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Sole Proprietorship/Agency

I.                    Formation

Single owner, no formality requirement.  Only have to file with the state if doing business under fictitious name.  Significant risk for liability, no shield.  If the business grows and an employee is hired, the relationship becomes one of the principal and agent under the authority of the principal.

·         Has sole decision making authority

·         An exclusive claim to business profits

·         Direct ownership of all business assets

·         Legal identity of the sole proprietorship and its owner are one, no business entity

·         Unlimited liability

II.                  Liability

A.      Actual Express Authority

When principal instructs the agent to act, or expressly authorizes the agent to act in certain circumstances.

B.     Implied/Apparent  Authority

Legal fiction – provides authority where it would be necessary or natural for the agent to act.  Protects 3rd parties who want to bind the PRINCIPAL when there is a manifestation that creates a reasonable expectation that the agent has authority to act.

·         Fennell – his lawyer agreed to a settlement, but the principal did not authorize it.  The court  said that the attorney was NOT clothed with apparent authority because there wasn’t a manifestation to the third party that his attorney would have the authority to settle.  

·         African Bio-Botanical – Agent must fully disclose the principal to be released of liability.

·         Where 3rd party knows identity of the principal involved, agent not liable.


C.     Inherent Agency Principle

Watteau - Joe owns and runs a bar called “Joe’s Bar”.  One day he sells to Smith, who lets Joe continue to run the bar, leaves the name alone but requires Joe to only buy beer mugs from Smith Mugs, Inc.  Joe continues to run the bar, buys mugs from Smith, but also continues to buy mugs from Jones.  One day, Joe stiffs Jones and Jones finds out that Smith actually owns the bar.  Under inherent agency authority, Jones successfully collects from Smith. 

D.     Ratification

Doherty – Doctrine of ratification imposes liability for agent’s unauthorized acts.  Here there was an attorney drafting codicils to a will.  To the extent that the codicils were incorrectly drafted, they were “ratified” by the testator, thus the lawyer was relieved of liability.

E.     Estoppel

Another method of recovery for 3rd parties that have suffered from an agent’s unauthorized conduct.

III.                Fiduciary Obligation of Agent

Agent has a high fiduciary obligation to the principal, to act in the best interest of the principal.

·         Tarnowski – all profits made by an agent in the course of an agency belong to the principal, whether they are the fruits of performance or the violation of an agent’s duty.

General Partnerships

I.                    Formation of a GP

A Partnership is an association of 2 or more persons to carry on as co-owners a business for profit.

·         No need for a written agreement.

·         Partnership can be created from one transaction

·         Things the partnership agreement can NOT change:

1.       The filing requirements

2.       Unreasonably restrict access to the books and records

3.       Can’t eliminate the duty of loyalty

4.       Reduce the duty of care

5.       Eliminate obligation of good faith and fair dealing (can limit though)

6.       Can’t alter the power to dissociate as a partner

7.       Can’t vary the court’s discretion to expel a partner

8.       Can’t vary the wind up requirement

9.       The P’ship agreement cannot alter joint and several liability to 3rd parties.

10.   Can’t vary the law applicable to registered LLPs.

II.                  Determining Existence of a Partnership

·         §16202 – purpose is to make a profit, need to associate as co-owners, need to share ability to control business decisions.  Any person receiving a share of the profits is presumed to be a partner unless:

1.       mere sharing of gross returns

2.       joint tenancy, common property does not establish a partnership

3.       debt repayment

4.       rent payment

5.       independent contractor for wages

6.       annuities payment or retirement benefits

7.       payment of interest on a loan

III.                Inadvertent Partnerships

A.      Intent

Courts usually give weight to intent, by looking to see if a person tried to restrict their rights in managing the partnership. 

B.  Control

Actual control of the day to day business is more determinative.

·           Martin – here, even though D shared in the profit and had veto power, court did not find an existence of a partnership because his actions were only safeguards for his loan.  Where a person shares in profits, but delineates in agreement that he is NOT a partner AND has no degree of control over partnership decision, Courts will be reluctant to find a partnership b/c the control factor is the essence of a partnership.

·           §16202(c) – if you don’t indicate any particular degrees of control or profits, it will be presumed to be a partnership.

·           Typical safeguards for a Lender-Debtor relationship, even though they may impact control:

1.       provision on the use of proceeds/profit

2.       right to inspect books

3.       limited ability of the borrower to incur add’l debt

4.       provision stating change in CEO makes entire loan amt due immediately

5.       limits on distributions of assets, dividends, etc.

IV.                Liability of GP

§16305 – Partnership is liable for acts of the partners.

§16306 – Partners are jointly and severally liable for ALL obligations of the partnership.

V.                  Sharing of Profits/Losses

When not expressly stated in the partnership agreement, §16401 provides that each partner is entitled to an equal share of the profits/losses, regardless of the contribution.

·         Services are not provided for statutorily, so if a partner will be contributing more services and less capital, put it in the partnership agreement.

·         No partner is entitled to remuneration for their services except for winding up the partnership.

·         §16807(b) – if there’s a deficiency in the account during windup, requires partners to contribute to payoff all creditors.

·         Richert – joint logging venture.  When a partnership ends, the capital contributions of each GP must first be repaid before profits are distributed.  Then, profits, losses, dividends may be paid out.

VI.                Fiduciary Relationship of Partners

Co-partners owe to one another the duty of loyalty and the duty of care.  §16404

1.       account to the partnership any partner info, property or opportunity

2.       refrain from dealing with parties adverse to the partnership

3.       refrain from competing with the partnership

4.       refraining from grossly negligent or reckless misconduct, intentional misconduct or knowing violation of the law

5.       a partner does not violate this duty merely by furthering his own interest

6.       a partner may lend $ to and transact other bus w/the partnership

·         Meinhard – partner must disclose opportunities to other partners out of fiduciary duty.

VII.              Partnership Property

The Partnership is an entity and the assets are owned by the entity, rather than by all the individuals.  Each partner has a partner account

·        §16401(g) – a partner may use or possess partnership property only on behalf of the partnership.

VIII.            Ability of a Partner to Bind the Partnership

§16301 – each partner is an agent of the partnership and can bind the partnership in the ordinary course of business. Exc – if partner had no authority to act in the dealing and the other party was aware that the partner had authority.


§16401(j) – if outside the ordinary course of business, then need the consent of ALL the partners to bind the partnership.

IX.               Rights of the Partners in Management/Control

§16401(f) – unless stated otherwise in the p’ship agmt, each partner has equal rights in management of the partnership.


