] Proxy valid for three years unless the proxy itself provides for a longer period [DGCL 212(b), (c); MBCA 7.22(b), (c) stating that proxy valid for 11 months unless the authorization provides for a longer period) Irrevocable Proxy must be coupled with an interest [DGCL 212(e); MBCA 7.22(d)] Proxy may be made irrevocable regardless of whether the interest with which it is coupled is an interest in the stock itself or an interest in the corp generally [DGCL 212(e)] MBCA 7.22(d) proxies are coupled with an interest when given in favor of: (non-exclusive list) o A pledge o One who has purchased or agreed to purchase shares o A corporate creditor who extends credit under a contract requiring the proxy o A corporate employee whose employment contract requires the proxy o A party to a voting agreement o Voting Trusts A voting trust has legal title to the shares vested in one or more trustees DGCL has three requirements for the creation of a voting trust Trust agreement must be in writing Copy of the trust agreement must be deposited with the corp at its registered office where it must be available for inspection 33

34 The shares subject to the trust must be transferred to the trustee or trustees o The corp cancels the shares transferred to the trustee and issues new shares in the name of the trustee or trustees If there is more than one trustee, the stock is voted as the trust agreement directs If the trust agreement is silent, the stock is voted as a majority of the trustees direct o If the trustees are equally divided, the vote of the stock is divided equally among the trustees [DGCL 218(a)] Under MBCA 7.30(a), a voting trust expires in ten years unless it is extended for an additional ten year period Voting trust agreements usually provide that all dividends or other corp distributions are to be passed through to the equitable owners of the shares o Classified Voting Dividing shares into classes is a method of disaggregating voting rights from the other incidents of stock ownership Useful in apportioning control of the board of directors DGCL 141(k); MBCA 8.08(b) only shareholders who may vote to elect a director may vote to remove that direcdtor May be used to prevent a deadlock on the board Controlling Matters Within the Boards Discretion o DGCL 141 o MBCA 8.01 The power of shareholders to unite is limited to the election of directors and is not extended to contracts whereby limitations are placed on the power of directors to manage the busn of the corp by the selection of agents at defined salaries Damage suffered or threatened is a logical and practical test Supermajority Quorum and Voting Requirements o DGCL 109, 141(b), 216, 242 o MBCA 7.25, 7.27, 8.24, 10.20 Supermajority quorum and voting requirements (up to and including unanimity) are legal at the board and shareholder levels [DGCL 141(b), 216; MBCA 7.25(a), (c), 8.24] Share Transfer Restrictions o DGCL 202 o MBCA 6.27 o which it was originally received for it is not an unreasonable restraint Courts do not look fondly upon absolute requirements of sale to certain indivs To be invalid, more than mere disparity btwn option price and current value of stock must be shown Note on the Operation and Legality of Share Transfer Restrictions

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35 o The most common types of share transfer restrictions are: [DGCL 202(c); MBCA 6.27(d)] An obligation to offer the shares to the corp or the other shareholders at a specified price prior to selling to a third party (a first option agreement) Principal methods for setting an option price o State price o Book value o Capitalization of earnings o Appraisal or arbitration An obligation to offer the shares to the corp or the other shareholders at the same price and on the same terms, offered by a third party (first refusal agreement) Allows market to determine the option price An obligation to obtain the consent of the corp or the shareholders prior to selling to a third party (consent agreement) Viewed with hostility from courts b/c of fears that such agreements would be exercised arbitrarily and would function to prevent transfer of shares An agreement that gives a shareholder the opportunity or obligation to sell and the corp or other shareholders the opportunity or obligation to purchase, shares at a specified price upon the happening of certain events, such as death or termination of employment (buy sell agreement) A provision prohibiting transfer to designated classes or persons Cannot be manifestly unreasonable [DGCL 202(c)(5); MBCA 6.27(d)(4)] o Share transfer restrictions are strictly construed It is important to specify clearly and unambiguously the essential attributes of the restriction Must be reasonable to be enforced Reasonable if to serve tax or regulatory advantage [DGCL 202(d); MBCA 6.27(c)] Statutory Close Corporations o DGCL 141(a), 342-343, 350-351, 346, 355 o MBCA 7.32 o Model Stat Close Corp Supp 3, 20-21, 31, 33 Many states have enacted statutory close corporation provision that allow shareholders in smaller corps greater leeway in varying corp norms by contract [DGCL 341] o In Delaware a corp is eligible to elect statutory close corp status in its original certificate of incrop if three conditions are met [DGCL 342(a); 343(1)] Corp does not have more than 30 shareholders Corps shares are subject to some restriction of transferability The corp does not make any public offering of its shares within meaning of securities act of 1933 o An existing Delaware corp that meets these requirements may elect statutory close corp status by amending its certificate of incorp to include a statement that it 35

36 is a close corporation. Amendment must be approved by a 2/3 vote of each clase of shares [DGCL 344] Same procedure applies under the model act [3(b)] Model Act contains no eligibility requirements for electing statutory close corp status in the orig articles of incorp [3(a)] o If existing corp, cannot have more than 50 shareholders Statutorily Close Status o Written shareholder agreements inovling shareholders with a majority of the voting power may restrict the authority of the board of directors [DGCL 350] o By unanimous vote, the shareholders may go further and provide in the certificate that the shareholders, rather than the board of directors, will manage the busn of the corp [DGCL 351] o All of the shareholders may also vote to privde the certificate of incorp that those holding a specified percentage of shares shall have the option to dissolve the corp, or tha thte corp will be dissolved upon the happening of a specified event [DGCL 355(a)] o Model Act requires that all shareholders be parties to a written agreement restricting the boards power [20-21, 33] o A corp may terminate statutory close corp status by eliminating from its certificate the statement that the corp is a close corp. must be approved by a 2/3 vote of each class of shares [DGCL 346(a); model stat 31]

Limited Liability and Piercing the Corporate Veil o DGCL 102(b)(6) o MBCA 6.22(b) Almost every case in which a court has allowed creditors to reach the assets of shareholders has involved a close corporation o In close corporations, there is much less separation btwn management and risk bearing Tort Cases o Courts will pierce the corp veil whenever necessary to prevent fraud or to achieve equity To reach assets beyond those belonging to the corp the courts are guided by the general rules of agency Whenever anyone uses control of the corp to further his own rather than the corps busn, he will be liable for the corps acts upon the principle of respondeat superior applicable even where the agent is a natural person o Extends to commercial and negligent acts o Horizontal Veil Piercing sought to make multiple corps all liable for any one corps debts o Vertical Veil Piercing makes indivs liable for debts of corps o Alter ego/Disregard of the corp entity generally refers to the various situations that are an abuse of the corp privilege The equitable owners of a corp are personally liable (1) when they treat the assets of the corp as their own and add or withdraw capital from the 36

37 corp at will; (2) when they hold themselves out as being personally liable for the debts of the corp; or (3) when they provide inadequate capitalization and actively participate in the conduct of corporate affairs o Veil piercing cases tend to be conclusion oriented Court asks whether there has been an abuse of the corp privilege, examines various factors and then holds that veil piercing is or is not justified o Tx Busn Corp Act art. 2.21A(3) providing that a shareholder will not be responsible for a corp obligation based on the failure of the corp to observe any corp formality Contract Cases Proof that some person may dominate or control the corp or may treat it as a mere dept, instrumentality, agency etc is not enough to pierce the veil o Something more is required to induce the court to disregard the entity of a corp o Must also establish that the corp was a device or sham used to disguise wrongs, obscure fraud or conceal crime Courts have been extraordinarily reluctant to lift the veil in contract cases where the creditor has willingly transacted busn with the corp Parent Subsidiary Cases As a general matter, the courts will not pierce the corp veil to reach the parent if the parent respects the separate identify of the subsidiary and does not exercise undue domination and control over the subsidiarys activities In other cases, an outside party seeks to hold a parent corp liable for activities of a subsidiary that are controlled by the parent. In these cases, the plaintiff seeks to hold the parent liable for its own misconduct instead of piercing the corp veil Equitable Subordination If a shareholder-creditor of a corp engages in inequitable conduct, a bankruptcy court has the power to subordinate his claim to those of other creditors o Penalty is less severe than veil piercing o Shareholder is less likely to have his claim satisfied in bankruptcy but the shareholder is not required to pay the corps debts As a consequence, less misconduct is required to justify equitable subordination than veil piercing THE TRADITIONAL ROLE OF FIDUCIARY DUTY Two Primary duties of directors and officers Duty of Care Duty of Loyalty The Duty of Care and Business Judgment Rule Two distinct areas in which director responsibilities arise [MBCA 8.31] o Oversight 37

