Outline Bus Orgs

8/3/2019 Outline Bus Orgs

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INTRODUCTION

1. Role of Agency

a. actual authority (defined p. 4)

b. apparent authority (defined p. 4)

2. Publicly and Closely Held Corporations

a. publicly held corporations shares are widely owned, publicly traded, many shareholders

b. closely held corporations corporations with few shareholders, shares have no public marketi. often, shareholders have agreements that:

1. restrict transferability of shares to ensure that outsiders cannot become

shareholders without existing shareholders consent

2. allow existing shareholders to have their shares purchased when they die or left

to corporation

3. Some Factors Influencing the Selection of Business Forms

a. (1) taxation

b. (2) ease of internal operationsc. (3)probability that business might go public

i. if ownership interests are publicly traded, corporation is best form

d. (4) sophistication of participants

e. (5) whether participants relationship is permanent / temporary

4. LLC vs. Corporation (Non-TaxDifferences) (need to know?? p. 40)a. franchise tax:

i. LLC does not obtain charter/franchise from state (although filing is required)

1. corporation subject to franchise tax (LLC is not)b. management:

i. LLC:

1. structure:a. informal (formal for corporations)

2. no procedural requirements for meetings / decision-making (yes for corporation)a. decisions made informally

b. question of whether specific action was taken is matter of evidence (not

reliance on formal corporate records)

ii. corporation:

1. structure:

a. formal (informal for LLC)i. power to vary structure may be limited

1. sometimes, state statute may permit corporation to vary

internal structure by unanimous consent

b. 3-tiered:

i. shareholders

ii. directors

iii. officers

c. each tier has its own rights / duties (established by statute)

2. procedural requirements for meetings / decision-making (none for LLC)a. likely ignored in close corporations

b. failure to follow formalities:

i. is consideration for whether to pierce

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ii. may raise questions about whether certain corporate actions were

taken (answers depend on formal corporate records)

5. LLC vs. Partnerships (differences tend to favor LLCs flexibility)

a. limited liability:i. LLC:

1. limited liability forallmembers

a. co-owners should be careful not to consent (expressly/impliedly) tobeing called partner, because then they run the risk of partner liability

by estoppel (see ??)

ii. partnerships:1. some state statutes:

a. contain minimum capital requirements that may (if inadvertently

violated) result in loss of limited liability shield

b. limit shield:

i. for partners with oversight responsibilities / personal knowledge

of misconduct they dont correct

ii. from protecting partners participate in control beyond safe

harbor provisions

b. number of participants:

i. LLC:

1. may have single member

ii. partnerships:

1. 2+ people (by definition)

c. management:

i. LLC:

1. centralized management easier formanager-managedLLCii. partnerships:

1. centralized management difficult forcommittee-managedpartnership

2. but limited partnership may create centralized management analogous to LLCd. termination of entity:

i. LLC:

1. continuity equivalent to that of corporation (what does this mean?)ii. partnerships:1. 1914 Act individual partner can compel winding up and termination

e. fiduciary duty:

i. LLC:

1. (is there one??)

2. fiduciary duty may not be desirable in closely held business if individual

participants are allowed to act in their own self interest in certain areas

ii. partnerships:

1. broad fiduciary duty

6. Selection of Business Form for Start-Up Business

a. majorareas of consideration:i. (1) considering the nature of business, # of owners, and owners relationships:1. internal efficiency

2. operational cost

3. organizational convenience

ii. (2) conserving of scarce resources/capital before business is well-established

iii. (3) ease of raising future capital

iv. (4) possibility of going public

b. non-majorareas of consideration:i. limited liability:

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1. generally available for business that desire it

ii. tax regime:

1. check the box has made selection of tax regime largely (but not entirely)

elective

UNINCORPORATED BUSINESS ENTERPRISES

SOLE PROPRIETORSHIP

1. business owned by single person with:a. sole right to manage

b. sole entitlement to profits

c. unlimitedly responsible for business debts

2. if there is more than one ownership interest, there is no sole proprietorship3. not separate entity (from proprietor himself) for tax purposes

4. to gain limited liability:

a. proprietor can incorporate his business by creating a corporation and execute transactions in

name of the corporation

THE GENERAL PARTNERSHIP

1. 2 Uniform Partnership Acts (UPAs): 1914, 1994

a. dual function:

i. mandatory rules operate regardless of partner agreementsii. default rules subject to change by agreement

b. UPA 1914 governs in about the states

c. RUPA 1997 governs in about the states

i. 103(a) all rules are default (i.e. subject to change by agreement) in nature exceptforthose in 103(b)

2. How Created

a. UPA (1997) 202 co-ownership in for-profit business defaults to general partnership withjoint and several liability

i. created by oral/written agreement express / implied1. no person can become partner without consent of all the partners

a. this right can be waived if partners agree otherwise or if another

arrangement is casually fallen into

ii. what is notneeded:1. documents

2. knowledge of existence of partnership relationship

b. Who/What Can Be Partneri. individuals

ii. corporations

iii. other partners

c. What Partners Share Ini. right to manage

ii. right to profits

iii. partnership losses

iv. personal responsibility for partnership obligations

d. Determining Whether Partnership Exists

i. (important if creditor sues seeking additional pocket for payment of firm debts)

ii. UPA 7:

1. receipt of share in profits isprima facie evidence that he is partner

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iii. Martin v. Peyton where creditors had negative control (right to veto business) but nopositive control (right to initiate transactions), the creditors were notconsideredpartners

1. creditors receipt of profits was as interest on their loan and did not constitutepresumptive evidence of partnership status

3. Nature of Entity

a. Partnership Distinct from Partnersi. 201 (UPA 1994) partnership is entity distinct from its partners

b. General Limited Partnership

i. UPA (1994) partnerships can merge / convert from general to limited partnership (or

vice versa)

c. Contractual Powers of Partners

i. partners are general agents of their partnership

1. act by partner that is usual part of business binds the partnership2. if act is not part of usual part of business, but is agreed upon by partners, it binds

the partnership

ii. if third party is not sure, but is suspicious, about whether partner is unauthorized to act

for partnership:

1. 1914 third party has duty of inquiry

a. if they dont inquire, they arebound by dealing with partner who has noauthority

2. 1997 third party is notbound by dealings with partner who has no authorityunless they had actual knowledge that partner was not authorized to act

a. does nothave duty of inquiry

4. Written Partnership Agreements

a. Written Agreement NOT Required

i. written instrument is not required for formation of partnership

b. Benefits of Written Agreement

i. avoid future disagreement regarding substance of partnership

ii. permit allocation of tax burdens

iii. establish method for dissolution and terminationiv. provide method to divide profits / losses

c. Partnership Agreements

i. UPA (1994) agreement may modify most of partnership statutory provisions1. but there are some that can only be modified in limited ways

ii. action that differs from partnership agreement may notbe done without the consent of allthe partners

iii. third parties cannot be bound by partnership agreements

5. Sharing of Profits & Losses (other than liability for partnership debts see below)a. Partnership Agreement Controls

i. agreement can provide for any method of sharing profits / losses

b. If No AgreementDefault to Statutei. profits / losses shared equally

c. Contribution of Services and Capitali. one court held that where one partner gave capital and another services:

1. upon termination capital contribution must be reimbursed unless partiesintended otherwise (Richert)

2. partner who gives services required to contribute toward capital losses accordingto his share of profits (Richert)

6. Liability

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a. 1914 Partners Jointly Liablei. joint liability for partnership debts / obligations

1. all partners joined as s in litigation

b. 1997 Joint & Several Liability

i. joint and several liability each partner is personally liable forpartnership obligations(both contractual and tort)

1. each partner is liable for the whole amount

a. non-partners may recover on partnership obligations from any partnerwithout regard to loss-sharing or partnership agreement

b. partnercannotlimit his liability for partnership debts by informingcreditors that he is not liable for co-partners purchases made in ordinary

course of business (Nabisco)

2. creditor can only obtain satisfaction against individual partner if:

a. judgment obtained against both partnership andspecific partnerb. writ of execution against partnership is unsatisfied

ii. indemnification partnership must reimburse partner who personally satisfies partnership

liability

iii. contribution on dissolution, each partner must contribute to partnership to cover hisshare of losses

iv. vicarious liability partnership and individual partners are liable for wrongs committed

by partners acting within the scope of the business1. this changes if LLP status is elected

c. When Partnership Is / Is Not Liable for Partner Malfeasance

i. partnership is liable for malfeasance of partner whose acts are withinordinary scope ofbusiness (Rouse)