§16503 – a partner may transfer only the profit interest in the partnership, not the management of the partnership, w/o the consent of the other partners. 

·         By itself, it does not cause the dissociation or a dissolution and winding up of the P’ship.

·         The partner retains all the rights and duties of the partner.


§16601(4)(B) – if there has been a transfer of all or substantially all of the partner’s interest, the remaining partners may unanimously vote to expel them.


§16303 (d) – a partnership that wishes to limit authority of certain partners may file a supplemental authority statement, which puts 3rd parties on notice of the ability of the partner to act and transact on behalf of the p’ship.  For real property, file statement with county recorder’s office.


·         Nabisco – 2 person partnership, conflict on choosing bread vendors, but one went ahead and ordered anyway, the other refused to pay.  Court held that the partnership still bound to pay for the bread, which the other partner had the authority to order. 

X.                 Liability for Misrepresentation of Person as a Partner

§16308 – If 3rd party relied on representation by a party that they are a partner, then they will be treated as a partner.  To be liable, there must be an affirmative act of representation, in a public manner.


§16308(c) – a person is not liable merely because someone else names them as being a partner.


·         Standard Oil – father not liable w/o affirmative act.  Possible to have implied consent in the rare event that someone confronts the alleged partner and they fail to deny.


XI.               Dissolution of Partnership

·         When one party leaves, they “dissociate”, which could but not necessarily cause the dissolution.  The partnership is an entity, so it still exists if 1 out of 3 partners leaves.

§16601 Events causing dissociation:

1.       partner gives notice of express will to withdraw from the p’ship

2.       event agreed upon in the p’ship agrmt occurs

3.       expulsion pursuant to the p’ship agrmt

4.       unanimous vote to expel for the following reasons:

·         illegal to deal w/that partner

·         transfer of that partner’s interest

·         a corporate partner’s charter has been revoked, or it has filed a certificate of dissolution

·         a partnership, LP, or LLP has been dissolved and is winding up.

5.       judicial act to expel for the following:

·         partner engaged in wrongful conduct that adversely affected the p’ship

·         partner willfully or persistently committed a material breach of the p’ship agrmt or duty owed to the p’ship or other partners.

·         Partner engaged in conduct making it unreasonable to carry on business with p’ship.

6.       partner’s act or failure to act:

·         by being insolvent, going bankrupt

·         assigning interest to creditors

·         agreeing to the appointment of a trustee/receiver to liquidate most or all of the partner’s property.

·         By failing to stop the appointment of above

7.       occurrences in the individual’s life:

·         death

·         appointment of guardian or conservator (incompetence)

·         judicial determination of incapacity to serve

8.       partner that is a trust, distribution of trust property

9.       partner that is an estate, distribution of that estate

10.   termination of a partner that is not an individual, partnership, corp, trust or estate.

·         §16602 – a partner has the power to dissociate at any time, rightfully or wrongfully.

·         §16701 – if a partner is dissociated from a p’ship, their share will be bought out by the p’ship.  Liquidation value = value at date of dissociation, plus interest

·         §16801 – what causes dissolution:

1.       partnership at will – half the partners agree to dissolve and terminate

2.       partnership for a term (fixed undertaking): dissociation by bankruptcy or death, wrongful dissociation by a partner, an automatic dissolution will happen unless the remaining partners agree to continue the partnership.

3.       Express will of all partners to dissolve

4.       An event that makes it illegal for the partnership to continue doing business

5.       Judicial determination


·         When you have a dissolution, you automatically have a winding up/liquidation

·         §16802 – on dissolution, the p’ship is not terminated, but continues until the “winding up” of p’ship affairs is completed.


Limited Partnerships

I.                    Definition of LP

·         An association of 2 or more persons or which, at least 1 is a GP and one is an LP.

·         GP has full personal liability for partnership debts, assumes management responsibilities and control – GP can be a corporation.

·         LP contributes cash, other property or services but is not active in running the business and their liability is limited to their investment.

II.                  Reasons to Form LP

·         LP liability is limited to amount of investment

·         Attracts more funding

·         LP taxes are attributed to each partner’s profits.  Corp. entities are taxed separately.

III.                Formation of LP

·         Filing required (unlike GP) – need to disclose to public that there are some limited partners.

IV.                Liability

·         §15632 – When an LP takes active control in the business s(he) becomes a GP.  If an LP participates in the control of the business w/o being named as a GP, that person may be held liable as a GP only to persons who transact business with the LP w/actual knowledge of that partner’s participation AND with a reasonable belief that the partner is a GP based on the LP’s conduct at the time of the transaction.

·         LP does not take part in control by doing any of the following:

1.       being a contractor, agent, or employee of the LP or transacting business w/a GP

2.       being an officer, director, or shareholder of corporate GP

3.       consulting or advising a GP (unless there’s a serious impact)

4.       acting as a surety for the LP or the GP

5.       voting or calling a meeting of the partners

6.       approving or disapproving an amendment

V.                  Errors

·         Future claims – no liability if certificate filed promptly

·         Past claims – not liable unless 3rd party reasonably believed he was a GP

Limited Liability Partnership

I.                    Definition of LLP

·         §16101(6)(A) – for lawyers, CPAs and architects.  Must be registered

·         §16306(c) – a partner in a registered LLP is not liable or accountable for debts, obligation,s or liabilities of another partner, whether arising in tort, contract, or otherwise.

·         §16306(e) – partner is still liable for personal tortious conduct.

·         §16956 (1)(A) – LLP required to maintain an insurance policy of $100k for each partner, shall not be less than $500K and doesn’t need more than $5M.

II.         Purpose

·         it’s a variant of the GP, so maintains the same tax benefits but shields partners from liability of a general partnership



I.                    Overview

A corporation is a shielded entity, and can only be created by the state.  The investors of a corp have limited liability and creditors understand that any liability must be satisfied out of the assets of the corporation.

II.                  Formation

A.      Formality

·         Must file Articles of Incorporation, can be formed by 1 or more persons.  Existence of a corp. begins upon filing §200.

·         §202 – Articles must state:

1.       name of the corporation

2.       purpose of the corp

3.       address for service of process

4.       # of authorized shares

It is difficult to amend the AOI, requires a shareholder vote for approval.

·         After filing, an organizational meeting occurs where:

1.        Board of Directors are elected

2.        §212 Bylaws are passed  – not public record, this is kept internally w/the records of corporation.  The bylaws contain duties of officers, corporation seal, # of officers.  Management may alter the bylaws w/o shareholder approval.

B.     Obtaining Capital for Corp.

·         Common Stock – owners have residual rights to the profits of the corp, right to vote and control.

