rrayBA OUTLINE PROFESSOR GROVES FALL 07 Entity Types: Biz class 1 Unincorporated - Partnership - Limited Partnership - Limited Liability

y Company Incorporated - Corporation Biz class 2 - Small ( closely held) - Large ( Publicly traded) Publicly traded company more likely to be corporation due to the higher level of regulation they often have.

Relations Among Owners (Internal) y y y y y y Financing the entity Fiduciary duties Sharing profits Liability allocations Control someone who puts up the money ask is it your money Termination

Relations-Owners & 3rd Parties (External distributors, purchasers, suppliers, etc.) y y Liability Asset Protection o Creditors

Competing Interst: y CORP. o Connected to Corp. are;  Officers  Directors directors often have different issuesthey want nest eggs, retirement, etc. These are the ones who set the policy directors fight with other directors, etc.  Employees

Agency Principles: y Principals and Agents: o The Agency Relationship:  Principal: The person or entity who manifests assent for another to act on her behalf.  Agent: Assents to so act. 1

o At a friends birthday party someone said mike vick should be electrocuted like he did to dogs (THE AGENT). The secretary of the organization overheard the comment and did it. (THE PRINCIPAL)  A. The secretary is an agent of the Organization  B. The secretary is not an agent. o Types of Principals for the I am going to electrocute you agent  A: I am an agent for kill Vick, Inc. Is disclosed because you know who the agent is, you know who the principal is  B: I am an agent but I am not telling you who I represent Partially disclosed because you know who the agent isbut not the principal.  C: I am going to electrocute you. Undisclosed because neither is disclosed. o For all answers, A is Disclosed, B is for partially disclosed, and C is for Undisclosed. Term 3rd party notice of agent role 3rd party notice of principal i.d.

Disclosed principal Partially disclosed Undisclosed principal (2.06)

Yes Yes No

Yes No No

AGENT IS MOST LIKELY RESPONSIBLE WHEN THERE IS AN UNDISCLOSED PRINCIPAL. BUT IS THE PRINCIPAL OFF THE HOOK? No they are not off the hook because it is in the scope of actual authority. y Undisclosed principal can still have liability if done within the scope of actual authority.

Hypo: A clerk was asked to take a settlement agreement to another party by a partner in the firm. They get into a car accident and the settlement never gets there. The clerk acted.and thus is responsible. Undisclosed puts themselves at more risk because they havent identified themselves. y 2.06 Estoppel of Undisclosed Principal cant get out from under liability just because you try to change the relationship to the party.

CONSENT v. CONTRACT: y Does the relationship between the principal and the agent need to be by contract, or just by consent? o Consent is enough. What is the difference? Consideration.meaning you dont have to have consideration to be an agent. What happens now if you bring the deal and you sign on behalf or believe that they are entitled to the deal? o If you did it and there was something traceable by the 3rd party or if it appeared to be an agent.

BONDS HYPO: y y y y Bonds walks into managing Partners office. MP tells associate Lets surprise Bonds and get him a potent pill and then winks. MP says, tell the firms pharmacist its for Bonds Firm has an account there. 2

o 1st role of analysis: Who are the Parties?  Bonds no manifest assentbecause he didnt say anything  Managing Partner Is the principal  Associate Is an agent of the firm.  Pharmacist/Store Owner doesnt manifest assent to do something. o But what if Bonds did say something like he needed something?  Bonds = Principal  MP = agent  Assoc. = co-agent  Pharma = co-agent y Associate used firm credit card to buy steroids without firm permission? o What kind of authority does associate have? Actual Authority 2.01 (page 5) Meaning actual authority is not limited to what happens in actual terms But what if Associate says, MP wants me to do something that could get me in trouble and the associate gets him a generic alternative. The MP says that isnt what he ordered and will not pay for it. And the Pharm wants payment. Who is liable? o Bonds o MP Because it is in the scope of the authoritybecause he just said a potent pill. o Associate o Store Owner  Therefore the specificity concerns what is within the scope.  2.02 Scope of Actual Authority Whats the difference between apparent and actual authority? o Actual authority is dealing with the situation between the principal and the agent. o Apparent deals with the expectations of a 3rd party. What if the associate takes it upon himself to get the steroids? o As long as the store owner/pharmacist would have reason to believe that he was acting on behalf of the principal. o Agent (Associate) has breached the fiduciary duty to principal (MP) o The pharmacist would then go after the MP and the MP would have to go after the associate. What if, associate calls and says I quit but still buys the steroids. o Still has apparent authority because the 3rd party still has reason to believe he is an agent of the firm. o Actual authority is terminated, because there was a revocation or a renunciation to the principal Type Actual Actors Principal/agent Scope Implied, nec, or incidental to principals objective Reasonable belief and traceable End Natural termination Agent renounces Principal revokes No longer appears actual

Apparent

3rd party / agent

AGENCY 6-STEP ANALYTICAL CONSTRUCT (PATAAT) 3

y y y y y y LLLP:

Whos Principal? Agent? 3rd Party? Scope of the Agents Actual Authority? Scope of the Agents Apparent Authority? When does the Agent Authority Terminate?

LLC: Provides limited liability for all participants whether in management or not. Provides the benefits of being incorporated without the limitations and rules applied to corp.

The Corporation: In the AB senerio, A can form a Corporation but is subject to federal income taxation and mandatory procedural requirements that may increase the cost of operation. Corp. provides limited liability for all participants whether active or passive. (meaning investors) Are either Publicly held or closely held. Theoretically a Corp. consists of 3 layers, shareholders, board of directors, and officers. A and B Hypo: y y y A provides the money. B provides services. A wants veto power over the business activities since he put up the money. AB = Not an employer employee relationship because they are profit sharing. And even though A states he has veto power it works more like a Partnership. AB is not a creditor debtor relationship because there is no repayment planned and they both share an interest whereas creditors dont have these. A and B are not Principals and Agent relationships because they are both Agents of the Principal (the Partnership)

AB = PARTNERSHIP; 202 2 or more persons who are co-owners for profit, whether or not the 2 intend a partnership. WEEK 2__________________________________________________________________________________ y y Who Ya Runnin With? & Whats in a Name? (Agency Relationships) THE PARTNERSHIPS

A and B Hypo: y y y A provides the money. B provides services. A wants veto power over the business activities since he put up the money. AB = Not an employer employee relationship because they are profit sharing. And even though A states he has veto power it works more like a Partnership. 4

AB is not a creditor debtor relationship because there is no repayment planned and they both share an interest whereas creditors dont have these. A and B are not Principals and Agent relationships because they are both Agents of the Principal (the Partnership) AB = PARTNERSHIP; 202 2 or more persons who are co-owners for profit, whether or not the 2 intend a partnership.

Independent Contractors: When there is a lack of control by the client. Text: (Inadvertent Partnerships) p. 117.
y y

Text: Martin v Peyton, p 118-121 KNK, a partnership in securities had financial difficulties. Hall, a partner arranged for a loan of some securities from Payton and some other friends (Ds) to be used as collateral for a bank loan to KNK ($500k in Liberty Bonds). Loan agreement stipulated no partnership intentions, and until the loan was repaid, Ds were to receive 40% of profits from the firm. Ds could inspect the books and were to be held in the loop about the firms business. Ds could also veto risky ventures. All partners had to assign their interests to D as security for the loan. The creditors of KNK claimed that Ds had a partnership. Trial court found transaction to be a loan, Ps appeal. Issue: Has partnership been established? NO! A Partnership is an association of 2 or more persons to carry on a business for profit. Creation is by express or implied agreement. Ps claim that written agreement of the firm with Ds constitute the formation of an express partnership. Furthermore, profit sharing indicates partnership. But doesnt have to be. AND just because the language says no partnership doesnt mean it does not exist. The whole agreement will be considered. All the features of the agreement between the Ps and Ds follows a loan agreement. The defendants are trusteesand the precise issue is whether the trustees are partners. This was the case in that another creditor likely wanted to collect from the business and thus the trustees who lent money. BUT the trustees want to be known as lenders and thus without liability from other creditors. THIS CASE IS TO SHOW THAT THERE ARE FACTORS THAT WEIGH FOR AND AGAINST BEING A PARTNER IN A FIRM OR BUSINESS. How to resolve such an issue o Examine the agreement o Identify the partnership attributes o Identify the non-partnership attributes

y y

y y y

UPA 101(6) - "Partnership" means an association of two or more persons to carry on as co-owners a business for profit formed under Section 202, predecessor law, or comparable law of another jurisdiction. 202(a) Except as otherwise provided in subsection (b), the association of two or more persons to carry on as coowners a business for profit forms a partnership, whether or not the persons intend to form a partnership. 202 (C) In determining whether a partnership has been formed, the following rules apply: 5

202(C)(3) - A person who receives a share of the profits of a business is presumed to be a partner in the business, unless the profits were received in payment: (i) (ii) (iii) (iv) (v) of a debt by installments or otherwise( there is a clear repayment schedule and interest rate); for services as an independent contractor or of wages or other compensation to an employee; of rent; of an annuity or other retirement or health benefit to a beneficiary, representative, or designee of a deceased or retired partner; of interest or other charge on a loan, even if the amount of payment varies with the profits of the business, including a direct or indirect present or future ownership of the collateral, or rights to income, proceeds, or increase in value derived from the collateral; or for the sale of the goodwill of a business or other property by installments or otherwise.

(vi)

ISSUE: Is someone a partner? Analysis: y y y sharing of profits? If you see additional facts of whether there are other facts surrounding Examine case law traditional partnership Examine statutory exceptions

Simpson v Ernest and Young, 850 F. Supp. 648 (1994) y y y y 2 companies merged to make the largest accounting firm in the world. But they didnt have enough money in their retirement fund for all of their employees. So they started letting go some of the older employees (40s) like Simpson who made $140k a year and hired younger CPAs thus preventing high pensions AND retirement benefits. So Simpson files suit for discrimination of age. But to do this you must be an employee. Thus E and Y claimed he was a partner. The COURT resolved this issue by; o SASMOVF o S SHARING IN PROFITS o A ACCESS TO BOOKS AND RECORDS o S SECURITY permanence o M MANAGEMENT AUTHORITY OVER OWN EMPLOYEES o O OWNERSHIP INTERESTS o V VOTING RIGHTS o F FIDUCIARY DUTY Court found that he didnt have these factors to be a partner. Simpson had illusory voting rights, Advisory board could veto his vote, board selected by nominating committee, nominating committee selected by management committee , management committee selected by Chairman of the Board Court said often that no one factor is determinable..but that doesnt mean that some arent more important than others. o Which of the SASMOVF factors is primary?  Management or Access to Books and Records? 6

y y

y y

In Rhoads v. Jones Financial Co., - We must wonder just how many partnersin the real world (actually) control factors such as the management of the firm and the critical elements of his or her work Therefore, management may not be as important..it is a delegable right. Voting rights are not delegable.

SHARING PROFITS AND LOSSES: y y Often times business owners are blinded by profits and dont see the losses. 90% of American businesses have losses at first.

SHARING PROFITS BY AGREEMENT OR STATUTE: y y Agreement: 103(A) Relations and agreements trump what is said in statutory language. ONLY when you dont have that agreement is when you turn to statutory language. Statutory by Default: 401(b) It is when you dont have an agreement is when you share equally.

Profit Sharing Agreements (PUCSAS) y y y % (flat) but problem with this is often times other partners work harder, etc. Units (ratio) *(preferred) you will have certain units Partner Units / Total Units, because if the number of partners change, the units stay the same. Capital Investment: The profits will be divided based upon who puts up money % of total investment in the firm ( money or equipment). But what happens when you dont have capital but you bring in the most business? Salary (Plus Profit) What happens if you dont have profits? Annual Agreement Just figure out at the end of the year. Sales/Billables hours worked.

y y y

What happens when you dont have an agreement? AB hypo? The have a profit of 10k, and B didnt put up any cash, how much does he get? 5keven if he didnt do shit. How much of an agreement is necessary to avoid default statutory provisions? BANE v. FERGUSON: y Bane was an attorney for Isham, Lincoln and Beale and in 1985 the firm entitled every retiring partner a pension. Bane retired 4 months after it took effect and then the firm merged. The merger eventually led to the dissolve of the firm. Bane sued for the negligence of the managing partners to merge that cause him to lose his pension. Judgment affirmed. P claims violation of UPA section 9(3)(c) but this is to protect active partners from the unauthorized acts of another partner. When he retired, he ceased as a partner. The fiduciary duty claim is void also because once he ceased as a partner, there was no fiduciary duty to him. The breach of k also failed because of the clause contained about benefits ceasing if the firm failed. 7

y y y y y

Similarly cannot find a duty of care to a retired partner. (tort law)

Partnership losses and Ambiguities y 306(a) All partners are joint and severally liable.