1. ordinary scope of business courts are split:

a. may / may not be determined by what injured party reasonably believed(Roach / Fanaras)

d. Ways Creditors Can/Must Proceed

i. creditors mustfirst exhaust partnership assets before proceeding against individualpartners

ii. charging order surcharge the partners interest in partnershipso that distributions go to

creditoriii. proceed against partnership assets and enforce claim against partners

1. partners are jointly and severally liable

e. Partner Liability by Estoppel

i. partner liability by estoppel = non-partner is estopped from denying non-partner status

(and forced to accept partner status)

1. such estoppel occurs if:

a. non-partner carelessly/intentionally creates misimpression that he is apartner

i. estopped from denying partner status with people who changed

position in reliance on the misimpression

b. non-partner is held out by someone else as partner, and he affirmatively

consentsi. however, if non-partner does not affirmatively consent, but just

does nothing, liability by estoppel willprobably not apply

(courts differ)

7. Managementa. 2 things each partner has equal right to:

i. (1) participate in management

ii. (2) bind the partnership

b. How Rights Can Be Limited

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i. rights can onlybe limited by written agreement

1. (ex.) partnercannotlimit his liability for partnership debts by informing creditorsthat he is not liable for co-partners purchases made in ordinary course of

business (Nabisco)c. When Partners are Bound by One Partners Acts

i. when partners acts are within the ordinary scope of partnership business

1. ordinary scope of business courts are split:

a. may / may not be determined by what injured party reasonably believed

(Roach / Fanaras)ii. third partys Reliance on apparent authority

1. partnership may still be bound if third party relies on one partners: (Smith v.Dixon)

a. apparent authority

b. for acts within the ordinary scope of business

8. Disagreement & Deadlock

a. disagreements may be decided by majority of partners

i. no majority if there are only 2 partners

b. deadlock = when partners split evenly on a matter

i. no restriction can be placed on power to act

1. actions within scope of business should not be limited exceptby expressed willof the majority (Nabisco)a. only option of dissenting partner(s) is dissolution

9. Fiduciary Duties

a. 1914 broad fiduciary duty (duty of finest loyalty) exists among partners

i. Mienhard v. Salmon partners owe each otherbroadgeneralfiduciary duty with respectto interests of partnership business

1. duty of loyalty partner must:

a. account for profits

b. refrain from dealing with partnership as / on behalf of party with adverse

interest to partnership

c. refrain from competing with partnershipi. partners have fiduciary duty to share business opportunities

d. act in best interest of partnership

e. duty of disclosure

f. duty of good faith and fair dealing

ii. mandatory cannotbe modified by partnership agreement

1. however, basic partnership duties may be waived (Singer)iii. rationale:

1. personal liability of each partner for partnership obligations

2. mutual sharing of control

b. 1994 narrows scope of fiduciary duty (loyalty and care) and permits partnership to limit it

further

i. no fiduciary duty during partnership formationii. only 2 fiduciary duties owed by partner to partnership:

1. (1) duty of loyalty partner must:a. account for profits

b. refrain from dealing with partnership as / on behalf of party with adverse

interest to partnership

c. refrain from competing with partnership

d. act in best interest of partnership

e. duty of disclosure

f. duty of good faith and fair dealing

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2. (2) duty of carea. partners must refrain from negligent conduct and intentional misconduct

c. When Fiduciary Duty Applies

i. fiduciary duties only apply to currentpartners

1. after partnership dissolves, no claim of breach of fiduciary duty can be brought(Bane)

ii. partnership claim must be brought for event that occurred duringthe existence of thepartnership

d. Leaving the Businessi. generally, former partners are free to compete for business after leaving firm as long as:1. competition is fair (i.e. no use of confidential information / trade secrets)2. there was no agreement between partners stating otherwise

3. partner does not compete before leaving firme. Right to Account

i. when partner breaches fiduciary duty, other partners have right to have reviewed all

transactions / alleged improprieties

10. Partnership Propertya. Co-Ownership (Joint Tenancy)

i. partners are co-owners of partnership property (holding as joint tenants)

1. rights as co-owners depend on necessities of partnershipb. Property Rightsi. 1914 partner has 3 property rights:

1. (1) tenancy in partnership rights to partnership property only for partnershippurposes

a. partner cannot possess partnership property for non-partnership purposes

without the consent of other partners

b. not assignable

i. partner may notassign his interest in partnership property (butcan assign financial interest)

c. if partnership / individual partner is insolvent:

i. partnership creditors have priority with respect to partnership

propertyii. individual creditors have priority with respect to individual

property

2. (2) financial interest in partnership

a. this is the only transferable property interest

3. (3) right to participate in management

ii. 1997 property acquired by partnership is property of thepartnership notof thepartners individually (partner is notco-owner)

c. When Property is Partnership Property

i. property acquired with partnership funds is partnership property (even if not acquired inpartnership name) unless contrary intention appears

1. problems:

a. its not always easy to identify source of fundsb. sometimes unclear whether partner has contributed ownership of certain

property or merely the use of the property to the partnership

c. sometimes intent of parties (which always controls) is ambiguous

i. the intent must be clearthat the partners intend to convertindividually owned property into firm property (need to

know??)

d. Real Property

i. partnership can acquire title to real property (treats partnership as entity)

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11. Financesa. Partnership Separate From Partners

b. Financial Interest is Transferable

i. partner can transfer interest in profits, losses, and distributions

1. cannotassign property interestii. assignee is entitled to distributions, but is not a partner (partnership relation is personal)

c. Amount Received Upon Withdrawal

i. partner typically entitled to amount in capital account when he withdraws

d. Amount Received Upon Termination

i. if partnership is terminated, accounts are reduced to zero by distribution / contribution

e. 3 Financial Statements:

i. (1)income statement1. determines net profit

a. income = revenues expenses

2. reflects whether business is profitable

3. distributions have no effect on profits/losse

ii. (2)balance sheet1. determines equity/value in business

a. equity = assets liabilities

iii. (3) capital account (for each partner)

1. capital account = (original contribution) (disbursements received) + (profits) (losses)

2. partner with negative capital account has obligation to repay upon winding up

12. Taxationa. pass through taxation:

i. partnership income flows directly through to partners

1. partnership as a whole does not pay tax on its income

2. each partner is taxed on his share of partnerships incomeii. result of check the box taxation

13. Dissolution, Winding Up, Termination

a. Rules Under 1914 & 1997:i. how they are the same:

1. dissolution (1914)/dissociation (1997) change in partnership relationships when

partner is no longer partner

ii. how they differ:

1. 1914 dissolution always causes winding up / termination

2. 1997 dissociation only causes winding up in certain circumstances

iii. 1914 dissolution = mere change in relationship when partner is no longer partner(does NOT terminate partnership), but UNLIKE 1997 it always causes winding up

(which leads to termination)

1. dissolved automatically when partner:

a. dies

b. withdraws (leaves partnership)i. 2 options upon withdrawal of partner:

1. (1)partnership can be dissolved and reformed whenthere is change in members, but business continues

2. (2) withdrawing partner can compel winding upc. states he doesnt want to be partner

2. after dissolution:

a. despite dissolution, partnership exists for period of winding up

b. termination = final settlement and distribution of remaining assets

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iv. 1997 dissociation (notdissolution) = change in relationship when partner leaves(does NOTterminate partnership), but UNLIKE 1914 it only causes winding up in

certain circumstances1. dissociation caused by:

a. death

b. withdrawal

i. partner leaves partnership and receives value of partnership

interest

ii. does notcause winding upc. cessation of existence (for corporate partners)

d. expulsion2. dissolution vs. dissociation:

a. dissolution event that leads to termination of partnership

b. dissociation event causing partner to cease participating in

partnership

3. rights of dissociated partners:

a. entitled to receive buyout price offset by damages

b. no right to share in profits if business continues4. apparent authority of dissociated partner:

a. dissociated partner has apparent authority to bind partnership and may be

liable for post-dissociation liabilities for 2 years after dissociation

b. Right to Dissolve

i. if partner chooses to dissolve partnership in bad faith (without statutory / contractualright), equity will prevent dissolution (Collins)

c. Partnership Agreements

i. may provide their own rules outlining rights/duties of withdrawing partner (Adams v.Jarvis)

ii. enforceable if it:

1. provides for continuation

2. sets forth method of paying withdrawing partner his agreed share

3. does not jeopardize the rights of creditors

d. Continuation

i. continuation agreement exists:1. partnership agreement allows for continuation of business after dissolution

ii. no continuation agreement exists:

1. business may continue after dissolution, or2. dissociating partner may compel windup

iii. remaining partners remain liable for partnership debts (Sheehan)

iv. retired partner / estates have right to share in profits (Cauble)e. Rights of Creditors

i. withdrawing partner:

1. notdischarged from liability for contractual obligations incurred by partnershipunless creditor agreed (Sheehan)

ii. incoming partner:

1. liable for preexisting debts to the extent of his interest in partnership assetsf. Withdrawal

i. covenant not to compete:

1. partnership agreement may contain covenant not to competeso long as it is:a. reasonable

b. not unduly burdensome

ii. duties of withdrawing partners:

1. cannot disclose confidential partnership information without notifyingpartnership (Gibbs)

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2. withdrawing partners cannot violate fiduciary duties by wrongly solicitingpartnerships employees (Gibbs)

iii. 2 options available to partnership upon withdrawal of partner:

1. partnership can be dissolved and reformed when there is change in members butbusiness continues

a. if partner chooses to dissolve partnership in bad faith (without statutory /

contractual right), equity will prevent dissolution

2. withdrawing partner can compel winding up

g. Expulsion

i. power to expel:

1. partnership agreement may provide for involuntary dismissal, with / without

cause, of partner

2. 1914 only exists when provided for in partnership agreement

3. 1994 power to expeleither:

a. when provided for in partnership agreement, orb. by unanimous vote (limited circumstances)

c. can vote to dissolve firm and form new partnership without unwanted

partner

4. partnership has no fiduciary duty to refrain from expelling partner for bona fidewhistle-blowing (Bohatch)

ii. expelled partner no right to compel winding upiii. expulsion does cause dissolution, but expelled partner has no right to compel winding up

14. Law Firm Partnerships (most excluded)a. Not All Law Firm Partnerships Created Equal

i. income partner:

1. partnership interest maxes out at certain income level

2. maximum amount to pay in event of loss

ii. equity partner:

1. income fluctuation

2. share risk in proportion to ownership

3. fluctuation in amount paid in event of loss

b. Liability to Retired Partnersi. rights of partners only exist while partnership exists

1. partners are not liable to retired partners for negligent mismanagement causingcessation of retired partners pension benefits (Bane v. Ferguson)

15. Inadvertent Partnerships

a. Implied from Parties Conduct

i. partnership may be implied from conduct of parties (Martin v. Peyton) ifthere is intent toform partnership (Smith v. Kelley)

1. sharing profits (differs between 2 UPAs):

a. 1914 sharing profits (without more) does notcreate inadvertentpartnership

b. 1997 sharing profitspresumes partner status2. even if there is share of profits and some management control, there is no

partnership without intent to form partnership (Martin v. Peyton)

3. holding oneself out as partner doesnt mean that person is partner for intra-firmpurposes (Smith v. Kelley)

b. Partnership Calling Person Partner

i. a person is nota partnermerely because partnership calls him one

LIMITED LIABILITY PARTNERSHIP (LLP)

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1. How Created

a. election to LLP status

i. (any) general partnership can elect to become an LLP by filing a statement with Secretary

of State electing LLP status

2. Nature of Entity

a. partners have limited liability for contractual and(non-personal) malpractice claimsi. no personal liability for liabilities that exceed partnership assets

1. all that is at risk is investment in corporation (capital investment)

ii. notavailable forpersonalacts of malpractice/negligence1. often not available for those who:

a. have oversight obligations over these partners

b. were aware of malpractice/negligence and failed to prevent it

b. if partners elect limited liability:

i. they cannotparticipate in control/management1. once they start to manage the business, theyre treated as general partners

ii. they can only lose their investment in the corporationc. full vs. partial shield state statutes:

i. full shield statutes:

1. shield partners from allbusiness obligationsii. partial shield statutes:1. only protect partners from malpractice / torts of fellow partners

3. When Electeda. primarily used in professional firms

i. notcommercial enterprises (which usually use corporate form / LLC)

FEDERAL INCOME TAXATION

1. Introduction

a. taxation is now the most significant factor in the selection of a business form

2. Taxation of Partnerships and Corporations

a. Proprietorships

i. nottreated as separate taxable entity1. income / loss is included in proprietors tax return

b. Unincorporated Businesses

i. pass-through taxation

1. partnership itself is not taxed only the partnersa. partnership allocates income / losses to individual partners in accordance

with partnership agreement

ii. Check the Box Regulations

1. check the box rules = elective rules that determine what business associationswill be taxed as corporations

2. apply to:

a. partnerships

b. LLCs

3. doNOTapply to:a. publicly traded corporations (taxed exclusively under C)

4. did 2 things:

a. made election of 3 tax regimes (C, S, K) voluntary forunincorporatedbusiness forms

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b. limited corporations to S/C Corporation rules

i. which tax regime applies depends on whether corporation isclosely/publicly held (is this right??)

5. rules of check the box: (need to know?? p. 34)a. how entity is taxed:

i. corporation:

1. classified as corporation (i.e. created under corporation

statute)

ii. corporation OR partnership:1. 2+ members(i.e. not sole proprietorship)2. not classified as corporation

iii. corporation OR proprietorship:1. 1 member only

b. entity cannot change classification twice within 5 years without

administrative approval

c. Corporations

i. corporations taxed as separate entities

ii. C Corporationspublicly held corporations1. double taxation (i.e. corporation is separate taxable entity), but taxed at lower

rates

a. double taxation = corporation + shareholders (dividends) are taxediii. S Corporationsclosely held corporations (maximum 75 shareholders) (that meet

specific eligibility requirements)

1. pass-through taxation avoids double taxation

a. pass-through taxation = only shareholders are taxed (corporation nottaxed)

i. corporate income is passed through corporation and taxed to

shareholders (whether or not actually distributed)

2. no discretion on how to allocate income

a. income must be allocated according to shareholders interest

iv. Subchapter K - (need to know?? p. 30, 36)3. Individual Taxation

a. need to know ??4. Taxation of Capital Gains

a. need to know ??

5. Estate Taxes

a. need to know ??

6. Technical Language

a. need to know ??

LIMITED PARTNERSHIP

1. Traditional Limited Partnership

a. How Created:i. created by statute (different statutes between states, often based on Uniform Limited

Partnership Act (ULPA))

ii. formed by filing document with Secretary of State

1. failure to file creates general partnership

b. Nature of Entity:

i. 1+ general partner (GP) plus 1+ limited partners (LP)

ii. GP (usually corporation) viewed as having rights and duties of partners in general

partnership

1. unlimitedly liable

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2. general management powers

iii. LP no personal liability exceptto extent of their capital contributions1. very limited management rights

a. if they exceed their limited rights, they become GP and personally liablei. ULPA (1916) limited partners who participated in control of

business lost shield

ii. ULPA (1976) safe harbor for certain management activities

that wont lose shield

iii. ULPA (1983 amendment) limited partner loses shield if

creditor dealt with him reasonably believing he was a general

partner

iv. limited partnership statutes rely on general partnership statutes for matters not

specifically dealt with in limited partnership statute

c. Use of Limited Partnership

i. popularity of limited partnership has waned with creation of LLC and LLP

ii. used mostly by:

1. venture capital firms

a. invest in portfolio companies, which are usually run by venture capitalGPs (need to know??)

i. confidentiality provisions may give rise to litigation for breachof contract / breach of fiduciary duty if confidential information

concerning portfolio company is improperly disclosed (In ReSpree.com)

2. companies involving long-term investments

3. families seeking to reduce effect of estate and gift taxes

d. Master Limited Partnerships(need to know??)

e. Family Limited Partnerships(need to know??)

2. Limited Partnership with Corporate General Partner

a. How Created

i. limited liability entity (like corporation) is sole GP

b. Nature of Entity

i. typically, the GP:1. is controlled by the LPs

2. has a small equity interest (usually 1%)

ii. LPs cannot withdraw during term of partnership agreementiii. controlled by other individuals (board of directors)

iv. transfer of control is difficult

v. may have only nominal assets to satisfy partnership debts

vi. may simultaneously owe conflicting duties to limited partners and its shareholders(USACafes)

c. Liability

i. LPs can be shareholders / directors / officers of GP and still have limited liability1. LPs can take control of business and still have no personal liability

2. directors of corporate GP still owe fiduciary duty to limited partners (USACafes)ii. gets limited liability where GP is only marginally capitalized (??)d. 3 Major Advantages

i. (1) combines limited liability for all

ii. (2) favorable tax treatment

iii. (3) can change ownership interests in GP without causing change in GPs identity

3. Limited Liability Limited Partnership

a. LLLP = limited partnership in which GP has limited liability protection provided by LLP election

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i. sometimes, GP in LLLP may have broader protection against liability than broader

protection against liability than the limited partners (accident, not design)

LIMITED LIABILITY COMPANY (LLC)

1. Introduction

a. most popular and widely used unincorporatedbusiness form with limited liability

2. How Created:

a. created by filing articles of organization with Secretary of State

i. operating agreement / regulations sets forth detailed rules of operation

3. Nature of Entity

a. 1+ members

b. LLC can take on characteristics ofboth corporations andpartnerships (Poore)i. corporations:

1. limited liability

2. creature of contract

3. must be represented by attorney (Poore)a. cannot represent itself

ii. partnerships:

1. pass-through taxation

c. LLC agreements:

i. LLC members may enter agreements to:

1. carry out operation

2. arbitration

3. forum selection

ii. usually valid

1. will only be invalidated where inconsistent with statutory provisions (ElfAtochem)

iii. DE nothing prohibits members from:

1. altering default jurisdictional provisions

2. contracting away right to file suit in the state

iv. some courts have held that an operating agreement is not enforceable against LLC whereLLC has not signed agreement (Bubbles & Bleach)

4. Management

a. can be either:

i. member-managed rules are similar to partnership

ii. manager-managed rules are similar to corporation

5. Fiduciary Duties

a. scope differs from state to state can be similar to those of:

i. partner

ii. corporate director

b. DE most liberal

i. LLC decides which fiduciary duties to impose

6. Liabilitya. can be analogized to limited partnership composed only of limited partners

i. however, all members an freely participate in management of the business without

becoming liable for business obligations

1. (provided by provision in LLC statute that members are not personally liable fororganizations debts)

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b. piercing doctrine generally applies

7. Taxation

a. can choose pass-through taxation OR entity taxation (like corporation)

8. Uniform Limited Liability Company Act (ULLCA) (High Courts, p. 38, need to know??)

9. Characteristics of Alternative Types of Business Organizations (High Courts, p. 39, need toknow??)

10. 3 Major Advantagesa. (1) limited liability for all participants

b. (2) complete flexibility in internal structure and managementi. membership interest may be made readily transferable

c. (3) no double taxation (pass-through)

CORPORATIONS

DEVELOPMENTOF CORPORATION LAW

1. State Corporate Lawa. corporations are creatures ofstate statute

2. DE Corporate Law / Policy

a. shaped by 3 groups:

i. corporation service companies

ii. legislature

iii. DE bar

b. reasons for incorporating in DE:

i. courts:

1. skilled, speedy Chancery Court

2. pro-management judiciary

ii. agencies:1. efficient administrative agencies

iii. precedent:

1. consistent, well-developed precedents

iv. statute:

1. statutes sophistication and flexibility

v. responsiveness to business needs

c. distinguishing features of DE law:

i. can adopt measures by 30% shareholder vote (as opposed to 50%)

ii. can limit/eliminate directors liability to shareholders/corporation (except for personal

misconduct)

iii. if officer/director is sued and:

1. wins he must be reimbursed (indemnified)2. loses/settles corporation may reimburse him if he acted in good faith

iv. dividends may not exceed net profits

v. allows anti-takeover measures (gives management lifetime tenure)

3. 2 Reasons Why Incorporation State is Important

a. (1) determines corporations franchise taxes

b. (2) internal affairs doctrine:

i. suits brought in other states must apply incorporation states corporate laws

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FORMATIONOF CLOSELY-HELD CORPORATION

1. Where to Incorporate

a. 2 factors in selecting state of incorporation:

i. (1) cost of being chartered in the state

ii. (2) benefits of being governed by that states law1. including:

a. how much control shareholders are allowed

b. scope of fiduciary duty

c. executive compensationd. taxes

2. choice is usually between DE and state where corporation does business

a. for closely-held corporations with most business in its state, in-state

incorporation is usually preferable

2. How to Incorporate

a. Where Substantive Agreements Should Be Placed

i. 3 choices:

1. articles (public)

a. usually limited to provisions required by law to appear

i. however, placing provisions here may constitute general legal

notice

2. bylaws (not public)

3. shareholder agreement (not public)

b. Formal Requirements

i. (1) usually filing is minimal (postcard / electronic filing)1. more extensive requirements are pointless

2. filing goes to state secretary of state

ii. (2) naming requirements:1. corporation name:

a. name must be distinguishable on their face from other corporations

(Trans-Americas Airlines)b. can use assumed / fictitious names if no intent to defraudc. corporation has perpetual duration for its name

2. name / address of each incorporator

iii. (3) listing corporate powers in articles1. power = activity corporation can do to promote its purposes

2. must list number of shares corporation is authorized to issue

3. listing powers is good in states that declare unlisted powers as ultra vires (void asbeyond corporations powers)

4. however, listing express powers might create inference that unlisted powers are

denied

iv. (4) designate registered office and agent

1. the address must be listed (so corporation can be sued)c. Permissive Requirements

i. MBCA sets forth permissive requirements

1. if they are not included in filing, they may be:

a. covered by bylaws / shareholder agreements

b. rejected

ii. permissive requirements include:

1. state business purpose

a. statute defaults to any lawful purpose (broad statement)

i. default does notapply if there is a stated restriction on purpose1. reasons for restricting purpose might include:

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a. not having conflict between business activities

and owners other activities

b. define limited venture

c. preclude a power on a permanent basis

b. purpose = line of business

d. Incorporators

i. who can serve as incorporator:

1. initial directors

2. attorneys

3. artificial persons (corporations, organizations, trusts)ii. how many incorporators needed:

1. one is usually enough

e. Initial Capital

i. most states do notrequire minimum initial capitalf. Documents Specifying Corporate Governance & Shareholder Relations

i. shareholder agreement:

1. tells how shareholders will govern the corporation

2. can protect:

a. shareholders right to participate in management

b. terms on which they can exit

ii. compared to partnerships / LLCs:

1. corporation members have less freedom to structure governance than partners /members of LLC

iii. bylaws:

1. internal operating rules and management rights

2. what they may contain:

a. anyprovision for managing business that is notinconsistent with:i. law

ii. corporations articles

3. typically include:

a. number of directors and their qualifications

b. how to add/remove directors

c. resignation procedures

d. replacements

e. directorial powers/duties

f. rules for meetings, subcommittees, salaries, and indemnification

3. Premature Commencement of Business

a. Promoters

i. Definition

1. promoter = person who directly/indirectly takes initiative in founding /

organizing the business of a corporation

a. notconducting businessii. Fiduciary Duties

1. promoters owe fiduciary duties to other participants in venture

iii. Who Can Sue Promoters

1. investors, for:

a. deception in dealing with promoter

b. 10b-5 fraud, if:i. misrepresentation related to purchase/sale of security

ii. through interstate communication facility

2. corporations general creditors

3. corporation itself

4. co-promotersiv. Disclosure of Promoter Transactions

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1. corporations transactions with promoters must be disclosed under:

a. Securities Act of 1933

b. state blue sky laws

v. Promoter Liability

1. personal liability for contracts(even ifpromoter transacts on behalf ofcorporation) unless:

a. other party agrees to looksolely to the corporation for payment (StanleyJ. How)

i. there might be an exception:1. if other party knows corporation isnt formed but agreesto look solely to corporation anyway (Sherwood)

a. promoter would not be personally liable

i. prof & MBCA think this is wrong, sinceother party had assumed risk of not

pursuing promoters with the assumption

that they would try to incorporate (i.e. bad faith by promoters)

2. MBCA rejects this exception (see DefectiveIncorporation below)

a. if a promoter, knowingthat there is no

corporation, purports to act on behalf of thecorporation, he will be jointly and severally

liable

2. promoters should protect themselves by:

a. writing out basic rights/duties

b. including provision for payment if promotion fails

c. make contracts only in the name of corporation

d. corporate contracts should specify that other party should look only to

corporation for payment

vi. Adopting Promoter Agreements

1. corporations are notbound by agreements made on their behalf by its promotersbefore its organization, but

a. after organization, it may adopt these contracts (expressly/impliedly)b. Defective Incorporation

i. Definition

1. defective incorporation = person who represents himself as corporations

agent, even though corporation is not yet officially approved

ii. Corporations Official Existence

1. corporation officially exists only when certificate has been issued by secretary ofstate

iii. Liability

1. if individuals purport to act on behalf of corporation before certificate issues,they are personally liable (Robertson)

a. it does notmatter whether third parties believed they were dealing with a

corporation2. however, if incorporation is defective due to the fault of someone other than the

agent, courts may nothold the agent liable (Cranson attorney misfiled)

a. 2 theories: (which MBCA REJECTS)

i. (1) doctrine ofde facto corporations1. applies where:

a. (a) law would have authorized the incorporation

b. (b) agents made good faith efforts to incorporatelegally

c. (c) they actually exercised corporate powers

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ii. (2) doctrine of estoppel to deny corporate existence1. applied where:

a. defective corporation dealt with third party as if

it were valid2. agent is estopped from claiming that no corporation

actually happened

b. courts may consider other factors: (Kunkels)

i. one court held that members of defectively incorporated

businesses are jointly and severally liable only if:1. (a) they represented themselves as incorporated