·         Preferred Stock – owners have priority rights that limited to the investment document they entered into. (VC’s get this to cash out.)  Bylaws specify the rights of preferred stock owners.  Anything left over is reserved to the common stockholders.

·         Other than stock, corps can take loans (corp IOUs), or make money from licenses of their patents.

C.     Structure of Power

·         Officers – execute the policy of the board, run the day to day operations

·         Board of Directors – directs and manages the affairs of the corporation, elects the officers

·         Shareholders – elect the board, own stock, not involved in management

D.     Premature Commencement of Business

1.       Promoters

·         Function – participate in the formation, arrange legal compliance, secure capital, enter into contracts pre-incorp

·         Fiduciary Duty – promoters owe this duty to the corp they are formng, should not make secret profits on selling property to corp.  They are in charge of creating the corp, and signing for a corp which does not yet exist (ie, commercial lease).

2.       Liability

·         Promoter signing for non-existent corp is personally liable when no corp is formed (even if promoter says only want to be liable as agent of corp).

·         If corp is formed, promoter is still liable b/c law rejects idea that promoter was agent of principal (corp) since the principal did not exist at time of k.

·         NOVATION – is the only way principal can avoid being liable, agreement w/3rd party that they will look only to the corporation to repay obligation.  If no agreement, promoter still personally liable.

·         3rd party v. new corp – when corp knows the benefit they’re receiving, or promoter still in control of corp. then 3rd parties can enforce against corp after it’s formed, even if the corp doesn’t adopt the k.

·         A new corp. can enforce k against 3rd party if 3rd party’s rights have not been substantially altered, contract is not necessarily void.

·         Southern Gulf – 3rd party k w/promoter to build ship for the corp, 3rd p wants to break the k, so argues that corp was formed in different place than they were told.  Court said 3rd p still got what they bargained for, k valid.

E.     Defective Incorporation

·         If the Corp failed to comply w/statutory formalities for incorporation (papers not filed), there may not be a valid corp.  Whether owners can be held liable for corp debts depends on whether a corp exists, de facto, or by estoppel.

1.       de facto (not followed in CA or majority j/x)

·         existence of a statute under which you have incorporated AND

·         an effort in good faith to incorp under existing law (difficult to prove) AND

·         conduct, acting like a corp (using corp powers, issuing stock etc)

2.       Estoppel (doctrine exists in CA)

·         Different than normal estoppel, which protects P (D is estopped), here P is the one estopped from denying existence of corporation b/c acted like a corp existed.  Court holds the attacking party is “estopped” to treat the entity as anything other than a corp.

·         P must have dealt w/entity as if it were a corp, in effect admitting its existence as such

·         P must have relied on credit of corp, rather than that of shareholders or officers

·         In most j/x, courts will allow estoppel doctrine for investors (who didn’t have any management control) to avoid personal liability when defective incorp occurs.


III.                Powers of Corporation

·         Under CL, acts beyond the corporation AOI were held to be “ultra vires”, and were unenforceable, but there were numerous exceptions.

·         §207 – A corp shall have ALL the powers of a natural person in carrying out its business activities

·         §207(e) – can make charitable contributions, s/h can restrict this in AOI (cannot be a “pet charity” of the board)

·         §207(h) – gives corp power to enter into a p’ship

·         §207(f) – power to pay pension, carryout profit sharing, bonus plans

·         §207(g) – allows corp to secure debt w/assets of its franchises, property, income

Powers can be limited in AOI, must be explicitly stated what the corporation cannot do.

IV.                Piercing the Corporate Veil

Even if corp has been properly formed, the owners can still be personally liable to creditors. 

·         GR: courts will pierce whenever necessary to prevent fraud (tort) or to achieve equity (k)

·         GR for nonK-tort: if corp is run for profit, there are sufficient assets and formalities are followed, unless it is totally egregious, the court will not pierce.


1.       fraudulent representation by corporation directors

2.       undercapitalization

3.       failure to observe corporate formalities

4.       absence of corporate records

5.       payment by the corporation of individual obligations, OR

6.       use of the corporation to promote fraud, injustice or illegalities


·         Occurs most commonly with close corporation and parent/subsidiary corporation.

·         Party asking to pierce must prove that honoring the separate corporate existence would cause fraud, inequity or promote injustice.  Act of the corp must have misled 3rd party to their detriment.

  1. Mere Instrumentality – applies when owners do not act in the best interest of the corp, usually parent/sub situation where sub is a mere puppet of the parent, ie, parent buys products from the sub at below cost
  2. Alter ego – when owners themselves disregard corporateness, commingling funds, treating corporate funds as personal, not having meetings, no minutes taken, elected officers, etc.
  3. Inadequate Capitalization – that alone is not sufficient to pierce, need alter ego or instrumentality showing.

·         Walkovszky (tort)  – one owner, numerous small taxi corporations, each holding the minimum insurance, with few assets.  Court held that undercapitalization alone was not sufficient to disregard corporate shield as the structure was not illegal.

·         Baatz (tort) – dram shop, family run bar.  Court found no indication that corp was set up as fraud to avoid liability.

·         Sea-Land Services (reverse pierce) – d owned 4 corps, p was owed $ by one of them that had no assets, so went after assets of sister corps (not owner).  If you can show that all of the corps are essentially engaged in a single enterprise and just artificially compartmentalized, you can attach to the assets of the entire enterprise.

·         Kinney Shoe – P wants to sue D personally for rent owed by one of D’s corps.  Court found undercapitalization and no formalities were followed, so allowed piercing.  Court looked at “totality of the circumstances”:

1.       unity of interest and ownership (owner indistinct from corp)

2.       equitable reason for piercing

·         Equitable subordination (used if piercing fails) – applies to bankruptcy settings and is NOT piercing the corporate veil.  Court subordinates a shareholder’s loan, raising priority on debts held by other creditors. 

·         known as Deep Rock Doctrine, occurs in bankruptcy.  If SmallCo sells all shares to BigCo for $5K, and BigCo turns around and lends SmallCo $50M.  BigCo’s “loan” is not really a payment obligation, so if SmallCo goes bankrupt, the court will allow other creditors to attach first, ensuring some payment, as opposed to virtually nothing if BigCo’s “loan” were repaid first.

Reasons for subordination:

1.       loan was part of a capital structure which consisted of too high a proportion of debt

2.       s/h corp $ really meant as contribution to capital, not “loan”

3.       claim creditors had no prior warning of evidence for subordination

4.        s/h engaged in transaction which unfairly hindered collection of creditor claims

V.                  Director/Shareholder Powers

A.         Control and Management of the Corp

GR – the right to manage the corp is vested in the BOD, not in the S/H, unless otherwise provided in the AOI, by law or valid agreement

·         President or VP may bind the Corporation even if they have no actual authority b/c they have “apparent authority” to 3rd parties.