Partnership Obligations: y y y y y y y y 3rd party wins suit against partnership 301 (1) 305 (a) 306 (a) ( all partners are liable jointly and severally liable unless otherwise agreed by the claimant) (b) ( new partners should not have liability for transactions made before they got there) All partners are responsible ( unless otherwise agreed) Can allocate liability between partners BUT 1 partners failure is other partners liability Between partners 401 (b), allocates the losses by the % of shares of profit if no agreement otherwise. o Allocation of loss by agreement OK o Like Profits agreement, if no agreement on losses BUT 3rd party claims, 306 (a) o Allocation ineffective (Joint and Several) cant vary -103(10) UNLESS;  3rd party stipulation  New partner  LLP [cant vary - 103(9)]

Kessler v. Antinora y P and D entered into an agreement for purchase of a building. Agreement provided P to put up money and D to act as contractor. 60% was to go to Kessler and 40% to D after P had been repaid. Venture lost money and P sued for repayment of approx. 65k. Court P argued that he should be repaid by D but the court found that the intent of the agreement shows that P was supposed to be reimbursed by the sale of the housenot by D. Joint-venture was to repay P with the sale of the house. Therefore, they both shared in the losses, ie. P for his money and D for his labor on a 3 year job. 401(d) is the section that could help. ARTICLE III deals with 3rd parties and thus doesnt deal with this case since it is partner between partner. COURT says that there is an agreement there.most scholars disagree. 401(c), partner shall reimburse.therefore you can have clause certain funds xyz, shall be refundable OR 401(h) Key to take away is.be specific in k language.

y y y y y y y y

ROCA, et al. y First red flag: o Oral agreement 8

o 2 partners had 65% and 35% going to 5 others but no clarity about how it was going to be divided or what it actually was o They had no idea what to with the % if a partner left. o Roca ended up leaving because he thought the profits werent being shared fairly. Once the court determined that there was an agreement, the court still said that a partnership exists. o Court distinguished this case from the other because there was some mention of profits and profit sharing. SUMMARY: o You can have an oral agreement o And the agreement can lack many things

620.8202. Formation of partnership

620.8401. Partner's rights and duties

WEEK 3__________________________________________________________________________________ PARTNERSHIP CREDITORS: y y Creditor: The person who lent you something in and expects repayment. The enforcement of partnership obligations is the least uniform and most confusing of all aspects of American partnership law. -Thompson 640 N.E.2d 408,410

DISTINCT ASSESTS FOR COLLECTION ON JUDGMENT PARTNER FROM PARTNERSHIP: y 201(a); a partnership I an entity distinct from its partners y 203; property acquired by a partnership is property of the partnership and not the individuals y 307(c); judgment against a partnership is not necessarily a judgment against the partner. y 501; partner is not a co-owner of partnership property. y 401(a)(1); Thompson v. Wayne Smith Issue: Whether a creditor may collect from individual partners for debts incurred by the partnership? Yes. So long as the partnership assets are depleted or other scenarios under UPA 307(d) FACTS: y P hired D to build homes on Hilton Head SC. Dispute broke out, Smith sued both the Partnership and individuals in the partnership. Court awarded 107k against the partnership but dismissed against individuals. He was also awarded attorneys fees. y Then in Ohio turned the SC judgment in there where he believed the partnership to hold their assets. y Collected 2500k and exhausted the assets and filed new judgment in Ohio for the remaining cash. y Partnership argued that since SC vacated the judgment against individuals that Ohio must follow full faith and credit and res judicata. y Ohio trial court did enter judgmentwas on appeal. BUT while Ohio was being appealed, Smith filed case against Partner Thompson in Indiana and Summary judgment was entered for Smith in the full amount of 157k. After this judgment, Ohio ruled that each partner was responsible for a 1/3 of judgment. 9

Analysis: y SC ruled that a Partnership is a distinct entity and to prove against individuals, he would have to prove a K existed between each partner. (Modern View) y Court reasons though that there are 2 ways to prove individual liability. 1. Is against each individual and 2. is when partnership assets have been exhausted. And 3. If the Partnership is insolvent at the time suit is brought by individual debt (BUT is not the case here) y Exhaustion of Partnership is recognized in jurisdictions where liability is joint. y RULE: ONCE partnership assets have been exhausted, a partnership creditor becomes a creditor of the individualif Partnership prop. is insufficient for debt, it is to be held pro rata. Essentially, once the Partnership funds have been exhausted, it becomes joint and several. y 2nd Defense is that the suit against individuals is essentially an attempt to re-litigate the SC claim. y Difference between Joint liability and joint and several is that in joint, all parties must be sued but in the latter, just one party may be sued.but once all the parties are named, and the judgment is in place, the creditor may force any one of the debtors to pay in whole. y On appeal, the court affirmed, holding that a prior decision in another state vacating the judgment against the partner in his individual capacity was not res judicata. The court held that that decision merely established that the partner's individual assets were not yet at risk because the assets of the partnership had not been exhausted at that point in time. The court held that once the partnership assets were exhausted, the partner's individual assets could be used to satisfy the entire outstanding amount of the judgment. The court held that since it was proved that the partnership's assets were exhausted, no question of fact existed precluding summary judgment against the partner. y OUTCOME: The court affirmed summary judgment against defendant partner in plaintiff judgment creditor's suit to collect on a foreign judgment. y REAL ISSUE: o If the individual has separate k with the creditor = creditor of the individual =  Immediate Access Partners personal assets o Creditor of the Partnership  Must 1st attempt to satisfy judgment from partnership property y No initial access to partners personal assets  WHY? y Because if there is a creditor of a partnership, and a creditor of the individual, and the creditor of the partnership goes for the individual first, the individual creditor is SCREWED.  HENCE the exhaustion rule.  UNDER what circumstance (other than exhaustion) should a partnership creditor be able to access partners assets to cover for the partnership debts? (Martin v. Peyton) y BY stipulation of the creditor (we can collect individually) provision. y Other Independent Basis; i.e. if 1 partner went outside to scope of the other partners to strike a deal, etc. y Bankruptcy y What if you (as creditor) find out they havent been paying their bills, and you dont know how they will pay their debt, y Can take them to COURT; UPA 307(d); o d) A judgment creditor of a partner may not levy execution against the assets of the partner to satisfy a judgment based on a claim against the partnership unless the partner is personally liable for the claim under Section 306 and:

10

y y

o (1) a judgment based on the same claim has been obtained against the partnership and a writ of execution on the judgment has been returned unsatisfied in whole or in part; o (2) the partnership is a debtor in bankruptcy; o (3) the partner has agreed that the creditor need not exhaust partnership assets; o (4) a court grants permission to the judgment creditor to levy execution against the assets of a partner based on a finding that partnership assets subject to execution are clearly insufficient to satisfy the judgment, that exhaustion of partnership assets is excessively burdensome, or that the grant of permission is an appropriate exercise of the court's equitable powers; or o (5) liability is imposed on the partner by law or contract independent of the existence of the partnership. o ANY OF THESE CAN BE A BASIS FOR GOING AFTER. UPA 1997 collection against Partner; BAIL; IF you were the attorney, you should name in the complaint, ALL individuals in the partnership. Furthermore, many states assert that in order to bring a claim, all partners MUST be named. Exhaustion rule: 1) P liability= partnership assets first 2) receive judgment 3) court ordered writ unsatisfied 4) then pursue partners individual assets

LIMITED LIABILITY PARTNERSHIPS; y y y If you have a partner who is negligent, you will be shielded from such negligence. (NARROW) 306(c) allows for the innocent partner to be protected against k problems, torts problems, otherwise (quasi ks, quantum merit) A is an llp fails to pay for a printer is ordinary course of business. Printing co. is entitled to 500, if state has narrow protection of llp, which is true? A or b?

LLP LIABILITY SHIELD y y y 306(c) (BROAD PROTECTION) protects from contract, tort or otherwise. NARROW, negligence and malpractice. EVEN in an LLP, you cannot protect against your own malpractice, under 306(a) version.

MANAGEMENT NIGHTMARE y Question is always what is the scope of authority of the jerkoff who screwed up. National Biscuit v. Stroud: UPA section 15, FACTS: y D and Freeman entered into a partnership to sell groceries under the name Strouds Food Store. No restrictions in partnership agreement or managerial functions or authority. y Stroud advised P that he would not be responsible for any other delivery of bread but at the request of Freeman, they bought and sold bread in the amount of $171.04. y D and Freeman ended partnership and D was responsible for tying up loose ends. He thus refused to pay the Ps bill. 11

ISSUE: Even though there are no restrictions in the partnership agreement, can equal partners escape responsibility for partnership obligations by notifying a creditor that the individual will not be responsible for partnership debts incurred? ANSWER: NO, unless the partnership dissolves and that partner notifies the creditor before such transactions that make the debt are incurred. y y y Even if they would have contracted for different methods of payment, the payment of equality would be binding. Just change the facts to Freeman as an employee. Is that enough to change liability. The 3rd party was not on notice that he was a partner. Statement of Partnership Authority, 303(2) - may state the authority, or limitations on the authority, of some or all of the partners to enter into other transactions on behalf of the partnership and any other matter. BUT 103, and 301, require that the 3rd party MUST be notified..therefore, notice to a 3rd party is necessary. MUST HAVE STATEMENT OF PARTNERSHIP AUTHORITY AND NOTICE TO THE 3RD PARTY. REMEMBER employee could be acting under apparent authority and the outcome would be much the same.

y y y

Smith v. Dixon: FACTS: y Sale of land amongst a family and a partnership is made for farming. Eventually, the manager of the partnership WR Smith contracted to sell the land for 200k, and the dispute lies within. y Had actual authority to k for 225k but instead kd for 200k. BECAUSE he had apparent authority and the 3rd party was not aware of the provision of 225k, he thus acted within the scope of his authority. (outcome different if section 303 UPA applied) y Rule: The acts of a partner done in the ordinary course of business bind all partners. Unless authority is limited and 3rd party has notice. Rouse v. Pollard FACTS: y Elderly woman had a lot of money and attorney said that he could invest it for her. BUT he put it into his own private bank account. y Analysis is that the lawyer was using his own discretion to invest the funds. Partner would not be liable because other partner is not acting within the scope of the business. ROACH v. MEAD; y y y y Lawyer is broketells client he will pay him back. Cant pay him back, and files bankruptcy. Therefore is the partner liable for the loan? YES.here it is within the scope of the employment. It differs from the other case in that it was reasonable..( lawyer has handled business transactions for client before) Should give advice of interest, security.and therefore he didnt advise him of anything. He shouldve made him aware of various securities.

Notification to 3rd party 12

Section 301 (1) Each partner is an agent of the partnership for purposes of its business. An act of a partner, including the execution of an instrument in the partnership name, for apparently carrying on in the ordinary course of the partnership business, unless the partner had no authority to act for the partnership and the person with whom the partner was dealing knew or had received notification that the partner lacked authority. 303(a) (2) Partnership may limit authority, but (access to public records not enough for notification) 303 (f) non-partner not deemed to know limitation 303 (e) exception is for real estate - partner limitation is recorded in office that records transfers

Thoughts About These Cases: INVESTMENT DECISIONS BY A PARTNER; Right Results? Right Reasons? ROUSE: Ends up with no liability to the partnership, is this the right result? y What could she have done? y Get a letter from the firm.no longer just the individual partner responsible. y Even better, can I get some securities to make the partnership liable. MEAD y Court looked at it in a broader sense in that they looked at the scope as entailing ideas that they should have given advice on securities, interest, etc. Should the rule be road to hold the Partnership who didnt know about it, liable? y Think about it in terms of WHOS INTEREST DO WE PRIORITIZE?

