Business Organizations

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BUSINESS ORGANIZATIONS BUSINESSES AND BUSINESS LAWYERS • Purposes of businesses o Reasons for starting a business – make money, serve the community, political reasons, other personal benefits or gains o Problems faced by business people – start-up capital and organization, ethical problems, liability (both legal and for debt), employee relations o Two views of why businesses operate  Milton Friedman – to create value – businesses are “for-profit” enterprises  Ben and Jerry’s – businesses are developed to implement social changes • Role of the business lawyer – describe the risks and rewards to potential business owners and other owners so they can make informed decisions about their business o Life cycle of a business – creation, funding, growth, acquisition or divestiture, winding down and liquidation o Who is the client (and why is this a difficult question)  Formation issues – look at what type of business is being formed  Ongoing representation  Legal ethics  Company v management v owners v other constituencies (3rd parties, lenders) • Problem 28-2 – when people start wearing multiple hats, then be more aware! • Ralph Nader – “zealous” representation is bad for business o Seeking to do justice is the ultimate goal of being a business lawyer and talking to the client • Financial records and leverage o Income statement – shows the financial condition during a period of time; contains sales, expenses, and other various things – essentially calculates the profit for a business organization o Cash-flow statement – details what CASH comes in and out of the business o Balance sheet – snapshot at a moment in time; contains Assets, Liabilities, and Owner’s Equity  Formula: A = L + OE o Problem 26-1 – conservatism – these sheets show lower of purchase price or FMV of an asset; high estimates of liabilities are usually put on the statements o Leverage – taking on increased debt to run a business  This increases the ROI, but it is damaging because it accelerates profits AND losses • Types of business structures (4) – AGENCY LAW FLOWS THROUGH ALL OF THESE o Sole proprietorship – default form with one owner doing business o Partnership – two or more individuals engaged in a business (general vs. limited) 1

o Corporations – creatures of the state in which they are formed; articles of incorporation create the business (subject to state law)  Tax distinction – C Corporation vs. S Corporation o Limited liability companies – business registered with the state that contains elements of both a partnership and corporations AGENCY LAW (3 major players – Agent, Principal, and 3rd party) • The agency relationship – a fiduciary relationship between an AGENT and a PRINCIPAL (RSA 1), where there is a manifestation of consent by P to A to act on P’s behalf AND acceptance by A o There needs to be agreement by both parties AND some form of direction or control by P over A o Agent – person who by mutual assent (1) acts on behalf of another and (2) is subject to the other’s control  RSA 385 – duty to obey – Unless otherwise agreed, A is subject to a duty to obey all reasonable directions regarding the manner of performing a service that he has contracted to perform • Unless he is privileged to protect his own or another’s interests, A is subject to a duty not to act in matters entrusted to him on account of P contrary to directions of P, even though the terms of the employment prescribe that such directions shall not be given  General Agent – A holds a position with P that is very important (officer of corporation); acts on a series of transaction for P  Special Agent – A is hired by P for certain tasks or for a specific purpose o Principal – person on whose behalf and subject whose control an agent acts – duty to pay expenses/compensation, duty to perform  Disclosed P – RSA 4(1) – 3rd party is aware that A is acting on behalf of P and knows the identity of P; if A has authority, A may bind P and A is NOT a party to the agreement – RSA 320  Partially disclosed P – RSA 4(2) – 3rd party is aware that A is acting on P’s behalf but is NOT aware of P’s identity; if A has authority, A may bind P but A is a party to the agreement  Undisclosed P – RSA (3) – 3rd party is NOT aware A is acting on behalf of P and is not aware of P’s identity; if A has authority, then he becomes part of the agreement and is liable for any damages  Nonexistent or incompetent P – both A and 3rd party know the status of P; A may NOT bind P and A becomes a party to the agreement – RSA 326 • Authority – the power of A to affect the legal relations of P by acts done in accordance with P’s manifestations of consent to him (AGENTS CANNOT CREATE THEIR OWN AUTHORITY) o Actual authority – RSA 7, 26 – actual authority exists if P’s words (written or spoken) or conduct would lead a reasonable person in A’s position to believe that P had authorized him to act  Express authority – the literal words of P that grant authority to A  Implied authority (incidental authority) – acts that are usual and incidental to the act directly authorized, including acts reasonably 2



necessary or generally considered appropriate to accomplish the agency o Apparent authority – RSA 8, 27 – manifestation of authority of A by P that reaches 3rd party and that the 3rd party reasonably believes; A has apparent authority on P’s behalf in relation to a 3rd party IF the words or conduct of P would lead a reasonable person to believe that P had authorized A to so act  Focus in on P’s actions that lead a person to reasonably believe A had the power to act  Look for a position of power – A expresses something or wears something that gives 3rd party the idea that A has the authority to act on behalf of P  Focus: REASONABLE EXPECTATIONS of 3rd party o Inherent authority – RSA 8A – A has power arising from the agency relationship and not dependent on express authority or apparent authority; exists for the protection of persons harmed by or dealing with a servant or other agent (doesn’t normally apply to special agents)  RSA 161 – a general agent for a disclosed or partially disclosed P subjects P to liability for acts done on his behalf which usually accompany or are incidental to trxns which A is authorized to conduct if, although they are forbidden by P, the other party reasonably believes that A is authorized to act on behalf of P and has no notice that he is not so authorized Other ways to bind P o Ratification – RSA 143 – upon ratification with knowledge of material facts, P becomes responsible for contracts and conveyances made for him by one purporting to act on his behalf as if the trxn had been authorized, if there has been no supervening loss of capacity by P or change in law which would render illegal the authorization or performance of such a transaction  Ex: janitor signs renter up and then LL goes down to renew lease – ratification o Estoppel – RSA 8B  A person who is not otherwise liable as a party to the trxn purported to be done on his account, is nevertheless subject to liability to persons who have changed their positions because of their belief that the trxn was entered into by or for him, if • He intentionally or carelessly caused such belief, or • Knowing of such belief and that others might change their positions because of it, he did not take reasonable steps to notify them of the facts  An owner of property who represents to 3rd persons that another is the owner of the property or who permits the other so to represent, or who realizes that 3rd persons believe that another is the owner of the property, and that he could easily inform the 3rd persons of the facts, is subject to the loss of the property if the owner disposes of it to 3rd persons who, in ignorance of facts, purchase the property or otherwise change their position with reference to it  Change of position – payment of money, expenditure of labor, suffering a loss, or subjection to legal liability  Ex: LL cashes renter’s checks for a couple of months and then tries to 3



kick him out when another renter offers to pay more – no way because there is reliance Extent of and termination of A’s authority – existence and extent of A’s duties to P are determined by the terms of the agreement between the parties, interpreted in light of the circumstances under which it is made, except to the extent that fraud, duress, illegality, or the incapacity of one or both of the parties modifies it or deprives it of legal effect o If no agreement exists, then either P or A can terminate at will; an irrevocable agency can exist if it is coupled with an interest o Master – a principal who employs A to perform service in his affairs and who controls or has the right to control the physical conduct of A in the performance of the service  Master is subject to liability for torts of servants committed while acting within their scope of employment  Master NOT subject to liability for torts of servant acting OUTSIDE scope of employment, unless: • Master intended the conduct or consequences, or • Master was negligent or reckless, or • Conduct violated a non-delegable duty of the master, or • Servant purported to act or speak on behalf of principal and there was reliance upon apparent authority o Servant – A employed by a master to perform service in his affairs whose physical conduct in the performance is controlled or is subject to the right to control by the master  Not all agents are servants (servants are usually employees under A LOT of control) o Independent Contractor – person who contracts with another to do something for him but who is not controlled by the other nor subject to the others right to control with respect to his physical conduct in performance (may or may not be an agent) o Factors to distinguish between servant and independent contractor  The extent of control which, by agreement, master may exercise over details of the work  Whether or not the one employee is engaged in a distinct occupation or business  Kind of occupation, with reference to whether, in the locality, work is usually done under the direction of the employer or by a specialist without supervision  Skill required  Who supplies the materials  Length of employment  Method of payment  Whether the work is part of regular business of employer  Whether or not parties believe they are creating an agency relationship o Scope of employment (if agent has NOT breached duty of care, then he can get indemnification from principal) – this is mostly a RESPONDEAT SUPERIOR analysis  To be within the scope of employment, conduct must be of the same 4



• •

general nature as that authorized, or incidental to the conduct authorized  Factors to consider: • Whether or not the act is one commonly done by servants • Time, place, and purpose of the act • Previous relations between master and servant • Extent to which business is apportioned between different servants • Master’s expectations and whether the instrumentality that caused harm was furnished by the master  Detour – different route, but still in the scope of employment  Frolic – A does something completely separate and apart from his employment Liability under agency relationships o Binding the P – simple negligence is not enough to cause a breach of a duty between A and P; if there is gross negligence or recklessness, then no indemnification  If A transacts with a 3rd party on behalf of P, the trxn is legally binding on the 3rd party and P, provided: • A acted within the scope of his authority, or • Even if A exceeded his authority, P ratified the act  If A operates outside actual authority, but P is bound (i.e. due to apparent or inherent authority), then A has breached his fiduciary duty (i.e. duty to obey) to P and is liable for P’s actual damages o A’s duty of loyalty – agent must not put his own interests ahead of P’s in any matter relating to the agency relationship Problems 39-1, 40-2, 40-3, 42-1, 42-2, 42-3 Hayes v National Service Industries – H sued NSI alleging wrongful discharge and got a lawyer; lawyer negotiate settlement and H wasn’t satisfied; court held that lawyer ha apparent authority to bind H; H would have needed to tell lawyer and NSI that she restricted any settlement negotiations; this was reasonable because it is normal procedure for lawyers to negotiate for their clients

SOLE PROPRIETORSHIPS • Generally – this is the default category where there is only ONE business owner (natural person) • No distinction is made between the business entity and the individual running the business o They are treated as one for legal purposes • State filing is NOT necessary – business automatically starts • Business may apply for a “d/b/a” designation – “doing business as” (this is simply a different name that the owner may use for his business

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PARTNERSHIPS (use RUPA provisions) • Generally o Partnership: RUPA 101(6) – an association of two or more PERSONS to carry on as co-owners a business for profit formed under 202, predecessor law, or comparable law of another jurisdiction  RUPA 202 – the association of two or more persons to carry on as coowners a business for profit forms a partnership  RUPA 101 (10) – PERSON: individual, corporation, business trust, estate, trust, partnership, association, joint venture, government, governmental subdivision, agency, or other instrumentality, legal, or commercial entity  RUPA 201 – Partnership is an entity separate from its partners • LLP continues to be the same entity that existed before the filing of a statement of qualification under 1001 o Aggregate vs. Identity theories – how to interpret the code provisions o Compare and contrast with sole proprietorship  Q 75-1, 2, 3 – partnership CANNOT be a sole proprietorship or corporation; BUT a corporation CAN be a partner because “person” is very broad o Sources of partnership law – (1) partnership agreement, (2) statutory provisions (RUPA) and (3) common law and equity  RUPA 103: Relations among the partners and between partners and the partnership are governed by the partnership agreement; to the extent the agreement does not otherwise provide, RUPA governs the relations among and between the partners  The partnership agreement MAY NOT: • vary the rights and duties under Section 105 except to eliminate the duty to provide copies of statements to all of the partners • unreasonably restrict the right of access to books and records • eliminate the duty of loyalty, but o the partnership agreement may identify specific types or categories of activities that do not violate the duty of loyalty, if not manifestly unreasonable; or o all of the partners or a number or percentage specified in the partnership agreement may authorize or ratify, after full disclosure of all material facts, a specific act or transaction that otherwise would violate the duty of loyalty • unreasonably reduce the duty of care • eliminate the obligation of good faith and fair dealing, but the partnership agreement may prescribe the standards by which the performance of the obligation is to be measured, if the standards are not manifestly unreasonable • vary the power to dissociate as a partner under Section 602(a), except to require the notice under Section 601(1) to be in writing • vary the right of a court to expel a partner 6





vary the requirement to wind up the partnership business in cases specified in Section 801(4), (5), or (6) • vary the law applicable to a limited liability partnership under Section 106(b); or • restrict rights of third parties  Q 77-1, 2 – don’t need a written partnership agreement or a lawyer, but it is advisable o Partner as a fiduciary – RUPA 404 – partners owe a duty of loyalty and a duty of care to the partnership and the other partners, along with obligation of good faith and fair dealing  Duty of Loyalty – duty to account for profits or property received; duty to refrain from acting on behalf of a party having an adverse interest to the partnership (conflict of interest); duty to refrain from competing with partnership business  Duty of Care – duty to refrain from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of the law • Simple negligence is NOT a breach of this duty o Partnership property – RUPA 203 and 204: property acquired by a partnership is property of the partnership and not of the partners individually  Property is partnership property if acquired in the name of • The partnership, or • One or more partners with an indication in the instrument transferring title to the property of the person’s capacity as a partner or of the existence of a partnership but without an indication of the name of the partnership  Property is acquired in the name of the partnership by a transfer to • The partnership in its name, or • One or more partners in their capacity as partners in the partnership, if the name of the partnership is indicated in the instrument transferring title to the property  Property is presumed to be partnership property if purchased with partnership assets, even if not acquired in the name of the partnership or of one or more partners with an indication in the instrument transferring title to the property of the person’s capacity as a partner or of the existence of a partnership  Property acquired in the name of one or more of the partners, without an indication in the instrument transferring title to the property of the person’s capacity as a partner or of the existence of a partnership and without use of partnership assets, is presumed to be a separate property, even if used for partnership purposes  Q 79-1, 2, 3, 4 – property owned by a partner BEFORE the formation of the partnership is NOT partnership property unless it is transferred to the partnership Agency and partnership decision making o Two forms of disputes that occur  Disputes between partners – ordinary course vs. non-ordinary course  disputes with 3rd parties 7

o RUPA 301 – each partner is an agent of the partnership  An act of partner, including execution of an instrument in the partnership name, for apparently carrying on in the ordinary course the partnership business or business of the kind carried on by the partnership binds the partnership, UNLESS the partner had no authority to act for the partnership in the particular matter and the person with whom the partner was dealing knew or had received notice that the partner lacked authority  An act of a partner which is not apparently for carrying on in the ordinary course the partnership business binds the partnership only if the act was authorized by the other partners o RUPA 401(f) – each partner has equal rights in the management and conduct of the partnership business o RUPA 401(j) – a difference arising as to a matter in the ordinary course of business may be decided by a MAJORITY OF THE PARTNERS; an act outside the ordinary course of business and an amendment to the partnership agreement may be undertaken only with the consent of ALL THE PARTNERS o RUPA 404 – DUTY OF LOYALTY, CARE, GOOD FAITH – to partners and the partnership  (a) The only fiduciary duties a partner owes to the partnership and the other partners are the duty of loyalty and the duty of care set forth in subsections (b) and (c).  (b) A partner's duty of loyalty to the partnership and the other partners is limited to the following: • (1) to account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partner in the conduct and winding up of the partnership business or derived from a use by the partner of partnership property, including the appropriation of a partnership opportunity • (2) to refrain from dealing with the partnership in the conduct or winding up of the partnership business as or on behalf of a party having an interest adverse to the partnership; and • (3) to refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership  (c) A partner's duty of care to the partnership and the other partners in the conduct and winding up of the partnership business is limited to refraining from engaging in grossly negligent or reckless conduct, intentional misconduct, or a knowing violation of law  (d) A partner shall discharge the duties to the partnership and the other partners under this [Act] or under the partnership agreement and exercise any rights consistently with the obligation of good faith and fair dealing  (e) A partner does not violate a duty or obligation merely because the partner's conduct furthers the partner's own interest  (f) A partner may lend money to and transact other business with the partnership, and as to each loan or transaction the rights and obligations of the partner are the same as those of a person who is not a partner, subject to other applicable law 8



o Q 81-1, 2, 3 – partnership is obligated to pay 3rd parties if the agreement says so; if agreement says nothing, partnership might still be obligated to pay o Meinhard v Salmon – Co-adventurers vs. Partners – co-adventurers are subject to the same fiduciary duties akin to those of partners; S was in the title for a leased building and M provided the money for the investment which was to last for 20 years; S made a new agreement with G (building owner) to renovate other buildings without telling M; court held that S breached the DUTY OF LOYALTY (the punctilio of an honor the most sensitive) because he excluded his partner from any chance to compete and make money in the new agreement; if S had approached G, then it would have been permissible for him to undertake the opportunity  Key point in time: the date when the opportunity COMES to the business  GR – you must involve other partners if agreement is renewed or extended in any way; If the agreement was separate from M and S venture, instead of an extension, then it would have been permissible as well.  RUPA 102(d) – a person receives notification when it: • Comes to the person’s attention; or • Is duly delivered at the person’s place of business or at any other place held out by the person as a place for receiving communications o Q 88-1, 89-1, 2, 90-8 – partners CANNOT vary the rights of 3rd parties!! Liability and tax matters o RUPA 305 – partnership liable for partner’s actionable conduct (simple negligence not enough)  Partnership is liable for loss or injury caused to a person, or for a penalty incurred, as a result of a wrongful act or omission, or other actionable conduct, of a partner acting in the ordinary course of business of the partnership or with authority of the partnership  If, in the course of the partnership business or while acting with authority of the partnership, a partner receives or causes the partnership to receive money or property of a person not a partner, and the money or property is misapplied by a partner, partnership is liable for the loss o RUPA 306 – joint and several liability  All partners are liable jointly and severally for all obligations of the partnership unless otherwise agreed by the claimant or provided by law  A person admitted as a partner into an existing partnership is not personally liable for any partnership obligation incurred before the person's admission as a partner  An obligation of a partnership incurred while the partnership is a limited liability partnership, whether arising in contract, tort, or otherwise, is solely the obligation of the partnership. A partner is not personally liable, directly or indirectly, by way of contribution or otherwise, for such an obligation solely by reason of being or so acting as a partner. 9