2. (b) debt was incurred in corporations name

3. (c) granting personal liability would be equitable

3. MBCA (which REJECTS above theories) states that agents should usually beliable for defective incorporation, unless:

a. (a) agent believes articles are filed, but attorney made mistake

b. (b) articles were sent, but not received/processed

c. (c) third party knows corporation is unformed, but insists on contractingwith corporation immediately

d. (d) agent represents that corporation exists, but third party demandsrecourse only from corporation

e. (e) agent received advance funds with instructions not to act untilcorporation is formed, but acts prematurely

DISREGARDOF CORPORATE ENTITY

1. Piercing the Corporate Veil

a. Definition

i. piercing corporate veil = holding shareholders liable for corporate debts

1. very fact-specific

2. law permits incorporation for the very purpose of escaping personal liability(Bartle)

a. but, in certain situations, courts may pierce the corporate veil and holdowners/shareholders liable for corporate debts

i. to pierce, there must be:1. fraud

2. misrepresentation

ii. reality:

1. its hard to pierce

2. usually only done for close corporations

b. Purpose for Piercing

i. piercing is used to:

1. (1) prevent fraud

2. (2) achieve equityc. Tests for Piercing the Corporate Veil

i. requirement:

1. there must be fraud/misrepresentation, injustice / fundamental unfairness

a. factors to consider in deciding whether unfairness exists (multiple factorsrequired): (DeWitt)

i. (a) * undercapitalization (* key element)1. measured by:

a. money put into business

b. procurement of insurance

ii. (b) failure to observe corporate formalities

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iii. (c) non-payment of dividends

iv. (d) insolvency of debtor corporation

v. (e) siphoning of corporate funds by dominant stockholder

vi. (f) non-functioning of other officers/directors

vii. (g) absence of corporate records

viii. (h) corporation being faade for operations of dominantstockholder

2. if there is only one shareholder:

a. corporate entity is disregarded where corporation is merely used asshareholders alter ego or instrumentality (DeWitt)

i. alter ego = running corporation for own benefit

3. 2 possible tests for whether to pierce:

a. (1) fraud / misrepresentation

b. (2) alter ego + injustice (need multiple factors from above)ii. contract actions:

1. some cases wont pierce where there was contract between corporation and third

party because:

a. third party knowingly and voluntarily agreed to do deal with corporation

without requesting personal guarantee from shareholders

iii. tort actions:

1. piercing in tort actions requires more than shareholder personally guaranteeingcorporate obligations (Baatz)

a. requires more than in contract cases because:

i. usually third party has not dealt voluntarily with corporation

b. factors indicating injustice:

i. (a) fraudulent representation by corporation directors

ii. (b) undercapitalization (seebelow)

iii. (c) failure to observe corporate formalities

iv. (d) absence of corporate records

v. (e) payment by corporation of individual obligations

vi. (f) use of corporation to promote fraud / injustice

iv. parent/subsidiary cases:1. general rule:

a. parent is not liable for actions of its sub

2. 2 tests for whether to pierce parent:

a. (1) undercapitalization of subsidiary +fraud / injusticei. undercapitalization creates the inference that parent recklessly

created business that was unable to satisfy judgments

1. piercing is not proper where subsidiary had liabilityinsurance (i.e. insurance means sub was capitalized)

(Radaszewski)

b. (2) alter ego 2 requirements: (Fletcher)

i. (a) parent and subsidiary operated as single economic entity

ii. (b) overall element of injustice is presentv. what kind of corporation is most likely to be pierced:

1. closely-held

d. Piercing Doctrine in Federal & State Relations

i. CERCLA

1. CERCLA federal statute that imposes responsibility for clean up costs on

owners of hazardous waste disposal sites

a. parent corporation may be: (Bestfoods)

i. (a) directly liable forits own conductinvolving facilitycontrolled by its subsidiary, or

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1. active participation / control oversubsidiarysoperations, without more, is notenough to hold parentliable as operator of polluting facility

2. however, active participation / control over thepollutingfacility itselfis enough to hold parent liable asoperator

ii. (b) indirectly liable under piercing doctrine1. requirement:

a. evidence ofextensive control of subsidiaryii. Using Corporate Entity to Defeat Public Policy1. corporation will be pierced where corporate entity is used to defeat public policy

(Stark/Roccograndi)

e. Reverse Piercing (need to know??)

2. Alternative to Piercing: Deep Rock Doctrine

a. deep rock doctrine = subordination of inequitable claims by shareholders to claims of othercreditors (Pepper)

i. in bankruptcy action, court cansubordinate a shareholders to other creditors claimswhere shareholders claim was inequitable (laid dormant until bankruptcy)

1. subordination changing the order of payments of debts by corporation

a. i.e. other creditors are paid first2. even though shareholders claim was notfraudulent, it was inequitable

a. this is not piercing because there was no fraud

ii. alternative to piercing

1. (nota form of piercing)iii. equity decision

3. Liability of Successor Entitiesa. Definition

i. successor entity = corporation acquiring all or portion of another corporations assets

b. General Rule

i. successor entities do notacquire the liabilities of the corporation they acquire (Nissen)

1. (butsee exceptions)c. Exceptions

i. successor entitiesDO acquire liabilities of the corporation they acquire where: (Nissen)

1. (1) it is expressed/implied in the agreement

2. (2) the acquisition amounts to merger/consolidation

3. (3) successor is continuation of predecessor

4. (4) agreement was fraudulent, lacked good faith, or was made with inadequateconsideration

5. (5) (some courts) continuity of enterpriseii. a number of courts reject these exceptions

iii. the form of a successor company becomes very important

1. in buying assets of a predecessor company, the successor can avoid thepredecessors liabilities by making sure it falls outside the exceptions

FINANCIAL MATTERS & CLOSELY-HELD CORPORATIONS

1. Capital

a. Definition

i. capital = financing necessary to run a business

b. 2 Categoriesi. 2 kinds of capital:

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1. 1) debt = capital raised through borrowing with unconditional promise to repaya. must be repaid

i. fixed repayment schedule

ii. fixed amount = principal + interestb. 2 kinds of debt securities:

i. (1)bonds

1. secured by lienon corporate property

ii. (2) debentures

1. unsecuredc. benefits:

i. to corporation1. can be beneficial to corporation if borrowed capital

creates leverage

a. i.e. when borrowed capital can be used to

create more money than corporation is required

to pay

2. interest on debt is a deduction (no double taxation)

ii. to investor

1. loans to corporation receive more favorable tax

treatment than purchase of shares

d. downsides:i. cant have too much debt investors wont like it

2. (2) equity capital = financing obtained by giving away ownership interest inbusiness in exchange for contributions from owners / investors and retained

earnings of business

a. 2 characteristics:

i. (a) ownership1. i.e. interest in net assets of business

a. net assets = what is left after all liabilities are

paid

2. measured as percentage

ii. (b) voting

b. usually evidenced by holding of sharesc. downsides:

i. dividend payments are not deductible (double taxation)

1. (as opposed to debt financing debt is deductible)

ii. once its given away, its gone forever

1. (as opposed to debt financing, which has a return rate)

iii. if the business takes off, it wont know the value of equity

1. (as opposed to debt, which is a value that is always

known)

ii. best planning device for investor:

1. mix of debt and equity investment

a. if business is a success, equity will be more valuable

b. debt to equity ratio:i. banks require certain amount of equity

ii. cant be so highly leveraged that liabilities take over the business

iii. thin corporation = debt to equity ratio is dangerously thin

2. if business fails, investor may still be able to recoup his loanc. Capital Surplus

i. capital surplus = amount in owners equity that is above stated capital

ii. it makes a difference if something is recorded as stated capital or capital surplus

1. if statute mandates that dividends come out of surplus:

2. the higher the stated capital, the less dividends can be made

d. Raising Capital

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i. raising capital vs. raising equity:

1. how to raise capital:

a. issue shares2. how to raise equity:

a. sellsharesii. corporations seeking to raise capital should always consider:

1. state blue sky laws

2. federal securities statutes

2. Shares (a.k.a. Equity Securities)

a. Definitioni. shares = units into which proprietary interests of corporation are divided

1. traditional way of receiving capital

b. 2 Rights of Shareholders

i. (1) voting

ii. (2) ownership1. i.e. right to distributions / dividends

a. distribution = payment to shareholders out of corporations capital

b. dividend = distribution made out of corporations earningsc. Different Classes

i. corporations musthave shares and equity1. articles must authorize one or more classes of shares

ii. corporations may create different classes of shares (set forth in articles)

1. each class can have different rights

2. all shares within the same class must have equal rights

3. together, the classes of shares (or the single class) musthave unlimited votingrights

iii. most common distinction common vs. preferred (each may be issued in classes with

junior/senior rights)