FANARAS:

25k retainer, gets loan from client for 400k. Court rules that the retainer only held for the advice and that the loan agreement was separate from the legal agreement. WEEK 4__________________________________________________________________________________ MANAGEMENT SUMMARY AND FAIRNESS ANALYSIS: DUTIES OF PARTNERS TO EACH OTHER:

Meinhard v. Salmon FACTS: y Louisa Gerry leased to D the Bristol Hotel on 5th ave of NY for 20 years, ending April 1922, at the cost of 200k. y Salmon contracted with P in a joint venture. P was to pay D half of the money to reconstruct, alter, manage, and operate the prop. D was to pay 40% of the net profits to P for the 1st five years and 50% 13

thereafter. D was to have sole power to manage, lease, underlet, operate the building. Certain rights upon death existed for the 2. y Upon the termination, Elbridge Gerry had a reversion. Wants to demo the place but cant and contracts with D for 20 years with successive covenants, so totaling 80years at will of either party. y D does not tell P of the k with Gerry. D found out about the k and demanded that it be held in a trust of their joint venture. y Lower court held that P was entitled to half interest in the new lease and must assume responsibility for half obligations. D appeals. ISSUE: y Does the new lease carry with it the duty to extend such an obligation to his joint venture the new opportunity? y YES: o Duty is higher for a managing co-adventurer, and thus Gerry owed his co-venturing partner a stake in the new venture. It seems underhanded not to. o There was a close nexus between the new opportunity and the old venture. It was actually an enlargement of the first opportunity they were in. Since D was in control he should receive 51% and P 49%. Any nexus of relation between the new opportunity and the old business is key to evaluating. o A trustee is held to something stricter than the morals of the marketplace. Not honesty alone, but the punctilio of an honor the most sensitive o LOOK AT WHETHER IT IS AN ENLARGEMENT OF THE SUBJECT-MATTER OF THE 1ST VENTURE. ( proximity is an important factor) ROL-Each partner in a partnership owes the other partners a fiduciary duty to act in the best interests
of the partnership over the interests of the individual in matters concerning the partnership

DISSENT: y Not a general partnership, and no expectancy of a renewal of the lease and no intention that P would be a part of Ds business forever. P had the opportunity to renew his interest in the existing k between the 2. Dissent holds that it was a limited venture for a specific term. HYPO: y A and B have a partnership to build apartments in Atlanta. 2 weeks before the completion of the apartment complex, C offers A an opportunity to build single family home in Jax. A does it. Does A owe a fiduciary duty to B? o NO different venture all together according to Meinhart case. HYPO 2: y A and B form a partnership (AB Planes) to build a plane in Jax. 2 weeks before finish C offers A job to build train with AB engine. Engine design for AB planes is adaptable to trains. A does.does he breach duty to B? o Yes, o APPROPRIATION OF Partnership Knowledge and capabilities. Commonality of engine designs makes this a loyalty issue. Starr v. Fordham: FACTS: y P had become a partner at Foley Hoag in 1982, he was actively seeking to leave the firm in early 1984. During this time, the founding partners were also partners at Foley Hoag. 14

Fordham invited the plaintiff to join the new law firm Kilburn, Fordham & Starrett in January, 1985. P withdrew from Foley Hoag on March 1, 1985. The founding partners and another attorney, the defendant Brian W. LeClair, withdrew from Foley Hoag on March 4, 1985. The founding partners had divided the firm's profits equally among the partners in 1985. Each of the five partners received $ 11,602. In 1986, the firm's financial fortunes improved significantly. On December 31, 1986, the firm's profits were $ 1,605,128. In addition, the firm had $ 1,844,366.59 in accounts receivable and work in progress. They didnt factor in accounts receivable when they calculated his earnings when he left. Arg. 1: They were self dealing Argument 2; the business judgment rule does not apply if the plaintiff can demonstrate self-dealing on the part of the allegedly wrongdoing partner. GOOD FAITH ARG: judge then made extensive findings concerning the fairness of the plaintiff's share of the profit distribution. The judge found that the plaintiff had produced billable hour and billable dollar amounts that constituted 16.4% and 15%, respectively, of the total billable hour and billable dollar amounts for all of the partners as a group. The judge noted, however, that the founding partners distributed only 6.3% of the firm's 1986 profits to the P. judge noted that Fordham and Starrett were the sole shareholders of Fordham, P.C., and Starrett, P.C., respectively. As the sole shareholders of a corporate general partner, the judge concluded that Fordham and Starrett were personally liable for the breaches of fiduciary duty by the founding partners. The founding partners were not unfair in refusing to consider the plaintiff's accounts receivable and work in process for 1986 when they determined his share of the profits. The judge concluded that the founding partners were liable because they refused to consider billable hour and billable dollar figures when they allocated the firm's profits to the partners. Who won? PARTNERS OR Withdrawing partner. Partners got all work in progress, WP just got a larger percentage of profits already accounted for. Finders = originators Minders = managers got 28% (400+K) Grinders = billers (16% 100k) NORMALLY it is ok for Partners to figure out the profitbut when they are self dealing, meaning that the assigned profits to the GRINDERS, had a direct reflection on their own profits. The less that the billers got, the more they got. BUSINESS JUDGMENT RULE APPLIES UNLESS YOU ARE SELF DEALING!!!! THOSE who are self dealing (less you give one side, the more you gain), need to be fair. Even if you have some kind of legitimate business purpose need to be fair. D lured the biller and told him that origination is not a significant factor. Cannot hold weight though because is a misrepresentation claimFURTHERMORE, there is an implied notion of GOOD FAITH AND FAIR DEALING.which is not fiduciary duty. GF AND FD is not a fiduciary duty.

Analysis: y y y

FUNCTION: y y y y

y y

15

OTHER concern of P was, accounts receivable.BUT courts says NO! That long term lease was an obligation to pay.including the biller.and until your liabilities are taken out.and you reduce your liabilities below your accounts receivable you cannot get them. Profits are a residual to ascertain your debt. SO what do you do to avoid getting into this kind of situation? Get a DEFINITION of current liabilities (i.e. lease), provision that my WIP is not subrogated to the lease (you would have to add it in). o

y y

UPA 1997 404; 404(b) = Meinart Case..this is what resulted from this case. By the language in this, the duty of loyalty is limited to the following No A.A.I.C. y (1)Appropriations cant appropriate the partnership opportunity. y (2)Adverse Interests (cannot do things adverse to the interest of the partnership y (3)Competing (cannot do things that will compete with the partnership) Section 103; cant limit the duty of loyalty. AND in most states, can limit loyalty, but cannot completely nix the notion of loyalty. Hypo: A and Bare considering creating a public relations Firm CC to repair reputations of damaged sports coaches. Coach W and S agree to hire CC if CC takes them to the Carribean for discussions. A and B agree to the partnership. Both parties are to contribute costs equally, unless one party doesnt have the money. Prior to that agreement B says he had no cash so A put up all the money. In fact prior to signing the Partnership Agreement, B had more available cash than A had. A finds out B had the funds available, and claims B violates Bs duty of loyalty. Ans: No, violation of the duty of loyalty not 404(b)&(c). But possibly violates 404(d). Hypo: HALL OF Fame Felons is a general partnership in the business of auctioning sports memorabilia of OJSimpson and other notorious stars. The entity is cash poor and needs to buy items for eventual auction. Partner A had personal funds in a CD only making 1.5%. A offers to take those funds and loans it to HHF at 7%. This is the same rate as the banks charge on comparable loans. HHF accepts knowing nothing of As prior less profitable investing experience. Did A violate his fiduciary duties to HHF? Ans: No, although he is furthering his own interests it is not adverse to HHF by doing this so there is no violation of 404(e). The banks would charge the same amount. There is no taking advantage of anyone here. However, things get more questionable if the interest rate was 25%. WEEK 5__________________________________________________________________________________ KEEP in mind that things that occur PRIOR to the formation of the partnership. (404(b)) BUT in 404(d) it says nothing that looks to prior, during, or winding up 404 cont: If you further your own interest as a party, and nothing is adverse, look at subsection (d) but.you can further own interests. LOOK at 404(b) but compare with the other Provisions..(e) and (f). 404(c)DUTY of CARE: y Prohibits gross negligence, reckless conduct, intentional 16

o Gross Negligence: A conscious, voluntary act or omission in reckless disregard of a duty and of consequences to another. Hypo: Roger Clemmons and Wife Partnership owns a human growth hormone distribution company. Ule a baseball trainer won a suit against Roger personally for defamation when Clemmons claimed Ule lied about giving HGH to Roger and his wife. Ule sought to satisfy his judgment against Roger from the assets of the partnership. Neither Roger or the partnership are in any financial distress. Which is the most likely holdong? Roger prevails under 501

Hypo: S& G partnership there is no partnership agreement. Susan was losing faith in the partnership so she transferred her partnership interest to John. John told George I am going to find a new client base and receive a higher rate of return then you previously received and I HAVE A TRACK record to support it. George objects to Johns intrusion and files an injunction against john to keep john from participating in the business? Whats the likely court ruling? George wins under 503a3 and 502. George prevails b/c john only received a transferrable right to profits, losses, and distributions, not management. Transferees and Creditors of partner ARTICLE 5
501- Partner not co-owner of partnership property, he has no interest in partnership property which can be transferred 502- Partners transferable interest in partnership- the only transferable interest in a partnership is the partners share of profits and losses of the partnership and the partners right to receive distributions 503-Transfer of Partners Transferable Interesta) a transfer in whole or in part 1) is permissible 2) does not by itself cause the partners dissociation 3) does not, however, allow the transferee to participate in the management or conduct of the partnership business, or to access books and records d) upon transfer, the transferor retains the rights and duties of a partner other than the interest in distributions transferred

DISSOLUTION: y Most people are upset that they are losing the opportunity to make money in the future. PAGE v. PAGE: FACTS: y Partners entered into oral agreement in 1949 contributing 43k in first 2 years. Business lost money until 1957. Ds creditor is corp. owned by P (the supplier). Partnership did make money in 2 years but want to end anyway. y SO A and B own partnership, A is the creditor, B offers services, A wants to end partnership because Air Force base was opened and A wanted money for himself. y The former partnership was a limited partnership and provided for a definite term of five years and a partnership at will thereafter. Defendant insists, however, that the method of operation of the former partnership showed an understanding that all obligations were to be repaid from profits. He nevertheless concedes that there was no understanding as to the term of the present partnership in the event of losses. y ALL they had were a hope for profits so their really isnt an agreement that the profits would repay thator that there would be any profits. y D contends, when a partner advances a sum of money to a partnership with the understanding that the amount contributed was to be a loan to the partnership and was to be repaid as soon as feasible from the prospective profits of the business, the partnership is for the term reasonably required to repay the loan. y However, d failed to prove any facts from which an agreement to continue the partnership for a term may be implied. The understanding to which d testified was no more than a common hope that the partnership earnings would pay for all the necessary expenses. 17

HELD: reversed - If, however, it is proved that plaintiff acted in bad faith and violated his fiduciary
duties by attempting to appropriate to his own use the new prosperity of the partnership without adequate compensation to his co-partner, the dissolution would be wrongful and the plaintiff would be liable for violation of the implied agreement not to exclude defendant wrongfully from the partnership business opportunity. WRONGFUL DISSOLUTION.

y y

At will ----- P benefits TERM or UNDERTAKING (Until that term or undertaking has been accomplished): (IMPLIED INTO AGREEMENT UNTIL: o Loan is repaid (from profits) o Revenue goal reached o Debts are paid o Property disposed of favorably

At will: Plaintiff benefits

Dissolution Caused By Specified Term or undertaking:

Hypo: AB have a partnership, no written agreement, A loans 20k, business usually takes 5 years to make profit. B agrees to As decision to wait the 5 years before making profit. B decides wants out after 2 mos. Can he do this? o Case law suggests that they can imply a reasonable time to allow A to get repaid. y What if they stayed in business for 4 years? o Not really can say either waybut need to investigate the facts. FOR EXAM PURPOSES USE RUPA AND THE PAGE CASE BAD FAITH by DISSOLVING PARTNER? y Situation arrives when they start making money, one partner wants to drop the other. o BUT court didnt buy into this o He was put on notice and there werent any other instances of fraud, etc.

BAD FAITH BRINGING WRONGFUL DISSOLUION: y Can be an at will partnership but not to DEFRAUD partners. y Freeze out minority partners y Sells assets at inadequate price y FREEZE OUT A process, usually in a closely-held corp., by which the majority shareholders or the board of directors oppresses minority shareholders in an effort to compel them to liquidate their investment on terms favorable to the controlling shareholders. Hypo: A, B AND C form a partnership the partnership agreement states it is a partnership at will and that no partner are bound to remain a partners. Under the agreement a majority of the partners can demand that all partners make a required additional contribution when a viable business opportunity to the partnership demands it. The agreement also states if one partner cannot make a capital contribution then the non-partner must relinquish his interests and the other partners can terminate the partnership. As wife contracts a diseases and a is near bankruptcy trying to pay the medical bills Band C demand contribution of all partners consistent w the partnership agreement at a price that includes a 38% premium beyond the financed need for the investment opportunity. If b CANNOT MAKE THE CONTRIBUTION THEN CAN b AND c terminate the partnership? No most courts say. 18

CONSEQUENCES FOR TRANSITIONS OUT OF PARTNERSHIPS 8182 Maryland Partnership v. Sheehan: y Lease execution Sheehan y Withdrawal and assignment with old partnership y Lease rent / occupy y Withdrawal (of occupiers) y Default of lease. y ISSUES: Still liable for the lease? Yes. o Plus lease held that they were liable for all the years if defaulted. o AND argued that he never actualized it. But court holds it started when he signed the lease. o Can a partner be liable if they withdrawal from the partnership later?  RULE: Obligations or debts incurred while a partner is still in the partnership, partner will still be obligated after dissolution. GIBBS v. BREED, ABBOT & MORGAN y y y y y y Trust and Estate lawyers left one firm to another and with them took certain information, such as lawyers, etc. The former partners first sued to get money back when they left. Hence the Ds filed a counter-claim Court ruled that this information The manner in which partners plan for an implement withdrawals.is still subject to the constraints imposed on them by virtue of their status as fiduciaries. Issue 1: Did Gibbs breach FD in discussing joint move with Sheehan? No. Sheehan moved because of his own interests and is allowed to dissociate from the firm. Issue 2: Did Ps breach FD when giving up confidential info about other employees to new firm? Yes. Court finds that Ps were still part of the firm and had not submitted intent to withdrawal yet, and new firm had unfair advantage in recruiting new employees from old firm.