o RUPA 307 – actions by and against partnership and partners  Partnership may sue and be sued in the name of the partnership  An action may be brought against the partnership and, to the extent not inconsistent with 306, any or all of the partners in the same or separate action  A judgment against a partnership is not by itself a judgment against a partner; judgment against a partnership may not be satisfied from a partner’s assets unless there is also a judgment against the partner  (EXHUASTION RULE) 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 306 and: • See provisions in 307 o RUPA 401 (c) – partnership shall reimburse partner for any payments made and indemnify a partner for liabilities incurred by the partner in the ordinary course of the business of the partnership or for the preservation of its business or property o Collecting on judgment  Tortfeasor partner – creditor may execute judgment directly against the tortfeasor partner irrespective of its collection efforts against the partnership, as such partner is personally liable for his actions • If simple negligence, then partner has indemnification and contribution rights • If gross negligence, then partner breaches duty of care and has no rights  Non-tortfeasor partner (EXHAUSTION RULE) – creditor must first seek to collect from the partnership assets; if creditor cannot satisfy judgment, then he can go to the partner; creditor must first exhaust all partnership assets or have some other reason to go after him • If partner makes a personal guarantee, then creditor can sue AND collect o Q 92-1, 2, 3, 4, 6 Select partnership matters concerning growth o Capital contributions (non-contributing partners) o Outside lenders – personal guarantees o New partners – requires unanimous consent unless changed by partnership agreement; A new partner is NOT liable for any partnership obligation incurred before the person’s admission as a partner o Q 95-1, 2 How do partners make money; use of partnership earnings o Partner salaries  98-1 (401h) – partner is not entitled to remuneration for services performed for the partnership, except for reasonable compensation for services rendered in winding up the business of the partnership  98-2 (401j) – if a partner wants to prevent an increase in partner salaries, he must obtain unanimous consent from ALL of the partners (outside of ordinary course of business)  98-3 – one partner CANNOT compel other partners to pay him a salary 10

unless ALL the partners agree to do so o Distribution of profits – allocation of profits and losses is governed by the partnership agreement; there must be unanimous approval to change allocation amounts  RUPA 401(a) – each partner is deemed to have an account that is: • Credited with an amount equal to the money plus the value of any other property, net of the amount of any liabilities, the partner contributes to the partnership and partner’s share of the partnership profits, and • Charged with an amount equal to the money plus the value of any other property, net of the amount of any liabilities, distributed by the partnership to the partner and the partner’s share of the partnership losses  98-1, 2, 99-3 – distributions are in the ordinary course of business (contrast with salaries) and this would only need a MAJORITY to be increased  Partner is liable for taxes on his share of the profits, even if he hasn’t taken a distribution o Sales generally – distinguish between sales of an ownership interest to a 3rd party and the sale of an interest back to the partnership (redemption)  RUPA 502 – only ECONOMIC RIGHTS of a partner can be transferred: share of profits or losses, and right to receive distributions; the interest is personal property  RUPA 503 – transfer of partner’s transferable interest • A transfer, in whole or in part, of a partner's transferable interest in the partnership: o is permissible o does not by itself cause the partner's dissociation or a dissolution and winding up of the partnership business; and o does not, as against the other partners or the partnership, entitle the transferee to participate in the management or conduct of the partnership business, to require access to information concerning partnership transactions, or to inspect or copy the partnership books or records • A transferee of a partner's transferable interest in the partnership has a right: o to receive, in accordance with the transfer, distributions to which the transferor would otherwise be entitled o to receive upon the dissolution and winding up of the partnership business, in accordance with the transfer, the net amount otherwise distributable to the transferor; and o to seek under (6) a judicial determination that it is equitable to wind up the partnership business • In a dissolution and winding up, a transferee is entitled to an account of partnership transactions only from the date of the latest account agreed to by all of the partners • Upon transfer, the transferor retains the rights and duties of a partner other than the interest in distributions transferred 11





A partnership need not give effect to a transferee's rights under this section until it has notice of the transfer • A transfer of a partner's transferable interest in the partnership in violation of a restriction on transfer contained in the partnership agreement is ineffective as to a person having notice of the restriction at the time of transfer  RUPA 504 – Charging orders (creditor’s exclusive remedy) • A court can give a judgment creditor the right to receive partnership distributions to which debtor partner would otherwise be entitled to satisfy a judgment • A charging order constitutes a lien on the judgment debtor's transferable interest in the partnership. The court may order a foreclosure of the interest subject to the charging order at any time. The purchaser at the foreclosure sale has the rights of a transferee • At any time before foreclosure, an interest charged may be redeemed: o by the judgment debtor o with property other than partnership property, by one or more of the other partners; or o with partnership property, by one or more of the other partners with the consent of all of the partners whose interests are not so charged  Q 100-1, 2, 3 – if new guy buys interest FROM partnership, then he has managerial rights and can make decisions  Creel v Lilly – C sold Nascar stuff as sole proprietor, then formed partnership with L and A; C died and his wife wanted the business terminated; L and A wanted to buyout wife’s interest and continue the business; partnership agreement governed in this case so there was no need to look at the model rules; agreement stated that business would continue instead of mandatory forced sale so wife couldn’t force the business to close o Buy-sell agreements – an agreement that governs the sale of any ownership interest Partnership dissociation – withdrawal of a partner; discontinuation of partner’s association o Two main things that can happen when a partner dissociates:  Buyout of the dissociated partner’s interest – go to Article 7, OR  Dissolution of the partnership – go to Article 8 o RUPA 602 – partner’s power to dissociate (partnership agreement can require it to be in writing)  A partner has power to dissociate at any time, rightfully or wrongfully, by express will  A partner's dissociation is wrongful only if: • it is in breach of an express provision of the partnership agreement; or • in the case of a partnership for a definite term or particular undertaking, before the expiration of the term or the completion 12

of the undertaking: o the partner withdraws by express will, unless the withdrawal follows within 90 days after another partner's dissociation by death or otherwise under Section 601(6) through (10) or wrongful dissociation under this subsection; o the partner is expelled by judicial determination under Section 601(5); o the partner is dissociated by becoming debtor in bankruptcy; or o in the case of a partner who is not an individual, trust other than a business trust, or estate, the partner is expelled or otherwise dissociated because it willfully dissolved or terminated  A partner who wrongfully dissociates is liable to the partnership and to the other partners for ACTUAL damages caused by the dissociation. The liability is in addition to any other obligation of the partner to the partnership or to the other partners o RUPA 601 – events causing dissociation (applies if partnership agreement says nothing)  the partnership's having notice of the partner's express will to withdraw as a partner or on a later date specified by the partner  an event agreed to in the partnership agreement as causing the partner's dissociation  the partner's expulsion pursuant to the partnership agreement  the partner's expulsion by the unanimous vote of the other partners if: • it is unlawful to carry on the partnership business with that partner • there has been a transfer of all or substantially all of that partner's transferable interest in the partnership, other than a transfer for security purposes, or a court order charging the partner's interest, which has not been foreclosed • within 90 days after the partnership notifies a corporate partner that it will be expelled because it has filed a certificate of dissolution or the equivalent, its charter has been revoked, or its right to conduct business has been suspended by the jurisdiction of its incorporation, there is no revocation of the certificate of dissolution or no reinstatement of its charter or its right to conduct business; or • a partnership that is a partner has been dissolved and its business is being wound up;  on application by the partnership or another partner, the partner's expulsion by judicial determination because: • the partner engaged in wrongful conduct that adversely and materially affected the partnership business • the partner willfully or persistently committed a material breach of the partnership agreement or of a duty owed to the partnership or the other partners under Section 404; or • the partner engaged in conduct relating to the partnership 13

business which makes it not reasonably practicable to carry on the business in partnership with the partner  the partner's: • becoming a debtor in bankruptcy • executing an assignment for the benefit of creditors • seeking, consenting to, or acquiescing in the appointment of a trustee, receiver, or liquidator of that partner or of all or substantially all of that partner's property; or • failing, within 90 days after the appointment, to have vacated or stayed the appointment of a trustee, receiver, or liquidator of the partner or of all or substantially all of the partner's property obtained without the partner's consent or acquiescence, or failing within 90 days after the expiration of a stay to have the appointment vacated  in the case of a partner who is an individual: • the partner's death • the appointment of a guardian or general conservator for the partner; or • a judicial determination that the partner has otherwise become incapable of performing the partner's duties under the partnership agreement o RUPA 701 – Purchase of dissociated partner’s interest  If a partner is dissociated from a partnership without resulting in a dissolution and winding up of the partnership business under Section 801, the partnership shall cause the dissociated partner's interest in the partnership to be purchased for a buyout price • Buyout price – the amount that would have been distributable to the dissociating partner under Section 807(b) if, on the date of dissociation, the assets of the partnership were sold at a price equal to the greater of the liquidation value or the value based on a sale of the entire business as a going concern without the dissociated partner and the partnership were wound up as of that date. • Interest must be paid from the date of dissociation to the date of payment  Damages for wrongful dissociation, and all other amounts owing, whether or not presently due, from the dissociated partner to the partnership, must be offset against the buyout price.  A partnership shall indemnify a dissociated partner whose interest is being purchased against all partnership liabilities, whether incurred before or after the dissociation, except liabilities incurred by an act of the dissociated partner under Section 702  If no agreement for the purchase of a dissociated partner's interest is reached within 120 days after a written demand for payment, the partnership shall pay, or cause to be paid, in cash to the dissociated partner the amount the partnership estimates to be the buyout price and accrued interest, reduced by any offsets and accrued interest under subsection (c). 14

If a deferred payment is authorized under subsection (h), the partnership may tender a written offer to pay the amount it estimates to be the buyout price and accrued interest, reduced by any offsets under subsection (c), stating the time of payment, the amount and type of security for payment, and the other terms and conditions of the obligation  The payment or tender required by subsection (e) or (f) must be accompanied by the following: • a statement of partnership assets and liabilities as of the date of dissociation • the latest available partnership balance sheet and income statement, if any • an explanation of how the estimated amount of the payment was calculated; and • written notice that the payment is in full satisfaction of the obligation to purchase unless, within 120 days after the written notice, the dissociated partner commences an action to determine the buyout price, any offsets under subsection (c), or other terms of the obligation to purchase  A partner who wrongfully dissociates before the expiration of a definite term or the completion of a particular undertaking is NOT entitled to payment of any portion of the buyout price until the expiration of the term or completion of the undertaking, UNLESS he establishes to the satisfaction of the court that earlier payment will not cause undue hardship to the business of the partnership. A deferred payment must be adequately secured and bear interest  A dissociated partner may maintain an action against the partnership, pursuant to Section 405(b)(2)(ii), to determine the buyout price of that partner's interest, any offsets under subsection (c), or other terms of the obligation to purchase. The action must be commenced within 120 days after the partnership has tendered payment or an offer to pay or within one year after written demand for payment if no payment or offer to pay is tendered. The court shall determine the buyout price of the dissociated partner's interest, any offset due under subsection (c), and accrued interest, and enter judgment for any additional payment or refund. If deferred payment is authorized under subsection (h), the court shall also determine the security for payment and other terms of the obligation to purchase o Q 102-1, 2, 3, 111-4, 113-6, 7 – Buyout price = greater of liquidation value OR the value of the business as a going concern less the partner that withdraws o Liability of dissociating party – if dissociating partner gives NOTICE to 3rd parties, then he is NOT liable for any debts; but if 3rd party reasonably believes he is still a partner, then he is liable for any debts for up to 2 years; even if statement of withdrawal is filed, he would still be liable for 90 days (RUPA 703) Partnership Dissolution – triggers the end of a partnership – dissolution is outside the ordinary course of business and thus needs a unanimous vote o RUPA 801 – events causing dissolution and winding up 



15

in a partnership at will, the partnership's having notice from a partner, of his express will to withdraw as a partner  in a partnership for a definite term or particular undertaking: • within 90 days after a partner's dissociation by death or otherwise under Section 601(6) through (10) or wrongful dissociation under Section 602(b), the express will of at least half of the remaining partners to wind up the partnership business, for which purpose a partner's rightful dissociation pursuant to Section 602(b)(2)(i) constitutes the expression of that partner's will to wind up the partnership business • the express will of all of the partners to wind up the partnership business; or • the expiration of the term or the completion of the undertaking  an event agreed to in the partnership agreement  an event that makes it unlawful for all or substantially all of the business of the partnership to be continued, but a cure of illegality within 90 days after notice to the partnership of the event is effective retroactively to the date of the event  on application by a partner, a judicial determination that: • the economic purpose of the partnership is likely to be unreasonably frustrated • another partner has engaged in conduct relating to the partnership business which makes it not reasonably practicable to carry on the business in partnership with that partner; or • it is not otherwise reasonably practicable to carry on the partnership business in conformity with the partnership agreement; or  on application by a transferee of a partner's transferable interest, a judicial determination that it is equitable to wind up the partnership business: • after the expiration of the term or completion of the undertaking, if the partnership was for a definite term or particular undertaking at the time of the transfer or entry of the charging order that gave rise to the transfer; or • at any time, if the partnership was a partnership at will at the time of the transfer or entry of the charging order that gave rise to the transfer o RUPA 802(b) – at any time after the dissolution of a partnership and before the winding up of its business is completed, all of the partners, including any dissociating partner other than a wrongfully dissociating partner, may waive the right to have the partnership's business wound up and the partnership terminated. In that event:  the partnership resumes carrying on its business as if dissolution had never occurred, and any liability incurred by the partnership or a partner after the dissolution and before the waiver is determined as if dissolution had never occurred; and  the rights of a third party accruing under Section 804(1) or arising out of conduct in reliance on the dissolution before the third party knew or 

16







received a notification of the waiver may not be adversely affected o Q 114-1, 2, 3, 4 The winding up process – partnership business is wound up, existing K’s completed, creditors paid o RUPA 807 – settlements of accounts and contributions among partners  In winding up a partnership's business, the assets of the partnership, including the contributions of the partners required by this section, must be applied to discharge its obligations to creditors, including, to the extent permitted by law, partners who are creditors. Any surplus must be applied to pay in cash the net amount distributable to partners in accordance with their right to distributions under subsection (b).  Each partner is entitled to a settlement of all partnership accounts upon winding up the partnership business. In settling accounts among the partners, profits and losses that result from the liquidation of the partnership assets must be credited and charged to the partners' accounts. The partnership shall make a distribution to a partner in an amount equal to any excess of the credits over the charges in the partner's account. A partner shall contribute to the partnership an amount equal to any excess of the charges over the credits in the partner's account but excluding from the calculation charges attributable to an obligation for which the partner is not personally liable under Section 306  If a partner fails to contribute the full amount required under subsection (b), all of the other partners shall contribute, in the proportions in which those partners share partnership losses, the additional amount necessary to satisfy the partnership obligations for which they are personally liable under Section 306. A partner or partner's legal representative may recover from the other partners any contributions the partner makes to the extent the amount contributed exceeds that partner's share of the partnership obligations for which the partner is personally liable under Section 306  After the settlement of accounts, each partner shall contribute, in the proportion in which the partner shares partnership losses, the amount necessary to satisfy partnership obligations that were not known at the time of the settlement and for which the partner is personally liable under Section 306 o Q 115-1, 2 Partnership termination – business ceases, assets are sold, partners are entitled to cash if any is left o RUPA 802(a) – partnership continues after dissolution only for the purpose of winding up its business. The partnership is terminated when the winding up of its business is completed “Freeze-Out” of a partner – occur when majority partners push a minority partner out; usually because of oppression or like circumstances o Page v Page – partnership’s major creditor was a corporation owned by P and P wanted to terminate the partnership; court held that this was an “atwill” partnership and P had the right to expressly withdrawal UNLESS there was bad faith; case was remanded so D could try to prove bad faith – here, D 17



did have a good cause of action for breach of duty of good faith and the partnership will dissolve o Q 132-1, 2, 3 Limited Partnerships o Generally; compare with partnerships  Limited partners are NOT personally liable for debts; they are only liable for taxes on distributions to them, whereas general partners are liable for all of it o Formation of a limited partnership (Q 752-1) – a filing needs to be made with the state in order to put the world on notice that some of the partners are not subject to personal liability  RULPA 303 o Decision-making in a limited partnership – under current law, limited partners are allowed to participate in management decisions without incurring liability for those decisions o Liability issues – Course Supp. Item 2 o Q 755-1, 2 – if a limited partner takes over general control of the partnership, then he might become personally liable for any debts incurred