38 Obligated to use care in monitoring the activities of the officers and the general affairs of the corp as a whole o Decision Making Obligated to use care in making decisions that affect the corps welfare o The Oversight Context MBCA 8.30, 8.31, 8.42 ALI Principles of Corp Gov 4.01 Directors owe a degree of care that a businessman of ordinary prudence would exercise in the management of his own affairs Nature and extent of reasonable care depended upon the type of corporation, its size and financial resources Must act honestly and in good faith Basically discharge their duties in good faith and act as ordinary prudent persons would under similar circumstances in like positions o As a general rule, a director should acquire at least a rudimentary understanding of the busn of the corp o Director should become familiar with the fundamentals of the busn in which the corp is engaged [lack of knowledge is not a defense] Directors are under a continuing obligation to keep informed about the activities of the corp Directors may not shut their eyes to corp misconduct and then claim that b/c they did not see the misconduct, they did not have a duty to look o Regular attendance at board meetings [if absent then presumed to concur in action taken on a corp matter unless a dissent filed Maintain familiarity with the financial status of the corp by regular review of financial statements Need to be proactive in developing systems that keep directors properly informed of corp info A director is not an ornament but an essential component of corporate governance Dummy, figurehead and accomondation directors have no place and are still responsible for managing the busn and affairs of the corp Directors owe a fiduciary duty to the stockholders May owe a fiduciary duty to creditors also o Generally not recognized in the absence of insolvency o However with certain corps, directors are seemed to owe a duty to creditors and other third parties even when the corp is solvent [banks, corps that hold trusts, insolvency] Negligence of a director does not result in liability unless it is a proximate cause of the loss [MBCA 8.31(b)(1); ALI 4.01(d)] Necessary antecedent of the loss. If director had done duty, this would not have occurred 38

39 Some courts the standard is gross negligence [De SC]. In other courts it is simple negligence An action for breach of the duty of care can traditionally be brought only by the corp either in a direct or more commonly in a derivative actions (shareholder suit on behalf of corp) Some courts have distinguished btwn inside and outside directors Inside directors, as officers of the corp, should have a greater knowledge about the goings on of the company [ALI 4.01] o The Decision Making Context Substance The Basics of the Business Judgment Rule MBCA 8.31 ALI Principles 4.01 o An ordinary prudent person acting in (1) good faith under a (2) reasonable decision making process for (3) a rational busn purpose (4) without a conflict of interest o If no fraud, illegality or conflict of interest in the busn decision then court will not intervene You must then attack the decision making process as flawed to make a case However it must be an informed decision o Illegal Conduct and the Business Judgment Rule Busn judgment rule does not protect decisions to engage in knowingly illegal conduct even if the conduct is in furtherance of the corps interests Directors and officers who knowingly authorize illegal conduct on behalf of a corp are personally responsible for the violations [model penal code 2.706(a)] Process o DGCL 141(e) Directors fully protected in relying in good faith on reports made by officers provided it is reached on sound basis o MBCA 8.30(d), (e), (f) Director may rely on anothers delegated performance Director may rely on info, opinion, reports/statements, financial statements prepared by anothers delegated performance Rely on other directors, outside counsel and other committees in board of directors The determination of whether a busn judgment is an informed one turns on whether the directors have informed themselves prior to

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40 making a busn decision of all material info reasonably available to them o Need to be making decisions under an informed basis for the busn judgment rule to apply The Duty of Loyalty In general, the duty of loyalty requires directors and officers to put the corps interests ahead of their personal interests Normally arises in two principal contexts o Conflict of Interest Transactions o Corporate Opportunities Traditional remedies for duty of loyalty violations are restitutionary in nature o Rescission corp gets back what it paid and returns what it received in the transaction o Damages for the difference btwn contract price and a fair price o Hold fiduciary liable for any profits made Corp must reimburse any investment fiduciary made to obtain the opportunity Courts have sometimes awarded additional damages o Punitive damages o Ordering the fiduciary to repay any salary received from the corp during the time of breach of duty o Ordering the fiduciary to pay the corps atty fees and other expenses that were incurred in establishing the breach of duty Conflict of Interest Transactions o Common law has a rule of fairness a conflict of interest transaction would be upheld so long as it was fair to the corp o DGCL 144 1) the fact of such relationship or interest is disclosed or known to the board of directors or committee which authorizes, approves or ratifies the contract or transaction without counting the votes of such interested director 2) The fact of such relationship or interest is disclosed or known to the shareholders entitled to vote on the transaction and they authorize such contract or transaction by vote or written consent 3) The contract or transaction is fair and reasonable to the corp o Underyling issues of fairness must also be established in addition to DGCL 144 Look at entire fairness and issue as a whole o MBCA 8.60-8.63 8.60 conflicting interest the director knows at the time of commitment that he or a related person is a party to the transaction or has a beneficial financial interest in or so closely linked to the transaction and of such financial significance to the director or a related person that the interest would be reasonably expected to exert an influence on the directors judgment if he were called upon to vote on the transaction 40

41 Thus when a director does not personally benefit from the transaction but b/c of that directors relationship to a party interested in the transaction, it would reasonably be expected that directors exercise of independent judgment would be compromised, that director will be deemed an interested director within the meaning of the statue 8.60 related person means spouse, step/child, grandchild, step/parent, grandparent, step/sibling, half sibling, aunt, uncle, niece, nephew (or any spouse thereof) of the director or the directors spouse, an indiv living in same house as director, an entity controlled by the director or listed above, entity controlled by corp of which director is a director, a person or entity that is controlled by an employer of the director 8.62 directors conflicting interest transaction effective if authorized by the affirmative vote of a majority of the qualified directors who voted on the transaction after required disclosure by the conflicted director of info not already known by such qualified directors or after modified disclosure in compliance 8.63 if a majority of the votes cast by the holders of all qualified shares are in favor of the transaction after (1) notice to shareholders describing action to be taken (2) communication to the shareholders entitled to vote on the transaction of the info that is subject of required disclosure to the extent the info is not known to them 8.61 court will not take judicial action for equitable relief if not a conflicting interest transaction, it complies with 8.62 or 8.63 or the transaction is judged according to the circumstances of the time to be fair to the corp o Burden of Proof -When self dealing is demonstrated, the duty of loyalty supersedes the duty of care and the burden shifts to the director to prove that the transaction was fair and reasonable to the corp o Standard of Law self dealing transactions must have the earmarks of arms length transactions before a court can find them to be fair or reasonable Corp profitability should not be the sole criteria by which to test the fairness and reasonableness of directors fees Director needs to show fair price but also a showing of the fairness of the bargain to the interests of the corp The Corporate Opportunity Doctrine o Corp fiduciaries must discharge their duties in good faith with a view toward furthering the interests of the corp They must disclose and not withhold relevant info concerning anyu potential conflict of interest with the corp and they must refrain from using their position, influence or knowledge of the affairs of the corp to gain personal advantage o The corp opportunity doctrine recognizes that a corp fiduciary should not serve both corp and personal interests at the same time o ALI 5.05

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42 (a) A director or senior exec may not take advantage of a corp opportunity unless (1)First offers the corp opportunity to the corp and makes disclosure concerning the conflict of interest and corp opportunity (2) Corp opportunity is rejected by the corp AND (3) Either o (A) Rejection of the opportunity is fair to the corp o (B) Opportunity is rejected in advance following such disclosure by disinterested directors or by a disinterested superior in a manner that satisfies the standards of the busn judgment rule OR o (C) Rejection is authorization in advance or ratified, following such disclosure by disinterested shareholder and the rejection is not equivalent to a waste of corp assets (b) A corp opportunity means An opportunity to engage in a busn activity of which a director or senior exec becomes aware either o In connection with the performance of functions as a director or senior exec or under circumstances that should reasonably lead the director or senior exec to believe that the person offering the opportunity expects it to be offered to the corp o Through the use of corp information or property, if the resulting opportunity is one that the director or senior executive should reasonably be expected to believe would be of interest to the corp OR Any opportunity to engage in a busn activity of which a senior executive becomes aware and knows is closely related to a busn in which the corp is engaged or expects to engage (c) Burden of proof is typically on party challenging the taking of a corp opportunity unless (a)(3)(B) or (C) not met (d) A good faith but defective disclosure of the facts concerning the corp opportunity may be cured if at any time the original rejection of the corp opportunity is ratified, following the required disclosure by the board, shareholders or corp decision makers (e) Relief based solely on failure to first offer an opportunity to the corp is not available if (1) such failure resulted from a good faith belief that the busn activity did not constitute a corp opportunity AND (2) no later than a reasonable time after suit is filed challenging the taking of the corp opportunity, the corp opportunity is to the extent possible offered to the corp and rejected in a manner that satisfies the standards of the first bullet and sub bullets o A corp opportunity includes opportunities closely related to a busn in which the corp is engaged It also encompasses any opportunities that accrue to the fiduciary as a result of their position within the corp 42