BOHATCH v. BUTLER & BINION y Bohatch met with Louis Paine, the managing partner over her concerns that Mcdonald was over billing Pennzoil. y Investigation ensued, Pennzoil was made aware but said satisfied with their coverage. y Bohatchs tentative distribution share was reduced to zero. y ISSUE: o Is there a duty not to expel someone for reporting suspected unethical conduct? o No. Partners may choose with whom they wish to associate, and they have no obligation to remain partners. o But argument exists against firing those who whistle blow because of wrongful conduct. If this is or was the case, such whistleblowers wouldnt come forward. o COURT rejects this because the fundamental aspect of a partnership is trust and a whistleblower thus dissipates this aspect. DISSOLUTION UNDER UPA 1997: 1. Page 116 Dissolution Overview: 1. Dissociation (step 1) ceasing activity as a partner 19

2. Dissolution (step 2) eventually leading to termination, think of as next step for termination. Event that leads toward the end of activity all together. Still duty to pay bills during dissolution. 3. Winding up (step 3)finalizing the termination, when the entity no longer exists and monies left over can be distributed. Dissociation Causes WEEI 601 -Will of Dissociated partner -Event per agreement -Expulsion by partnership -Incapacity ( financial, physical)

WEEK 6__________________________________________________________________________________ TAXATION: Proprietorships: Businesses wholly owned by a single individual. Unincorporated Business Forms: DISSOLUTION UNDER UPA 1997 See Pg. 116 for more

Dissolution Overview (a 3 step process) - Dissociation o End of activity as a partner - Dissolution o The next step toward termination  An event leading toward the end of activity all together. - Winding Up o The final termination where the entity (partnership) no longer exists  You are paying the final bills and splitting up the profits. Dissociation Causes - WEEI 601 - Will of Dissociated Partner o If partner says hey I want out. - Event Per Agreement o There is an event in the future agreed to in a partnership agreement that triggers a dissociation  DUI conviction  Felony Conviction - Expulsion by Partnership - Incapacity (physical, financial) EXPULSION TYPES PUJI [ 601 (3) (4) (5) (6) (7)] ( These are permitted ways expulsion can happen) - Partnership agreement - Unanimous Vote of Other Partners If: o Unlawful to be in business with that partner o Partner transfers his partnership interest or a substantial portion of his interest (75%, maybe more than 50%)  Profits/losses and distributions ( 502) 20

Hypo: Sam, Jule, Ginger are general partners as subcontractors to Tanwater, providing private security the state department in Angola. B/c Sam was overly aggressive in this tasks, 20 civilians were killed while he was on duty. A U.S. court issued an order prohibiting him from engaging in any of the firms activity. There is no provision for expulsion in the partnership agreement. Nor did the court order address the issue of expulsion. Jule and Ginger nonetheless voted to expel Sam. Sam objects b/c there is no authority under the court order or the partnership agreement for expulsion. Has Sam been properly expelled? Yes, 601(4)(i) it is unlawful to carry on partnership business w/that partner.  Hypo: Sam and Jule decide to have Sam back. Sam then sells of his rights to profits, losses, and distributions on dissolution to Jamie. Nothing in the partnership agreement prevents a transfer of interests. Jule and Ginger again expel Sam. Which of the statements are true under UPA1997? 601(4)(ii) This is a proper dissolution b/c of the transfer of a substantial part of the partners partnership interest. Judicial Determination b/c: o Wrongful Conduct o Breach of agreement or duty o Not reasonably practicable ( Bohatch) materially affected the business Incapacity of partner o Financial (Bankruptcy) o Physical (Guardian) o Or JAV judicial determination b/c of partnership agreement-wrongful conduct, breach of agreement or duty, not reasonably practical//

Power to Dissociate; Wrongful Dissociation - 602 (a) a partner has the right to dissociate at any time, rightfully or wrongfully (b) a partners dissociation is wrongful only if: (1) it is in breach of an express provision of the partnership agreement; or (2) in the case of a partnership for a definite term or particular undertaking, before the expiration of the term or the completion of the undertaking: (i) partner withdrawals by express will, unless the withdrawal is within 90 days of another partners dissociation or death (ii) the partner is dissociated by judicial determination (iii) the partner dissociated by becoming a debtor in bankrupcy.

Rightful <----------------Dissociated by WEEI 601 ---------------| | All that is not Wrong

Wrongful | |

Breach Agreement Premature from term/undertaking  unless other Ptr incapacity, bad acts  Own Incapacity (Financial Only)  Judicial -Wrongful Conduct -Not Practicable to continue Also under (c) wrongful ptr. liable for damage

Once we say who is right or wrong under 601/602 21

Hypo: Partnership X is in the business of selling whole life insurance. The partnership agreement states(1) it will remain a partnership for 2 years while it tests the market and (2) a partner cannot also have a financial interest in any entity that is in a related business of the partnership. Partner G invests in company Y that sells all types of life insurance, but defers receiving any commissions from company Y until the 2 years test run of the partnership X. Is that partner properly described under UPA1997 as wrongly disassociating himself from partnership X? 602 what he did was in direct violation of non-competition provision. Hypo: X, Y, and Z form a partnership to build 2 condos. Just before the 2nd is completed Z tells X and Y he has to stop working with them b/c his 2 year old son is sick. Z indeed stops working. Under UPA 1997 has Z wrongfully dissociated himself from the firm? Yes, under 602(b)2 Hypo: Zs son has cancer and Z has no health insurance and Zs bills far exceed his income forcing into bankruptcy before the 2nd Condo is completed. Z tells the partnership he will work b/c he has no other choice. Under UPA 1997 has Z wrongfully dissociated himself from the partnership? Yes 602(b)2(iii) Dissolution Big Picture Rightful ---------------------Dissolution By WEEI 601 --------- Wrongful

Actions of Non-Dissociated Partners Or Rightful Partner 603(a) - 801(1) (2) 603 (a) If partners dissociation results in dissolution and winding up, Article 8 applies, otherwise Article 7 applies (b) Upon partners dissociation (1) the partners right to participate in the management and conduct of the partnership terminates, subject to 803 (2) the partners duty of loyalty under 404 terminates (3) the partners duty of loyalty under 404 continue with regard to matters arising before the partners dissociation, unless the partner participates in the winding up of business pursuant to 803 701 Purchase of Dissociated Partners Interest (a) if a partner is dissociate from a partnership without resulting in a dissolution and winding up, the partners interest must be purchased for a buy out price pursuant to section b (b) the buyout price of a dissociated partners interest is the amount that would have been distributable to the dissociating partner under 801 (c) damages for wrongful dissociation under 602, must be offset against the buyout price, interest must be paid from the date the amount owed becomes due to the date of payment (d) a partnership shall indemnify a dissociated partner whos interest is being purchased against all partnership liabilities, whether incurred before or after dissociation, except liabilities incurred by an act of the dissociated partner (e) if no agreement of payment to dissociated partner within 120 days, partnership shall estimate buyout price (h) A partner who wrongfully dissociates before the expiration of a term or undertaking, is not entitled to payment until the end of the term, unless the partner establishes to a court that earlier payment will not cause undue hardship to the business of the partnership. 702 Dissociated Partners Power to Bind and Liability to Partnership

22

(a) for two years after a partner dissociates without resulting in a dissolution or winding up, the partnership is bound by an act of the dissociated partner which would have bound the partnership under 301 only if the 3rd party (1) reasonably believed that the dissociated partner was then a partner (2) did not have notice of the partners dissociation; and (3) is not deemed to have had knowledge under 303 or notice under 704 (b) a dissociated partner is liable to the partnership for any damages caused to the partnership arising from an obligation incurred by the dissociated partner after dissociation for which the partnership is liable under (a) 703 Dissociated Partners Liability to Other Persons (a) A partners dissociation does not by itself discharge the partners liability for a partnership obligation incurred before dissociation. A dissociated partner is not liable for a partnership obligation incurred after dissociation, except as otherwise provided in subsection (b) (b) A partner who dissociates without resulting in a dissolution and winding up of the partnership business is liable as a partner to the other party in a transaction entered into by the partnership, within 2 years after the partners dissociation, only if the partner is liable for the obligation under section 306 and at the time of entering into the transaction the other party (1) reasonably believed that the dissociated partner was then a partner (2) did not have notice of the partners dissociation; and (3) is not deemed to have had knowledge under section 303 or notice under 704 (c) By agreement with the partnership creditor and the partners continuing the business, a dissociated partner may be released from liability for a partnership obligation. 704 Statement of Dissociation (a) A dissociated partner or the partnership may file a statement of dissociation stating the name of the partnership and that the partner is dissociated from the partnership. (b) A statement of dissociation is a limitation on the authority of a dissociated partner for the purposes of section 303 (c) For the purposes of section 702 and 703, a person is deemed to have notice of the dissociation 90 days after the statement of dissociation is filed. 801 Events Cuasing Dissolution and Winding Up of Partnership Business Musts Dissolve and Wind Up (a) P/S at will a. Express will of a non-dissociated partner (b) P/S for term or undertaking a. Express will of at least half of remaining partners b. Expiration of term (c) P/S agreement a. illegal Hypo: X, Y, and Z are partners in the carpentry business. There is no partnership agreement or limits on the time or the endeavors of their business. Z tells his partners he is leaving b/c he wants to go to law school. He demands a dissolution and winding up of the partnership. X and Y object and want to continue the partnership w/out Z. Will Z be able to cause the dissolution of the partnership under UPA 1997? Yes 801(1) Hypo: X, Y, and Z form a partnership to build 2 condos. Before the 2nd condo is completed Z files for bankruptcy b/c of mounting medical bills for his 2 year son. But Z wants the partnership to continue b/c he believes he can soon receive ? Yes 602(b)(2)(iii) and 801(2) even if either X or Y change their minds.

Hypo: Z tells X and Y he has to stop working for the partnership and he files bankruptcy. On june 1 Z files bankruptcy and ceases activity w/ the partnership, but X and Y waqnt the part to continue w/out z b/cthey have 23

a replacement for him w/out any loss to the partenrshiup. Even though Z us the oine unable to perform the duties iof the partenship. Z claims (1) he is entirtled to cash for the value of this part interests as Hypo: In the above case where the partnership continues w/out Z. Zs withdrawal causes the partnership to discontinue working on the condo . X and Y had to pay the purchaser 50,000 as a partnership obligation. X and Y tell Z they will deduct the 50,000 from the amount Z would have otherwise been entitled to receive when they bought him out. Can X and Y deduct the 50,000 from Zs buyout price under the UPA 1997? Yes, under 801(2) and 701(c). Dissolution and Winding Up --------------WHEN BUSINESS CONTINUES Rightful ---------------- (1)Dissociation By WEEI 601--------------| | | | V Actions of Non-dissociated partners or rightful partner 603(a)- 801(1)(2) | Wrongful =liability/Damages | | | | Buyout minus Damages (701c) Wait for Term (701h)

------------Buyout------------- or Continue Business

When the Business Winds Up: Rightful -------------Dissociation By WEEI 601 ------------- Wrongful - participation in wind up - no participation in wind up - judicial supervision of wind up - no wind up supervision - charges to account/ Damages Lingering Issues on Wind Up: y Change Mind Option (802) o After dissolution before wind up o Resume operations o Preserve 3rd party rights y Pre Dissolution Transactions Still Binding (804) y Post Dissolution filing of statement of dissolution can limit liability. Partnership Accounting: Rudimentary Formula For balance Sheet: Kind of a snap shot for that particular time Assets = liabilities + equity: To see the financial condition of a transaction: Assets: | Cash $10,000 |

Liabilities 0 Owners Equity $10,000

24

Liabilities is money that is owed but not paid out yet such as accounts payable or bank loan, so still considered part of assets. RUDIMENTARY FORMULA FOR PROFIT AND LOSS STATEMENT: This reflects expenses and income of a period of time. (aka: Income Statement) Revenue Expenses = income Balance Sheet (year 1) ------owners equity -------Balance sheet year 2 Profits and Loss || V Reflects operations between year 1 and 2 Ask them did your accountant manage the P & L from year 1 and 2. NET CASH FLOW STATEMENT: Eliminates those items that dont really reflect the cash. y Keeps track of cash in / cash out. y Gross Receipts o Less expenses = y NOI o Less mortgage Payments = y Cash Flow Before Tax y Income Tax Savings (add on) = y Cash Flow After Tax Purpose for examination of financial statements -when investing in a business - when buying the business outright -when lending to our buying goods from the business -to get accurate financial picture to minimize exposure (enough liquidity to repay debts_

Over what period of time do we track the company? y Accounting Periods: o If we close our books on Dec. 31st I called a calendar year. o Fiscal Year: Matching income and expense items and CASH v. ACCRUAL Accounting Method Item Income Cash Received Accrual Earned