CORPORATIONS – owners (shareholders) are not personally liable for any debts; the corporation is run by management (directors, officers, and employees) and is a separate legal entity A. General matters and formation of a corporation • Sources of corporate law o State statutes (MBCA) – corporations are a creature of state law o Organizational documents – articles of incorporation, bylaws, and other agreements o Case law (common law) o Federal statutes • State of incorporation/qualifying as a foreign corporation – Incorporation can occur in any state, but most corporations incorporate in state that it does business in o Delaware is a popular state because their laws are corporation-friendly o Q 154-1, 3 – to qualify as a foreign corporation there must be sufficient minimum contacts (very fact intensive) and the requirements in the state statute must be followed • Forming a corporation o MBCA 2.01 – one or more persons may act as the incorporator or incorporators of a corporation by delivering articles of incorporation to the secretary of state for filing o MBCA 2.03 – Unless a delayed effective date is specified, the corporate existence begins when the articles of incorporation are filed  Secretary of state’s filing of the articles is conclusive proof that the incorporators satisfied all conditions precedent to incorporation except in a proceeding by the state to cancel or revoke the incorporation or involuntarily dissolve the corporation o Articles of Incorporation (MBCA 2.02) – document that puts world on notice that corporation is doing business (prevail over the bylaws because they are 18

a PUBLIC document)  The articles of incorporation MUST set forth: • a corporate name for the corporation that satisfies the requirements of section 4.01; • the number of shares the corporation is authorized to issue; • the street address of the corporation's initial registered office and the name of its initial registered agent at that office; and • the name and address of each incorporator  The articles of incorporation MAY set forth: • the names and addresses of the individuals who are to serve as the initial directors; • provisions not inconsistent with law regarding: o the purpose or purposes for which the corporation is organized; o managing the business and regulating the affairs of the corporation o defining, limiting, and regulating the powers of the corporation, its board of directors, and shareholders; o a par value for authorized shares or classes of shares; o the imposition of personal liability on shareholders for the debts of the corporation to a specified extent and upon specified conditions; • any provision that under this Act is required or permitted to be set forth in the bylaws; • a provision eliminating or limiting the liability of a director to the corporation or its shareholders for money damages for any action taken, or any failure to take any action, as a director, except liability for (A) the amount of a financial benefit received by a director to which he is not entitled; (B) an intentional infliction of harm on the corporation or the shareholders; (C) a violation of section 8.33; or (D) an intentional violation of criminal law; and • a provision permitting or making obligatory indemnification of a director for liability (as defined in section 8.50(5)) to any person for any action taken, or any failure to take any action, as a director, except liability for (A) receipt of a financial benefit to which he is not entitled, (B) an intentional infliction of harm on the corporation or its shareholders, (C) a violation of section 8.33 or (D) an intentional violation of criminal law.  Articles of incorporation need not set forth any corporate powers enumerated in this Act. o Bylaws – not required to be filed in the state of incorporation because they are internal documents; they essentially tell how the corporation runs and what management does  MBCA 2.06 – The incorporators or board of directors shall adopt initial bylaws  The bylaws may contain any provision for managing the business and regulating the affairs of the corporation that is not inconsistent with 19



law or the articles of incorporation o Q 143-1, 2 Pre-incorporation transactions – REMEMBER: if several guys get together BEFORE incorporation, then a partnership technically exists and those rules must be followed as well o Promoters – acts on behalf of the corporation and does most everything in preparation; promoter must take SOME action  MBCA 2.04 – all persons purporting to act as or on behalf of a corporation, knowing there was no incorporation under this act, are jointly and severally liable for all liabilities created while acting (basis for promoter liability) • Agency law kicks in here too because promoter is an agent of the corporation; Promoter becomes a party to the K if the corporation is non-existent  Q 144-1, 145-2, 3, 4 – after the corporation is formed, the promoter is still liable UNLESS the 3rd party that entered into the transaction with the corporation relieves him of liability (novation) o Incorporators – files the documents with the secretary of state; liability only extends to screwed up filings

B. Issuing Stock and Associated Matters – Financing a corporation • Authorized Shares (MBCA 6.01) – the number of shares that a corporation can issue (maximum) o The articles of incorporation must set forth any classes of shares and series of shares within a class, and the number of shares of each class and series, that the corporation is authorized to issue. If more than one class of shares or series of shares is authorized, the articles of incorporation must prescribe a distinguishing designation for each class or series and must describe, prior to the issuance of shares of a class or series, the terms, including the preferences, rights, and limitations, of that class or series. Except to the extent varied as permitted by this section, all shares of a class or series must have terms, including preferences, rights and limitations, that are identical with those of other shares of the same class or series. o The articles of incorporation must authorize (1) one or more classes of shares that together have unlimited voting rights, and (2) one or more classes of shares (which may be the same class or classes as those with voting rights) that together are entitled to receive the net assets of the corporation upon dissolution. o The articles of incorporation may authorize one or more classes or series of shares that:  have special, conditional, or limited voting rights, or no right to vote, except to the extent otherwise provided by this Act;  are redeemable or convertible as specified in the articles of incorporation: • at the option of the corporation, the shareholder, or another person or upon the occurrence of a specified event; • for cash, indebtedness, securities, or other property; and • at prices and in amounts specified, or determined in accordance with a formula; 20

entitle the holders to distributions calculated in any manner, including dividends that may be cumulative, non-cumulative, or partially cumulative;  have preference over any other class of shares with respect to distributions, including dividends and distributions upon the dissolution of the corporation Issued and Outstanding Shares (MBCA 6.03) – shares that are currently in hands of stockholders o A corporation may issue the number of shares of each class or series authorized by the articles of incorporation; shares that are issued are outstanding shares until they are reacquired, redeemed, converted, or cancelled o The reacquisition, redemption, or conversion of outstanding shares is subject to the limitations of subsection (c) of this section and to section 6.40 o At all times that shares of the corporation are outstanding, one or more shares that together have unlimited voting rights and one or more shares that together are entitled to receive the net assets of the corporation upon dissolution must be outstanding. Share issuance (MBCA 6.21 (b and c)) – validly issued, fully paid, and nonassessable o (b) The board of directors may authorize shares to be issued for consideration consisting of any tangible or intangible property or benefit to the corporation, including cash, promissory notes, services performed, contracts for services to be performed, or other securities of the corporation o (c) Before the corporation issues shares, the board of directors must determine that the consideration received or to be received for shares to be issued is adequate. That determination by the board of directors is conclusive insofar as the adequacy of consideration for the issuance of shares relates to whether the shares are validly issued, fully paid, and nonassessable o (d) When the corporation receives the consideration for which the board of directors authorized the issuance of shares, the shares issued therefore are fully paid and non-assessable o (f)  An issuance of shares or other securities convertible into or rights exercisable for shares, in a transaction or a series of integrated transactions, requires approval of the shareholders, at a meeting at which a quorum consisting of at least a majority of the votes entitled to be cast on the matter exists, if: • the shares, other securities, or rights are issued for consideration other than cash or cash equivalents, and • the voting power of shares that are issued and issuable as a result of the transaction or series of integrated transactions will comprise more than 20 percent of the voting power of the shares of the corporation that were outstanding immediately before the transaction  In this subsection: • For purposes of determining the voting power of shares issued and issuable as a result of a transaction or series of integrated 21 







transactions, the voting power of shares shall be the greater of (A) the voting power of the shares to be issued, or (B) the voting power of the shares that would be outstanding after giving effect to the conversion of convertible shares and other securities and the exercise of rights to be issued • A series of transactions is integrated if consummation of one transaction is made contingent on consummation of one or more of the other transactions Classes of stock – determines voting and dividend rights o MBCA 6.02 – terms of class or series determined by board of directors  If the articles of incorporation so provide, the board of directors is authorized, without shareholder approval, to: • classify any unissued shares into one or more classes or into one or more series within a class • reclassify any unissued shares of any class into one or more classes or into one or more series within one or more classes, or • reclassify any unissued shares of any series of any class into one or more classes or into one or more series within a class  (b) If the board of directors acts pursuant to subsection (a), it must determine the terms, including the preferences, rights and limitations, to the same extent permitted under section 6.01, of: • any class of shares before the issuance of any shares of that class, or • any series within a class before the issuance of any shares of that series  (c) Before issuing any shares of a class or series created under this section, the corporation must deliver to the secretary of state for filing articles of amendment setting forth the terms determined under subsection (a).  (d) Before issuing any shares of a class or series created under this section, the corporation must deliver to the secretary of state for filing articles of amendment, which are effective without shareholder action, that set forth: • the name of the corporation; • the text of the amendment determining the terms of the class or series of shares • the date it was adopted; and • a statement that the amendment was duly adopted by the board of directors o Common stock – simple stock o Preferred stock – any class of stock that has a preference over another class of stock (dividend, liquidation, redemption rights) o Certificate of Determination – document that establishes the rights of certain stockholders; board approval is needed if new rights of shares of stock change the rights of other shares o Par value – amount per share that a share is worth before it is sold to the public; this is the minimum price that a share of stock can be sold to the public for 22

Stated capital – includes at least the aggregate par value of all issued shares  Capital surplus – additional paid-in capital that may be distributed back to shareholders in the form of dividends  Q 150-1, 8 – ratio of shares and how many shares one has determines voting power, right to dividends, etc. Stock markets and liquidity – how easily the market place can absorb a transaction o Distinguish between issuance, in which corporation sells their own shares to someone else and 3rd part transaction, in which the stocks are traded in a market o When the corporation sells increased number f shares, illiquidity is increased Dividends – payments to shareholders of profits based on stock ownership 





C. Ultra Vires (without power) and Intra Vires (within power) Acts – Corporate Powers • Purposes (MBCA 3.01) – Every corporation incorporated under this Act has the purpose of engaging in any lawful business unless a more limited purpose is set forth in the articles of incorporation • General Powers (MBCA 3.02) – Unless its articles of incorporation provide otherwise, every corporation has perpetual duration and succession in its corporate name and has the same powers as an individual to do all things necessary or convenient to carry out its business and affairs, including without limitation power: o to sue and be sued, complain and defend in its corporate name o (2)to have a corporate seal, which may be altered at will, and to use it, or a facsimile of it, by impressing or affixing it or in any other manner reproducing it o to make and amend bylaws, not inconsistent with its articles of incorporation or with the laws of this state, for managing the business and regulating the affairs of the corporation; o to purchase, receive, lease, or otherwise acquire, and own, hold, improve, use, and otherwise deal with, real or personal property, or any legal or equitable interest in property, wherever located o to sell, convey, mortgage, pledge, lease, exchange, and otherwise dispose of all or any part of its property; o to purchase, receive, subscribe for, or otherwise acquire; own, hold, vote, use, sell, mortgage, lend, pledge, or otherwise dispose of; and deal in and with shares or other interests in, or obligations of, any other entity o to make contracts and guarantees, incur liabilities, borrow money, issue its notes, bonds, and other obligations (which may be convertible into or include the option to purchase other securities of the corporation), and secure any of its obligations by mortgage or pledge of any of its property, franchises, or income o to lend money, invest and reinvest its funds, and receive and hold real and personal property as security for repayment o to be a promoter, partner, member, associate, or manager of any partnership, joint venture, trust, or other entity; o to conduct its business, locate offices, and exercise the powers granted by this Act within or without this state; 23







o to elect directors and appoint officers, employees, and agents of the corporation, define their duties, fix their compensation, and lend them money and credit o to pay pensions and establish pension plans, pension trusts, profit sharing plans, share bonus plans, share option plans, and benefit or incentive plans for any or all of its current or former directors, officers, employees, and agents o to make donations for the public welfare or for charitable, scientific, or educational purposes o to transact any lawful business that will aid governmental policy o to make payments or donations, or do any other act, not inconsistent with law, that furthers the business and affairs of the corporation Ultra Vires Acts (MBCA 3.04) o Except as provided in subsection (b), the validity of corporate action may not be challenged on the ground that the corporation lacks or lacked power to act o A corporation's power to act may be challenged:  in a proceeding by a shareholder against the corporation to enjoin the act;  in a proceeding by the corporation, directly, derivatively, or through a receiver, trustee, or other legal representative, against an incumbent or former director, officer, employee, or agent of the corporation o In a shareholder's proceeding under subsection (b)(1) to enjoin an unauthorized corporate act, the court may enjoin or set aside the act, if equitable and if all affected persons are parties to the proceeding, and may award damages for loss (other than anticipated profits) suffered by the corporation or another party because of enjoining the unauthorized act. AP Smith v Barlow – board of directors donated $1500 to Princeton and company argued it was an ultra vires act because the company was formed before the law went into effect and the certificate of incorporation did not authorize such donations; company also argued that common law did not allow it either (management cannot donate funds for philanthropic reasons unless it is beneficial to the company); court held that the law allowing donations applied retroactively and that the board could make the donation Q 10-1, 11-1

D. Liability of Shareholders • GR – no personal liability of shareholders – MBCA 6.22 o A purchaser from a corporation of its own shares is not liable to the corporation or its creditors with respect to the shares except to pay the consideration for which the shares were authorized to be issued or specified in the subscription agreement o Unless otherwise provided in the articles, a shareholder of a corporation is not personally liable for the acts or debts of the corporation except that he may become personally liable by reason of his own acts or conduct • Contractual exceptions – corporation can alter the contract to make a shareholder liable, such as a personal guarantee • Piercing the Corporate Veil – a combination of factors that allows P to pierce the corporation and go after a shareholder (usually a majority shareholder) 24





o Dewitt Truck v W Ray Fleming Fruit – RF got trucks to deliver his fruit; truck company owed $15,000 and RF went bankrupt so RF made a personal guarantee on the debt; court held that creditor could pierce the corporate veil because RF was using the corporation as a façade to do business – he didn’t have board meetings, didn’t know about shares issued, he took money from the corporation; creditor was essentially led to believe he was dealing only with RF  Factors to Consider (Q 164-1) – undercapitalization (not enough funds to operate – determined at the time shares are purchased or when money is taken out), failure to observe corporate formalities, non-payment of dividends, insolvency of the debtor corporation at the time, siphoning funds of the corporation by dominant shareholder (fraud), non-functioning of other directors or officers, absence of corporate records, fact that the corporation is a façade for the operations of the dominant stockholder o In re Silicon Breast Implants – Bristol was parent of MEC, which was selling breast implants; issue was whether a corporation who is the sole shareholder of a subsidiary can be held liable for wrongful action; court applied similar factors as Fleming Fruit and held that corporate veil could be pierced here because B execs were board of directors of MEC, B provided money for testing, B marketed the implants, revenue went directly to B, and MEC essentially acted as a bank account for B; P essentially thought they were buying implants from Bristol  Q 173-1 Enterprise Liability – ALL of the brother or sister corporations engaged in a given industry form a collective enterprise getting direction from a single source – the ultimate parent o Walkovszky v Carlton – 10 taxi companies all owned by the same actor but each is separately incorporated; court held that enterprise liability pierces the walls of one corporation not to go after the assets of a shareholder, BUT to go after the assets of related companies  The companies have to be engaged in the same BUSINESS PURPOSE – subsidiaries are formed for that same purpose o For liability, the enterprise as a whole would be liable and the assets of all of the members would be available to pay claims against the enterprise Secondary sales of stock – this is very rare

E. Management and other constituents of a corporation • The Board of Directors – NOT agents of the corporation; but look out for multiple hats; manage the business, set policy, select officers and other agents o Requirements for and duties of Board (MBCA 8.01) – Except as provided in 7.32, each corporation must have a board of directors; all corporate powers shall be exercised by or under the authority of, and the business and affairs of the corporation managed by or under the direction of, its board of directors, subject to any limitations in the articles or 7.32 o Qualification of Directors (MBCA 8.02) – The articles of incorporation or bylaws may prescribe qualifications for directors. A director need not be a resident of this state or a shareholder of the corporation unless the articles of incorporation or bylaws so prescribe 25

o Five major procedural questions to ask (Course Supp. Item 3; Q 186-1, 2):  Who has the power to call or convene meetings?  What notice is required for meetings?  How many directors must be present to constitute a quorum?  What vote is required for approval of a resolution?  May the board act informally? o Meetings (MBCA 8.20)  The board of directors may hold regular or special meetings in or out of this state  Unless the articles of incorporation or bylaws provide otherwise, the board of directors may permit any or all directors to participate in a regular or special meeting by, or conduct the meeting through the use of, any means of communication by which all directors participating may simultaneously hear each other during the meeting. A director participating in a meeting by this means is deemed to be present in person at the meeting o Action without a meeting (MBCA 8.21)  Unless the articles of incorporation or bylaws provide otherwise, action required or permitted by this Act to be taken at a board of directors' meeting may be taken without a meeting if the action is taken by all members of the board. The action must be evidenced by one or more written consents describing the action taken, signed by each director, and included in the minutes or filed with the corporate records reflecting the action taken  Action taken under this section is effective when the last director signs the consent, unless the consent specifies a different effective date  A consent signed under this section has the effect of a meeting vote and may be described as such in any document o Notice of a meeting (MBCA 8.22)  Unless the articles of incorporation or bylaws provide otherwise, regular meetings of the board of directors may be held without notice of the date, time, place, or purpose of the meeting  Unless the articles of incorporation or bylaws provide for a longer or shorter period, special meetings of the board of directors must be preceded by at least two days' notice of the date, time, and place of the meeting. The notice need not describe the purpose of the special meeting unless required by the articles of incorporation or bylaws o Waiver of notice (MBCA 8.23)  A director may waive any notice required by this Act, the articles of incorporation, or bylaws before or after the date and time stated in the notice. Except as provided by subsection (b), the waiver must be in writing, signed by the director entitled to the notice, and filed with the minutes or corporate records.  A director's attendance at or participation in a meeting waives any required notice to him of the meeting unless the director at the beginning of the meeting (or promptly upon his arrival) objects to holding the meeting or transacting business at the meeting and does not thereafter vote for or assent to action taken at the meeting. 26





o Quorum and Voting (MBCA 8.24)  Unless the articles of incorporation or bylaws require a greater number or unless otherwise specifically provided in this Act, a quorum of a board of directors consists of: • a majority of the fixed number of directors if the corporation has a fixed board size; or • a majority of the number of directors prescribed, or if no number is prescribed the number in office immediately before the meeting begins, if the corporation has a variable-range size board.  The articles of incorporation or bylaws may authorize a quorum of a board of directors to consist of no fewer than one-third of the fixed or prescribed number of directors determined under subsection (a).  If a quorum is present when a vote is taken, the affirmative vote of a majority of directors present is the act of the board of directors unless the articles of incorporation or bylaws require the vote of a greater number of directors.  A director who is present at a meeting of the board of directors or a committee of the board of directors when corporate action is taken is deemed to have assented to the action taken unless: (1) he objects at the beginning of the meeting (or promptly upon his arrival) to holding it or transacting business at the meeting; (2) his dissent or abstention from the action taken is entered in the minutes of the meeting; or (3) he delivers written notice of his dissent or abstention to the presiding officer of the meeting before its adjournment or to the corporation immediately after adjournment of the meeting. The right of dissent or abstention is not available to a director who votes in favor of the action taken. Officers – they ARE agents of the corporation; execute board decisions, manage day to day operations o A corporation has the offices described in its bylaws or designated by the board of directors in accordance with the bylaws. o The board of directors may elect individuals to fill one or more offices of the corporation. An officer may appoint one or more officers if authorized by the bylaws or the board of directors. o The bylaws or the board of directors shall assign to one of the officers responsibility for preparing minutes of the directors' and shareholders' meetings and for maintaining and authenticating the records of the corporation required to be kept under sections 16.01(a) and 16.01(e). o The same individual may simultaneously hold more than one office in a corporation. o Duties of Officer (MBCA 8.41) – Each officer has the authority and shall perform the duties set forth in the bylaws or, to the extent consistent with the bylaws, the duties prescribed by the board of directors or by direction of an officer authorized by the board of directors to prescribe the duties of other officers. Shareholder Agreements (OWNERS) – elect board of directors, vote on major corporate actions or fundamental changes o MBCA 7.32 Agreements – shareholder agreement that permits agreements 27