43 The Dominant Inquiry is whether the corp opportunity at issue falls within the corps avowed busn purpose o Once the opportunity is defined as a corp opportunity, the corp must either show the person did not offer the opportunity to the corp or that the corp did not reject it What do defendants need to show for good faith when burden shifts to them??? Proving fair dealing through adequate disclosures o To whom should a corp fiduciary make disclosure and what info must be communication? Disinterested directors and full disclosure ceases to be a corp opportunity o In the absence of an appropriate disclosure, can a corp fiduciary interpose other defenses in order to avoid liability There can be no expectancy in a transaction unless the corp is financially able to undertake it o If other defenses are available to the corp fiduciary, in the absence of appropriate disclosure, what does a corp fiduciary have to prove in order to establish a good faith defense to a claim of usurpation of a corp opportunity? Without prior adequate disclosure, a corp fiduciary still may prove bona fides by clear and convincing evidence by establishing that their conduct has not harmed the corp Note on the Use of Corp Assets and Competition with the Corp o Prohibition on using corp property to acquire an opportunity o Prohibition on the use of corp assets prevents a corp fiduciary from using corp property for personal purposes [ALI 5.04] Defenses Proof of advance authorization Later ratification after full disclosure by disinterested directors or shareholders o Prohibition of a corp fiduciary from competing with the firm Incorporation the new busn and lining up its finances and facilities is generally ok Soliciting the employers customers is unacceptable Borderline Soliciting ones fellow employees to leave and join the new venture Notifying customer of the employees intentions without soliciting their busn Courts often condemn employees for concelaign from or misrepresenting to their employers, the employees intention to leave and set up a competing busn o ALI 5.06 prohibits a senior exec or director from competing with the corp unless (1) the benefits to the corp from allowing the competition outweigh the harm or 43

44 (2) the competition is authorized or ratified after full disclosure, by disinterested directors or shareholders Executive Compensation and the Waste Doctrine o Executive compensation is set by the board of directors and in the typically closely held corporation, all of the directors also serve as officers of the company The authority to compensate corp officers is normally vested in the board of directors and the compensating of corporate officers is usually a matter of contract Look at issue of reasonableness of compensation in this case A court is more hesitant to inquire into the reasonableness of executive compensation when it is fixed by a disinterested board but the standard for fixing executive compensation is obviously more strict when it is fixed by the recipient himself Look at all the facts and circumstances of the case surrounding defendants services to the corporation. Find comparative numbers o Waste doctrine prohibits an exchange that is so one sided that no busn person of ordinary, sound judgment could conclude that the corporation has received adequate consideration Entails an exchange of corp assets for consideration so disproportionately small as to lie beyond the range at which any reasonable person might be willing to trade If however, there is any substantial consideration received by the corp and if there is a good faith judgment that in the circumstances the transaction is worthwhile, there should be no finding of waste, even if the fact finder would conclude ex post that the transaction was unreasonably risky High standard bordering on irrationality in decision making Shareholders cannot ratify corp waste except by unanimous vote Stock option compensation are more scrutinized, even with valid shareholder ratification, and subject to a two part test Grant of options contemplates that the corp will receive sufficient consideration [retention of services of an employee or the gaining of the services of a new employee, provided there is a reasonable relationship btwn the value of the services and the value of the options] The plan or the circumstances of the grant must include conditions or the existence of circumstances which may be expected to insure that the contemplated consideration will in fact pass to the corp o Circumstances which may reasonably be reagarded as sufficient to insure that the corp will receive that which it desires Weighing of the reasonableness of the relationship btwn the value of the consideration flowing both ways Evaluating the sufficiency of the circumstances to insure receipt of the benefit sought, 44

45

Duties of Controlling Shareholders Absent a contractual obligation, a shareholder normally has not duty to the corp or the other shareholders. In certain situations however, the common law has imposed duties upon shareholders o Generally, controlling shareholders in any corp, closely or publicly held, have certain duties to the corp and the minority investors. Duties typically arise in two contexts Conflicts of interest transactions Sales of the controlling interest A shareholder owes a fiduciary duty only if it owns a majority interest in or exercises control over the busn affairs of the corp o When a true majority leader is absent, the test for control is a functional one that focuses on the shareholders ability to control the conduct of the corp The duties owed by a controlling shareholder focus on fairness Conflict of Interest Transactions o The standard of intrinsic fairness involves both a high degree of fairness and a shift in the burdened of proof. Prove that transactions were objectively fair o When the situation involves a parent and subsidiary, with the parent controlling the transaction and fixing the terms, the test of intrinsic fairness, with its resulting shifting of the burden of proof is applied Basic situation for application is when the parent has received a benefit to the exclusion ad at the expense of the subsidiary [self dealing] If subsidiary suffers a loss but the parent gains nothing either, then busn judgment rule may be employed o A parent does indeed owe a fiduciary duty to its subsidiary when there are parent subsidiary dealings but this alone will not invoke the intrinsic fairness standard Self dealing situations only, when the parent is on both sides of the transaction When the parent by virtue of its domination of the subsidiary, causes the subsidiary to act in such a way that the parent receives something from the subsidiary to the exclusion of, and detriment to, the minority stockholders of the subsidiary Note on Ratification in the Controlling Shareholder Context o When a controlling shareholder has engaged in a conflict of interest transaction, what is the effect of director or shareholder approval/ratification? Effective approval/ratification shifts the burden of proof but does not change the standard of review Minority stockholder ratification of a parent-subsidiary merger will not cause the transaction to be evaluated under the busn judgment review standard that normally applies to challenged stock options or other described corp transations Minority shareholder ratification operates only to shift the burden of persuasion, not to change the substantive standard of review

45

46 away from entire fairness [same result if independent disinterested directors do the same] o Regardless, of where the burden lies, when a controlling shareholder stands on both sides of the transaction the conduct of the parites will be viewed under the more exacting standard of entire fairness as opposed to the more deferential busn judgment standard Duties of Controlling Shareholders Sales of Control o The General Rule Absent looting of corp assets, conversion of a corp opportunity, fraud or other acts of bad faith, a controlling stockholder is free to sell, and a purchaser is free to buy, that controlling interest at a premium price Absent egregious circumstances, a controlling shareholder may sell his ownership stake whenever he wishes and keep any premium for himself o The Looting Exception ALI Principles 5.16 A controlling shareholder does not satisfy the duty of fair dealing to other shareholders if o It is apparent from the circumstances that the purchases is likely to violate the duty of fair dealing in such a way as to obtain a significant financial benefit for the purchaser or associate Facts must be sufficient to put the controlling shareholder on notice that it would be imprudent to proceed with the transaction without making further inquiry as to the purchaser and its motives for acquiring control of the corp Most courts require investigation of the buyer only when suspicious circumstances are present A number of factors may be relevant to make a seller suspect looting Excessive price that is willingly paid by a purchaser Liquid and readily salable assets owned by the corp A purchasers insistence on immediate transfer of control A purchasers insistence that the companys assets be made available immediately A purchasers lack of concern with the operations of the company A purchasers plan to use the corps assets to fund the purchase The prior history of the purchaser o Other Exceptions Courts may also intervene when they perceive that a sale of the controlling interest involves a conversion of a corp opportunity Controlling shareholder should not divert to himself an offer or opportunity that would have benefitted all of the shareholders proportionately 46

47 Controlling shareholder is liable for selling control in a secret transaction, particularly when the minority owners are induced to sell their shares without disclosure that the shareholder has received a premium

Exculpation Statutes DGCL 102(b)(7) o Authorizes a corp to adopt a provision eliminating or limiting the personal liability of a director to the corp or its stockholders for monetary damages for breach of fiduciary duty as a director o Do not apply to suits by third parties o 6 Exceptions Breach of the directors duty of loyalty to the corp or its stockholders Acts or omissions not in good faith Intentional misconduct Knowing violation of law Improper distributions Any transaction from which the director derived an improper personal benefit MBCA 2.02(b)(4) o Permits the articles of incorp to eliminate or limit, with certain exceptions, the liability of directors to the corp or its shareholders for money damages o May include any provision not inconsistent with law defining, limiting and regulating the powers of the corp, its board of directors and shareholders o Exceptions The amount of a financial benefit received by a director to which he is not entitled An intentional infliction of harm on the corp or the shareholders Liability for unlawful distributions An intentional violation of criminal law Indemnification and Insurance o DGCL 145 (a) person must have acted in good fiath and in a manner the person reasonably believed to be in or not opposed to the best interests of the corp and, with respect to any criminal action or proceeding, had no reasonable cause to believe the persons conduct was unlawful (b) no indemnification if made liable to the corp unless court says otherwise (c) to extent that present/former director/officer has been successful on the merits or otherwise in defense of any action shall be indemnified against expenses including atty fees actually and reasonably incurred 145(c) a director is not vindicated when the reason he did not have to make a settlement payment is b/c someone else assumed that liability (d) Determination of standard of (a)&(b) shall be made by (1) a majority vote of directors who are not parties to such action even though less than 47