25

Expense

Paid

Obligation incurred

HYPO: Dec. 2005 Services and billings by A, receipt of bill by B. Cash Accrual Deduction to B, Income to A Jan. 2006 Payment by B, receipt by A. Deduction to B, Income to A

WEEK 7__________________________________________________________________________________ Introduction to Business Forms: Floating in the Legal Universe Reasons for Picking Certain Business Forms: y y y Protection from 3rd parties (limited liability) Protection of money Taxes, etc

Protection Against Others Liability Shield: y Sole proprietor: Single individual with no filing. o No shield against personal liability. y General Partnership: More than one person in business o Shield only for activity outside the scope of business activity. o Joint and Several liability for business activity. y Limited Partnership: o Shield of limited partner, liability for general partner  Except own misconduct (306(c))  Unless active participation  No management for limited partner basically just an investor  If Limited partner takes part in management he may become a general partner Limited Liability Partnership - shield of all partners against personal liability - except own misconduct 306 - unless active participation y Limited Liability Company o Shield of all partners even if active participation o LLC BASICS o 1 or more members o Articles of organization608.407 File with state Contains address, principle office, registered agent for service of process, signed by 1 member Option to ID member/manager Member managed by default 608.422 o Contribution 608.421 o Cash, property, services, promissory note w/ cash guarantee 26

o Profits and losses allocated per operating agreement o Duration is perpetual, unless operating agreement specifies dissolution via time or event Florida LLC Act re Operating Agreement 608.423 o Can be oral, but writing trumps oral if conflict o Can be created before, after, or time of filing articles of organization o Can take effect on formation or other date o Cannot unreasonably restrict a right to information or access to records 608.423(1) Hypo: So which statement below illustrates how are LLCs and S Corps are both different from a sole proprietor? Both the LLC and S Corps have shields against personal liability, sole proprietors do not. LLC vs. S Corp Unlimited members 100 shareholder limit Members can be corps(either c or s) shareholders cannot be corps or LLCs Members can be non-US residents shareholders cannot be non-US residents No tax free mergers, stock swaps, reorganizations tax free mergers allowed Chameleon management reqd board of directors (exceptions) LLC Fiduciary Duties Federal Taxation Among Entity Types: Proprietorship ( sole owner in owners name) - Profit or losses are reported on owners personal income tax return Unincorporated business forms ( GP, LP, LLP, LLC) - Partnership with two or more partners must provide each partner with K-1 form informing them of the share of profits or losses, these are then reported on individual income tax returns, Taxation is imposed only at the level of owners, not at the entity level C Corporations - Double taxation, entire taxable income for entity is taxed, then each partner or shareholder reports their profit or losses for their individual income tax return. S Corporations - Similar to taxation of unincorporated business forms, 100 shareholder max and cannot be nonresident aliens.

y y

Taxable Income Range is Established Within that Range, the tax is computed on: o Set amount at start of the range o After starting amount, a % is used to compute additional tax until the end of the range.  % is the marginal rate  Marginal rate is progressive y Marginal = table rate going forward w/n bracket y Effective = average of rates (tax + taxable income)

TAX PLANNING AS A PRIORITY? Consider that you know that you will pay taxes but not always certain about liability. Therefore, protection of liability often takes precedent. y Taxes o Certain 27

y y

o Immediate Bracket Buster o Minimize tax for highest bracket owners (LLC allocation) Business form: o Small = pass thru o Larger corp or independent cash rich = retain earnings & defer taxes while getting appreciation and interest.

______________________________________________difference of liability planning. y Liability shield o Uncertain o Unknown y LLCs are taxed like Partnerships. Meaning that the partners pay the tax only once.

C Corp Double Whammy [On 75k taxable income @ 35% rate] y y Corp Tax - $13750, owners 21437 = total tax burden 35,187 (48%) Unincorp tax 0 owners 26250 = 26250 (35%) Corp is 34% increase.

S Corp y y Same Pass through treatment 100 shareholders max o Individuals only (no corps or llcs) o Exception for certain trusts One class of stock

Tax Planning on rates: y Try to get your client the best tax rate.

Accumulation C-Corp. Planning Advantage y C Corp retained earnings not taxed until sold at more favorable rates (e.g. post retirement) Meaning that they will be at a lower taxable rate when they retirenot as much coming in. y Inincorp and S corp annual allocation taxed each year at individual rate. Capital Gains Tax -capital assets: assets held for profit making or investment purposes -tax in on the gain -short term ( 1 year or less)= ordinary rate, usually higher than long term -long term (more than one year)= 15% -Strategy

CORP GENERAL PARTNER MODEL FOR TAX SHELTER A business form was created that assured that losses could be passed through to investors, that investors had no personal responsibility for losses, and that the promoters (corp gen partner) of the tax shelter could run things without personal responsibility for the debts and losses arising when the business ultimately collapsed. 28

LIMITED PARTNERSHIPS WITH CORPORATE y Tax Shelter Rationale: o page (139) a business form was needed that assured that losses could be passed through to investors, that investors had no personal responsibility for losses, and that the promoters of the tax shelter could run things without personal responsibility for debts and losses arising when the business ultimately collapsed. (Just want to make sure they have all possible advantages without the downside.) o Note: There is no law preventing a board member of a corporate general partner from being a limited partner as well by investing in the limited partnership. In Re USA Cafes: - General Partner (the two brothers own virtually all the corporate gen partner) was owner 47% of Limited Partnership ( USA Cafes) - General Partners board members were paid side purses(15-17 mil side deal) to sell Partnership to Metsa Acquisitions at an unreasonably low price - Ps claim Good Faith and Fiduciary Duties principles apply here and board members breached 404 duty of loyalty - Issue: Do the directors of a corporate general partner owe fiduciary duties to the partnership and to its limited partners? YES - If youre in a TRUST relationship you cant WASTE the assets. VENTURE CAPITALIST FIRM: y OVER 15 BILLION given as basically private equity. y Raising money for ventures is what they do. y Venture Capital Scheme: o Investors to v.c.s gen partners, then to give money raise all capital, management, etc., portfolio co., and then they retain preferred shares / voting rights. VC /General Partner: can raise all capital, has the management expertise, can get potential new funding VC: wants preferred shares, and voting rights, and conversion rights (into common stock) VC: doesnt put money in only one company; they put it in a portfolio of companies (this usually lasts 7 to 10 years and they typically specialize in a particular area) In Re Spree.com Corp: y Ps want to do business with V.Cs (TCV) and Spree.com, and the director makes harsh statements while Spree.com was trying to make money. y Sued for breach of confidentiality and breach of fiduciary duty. y But the court says that they would have had to disclose the info about not having money and hence it is not confidential. y The other claim is tortious interference: intent by D to harm, y Issue: Did the statements made to the reporter and thereafter published constitute a wrongful disclosure of confidential material as defined by the parties agreement? No. In the course of soliciting 3rd party investors, P would have been forced to make a complete disclosure of its financial condition to investors. Since any information that becomes publicly available is no longer confidential information, the statements indicating that P is running out of cash do not provide the basis for a claim of breach of contract. y Potential breach of fiduciary duty, but none here probably because of loophole in confidentiality clause. But corporate general partners do generally have FD to limited partners. Adverse Interest to partnership. 29

LLCS: y LLCs were motivated by the pass through (taxing) treatment of the IRS. y BUT they are different in management structure. o Chameleon management Structure:  LLCs have members, not shareholders.  Instead of having a board of directors, there is a manager.  AND thus the Chameleon nature is the choice of who manages. -member management - OR single manager o Similarly file articles of organization which is essentially the operating agreement that goes through the details of the liabilities and responsibilities of the members of the LLCS. y Good question isshould an LLC have details like Corporations? o One reason is creates a good paper trail. o May enhance professionalism LLC basics 1 or more members Name= limited liability company or limited company LLC or LC Articles of Organization 608.407 - File with state - Contains address, principal office - Option to ID member manager selection - Member managed by default Contribution 608.422 - Cash, property, services, promissory note Profits and losses allocated per operating agreement Duration is perpetual, unless operating agreement specifies dissolution via time or event. Florida LLC Act re Operating Agreement 608.423 Can be oral, but writing trumps oral if conflict Can be created before, after, or time of filing article of organization Can take effect on formation or other date Cannot unreasonably restrict a right to information or access to records 608.423 (1) Cannot eliminate duty of loyalty or duty of care 608.423 (2)

LLC v. S Corp: LLC: y y y y y

Unlimited members Member can be corporation (C or S) or LLCs Members can be non us residents No tax free merger, stock swaps, reorganizations Chameleon Management

S Corp: y 100 shareholder limit y Shareholders cannot be Corps (C or S) or LLCs y Shareholders cannot be non-US residents y Tax free mergers, etc., allowed 30

Required Board of Directors (exceptions)

LLC FIDUCIARY DUTIES: y Blackmore Partners, LP v. Link Energy LLC: could see test question y Link Energy is an LLC formed in hopes of assuming and continuing EOTT Energy Partners, LP upon emergence from bankruptcy. (Related to crude oil sales) y P is an investment partnership who were unit holders. y Bought them and the creditors became a senior unsecured creditor who would get 9%. y Link was in bad shape and decided to sale to Plains All American Pipeline, LP. According to Link operating agreement, the Board of directors could effectuate the transaction without a vote from unit holders (members). Most assets have been sold, and is in the process of winding up. y Link eventually sold units for below $1 a unit down from $5. y The shady thing was that there was 25mil paid to the 9% creditors, they would waive their covenants. y Complaint alleges that there was an alternative proposal, meaning that they wanted to have the company to remain independent and not to go under and also that Chevron/Texaco wanted to take over marketing operations which would have been lucrative as revenue and allows improvement of the balance sheet. y To combat the motion to dismiss, must show an inference of disloyalty or lack of good faith. y The inference was that the actual agreement could not have been any worse for the members. And thus the motion to dismiss was denied but in the factual ruling of the trial, the Company was found to be in the ZONE of insolvency. AND thus their fiduciary duty shifted from the members to the Creditors. y The final result of the case notes that there was no other factual instance that there was a viable alternative. y When the operating agreement gives the managing partner power to make decisions without the members, could violate fiduciary duty. However, perhaps paying off creditors was in the best interest of the partnership and there was no other viable option. The closer you get to a business failure, the more the court is going to say they can use their business judgment of whether to keep the money for the members or pay the creditors and if they pay the creditors it will probably be okay. Elf Atochem North America, Inc. v. Jaffari and Malek LLC y Made airplane maskant and the plaintiff and the d formed an LLC. The benefit was to get the EPA friendly product. y P put up a mil and got 30%. D gave the rights to the product for 70%. y Operating agreement had arbitration clause to exclusive jurisdiction in California. y Elf signed and Jaffari signed but not the LLC formed together. y P trying to avoid arbitration clause because they want the benefits of Delaware law. y Court dismisses for lack of subject matter jurisdiction because of the arbitration clause. y But it is the members that are the real party and the LLC is just a circumstance of the members. y BUT the real underlying rationale is that LLCs have maximum authority to create stipulations in the operating agreement, including but not limited to removal from domiciled state to state of choice. y Courts will bend over backwards in Delaware to give LLCs, especially managing parties, maximum rights without breaching fiduciary duty. y LLC Operating Agreements are most akin to PARTNERSHIP AGREEMENTS. b/c it outlines the parties responsibilities and organization. y BUT cannot waive fiduciary duties. 31

Issue: May the members of a limited liability company, though the use of a forum selection clause in their membership agreement, vest jurisdiction in a particular forum? y YES. Delaware Limited Liability Company Act provides broad discretion in drafting LLC agreement. The policy of the act is to give maximum effect of the members freedom of contract to govern their relationship provided that they do not violate any mandatory provision of the Act. y Red flag operating agreement and statutes disagreement Abry Partners V, L.P. v F & W Acquisitions LLC y FACTS: y P is a group of entities affiliated with private equity firm ABRY (Buyer) bought a portfolio from another private equity firm Providence Equity Partners (Seller). The portfolio company that was purchased by Ds (company) was in the business of publishing magazines. y Purchase agreement was to only be contained within the 4 corners of doc. y Ps look to rescind contract due to undisclosed financial conditions. y Issue: Is the Buyer permitted to seek rescission in this court despite the exclusive remedy of terms of the Stock Purchase Agreement? YES, see below y Agreement is against public policy if 1) the Seller knew that the contractual representations and warranties were false or 2) that the Seller itself lied to the Buyer about a contractual representation and warranty. LEXIS NEXIS: Defendant portfolio company seller, a sophisticated private equity firm, filed a motion to dismiss the complaint of plaintiff buyer, a similar type of firm, which sought to rescind the parties' stock purchase agreement (SPA) and asserted claims of fraudulent inducement and negligent misrepresentation. Alternative claims for damages were also sought. The parties entered into the SPA for the buyer's purchase of a portfolio company. The SPA indicated that the buyer only relied on representations and warranties within the four corners, it limited the liability of the seller for any misrepresentation of fact contained therein, and it provided that an indemnity claim was the buyer's exclusive remedy. Thereafter, the buyer filed suit, alleging that the financial statements contained material misrepresentations, resulting in excessive overpayment. The seller sought dismissal based on failure to state a claim. The court initially noted that due to the forum selection clause and the choice of law principles of Del. Code Ann. tit. 6, 2708, Delaware law was controlling. Further, the complaint was pled with sufficient particularity pursuant to Del. Ch. Ct. R. 9(b). The court found that as the parties were sophisticated, the exclusive remedy provision was enforceable to the extent that the seller did not make intentional misrepresentations or act with knowledge of the falsity thereof. However, if the buyer showed knowledge or intentional misrepresentations, then the limitation provision was invalid as against public policy. The court granted the seller's motion with respect to the negligent misrepresentation claim and it granted the remaining claims to the extent that the buyer could not show that the seller acted intentionally or with knowledge of falsity. In the event that such knowledge or intentional misrepresentations were shown, the motion was denied. y Alleged fraudulent scheme: o 10 x EBITDA (earnings) = higher purchase price (earnings before taxation, etc.)  Overstated earnings + understated Expenses, = higher EBITDA = higher prices (ie. Higher base to apply the multiple) CASE = For all the artful drafting, cannot completely release your client from liability if fraud exists. 32