1. common shares:

a. rights:

i. voting

ii. ownershipiii. inspect financial records

iv. sue on behalf of corporation

v. receive certain financial information

b. default when corporation only has one kind of shares

2. preferred shares:

a. rights are preferential in some way to common sharesi. rights:

1. priority to receive dividends / distributions (duringwinding up)

2. maybe entitled to vote but often are not

a. ifthey have voting rights:

i. articles may designate certain number ofdirectors that preferred shareholders areauthorized to elect

b. ifno voting rights:i. articles often authorize them to vote in

cases where preferred

dividends/distributions havent been

paid for a certain period

3. 1 of 3 kinds of dividend rights:

a. (1) cumulative rights

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i. give holder priority to receive any prior

unpaid dividends from a previous year

b. (2) non-cumulative rights

i. do notcarry over from year to year

c. (3)partially cumulative

i. carry over dividends based on earningsduring a year, but notthose based onexcess dividend preference

4. liquidation prioritya. to be paid upon dissolution before common

shares5. redemption rights (at option of corporation)

a. allows corporation to buy back redeemable

shares at any time at fixed price

i. shareholder is obligated to accept

6. right to convert preferred shares to common at fixed

ratio

a. allows holder to obtain part of long-term

appreciation of corporations assets

7. protections including:

a. sinking fund provision requires corporation toreserve funds each year to redeem portion ofpreferred stock(need to know??)

b. anti-dilution provisions

ii. participating preferred shares / Class A common

1. entitled to their dividends andshare additionaldistributions with common shares

d. Issuance of New Sharesi. certain questions are up to those forming corporation:

1. number of shares to be authorized

a. useful to authorize more shares than will be initially issued

i. corporation may need to raise additional capital later, and

corporation cannot issue more shares than are authorizedb. however, shouldnt authorize too many shares

i. need to protect minority shareholder interests

ii. avoids additional taxes on authorized shares

2. number of shares to be issued

a. cannot issue more shares than are authorized

i. however, can amend articles to authorize more shares3. type of shares being issued

4. price

ii. reason shares are issued:

1. raise capital

iii. issues raised by issuance of new shares:

1. dilution: (see below)a. what the rights are of existing shareholders to purchase portion of new

shares to protect themselves against dilution of ownership interests

2. recapitalization:

a. shareholders exercising their will in shaping any recapitalization of the

corporation

e. Dilution, Preemptive Rights, & Recapitalization

i. dilution = reducing the value of proportionate ownership interest

1. (ex.) if there are 3 stockholders and corporation sells shares to fourth shareholder,

the ownership rights of the 3 original shareholders are diluted

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ii. preemptive rights:

1. preemptive right = right of existing shareholder to purchase more shares so thatownership interest is not diluted by the issuance of new shares (Stokes)

a. articles mustinclude anti-dilution provisions for there to be preemptiveright

i. if articles are silent, then none are granted

2. shareholders have to opt in to get preemptive rights

3. there must also be a valid business purpose to perform an action that will dilute

shares (Katzowitz)a. shareholders can prevent the sale of shares at unfair prices to avoiddilution (Katzowitz)

i. a price set to achieve a fundamental goal for the good of thebusiness willbe upheld

ii. this is a fiduciary duty to minority shareholders

iii. recapitalization:

1. shareholders have right to exercise their will over proposed recapitalization of thecorporation (Lacos Land)

a. (ex.) a shareholder vote to authorize a new class of shares was invalid

where threats of adverse action by a shareholder seeking such

authorization acted to subvert the will of the shareholders

2. even if action is not preemptive, shareholdersstillowe fiduciary dutyf. Raising Capital vs. Raising Equity

i. how to raise capital:

1. issue sharesii. how to raise equity:

1. sellsharesg. Par Value

i. par value = arbitrary value assigned to shares

1. represents minimum amount for which share may be initially sold

a. if shares are sold for less than par value, purchasers may be liable tocreditors for the differencebetween what they paid and what they shouldhave paid

ii. no longer used in most states1. most states use nominal par value

a. requires corporation to declare less stated capital

i. leaves more money in capital surplus category (flexible)

1. more capital available for distributions

iii. most important effect of par value is:

1. on corporations stated capital

a. stated capitalshould= (# shares) x (par value)

iv. par value of issued shares is public representation of corporation (Hospes)1. stops unscrupulous practices where corporations would give out shares of par

value stock without requiring payment

h. Watered Stock

i. definition:1. watered stock = shares that have been issued for inadequate/improper

consideration

a. improper consideration includes:

i. future services

ii. promissory notes

b. improper consideration may include:i. intangible property

1. this is hard to judge, since may have real value, but theyare difficult to assess

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ii. shareholders who do not initially pay for shares are statutorily liable to creditors to theextent their stock is not paid for (Hanewald)

1. liability for watered stockonly applies to initialissuance of shares (Torres)

a. does notapply to resale of shares2. creditors may sue shareholders directly

iii. payment for shares is what triggers corporate shield

i. Bonus / Discount Shares

i. bonus shares = shares for which no consideration was paid

ii. discount shares = sold for cash, but cash is less than par value

3. Assessing Capital Structure of Close Corporation

a. 5 factors attorneys should look at:

i. (1) feasibility of structure and potential to withstand legal scrutiny

ii. (2) fit of structure to the planned/hoped for financial result

iii. (3) fits of structure to desirable tax treatment

iv. (4) possibility that structure would lead to unexpected liabilities

v. (5)protections the structure affords to investors investments

4. Declaring Dividends

a. directors (notshareholders) usually have discretion over whether and when to declare dividends

i. as general rule, courts will not upsetgood faith business judgment of directors

1. badfaith occurs when:a. directors policy was dictated by personal interests rather than

corporations welfare

i. (ex.) directors withholding dividends (freeze-out attempt) eventhough adequatesurplus is available (Gottfried/Dodge)

2. court will force declaration of dividends ifthere is:

a. (a) surplus, and

b. (b)bad faith

5. When Distribution is Lawful

a. distribution = corporations direct / indirect transfer of money/property, or incurring ofindebtedness to / for the benefit of its shareholders

i. (ex.)

1. dividend payment out of current or past earnings

2. repurchase of sharesa. same effect as dividend company is poorer

b. 2 tests for when distribution is / is not lawful: (MBCA)

i. (1) equity insolvency test = illegal to authorize distribution when:

1. (a) corporation is insolvent, or

2. (b) giving out distribution would make corporation insolvent

ii. (2) balance sheet test = illegal to grant any distribution after which:

a. (corporations liabilities) + (senior securities dissolution preferences)would exceed its assets

c. articles governance of distributions:

i. articles can be amended to restrict(but notenhance) ability to make distributions

6. Authority to Compensate Officersa. directors usually have authority to compensate corporate officers

b. where officer determines his own compensation: (Wilderman)

i. (a) he has the burden of proving the salary was reasonable

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ii. (b) court will order officer to return unreasonable compensation to corporation forpayment out as dividends

1. focus on removalof adequatesurplus

c. close corporation can avoid double taxation by paying out profits as compensation (rather thandividends)

7. Unreasonable Spending by Corporate Officer

a. where officer is accused of unreasonable expenditures:

i. (a) he has the burden of proving the expenses were reasonableii. (b) court will order officer to return unreasonable expenses to corporation for payment

out as dividends

b. focus on removalof adequatesurplus

8. Stock as Asset

a. corporation that repurchases its own shares as distribution cannottreat repurchased stock as asset

b. however, corporation can treat as asset another entitys stock that corporation purchases asinvestment

9. Fiduciary Duties ofShareholders in Close Corporations

a. shareholders in close corporations (** this is differentfrom directors duty of loyalty / due care)owe each other fiduciary duty similar to that of partnership (Donahue)

i. test for whether shareholders fiduciary duty has been violated:

1. (1) was there valid business purpose?a. if not probably no good faith

2. (2) was there less harmful alternative to achieve the objective?ii. freeze-outs:

1. minority shareholders are vulnerable to freeze-outs (oppressive action by

majority)

a. (ex.):

i. refusal to declare dividends

ii. payment to majority of exorbitant salaries/bonuses

iii. exclusion of minority from corporate offices / employment2. notillegal in and of themselves, butmust be done in accordance with fiduciaryduty

iii. repurchase of shares:

1. if controlling shareholder causes corporation to purchase his shares:

a. corporation must offer other shareholders the option to sell ratable

number of shares to corporation at same price

b. DE rejects shareholder fiduciary dutyi. entire fairness test adopted instead

MANAGEMENT & CONTROLOF CORPORATIONS

1. Management Roles

a. Traditional Roles in Corporate Management

i. directors manage affairs

ii. officers carry out board decisions

iii. shareholders vote for directors

b. Historical(** NOT Modern!**) View of Corporate Managementi. preserve independence of directors in questions of corporate management