48 quorum, (2) by a committee of such directors designated by majority vote of such directors even though less than quorum, (3) if there are no such directors, by independent legal counsel in written opinion OR (4) by the stockholders (e) legal fees may be paid in advance by corp before the final dispositong of the action 145(e) and MBCA 8.53 o If it is ultimately determined that the prospective indemnitee is not entitled to indemnification, the advanced sums must be repaid to the corp (f) indemnification and advancement of expenses provided by this seciont shall not be exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under any bylaw, agreement, vote of stockholders or disinterested directors or otherwise 145(f) does not permit a person to bypass the good faith requirement of 145(a) o Must be read consistently 145(g) and MBCA 8.57 provides a crop with the power to purchase an insurance policy on behalf of a person whether or not the corp would have the power to indemnify such person against such liability under this section Two parts of insurance o Provides coverage to reimburse the corp for its costs in indemnifying its directors and officers o Extends coverage directly to the indiv officer or director for sums for which indemnification from the corp is not available or forthcoming o MBCA 8.50-8.59 Concept of indemnification recognizes that there will be situations in which the director does not satisfy all of the elements of the standard of conduct set forth in 8.30(a)

DISSENTION IN THE CLOSELY HELD CORP Dissolution in General o DGCL 273, 275, 355 o Ny Bus Corp Law 1002 o MBCA 14.02, 14.20, 14.30 o Model Stat Close Corp Supp 33 Three types of dissolution are usually possible o Voluntary [DGCL 275, 355; MBCA 14.02; NY 1002, Stat 33] o Involuntary [DGCL 273; MBCA 14.30 o Administrative [DGCL 510; MBCA 14.20] Deadlock o DGCL 273 48

49 o NY Bus Corp Law 1101, 1111 o MBCA 14.30, 14.34 Wollman v. Littman (NY SC 1970) o Irreconcilable differences even among an evenly divided board of directors do not in all cases mandate dissolution

Oppression Protecting Minority Shareholders from Oppressive Majority Conduct o Protection in the Absence of Contract The Special Rules Approach Breach of Fiduciary Duty o Stockholders in the close corp owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another Court must carefully analyze actions taken by controlling majority shareholders [is there a legitimate busn purpose for their actions] o Court must weigh the legitimate busn purpose against an alternative course of action less harmful to the minoritys interest o Stock purchased after busn established and after the plaintiff already attained a job at the busn Not every discharge of an at-will employee of a close corp who happens to own stock in the corp gives rise to a successful breach of fiduciary duty claim o Minority shareholder owed a fiduciary duty to controlling shareholders Dissolution for Oppressive Conduct NY Busn Corp Law 1104-a, 1118 MBCA 14.30, 14.34 o 1104-a permits dissolution when a corps controlling faction is found guilty of oppressive action toward the complaining shareholders Exercised when majority shareholders engaged in certain egregious conduct o Two general categories that invoke 1104-a Mistreatment of complaining shareholders Misappropriation of corp assets by controlling shareholders, directors or officers o Three types of proscribed activity Illegal Fraudulent Oppressive conduct Conduct that substantially defeats the reasonable expectations held by minority 49

50 shareholders in committing their capital to the particular enterprise o a court investigation a petition alleging oppressive conduct must investigate what the majority shareholders knew, or should have know, to be the petitioners expectations in entering the particular enterprise oppression should be deemed to arise only when the majority conduct substantially defeats expectations that, objectively viewed, were both reasonable under the circumstances and were central to the petitioners decision to join the venture note on general and specific reasonable expectations o specific reasonable expectations refer to these extra rights extra to the extent that they go beyond the rights normally associated with shareholder status in a publicly held corp ie, employment or management o removal form board of directors, termination of emplolyment and loss of his share of corp earnings are not considered inherent stockholder rights o a court must also consider whether liquidation of the corp is the only feasible means to protect the claiming shareholders expectation of a fair return on their investment and whether dissolution is reasonably necessary to protect the rights or interests of any substantial number of shareholders not limited to those complaining o every order of dissolution must be conditioned upon permitting any shareholder of the corp to elect to purchase the complaining shareholders stock at fair value The NO Special Rules Approach DGCL 341-356 o Courts in Delaware refuse to create special common law rules to protect minority shareholders in closely held corps Texas o Courts can decide what is fair even if statue doesnt give courts express power to do so o Courts have general equitable powers to decide these situations o Courts can craft a remedy to reach an equitable result

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51 Remedies for Dissension Moving Beyond Dissolution Cal Corp Code 308, 1802, 1804 DGCL 226, 352, 353 NY Bus Corp Law 1104-a, 1118 MBCA 14.30, 14.32, 14.34 Model State Close Corp Supp 14-17, 40-43 o Davis v. Sheerin (Tx ct app 1988) The Tx Busn Corp Act does not expressly provide for the remedy of a buy out for an aggrieved minority shareholder Court concludes that under their general equity power, may decree a buy out in an appropriate case where less harsh remedies are inadequate to protect the rights of the parties Buy out is a less drastic remedy than liquidation which is expressly provided by the Tx Busn Corp Act o MBCA 14.34(b) the corp or one or more shareholders can elect to purchase the petitioning investors shares within 90 days after the filing of the dissolution petition or at such later time as the court in its discretion may allow 14.34(c) after an election is made, the parties have 60 days to reach agreement as tot the fair value and terms of prucahse of the petitioners shares 14.34(d) if cannot reach agreement, the court upon application of any party, shall stay the dissolution proceedings and determine the fair value of the petitioners shares as of the day before the date on which the dissolution petition was file or other such date as the court deems appropriate under the circumstances The Concept of Fair Value Cal Corp Code 1800, 2000 Minn Stat 302A.751 NY Bus Corp Law 1104-a, 1118 MBCA 13.02, 14.30, 14.34 ALI Principles 7.22(a) o What is fair value? FMV Pro rata share of a companys overall value o Should not receive less for stock than what a dissolution proceeding would bring o Fair buyout means the pro rata share of the value of the corp as a going concern without marketability discount Absent extraordinary circumstances SECURITIES FRAUD Unlawful to misrepresent or fail to disclose material info in connection with the purchase or sale of securities o an omission or misstatement is material if there is a substantial likelihood that, under all the circumstances, the omitted or misstated fact would have assumed actual significance in the deliberations of the reasonable shareholder 51

52 materiality of the info misstated or withheld is determined in light of what the defendants knew at the time the plaintiff committed himself to sell the stock must also prove sceinter an intent to deceive must also prove that he was induced to act by the defendants misstatement or omission o reliance is presumed when the plaintiff proves that the withheld info was material must prove fraud in connection with the purchase or sale of any security

FUNDAMENTAL TRANSACTIONS Certificate Amendments DGCL 216, 241, 242 MBCA 7.25, 7.27, 10.01-10.09 o Certificates of incorporation may be freely amended subject to tow broad requirements An amended certificate may contain only such provisiosn as may be lawfully contained in an original certificate of incorporation AND If a change in the rights of shares or shareholders, or an exchange, reclassification, or cancellation of shares or rights is to be made, the provisions necessary to effect such change, exchange, reclassification or cancellation must be set forth in the amendment [DGCL 241(a), 242(a); MBCA 10.01(a)] o If a corp has not received payment for any of its shares, its certificate may be amended by a majority of directors or, if no directors are named in the original certificate and directors have not been elected, a majority of incorporators [DGCL 241(b); MBCA 10.02] If a corp has received payment for any of its shares, the amendment procedure begins with a formal resolution by the board of directors setting forth the proposed amend and directing that it be submitted to a vote of the shareholders Written notice setting forth the text or a summary of the amend must then be given to each shareholder of record [DGCL 242(b)(1); MBCA 10.03(a), (d)] o In Delaware the amend must be approved by a majority of all shares entitled to vote on the matter [DGCL 242(b)(1)] According to the MBCA, the quorum requirement for an amendment of the articles is a majority of all shares entitled to vote [10.03(e)] However there is no special approval rule. An amend to the articles is approved if the yes votes exceed the no votes [7.25(c), 10.03 cmt 3] Bylaw Amendments DGCL 109 MBCA 10.20, 10.21 o In Delaware, the subsequent power to adopt, amend or repeal bylaws is vested in the shareholders entitled to vote However the shareholder retain the power to adopt, amend or repeal bylaws even if the board has been granted such power [DGCL 109(a)] 52