Poore v Fox Hollow Enterprises FACTS: y Campbell filed motion although he is/was not an attorney, because he believed D is not a Corporation and thus he could represent them or they could be represented without a licensed attorney. y IS LLC more corporate like or partnership like? More corporate like in terms of representation since there is a certain shield of liability with the members of the LLC that acts like shareholders of the corporation. y Issue: Should the Court apply the theory of corporate representation in this case? Yes, LLCs are required to have legally certified representation since the LLC is more like an artificial entity and not a natural person. Marie L. Kasten v Doral Dental USA, LLC FACTS: y P was given 23.1% membership interest in D as part of a divorce settlement. y D began negotiating with potential buyers, P wanted access to certain docs (business records, financial/tax statements, etc.) y They complied with some but not all.she wanted emails to/from/by. Court ruled e-mails not docs or records but communications. She could review other correspondence. y Emails can be company documents and drafts, LLC act requires managers to provide info of all things affecting members doesnt limit docs to only tax articles. y Drafts are company documents. y Another factor is whether the request is too burdensome requires balancing laws bias for accessing the costs to the LLC. Supreme Court Ruled they should have access to e-mails and drafts but must be relevant. FLORIDA LLC ACT re Operating Agreement 608.423: y y y y y Can be oral but writing trumps oral. Can be created before, after, or time of filing articles of organization Can take effect on formation or other date Cannot unreasonably restrict a right to information or access to records 608.423(1) Cannot eliminate duty of loyalty or duty of care 608.423(2)

WEEK 8__________________________________________________________________________________ CORPORATIONS: Mistrust articulated, limitations imposed, but then removed? y Incorporations for business was commonly deniedbecause or fearof encroachment upon the liberties and opportunities of the individual. Fear of the subjection of labor to capital. Fear of monopoly.some insidious menace inherent in large aggregations of capital, particularly when held by corps. y The general laws long embodied severe restrictions upon size and scope of corporate activity, were in part, an expression y Does the state of incorporation matter? Traditional Statutory Corporate Scheme 33

 Directors/ ultimate authority to bind/act the corporation; fiduciary duty to corp and shareholders; set policy Officers/ delegated management; answer to directors; implement policy Shareholders/ elect directors; non-managers Louis K. Liggett Co. v. Lee: y Notes: 2. California makes Corps incorporated in other states but do business in California follow Cali Corporate Disclosure Act. y y y y y y y y Predictable Attract and Retain Quality Directors/officers Statutory flexibility to self manage (contractarian freedom) Court experience and stocked w/ corpspeak Bar corpspeak legislative listens. Contractarian Freedom: FIRM is the entity that equity owners contract with. Corpspeak: Protecting your own against your own. Dont have to reimburse the shareholders History of Corps and limits in the US and why the limits were withdrawn.

Dole Food Co. v. Proxy Statement: FACTS: y Dole Hawaii was moving to Dole Delaware. y Moved to Delaware because Delaware is known to be most advanced and flexible Corp law. y Move will only effect company domicile. Contractarian theory Nexus of Contracts Capital, Risk, Management(equity owners) | v Labor (employees) >>> Firm <<<< Debt Capital(creditors) | v Good & Services Predictable Case Precedents, which allows corps to: Attract and retain quality officers/directors Statutory flexibility to self manage (contractarian freedom)

Chapter 6: Formation of a Closely Held Corporation: y Some states will determine filing fee on amount of authorized shares. y If business activity is in one state think about incorporating in that state. y MBCA15.05 (c) 34

Shareholder Agreements: y y y y y y What is the name of the doc that legally creates the corporation? o Articles of Incorporation Can they be printed? o Yes Can articles be in foreign language? o No. Must be written in English Must there be a corporate seal? o No, not required, but should do it. b/c it can verify authorized transactions by using seal. Which list below is the full range of those who may execute the articles? o Any fiduciary, a board director, chairman, etc. Page 214 is example of articles of incorporation. o What if ab just ended in stores. Not valid because must signify it is incorporated. o What if existing corp was named ab software store. (section 4.01) Must be distinguishable. o What if submission was date of mailing? Is that enough? Is a difference between mailing and filing (2.03) says, Corp. existence begins when articles are filed. Duration of entity: o I want the entity to die when I do.  Put it in the articles.or Any lawful purpose  BUT remember articles are public doctrines, may want to put items in your bylaws instead. o Registered Office:  Which office should be the registered office? Your or theirs? y Should have one place to be served with process.  What happens next? Look at section 2.05.

In Most states you only need one or more person as an incorporator. y y In most states need 1 or more board of directors, 9 states you need 3. FLA says if you have shareholders with preemptive rights, that must be in ARTICLES. Preemptive rights means that shareholders have rights to buy

How much money do you have to have in most states? y None but in DC it is $1000. LOOK at check list page 220 221 1-8. WEEK 9__________________________________________________________________________________ Premature Commencement of Business: y Promoter (Fiduciary Duties) (MMOPP) o Person who acting alone or in conjunction with one or more other persons, directly or indirectly takes initiative in founding and organizing the business or enterprise of an issuer.  Material Fact Disclosure  Misrep. Of facts avoidance  OR  Personal interest disclosure y Of her transactions re: corporate enterprise 35

Personal Gain Avoidance y At the expense of Corp. Promoter Enemies SCCCs o Creditors, other promoters, other corps.  Subsequent purchasers of corp interests (suckers)  Co promoters  Corps.  Creditors o Creditors should be able to sue because of conversion.

Stanley J. How & Associates, Inc. v. Boss FACTS: y Facts dont make clear if corp. was ever formed. Project becomes abandoned and Architect does not get paid. y Issue: Is the person signing for the nonexistent corporation liable under the contract if the corporation subsequently does not materialize? YES. o This would make the promoter liable to the plaintiff unless there was the unambiguous intent that the contract was construed to mean 1) that the plaintiff agreed to look solely to the new corporation for payment 2) that the promoter did not have any duty toward the plaintiff to form the corporation and give the corporation the opportunity to assume and pay the liability. o The person signing for the nonexistent corporation is to be held personally liable, unless the intent is clearly expressed otherwise. o What if the promoter relies on the attorney but the attorney screws up, is the promoter still on the hook? Promoter is still liable. Robertson v. Levy: FACTS: y RULE 2.04 y Can the president of an association that filed its articles of incorporation ( which were first rejected but later accepted) be held personally liable on an obligation entered into by the association before the articles of incorporation has been issued? YES. y MBCA section 146: If an individual or group assumes to act as a corporation before the certificate of incorporation has been issued, joint and several liability attaches. y MBCA section 56 provides that the corporation comes into existence only when the certificate has actually been issued

DISREGARD OF THE CORPORATE ENTITY: To bleed is not to pierce Piercing the Corp. Veil: Bartle v. Homeowners: FACTS: y Builders (subsidiary) y Build house at cost 36

y y

COOP members Vet Cooperative (Parent) o Corporate veil will be pierced only when there is fraudulent use of subsidiary by the parent or when the parent has committed acts with the subsidiary to its benefit and to the detriment of the creditor. No fraud or act by D injuring creditors by depleting assets or otherwise. o Dissent in this case simply says that the builder was simply an AGENT of the Parent. Same company. o Generally speaking, the doctrine of piercing the corporate veil is invoked to prevent fraud or to achieve equity o These were separate corporations and it is within the law to form a corporation for the very purpose of escaping liability.

Dewitt v Fleming Fruit Co FACTS: y Alter Ego Theory: When the individual uses the corp. as a faade. y FACTORS courts look at: o Gross undercapitalization o No corp formalities o No payment of dividends o Siphoning of funds o No corp. records o Faade for principal stockholders o Only for specific shareholder for specific corporate obligation not all shareholders are pierced not all creditors pierce shareholders y Even though had Corp. set up, didnt act like a corp. y Alter ego theory: using a corporate entity to conduct personal business that perpetuates injustice so that the corporate veil is pierced to personally hold shareholder liable. y Issue: Can the corporate veil be pierced and the corporation and its stockholders be treated as identical, without fraud being alleged? YES y A single factor is not enough to pierce, but if several alter ego factors along with elements of injustice or fundamental unfairness, the court can pierce. y When a corp. pays out money they have to make a declaration of dividends Baatz v. Arrow Bar: FACTS: y This is a contractual basis (meaning the corporation) and not made to be allowed to pierce the corporate veil. y Furthermore there is no evidence that they did anything other than pour drinks. y POINT: Alter ego theory is when they are using the corp. for their personal use. y Issue: May a court disregard the corporate entity if the evidence fails to indicate injustice and inequitable consequences? NO. y Ps argue that Ds corporation was an alter ego, but no evidence to support allegations. Failure to comply with all corporate formalities will not necessarily justify piercing the corporate veil. y UNDERCAPITALIZATION: o Had 155k o 5 k of own money o = 150k balnce 37

o So total owed was 145k  But courts and industry doesnt want to get involved and say how much capital someone should have to run or start a business.  UNDERCAPITALIZATION means not enough money to run the business. Not just that you dont have your own money. Money can be borrowed. o Draw a distinction between losing money and undercapitalization.  Losing money is losing money.  Undercapitalization doesnt mean you just keep throwing good money after bad just to avoid liability.it is difficult to know when undercapitalization as a stay alone factor is enough to pierce the corporate veil.

Radaszewski v. Telecom Corp.: FACTS: y Rad was struck by truck who was owned by a subsidiary of Telecom. y Difference in this case is that there was insurance and possibility to pay judgments etc. y RULES: 1) control, complete domination of money, policy and business practice 2) such control is used to commit fraud or wrong 3) the aforesaid control and breach of duty must proximately cause the injury or unjust loss complained of y Factors looked into this case for undercapitalization is they looked at the federal minimum for insurance. y IF doesnt look like there was something going on when the co. was set upnot likely court will rule that the corp. veil was pierced. y Issue: Is a subsidiary corporation undercapitalized for purposes of piercing the corporate veil (created by its parent without adequate funds to pay its bills and satisfy judgments against it if the subsidiary has adequate liability insurance? NO. y Parent company was financially responsible through having adequate insurance. Insurance carrier became insolvent two years after the accident but this was not the fault of D. Parent-Subsidiary Undercapitalization Rule Parent is so deliberate or reckless In the creation of the Subsidiary that Subsidiary is unable to satisfy Creditors or Judgments Fletcher v. Atex, Inc. Atex was a wholly owned subsidiary of Kodak. Because Atex was a DE corp. DE law determines whether the corp. veil can be pierced. DE Rule The corp. veil can be pierced where there is fraud or where it is in fact a mere instrumentality or alter ego of its owner. Under an alter ego theory, there is no requirement of a showing of fraud. To prevail on an alter ego claim a P must show: 1. that the parent and the subsidiary operated as a single economic entity; and factors: i. capitalized and solvent ii. corporate formalities iii. siphoning of corporate funds by dominant shareholders iv. dividends paid v. lack of overall parent domination 2. That an overall element of injustice and fairness is present.