that would be unenforceable under traditional notions of acceptable corporate practice  An agreement among the shareholders of a corporation that complies with this section is effective among the shareholders and the corporation even though it is inconsistent with one or more other provisions of this Act in that it: • eliminates the board of directors or restricts the discretion or powers of the board of directors; • governs the authorization or making of distributions whether or not in proportion to ownership of shares, subject the limitations in section 6.40; • establishes who shall be directors or officers of the corporation, or their terms of office or manner of selection or removal; • governs, in general or in regard to specific matters, the exercise or division of voting power by or between the shareholders and directors or by or among any of them, including use of weighted voting rights or director proxies; • establishes the terms and conditions of any agreement for the transfer or use of property or the provision of services between the corporation and any shareholder, director, officer or employee of the corporation or among any of them; • transfers to one or more shareholders or other persons all or part of the authority to exercise the corporate powers or to manage the business and affairs of the corporation, including the resolution of any issue about which there exists a deadlock among directors or shareholders; • requires dissolution of the corporation at the request of one or more of the shareholders or upon the occurrence of a specified event or contingency; or • otherwise governs the exercise of the corporate powers or the management of the business and affairs of the corporation or the relationship among the shareholders, the directors and the corporation, or among any of them, and is not contrary to public policy.  An agreement authorized by this section shall be: • (1) set forth (A) in the articles of incorporation or bylaws and approved by all persons who are shareholders at the time of the agreement or (B) in a written agreement that is signed by all persons who are shareholders at the time of the agreement and is made known to the corporation; • (2) subject to amendment only by all persons who are shareholders at the time of the amendment, unless the agreement provides otherwise; and • (3) valid for 10 years, unless the agreement provides otherwise.  The existence of an agreement authorized by this section shall be noted conspicuously on the front or back of each certificate for outstanding shares or on the information statement required by section 6.26(b). If at the time of the agreement the corporation has shares 28

outstanding represented by certificates, the corporation shall recall the outstanding certificates and issue substitute certificates that comply with this subsection. The failure to note the existence of the agreement on the certificate or information statement shall not affect the validity of the agreement or any action taken pursuant to it. Any purchaser of shares who, at the time of purchase, did not have knowledge of the existence of the agreement shall be entitled to rescission of the purchase. A purchaser shall be deemed to have knowledge of the existence of the agreement if its existence is noted on the certificate or information statement for the shares in compliance with this subsection and, if the shares are not represented by a certificate, the information statement is delivered to the purchaser at or prior to the time of purchase of the shares. An action to enforce the right of rescission authorized by this subsection must be commenced within the earlier of 90 days after discovery of the existence of the agreement or two years after the time of purchase of the shares.  An agreement authorized by this section shall cease to be effective when shares of the corporation are listed on a national securities exchange or regularly traded in a market maintained by one or more members of a national or affiliated securities association. If the agreement ceases to be effective for any reason, the board of directors may, if the agreement is contained or referred to in the corporation's articles of incorporation or bylaws, adopt an amendment to the articles of incorporation or bylaws, without shareholder action, to delete the agreement and any references to it.  An agreement authorized by this section that limits the discretion or powers of the board of directors shall relieve the directors of, and impose upon the person or persons in whom such discretion or powers are vested, liability for acts or omissions imposed by law on directors to the extent that the discretion or powers of the directors are limited by the agreement.  The existence or performance of an agreement authorized by this section shall not be a ground for imposing personal liability on any shareholder for the acts or debts of the corporation even if the agreement or its performance treats the corporation as if it were a partnership or results in failure to observe the corporate formalities otherwise applicable to the matters governed by the agreement.  Incorporators or subscribers for shares may act as shareholders with respect to an agreement authorized by this section if no shares issued when the agreement is made o Villar v Kiernan – V was in a bad situation with K; K broke an agreement that said they wouldn’t get salaries, only distributions; K was hired as a consultant and got paid a salary; V claimed the agreement was valid; K argued it was invalid because it wasn’t in writing as required by state statute; court held that the agreement was INVALID because it wasn’t in writing – this is an express requirement in the state statute (7.32 agreements must comply EXACTLY with the rules) F. Voting Agreements and Shareholder Matters 29





Voting Agreements o Director voting agreements – valid if they elect board of directors; invalid if they elect the board as officers (unless it is a 7.32 agreement)  McQuade v Stoneham – S became majority shareholder and McQ and McG got smaller shares; they made an agreement in which they took different officer positions; McQ and S got into an argument and McQ was fired and kicked off Board of Directors; court held that S could do this because it was in the best interest of the corporation; court held that the agreement was invalid because it restricted the board from properly managing the company – directors could not agree to make themselves officers o Shareholder voting agreements – contrast with director voting agreements  MBCA 7.31 – voting agreements – (a) Two or more shareholders may provide for the manner in which they will vote their shares by signing an agreement for that purpose. A voting agreement created under this section is not subject to the provisions of section 7.30; (b) A voting agreement created under this section is specifically enforceable  Ringling Brothers – shares divided between R, H, and N; R claimed that her and H agreed to vote for the same directors and H claims that the agreement was invalid because she wanted to vote differently than the agreement stated; court held that agreement was valid and that H must vote accordingly because shareholders have the ability to make voting agreements and they are absolutely enforced Shareholder voting – Electing directors, removing directors, and filling vacancies o MBCA 7.21 – voting entitlement of shares  Except as provided in subsections (b) and (c) or unless the articles of incorporation provide otherwise, each outstanding share, regardless of class, is entitled to one vote on each matter voted on at a shareholders' meeting. Only shares are entitled to vote.  Absent special circumstances, the shares of a corporation are not entitled to vote if they are owned, directly or indirectly, by a second corporation, domestic or foreign, and the first corporation owns, directly or indirectly, a majority of the shares entitled to vote for directors of the second corporation.  Subsection (b) does not limit the power of a corporation to vote any shares, including its own shares, held by it in a fiduciary capacity.  Redeemable shares are not entitled to vote after notice of redemption is mailed to the holders and a sum sufficient to redeem the shares has been deposited with a bank, trust company, or other financial institution under an irrevocable obligation to pay the holders the redemption price on surrender of the shares. o 8.03 – number and election of board of directors  A board of directors must consist of one or more individuals, with the number specified in or fixed in accordance with the articles of incorporation or bylaws.  The number of directors may be increased or decreased from time to time by amendment to, or in the manner provided in, the articles of incorporation or the bylaws.  Directors are elected at the first annual shareholders' meeting and at 30



each annual meeting thereafter unless their terms are staggered under section 8.06. o 8.06 – staggered terms for directors – The articles of incorporation may provide for staggering the terms of directors by dividing the total number of directors into two or three groups, with each group containing one-half or one-third of the total, as near as may be. In that event, the terms of directors in the first group expire at the first annual shareholders' meeting after their election, the terms of the second group expire at the second annual shareholders' meeting after their election, and the terms of the third group, if any, expire at the third annual shareholders' meeting after their election. At each annual shareholders' meeting thereafter, directors shall be chosen for a term of two years or three years, as the case may be, to succeed those whose terms expire. o 8.08 – removal of directors by shareholders  The shareholders may remove one or more directors with or without cause unless the articles of incorporation provide that directors may be removed only for cause.  If a director is elected by a voting group of shareholders, only the shareholders of that voting group may participate in the vote to remove him.  If cumulative voting is authorized, a director may not be removed if the number of votes sufficient to elect him under cumulative voting is voted against his removal. If cumulative voting is not authorized, a director may be removed only if the number of votes cast to remove him exceeds the number of votes cast not to remove him.  A director may be removed by the shareholders only at a meeting called for the purpose of removing him and the meeting notice must state that the purpose, or one of the purposes, of the meeting is removal of the director. o 8.10 – vacancy on the board  Unless the articles of incorporation provide otherwise, if a vacancy occurs on a board of directors, including a vacancy resulting from an increase in the number of directors: • the shareholders may fill the vacancy; • the board of directors may fill the vacancy; or • if the directors remaining in office constitute fewer than a quorum of the board, they may fill the vacancy by the affirmative vote of a majority of all the directors remaining in office.  If the vacant office was held by a director elected by a voting group of shareholders, only the holders of shares of that voting group are entitled to vote to fill the vacancy if it is filled by the shareholders.  A vacancy that will occur at a specific later date (by reason of a resignation effective at a later date under section 8.07(b) or otherwise) may be filled before the vacancy occurs but the new director may not take office until the vacancy occurs. Forms of voting o MBCA 7.28 – voting for directors and cumulative voting  Unless otherwise provided in the articles of incorporation, directors are elected by a plurality of the votes cast by the shares entitled to vote in 31



the election at a meeting at which a quorum is present. • Straight voting – for each shareholder for each position up for election, the number of votes equals the number of shares; top vote getters are elected • Normal v Plurality – majority shareholder has significant power under this type of voting scheme because he can elect an entire board  Shareholders do not have a right to cumulate their votes for directors unless the articles of incorporation so provide. A statement included in the articles of incorporation that [all] [a designated voting group of] shareholders are entitled to cumulate their votes for directors (or words of similar import) means that the shareholders designated are entitled to multiply the number of votes they are entitled to cast by the number of directors for whom they are entitled to vote and cast the product for a single candidate or distribute the product among two or more candidates. • Cumulative Voting – unlike straight voting, cumulative allows shareholders to accumulate all of their votes and split them among a few candidates or even cast all of them for one candidate; this increases the chances of at least some board representation for minority shareholders • Cumulative voting only affects the election of directors; it does not apply to any other shareholder voting at meetings of shareholders; such as whether to approve an amendment to the articles or a merger with another corp. • Q 201-1, 3 • Formula for smart voting: (S/D+1) + “1” = shares needed to elect one director o (S/D+1) – tells how many shares are needed to tie o “1” – the amount needed to round up to number of votes needed to win  Shares otherwise entitled to vote cumulatively may not be voted cumulatively at a particular meeting unless: • the meeting notice or proxy statement accompanying the notice states conspicuously that cumulative voting is authorized; or • a shareholder who has the right to cumulate his votes gives notice to the corporation not less than 48 hours before the time set for the meeting of his intent to cumulate his votes during the meeting, and if one shareholder gives this notice all other shareholders in the same voting group participating in the election are entitled to cumulate their votes without giving further notice. Supermajority provisions – Distinguish between majority of outstanding shares and majority of shares present (so long as quorum is present) (MBCA 7.27 – quorum generally and greater quorum or voting requirements) o The articles of incorporation may provide for a greater quorum or voting requirement for shareholders (or voting groups of shareholders) than is provided for by this Act. 32





o An amendment to the articles of incorporation that adds, changes, or deletes a greater quorum or voting requirement must meet the same quorum requirement and be adopted by the same vote and voting groups required to take action under the quorum and voting requirements then in effect or proposed to be adopted, whichever is greater. Fundamental corporate changes – mostly involves changes in the organization of the business o Normally, first step is board recommending approval o Second step is shareholder approval Mechanics of the voting procedures of meetings – Shareholder Meetings o Annual Meeting (MBCA 7.01)  A corporation shall hold a meeting of shareholders annually at a time stated in or fixed in accordance with the bylaws.  Annual shareholders' meetings may be held in or out of this state at the place stated in or fixed in accordance with the bylaws. If no place is stated in or fixed in accordance with the bylaws, annual meetings shall be held at the corporation's principal office.  The failure to hold an annual meeting at the time stated in or fixed in accordance with a corporation's bylaws does not affect the validity of any corporate action. o Special Meeting (MBCA 7.02)  A corporation shall hold a special meeting of shareholders: • on call of its board of directors or the person or persons authorized to do so by the articles of incorporation or bylaws; or • if the holders of at least 10 percent of all the votes entitled to be cast on any issue proposed to be considered at the proposed special meeting sign, date, and deliver to the corporation's secretary one or more written demands for the meeting describing the purpose or purposes for which it is to be held, provided that the articles of incorporation may fix a lower percentage or a higher percentage not exceeding 25 percent of all the votes entitled to be cast on any issue proposed to be considered. Unless otherwise provided in the articles of incorporation, a written demand for a special meeting may be revoked by a writing to that effect received by the corporation prior to the receipt by the corporation of demands sufficient in number to require the holding of a special meeting.  If not otherwise fixed under sections 7.03 or 7.07, the record date for determining shareholders entitled to demand a special meeting is the date the first shareholder signs the demand.  Special shareholders' meetings may be held in or out of this state at the place stated in or fixed in accordance with the bylaws. If no place is stated or fixed in accordance with the bylaws, special meetings shall be held at the corporation's principal office.  Only business within the purpose or purposes described in the meeting notice required by section 7.05(c) may be conducted at a special shareholders' meeting. o Action without a meeting (MBCA 7.04) 33

Action required or permitted by this Act to be taken at a shareholders' meeting may be taken without a meeting if the action is taken by all the shareholders entitled to vote on the action. The action must be evidenced by one or more written consents bearing the date of signature and describing the action taken, signed by all the shareholders entitled to vote on the action, and delivered to the corporation for inclusion in the minutes or filing with the corporate records.  If not otherwise fixed under sections 7.03 or 7.07, the record date for determining shareholders entitled to take action without a meeting is the date the first shareholder signs the consent under subsection (a). No written consent shall be effective to take the corporation action referred to therein unless, within 60 days of the earliest date appearing on a consent delivered to the corporation in the manner required by this section, written consents signed by all shareholders entitled to vote on the action are received by the corporation. A written consent may be revoked by a writing to that effect received by the corporation prior to the receipt by the corporation of unrevoked written consents sufficient in number to take corporate action.  A consent signed under this section has the effect of a meeting vote and may be described as such in any document.  If this Act requires that notice of proposed action be given to nonvoting shareholders and the action is to be taken by unanimous consent of the voting shareholders, the corporation must give its nonvoting shareholders written notice of the proposed action at least 10 days before the action is taken. The notice must contain or be accompanied by the same material that, under this Act, would have been required to be sent to nonvoting shareholders in a notice of meeting at which the proposed action would have been submitted to the shareholders for action. o Notice of meeting (MBCA 7.05)  A corporation shall notify shareholders of the date, time, and place of each annual and special shareholders' meeting no fewer than 10 nor more than 60 days before the meeting date. Unless this Act or the articles of incorporation require otherwise, the corporation is required to give notice only to shareholders entitled to vote at the meeting.  Unless this Act or the articles of incorporation require otherwise, notice of an annual meeting need not include a description of the purpose or purposes for which the meeting is called.  Notice of a special meeting must include a description of the purpose or purposes for which the meeting is called.  If not otherwise fixed under section 7.03 or 7.07, the record date for determining shareholders entitled to notice of and to vote at an annual or special shareholders' meeting is the day before the first notice is delivered to shareholders.  Unless the bylaws require otherwise, if an annual or special shareholders' meeting is adjourned to a different date, time, or place, notice need not be given of the new date, time, or place if the new date, time, or place is announced at the meeting before adjournment. 