53 Under the MBCA, the directors have the power to amend the bylaws unless The articles provide that such power is reserved exclusively to the shareholders OR The shareholders adopt, amend, or repeal a bylaw that expressly provides that the board may not repeal, amend or reinstate that bylaw [MBCA 10.20] Sales of Assets o Transactions Triggering Shareholder Rights DGCL 262(b), 271 o If the portion of the busn not sold constitutes a substantial, viable, ongoing component of the corp, the sale is not subject to 271 o Otherwise a majority of shares is required to approve MBCA 7.25, 12.01, 12.02, 13.02(a) o A transfer of assets in the usual and regular course of busn does not require a shareholder vote o For transfers other than in the usual and regular course of busn, the shareholders, as well as the board, must approve any sale of assets that would leave the corp without a significant continuing busn activity Must retain 25% of total assets and 25% of either income from continuing operations before taxes or 25% of revenue from previous year o Need quorum equal to at least a majority of all shares entitled to vote. Then simple majority Tex Busn Code provides two procedure for authorizing a sale when all or substantially all of the property and assets of a corp are to be sold The procedure that is followed is generally determined by whether the sale is deemed in the usual and regular course of busn of the corp o Considered in the suual and regular course of busn if after the sale, the corp shall, directly, or indirectly, either continue to engage in one or more busns or apply a portion of the consideration receive in connection with the transaction to the conduct of a busn in which it engages following the transaction [so long as the corp is not liquidated and continues in some busn, either directly or indirectly after the sale] o A sale in the usual and regular course of busn can be authorized by the board of directors without shareholder approval if the sale is not in the usual and regular course of busn, the board must obtain approval from 2/3rds of the outstanding shares entitled to vote on the proposed sale

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54 o dissenters to the sale have certain rights including the right to redeem their shares for fair value o Appraisal Three ways to determine stock price Market value Earnings value Net asset value DGCL 262 o In Delaware, appraisal is not available MBCA 13.01, 13.02, 13.20-13.26, 13.30, 13.31 o Under the MBCA a shareholder dissenting from a sale of assets transaction has the right to an appraisal [13.02(a)(3)] If a shareholder has the right to an appraisal in connection with a fundamental transaction, he must follow elaborate statutory procedures to perfect this right In Delaware, a corp must notify shareholders of this right 20 days before the rights are available o Any shareholder desiring appraisal must make a written demand for appraisal prior to the vote and must not vote in favor of the transaction [DGCL 262(d)(1)] If the transaction is approved, the shareholder must continuously own hi shares through the effective date of the transaction [DGCL 262(a)] Within 120 days of the effective date of the transaction, any shareholder who is entitled to an appraisal may file a petition in court demanding a determination of the value of the shares of all shareholders who are entitled to an appraisal [DGCL 262(e)] The corp and any shareholder may agree on the value of the shares. Absent such agreement, the court determines the fair value of the shares exclusive of any element of value arising from the accomplishmen tor expectation of the transaction, together with a fair rate of interest [DGCL(h)] o Thus if the transaction itself creates value, dissenters do not share in this value MBCA contains similar rules [13.01(4), 13.20-13.26, 13.30-13.31] o Freeze Out Transaction Farnsworth v. Massey (Tx SC 1963) Freeze out transactions are permitted by law providing such action is authorized by 4/5ths of the outstanding capital stock of the corp which is selling its assets Mergers 54

55 o Basic Statutory Mergers DGCL 103, 251, 254, 259, 263, 265 MBCA 1.23, 7.25, 11.02, 11.04, 11.06, 11.07 In Delaware, a merger is the combination of two or more corps into a single corp with one of the constituent corps as the surviving entity In a consolidation, two or more corps combine to form a new corp [DGCL 251(a)] Corps may also merge with joint stock associations, partnerships and LLCs [DGCL 254, 263-264] MBCA 11.02(a) contains similar rules In Delaware, the merger agreement must be approved by a majority of the shares entitled to vote [DGCL 251(c)] The MBCA requires a quorum equal to at least a majority of all shares entitled to vote [11.04(e)] followed by a simple majority of those shares [7.25(c)] If the shareholder approve the merger agreement, it is filed with the secretary of state and the merger becomes effective [DGCL 103, 251(c); MBCA 1.23, 11.06] The surviving corp succeeds by operation of law to all of the assets and liabilities of every corp participating in the merger [DGCL 259(a); MBCA 11.07(a)] Mergers do not trigger anti-assignment clauses o Mergers with Summary Procedures DGCL 251(f), 253 MBCA 6.21(f), 11.04(g), 11.05 A small scale merger must be approved by the surviving corps board of directors and by the board and shareholders of all other corps participating in the merger However, the shareholders of the surviving corp have no voting rights To qualify as a small scale merger (1) the surviving corps certificate of incorp must not be amended by the agreement of merger, (2) the shares of the surviving corp must be identical before and after the merger, and (3) the number of voting shares of the surviving corp must not increase by more than 20% [DGCL 252(f); MBCA 6.21(f), 11.04(g)] In Delaware short form merger, a parent corp owning at least 90% of the shares of one or more subsidiaries merges with the subsidiary or subsidiaries [DGCL 253(a)] A short form merger must be approved by the parents board of directors If the parent corp survives the merger, the parents shareholders have no voting rights o However if the parent corp is extinguished by the merger, the parents shareholders enjoy the usual voting right in connection with a merger 55

56 A short form merger does not have to be approved by the subsidiaries board MBCA 11.05 short form merger is similar except that the shareholders of the parent corp are not excluded from voting rights unless the transaction also qualifies as a small scale merger o Appraisal DGCL 253, 262 MBCA 13.02 In Delaware as a general rule, the shareholders of every corp participating in a merger have appraisal rights [262(b)] There are two exceptions that parallel the exceptions for voting rights o The shareholders of the surviving corp in a small scale merger do not enjoy appraisal rights o The shareholders of the parent corp in a short form merger do not enjoy appraisal rights Should be noted that in a short form merger, the shareholder sof the subsidiary have appraisal rights [254(d), 262(b)(3)] There is an additional exception applicable to publicly held corps [efficient market exception] o A shareholder has no right to an appraisal in connection with any merger if His shares are listed on a national securities exchange or NASDAQ or held of record by at least 2,000 shareholders He is not required to accept any merger consideration other than Shares of the corp surviving the merger Shares that are listed on a national securities exchange or NASDAQ or held of record by at least 2000 shareholders OR Cash in lieu of fractional shares [262(b)(1),(2)] o De Facto Mergers Hariton v. Arco Electronics Inc (De SC 1963) The sale of assets statute and the merger statute are independent of each other o A sale of assets followed by a separate proceeding to dissolve and distribute, would be legal o Freezeout Mergers Fairness test applicable to parent-subsidiary mergers. Must provide sufficient protection to the frozen out minority Two basic steps o Fair dealing o Fair price 56

57 Self dealing and conflicts of interest transactions should not be tolerated. Fiduciary duty to stockholders Defendants bear burden of a legitimate busn purpose and then fairness to the minority Damages should be the present value of the corp stock if the merger had not taken place In Delaware, the majority may eliminate the minority interest through a freeze out merger without demonstrating a legitimate busn purpose Minority may pursue an appraisal remedy or in some circumstances, bring a breach of fiduciary duty claim o Breach of fiduciary claim will require defendants to demonstrate entire fairness of the transaction

Dissolution DGCL 275 MBCA 7.25, 14.01, 14.02 o In Delaware dissolution requires approval by the board of directors and a majority of the shares entitled to vote [275] o MBCA a dissolution must be approved by the board and the shareholders A quorum for shareholder approval is at least a majority of all shares entitled to vote [14.02(a),(e)] followed by a simple majority decision [7.25(c)]

DERIVATE SUITS Direct vs Derivative Suits o A direct suit involves the enforcement of rights belonging to a shareholder o A derivative suit is an action brought by one or more shareholders to vindicate rights belonging to the corp o General rule that a shareholder may not bring a direct claim by alleging that harm to the corp resulted in a reduction in the value of his shares Thus when all shareholders are harmed in proportion to their share ownership, the claim is usually derivative As a consequence, claims for corporate mismanagement or breach of fiduciary duty are ordinarily derivate in nature o Many courts view that a shareholder who suffers a special injury has standing to bring a direct action Courts have held that direct suits include actions to Compel the declaration or payment of a dividend Prevent interference with the shareholder franchise or a particular shareholders voting power Vindicate preemptive rights Permit a shareholder to examine the corps books and records Enforce a shareholders agreement Challenge ultra vires conduct Effect dissolution o ALI permits courts to treat shareholder disputes in closely held corps as if they were direct actions 57