1. shareholder agreements that restricted boards discretion were historicallydeclared void as against public policy (McQuade)

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a. however, where the interference with directors power was onlyslight, soas not to cause damage, the agreement would notbe invalidated(eventhough technically, this restricted directors discretion) (Clark)

b. agreement involving more than slight restriction on directors powerswas notenforceable

i. shareholders could notdeprive board ofallpowers to manageprincipal business of corporation (Long Park)

c. Modern View of Corporate Management

i. recognizes that close and public corporations are different1. lines between management and ownership are often blurred

2. minority shareholders need more protection

a. these kinds of agreements are often necessary

ii. in close corporation shareholder agreements restricting boards discretion are notautomatically invalid(Galler / Zion)

1. in CLOSEcorporations, shareholder agreement limiting boards discretionwill notbe invalid where:

a. (1) no minority shareholder is prejudiced

b. (2) neither creditors nor public is injuredc. (3) no clearly prohibitory statutory language is violated

2. MBCA adopts this view

iii. what shareholders can an cannot do:1. shareholders do not:

a. run the day-to-day operations of the business (directors do)

2. shareholders in allcorporations can:

a. elect directors to run the business

b. remove directors for cause after giving director notice and reasonableopportunity to be heard (Matter of Auer)

c. approve fundamental transactions

i. (ex.) mergers, sales, dissolutions, amendment of articles, etc.

d. make payments of indemnification

2. Minority Voice in Corporate Control

a. Shareholder Votingi. voting is traditional way of giving owners of corporation a voice in its management

ii. in determining who owns shares (and is thus entitled to vote): (Salgo)

1. corporations must rely on corporate records in determining who owns shares

2. who does notget to vote:

a. beneficialowner (i.e. the person in whom the beneficial rights of theshares have been designated to rest)

i. may or may not be the same person who is the record owner of

the shares

iii. cumulative vs. straight voting:

1. straight = majority of votes controls

2. cumulative = shareholder can cast his votes by multiplying # shares by # opendirectorships and thereby cast total vote for single / select few candidate(s)a. shareholders are allowed to give all votes to one candidate rather than

having to split their votes among candidates

i. gives minority shareholders opportunity to elect some directors

to represent their interests

b. if required by articles, corporation mustvote as suchc. may be authorized / required by statute

i. if required by statute, bylaws cannotrestrict the right to votecumulatively (Humphrys)

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d. formula for determining the number of shares needed to elect morethan one director = ((total# shares voting x n) / (directorships open

+1)) +1

i. n = # directors a shareholder wants to elect

3. (ex.) F is majority shareholder. He holds 750 shares of the 1000 sharesoutstanding (i.e. he gets 750 votesper director). C holds the remaining 250

outstanding shares (i.e. he gets 250 votesper director). 4 directors are to beelected at next election.

a. how many shares would it take to elect 1 director?i. # shares necessary to elect 1 director = (1000/(4+1)) + 11. (1000/5) + 1 = 201

2. C has 250 shares so he can elect 1 director

a. F can elect the remainder

b. how many shares would it take to elect all 4 directors?

i. # shares necessary to elect all 4 directors = ((1000 x 4)/(4+1)) +

1

1. (4000/5) + 1 = 801

2. F has 750 shares so he cannotelect all 4 directorsc. if corporation uses cumulative voting, how many of the 4 directors may

C elect if he uses cumulative voting?

i. 1 (it takes 201 shares to elect 1 director, and C only has 250)1. if electing 4 directors, C has 1000 total votes (250 x 4)

and F has 3000 total votes (750 x 4)

a. F1 1000 C1 0

b. F2 1000 C2 0c. F3 1000 C3 0

d. F4 0 C4 1000d. if corporation uses straight voting, how many of the 4 directors may C

elect if he uses straight voting?

i. 0 (Cs 250 will always be outweighed by Fs 750)

1. C will get 250 votesper director(cant combine hisvotes toward one director), and F has 750 per director

a. F1 750 C1 250 b. F2 750 C2 250

c. F3 750 C3 250

d. F4 750 C4 250iv. vote-pooling agreements:

1. definition:

a. shareholders make binding agreements to vote a certain way

2. another way for shareholders to ensure some degree of control by electingmanagement (Ringling Bros.)

v. proxy:

1. proxy = when record shareholders authorizeanother person to vote their shares

a. directors may notvote by proxy (would violate fiduciary duty)

2. proxy is unilaterally revocable by shareholdera. it is only irrevocable if:

i. (1) it states its irrevocable, and

ii. (2)proxy holder has interest in stock / corporation1. ensures voting with good motive

vi. voting trust:

1. voting trust = shareholders transfer legal title of their shares to another so theother may vote those shares

a. mustbe:

i. (a) written

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ii. (b) filed

iii. (c) limited in duration

iv. (d) consistent with purpose of trust

1. trustees cannotexercise powers detrimental to thegrantor even ifthe general scope of the power isgranted (Brown)

a. based on:i. intent of parties

ii. general equitable principles2. way for shareholders to gather enough voting strength to elect management

a. (ex.) family situations where children are given shares but not allowed tovote

3. disfavored by courts

b. Ways for Shareholders to Control Who Participates in Management

i. (1) cumulative voting

ii. (2) vote-pooling agreements

iii. (3) voting trust

1. voting trust = existing right to vote is divested and separated from other aspectsof stock ownership (Lehrman)

2. what does notconstitute a voting trust: (Lehrman)

a. class of stock that has no rights other than to elect a director, simplybecause is dilutes the voting power of other voting shares

iv. (4) create different classes of stock (Lehrman)1. allow each class the right to elect a certain number of directors

v. (5) restrictions on purchase / sale of stock1. notice:

a. 2 requirements notice of restriction on transfer of stockmustbe: (Ling)

i. (1) conspicuous1. conspicuous = written so that treasonable person

would notice it

a. (ex.) capital letters, bold face, etc.

ii. (2) reasonable2. buy-sell agreements:

a. determine what happens to stock upon particular triggering events

i. (ex.) death of shareholder, bankruptcy of shareholder, divorce ofmarried owners, etc.

b. proper valuation of business is essential for effective buy-sell agreement

i. ways of evaluating:

1. objective formula

2. independent appraisal

3. specific price that owners agree upon and update

regularly

ii. pitfalls of valuation experts:

1. internal inconsistency

2. intellectual dishonesty

c. 2 basis types of buy-sell agreements:

i. (a) cross-purchase agreement1. shareholders agree to buy each others stock when the

other dies

ii. (b) stock-redemption agreement1. corporation redeems/buys the shares of the first

shareholder to die

3. Deadlocks

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a. Definitioni. deadlock = when 2 factions compete for control of corporation and they cannot agree

how the corporation should be run results in paralysis

b. Shareholder Deadlock

i. definition:

1. shareholder deadlock = when shares are split evenly and arguing factions

cannot agree to elect new board

a. result:

i. incumbent board continues in power (Gearing)1. where shareholder refuses to attend a meeting in order to

avoid having quorum (when he knows he will lose

election), it is breach of fiduciary duty

a. board can vote anyway

ii. most statutes say that after a couple of years of shareholder

deadlock, factions may petition court for dissolution / other

modern remedy

c. Grounds for Dissolution When There is Deadlock

i. 5 categories (somewhat overlapping):

1. (1) is there deadlock?

2. (2) is there inappropriate oppression?

3. (3) has there been fraud?4. (4) has there been corporate waste?