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If a new record date for the adjourned meeting is or must be fixed under section 7.07, however, notice of the adjourned meeting must be given under this section to persons who are shareholders as of the new record date. o Waiver of notice (MBCA 7.06)  A shareholder may waive any notice required by this Act, the articles of incorporation, or bylaws before or after the date and time stated in the notice. The waiver must be in writing, be signed by the shareholder entitled to the notice, and be delivered to the corporation for inclusion in the minutes or filing with the corporate records.  A shareholder's attendance at a meeting: • waives objection to lack of notice or defective notice of the meeting, unless the shareholder at the beginning of the meeting objects to holding the meeting or transacting business at the meeting; • waives objection to consideration of a particular matter at the meeting that is not within the purpose or purposes described in the meeting notice, unless the shareholder objects to considering the matter when it is presented. o Record owner/street name and Record date (MBCA 7.07)  The bylaws may fix or provide the manner of fixing the record date for one or more voting groups in order to determine the shareholders entitled to notice of a shareholders' meeting, to demand a special meeting, to vote, or to take any other action. If the bylaws do not fix or provide for fixing a record date, the board of directors of the corporation may fix a future date as the record date.  A record date fixed under this section may not be more than 70 days before the meeting or action requiring a determination of shareholders.  A determination of shareholders entitled to notice of or to vote at a shareholders' meeting is effective for any adjournment of the meeting unless the board of directors fixes a new record date, which it must do if the meeting is adjourned to a date more than 120 days after the date fixed for the original meeting.  If a court orders a meeting adjourned to a date more than 120 days after the date fixed for the original meeting, it may provide that the original record date continues in effect or it may fix a new record date. o Proxies – 7.22 – shareholder can be present by (1) proxy or (2) physical presence  A shareholder may vote his shares in person or by proxy.  A shareholder or his agent or attorney-in-fact may appoint a proxy to vote or otherwise act for the shareholders by signing an appointment form or by an electronic transmission. An electronic transmission must contain or be accompanied by information from which one can determine that the shareholder, the shareholder's agent, or the shareholder's attorney-in-fact authorized the electronic transmission.  An appointment of a proxy is effective when a signed appointment form or an electronic transmission of the appointment is received by the inspector of election or the officer or agent of the corporation authorized to tabulate votes. An appointment is valid for 11 months 35

unless a longer period is expressly provided in the appointment.  An appointment of a proxy is revocable unless the appointment form or electronic transmission states that it is irrevocable and the appointment is coupled with an interest. Appointments coupled with an interest include the appointment of: • a pledgee; • a person who purchased or agreed to purchase the shares; • a creditor of the corporation who extended it credit under terms requiring the appointment; • an employee of the corporation whose employment contract requires the appointment; or • a party to a voting agreement created under section 7.31.  The death or incapacity of the shareholder appointing a proxy does not affect the right of the corporation to accept the proxy's authority unless notice of the death or incapacity is received by the secretary or other officer or agent authorized to tabulate votes before the proxy exercises his authority under the appointment.  An appointment made irrevocable under subsection (d) is revoked when the interest with which it is coupled is extinguished.  A transferee for value of shares subject to an irrevocable appointment may revoke the appointment if he did not know of its existence when he acquired the shares and the existence of the irrevocable appointment was not noted conspicuously on the certificate representing the shares or on the information statement for shares without certificates.  Subject to section 7.24 and to any express limitation on the proxy's authority stated in the appointment form or electronic transmission, a corporation is entitled to accept the proxy's vote or other action as that of the shareholder making the appointment. o Quorum – 7.25  Shares entitled to vote as a separate voting group may take action on a matter at a meeting only if a quorum of those shares exists with respect to that matter. Unless the articles of incorporation or this Act provide otherwise, a majority of the votes entitled to be cast on the matter by the voting group constitutes a quorum of that voting group for action on that matter.  Once a share is represented for any purpose at a meeting, it is deemed present for quorum purposes for the remainder of the meeting and for any adjournment of that meeting unless a new record date is or must be set for that adjourned meeting.  If a quorum exists, action on a matter (other than the election of directors) by a voting group is approved if the votes cast within the voting group favoring the action exceed the votes cast opposing the action, unless the articles of incorporation or this Act require a greater number of affirmative votes.  An amendment of articles of incorporation adding, changing, or deleting a quorum or voting requirement for a voting group greater than specified in subsection (a) or (c) is governed by section 7.27. 36



 The election of directors is governed by section 7.28 Course supp. 4; Q 204-1, 2

G. Problems with Close Corporations and Related Matters Selling Shares of Stock o Generally – the more private the corporation, the more difficult it is to sell shares of stock  Redemption – selling shares of stock back to the corporation  Partnership dissociation – partner leaving the business o Equal Access Rule (APPLIES ONLY TO CLOSE CORPORATIONS) – if the stockholder whose shares were purchased was a member of the controlling group, the controlling stockholders must offer each stockholder an equal opportunity to sell a RATABLE number of shares to the corporation at an identical price  Donahue v Rod Electric – dad wanted to sell back his shares to the close corporation because he wanted to retire; P (a minority shareholder) wanted to sell back her shares as well but RE said no because they didn’t have enough money; court held that all shareholders should have an equal access to sell back shares because there is no readily available market for stock of close corporations; majority shareholders should not breach their fiduciary duty of good faith when buying back shares  TRIGGER – when corporation makes the decision to buy back any shares  Q 597-1, 2, 3, 4 – equal access rule can be altered by bylaws or articles of incorporation o Shareholder Buy-Sell agreements – K requiring the corporation or the other shareholders to purchase shares in certain situations at a certain price  At a minimum, these should contain: • Trigger event • Purchase price mechanisms • Method or source of payment • Who the parties are and what they are dealing with in the agreement  Funding considerations  Types of agreements – One-way agreements, Cross-purchase agreement, Redemption agreement, Wait and see agreement  Other mechanics – valuing a business (goodwill multiplier, rate of return on assets, last X years average earnings, capitalization factor, combination book value, capitalization of net earnings); tailoring the agreement; corporate notice of these arrangements • Close Corporations – corporations with (1) a small number of stockholders, (2) no ready market for the corporate stock, and (3) substantial majority stockholder participation in the management, direction, and operations of the corporation o Overview of the problems in close corporations – advantages and disadvantages  Why buy stock in a close corporation – more control over management  Ways the majority can oppress the minority – various means 37

How the minority can fight back – equal access, voting agreements, etc. o Salaries – paid to someone working for the corporation  Hollis v Hill – dispute between H and Hill because H wasn’t working hard enough; Hill eventually kicked H out of the business; court held that Hill breached his fiduciary duty to H because he didn’t have the authority to kick H out of the business, but H let him walk all over him; H was still allowed to work there and receive a salary for his work  Factors to consider • whether the corporation typically distributes its profits in the form of salaries • whether the shareholder/employee owns a significant percentage of the firm’s shares • whether the shareholder/employee is a founder of the business • whether the shares were received as compensation for services • whether the employee expects the value of shares to increase • whether employee has made a significant capital contribution • whether the employee has demonstrated a reasonable expectation that the returns from the investment will be obtained through employment; and • whether stock ownership is a requirement of employment  Q 444-2, 3, 4, 5, 6  Gianotti v Hamway – statute said court had full power to liquidate assets of a corporation in certain situations involving fraud, illegality, or oppression; court held that oppression occurred and the exclusive remedy was dissolution because the burden shifted to D to prove that compensation was reasonable and he didn’t meet this burden; D had the burden because he was an interested director receiving increased compensation from corporate funds  Q 460-1, 2, 3 – money damages were not an option because they weren’t in the statute o Distributions – board of directors personally liable for unlawful distributions  MBCA 6.40(c) – distributions to shareholders • (a) A board of directors may authorize and the corporation may make distributions to its shareholders subject to restriction by the articles of incorporation and the limitation in subsection (c). • (b) If the board of directors does not fix the record date for determining shareholders entitled to a distribution (other than one involving a purchase, redemption, or other acquisition of the corporation's shares), it is the date the board of directors authorizes the distribution. • (c) No distribution may be made if, after giving it effect: o (1) the corporation would not be able to pay its debts as they become due in the usual course of business; or o (2) the corporation's total assets would be less than the sum of its total liabilities plus (unless the articles of incorporation permit otherwise) the amount that would be needed, if the corporation were to be dissolved at the time 

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of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution. • (d) The board of directors may base a determination that a distribution is not prohibited under subsection (c) either on financial statements prepared on the basis of accounting practices and principles that are reasonable in the circumstances or on a fair valuation or other method that is reasonable in the circumstances.  MBCA 8.33 – directors liability for unlawful distributions • (a) A director who votes for or assents to a distribution in excess of what may be authorized and made pursuant to section 6.40(a) or 14.09(a) is personally liable to the corporation for the amount of the distribution that exceeds what could have been distributed without violating section 6.40 or 14.09(a) if the party asserting liability establishes that when taking the action the director did not comply with section 8.30. • (b) A director held liable under subsection (a) for an unlawful distribution is entitled to: o (1) contribution from every other director who could be held liable under subsection (a) for the unlawful distribution; and o (2) recoupment from each shareholder of the pro-rata portion of the amount of the unlawful distribution the shareholder accepted, knowing the distribution was made in violation of section 6.40(a) or 14.09(a). • (c) A proceeding to enforce: o (1) the liability of a director under subsection (a) is barred unless it is commenced within two years after the date (i) on which the effect of the distribution was measured under section 6.40(e) or (g), (ii) as of which the violation of section 6.40(a) occurred as the consequence of disregard of a restriction in the articles of incorporation, or (iii) on which the distribution of assets to shareholders under section 14.09(a) was made; or o (2) contribution or recoupment under subsection (b) is barred unless it is commenced within one year after the liability of the claimant has been finally adjudicated under subsection (a).  Zidell v Zidell – P quit his job because the corporation wouldn’t double his salary; dividends then were paid, but corporation wouldn’t pay them to P and he sued to get them; P had burden of proving bad faith; court held that P did not meet his burden because corporation had sufficient evidence that the dividend policy was reasonable; court held that directors were NOT interested in this case  Q 468-1, 2, 469-4 – if P had been fired, then he might have met his burden Shareholder oppression issues – INVOLUNTARY DISSOLUTION o MBCA 14.30 – grounds for judicial dissolution – The court may dissolve a 39

corporation in a proceeding by a shareholder if it is established that:  the directors are deadlocked in the management of the corporate affairs, the shareholders are unable to break the deadlock, and irreparable injury to the corporation is threatened or being suffered, or the business and affairs of the corporation can no longer be conducted to the advantage of the shareholders generally, because of the deadlock;  the directors or those in control of the corporation have acted, are acting, or will act in a manner that is illegal, oppressive, or fraudulent;  the shareholders are deadlocked in voting power and have failed, for a period that includes at least two consecutive annual meeting dates, to elect successors to directors whose terms have expired; or  the corporate assets are being misapplied or wasted; o MBCA 14.34 – election to purchase in lieu of dissolution  In a proceeding under section 14.30(2) to dissolve a corporation that has no shares listed on a national securities exchange or regularly traded in a market maintained by one or more members of a national or affiliated securities association, the corporation may elect or, if it fails to elect, one or more shareholders may elect to purchase all shares owned by the petitioning shareholder at the fair value of the shares. An election pursuant to this section shall be irrevocable unless the court determines that it is equitable to set aside or modify the election.  An election to purchase pursuant to this section may be filed with the court at any time within 90 days after the filing of the petition under section 14.30(2) or at such later time as the court in its discretion may allow. If the election to purchase is filed by one or more shareholders, the corporation shall, within 10 days thereafter, give written notice to all shareholders, other than the petitioner. The notice must state the name and number of shares owned by the petitioner and the name and number of shares owned by each electing shareholder and must advise the recipients of their right to join in the election to purchase shares in accordance with this section. Shareholders who wish to participate must file notice of their intention to join in the purchase no later than 30 days after the effective date of the notice to them. All shareholders who have filed an election or notice of their intention to participate in the election to purchase thereby become parties to the proceeding and shall participate in the purchase in proportion to their ownership of shares as of the date the first election was filed, unless they otherwise agree or the court otherwise directs. After an election has been filed by the corporation or one or more shareholders, the proceeding under section 14.30(2) may not be discontinued or settled, nor may the petitioning shareholder sell or otherwise dispose of his shares, unless the court determines that it would be equitable to the corporation and the shareholders, other than the petitioner, to permit such discontinuance, settlement, sale, or other disposition.  If, within 60 days of the filing of the first election, the parties reach agreement as to the fair value and terms of purchase of the petitioner's shares, the court shall enter an order directing the 40











purchase of petitioner's shares upon the terms and conditions agreed to by the parties. If the parties are unable to reach an agreement as provided for in subsection (c), the court, upon application of any party, shall stay the section 14.30(2) proceedings and determine the fair value of the petitioner's shares as of the day before the date on which the petition under section 14.30(2) was filed or as of such other date as the court deems appropriate under the circumstances. Upon determining the fair value of the shares, the court shall enter an order directing the purchase upon such terms and conditions as the court deems appropriate, which may include payment of the purchase price in installments, where necessary in the interest of equity, provision for security to assure payment of the purchase price and any additional costs, fees, and expenses as may have been awarded, and, if the shares are to be purchased by shareholders, the allocation of shares among them. In allocating petitioner's shares among holders of different classes of shares, the court should attempt to preserve the existing distribution of voting rights among holders of different classes insofar as practicable and may direct that holders of a specific class or classes shall not participate in the purchase. Interest may be allowed at the rate and from the date determined by the court to be equitable, but if the court finds that the refusal of the petitioning shareholder to accept an offer of payment was arbitrary or otherwise not in good faith, no interest shall be allowed. If the court finds that the petitioning shareholder had probable grounds for relief under paragraphs (ii) or (iv) of section 14.30(2), it may award to the petitioning shareholder reasonable fees and expenses of counsel and of any experts employed by him. Upon entry of an order under subsections (c) or (e), the court shall dismiss the petition to dissolve the corporation under section 14.30, and the petitioning shareholder shall no longer have any rights or status as a shareholder of the corporation, except the right to receive the amounts awarded to him by the order of the court which shall be enforceable in the same manner as any other judgment. The purchase ordered pursuant to subsection (e), shall be made within 10 days after the date the order becomes final unless before that time the corporation files with the court a notice of its intention to adopt articles of dissolution pursuant to sections 14.02 and 14.03, which articles must then be adopted and filed within 50 days thereafter. Upon filing of such articles of dissolution, the corporation shall be dissolved in accordance with the provisions of section 14.05 through 14.07, and the order entered pursuant to subsection (e) shall no longer be of any force or effect, except that the court may award the petitioning shareholder reasonable fees and expenses in accordance with the provisions of the last sentence of subsection (e) and the petitioner may continue to pursue any claims previously asserted on behalf of the corporation. Any payment by the corporation pursuant to an order under subsections (c) or (e), other than an award of fees and expenses pursuant to subsection (e), is subject to the provisions of section 6.40. 41

o Massachusetts Rule – judicial solution (common law) to close corporation problems; shareholders stand in a fiduciary relationship with one another  Remedy – equitable relief; court uses a balancing test to award what is fair  Four step analysis • Did the controlling shareholders freeze-out a minority shareholder? – P’s initial burden (must show oppression) • Did the controlling shareholders have a legitimate business purpose for their action? – D now has the burden • Can the minority shareholder show a less harmful alternative to the action taken by the controlling shareholders? – P’s final burden of proof • Court balances the legitimate business purpose against the less ahrmful alternative  Wilkes v Springside Nursing – 4 guys entered into nursing home business and then W got fired after a dispute and was kicked off board of directors; court held there was oppression because W was fired for no reason; court held D could not provide a legitimate business purpose because there was no showing of misconduct by W; directors breached their duty of good faith here o New York Rule – legislative (statutory) solution to close corporation problems with important interpretation by the courts – statute didn’t define oppression so the court defined it; shareholders reasonable expectations shall be protected from oppression  Remedy – statutory dissolution unless court sees otherwise  Process: • Oppression arises when majority conduct substantially defeats expectations that, objectively viewed, were BOTH reasonable under the circumstances AND were central to the decision to join the venture • Once a prima facie case of oppressive conduct is set forth, D may demonstrate the existence of an adequate alternative remedy (buyout of shares is always a possibility) • Court will then have broad latitude in fashioning alternative relief, but should not hesitate to order dissolution when appropriate • Protection is only for minority shareholders whose reasonable expectations were frustrated and who has no adequate means of recovering his investment  Wollman v Littman – parties claimed they were in deadlock and could not reach an agreement so they wanted the court to figure it out for them; court held that deadlock did not necessarily trigger dissolution so it remanded the case to determine if the deadlock in this case warranted judicial dissolution  In re Kemp & Beatley – G and D mad because they weren’t receiving distributions from the corporation; court looked at statute and defined the word oppression and said that the reason G and D entered into the venture was to receive distributions and run the company; court held 42

that these expectations were reasonable and D couldn’t come up with a viable alternative remedy so dissolution or forced buyout were the best options o Michigan Rule – legislative (statutory) solution to close corporation problems; shareholders rights AS shareholders are to be protected from oppressive conduct  Remedy – look to statute; dissolution is main remedy  Test – Oppression arises ONLY when the conduct substantially interferes with the interest of a shareholder AS A shareholder • Interests protected – dividends, meeting requirements, etc. • Interests not protected – employment, other stuff  Franchino v Franchino – D fired P from the company and then elected a new board of directors to kick P off board; P sued because he thought he had been oppressed; court looked to statute that defined oppression as effecting the rights of a shareholder as a shareholder; court held that P had not been oppressed because employment was NOT a right as a shareholder; there was no right as a shareholder at stake here H. Miscellaneous Information regarding corporations • Limited Liability Companies – derivative of corporations and partnerships o Generally – most popular form of business today; permits owners (often called members) to have the option to exercise direct managerial power over the affairs of the business without risking personal liability  Owners get the benefit of pass-through taxation  Sources of LLC law – ULLCA 103 (very similar to RUPA 103) o Formation – must file articles of organization with a state o Decision-making and operations – owners have the option to manage the business  Operating agreements govern internal affairs of LLC (similar to partnership agreement or corporate bylaws); Most LLCs are extremely flexible (mostly default rules)  Member-managed – like a partnership  Manager-managed – like a corporation • Taxation of business entities o Flow through – informational tax return and the new income or loss flows through to the owners  Partnership, S corporation, LLCs with more than 1 member o Double taxation – business entity pays tax o its net income and the owners then include dividends on their individual tax returns  C corporation o Disregarded entity – the entity is disregarded for tax purposes (default rule); the owner reports income and expenses directly on his own tax return  LLC’s with only 1 member, sole proprietorships I. Directors’ Duties (EACH DIRECTOR IS DEALT WITH SEPARATELY) • MBCA 8.30 (Standards of Conduct) o Each member of the board of directors, when discharging the duties of a 43



director, shall act (1) in good faith (duty of good faith), and (2) in a manner the director reasonably believes to be in the best interest of the corporation (duty of loyalty) o The members of the board or a committee of the board, when becoming informed in connection with their decision-making function or devoting attention to their oversight function, shall discharge their duties with the care that a person in a like position would reasonably believe appropriate under similar circumstances (duty of care) MBCA 8.31 (Standards of Liability for Directors) o A director shall not be liable to the corporation or its shareholders for any decision to take or not to take action, or any failure to take any action, as a director, unless the party asserting liability in a proceeding establishes that:  any provision in the articles of incorporation authorized by section 2.02(b)(4) or the protection afforded by section 8.61 for action taken in compliance with section 8.62 or 8.63, if interposed as a bar to the proceeding by the director, does not preclude liability; and  the challenged conduct consisted or was the result of: • action not in good faith; or • a decision o which the director did not reasonably believe to be in the best interests of the corporation, or o as to which the director was not informed to an extent the director reasonably believed appropriate in the circumstances; or • a lack of objectivity due to the director's familial, financial or business relationship with, or a lack of independence due to the director's domination or control by, another person having a material interest in the challenged conduct o which relationship or which domination or control could reasonably be expected to have affected the director's judgment respecting the challenged conduct in a manner adverse to the corporation, and o after a reasonable expectation to such effect has been established, the director shall not have established that the challenged conduct was reasonably believed by the director to be in the best interests of the corporation; or • a sustained failure of the director to devote attention to ongoing oversight of the business and affairs of the corporation, or a failure to devote timely attention, by making (or causing to be made) appropriate inquiry, when particular facts and circumstances of significant concern materialize that would alert a reasonably attentive director to the need therefor; or • receipt of a financial benefit to which the director was not entitled or any other breach of the director's duties to deal fairly with the corporation and its shareholders that is actionable under applicable law. o The party seeking to hold the director liable:  for money damages, shall also have the burden of establishing that: 44