Board of Directors (elects officers)




Shareholders (elects BOD)

B.         Board of Directors

1.       Rights and powers – under §300, “all corp powers shall be exercised under the ultimate direction of the board.”

2.       Number of directors allowed - §212 requires no less than 3, can be a range.

3.       Filling of vacancies – under §305, BOD approves new member, unless vacancy was by removal, in which case, the S/H get to fill that slot.

4.       Formalities required for action by the board – need to act by resolution or vote at properly called meeting, at which there is a quorum.

a.       Quorum §307(a)(7)

·         Min. # of ppl needed to transact business

·         Members need not be physically present as long as they can hear each other (phone/video conference)

·         A majority of the authorized # of directors constitutes a quorum

1)      if 5 directors and 2 vacancies, still need majority of authorized directors, so 4 out of 7.

2)      Articles or bylaws may state that a quorum is other than majority, but

3)      Quorum can never be less than 1/3 of the authorized # of directors, so 3 out of 7.

b.       Meetings – can only be called by the chairman, president, vp, secretary, or 2 directors.

c.       Notice

·         Regular meetings of the board may be held w/o notice if time and place are fixed by by-laws

·         Special meetings require 48 hours notice by phone/personal service or 4 days by mail (starting when placed in mailbox, regardless of when received).

·         Notice doesn’t have to specify the purpose of the meeting

·         AOI & bylaws may not dispense notice, but

·         Waiver of notice  - if a quorum cannot be attained, action may be taken w/out meeting if

1)      all members give a unanimous written consent to that action and their consent is filed in the minutes.

2)      Approve minutes of meeting

3)      Sign waiver of notice before the meeting.  Can be after, but more difficult if they disapprove of action taken.

·         Protesting Notice – if all BOD are present, it still might not be sufficient for notice, b/c if they protest lack of notice, they aren’t counted as receiving notice.

d.       Majority vote of the quorum is needed for action to take effect

·         An act or decision done or made by the majority of the directors present at a meeting at which a quorum is present is an act of the board,

·         Does not need to be unanimous unless directors waived notice of meeting.

·         Even if a director leaves the meeting where there was a quorum, the board may continue to transact business.

1)      action only needs the approval of the majority of quorum for that meeting

2)      this prevents people from just leaving so that an action cannot be passed.

5.       Executive Committees §311

·         BOD may designate a committee (smaller group) to act for BOD in certain circumstances

·         Committee must be adopted by a majority of the authorized # of directors

·         Each committee consisting of 2 or more members of the BOD

·         EC has the same authority of BOD, except they may not act on important matters such as:

1)      dividend payments

2)      amendment/repeal of bylaws

3)      filling vacancies on BOD

4)      areas where S/H approval is required

5)      appointment of other committees of the BOD

6)      fixing compensation of BOD

C.        Shareholders

1.       Elect the Board

2.       Fundamental Corporate Changes that require S/H approval

·         Organic changes (mergers, dissolutions, reducing capital, etc)

·         Voluntary dissolution

·         Election and Removal of the Board

·         Sale of significant portion of assets

·         # of shares to be authorized (this amends the AOI, which requires S/H approval)

·         Amendment of the Articles

3.       Removal of Directors

·         §303(a) – any or all of the directors may be removed w/o cause if the removal is approved by the outstanding shares (very liberal)

·         §304 – can remove w/cause if 10% of outstanding shares bring suit

·         §305 – S/H may fill vacancies if they removed the director(s)

·         §152 – can vote by majority of outstanding shares (those entitled to vote) OR

·         §153 – can vote by majority of shares represented and at a meeting where quorum is present

·         difference between §152 and §153, getting the maj of outstanding shares is much more difficult

4.       Amending the AOI – amendments may be adopted if approved by the board and approved by the outstanding shares

5.       Amending the bylaws to add more directors

·         §212 bylaws; contents

1)      bylaws must state # of directors OR

2)      state that the # of directors shall not be less than a stated minimum, nor more than a stated maximum w/an exact number.  (Max can’t be greater than twice the stated minimum, minus one.)

·         §211 bylaws; adoption, amendment or repeal

1)      bylaws may be adopted, amended or repealed either by approval of the outstanding shares or OR by approval of the Board

2)      need §152 approval, exception is §212

6.       Formalities for a S/H action

·         Meetings: §600(d) – holders of at least 10% of shares may call S/H meeting (to change bylaws)

·         Notice (written)

a)      written notice must be given 10 days in advance of a meeting when S/H going to be taken

b)      S/H may waive notice if they give written consent

·         Quorum – majority of those entitled to vote

7.       Dissolution – §1900: if more than 50% of S/H approve of dissolution, court will order dissolution, even w/o Board approval.

D.     Sale of Assets

·         BOD – may sell assets acting alone if it is in the ordinary course of business, otherwise, needs the approval of the BOD plus S/H.


VI.                Duties of Directors, Officers and other Insiders

A.                  Duty of Care

1.       Director must act with such care, including reasonable inquiry as an ordinarily prudent person in a like position would use under similar circumstances. §309(a)

·         “in a like position” : obligation of care changes w/respect to complexity & size of Corp.

·         ordinarily prudent person : doesn’t require special skill or expertise, could be non business person using common sense.

·         Similar circumstances : duty of care varies for specific person depending on their experience, training & expertise.

·         Reasonable inquiry : keep current, explore suspicious circumstances, no duty to micro-manage.

2.       Director entitled to rely on opinions of officers, employees so long as director acts in good faith (no doubts) §309(b)

3.       If person is filling in as director, he is not liable if he follows §309(b)

4.       Liability of a director may be limited or eliminated in articles under §204(a)(10)

·         Only for negligence, not for reckless or intentional misconduct

5.       Indemnification §317

·         Against 3rd parties, corp can indemnify director for expenses involved and judgment, provided officer acted in good faith and in a manner s(he) believed was in the best interest of the corp.

·         In S/H derivative suits, can only indemnify for expense of litigation

·         Insurance, corp can buy for non-deliberate negligence action of director.