38

Issue: Is summary judgment proper when no evidence has been presented to indicate that a company is merely the alter ego of its parent company? YES. No evidence was provided to satisfy the elements. Courts have generally declined to find alter ego liability based on a parent corporations use of a cash management system. Plaintiff makes 5 arguments, all of which the district court correctly held, were insufficient as a matter of law to establish the degree of domination necessary to disregard Atexs corp. identity. (See p. 278-279). Ps also offer no evidence of injustice or unfairness that would result from respecting the 2 companies corporate separateness. It is clear that Atex never merged with Kodak or operated as a Kodak division. WEEK 10_________________________________________________________________________________ Nissen Corp v. Miller: y y y y y y y P sues Manufacturer, seller, and Nissen. Sued manufacturer, based on continuity of enterprise. Is easier to find a predecessor in business liable, but in this circumstance ownership was different. There must be a causal relationship between the injury and ds act. But this co. sold replacement parts, honored warranties, kept employees, so were they separate enough? Issue: Will the successor company be subject to product liability? NO. The court adheres to the general rule of nonliability of successor companies with the four traditional exceptions. 1. there is an express or implied agreement to assume the liabilities 2. the transaction amounts to a consolidation or merger 3. the successor entity is a mere continuation or reincarnation of the predecessor entity -same business operations - same owners involved, board of directors etc.

4. the transaction was fraudulent, not made in good faith, or made without sufficient consideration. May want to say that all the things done by the successor were done after the injury. Consumer (atlantic) Corp got the benefits of old Should get burdens- public policy Consumer who suffers personal injury from Productsome entity must be responsiblestrict Liability especially if holding out to public Successor (Nissan) not part of the manufacturing and selling chain

Fully negotiated- cut off liabilities- free alienation of business assets, chills buying b/c no finality

Cant have all benefits (assets) and no burdens (liabilities) overbroad to pass along liabilities would also hurt small purchasers for other comp.s defects Voluntary Dissolution For dissolution there must be a majority vote, the directors can say that there has to be more than a majority but it cannot be less than a majority. MBCA 14.02 39

Before operations (by incorporators 1st Directors) - Either no shares, no start, AND - Debts paid, AND THEN - Distribution to shareholders After Operations (By Directors) - Shareholders Approval via majority after notice - Quorum of a majority unless articles require more via article - Board Condition on any basis Financing The Corporation Methods of Corporate Capitalization Equity, Business Earnings, Debt (banks, angel investors) Angel investors = a family friend or close person that invests w/o inquiry into financials

I will let your company borrow $10K. pay me back if you make $5K in net profit in the first 2 years. Which of the following is the best characterization of the transaction? a) An Equity investment Contingent on success of operation b) A loan Equity Definition (Residual) - Equity In o Capital Raised for operations Equity Out o FMV of assets o Minus Debts o Equals ownership interests subject to distribution [6.40(c)]

TYPES OF EQUITY SECURITIES SHARES: Common and Preferred - Authorized = Can send to shareholders to buy in the future if corp. grows. [MBCA 1.40(2), 6.01] - Issued= did send to shareholders to buy MBCA 603 (A)

HYPO Corp. is authorized to sell 10,000 shares. They sell $20,000 worth of $1 shares = it is illegal because they sold more shares than they were authorized to sell.

HYPO Corporation has 50,000 shares they issue 100 to A and 100 B each has the same amount of voting rights if the corporations dissolves = common stock

Common Stock Pluses: VADISS 40

Voting Rights Appreciation (windfall R.E. (Retained Earnings) Benefits Beyond Fixed Return) Distribution of Net Assets (Post Debt) Inspect Books and Records Sue on behalf of and against to enforce fiduciary duties Security or Collateral for a debt

Issued: Common Shares: Common Stock: units into which the proprietary interests in a corporation are divided Only one class issued must have identical rights An owner of common stock cannot have a guarantee of Dividends because it would not be residual.

The ups and downs of common stock ownership [VADISS] \ \ \ \ [Residual if any, MBCA 601(b)] [No Guarnatee of Declared Dividend] Last in turn on liquidation] [Retained Earnings] Preferred Shareholders - Dont vote - Paid before holders of common stock - Usually have a cap on the amount they can get in return (50%, 60% etc) Preferred characteristics class with preference over other class fixed amount or percentage Cumulative (or not) Shadowy difference with common- voting of certain directors

Preferred Stock - Benefits o Fixed Cut before common stock o Participate ONLY on Director Default (decisions involving director misconduct e.g. doesnt pay guaranteed dividends Minuses o Non-Participating o Capped Rights to earnings

- Preferred stock is usually more valuable than common stock 41

Generally Risk Reward Scheme - Preferred First Distribution but fixed (low risk and lower reward) - Common Last distribution but residual windfall (higher risk, higher reward)

Authorized Stock Requirement MBCA 6.01 Articles MUST: - ID the class or series Authorized - Number of shares within the class/series authorized - Preferences, rights and limitations (PRLs per class/series) - All PRLs must be same within the class/series o Unless delegated to Board 602 CLASS & SERIES Class A-Preferred/No Par - Series 1: $5/share cumulative - Series 2: $10/Share non-cumulative Series allow the corp to issue new stock without amending the articles of incorporation every time. PREFERRED SHARES IN PUBLICLY TRADED CORPORATIONS DLIVCORP - Dividends (Cumulative) They can get the entire amount after a few years, it accumulates. - Liquidation on dissolution - Voting ( if nonpayment of dividends) - Conversion ( preferred to common) - Redemption ( Corp buys back at fixed $) - Participating ( post common dividends) - Protective sinking Fund ( set aside if breach fid. Duty) HYPO Corp. has X shares of Preferred stock out worth $10/Share on liquidation. Corp. wants to invest in a new company. So they call in the stock and pay $12/share. If authorized by the articles of incorporation can the corp. do this. YES HANEWALD v. BRYANs Inc. Capitalization (Or So It Seemed) SHARES PAR VALUE 50 to Keith $1,000 50 to Joan $1,000 100 Authorized

CAPITAL $50,000 $50,000 $100,000

Bryans Inc. did not receive any payment, either in labor, services, money, or property, for the stock that was issued. = the Bryans had a duty to pay for the stock. The court said this was a fraud on the creditor (Hanewald) and they were held personally liable.

42

Issue: Can a creditor sue shareholders of a corporation directly because they did not pay anything for their par value stock in the corporation? YES However, the shareholder is only liable to the extent of the difference between the par value and the amount actually paid and to such an extent only as may be necessary for the satisfaction of the creditors claim.

Watered Stock - There is not full value in the stock WATERED STOCK LIABILITY - Paid nothing for shares = Bonus - Paid Cash, but less than Par = Discount - Paid with property Worth less than par (technically watered) - Theory is analogous to Piercing the Corporate Veil Leverage ConceptWhen the borrower is able to earn more on the borrowed capital than the cost of borrowing it LAST CASE = PAR VALUE ONLY MATTERS AT THE BEGINNING OF OPERATIONS AND HAS LITTLE MEANING AFTER THE START OF THE CORPORATION. WEEK 11_________________________________________________________________________________ PUBLIC OFFERINGS: y Why would a company go public? o Expand capital o More public money, less of personal money. o Reduce debt and thus reduce the interest debt. o Opportunity cost of capital o Acquire other companies o Market exposure Why not go public? o Now you are regulated by the SEC.

SECURITIES REGULATION PROCESS: y Issuer Select underwriter y Registration statement/preliminary prospectus ( 1st price to public) y SEC review y Final Prospectus y Sale to investors Goals of Securities Act 1933 Disclosure by Issuer Build investor confidence Improve quality of investment decisions SEC v Ralston Purina Co. 43

FACTS: y Ralston Purina sold nearly 2mil of its stock to employees from all levels of the co. without registration and in doing so made use of the mails. y A Corp. resolution authorized the sale of common stock to employees who shall, without solicitation by the Co. or its officers or employees, inquire of any of them as to how to purchase common stock by Co. y Called all these inquiring employees key employees. y ISSUE: Was Ds offering of stock to key employees a public offering. YES. o Was this offering a public offering? o YES. PO need not be open to the whole world. o Act was designed to protect investors by promoting full disclosure of info thought to be necessary to informed investment decisions. Thus, the private offering exemption is available only where the protection of the ACT is not needed. o Exemption is for issuance of stock to an accredited investor, if so no registration required. o Burden of proof is on the issuer. o Since the employees here were not shown to have access to the kind of information that registration would disclose, D was not entitled to the exemption. o These stock require registration and is considered a public offering. y Private Placement Safe Harbor RULE 506 o 35 purchaser limit o Non-accredited with acumen o Unlimited sales volume o No state regulation y This case tells us that we dont have a good initiative regarding the small employee. Exempt securities, Rule 504 - Reg D- sell up to $1 million within 12 month period, and - without general advertising - sell the securities to accredited investor HYPO ABC corporation offers sends mailing to a group of potential investors that may have completed ABCs form which indicates they all have a net worth of 800,000 Securities Without Registration Under the Securities Act of 1933: y Need to sell to an Accredited Investor to avoid registering. o 1 million net worth o 200k in joint income over last 2 years or 300k o Any director, executive officer, or general partner of the issuer o Any trust worth 5,000,000 not formed for the specific purpose of acquiring securities. 230.506 is attractive: o Attractive because no limit set AND; o Purchaser requirements are relaxed o No more than 35 purchasers for securities

Smith v Gross FACTS: 44

y y

Ds represented to Ps that earthworms were easy to raise and multiply 64x per year and Ds would buy back earthworms produced by Ps at $2.25 per lbs. In fact, they only reproduce 8x a years and Ds could afford to pay $2.25 only for purpose of resale to other investors at an inflated price. Ps appeal from the dist ct. judgment dismissing action against Ds. ISSUE: Did the transactions between the parties involve an investment contract type of security? YES. o Ds violated fed. security laws. Supreme ct. in SEC v. Howey Co. the test is 1) an investment of money 2) in a common enterprise, 3) with profits to come solely from the efforts of others( effort of guy who started the business) o Ps invested money, and was interwoven with and dependent on efforts and success of Ds. o As to 3rd test, Ps sole manner by which to make profits was dependent on efforts of Ds. An investment k is a form of a security.

Stokes v Continental Trust Co. FACTS: y P is shareholder in the Ds which had 5,000 shares of $100 par value stock authorized and outstanding. P owning 221 shares. A brokerage firm offered to buy an additional 5k shares at $450 per share. D sought to authorize shares by 5k which P voted for, but P voted against issuing the shares to the new brokerage firm. Prior to the sale of the new shares, P protested and offered to buy his 221 shares at $100 par value. Was denied and P sues to compel D to issue new shares to him or for damages. y ISSUE: Does a shareholder have an inherent right to subscribe to his proportionate interest in newly authorized and issued shares? o Yes. Judgment for P. o Existing shareholders have inherent right to a proportionate share of new stock issued. o Right can be waived BUT is not the case here. P protested and offered to buy his share. o To exercise preemptive rights is not par value but the price fixed for issuing the shares by the board. This is $450 per share. Damages should be measured by difference between the market price of the shares at the time of sale and the price P would have had to pay for the shares at that time. Now 550 so damages 100 per share. y DILUTION OF SHARES y Old shares (4) y New Shares (8) y Total of 12 y y y y A = 2 (50%) B = 2 (50%) y y A=8 B=0 y y 10 of 12 (83%) 2 of 12 (17%)

He had more shares before. Pre-emption really means that the individual shareholder preempts (prevents) corp. from issuing new stock without it. By exercising pre-emptive right. Shareholder B prevents the dilution of the shares.

STATUTORY CODE 6.30: A. Shareholder of Corp. does not have a pre-emptive right. They are agreeing that it is not an inherent right under 6.30. Not inherent but what the articles provide. Called an OPT IN provision meaning you have to opt in to have the preemptive rights. B. If nothing more than just saying you have preemptive rights in the articles, means that on one hand, uniform terms and conditions, 45

Katzowitz v Sidler FACTS: y Disagreed and P agreed to withdraw from active management of Sulburn Corp on the stipulation that he receive the same benefits and compensation as D and Lasker and remain an equal shareholder. y Corp. owed the 3 2500k and issued it. y They wanted to issue more stock and if you pay for that stock, you increase the amount of money in the new corp. y They allowed him to opt in (buy in).but the price was unfair. y DILUTION WHEN TOTAL SHARES ISSUED INCREASES FROM 15 TO 65 WITHOUT CS PARTICIPATION: y Proportionate shares before new issuance y Proportionate shares after new issuance (all had right to buy 25 shares each, but only 50 added (25 to A and B) y A = 5 share (33%) (i.e. 15/5) y A = 30 shares (46%) same y B = 5 shares (33%) (same) y B = 30 shares (46%) same y C = 5 SHARES (33%) y C = 5 SHARES (8%) I.E. 65/5 y Can be sold but why would he not want to buy it at a discounted rate? Here they were funneling the money and he had a right to decide if he wanted to put more capital into it. BASICALLY he has the right to decide YES or NO. y Issue: Can a shareholder in a close corporation who refuses to exercise his preemptive rights set aside the issuance of shares to other shareholders as fraudulent when the shares are issued at an inadequate price? YES. y Ds can purchase the shares offered, but the price must be a fair price as to not dilute Ps interest. Stock was sold for $100 per share when they were worth $1,800, basically Ds were compensated for much more than they put in. Pre-Emptive Rights: y Board, Shareholders and New Investors:

WEEK12_________________________________________________________________________________ Dodge v. Ford FACTS: y Ps are minority shareholders of Ford. At time Ford had 112 million in surplus and profits were expected to be 60 mil. They refused to declare larger dividends not as an exercise of discretion of the directors but an arbitrary refusal to invest in capital and such to expand the business. y Ds planned to build new plant, increase production and employment and cut prices of cars. y Issue: When the directors purpose in not paying a dividend (when there is adequate surplus to do so) is to benefit the interests of persons other than the shareholders, will the court intervene to force payment? y YES. Here, the expansion plans of D may be carried out and there will still be a large amount of surplus available for dividends. Thus, the trial courts order that $19 million be paid in additional dividends be upheld. y General rule: shareholders do not have a right to demand payment of dividends unless there is a situation like this case. Because it was ARBITRARY. 46

Wilderman v. Wilderman FACTS: y Eleanor Wilderman (P) and Joe (D) are owners of Marble Craft Co. were formerly married. P was VP, treasurer, and secretary and was primarily the bookkeeper, D was also President. D was authorized so much and took much more. y Joe was authorizing excessive payments to himself from the profits. y Issue: Can the president of the corporation, acting on his own will, pay himself more than his authorized salary? NO. y The authority to compensate corporate officers is normally vested in the board of directors and is usually a matter of contract. In the absence of a board authorization setting salary, an officer may receive only the amount of compensation commensurate with his duties. ALSO ARBITRARY. Wilderman Test for reasonableness for executive compensation Compare pay of similarly situated executives IRS allowance of corporate deduction as salary Salary correlation to success of the corp Variance with prior salary The increased Salary Correlation to increased value in services that generated the salary Correlation with other salaries paid by employer Legal Restrictions on Distributions 6.40 Equity Insolvency Test based on existing and contemplated demand for the corporations products or services, it will be able to generate funds over a period of time sufficient to satisfy its existing and reasonably anticipated obligations as they mature, and indebtedness which matures in the near-term will be refinanced where, on the basis of the corporations financial condition and future prospects and the general availability of credit to business similarly situated -Exact language- No distribution may be made if, after giving it effect, the corporation would not be able to pay its debts as they become due in the usual course of business. 6.40 (c)(2): BALANCE SHEET TEST: y Assets = not just cash o Current: accounts receivable o Fixed: Land, Plant, equipment y For this, assets must = liabilities + liquidated press y This section requires that after giving affect to any distribution, the corporations assets equal or exceed its liabilities plus the dissolution preferences of senior equity securities. y IF YOU FAIL EITHER TEST, NO DISTRIBUTION 6.40 (d): BOARD IN MAKING decision to determine whether they have enough funds is from relying on financial statements, or other methods that is reasonable under the circumstances. 8.30(b) and (d) or (e) or (f) should be cross referenced with all of the above.

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If ABC Corp. complies with one of the MBCA 6.40(c) tests, but not the other, can the corp. properly issue the dividend? o No. You must comply with BOTH because if you fail either one, you cannot make the distribution. o 855 F. Supp 353 In Re SE Banking Corp., where the distribution was made because they passed both tests but broke the fiduciary duty of the corp.

TRADITIONAL STATUTORY CORPORATE SCHEME: y y y Shareholders elect DIRECTORS: ultimate authority to act bind. Fiduciary duty to corp and shareholders, set policy Officers: delegated management, answers to directors, implement policy Shareholders: elect directors, vote, non-managers

Zion v. Kurtz FACTS: y The Battle of discretionary Management Authority: y Under shareholder agreement the board couldnt do anything without the approval of the minority shareholder P. y Didnt state that they were a close corp. which is required in the state of Delaware. y Issue: Under Delaware law, may all shareholders of a general corporation agree that no action will be taken without the consent of the minority shareholder? YES. y Delaware law, provides that a corporation is to be governed by its board of directors, except when all shareholders agree and a provision is put in the articles of incorporation that the shareholders may govern the corporation. In this case, the agreement was not in the articles but was valid anyway. WEEK 13_________________________________________________________________________________ SHAREHOLDER VOTING AND AGREEMENTS: Voting Nuances: y Under MBCA does not have to have certificates (MBCA 6.25(a)) y MBCA 6.26: Although you dont have to have certificate you must have a written statement with; o Name of corp. o Name of shareholder o Number of shares o Particular class if any o 6.25 (c) (If preferred shares, should be noted as well) y 6.25 (b) the name issuing of corporation , the name of person to whom issued, the number and class of shares y 6.25(d) signed by two officers designated by bylaws or by board of directors, may bear corporate seal y Who can vote? o A and B are about to vote for new director. C the sec. says that B cannot vote because just became a shareholder yesterday and doesnt know the co. well enough yet. How should Bs eligibility to vote be determined?  Look at the BYLAWS.  If cannot be determined from bylaws, set future record date o How would you create the rule? 48

MBCA Sect. 7.07 (a) Record Date: Statute Rule is done by date rule. Meaning as by this date, you will be able to vote. What if you have 100 shareholders and 35 voted on who will be new director. Only 33% needed in Bylaws. Is this valid? o Yes. Florida Law says you can have something less than majority. (1/3rd majority) 33%  Who does this favor? o MBCA 7.25: QUORUM says must have majority unless articles list otherwiseBUT CANNOT HAVE A LESSER QUORUM ONLY A GREATER QUORUM. (7.27) the majority is the base and articles can require more than simple majority.  Who does this favor? y The ones already on the board because it takes more people to change. VOTING GROUPS: o Board of dir. Of ABC concluded that employee benefit packages are so complex that only those shareholders that pass a course given by an independent specialist in that area shall be able to vote on benefit packages for ABC. 10 shareholders were eligible but at annual meeting 8 voted but at this meeting no quorum generally exists. Should the articles provision for a voting group apart from the general shareholders be statutorily valid? o YES. MBCA 7.26 and 7.25(a) this is ok!

STRAIGHT V. CUMULATIVE VOTING: Straight voting: Shareholder can vote for each candidate, but can only vote for each director according to how many shared he has. 10-10-10-10-10

Cumulative voting: Shareholder can distribute his total votes however he sees fit. Otherwise a minority shareholder will never be able to elect a director 50-0-0-0-0 MBCA 7.28: Humphrys v. Winous: FACTS: y On one hand you have provision for cumulative votes and on the other have staggered elections. y If only have one director, only have the 15 votes. y They refused to disclose the existence of the changes and this frustrated the Ps shareholders legitimate efforts to run for the board of directors and may well be a breach of fiduciary duty. y Issue: Does a statute that provides for cumulative voting in corporate elections guarantee the effectiveness of the exercise of that right? NO. y The right to cumulate votes cannot be said to nullify the right to classify directors, which is also provided by state law. y STAGGERING CLASS DIRECTORSHIPS 1) fewer directors 2) fewer votes 3) fewer votes to aggregate 4) fewer chances for minority shareholders to elect a candidate. y DISSENT: When the minimum number of three directors is provided for, and their terms of office are for 3 years, one to be elected each year, the right to cumulative voting is, in such case, completely nullified. y In Re Engles: 364 fsupp 1202 (1973) 7.28 (b) cumulative rights are only allowed by articles of incorp. (*some states have mandatory cumulative rights but that number is on the decline) 49

There seems to be a loosening of what the directors can do by the MBCA.

Restrictions on Share Transactions: breaching tradition with internal controls on free alienation. 6.27: Restriction can be voided if manifestly unreasonable.(usually something arbitrary) y Think preserving S corp. status. BUYER/SELLER AGREEMENTS: y Cross Purchase: Usually on death y Corp. Redemption: y B/S agreement is beneficial for minority shareholders because it helps to eliminate freeze-out and dilution.

DISSOLUTION REMEDY: Oppression Deadlocks and Dysfunction: 14.30 & 14.34 Dissolution action can occur by: y Creditors: 14.30 (3)(i) if creditors claim has been reduced to judgment, and the judgment returned unsatisfied y Court ordered involuntary dissolution (14.30) if the corporation obtained its articles of incorporation by fraud. y Buy Out (voluntary or court supervised via 14.34) y Additional relief o Punitive, accounting, cancellation of stock, partial liquidation y WHICH REMEDY IS A LAST RESORT? o COURT ORDERED involuntary because they are forced to liquidate, etc. o Attorney General o Articles fraud or abuse. o o o Shareholder Creditor Corp. o Deadlock = business failure, oppressions, fraud, waste, buy out (14.34) o Insolvency (after judgment and execution or stipulation) o Voluntary with supervision.

14.30 (a)(2)(ii): Oppression is a broader scope than waste is. A continued course of conduct can be oppressive.

The prior treasurer, if fired.can an action still be filed? Even if youre fired, youre still a shareholder, hence can be brought. WEEK 14_________________________________________________________________________________ Directors and their Duties:

Shlensky v. Wrigley: (possible test ? with contrasting ford) 50

FACTS: y P is minority shareholder and D is owner of Chicago Cubs. Individual Ds are directors of Cubs and D Wrigley is pres. of corp. and owns approximately 80% of stock. y Directors refused to put lights in. P bitches about lack of attendance as a result. y May a shareholder bring a derivative action when there are no allegations of fraud, illegality, or conflict of interest? NO. y The court will not disturb the business judgment of a majority of the directors- absent fraud, illegality, or conflict of interest. FICC: y y y y

Fraud Illegality Conflict of Interest Corporate Charter Standard 8.30(a) Good Faith Out Clause

Function 8.30(b) Due diligence Oversight activity

Director can rely on Others 8.30(e) Reasonable.Belief.Best.Interest.of Burden on challenger 8.31 Corp.

A. Maybe the best way to look at it is if someone is not profiting from the entity, then they are doing what is best for the entity. 8.31 puts the burden on the minority shareholder to establish what the director couldnt win on. Furthermore, it makes it hard on the board of directors to be judged on hindsight. A. Self Dealing: a. Directors must place the interests of the corp. above their own personal gain. b. Early law was to hold that all ks were voidable whether fair or not. c. Majority then turned to conflict of interest dealings were voidable ONLY when the director had not made full and complete disclosure of the transaction (value, his interest, profit, etc.) or the transaction was shown to be unfair or unreasonable to the corp. i. Burden of proof was the fairness of transaction (fairness test) d. INTRINSIC FAIRNESS TEST: Marciano v. Nakash: FACTS: B. Ps owned 50% of Gasoline ltd., and Ds were the officers who owned 50%...the board was evenly divided and deadlocked. Ds through corps. loaned the corporation 2.5 mil. C. Loans were not approved by majority of directors or shareholders. D. Ps argued that loans should be invalidated because they were made by interested directors. E. Ds argued they were fair F. Is intrinsic fairness test the proper test for reviewing transactions made by interested directors?

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o Yes. Delaware Passed section 144.and courts have held that interested director transactions can be validated if found to be intrinsically fair. (consider effect on corp., shareholders, the motives of directors, etc.) o Motives were since the directors were deadlocked, there could be no ratification. Because of deadlock, approval of any corp. action was destined to be interested. Thus transactions should be approved based upon their intrinsic fairness. B. Corp. opportunities and other duties to the corp. a. Directors and officers cannot take what is the corps for their own interest. b. Director may not use corp. property to develop own business. c. Cannot assume properties in interest of corp. Interest is said to be tangible expectancy. C. LINE OF BUSINESS TEST REJECTED:

NE Harbor Golf Club, Inc. v. Harris: FACTS: y D was pres. of P for almost 20 years. She bought real-estate that abutts up against the golf course and never told the board until months after she bought each parcel. y Eventually she decided to develop the land with housing developments and she was asked to resign from position. y Club alleges breach of fiduciary duty to act in best interests of corp. y Issue: Is line of business test best? o No. The trial ct. used this test if there is a reasonable expectancy that it is in the course of the corps business..the self interest of the officer will be in direct conflict. BUT the course could not fund such a transaction anyway.trial court held that course didnt pass test. o This court finds fault with test. 1st, ? of whether particular activity is within the corps line of business is hard to answer. But Ds purchase caused the course to not be allowed to expand. o 2nd to consider the financial ability of corp is wrong because it may unfairly favor an inside director who has control of facts relating to corp fairness. o Similarly, courts have molded the line of business with fairness test as well.but the test that controls is the ALI disclosure oriented rule:  Director or senior exec. may not take advantage of a corp. opportunity unless; y Director first offers corp. opportunity And makes disclosure concerning conflict of interest y The opportunity is rejected by corp. y And either; o The rejection is fair to the corp. or in this case, o The opportunity is rejected in advance, following such disclosure, by disinterested directors or in this case of a senior exec who is not a director, by a disinterested superior in a manner that satisfies the business judgment ruleOR o The rejection is authorized in advance or ratified, following such disclosure by disinterested shareholders, and rejection is not equivalent to a waste of corp. asset.  Central to the ALI test is FULL DISCLOSURE.  P has burden to show that opp is corp opp. And D did not offer it to P and then D may defend actions that taking the opp was fair to the corp. BUT if she failed to offer it at all she cannot defend on this point. 52