harm to the corporation or its shareholders has been suffered, and • the harm suffered was proximately caused by the director's challenged conduct; or  for other money payment under a legal remedy, such as compensation for the unauthorized use of corporate assets, shall also have whatever persuasion burden may be called for to establish that the payment sought is appropriate in the circumstances; or  for other money payment under an equiable remedy, such as profit recovery by or disgorgement to the corporation, shall also have whatever persuasion burden may be called for to establish that the equitable remedy sought is appropriate in the circumstances. Business Judgment Rule – presumption that in making a business decision, the directors of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interest of the corporation (look for ANY rational basis for the decision) o Honest business decisions made in good faith on the basis of reasonable investigation are not actionable even though the decision is mistaken, unfortunate, or even disastrous o The party attacking the decision as a breach of the duty of care must rebut the presumption that the board’s business judgment was an informed one  Standard – GROSS NEGLIGENCE o BJR does not apply where:  The directors engaged in fraud, illegality, or conflict of interest (duty of loyalty analysis), or  Where the directors did not exercise an informed business judgment (duty of care analysis) o Burden shifting – if the shareholder succeeds in rebutting the presumption of the BJR, the directors are liable to the corporation for any damages that their actions proximately caused; at this point, the directors may argue (1) that their actions were not the proximate cause of the harm and/or (2) the shareholders suffered no damages o There must be a DECISION to have protection under BJR Directors’ Duty of Care (remember MBCA 2.02(b)(4) can limit director liability) o Duty of care and the BJR  Shlensky v Wrigley – P (minority shareholder) mad because Cubs don’t play night games when all other teams do – thinks it is hurting revenue; none of the courts that heard this case decided whether it was a good or bad decision – they all said it was a decision for the directors (application of business judgment); court held that P did not rebut the presumption because the director’s procedure in making the decision was okay – P can sell his shares if he is mad  Q 261-1, 2 o Breaches of the duty of care – ACTION – whether directors were “reasonably informed” under the circumstances  Smith v Van Gorkom – CEO gave oral speech at a special meeting with no information or reports and then the board approved sale of the company for $55 per share (cash out merger); individual shareholders 45

o

o

o

o

got pissed and claimed directors made a bad decision; court applied a “reasonably informed” test and held that the directors were not reasonably informed because they had no information to base their decision on; directors needed information to determine if the price was sufficient for sale  Q 275-2, 3, 4, 6, 7, 277-10 Breaches of the duty of care – INACTION – whether director was reasonably informed and whether the inaction proximately caused P’s claimed loss  Barnes v Andrews – P (receiver) claimed D breached the duty of care because he took no action to help the failing business; court held that D did breach his duty of care because he didn’t keep himself informed, BUT P did not get any damages because there was no proximate cause in this case – P couldn’t prove that D’s inaction caused the company’s losses  Q 282-1, 2, 3, 5 – there is no legal requirement for a director to be a specialist, but if he does have some knowledge, then he must bring it to the table  Francis v United Jersey Bank – husband died; wife did nothing, even when she had notice, when her sons stole money from the company; court held that there was proximate cause here because she could have stopped this from happening  Graham v Allis Chalmers – several employees of the corporation pleaded guilty to antitrust violations (price fixing) and thereby caused damage to the corporation; P sued directors claiming that they violated their duty of care by failing to monitor the employees sufficiently to uncover the problem; court held that the directors wee not required to set up monitoring system until they had some reason to suspect that their employees were not being honest Procedural aspects of the duty of care  In re Caremark – company fined $250,000,000 and P alleged directors didn’t have sufficient oversight regarding their employees actions; court held that directors did NOT breach their duty of care because they had no notice of employee violations – their monitoring system was adequate under the circumstances; court approved a settlement that increased monitoring would be used in the future; court used a different reasonable standard than the one used in Allis Chalmers because the standard had changed  Q 290-1, 2 Substantive aspects of the duty of care – if there is a waiver provision, sue for recklessness or intentional conduct  McCall v Scott – P alleged that directors were engaged in fraud because the company was growing too quickly; court analyzed the conduct as intentional because the P alleged conduct that approached recklessness; court held that only 5 directors were liable for their actions because the company had adopted a waiver provision similar to MBCA 2.02(b)(4) that limited director liability  Q 296-1, 2, 3, 4 Using the Articles of Incorporation to limit directors’ liability for duty of care violations – MBCA 2.02(b)(4) – (b) The articles of incorporation may set forth 46



a provision eliminating or limiting the liability of a director to the corporation or its shareholders for money damages for any action taken, or any failure to take any action, as a director, except liability for (A) the amount of a financial benefit received by a director to which he is not entitled; (B) an intentional infliction of harm on the corporation or the shareholders; (C) a violation of section 8.33; or (D) an intentional violation of criminal law o When may directors rely on others – 8.30 (c), (d), and (e)  In discharging board or committee duties a director, who does not have knowledge that makes reliance unwarranted, is entitled to rely on the performance by any of the persons specified in subsection (e)(1) or subsection (e)(3) to whom the board may have delegated, formally or informally by course of conduct, the authority or duty to perform one or more of the board's functions that are delegable under applicable law.  In discharging board or committee duties a director, who does not have knowledge that makes reliance unwarranted, is entitled to rely on information, opinions, reports or statements, including financial statements and other financial data, prepared or presented by any of the persons specified in subsection (e).  A director is entitled to rely, in accordance with subsection (c) or (d), on: • one or more officers or employees of the corporation whom the director reasonably believes to be reliable and competent in the functions performed or the information, opinions, reports or statements provided; • legal counsel, public accountants, or other persons retained by the corporation as to matters involving skills or expertise the director reasonably believes are matters (i) within the particular person's professional or expert competence or (ii) as to which the particular person merits confidence; o • a committee of the board of directors of which the director is not a member if the director reasonably believes the committee merits confidence. Directors’ Duty of Loyalty – P must show conflict of interest, then D must show action was fair o MBCA 8.30 (a) (2) sets out the duty of loyalty o Duty of loyalty issues generally arise in 3 situations:  Director competes with the corporation  Director takes a corporate opportunity  Director has a personal or pecuniary interest in the decision (selfdealing or conflict of interest) o Duty of care v. duty of loyalty – the lines becomes blurry so always plead in the alternative; finding that a conflict of interest does not exist may turn the issue into a duty of care analysis  Duty of loyalty deals with a decision in which the director has a conflict of interest, whereas duty of care can be breached without a conflict of interest  If conflict of interest exists, then BJR DOES NOT apply; conflict of interest transaction is presumed to be a breach, unless the directors 47

can meet certain procedural and substantive requirements • Conflict of interest might arise with FAMILY – spouse, children residing in the home, or people over whom the director has dominion and control • Look for lack of objectivity and SELF-DEALING • There is a SUBJECTIVE AND OBJECTIVE component to the analysis  Remedy for duty of care – director or officer is liable for all damages that the decision proximately caused the corporation, even if the directors have made no gain from the wrongful action (subject to 2.02(b)(4))  Remedy for duty of loyalty – rescission of the transaction; if rescission not feasible, director or officer is liable for whatever benefit the corporation did not, but should have received o Competing with the corporation  Directors – they CAN compete with the corporation as long as they act in good faith AND they don’t use corporate resources OR cripple or injure the business at issue (only 1 director will suffice) – can compete in good faith • You can prevent directors from competing in articles of incorporation or non-compete clause • Regenstein v J Regenstein – JR owned Whitehall store; 3 of JR’s directors owned the Mirror; P alleged that the Mirror was directly competing with Whitehall and taking business away from Whitehall; court held that since there were no facts that alleged bad faith, then the directors were allowed to compete with the corporation’s store • Q 299-2, 3, 300-6 • Officers – RSA 393 – unless otherwise agreed, an agent is subject to a duty not to compete with the principal concerning the subject matter of his agency o Usurping corporate opportunities  Corporate Opportunities Test (ALI Principles of Corporate Governance) – applies to directors AND senior executives • Corporate Opportunity o Any opportunity to engage in a business activity of which a director or senior executive becomes aware, in connection with performance of functions as a director or senior executive, or under circumstances that should reasonably lead them to believe that the person offering the opportunity expects it to be offered to the corporation, or o Any opportunity to engage in a business activity of which a director or senior executive becomes aware, through use of corporate information or property, if resulting opportunity is one that they should reasonably be expected to believe would be of interest to the corporation o Any opportunity to engage in a business activity of which a senior executive becomes aware and knows is closely related to a business in which the corporation is engaged 48



or expects to engage • GR – a director or senior executive may not take advantage of a corporate opportunity unless: o The director or senior executive offers the corporate opportunity to the corporation and makes disclosure concerning the conflict of interest and the opportunity o The corporate opportunity is rejected by the corporation o Either:  The rejection of the opportunity is fair to the corp. (SUBSTANTIVE)  The opportunity is rejected in advance, following disclosure, by disinterested directors, or in case of a senior executive who is not a director, by a disinterested superior, in a manner that satisfies the standards of the BJR (PROCEDURAL), or  The rejection is authorized in advance or ratified, following disclosure, by disinterested shareholders, and the rejection is not equivalent to a waste of corporate assets (PROCEDURAL) • Burden of Proof – a party who challenges the taking of a corporate opportunity has the burden of proof, except that if such party establishes that the requirements of (a)(3)(B) or (C) are not met, the director or senior executive has the burden of proving that the rejection and the taking of the opportunity were fair to the corp. • Ratification • Special rule concerning delayed offering – reasonable time after suit is filed • Northeast Harbor v Harris – H bought 2 different properties near the golf course of which she was president without first informing the board; board got mad when H decided to develop the properties; court applied the ALI test and held that the G property was a corporate opportunity because H learned about because of her presidency; H couldn’t show it was procedurally fair because she didn’t initially disclose • Q 309-1, 2, 3 Line of Business Test (Common Law) – 8 Factor Test: corporate fiduciary always has the burden of proof (don’t make fairness distinctions) • When director cannot take an opportunity o The corporation is financially able to exploit the opportunity o The opportunity is within the corporation’s line of business o Corporation has an interest or expectancy in the opportunity o By taking the opportunity for his own, fiduciary will thereby be placed in a position inimicable to his duties to the corporation 49



When director can take an opportunity o Opportunity is presented to the officer or director in his individual and not his corporate capacity o Opportunity is not essential to the corporation o Corporation holds no interest or expectation in the opportunity o Director or officer has not wrongfully employed the resources of the corporation in pursuing or exploiting the opportunity • Broz v CIS – B is directors of CIS and owner of RFBC; B approached by M to buy cellular service; M didn’t want to talk to CIS because CIS was selling off all of their services; B took the opportunity and CIS got mad; court applied the Line of Business Test and held that B didn’t usurp a corporate opportunity under the existing factors – B didn’t need to inform CIS of the deal because CIS couldn’t even purchase themselves; if B had approached CIS and they rejected, then he would have been free from suit • Q 316-1, 2, 3 o Interested director transactions – self-dealing: being on both sides of the transaction – if P shows that procedure was bad, then burden shifts to corporate fiduciary  Judicial Action (MBCA 8.61) – a directors conflicting interest transaction may not be enjoined, set aside, or give rise to an award of damages or other sanctions, in a proceeding by a shareholder or by or in the right of the corporation, because the director or any person with whom or which he has a personal, economic, or other association, has an interest in the transaction, if: • Directors action respecting the transaction was at any time taken in compliance with 8.62 (P has burden) • Shareholders action respecting the transaction was at any time taken in compliance with 8.63, or (P has burden) • The transaction, judged according to the circumstances at the time of commitment, is established to have been fair to the corporation (fiduciary has burden)  MBCA 8.62 – Director Action • Directors' action respecting a transaction is effective for purposes of section 8.61(b)(1) if the transaction received the affirmative vote of a majority (but no fewer than two) of those qualified directors on the board of directors or on a duly empowered committee of the board who voted on the transaction after either required disclosure to them (to the extent the information was not known by them) or compliance with subsection (b); provided that action by a committee is so effective only if: o all its members are qualified directors; and o its members are either all the qualified directors on the board or are appointed by the affirmative vote of a majority of the qualified directors on the board. 50





If a director has a conflicting interest respecting a transaction, but neither he nor a related person of the director specified in section 8.60(3)(i) is a party to the transaction, and if the director has a duty under law or professional canon, or a duty of confidentiality to another person, respecting information relating to the transaction such that the director may not make the disclosure described in section 8.60(4)(ii), then disclosure is sufficient for purposes of subsection (a) if the director (1) discloses to the directors voting on the transaction the existence and nature of his conflicting interest and informs them of the character and limitations imposed by that duty before their vote on the transaction, and (2) plays no part, directly or indirectly, in their deliberations or vote. • A majority (but no fewer than two) of all the qualified directors on the board of directors, or on the committee, constitutes a quorum for purposes of action that complies with this section. Directors' action that otherwise complies with this section is not affected by the presence or vote of a director who is not a qualified director. • For purposes of this section, qualified director means, with respect to a director's conflicting interest transaction, any director who does not have either (1) a conflicting interest respecting the transaction, or (2) a familial, financial, professional, or employment relationship with a second director who does have a conflicting interest respecting the transaction, which relationship would, in the circumstances, reasonably be expected to exert an influence on the first director's judgment when voting on the transaction. MBCA 8.63 – standard: if shareholder action results in waste, then director action is most likely wrong; sets out a higher vote requirement – majority of QUALIFIED shares OUTSTANDING • Shareholders' action respecting a transaction is effective for purposes of section 8.61(b)(2) if a majority of the votes entitled to be cast by the holders of all qualified shares were cast in favor of the transaction after (1) notice to shareholders describing the director's conflicting interest transaction, (2) provision of the information referred to in subsection (d), and (3) required disclosure to the shareholders who voted on the transaction (to the extent the information was not known by them). • For purposes of this section, qualified shares means any shares entitled to vote with respect to the director's conflicting interest transaction except shares that, to the knowledge, before the vote, of the secretary (or other officer or agent of the corporation authorized to tabulate votes), are beneficially owned (or the voting of which is controlled) by a director who has a conflicting interest respecting the transaction or a related person of the director, or both. • A majority of the votes entitled to be cast by the holders of all qualified shares constitutes a quorum for purposes of action that 51







complies with this section. Subject to the provisions of subsections (d) and (e), shareholders' action that otherwise complies with this section is not affected by the presence of holders, or the voting, of shares that are not qualified shares. • For purposes of compliance with subsection (a), a director who has a conflicting interest respecting the transaction shall, before the shareholders' vote, inform the secretary (or other officer or agent of the corporation authorized to tabulate votes) of the number, and the identity of persons holding or controlling the vote, of all shares that the director knows are beneficially owned (or the voting of which is controlled) by the director or by a related person of the director, or both. • If a shareholders' vote does not comply with subsection (a) solely because of a failure of a director to comply with subsection (d), and if the director establishes that his failure did not determine and was not intended by him to influence the outcome of the vote, the court may, with or without further proceedings respecting section 8.61(b)(3), take such action respecting the transaction and the director, and give such effect, if any, to the shareholders' vote, as it considers appropriate in the circumstances. Self-dealing transactions – the modern approach is that these transactions are not automatically void or voidable; rather, the burden is on the director/officer to show: • Substantive fairness – the transaction was fair and reasonable, whether or not disclosed, to the corporation; or o Fair price – any price which an unrelated party might be willing to pay or willing to accept following a normal arms length transaction o Benefit to the corporation – transaction must be reasonably likely to yield favorable results from the perspective of furthering corporate business o Fair process – the director having a conflict of interest must deal with the corporation honestly and in good faith • Procedural fairness – disinterested directors or qualified shareholders approved the transaction after the interested directors full disclosure (MBCA 8.61 (b)) – this is what P must argue if the transaction is approved by someone HMG Courtland v Gray; Q 323-1, 2 – G and F were directors of HMG; G negotiated real estate deal with NAF; F owned part of NAF and G indirectly owned part of NAF; F disclosed his status, but neither G nor F disclosed G’s status; court held that both G and F were liable because a material fact was left out of the disclosure; there was no fair dealing here because F and G were interested and didn’t fully disclose Cookies Food Products v Lakes and Q 333-1, 2, 334-1 – Cook created BBQ sauce and put plant in place with investors, including H, to improve the job market (no oppression because expectations were met); investors claimed H was self-dealing because he was getting all sorts of benefits, took over distribution; profits increased and H bought 52

majority share of stock; court applied MBCA 8.61 test and added an additional element of good faith, honesty, and fairness; court approached the procedural analysis and held that H didn’t have to disclose because there were enough disinterested directors to approve the transaction  Lewis v Vogelstein – motion to dismiss was denied; on remand, the entire discussion will revolve around whether the one-time options were a waste of corporate assets; option plan approved by shareholders because all directors were interested; P claimed proxy statement was misleading because it didn’t contain PV of stock options (procedural attack); court held that there was adequate disclosure so P had burden to show WASTE of corporate assets (unanimous shareholder approval required in waste standard)  MBCA 8.11 – Compensation of Directors – Unless the articles of incorporation or bylaws provide otherwise, the board of directors may fix the compensation of directors o Transactions with controlling shareholders  Sinclair Oil v Levien – SO owned 97% of S; P (common stockholders) owned 3% of S; P claimed they were being paid too much in dividends and the money should be reinvested in the corporation; court applied the BJR because shareholders were receiving the same dividend benefit that S was; court held that P could not meet their burden of proof because the dividend policy was a valid business judgment and MBCA 8.33 was not violated  Q 472-2 J. Derivative Actions – actions brought on corporation’s behalf against corporate fiduciaries or 3rd parties • Contrast with direct actions – brought on the shareholder’s own behalf against either corporate fiduciaries or the corporation itself o The distinction matters because various procedural hurdles need to be met in derivative actions in order for P to bring the suit o Eisenberg v FTL – FT own FTC, which created FTL, which merged with FT; shareholders of FT then own shares of FTC and they were mad because their votes were diluted; court held that this was not a derivative suit because the injury was to the shareholders themselves and not the corporation; the suit was direct o Q 342-1, 2 • Standing – MBCA 7.41(Contemporaneous Owner Rule) – A shareholder may not commence or maintain a derivative proceeding unless the shareholder: o was a shareholder of the corporation at the time of the act or omission complained of or became a shareholder through transfer by operation of law from one who was a shareholder at that time; and o fairly and adequately represents the interests of the corporation in enforcing the right of the corporation. o Q 347-1, 348-2, 3, 4, 5 • Joiner of other parties o Corporation is named as a “nominal” defendant since its interests are at stake 53





o Breaching directors are named as “actual” defendants Demand on directors o Universal Demand: MBCA 7.42 – No shareholder may commence a derivative proceeding until:  a written demand has been made upon corporation to take suitable action; and  90 days have expired from the date the demand was made unless the shareholder has earlier been notified that the demand has been rejected by the corporation or unless irreparable injury to the corporation would result by waiting for the expiration of the 90 day period. o Equitable Demand: Delaware Rule – demand does not need to be made if it would be futile: P must allege particularized facts which create a reasonable doubt that:  The directors are disinterested and independent, or  The challenged transaction was otherwise the product of a valid exercise of business judgment  Marx v Akers – P alleged that directors and senior executives were being paid too much; court applied the DL rule that demand does not need to be made if it would be futile; court held that P made conclusory allegations instead of alleging particularized facts about whether directors were disinterested; suit dismissed  Q 364-1, 2 Special Litigation committees and dismissal of derivative suits o Special litigation committees – group of disinterested people that board appoints in response to a demand to pursue a derivative suit; committee has full power to make litigation decisions  Committee usually comprised of directors who did not participate in the decision and cannot be named as defendants o When a shareholder wants to file a derivative suit, three things can happen  Board can reject the demand and shareholder is kicked out of the suit  Board can reject based on a business judgment so shareholder needs to show particular facts in the complaint, or  Board can ignore the demand, in which case BJR does not apply for inaction o Dismissal of an action (MBCA 7.44)  A derivative proceeding shall be dismissed by the court on motion by the corporation if one of the groups specified in subsections (b) or (f) has determined in good faith after conducting a reasonable inquiry upon which its conclusions are based that the maintenance of the derivative proceeding is not in the best interests of the corporation.  Unless a panel is appointed pursuant to subsection (f), the determination in subsection (a) shall be made by: • a majority vote of independent directors present at a meeting of the board of directors if the independent directors constitute a quorum; or • a majority vote of a committee consisting of two or more independent directors appointed by majority vote of independent 54