6.      Business Judgment Rule

·         Directors are shielded from personal liability even if they made a poor decision (not negligent)

·         Requirements:

a)      focused decision, made in good faith

b)      informed decision

c)      director disinterested (no conflict in interest)

d)      no fraud (legality)

e)      rational basis for decision

·         To invoke BJR, you cannot have a violation of the law

·         Smith v. Van Gorkom – Gross Negligence of Directors in LBO

a)      holding: directors are personally liable and cannot use the BJR as a defense since they did not properly obtain info to make informed decision.  Did not meet duty of care.

b)      Rationale:

1)      No independent study made to determine intrinsic value of company (didn’t get outside professional opinion)

2)      Directors didn’t read the agreement

3)      CEO’s presentation was inadequate for directors to actually make an informed decision.

B.                 Duty of Loyalty

·         In situations where there is a conflict of interest, the director has the duty to place the best interests of the corporation above their own personal gain.

·         Modern Law – transactions are voidable.  Director may make transaction w/corp so long as he does not breach fiduciary duty.  If it’s fairly priced and transacted for, then it’s ok for the director to make a profit selling it to the corporation.

·         §310 governs contracts where a direct has a material financial interest

(1)    If a transaction occurs between a Corp. and one or more of its directors; [OR]

(2)    If a transaction occurs between Corp A & Corp B, where Corp A director has a material financial interest in Corp B, then for the transaction to not be void or voidable,  the director must:

(a)    Fully disclose all material facts & financial interest AND get shareholder approval (quorum – w/o counting the votes of the interested director-shareholder); [OR]

(i)                  No possibility for litigation after the fact if full disclosure is made.

(b)    Fully disclose all material facts & financial interests, get BOD approval (again, not counting votes of interested director-shareholder), AND must show that the transaction was just & reasonable to the Corp at the time entered into [OR]

(i)                  Possibility for litigation after the fact because of just & reasonable requirement (what’s just & reasonable can only be determined after the fact.)

(ii)                One does not need to show just & reasonableness to get s/h approval because of the assumption of structural bias when dealing with fellow directors.

(c)    If no approval was granted (director doesn’t try to get BOD approval or s/h) prior to completing the transaction, the director can still be protected if he can show that the transaction was just & reasonable at the time it was entered into.

(3)    § 310(b) transaction between Corp A & Corp B where Corp A director is also a director in Corp B.  To not be voidable, the director must make complete disclosure.  He needs a good faith vote w/ either s/h or BOD.  If he gets approval, there is no need to show just & reasonableness.  DIRECTOR’S VOTE CANNOT COUNT.

(4)    Burden of Proof

(a)    Where the director does not get advanced approval for an interested transaction, the director has the burden of proving that the transaction was just & reasonable.

(b)    Fairness alone will meet the BOP:  Bayer – Director hired wife to sing.  The court held that even though directors didn’t ratify the contract, it was fair.  Corp. received good value for services so director met the BOP.

(c)    Where director has received advanced approval for an interested transaction, the P has the burden of proving that the transaction was not just & reasonable.

(5)    Full & Complete Disclosure Required:  Requires the director to information the BOD or s/h about any matters affecting the value of the property, the amount of his profit, and all other relevant info that might affect the Corp’s decision to enter into the contract.

(6)    Authorization for Transaction

(a)    BOD:  Interested directors may be counted at a director’s meeting to determine if there is a quorum, although the director’s vote may not be counted for a transaction in which he is interested.  § 310(c)

(b)    Shareholders:  Same as above—interested director-shareholder’s stock maybe counted toward quorum, but not for voting.

C.        Corporate Opportunity Doctrine

b)      Determination of Corporate Opportunity:  Courts find it is a Corp opportunity if it’s fair & just to offer to the Corp first.

(1)    Expectation of the Corp:  Corp had an expectancy (i.e. Corp leases building & when lease comes up for renewal, it has an expectancy.  If the director leases it himself, he’s stolen a Corp Opportunity.

(2)    Corp has interest:  Corp has interest in some sort such as Contractual interest and the director gets the license himself.

(3)    Necessity:  Where the Corp can show a provable need for the opportunity. (i.e. Where the Corp needs to expand & property next door becomes available).

(4)    Same Line of Business Test:  Where the opportunity is a natural extension of the business through the same technology, marketing or other expertise possessed currently by the Corp.

(5)    Opportunity closely related to Corp’s business: Present or Future

(6)    Opportunity involves business that’s a competitor of the Corp:  Or one that the Corp might buy or sell to.

c)      Circumstances by which Director Became Aware of Opportunity:  Courts may examine to determine if it’s a Corp. Opportunity.

(1)    If he is approached as a director of the Corp = Corp opportunity.

(2)    If director gets opportunity collaterally to his duties as director – probably Corp opportunity (even if director is playing golf when he gets the opportunity, it may still belong to the Corp.)

(3)    While on vacation:  look at actual facts, could still be a Corp opp as too easy excuse

(4)    3rd party wouldn’t have dealt w/ Corp:  Court has held that the director must still give the Corp opportunity, again, because this is too easy to use as an excuse.

d)      Director of Multiple Corporations:  If Corp is director of multiple Corps & gets the opportunity that would be of use to both companies:

(1)    Most courts let the director choose in good faith, which Corp to give the opportunity to.  Director doesn’t have to disclose opportunity to both Corps.

(2)    Courts look to reasonable expectations of s/h that director may not turn over every business opportunity if they know that the director is involved in a similar Corp.

e)      Financial Inability of Corp:  Can  a director exploit an opportunity, w/ out first offering it to the cop first, when the Corp is in financial constraints?  No.

(1)    Director has affirmative duty to find reasonable finances for the Corp.

(2)    Director must make a full disclosure of the opportunity to the Corp & have the Corp reject the opportunity before he exploits it himself.

(3)    Exception:  Where the Director can show that he has tried every available means to obtain needed funds for the Corp, he may take opportunity for himself.

VII.              Fiduciary Obligations of Controlling S/H (owed to minority)

A.                  Duty of Loyalty 

Where the majority Shareholders have the power to effectuate a Corp. transaction, the majority Shareholders must act in good faith and not to the detriment of the minority Shareholders

1.       Duty to operate Corp in the Corp’s best interest (Improperly Operating Corp):  Dominant S/H cannot cause the Corp to take action for the benefit of the Dominant S/H if the action taken is not in the best interest of the Corp.

a)      Hypo:  Standard Oil had many subsidiaries and owned 70% of sub C.  Outsiders owned 30%.  Standard caused C to sell all of the oil it drilled to a wholly owned sub of Standard (B).  30% of C (minority Shareholder) filed suit saying Standard caused C to sell oil below market price.

b)      The court held that Shareholder’s win because the only reason C sold at a below market price was b/c it was controlled by the Parent and these Majority Shareholder did not act in the best interests of the company.