58 ALI 7.01(d) determination when a shareholder of a closely held corp may proceed by direct or derivative action Cannot unfairly expose the corp or the defendants to a multiplicity of actions Cannot materially prejudice the interests of creditors of the corp Cannot interfere with a fair distribution of the recovery among all interested person o Delaware takes a different approach Requires derivative litigation Demand on the Board of Directors Del Ch Ct R 23.1 Must make two inquiries to determine whether demand on the directors is futile o Are the directors disinterested and independent o Was the challenged transaction otherwise the product of a valid exercise of busn judgment Three ways to demonstrate a reasonable doubt that the busn judgment rule protects the directors conduct o Directors had an interest in the transaction o The directors breached their duty of care in approving the transaction o The substance of the transaction is so egregious as to give rise to an inference that the directors breached their duties of loyalty or care A majority of the directos must be implicated by at least one of the three methods for a demand to be excused MBCA 7.42-7.44 The MBCA requires a derivative plaintiff to make a written demand upon the corp in every case [7.42(1)]. Plaintiff may proceed with court action 90 days after making demand unless irreparable injury to the corp would result in waiting [7.42(2)] A court shall dismiss a derivative action upon a majority vote of qualified directors present at a meeting of the board of directors if the qualified directors constitute a quorum as long as the court finds that the directors acted in good faith after conducting a reasonable inquiry [7.44(a), (b)(1)] o Johnson v. Steel Inc (Nv SC 1984) Under 23.1 when filing a complaint for a derivative action, plaintiff must allege with particularity the efforts, if any to obtain the action he desires from the directors and if necessary, from the shareholders or members and the reasons for failure to obtain the action or for not making the effort Exception where demand would be futile o Where the board participated in the wrongful act or is controlled by the principal wrongdoer, it si generally held that no demand is needed 58

59 Demand on the Shareholders o Dont need Shareholder Standing DGCL 327 Del Ch Ct R 23.1 MBCA 7.41 o Contemporaneous Ownership Rule to have derivative standing, a plaintiff must have owned his shares at the time of the alleged misconduct [DGCL 327, Del Ch Ct R 23.1; MBCA 7.41(1) Two recognized exceptions to the contemporaneous ownership rule A plaintiff who did not own his shares at the time of the alleged misconduct may still brign a derivative suit if o He acquired his shares by operation of law OR o The alleged misconduct began before the plaintiff acquired his shares but continued after the acquisition o In addition to being a contemporaneous and continuous owner, a derivative plaintiff must be an adequate representative of the corp on whose behalf he sues [MBCA 7.41(2)] Individual vs. Corporate Recovery o Glenn v. Hoteltron Systems Inc (Ny ct app 1989) Issue of allocation of damages to a closely held corp where a wrongdoer will indirectly benefit The mere fact that the wrongdoer as a substantial shareholder, will indirectly benefit from the award to the corp does not require an exception to this rule for actions involving closely held corporations General rule that any recovery obtained from a derivative suit is for the benefit of the injured corp. recovery under a direct suit is for the indiv shareholder alone Payment of the Plaintiffs Expenses MBCA 7.46(1) o The court may order the corp to pay a derivative plaintiffs expenses, including atty fees, fi the court finds that the proceeding has resulted in a substantial benefit to the corp [7.46(1)] o judgment to be entitled to an award of expenses If the plaintiff files suit and the corp takes action rectifying improper conduct, an award of expenses should still follow unless the corp can prove that the plaintiffs suti had no causal relationship to the corps remedial behavior Payment of the Defendants Expenses o Del Ch Ct R 11 Nope o MBCA 7.46(2) A court may order a derivative plaintiff to pay any defendants reasonable expenses, including atty fees, if the court dinds that the proceeding was commenced or maintained without reasonable cause or for an improper purpose 59

60 Settlement or Discontinuance o A derivative proceeding may not be discontinued or settled without the approval of the court If a settlement affects the interests of shareholders other than the plaintiff, notice must be given to those shareholders so that they have an opportunity to object to the settlement [Del CH Ct R 23.1; MBCA 7.45] o A court must determine whether the settlement is fair, adequate and reasonable

CHAPTER SEVEN: THE LIMITED LIABILITY COMPANY The LLC is a noncorporate busn structure that provides its owners, known as members, with a number of benefits Limited liability for the obligations of the venture even if a member participates in the control of the busn Pass through tax treatment Tremendous freedom to contractually arrange the internal operation of the venture Members are like Shareholders Managers are like Officers and Directors FORMATION o DLCCA 18-101(3), (7), (11), 18-102, 18-104, 18-201, 18-301, 18-901 o ULLCA 101(13, 103, 105, 108, 201-203, 401, 1001 LLCs are formed by filing a document, usually known as the articles of organization or certificate of organization, with the secretary of state or equivalent official of the appropriate juris o Articles of incorp are relatively skeletal and typically include only basic infor about the company o In Delaware, the certificate of formation is required to include only the name of the LLC, the address of its registered office and the name and address of its registered agent for service of process [DLLCA 18-201] ULLCA demands slightly more content in the articles of organization but the info required is still relatively basic [203] The real detail of the governance of an LLC is usually provided in a separate document known as an operating agreement or a limited liability company agreement o The operating agreement is a nonpublic document similar to a partnership agreement or a corps bylaws Some LLC statutes provide that an LLC is created so long as there has been substantial compliance with the formation requirements of the statute [DLLCA 18-201(b)] o Other statuets omit the substantial compliance language but provide that the filing of the articles is conclusive proof that formation requirements have been satisfied [ULLCA 202(c)] THE ROLE OF CONTRACT o DLLCA 18-101(7), 18-1101 o ULLCA 103 60

61 A number of LLC statues explicitly promote freedom of contract and encourage the enforcement of the parties private arrangements [DLLCA 18-1101(b)] o 18-1101(b) provides that it is the policy of the act to give the maximum effect to the principle of freedom of contract and to the enforceability of LLC agreements In general, only where the agreement is inconsistent with mandatory statutory provision will the members agreement be invalidated o 18-1101(7) defines the LLC agreement as any agreement, written or oral, of the member or members as to the affirs of a LLC and the conduct of its busn

MANAGEMENT AND OPERATION General Governance DLLCA 18-101(10), 18-201, 18-302, 18-401, 18-402, 18-503 ULLCA 101(11), (12), 203, 404 o Most LLC statutes assign, as a default rule, all management functions to members [DLLCA 18-402; ULLCA 101(11), (12), 203(a)(6)] o In manager managed LLCs, decisions are usually made by a majority vote of the managers although certain extraordinary decisiosn will often require a specified vote of the members as well [ULLCA 404(c)] Authority DLLCA 18-402 ULLCA 301 o Members in manager managed LLC usually have no authority to bind the venture at all [ULLCA 301(a), (b)] But DLLCA 18-402 provides unless otherwise provided in a LLC agreement, each member and manager has the authority to bind the LLC FINANCIAL RIGHTS AND OBLIGATIONS o DLLCA 18-502-503, 18-601, 18-607 o ULLCA 402, 404-407 With respect to members financial rights, LLC statutes tend to provide either a partnership like equal allocation or a corp/limited partnership like pro rata allocations based upon contributions to the firm o Many statutes provide that a member may be liable to a creditor for an unpaid contribution to the firm, even if the other members have decided to waive that obligation [DLLCA 18-502, ULLCA 402(b)] o Many statutes also indicate that members may have liability for receiving distributions that render the LLC insolvent [DLLCA 18-607; ULLCA 406-407] THE NATURE OF THE LLC: REGULATORY ISSUES An LLC is not prohibited from holding a license An LLC is a hybrid corp/partnership ENTITY STATUS o DLLCA 18-201, 18-701 o ULLCA 112, 201, 501

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62 Under most LLC statutes, an LLC is explicitly characterized as a separate legal entity whose identify is distinct from that of its owners [DLLCA 18-201(b); ULLCA 201] Nevertheless, judicial treatment of the LLCs entity status is not always spredictable LIMITED LIABILITY DLLCA 18-215, 18-303, 18-607 o 18-215 (a) - an operating agreement can designate a series or specified group of members, managers or LLC interests that have separate rights, powers or duties with respect to specified property or obligations of the LLC or profits and losses associated with specified property or obligation (b) - If the operating agreement creates one or more of these series, and if certain requirements are met, the debts, liabilities, obligations and expenses incurred, contracted for or otherwise existing with respect to a particular series shall be enforceable against the assets of such series only and not against the assets of the LLC generally or any other series thereof Similarly, none of the debts, liabilities, obligations and expenses incurred, contracted for or otherwise existing with respect to the LLC generally or any other series thereof shall be enforceable against eth assets of such series o 18-303 substantially the same as ULLCA 303 Protects members and manages of an LLC against liability for any obligations of the LLC solely by reasons of being or acting as LLC members or managers o 18-607 prohibits the stripping of corporate assets so as to render an LLC insolvent and creates a corp cause of action against LLC members who improperly receive a distribution of those assets (b) if an LLC member receives a distribution that results in the LLC becoming insolvent and knew at the time that the LLC would become insolvent as a result of the distribution, the LLC member is liable to the LLC for the amount of the distribution ULLCA 303 o The debts, obligations, and liabilities of a LLC, whether arising in contract, tort or otherwise are solely the debts, obligations and liabilities of the company o A member or manager is not personally liable for a debt, obligation or liability of the company solely by reason of being or acting as a member or manager Scope of Limited Liability o LLC protects members for their status but not their acts as agents of the corp entity Piercing the Veil o DLLCA 18-303 o ULLCA 303 The failure of an LLC to observe the usual company formalities or requirements relating to the exercise of its company powers or management of its busn is not a ground for imposing personal liability on the members or managers for liabilities of the company o Whether in the absence of fraud, the entity veil of an LLC can be pierced in the same manner as that of a corp [YES] 62