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directors present at a meeting of the board of directors, whether or not such independent directors constituted a quorum.  None of the following shall by itself cause a director to be considered not independent for purposes of this section: • the nomination or election of the director by persons who are defendants in the derivative proceeding or against whom action is demanded; • the naming of the director as a defendant in the derivative proceeding or as a person against whom action is demanded; or • the approval by the director of the act being challenged in the derivative proceeding or demand if the act resulted in no personal benefit to the director.  If a derivative proceeding is commenced after a determination has been made rejecting a demand by a shareholder, the complaint shall allege with particularity facts establishing either (1) that a majority of the board of directors did not consist of independent directors at the time the determination was made or (2) that the requirements of subsection (a) have not been met.  If a majority of the board of directors does not consist of independent directors at the time the determination is made, the corporation shall have the burden of proving that the requirements of subsection (a) have been met. If a majority of the board of directors consists of independent directors at the time the determination is made, the plaintiff shall have the burden of proving that the requirements of subsection (a) have not been met.  The court may appoint a panel of one or more independent persons upon motion by the corporation to make a determination whether the maintenance of the derivative proceeding is in the best interests of the corporation. In such case, the plaintiff shall have the burden of proving that the requirements of subsection (a) have not been met. o Two part test for analyzing Special Committee Decisions  Procedural component – corporation has the burden to prove independence, good faith, and a reasonable investigation  Substantive component – court applied its own business judgment to determine if the committee’s decision was an appropriate one o Auerbach v Bennett – board appointed special litigation committee after suit was brought against 4 directors; committee recommended dismissal and issue was whether BJR prevented this decision from being made; court held that it could only consider the PROCEDURAL aspects of the committee’s decision and since these were okay, the court didn’t get to the substantive aspect o Zapata v Maldonado – court applied the two part test above when the board appointed new directors to a special committee; court held that there are inherent conflicts of interest in these situations, so they remanded so lower court could follow the new rule o Q 371-1, 2, 3, 383-1 Security for expenses – this is no longer required by the MBCA Demand on shareholders – this is rare, but some states require that demand be made on shareholders before filing a derivative suit 55

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Right to jury trial – There is normally no right to a jury trial because the 7th Amendment does not apply to state courts, but P may be able to argue that that underlying action is law and may then have a jury Court approval of disposition – MBCA 7.45 – A derivative proceeding may not be discontinued or settled without the court's approval. If the court determines that a proposed discontinuance or settlement will substantially affect the interests of the corporation's shareholders or a class of shareholders, the court shall direct that notice be given to the shareholders affected. Recovery – any recovery in a derivative action goes directly to the corporation because the suit was brought on behalf of the corporation

K. Mergers and Acquisitions • Voluntary dissolution of a corporation (CONTRAST with Involuntary Dissolution) o MBCA 14.02(e) – Unless the articles of incorporation or the board of directors acting pursuant to subsection (c) require a greater vote, a greater number of shares to be present, or a vote by voting groups, adoption of the proposal to dissolve shall require the approval of the shareholders at a meeting at which a quorum consisting of at least a majority of the votes entitled to be cast exists. o Process – approval by board; approval by shareholders; winding up and payment to creditors; notice to known and unknown claimants; payment to shareholders of remnants • Types of Mergers o Stock Acquisition – buying stock; Board doesn’t need to be involved  Cash for Stock  Stock for Stock (share exchange)  Liability – no direct liability for obligations of the target; purchaser is a stock holder and indirectly inherits the liabilities and obligations of the target o Asset Acquisition – buying assets; Board involved because corporation is involved  Cash for assets  Stock for assets  Liability – generally the purchaser does NOT assume the target’s liabilities and obligations unless otherwise agreed or imposed by law – operation of law may impose some obligations o Statutory Merger  Stock for stock merger (straight merger)  Stock and cash for stock  Cash out merger (Van Gorkom)  Short form merger (parent/subsidiary)  Small scale merger (MBCA 11.04(g))  Liability – surviving corporation assumes the liabilities of the target by operation of law • Structure of a merger (MBCA 11.02) o One or more domestic business corporations may merge with one or more domestic or foreign business corporations or eligible entities pursuant to a 56



plan of merger, or two or more foreign business corporations or domestic or foreign eligible entities may merge into a new domestic business corporation to be created in the merger in the manner provided in this chapter. o The plan of merger must include:  the name of each domestic or foreign business corporation or eligible entity that will merge and the name of the domestic or foreign business corporation or eligible entity that will be the survivor of the merger;  the terms and conditions of the merger;  the manner and basis of converting the shares of each merging domestic or foreign business corporation and eligible interests of each merging domestic or foreign eligible entity into shares or other securities, eligible interests, obligations, rights to acquire shares, other securities or eligible interests, cash, other property, or any combination of the foregoing;  the articles of incorporation of any domestic or foreign business or nonprofit corporation, or the organic documents of any domestic or foreign unincorporated entity, to be created by the merger, or if a new domestic or foreign business or nonprofit corporation or unincorporated entity is not to be created by the merger, any amendments to the survivor's articles of incorporation or organic documents; and  any other provisions required by the laws under which any party to the merger is organized or by which it is governed, or by the articles of incorporation or organic document of any such party. o Terms of a plan of merger may be made dependent on facts objectively ascertainable outside the plan in accordance with section 1.20(k). o The plan of merger may also include a provision that the plan may be amended prior to filing articles of merger, but if the shareholders of a domestic corporation that is a party to the merger are required or permitted to vote on the plan, the plan must provide that subsequent to approval of the plan by such shareholders the plan may not be amended to change:  the amount or kind of shares or other securities, eligible interests, obligations, rights to acquire shares, other securities or eligible interests, cash, or other property to be received under the plan by the shareholders of or owners of eligible interests in any party to the merger;  the articles of incorporation of any corporation, or the organic documents of any unincorporated entity, that will survive or be created as a result of the merger, except for changes permitted by section 10.05 or by comparable provisions of the organic laws of any such foreign corporation or domestic or foreign unincorporated entity; or  any of the other terms or conditions of the plan if the change would adversely affect such shareholders in any material respect. Small Scale Mergers (MBCA 11.04 – action on plan of merger) o (e) Unless the articles of incorporation, or the board of directors acting pursuant to subsection (c), requires a greater vote or a greater number of votes to be present, approval of the plan of merger or share exchange requires the approval of the shareholders at a meeting at which a quorum 57





consisting of at least a majority of the votes entitled to be cast on the plan exists, and, if any class or series of shares is entitled to vote as a separate group on the plan of merger or share exchange, the approval of each such separate voting group at a meeting at which a quorum of the voting group consisting of at least a majority of the votes entitled to be cast on the merger or share exchange by that voting group is present. o (g) Unless the articles of incorporation otherwise provide, approval by the corporation's shareholders of a plan of merger or share exchange is not required if:  the corporation will survive the merger or is the acquiring corporation in a share exchange;  except for amendments permitted by section 10.05, its articles of incorporation will not be changed;  each shareholder of the corporation whose shares were outstanding immediately before the effective date of the merger or share exchange will hold the same number of shares, with identical preferences, limitations, and relative rights, immediately after the effective date of change; and  the issuance in the merger or share exchange of shares or other securities convertible into or rights exercisable for shares does not require a vote under section 6.21(f). Short Form Merger (MBCA 11.05 – merger between parent and subsidiary) o A domestic parent corporation that owns shares of a domestic or foreign subsidiary corporation that carry at least 90 percent of the voting power of each class and series of the outstanding shares of the subsidiary that have voting power may merge the subsidiary into itself or into another such subsidiary, or merge itself into the subsidiary, without the approval of the board of directors or shareholders of the subsidiary, unless the articles of incorporation of any of the corporations otherwise provide, and unless, in the case of a foreign subsidiary, approval by the subsidiary's board of directors or shareholders is required by the laws under which the subsidiary is organized. o If under subsection (a) approval of a merger by the subsidiary's shareholders is not required, the parent corporation shall, within ten days after the effective date of the merger, notify each of the subsidiary's shareholders that the merger has become effective. Effects of a merger on constituent corporations and shareholders of the target corporation o Problem 625-1 o MBCA 11.07 – When a merger becomes effective:  the corporation or eligible entity that is designated in the plan of merger as the survivor continues or comes into existence, as the case may be;  the separate existence of every corporation or eligible entity that is merged into the survivor ceases;  all property owned by, and every contract right possessed by, each corporation or eligible entity that merges into the survivor is vested in the survivor without reversion or impairment;  all liabilities of each corporation or eligible entity that is merged into 58

the survivor are vested in the survivor;  the name of the survivor may, but need not be, substituted in any pending proceeding for the name of any party to the merger whose separate existence ceased in the merger;  the articles of incorporation or organic documents of the survivor are amended to the extent provided in the plan of merger;  the articles of incorporation or organic documents of a survivor that is created by the merger become effective; and  the shares of each corporation that is a party to the merger, and the interests in an eligible entity that is a party to a merger, that are to be converted under the plan of merger into shares, eligible interests, obligations, rights to acquire securities, other securities, or eligible interests, cash, other property, or any combination of the foregoing, are converted, and the former holders of such shares or eligible interests are entitled only to the rights provided to them in the plan of merger or to any rights they may have under chapter 13 or the organic law of the eligible entity. o When a share exchange becomes effective, the shares of each domestic corporation that are to be exchanged for shares or other securities, interests, obligations, rights to acquire shares or other securities, cash, other property, or any combination of the foregoing, are entitled only to the rights provided to them in the plan of share exchange or to any rights they may have under chapter 13. o A person who becomes subject to owner liability for some or all of the debts, obligations or liabilities of any entity as a result of a merger or share exchange shall have owner liability only to the extent provided in the organic law of the entity and only for those debts, obligations and liabilities that arise after the effective time of the articles of merger or share exchange. o The effect of a merger or share exchange on the owner liability of a person who had owner liability for some or all of the debts, obligations or liabilities of a party to the merger or share exchange shall be as follows:  The merger or share exchange does not discharge any owner liability under the organic law of the entity in which the person was a shareholder or interest holder to the extent any such owner liability arose before the effective time of the articles of merger or share exchange.  The person shall not have owner liability under the organic law of the entity in which the person was a shareholder or interest holder prior to the merger or share exchange for any debt, obligation or liability that arises after the effective time of the articles of merger or share exchange.  The provisions of the organic law of any entity for which the person had owner liability before the merger or share exchange shall continue to apply to the collection or discharge of any owner liability preserved by paragraph (1), as if the merger or share exchange had not occurred.  The person shall have whatever rights of contribution from other persons are provided by the organic law of the entity for which the person had owner liability with respect to any owner liability preserved by paragraph (1), as if the merger or share exchange had not occurred. 59



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Stages of the acquisition process o Negotiate letter of intent o Negotiate purchase agreement or plan of merger o Board approval – course supplement item 10 and problem 626  Target corporation  Surviving corporation o Shareholder approval  Target corporation  Surviving corporation o Due diligence period o Closing – documents of transfer or the articles of merger Shareholder protections – (1) shareholder vote, (2) appraisal rights, (3) sue directors who approved the merger for breach of duty of care, or (4) sue directors who approved the merger for breach of duty of loyalty Appraisal rights (dissenters’ rights): MBCA 13.02 (DON’T APPLY TO SHORT FORM MERGERS) o A shareholder is entitled to appraisal rights, and to obtain payment of the fair value of that shareholder's shares, in the event of any of the following corporate actions:  consummation of a merger to which the corporation is a party (i) if shareholder approval is required for the merger by section 11.04 and the shareholder is entitled to vote on the merger, except that appraisal rights shall not be available to any shareholder of the corporation with respect to shares of any class or series that remain outstanding after consummation of the merger, or (ii) if the corporation is a subsidiary and the merger is governed by section 11.05;  consummation of a share exchange to which the corporation is a party as the corporation whose shares will be acquired if the shareholder is entitled to vote on the exchange, except that appraisal rights shall not be available to any shareholder of the corporation with respect to any class or series of shares of the corporation that is not exchanged;  consummation of a disposition of assets pursuant to section 12.02 if the shareholder is entitled to vote on the disposition;  an amendment of the articles of incorporation with respect to reduction of shares o Appraisal rights shall not be available for the holders of shares of any class or series of shares which is:  listed on the New York Stock Exchange or the American Stock Exchange or designated as a national market system security on an interdealer quotation system by the National Association of Securities Dealers, Inc.; or  not so listed or designated, but has at least 2,000 shareholders and the outstanding shares of such class or series has a market value of at least $ 20 million (exclusive of the value of such shares held by its subsidiaries, senior executives, directors and beneficial shareholders owning more than 10 percent of such shares). o Articles of incorporation may limit or eliminate appraisal rights o A shareholder entitled to appraisal rights may not challenge a completed 60





corporate action for which appraisal rights are available unless such corporate action:  was not effectuated in accordance with the applicable provisions of chapters 10, 11 or 12 or the corporation's articles of incorporation, bylaws or board of directors' resolution authorizing the corporate action; or  was procured as a result of fraud or material misrepresentation. o MBCA 13.01(4) – fair value means the value of the corporation's shares determined:  immediately before the effectuation of the corporate action to which shareholder objects;  using customary and current valuation concepts and techniques generally employed for similar businesses in the context of the transaction requiring appraisal; and  without discounting for lack of marketability or minority status except, if appropriate, for amendments to the articles pursuant to section 13.02(a)(5). o HMO-W v SSM, problems 638-1, 4 – SSM proposed merger; HMO got VR to give valuation report of $18 million, then HMO said that the value was only $7 million during the court proceedings; SSM argued that this valuation was error; court held that HMO was worth $10 million because it was its job to determine fair value and that all factors must be considered; court also held that no minority discount should be applied because minority shareholders should be protected in these situations Actions for breach of the duty of loyalty in mergers o Generally – the duty of loyalty analysis remains the same, except we are in merger land o Weinberger v UOP – S wanted to merge with UOP and become controlling shareholder; S had 6 of 13 directors on UOP board; 2 UOP/S directors prepared a feasibility study with UOP information and tuned it over to S, which valued UOP at $21-24 per share; UOP pissed because S used their info to conduct the study and breached their duty of loyalty; court held that directors had the burden of establishing substantive fairness (fair dealing and fair price); court held that directors did breach their duty of loyalty and awarded shareholders $24 per share because that is what company was really worth o Q 650-2, 3, 4, 6 Sales of all, or substantially all, assets o MBCA 12.01(1) – disposition of assets not requiring shareholder approval – No approval of the shareholders of a corporation is required, unless the articles of incorporation otherwise provide: (1) to sell, lease, exchange, or otherwise dispose of any or all of the corporation's assets in the usual and regular course of business o MBCA 12.02(a) – shareholder approval of certain dispositions – A sale, lease, exchange, or other disposition of assets, other than a disposition described in section 12.01, requires approval of the corporation's shareholders if the disposition would leave the corporation without a significant continuing business activity. If a corporation retains a business activity that represented at least 25 percent of total assets at the end of the most recently completed 61