2.       Dissolution to “freeze out” minority:  Dissolution of corporation for the sole purpose of “freezing out” the minority S/H, so that the dominant S/H can buy the assets and continue the business formerly carried on by the Corp, constitutes a breach of fiduciary duty. It is an organic change in the Corp structure which promotes the Majority’s self interest.

a)      INLAND STEEL:  Court found 70% majority’s dissolution of Corp in order to buy out minority 30% was unlawful due to the majority’s primary purpose of keeping profits for itself. (Majority did not want to pay minority a fair price for their stock.)

b)      Court found that even though there was a proper dissolution, the maj breached fiduciary obligation to the minority because after the sale, the barges were still in business continuing work.  Min Shareholders got liquid value rather than going concern value so the court awarded going concern value.

c)      Court held OK to liquidate assets if doing it for profit, but here the barge company was still continuing business, showing the goal of the transaction was just to squeeze out he minority.

3.       Full Disclosure Required Upon Corp Liquidation:  The maj S/H should fully disclose the material facts to the min S/H, where upon the min may have an equal opp to share in the profits.

a)      ZAHN v. TRANSAMERICA:  Maj S/H holding all B (common) stock, through it’s BOD “called in” A (preferred) stock per redemption agreement, but w/o disclosing material facts (true value of assets or that they planned liquidation afterwards).  Although neither calling stock or liquidation is wrong, under circ of nondisclosure, it becomes a breach of fiduciary duty b/c  no business purpose for doing it ( the purpose was to carve up the value of the Corp in an unfair manner to benefit the majority at the expense of the min)

b)      General Rule:  Maj S/H can’t use control of the BOD to gain at the expense of the Minority.

4.       Dominant Shareholder Action Outside of Corp which Excludes the Minority Shareholder:  Although actions by the Majority may not directly affect the minority, courts may find a breach of fiduciary duty where the majority indirectly benefits at the detriment of the minority.

a)      JONES v. AHMANSON:  Where the court found the majority breached by denying the 15% minority the ability to create a market for its stock.  Majority used their control of operating company to create an opportunity (publicly held holding company) solely for themselves & intentionally left out the Minority.

(1)    Majority cannot cause a holding company to be formed at the detriment to the minority.

(2)    Most Jx don’t follow this case because the court held that all that matters is inherent fairness so even if the action was not detrimental to the Corp, it is improper if not fair to the minority.

5.       Unfair allocation in Merger: if the allocation in the merger is unfair, it’s a breach of fiduciary duty.

·         Example:  B owns small Corp.  B is also a majority in larger Corp.  C is a minority in the larger Corp.  B causes his small Corp & large Corp to merge and B ends up owning half of the larger Corp.  This is an oppression of the minority Shareholder by the Majority causing Corp to enter into the transaction.

VIII.            Proxies

A.  Securities & Exchange Act of 1934: 

Act regulated a wide variety of transactions involving the securities market. (offerings & sales of securities to the public or information related to securities.)

B.   SEA § 14 Applies to Publicly Held Corp. Only: 

Regulates solicitation of proxies in publicly held corps & rules for contents of proxy solicitation, mandates public disclosure of publicly held Corp of massive info annually, quarterly, monthly, and if something important occurs.  Also requires:

1.       Full Disclosure: requires disclosure to S/H of sufficient information so S/H can make a rational judgment as to whether or not they want to give you their proxy.

a)      Proxy – power granted by a Shareholder to another person to exercise his voting rights.

b)      Proxy holder = Shareholder’s agent.

c)      Proxy statement:  Proxy solicitation must include a proxy statement that gives Shareholders specific information such as pension plans, director salaries, and what the director has been doing for the past 5 years.

(1)    Must also disclose whether there will be a material conflict of interest in the proxy statement. 

(2)    Management’s proxy statement must be accompanied by or include certain financial statements.  (These statements are set out in the annual report of the company which also serves a s a public relations document.)

(3)    These management proxy solicitations are not neutral.  They’re designed to give management a proxy for position they endorse.  (However, you can give mgmt your proxy and vote for all or w/ hold your vote for director “x”, but can’t vote for someone else).

(4)    You can give your proxy to any Shareholders or anyone as long as they go to the meeting.

2.       Anti Fraud:  Act states it is unlawful to make material untrue statements or omissions in connection w/ a proxy solicitation.  No solicitation of proxies shall be made containing false or misleading statement w/ respect to material facts or omissions.

a)      SEC Rule 14a-9 provides:  No solicitation subject to this regulation shall be made by means of any proxy statement…containing any statement which, at the time and in the light of the circumstances under which it was made, is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading.

(1)    Private Right of Action:  There’s nothing in § 14, but Borach  held there’s an implied private right of action for damages for a § 14 violation.  (Court held that a private cause of action helps to ensure disclosure of info).

(2)    Materiality:  A statement or omitted fact is material if there is a substantial likelihood that a reasonable Shareholder would consider it important in deciding how to vote.

b)      Causation = Necessary Link Requirement:

(1)    In MILLS, 54% majority needed 66.6% to merge and 46% minority claimed there was misrepresentation in proxy solicitation.  Court held that every P does not need to show that misrepresentation caused them to vote as the did (would have voted otherwise if it had been correct)  all that must be shown is:

(a)    The Omission was material.

(b)    The proxy solicitation was a necessary link to produce the action (i.e. must show that couldn’t have gotten merger through w/o solicitation).

(c)    Here proxy solicitation was necessary so causation was satisfied.

(2)    In VIRGINIA BANK SHARES, the solicitation was not necessary because 85% maj didn’t need the vote of the 15% min even though they solicited there proxies.  Therefore, existence of misleading material fact in proxy solicitation doesn’t satisfy causation.

C. Shareholder Proposals: 

Proposals Shareholders want to be disbursed to other S/H, included in the management’s proxy statement.

1.      Purpose:  The main reason why shareholders place proposals in the Corp’s proxy is the cost is too prohibitive for individuals to mail out the material themselves.

2.      Grounds for Omitting Proposal: 

a)      Proposal that’s part of ordinary business operations – It’s the role of the BOD to make decisions regarding ordinary bus operations so mgnt can exclude a S/H proposal that conflicts.

b)      Counter proposals

c)      Usual Business matters

d)      Contrary to Law

e)      Can’t be economically related.

D.  Shareholder Proxy Solicitation when Shareholder wants to Gain Control:

1.       Shareholder must send out material to other Shareholders to ask for their proxy.  This solicitation is also covered by § 14, so it is subject to anti fraud provisions.  In this case, the Corp must:

a)      Give them a Shareholder list [OR]

b)      Mail out & address solicitation material for Shareholders as long as the Shareholder pays.