63 o No reason exists in law or equity for treating an LLC differently than a corp is treated when considering whether to disregard the legal entity FIDUCIARY DUTIES DLCCA 18-406, 18-1101 o 18-406 protects members and managers from liability if they rely in good faith upon the info, opinions, reports, or statements of accts, lawyers or other experts ULLCA 103, 409 o Contains a statutory duty to disclose 409 duty to disclose is not fiduciary in nature 103 operational agreement cannot unreasonably restrict rights to information All owed a duty of loyalty to the LLC, its investors and managers May an operational agreement limit or define the scope of the fiduciary duties imposed upon its members [YES] A majority shareholder of an LLC stands in a fiduciary relationship to the minority OWNERSHIP INTERESTS AND TRANSFERABILITY o DLLCA 18-701 to 18-704 o ULLCA 501-504 An ownership interest in an LLC entitles a member to (1) the right to receive distributions and to share in the profits and losses of the venture and (2) the right to participate in the management and control of the busn All LLC statutes provide that an assignment of an LLC ownership interests transfers the members financial rights but not his management rights o Statutes usually specify that an assignee can acquire a members management rights only with the consent of all of the nontransferring members Therefore, an LLC member cannot feely transfer his full ownership interest EXIT RIGHTS: DISSOCIATION AND DISSOLUTION o DLLCA 18-603, 18-604, 18-801 to 18-804 o ULLCA 101(2), (19), 601-603, 701-704, 801-808 DLLCA 18-603 604 upon resignation any resigning member is entitled to receive the FMV of such members LLC interest. Unless an LLC agreement provides otherwise, a member may not resign from an LLC prior to the dissolution and winding up of the LLC ULLCA 603, 701 grant a member a right to be bought out at fair value upon dissociation and indicate that the timing of the buyout will vary based upon the at will or term status of the LLC at issue Dunbar Group LLC v. Tignor (Va SC 2004) o Considering the statutory standard for the judicial dissolution of an LLC On application by or for a member, the circuit court of the locality in which the registered office of the LLC is located may decree dissolution of a LLC if it is not reasonably practicable to carry on the busn in conformity with the articles of org and any operating agreement 63

64 ULLCA 801 authorizing dissolution on the basis of illegal, oppressive, fraudulent or unfairly prejudicial conduct by those in control ULLCA 803(a) after dissolution, a member who has not wrongfully dissociated may participate in winding up a LLCs busn

EXPULSION OF AN OWNER o DLLCA 18-1101 Rules of law and equity govern where the statute is silent o ULLCA 601 FINAL THOUGHTS Publicly traded LLC has no federal income tax advantages b/c they are taxed as corps if public Lack of exit rights in an LLC Lack of default rules and case laws for LLC o Flexibility of contract caused a highly tailored/specific operating agreement A merger btwn a corp and an LLC does not qualify for tax free treatment by IRS

CHAPTER FIVE: THE LIMITED PARTNERSHIP A limited partnership can only be created by complying with the formation requirements of the relevant statute Comprised of at least one general partner and at least one limited partner o While a general partner has unlimited liability for the obligations of the firm, a limited partner has no liability for the debts of the venture beyond the loss of his investment This limited liability can be forfeited if a limited partner participates in the control of the busn A limited partnership provides its owners with pass through tax treatment and structural flexibility HISTORICAL OVERVIEW RULPA 101(7), 403, 1105 o 101(7) defines a limited partnership as a partnership o 403 provides that a general partner in a limited partnership has the rights, powers, restrictions and liabilities of a partner in a partnership without limited partners o 1105 indicates that in any case not provided for in the act, the provisions of the UPA/RUPA govern General partnership law can be used to answer questions when the limited partnership statute is silent FORMATION General Requirements o RULPA 101(2), 102, 104, 201, 204, 501 64

65 o Limited partnerships can only be formed by filing a certificate of limited partnership with the secretary of state of the appropriate juris The certificate is relatively skeletal document that includes basic info about the company including the name of the limited partnership and the identity of the partners [201] o The real details of the rights and duties of partners and on the overall operation of a limited partnership is contained in the partnership agreement a separate nonpublic document that the parties draft to govern their particular firm Formation Defects o RULPA 201, 204, 304 201(b) a limited partnership is formed at the time of the filing of the certificate of limited partnership in the office of the secretary of state if there has been substantial compliance with the requirements of this section 304(a) provides protection to a person who makes a contribution to a busn enterprise under the mistaken but good faith belief that he is a limited partner. According to the statute, such a person is not a general partner in the enterprise and is not bound by its obligations if upon ascertaining the mistake he either (1) causes an appropriate certificate of limited partnership or a certificate of amendment to be executed and file or (2) withdraws from future equity participation in the enterprise by executing and filing in the office of the secretary of state a certificate declaring withdrawal under this section If the requirements are met 304(b) indicates that the mistaken person is only liable as a general partner to any third party who transacts busn with the enterprise before (1) and (2) of the above are accomplished o Even then, liability is imposed if the third party actually believed in good faith that the person was a general partner at the time of the transaction o Direct Mail Specialist Inc. v. Brown (Mt dist ct 1987) Where there is a failure to substantially to comply with the statues authorizing limited partnerships, the parties remain liable as general partners as to third persons having no knowledge of the limited nature of the partnership

MANAGEMENT AND OPERATION RULPA 302, 305, 402, 403 o 403(a) a general partner in a limited partnership has the same rights and powers as a general partner in a general partnership The statute explicitly links to general partnership law on the subject of a general partners management rights and powers o RULPA does not explicitly grant or deny management rights to limited partners. Nevertheless, severall cases have stated that limited partners cannot take part in the management of the busn and partnership agreements tend to explicitly deny management rights to limited partners

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66 303 limited partners who participate in the control of the busn risk liability for some or all of the obligations of the venture o RULPA does not speak to the issue of whether a limited partner is an agent of the limited partnership who can bind the venture via apparent authority, to transactions in the ordinary course of busn There is some case law stating that limited partners have no agency authority merely as a result of their limited partner status o 302 absent provisions in a partnership agreement, a limited partners has no voting rights o 305 provides limited partners with the right to inspect the limited partnerships records and the accompanying right to obtain info about the limited partnership FINANCIAL RIGHTS AND OBLIGATIONS RULPA 101(2), 501-504, 601, 604, 607, 608 o 503/504 state that unless otherwise agreed in a written partnership agreement, the profits, losses and distributions of a limited partnership shall be allocated on the basis of the value of the contributions made by each partner to the extent they have been received by the partnership and have not been returned 101(2)/501 define contribution broadly o 503 allocates distributions on the basis of partner contributions, although it does so without regard to whether a limited partnership has returned any of those contributions o 502 gives a creditor the right, under certain circumstances to enforce a limited partners promise to contribute to the venture o 607 a distribution to a partner is prohibited if it would leave the firm insolvent o 608 makes partners liable to the limited partnership for wrongful distributions and in some instances for rightful distributions o 608/509 does not impose liability for distributions that were rightfully made o 601 a partner is entitled to receive distributions from a limited partnership and before the dissolution and winding up thereof to the extent and at the times or upon the happening of the vent specified in the partnership agreement Ordinarily therefore, a partner (general or limited) has no default right to demand interim distribution, as the partnership agreement governs o 604 provides general and limited partners with a default distribution right upon withdrawal [default buyout right upon withdrawal ENTITY STATUS RULPA does not directly speak to whether a limited partnership is an entity Limited partnerships possess a number of characteristics that suggest a separateness btwn the partners and the busn itself o Limited partners possess limited liability for the obligations of the busn [303(a)] o Limited partners can bring derivate lawsuits on behalf of the limited partnership [1001] o The dissociation of a partner (general or special) does not necessarily result int eh dissolution of the limited partnership [801]

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67 Courts have traditionally treated RULPA limited partnerships as legal entities distinct from their owners o However when strong policy reasons exist, a contrary conclusion is possible