fiscal year, AND 25 percent of either income from continuing operations before taxes OR revenues from continuing operations for that fiscal year, in each case of the corporation and its subsidiaries on a consolidated basis, the corporation will conclusively be deemed to have retained a significant continuing business activity. o Effects of the transaction, particularly successor liability  Four situations when liability is typically imposed • Purchaser expressly or impliedly agrees to assumption of liabilities • Transaction amounts to a consolidation or merger of the two companies • The purchasing corporation is merely a continuation of the selling corporation, or • The transaction is entered into fraudulently to escape liability for debts  Determining when liability is imposed on successor corporation under mere continuation principle • No adequate cash consideration was given for the predecessor corporations assets and made available for meeting the claims of its unsecured creditors; OR • One or more persons were officers, directors, or stockholders of both corporations before and after the buyout  Franklin v USX – P alleged that asbestos exposure came from predecessor of USX; WPS was the original company, whose assets were bought by ConCal, whose assets were bought by ConDel, who merged with USX; issue was whether USX had successor liability because of these transactions; court held that USX assumed the liabilities of ConDel and that ConCal acquired the liabilities of WPS via a K agreement; BUT liability was NOT assumed by ConDel when it purchased ConCal, so USX is off the hook  Q 666-1, 2, 3 o De Facto Merger Doctrine – if the asset acquisition has the effect of a merger, shareholders receive merger-type voting and appraisal rights  As the Franklin case demonstrates, a creditor of the selling corporation may try to use the de facto merger doctrine to impose liability on the buying corporation o Board and shareholder approval – boards most likely need to approve of the sale under 8.01  Katz v Bergman – issue was whether shareholder approval of sale of assets was needed; court held that shareholder approval was needed because there was no significant business activity left after the sale of the assets; court said it was a sale made in the regular course of business instead of a sale that was an unusual transaction  Course Supp. Item 10 – Safe harbor provision in 12.02(a) – 25% of Assets AND (1) 25% Revenue OR (2) 25% Profit L. TENDER OFFERS • Definition – A bidder makes a “tender offer” for the stock of a corporation by 62







inviting shareholders through general solicitation or advertisement to tender their shares for purchase at a stated price (one way to takeover) o The stated price is generally at a substantial price premium over the stock market price of the target corporation o Typically, a bidder conditions the tender offer upon receiving a specified percentage of the target’s shares, sufficient to convey control to the bidder o Consideration is normally cash, but may often be cash, stock, preferred stock, debt, or any combination of those Hostile vs. Friendly Takeovers o Hostile – one that incumbent management and the board of directors oppose; board may adopt various defensive measures to try to thwart a hostile takeover o Friendly – one that management and the board support o Line between hostile and friendly may be blurred when a hostile bid induces the target to seek out a more appealing acquirer (WHITE KNIGHT) Defensive measures generally o State law may be favorable o Article based defenses – staggered boards, poison pills (preferred stock purchase plan), supermajority requirements o White Knight defenses  stock lock-up agreements – A board may sell its stock, or an option to purchase its stock, to a third party (i.e., white knight) who will support the incumbent management  crown jewels lock-up agreements – The corporation can sell its prized assets or subsidiaries (the “crown jewels”) to a third party (white knight) or it can grant a third party an option to purchase the crown jewels, which option may sometimes be made exercisable only if a hostile bidder acquires a specified percentage of the target’s shares  no-shop clauses – A board that enters into an agreement for a merger or other corporate combination (whether with a white knight or otherwise) may agree that it will not recommend the combination to the shareholders, that it will not shop around for a more attractive deal, or both  break-up fees o Leveraged Buyout defense o Golden Parachute agreements o Pac Man defense – who can come up with sufficient financing to buy out the other o Employee stock plan defense o Regulatory/litigation/antitrust defenses Unocal Test – When board considers a pending takeover bid it has an obligation to determine whether the offer is in the best interests of the corporation and its shareholders (enhanced duty before BJR will apply) – in the face of inherent conflicts, directors must show that they had reasonable grounds for believing that a danger to corporate policy and effectiveness existed because of another person’s stock ownership AND that the board’s response was reasonable under the circumstances o Good faith and reasonable investigation will meet this burden in most 63





circumstances o Unocal v Mesa Petroleum – M offered to purchase U so they could control the corporation; M owned 13% and they wanted another 37% for $54 per share; M’s offer included junk bonds as a back-end part of the deal; in response, U said it would buy the remaining shares for $72 in senior debt and M sued; court held that there was a threshold analysis before BJR is applied; court held that M’s offer was a reasonable threat because the price was inadequate it was coercive; U’s decision was reasonable under the circumstances; BJR comes into play after threshold conducted o Q 681-1, 2 Duties of the board when the corporation is up for sale o Revlon Duties – maximize shareholder value in a given sale – keep the sale open to all bidders  Revlon applies when the corporation moves away from protecting its business and becomes an auctioneer on the open market to other potential acquirers  Revlon v MacAndrews – PP made tender offer at 47.50; R went to F, who made a higher offer; PP and F went back and forth and finally, R and F signed an agreement that would bind them; PP sued and R argued they had BJR protections pursuant to Unocal; court held that BJR did not apply because R took action that signified it was for sale; R was no longer defending its corporation when PP increased their bid; R was essentially an auctioneer; court held that R did not maximize shareholder value because the auction was shut down when it made a deal with F  Q 691-2 o Paramount v Time, problems 707-1,2, 3 – Time wanted to expand business so they decided to merge with Warner; P then offered $175 per share for Time; Time then structured the deal as a stock for cash buyout of Warner so shareholders would not need to approve the agreement and so P would not have any influence over shareholders; court held that Time’s action were reasonable under a Unocal standard because they were responding to a reasonable threat to their corporate environment and long-term deal with Warner o Paramount v QVC, problem 728-2 – QVC wanted to takeover P; P pissed so they found Viacom to buy them out; court held that P was in Revlon land because they were essentially selling control of their corporation since the public owned P and Redstone owned Viacom; Redstone would become the majority owner after the deal; court held that actions were not reasonable under Revlon because they shut down the auction and didn’t maximize shareholder value Federal regulation of takeovers o Williams Act – passed in 1968 and it amends the Securities Exchange Act of 1934 to regulate tender offers  Added 13(d), (e), and 14(d), (e), and (f) to the Exchange Act  Mandates disclosure of stock accumulations of more than 5% of the target’s equity securities (Toehold Acquisitions)  Mandates disclosure and regulates the terms of tender offers o Schedule 13-D disclosures 64

The acquirer’s (and any group member’s) identity and background The source and the amount of funds for making the purchase The number of the target’s shares that the acquirer holds Any arrangements that the acquirer has with others concerning target’s shares  The acquirer’s purposes for the acquisition and its intentions with respect to the target o Substantive Terms of Tender Offers  Minimum open period – the tender offer must be left open a minimum of 20 business days (14e-1)  All-holders rule – tender offer must be open to all shareholders of the same class and not exclude any shareholders from tendering (14d10(a)(1)); an exclusionary self-tender is unlawful  Best price – each shareholder must be paid the best price paid to any other shareholder (14d-10(a)(2))  Withdrawal rights – shareholders can withdraw their shares (revoke their tenders) at any time while the tender offer is open (14d-7)  Pro rata purchases – when the bidder seeks only a portion of all the shares (partial tender offer) and the shareholders tender more than the bidder seeks, bidder must purchase the tendered shares on a pro rata basis (14d-8)    

M. INISDER TRADING • Federal Securities Laws o The Securities Act of 1933 – governs offers and sales of securities o The Securities Exchange Act of 1934 – Williams Act; Reporting obligations; Proxies – corporation may send out mass proxies so a meeting will have a quorum of voters to vote on a particular resolution o Select federal securities related statutes - Public Utility Holding Company Act, Trust Indenture Act, Investment Company Act, Investment Advisors Act, ERISA, Sarbanes-Oxley o State “Blue Sky” laws • Insider trading in general o Classic example – corporate fiduciary trades (buys or sells) shares of his corporation using material non-public information obtained through his corporation position – is there a duty and to whom is it owed? o Corporate fiduciary exploits his informational advantage (a corporate asset) at the expense of the corporation’s shareholders or others who deal in the corporation’s stock • Applicable Rules o Section 10b  It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or the mails, or any facility of any national securities exchange – to use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the SEC may prescribe as necessary or 65





appropriate in the public interest or for the protection of investors o Rule 10b-5 – It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or the mails, or any facility of any national securities exchange  To employ ay device, scheme, or artifice to defraud,  To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, or  To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person  IN CONNECTION WITH THE PURCHASE OR SALE OF ANY SECURITY o Rule 10b5-1 – purchase or sale on the basis or material non-public information in breach of a duty of trust or confidence – elements  There must have been a purchase or sale – no transaction, no liability  On the basis of (scienter requirement – person was aware of the material non-public information when he made the purchase or sale) • Exception – Affirmative Defense (see review of issues below)  Material – a reasonable investor would consider the information important to a buy-sell decision  Non-public information – confidential and not made known to the public; remains non-public until a reasonable period of time has passed  Breach of duty of trust or confidence – duty may run directly, indirectly, or derivatively to the issuer, shareholders, or other person who is the source of the material non-public information o Rule 10b5-2 – definitions of duty of trust or confidence  Recipient agreed to maintain the information in confidence  Persons involved have a history, pattern, or practice of sharing confidences so the recipient had reason to know the communicator expected the recipient to maintain the information’s confidentiality  Communicator was a spouse, parent, child, or sibling of the recipient, unless the recipient can show that there was no reasonable expectation of confidentiality Types of people involved in these situations (Course Supp. Item 12) o Pure insiders – corporate fiduciary (officer, director, employee) entrusted with confidential information that uses material, non-public information to buy or sell the corporation’s stock o Temporary or Constructive Insiders – person with a direct relationship of trust or confidence with the corporation through rendering professional advice to it who uses the information from that connection to buy or sell stock o Misappropriators (Outsiders) – outsiders with no relationship of trust or confidence to the corporation, but who have a duty of trust or confidence to the source of the material non-public information (tippees) Theories of Liability for Insider Trading o Common Law Fraud  Special Facts Doctrine – a fiduciary of a corporation has a duty to disclose “special facts” when engaging in a stock transaction with a stockholder of the corporation – fiduciary must seek out the 66

stockholder • Generally covers any facts that a reasonable investor would consider important in making a decision on whether to buy or sell shares • Duty arises when the fiduciary takes some action on the stock  Goodwin v Agassiz – G sold some stock in mining company and A just so happened to buy it at the same time because he had a thesis by a geologist that said business would be good; issue was whether A committed common law fraud because he didn’t disclose this information to G; court held that A did not have a duty to disclose because it was an arm’s length transaction and G didn’t even know who he was selling his stock to o Traditional Theory  Abstain or Disclose Rule – a person in a position of trust or confidence under 10b5-1 must disclose (generally via press release) the material, non-public information before trading in securities whose value would be effected by such information • If such person is unwilling or unable to disclose the information, he must refrain from trading until a reasonable time after the information becomes public • Standard for materiality of info – whether a reasonable man would attach importance to the info when determining his choice of action • Q 527-1, 2, 4 • SEC v Texas Gulf – TGS executives found lucrative minerals in Canada and kept it secret, then bought TGS stock; and the price increased; issue was whether the mineral info was material to see if disclosure was necessary; court held that info was material and TGS executives violated 10b-5(3) by not disclosing; the insiders were trading on unequal footing  Failure to disclose – under the traditional theory, people that have no connection to the corporation do not have a duty to disclose • Chiarella v US – C came across info from company while acting as a printer; C then traded on that merger info and made money; court held that C was not guilty and didn’t have a duty to disclose because he was a complete stranger to the corporation and had no connection or duty to them; misappropriation theory advanced by dissent not addressed by majority because it wasn’t in the jury instructions o Tipper and Tippee Theory  Tipper – must have duties to corporation (Cady, Roberts duties) AND receive some benefit or personal gain – insiders, temporary insiders, and outsiders with a duty of trust or confidence who knowingly make improper “tips” of material nonpublic information. The tip is improper if the tipper anticipates a personal benefit, such as pecuniary gain or reputational benefit, from making the tip • Sub-tipper – Liability extends to sub-tippers who know (or should know) a tip is material nonpublic information and came from someone who tipped improperly. 67





The tipper or sub-tipper can be held liable even though he does not trade, so long as a tippee or sub-tippee down the line eventually trades  Tippee – must have information come from tipper (know or should have known that there has been a beach by the tipper) – those without a duty of trust or confidence violate 10b-5 if they knowingly trade on improper tips. A tippee is liable for trading after obtaining material, nonpublic information that he knows (or has reason to know) came from a person who breached a duty of trust or confidence. • Duty of trust or confidence applies to the tippee derivatively through the tipper (or sub-tipper). • Sub-tippees tipped by a tippee have a duty not to trade, if they know (or should know) the information came from a breach of duty  Dirks v SEC – D received info from S about fraud; D tried to expose the fraud at EF and people starting selling the stock; SEC argued that D was a tippee and S was a tipper and everyone in the chain was guilty of insider trading; court held that S was not a tipper because he didn’t receive any personal gain from giving this info to D; court held that D was not a tippee because there was no derivative liability and D was only trying to expose the fraud o Misappropriation Theory  GR – a person commits fraud in connection with a securities transaction, and violates 10b-5, when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information • Fiduciary’s purpose defrauds the principal of the exclusive use of that info • If fiduciary discloses to source, then no more liability  US v O’Hagen – GM wanted to buy Pills; O’s firm worked for GM and O got a hold of this info and then traded on it and made money; court applied the misappropriation theory and held that O was guilty of insider trading because he traded the securities and was involved in deception; if O had disclosed the info to the SOURCE, then his liability would have been eliminated because there was no longer any deception involved Review of Issues presented o Standing in civil action – SEC, party to whom duty is owed, derivative actions o Material information – reasonable investor would consider the information important to a buy-sell decision o Scienter – must know or should have know o Damages – SEC – disgorgement of profits or damages for the amount of loss avoided AND a civil penalty equal t 3 times the profit made or loss avoided o Additional defenses – before obtaining the material non-public information, a person:  Entered into a binding K to purchase or sell the security  Instructed another person to purchase or sell the security, or  Adopted a written plan for trading securities 68



o Criminal liability – DOJ – criminal fine up to $100,000 AND jail sentence up to 10 years Short Swing Profits and Section 16(b) liability o Strict liability statute o Who is liable? – directors, officers, and shareholders that own more than 10% of the stock  Directors and officers must only be in that capacity for ONE of the transactions within the 6 month period  Shareholders have to be 10% owners for BOTH transactions for liability to attach o How long are they liable for? – 6 months – must match a buy and a sell within the 6 month period of time (ANY buy and sell)  The LOWEST buy and the HIGHEST sell are the numbers you want  If there is no profit on a matching transaction, then no liability o Once liability is attached, then money is paid back to the corporation

N. SECURITY DISTRIBUTION • Security – SEC gives security a broad definition to cover a multitude of different things o Test for whether something is an investment K – whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others  The effect must be material to the business o SEC v Edwards – E was CEO of ETS and sold payphones to the public; ETS offered leaseback and management agreements to the public, who did not have to do anything, but collect the profits from the agreements; issue was whether the agreements were investment K’s; court held that E was guilty because he offered the agreements, which were investment K’s because ETS was managing the profits; don’t distinguish between fixed and variable returns • Registration of a security – there is a legal obligation to register a security with the SEC unless there is an exemption that applies o Section 5 – makes it unlawful for any person or entity to make use of transportation or communication faculties to offer securities for sale without first registering them with the SEC o Process for registration  Pre-filing period – don’t change anything you are doing ; don’t prime the market for the sale; this is also known as the quiet period  Waiting Period (occurs after filing registration) – no one can buy any of the securities and only the prospectus can be distributed  Post Effective Period – company can sell their securities after SEC gives the ok on disclosure that company gave o Initial Public Offerings - company sells securities for the first time o Debt offerings – don’t happen very often o All SECURITIES offerings, unless an exemption applies • Exemption from registration – congress generally exempts securities that are regulated by someone else o Intrastate Offering Exemption: Section 3(a)-11 – the registration 69





provisions do not apply to:  Any security which is part of an issue offered and sold only to persons resident within a single state or territory, where the issuer of such security is a person resident and doing business within, or if a corporation, incorporated by and doing business within, such state or territory o Rule 147 Safe Harbor provision  Corporation incorporated in state;  At least 80% of assets in state;  At least 80% of revenues come from operations in state; and  Use 80% of offering proceeds in state;  ALSO, securities must come to rest in state – safe harbor held for at least 9 months by all purchasers (distinguish investor from underwriter – underwrite does not fit into this rule) Exempted transactions o Private Offering Exemption: Section 4 – Registration provisions of Section 5 do not apply to:  (1) transactions by any person other than an issuer, underwriter, or dealer  (2) transactions by an issuer not involving any public offering o Public offering – whether the particular class of persons to whom the offering is made have access to information that would allow them to make an informed decision – if this information is within the person’s knowledge, then no registration is necessary because it would be a private offering  SEC v Ralston – R offered securities to lots of employees without registering them with SEC; R argued that offering was private and SEC argued the offering was public; court held that the offering was public because the employees did not have access to information that would allow them to make informed decisions – the employees were low-level and did not have much authority; R was essentially taking advantage of the employees Regulation D exemptions o Rule 504 – small offerings of less than $1 million in securities o Rule 505 – offerings of less than $5 million in securities to “accredited investors” and less than 35 normal people  It is assumed that accredited investors have info to make informed decisions  Disclosure documents are needed for any non-accredited investors that the offering is made to  Be concerned with “Natural Person” classifications – directors, officers, or executives; natural persons with net worth of over $1 million; and natural persons who make $200,000 single or $300,000 married o Rule 506 – unlimited safe-harbor provision that allows offerings to nonaccredited investors that are considered “sophisticated” – have sufficient financial and business experience that would allow them to make informed decisions when investing their money

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Partner and Shareholder Traditional Rules Partnership Owners have management authority Profits and losses are equally allocated Owners determine distributions to each other Interests are not freely transferable Unlimited liability Owners are fiduciaries to each other

Corporation Owners do not have management authority No allocation of profits and losses Board of directors determines distributions and dividends paid to stockholders Interests are freely transferable Limited liability Shareholders are not fiduciaries and can act in their own interest Perpetual term and dissolution is difficult

Limited terms and dissolution is easy

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