2.       Reasons Shareholder wants to gain control

a)      (S)he may feel the present management sucks and could be more profitable.

b)      Wants to dismantle the Corp and give more dividends to Shareholders.

3.       Other ways to Gain Control for Shareholder

a)      Tender Offer:  Shareholders can make a tender offer to buy shares but this is limited by the amount of $ needed to buy all the required shares.

E.     Financing Proxy Solicitations

1.       Management Proxy Solicitations: When Management solicits proxies, the corp pays.

2.       Solicitations by Shareholder or a Group Trying to Take Control: Must pay themselves.

a)      Exception:  If they are successful in taking over, then they may be reimbursed for the costs incurred over the proxy fight.

(1)    They have a fiduciary duty to S/H so this justifies taking $ to reimburse themselves if they:

(a)    Justify – claim that by virtue of being the new management, they are conferring a benefit on the Corp and therefore deserve reimbursement.

(b)    Get Shareholders’ approval for reimbursement.

3.       Shareholder says costs of Management’s Proxy Solicitation is Unreasonable:

a)      Courts haven't given a solid answer on whether all acts of management should be reimbursed (i.e. take Shareholders’ to Bermuda to solicit proxy.)

b)      GR:  Reasonable” expenses are acceptable, but the Court doesn’t state what is reasonable.

IX.               Closely Held Corporations

A. Shareholders’ Voting Powers

1.       Straight Voting:  where Shareholder gets one vote for each share held.

a)      Person w/ majority of the stock may control who gets elected (51% or more of stock)

b)      Must distribute shares equally over number of candidates.

c)      If 5 candidates w/3 seats available & A owns 100 shares, then A gets to vote for 3 and each candidate A votes for gets the same 3 of votes (A can cast 100 votes for 3 candidates.  3 candidates w/ highest 3 of votes are elected).

2.       Cumulative Voting (Mandatory in CA):  each S/H may cast a # of votes equal to the # of directors to be elected multiplied by # of shares held.  S/H may distribute votes unequally over # of candidates.

a)      Example:  If 5 directors are to be elected, a Shareholder w/ 10 voting shares has 50 votes; and he may vote all 50 shares for one candidate (or split his voting among several candidates).

b)      Purpose:  Assures minority S/H of representation on the BOD.  Device for increasing S/H power in the publicly held Corp. 

c)      CA § 708:  Every Shareholder can vote cumulatively at any election of directors so long as:

(1)    Candidates names have been placed in nomination prior to the voting, AND

(2)    Shareholder has given notice at the prior meeting of intent to cumulate vote.  If any Shareholder has given notice, all Shareholders may vote cumulatively.

(3)    Exception §301.5:  Shareholder’s may vote to eliminate cumulative voting in listed companies (publicly held Corp – usually large publicly held corps. On AMEX, NASDAQ, NYSE, or 800 Shareholders or more).

d)      Staggering the BOD: in many Jx, rather than elect all directors each year, some Corps want to stagger their elections (i.e. 9 person BOD; elect 3 members each year)

(1)    Effect of Staggering on Cumulative Voting:  minority could be shut out (especially if 1 board member each year for 3 person board.)

(2)    § 301:  Can’t stagger boards (CA all directors must be elected each year).

(3)    Exception – CA § 301.5:  You can stagger the board in publicly held Corps if you vote to.  If stagger in 2 classes must have at least 6 directors and elect ½ of them at the annual S/H meeting;  3 classes must have at least 9 directors and elect 1/3 at annual meeting.

e)      § 303(a)(1) – Cumulative voting & removing directors w/o cause:  S/H can remove directors w/o cause if they want to remove the entire board.  But S/H may not remove one single director.  If the people who object to his removal could have elected him by cumulative votes.  (if votes against his removal would be sufficient to elect him in cumulative voting)

f)       Min S/H may try to increase # of BOD to keep place on the board if cumulative voting is allowed b/c the more individuals that are being voted on the smaller % of shares is needed to elect (fewer the board members, the more shares min needs to elect 1 director w/ cum. voting).

(1)    § 212(a) number of directors can’t be reduced if reduction is imposed by a minority sufficient to elect at least one director in cumulative voting.

B.     Devices By Which Shareholder’s May Control Voting Rights (Control Devices)

1.       Shareholder Voting Agreements (“Pooling”):  Where Shareholders agree between themselves in advance of voting that they’ll vote in a certain way.  (attempts to sterilize the board).

a)      General Rule:  Law says S/H has every right in the world to combine with 1 or more other S/H for the purpose of gaining control as long as not done fraudulently or to oppression of minority. 

b)      RINGLING BROS:  P and H entered into agreement that they would act jointly in exercising their voting rights and if they could not agree then the decision would be made by L, an arbitrator.  They disagreed, L told how to vote, and H violated the agreement.

(1)    Held:  Court did not enforce the agreement because agmt did not provide that on violation either party could vote the shares of the other, or that the arbitrator could vote them.

(2)    Solution = Proxy:  If they really wanted the agreement to be upheld an not irrevocable then they should have given L proxy to vote their shares.

(a)    Irrevocable Proxy:  Even if they give proxy to L because of agency law, it will be revocable so the solution would be to give irrevocable proxy.  If the proxy has been given for the benefit of the agent (person getting the proxy) rather then for the person giving the proxy, then it will be irrevocable.

(b)    If RINGLING BROS had been a  close Corp, and L was designated under Shareholder agreement [705(e)(5)] as holder of irrevocable then it would be irrevocable.

c)      §706 – voting agreement & statutory close Corp:  only applies to statutory close corporations – under706(a) voting agreements in close corporations will automatically be upheld.

2.       Proxies:  Power of attorney given by Shareholder to someone else to exercise the voting rights attached to shares.  Must be signed and filed w/ the Corp.

a)      Revocability of Proxy:  A proxy is revocable at any time, unless made irrevocable.

b)      Irrevocable Proxy:  If the proxy has been given for the benefit of the agent (person getting the proxy) rather than for the person giving he proxy, then it will be irrevocable.

(1)    § 705 (3):  If you label the proxy as irrevocable, it will be when it is held by someone in the 6 categories in the code.

(2)    § 705 (3)(e)(6):  If proxy was given to secure the performance of some obligation it will be irrevocable until the service is performed.

(3)    § 705 (f):  If transferee of shares takes w/o notice of irrevocability, the proxy may be revoked unless statement of irrevocability is on the face of the stock certificate.