LIMITED LIABILITY The Control Rule o RULPA 303 o Limited partners have no liability for the debts of the venture beyond the loss of their investments A limited partner can lose their limited liability protection if they participate in the control of the busn o If the limited partners participation in the control of the busn is not substantially the same as the exercise of the powers of a general partner, the limited partner is liable only to persons who transact busn with the limited partnership with actual knowledge of his participation in control o If a limited partner participates in the control of the busn, he is liable only to persons who transact busn with the limited partnership reasonably believing, based upon the limited partners conduct, that the limited partner is a general partner It is not sound public policy to hold a limited partner who is not also a general partner liable for the obligations of the partnership except to persons who have done busn with the limited partnership reasonably believing, based on the limited partners conduct, that he is a general partner Control of the Entity General Partner o RULPA 101(5), (7), (11). 303, 403 o Tx ct the personal liability which attaches to a limited partner when he takes part in the control and management of the business, cannot be evaded merely by acting through a corp FIDUCIARY DUTIES General Partners o Del RULPA 17-1101 o RUPLA 107, 305, 403, 1105 Does not specifically address the topic of general partner fiduciary duties Linkage to general partnership law through 403 is imported to deal with the topic 107 except as provided in the partnership agreement, a partner may lend money to and transact other busn with the limited partnership and subject to other applicable law, has the same rights and obligations with respect thereto as a person who is not a partner 305 limited partners have the right, upon reasonable demand, to obtain info from the general partners o When a general partner of a limited partnership is a busn entity, managers of the entity may personally owe fiduciary duties to the limited partners and the limited partnership 67

68 Gothman Partners LP v. Hallwood Realty Partners LP (De SC 2002) DRULPA 17-1101(d)(2) states the partners or other persons duties and liabilities may be expanded or restricted by provisions in the partnership agreement Unless limited by the partnership agreement, the general partner has the fiduciary duty to manage the partnership in its interest and in the interest of the limited partners 17-1101(e) read to insulate a general partner from liability if the general partner breached an ambiguous agreement provision in good faith but could not be read to immunize a breach of an unambiguous agreement provision o Would only protect a general partner from a fiduciary duty claim only where its actions were contractually authorized o Clause upon which defendants relied must be ambiguous Labovitz v. Dolan (Ill app ct 1989) Despite having wide discretion in the partnership agreement, the general partner still owed his limited partners a fiduciary duty which encompasses the duty of exercising good faith, honesty, and fairness in dealings with the limited partners and the funds of the partnership o In any fiduciary relationship, the burden of proof shifts to the fiduciary to show by clear and convincing evidence that a transaction is equitable and just In re Usacafes LP (De chance 1991) Whether directors of a corp general partners are fiduciaries for the limited partnership o Yes extends to the dealings with the partnerships property or affecting its busn

OWNERSHIP INTERESTS AND TRANSFERABILITY Overview o RULPA 101(10), 301, 401, 702, 704 101(10) & 702 like general partnership, financial rights are transferable while management rights are not 704 an assignee of a partnership interest has the right to become a limited partner if and to the extent that (i) the assignor gives the assignee that right in accordance with authority described in the partnership agreement or (ii) all other partners consent 301 addresses the admission of limited partners Entity General Partners o In re Asian Yard Partners (De bankr ct 1995) 401 allows the admission of general partners as provided in writing in the partnership agreement or if not so provided, with the written consent of all partners. Thus, a written agreement may permit the addition of general partners by act on the general partners, by act of a specified majority of the limited partners or by some other procedure 68

69 Changing Orders o RULPA 702, 703, 802 703 provides a charging order procedure whereby the court may charge the partnership interest of the partner with payment of the unsatisfied amount of the judgment with interest but to the extent so charged, the judgment creditor has only the rights of an assignee of the partnership interest o Baybank v. Catamount Construction Inc (NH SC 1997) Whether dissolution is available to a creditor of a limited partner 802 provides that on application by or for a partners, the superior court may decree dissolution of a limited partnership whenever it is not reasonably practicable to carry on the busn in conformity with the partnership agreement 702 an assignment of a partnership interest does not entitle the assignee to become or to exercise any rights of a partner o 702-704 do no operate as an unlimited assignment of all partnership rights or as a judicial swap of the creditor for the debtor partner

EXIT RIGHTS: DISSOCIATION AND DISSOLUTION Dissociation o RULPA 402, 602, 603, 604 402 specifies the events of withdrawal for a general partner 602 allows a general partner to withdraw at any time by giving written notice to the other partners, but if withdrawal violates the partnership agreement, the limited partner may recover damages 604 a withdrawing partner (general or limited) is entitled to receive any distribution provided for in the partnership agreement If the partnership agreement is silent, 604 specifies that a partner shall receive within a reasonable time after withdrawal, the fair value of their interest in the limited partnership as of the date of withdrawal based upon their right to share in distributions from the limited partnership 603 allows a limited partner to withdraw under circumstances specified in a written partnership agreement If the agreement is silent, a limited partner may withdraw upon not less than six months prior written notice to each general partner o When withdrawal occurs, 604 provides for fair value buyout Dissolution o RULPA 801, 802, 803, 804 801 a limited partnership is dissolved (1) at the time specified in the certificate of limited partnership; (2) upon the occurrence of events specified in a written partnership agreement; (3) upon the written consent of all partners; (4) upon an event of withdrawal of a general partner under 402 (except when certain requirements are met); and (5) by the entry of a decree of judicial dissolution under 802 69

70 801(4) a partnership agreement cannot modify to avoid dissolution on less than a unanimous vote 802 provides that a court may decree dissolution of a limited partnership whenever it is not reasonably practicable to carry on the busn in conformity with the partnership agreement Dissolution is not caused by the dissociation of a limited partner

CHAPTER SIX: THE LIMITED LIABILITY PARTNERSHIP The limited liability partnership (LLP) is a general partnership that, depending on the relevant statute, provides the partners with limited liability for the firms tort obligations or for both its tort and contract obligations b/c the LLP is a general partnership rather than a limited partnership, all of the partners have the right to participate in the management of the venture without risking a loss of their limited liability b/c partnership statutes provide that an LLP is a partnership,, general partnership law is applicable to LLPs when it is not explicitly altered by LLP specific provisions FORMATION Tex Rev Civ Stat art 6132(b) Section 3.08 RUPA 101(5), 201, 1001, 1002, 1003 o 101(5) LLP are partnerships. An association of two or more persons to carry on as co-owners a busn for profit o 1001(d) limited liability begins as soon as the registration statement is filed An LLP must satisfy certain statutory formalities o Required to file a document (application/registration/certificate) with the secretary of state or other designated official Must provide prescribed info, which usually includes, the firms name (with limited liability terms), address and a statement of its busn or purpose [Tx Civ Stat; RUPA 1001, 1002 o Provide a specified amount of liability insurance or, alternatively, a pool of funds designated and segregated for the satisfaction of judgments against the partnership Tx requires 100,000 liability or pool fund An LLP that fails to comply with the insurance/segregated funds requirement presumable loses its limited liability protection, at least up to the amount that insurance or segregated funds should have provided Most states require registration fees per partner per year o In a state that requires an LLP to renew its registration, a failure to comply may jeopardize the partners limited liability LIMITED LIABILITY o Tex Rev Civ Stat art 6132(b) Section 3.08 o RUPA 106, 306 306 limited liability for all types of claims Megadyne Information Systems v. Rosner, Owens & Nunziato (Ca ct app 2002)

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71 o An indiv partner of a registered LLP has no vicarious liability for the torts of another partner. Only the partnership and the indiv partner are liable Kus v. Irving (Conn SC 1999) o A partner in a registered LLP is not liable directly or indirectly, including by way of indemnification, contribution or otherwise, for any debts, obligations and liabilities of or chargeable to the partnership or another partner(s) whether arising in contract, tort or otherwise, arising in the course of the partnership busn while the partnership is a registered LLP Many LLP provisiosn specify that a partner is laible for the misconduct of other under the partners supervision, direction or control [Tex Rev Civ Stat]

THE LIMITED LIABILITY LIMITED PARTNERSHIP o Tex Rev Civ Stat art 6132a-1, Section 2.14 If a limited partnership wishes to become an LLLP, it must comply with the registration and insurance/segregated funds requirements of the relevant LLP statute o Tex Rev Civ Stat art 6132b, Section 3.08 o RUPA 306 (c) When a limited partnership has elected LLP status, a general partner canparticpate in the control fo the busn without becoming personally liable for any of the ventures obligations Some states allow limited partnerships to register as LLPs creating an LLLP o A general partner in an LLLP is liable for the obligations of the busn only when a general partner in an LLP would be liable o For limited partners, this protection presumable means that conduct that would result in control rule liability in a tradition limited partnership will not result in liability in an LLLP unless a partner in an LLP would be liable for such conduct

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