5. (5) has there been misconduct?d. Remedies

i. historical(**NOT modern**) remedies:

1. traditionally, courts were hesitant to dissolve corporations and would only do sowhere they were no longer viable business entities (In re Radom)

a. however, court that didnt want to order dissolution could order otherequitable remedies

ii. modern remedies:

1. buy-out (most common relief)

a. even if only statutory remedy is dissolution, the court is warranted in

using its equitable power to order a buy-out if: (Davis)i. majority shareholders in close corporation engage in oppressive

conduct toward minority shareholder

1. although note that minority shareholders can also actoppressively toward majority shareholders (such as by

breaching fiduciary duty) (Rexford Rand)a. if this is the case, they cant claim oppression

2. provisional director

a. where board is likely to deadlock, court may order provisional director tosit on bard and break deadlocks until corporation can run without him

4. Authority of Officers

a. 3 Sources of Authority in Corporations

i. (1) articles and internal corporate documents

ii. (2) statute permissive / mandatory rules providing for responsibilities to be excercised

iii. (3) written agreements between partiesb. Hierarchy of Rights & Responsibilities

i. corporations exist for benefits of shareholders

ii. shareholders rights fall into 2 categories:

1. ownership

2. votingiii. directors elected by shareholders

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1. manage day-to-day business

2. where to find directors powers:

a. look at statute generally provides for powers

b. bylaws specifically addresses authority

i. must be consistent with statute

1. sometimes statute will defer to bylaws

iv. officers serve the will of directors

c. Decision-Making

i. traditionally, board makes all decisions for corporation

1. large corporations:

a. however, in very large corporations, the officers make the day-to-dayoperating decisions(board is merely supervisory)

i. this creates issues of corporate control

1. this takes away control by owners, since officers are notelected by the shareholders

ii. when officers can bind corporation (rules of agency apply):

1. when actions are:

a. explicitly within the scope of their authorityunless: (Drive-In Dev. Corp.)

i. third party had knowledge that there was

an untruth / lack of authority

b. taken in the usual and ordinary course of theofficers business (Lee)

i. i.e. apparent authority

iii. when actions are not binding:

1. if mandatorily assigned to boardby statute2. if they significantly change the structure of the business /

control

2. small corporations:

a. officers, directors, and shareholders are often the same people

5. Controlling Shares

a. Majority Shareholders in Close Corporationsi. in close corporations, it is common for one shareholder / faction to have either:

1. majority of shares, or2. substantially more shares than any other shareholder / faction

ii. control / domination:

1. in such a case, majority shareholder can control / dominate the corporation by

electing himself and his slate of directors to board

iii. duties when selling shares:1. majority shareholders:

a. duty to act reasonably with respect to selling shares/assets

i. duty owed to:1. corporation

2. minority shareholdersii. if controlling shareholder is selling his shares and knows / has

reason to believe that purchaser is a looter (i.e. intends to use

his control to harm the corporation) he has a duty to refrain from

the sale (DeBaun)

2. directors:a. also have duty of business judgment / reasonable behavior when selling

shares/assets

i. duty owed to:

1. corporation

2. minority shareholders

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iv. premium:

1. if the premium that a controlling shareholder is to receive is for control over acorporate asset(as opposed to control over the corporation): (Perlman)

a. shareholder may notreceive the premium

DUTYOF CARE & BUSINESS JUDGMENT RULE (BJR)

1. Directors Duty of Care andSubstance-Based BJRa. no personal liability:i. corporate directors who exercise reasonable prudence in approving / participating in

corporate transactions are notpersonally liable for losses caused by the transactions as

long as they: (Litwin)

1. (1) made decision in good faith2. (2) with minimum rationality

a. minimum rationality test = director must exercise same level of care as

reasonably prudent person in the same circumstances

i. 2 factors:

1. (a) directors actions

2. (b) results

3. (3) without self-dealingb. when personal liability arises:

i. when directors are negligent in performing their duties

2. Process-Based BJRa. Directors Duty of Good Faith

i. officers/directors have duty to perform functions in good faith

1. 4 requirements:

a. (1) use ordinary prudent care under the circumstances

b. (2) no self-interestc. (3) reasonable self-informing

i. director must:

1. ascertain relevant facts / law before making decision2. make decision after reasonable deliberation

ii. due care standard may vary with industryiii. directors may be liable for neglecting decision-making duties,

even if the decision turns out to be good

1. (ex.) corporate directors who sell corporation withoutdetermining its true value breach duty of care, even if

price is above market value (Van Gorkom)

iv. directors must obtain third-party consulting (Van Gorkom)1. where board has relied on independent third party

advice:

a. court will notapply hindsight to overturnboards business judgment

d. (4) reasonable belief that judgment is in corporations best interestii. in shareholder suits, shareholder must prove that:

1. duty of care was breached

2. there was casual connection to loss

b. Director Discretion Generally Upheldi. courts try to avoid second-guessing directors business decisions

1. exceptions cases of:

a. bad faith

b. egregiously bad judgment

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c. When Personal Liability Arises BJR

i. BJR requires more than ordinary negligence for directors to be liable

1. there must be wrongdoing such as: (Schlensky)a. fraud

b. illegality

c. conflict of interest

2. it is not whatdirectors do, but how they do it that matters

a. decision need notbe that of ordinarily prudent person

3. Limitations on Directors Liability

a. States Often Limit Directors Personal Liability

i. almost all states say that certificate of incorporation can limit directors personal liabilityfor breach of duty of care exceptfor:

1. breach of duty of loyalty

2. bad faith acts/omissions

3. intentional misconduct / knowing legal violations

4. approving illegal dividends, stock repurchases, or redemptions

5. approving transactions where director benefited personally

ii. safe harbor provisions:

1. entire fairness standard:

a. even if directors have breached duty of care in approving transaction,they can still escape liability if they prove transactions entire fairness

i. i.e. that its terms are completely fair to shareholders

4. Duty to Institute Monitoring Systema. Alerts Re: Material Events

i. directors have duty to institute corporate monitoring system to alert them to materialevents (In Re Caremark)

1. merely putting in the system is not enough it must also give alerts which the

directors receive on regular basis

2. however, they are notliable if the system fails to detect wrongdoingb. Duty to Investigate

i. if officer knows facts thatshould have alerted him to wrongdoing, but he failed toinvestigate, he will be held liable

c. Duty to Keep Informed

i. director has continuing obligation to keep informed about and supervise corporate

activities includes:

1. regularly reviewing financial statements

2. making reasonable attempts to detect and prevent illegal conduct

5. Duty of Full Disclosure of Informaiton

a. directors have a duty to fully and fairly disclose all information to shareholders (comes from

duties of care and loyalty)

i. directors who knowingly disseminate false information which injures corporation /

shareholders have violated fiduciary duties (Malone)1. may be personally liable

2. what is notrequired:

a. shareholder action on the basis of the false information

6. Litigation Committees Power Over Derivative Suits (** NOT that important **)a. Litigation Committees

i. directors often delegate power to deal with threatened shareholder derivative suits to

litigation committees (staffed of independent directors)

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1. once shareholder makes demand that corporation file derivative suit against

officers for breach of fiduciary duty, committee decides whether corporation will

sue or not

a. demand = derivative suit against officers for breach of fiduciary duty

ii. decisions covered by BJR:

1. shareholders cannot compel committee to file suit unless refusal to prosecute isbased on directors:

a. fraud

b. collision

c. self-interest

d. dishonesty

e. breach of trust

f. grossly unsound judgment

iii. reality:

1. committees almost always decide not to sue

a. citing reasons that it would be too expensive, chance of recovery too

remote, etc.

b. it is suspected that these are pretexts to hide directors reluctance to sue

each other

b. Demand Excused

i. where demand is excused, directors decision not to sue does notget benefit of BJR(Zapata)

1. excused = not required because deemed futile

a. demand is deemed futile only where: (Aronson)

i. complaint allegesspecific facts that create reasonable doubt thatdirectors actions qualified under BJR

1. i.e. directors must have directfinancial self-interest intransaction

b. demand notdeemed futile when:

i. directors approve transaction with dominant shareholder whoelected them (Aronson)

ii. suit charges all the directors (Aronson)

ii. if a shareholderproperly files a derivative suit where demand is excused, corporationslitigation committee may dismiss suit ifit: (Zapata)

1. makes thorough objective investigation, and

2. moves to dismiss complaint, and3. proves the committee:

a. was independent

b. acted in good faithc. made a reasonable investigation

d. can justify the basis of its conclusions

4. court determines (de novo) that derivative suit should be dismissed, considering:a. merits

b. corporations interest in avoiding suit

c. public policy

iii. modern s rarely make demand1. usually litigate to see whether demand was excused

c. Alternative Approaches

i. ALI approach:

1. allows boards / litigation committees to dismiss derivative suits as long as theyqualify for BJR: (Cuker)

a. i.e.. they:

i. (1) acted without fraud / self-dealing

ii. (2) did not exceed their authority

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iii. (3) exercised reasonable diligence

iv. (4) honestly and rationally believed dismissal was incorporations best interests

ii. MBCA:

1. requires written demand in allcases

2. allows corporation to take over a derivative suit if it so chooses unless:a. it is shown that corporation will not adequately pursue the matter

3. requires board/committee to make determinations:

a. in good faithb. after reasonable inquiry

c. that are logically based on the results of the inquiry

DUTYOF LOYALTY & CONFLICTOF INTEREST

2. Duty of Loyalty

a. Definition

i. duty of loyalty = corporate directors uncompromising responsibility to put corporate

interests first

1. focuses on actions alone

2. requires corporate director to:a. refrain from doing anything that would harm the corporation

b. use all resources available to maximize corporations profit and

advantage

b. Test

i. unless directorconsciously ignores companys interests, BJR wil

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