(4)    Example:  B tells C he wants to buy the stock of C’s co. but does not have sufficient money, and wants to spread the payments out over 5 years.  C agrees, but wants to retain title to the stock until final payment.  B agrees, but wants proxy so he can vote on the stock.  C agrees then wishes to revoke the proxy.  C cannot because the proxy is irrevocable.

(5)    Example:  B (agent) is VP of ABC co. for the manufacturing division.  C (principal) is the owner & CEO of widget Corp & needs new VP of manufacturing & goes to B and asks “I need you to be my VP.”  B agrees but wants a proxy on voting the stock because he does not want to be ousted for people not liking his management.  C agrees for 5 years.  After the first 2 years, C does not like B’s management style so tries to terminate proxy.  C is unable because the proxy is irrevocable.

(6)    RINGLING BROS – If ladies had given proxy, it would be revocable because it was for the benefit of the ladies, not for the benefit of Mr. L.

3.       Voting Trusts:  Device employed by Shareholders to assure control of voting whereby each Shareholder transfers legal title of his shares to a trustee and trustee votes all the shares in accordance w/ instructions in the document establishing the trust.  Dividends must be distributed to beneficial owners (trustee has voting rights for life of the trust)

a)      Transferability:  The certificates are transferable, but the trustee (not transferee) always has the right to vote.

b)      Example: HH controlled TWA & TWA needed $ to buy new planes.  Bank would not lend b/c  feared that HH would use funds improperly.  Bank agreed to lend if the voting rights of the stock in TWA were put into a voting trust managed by the bank until the loans were paid off.

c)      Example:  B owns 60% in Corp A.  B wants to acquire C Corp that’s very anxious to join w/ A.  A has no cash so to merge C to A & old C’s Shareholder stock in the new larger A.  B is worried that if he carries it out, old A stock will be redistributed & his % will decrease and he will lose control.  B says he will only do it if Shareholder of 40% put their votes in a voting trust w/ B as the trustee.

4.       Non Voting Stock: Can be owner of the stock & yet not have the rights to vote because of the type of stock.

5.       Classify Vote:  Turn Stock into 3 classes & put in AOI that class A gets 2 directors, B gets 2, etc.

C.     S/H Agreements:  Shareholder’s can try using agreements to cause the BOD to take certain action. This depicts a deviation from the corporate norm since traditionally, the BOD has independent judgment.

1.       General Rule:  Can’t tie the hands of the BOD by deciding in advance who will be officer or director, but S/H can decide who they want to elect as directors.  (Rationale:  Directors are charged w/ fiduciary duties to the Corp, therefore the S/H agreement which restricts their actions is void.)

2.       MCQUADE – Minority S/H Agreement:  M was controlling Shareholder of the Giants and wanted to sell shares but still vote & sold to D’s but made agreement so D would vote their stock so M would be director & be employed as treasurer of the co.  D then had M fired & not voted as director.

a)      Held:  Shareholders can get together & agree to vote their shares any way the want but they cannot agree among themselves as to how they will act as directors in managing the affairs of the Corp because directors are supposed to use independent judgment.

b)      Rationale:  Protects the minority Shareholders that didn’t agree because every Shareholder has the right to expect these norms & one of the norms is that the directors will be independent.

3.       CLARK – Agreement Between 100% of Shareholders:  C (25% owner) & D (75%) enter into a Shareholder agreement agreeing to elect people as directors & then agree how they would act once they were directors.  C performed, then D refused.

a)      Held:  court enforced the agreement because there was no minority Shareholders.  Here 100% of the Shareholders agreed to tie the hands of the BOD.

b)      When 100% of the Shareholders agree, then the court will enforce. 

4.       GALLER –Shareholders voting agreement:  E-B (475.5%), I-S(47.5), and R (5.4% employee) are owners of Corp.  E-B & I-S sign S/H agmt that each group gets to vote for 2 of the 4 BOD; they would get paid a fixed dividend and that upon death of either brother, Corp would give the widow a pension. B died & Corp refused to pay agreed pension.  R had sold his shares back to I-S.

a)      Held:  Agreement enforced because even though there was a minority Shareholder, he was no longer there & he never complained about the agreement when he was part of the company.

5.       Summary:  As long as there’s no dissenting minority & not in violation of law, and it’s reasonable, the courts will uphold the agreement.  CA came up w/ statutory close corps to solve this problem.

D.     Statutory Close Corporations:  Device where S/H may participate in the mngmt of the business; limits BOD decision making power due to prior agrmt, but must fit w/in statutory definitions of a close Corp.

1.       Definition of a Close Corp.  CCC § 158: 

a)      AOI must state a max of Shareholders and that number cannot exceed 35 Shareholders [AND]

b)      Must state “This is a close Corp” in stock certificates.  (Also need “Inc., Corp.” in the name)

2.       Shareholder Agreements § 706:

a)        They are 100% enforceable by becoming a close Corp, you can enter into Shareholder agreements to alter statutory norms of the Corp. (can provide anything about internal governance.)  Agreement can provide for any thing[300(b)] and these agreements will be enforced in a close Corp because they are provided for in §300.

b)      To enter into a binding Shareholder agreement:

(1)    Agreement must be written [AND]

(2)    Must be unanimous (signed by 100% of Shareholders).

3.       Losing Close Corp Status:

a)      Shareholders can just agree they no longer want to be a close Corp.  All that is needed is a 2/3 vote.  (Ordinary corps can agree to be a close Corp, but this is difficult because 100% shareholder approval is needed.  These Shareholders expected a general Corp.)

b)      § 418(d):  S/H agrmt & close Corp status are terminated (left w/ nothing) if # of S/H in Corp becomes greater than max # stated in AOI unless it is written into the S/H agreement that the Corp loses close Corp status, the agrmt will be enforced as much as possible under CL.

c)      Issue of New Stock:  If 100% of Shareholders in close Corp sign agreement, then Corp decides to sell additional stock (w/ o surpassing max in AOI), if the new Shareholder refuses to sign agreement, then Shareholder agreement is terminated.

4.       Transfer of Shares - § 418:

a)      Transferee is bound by Shareholder agreement [(§ 300(b)]

b)      Transferee must have either actual or constructive knowledge.

5.       Piercing the Corporate Veil: court examines if the Corp has complied w/ formalities.  This argument cannot be used to Pierce a Corp Veil of a “close Corp” if a close Corp puts something in the AOI that says they don’t have to follow formalities.  § 300(e)

6.       Dissolution: Any Shareholder in a close Corp can petition for dissolution and they automatically have standing.

7.       Other Control Devices (Only in Close Corps):  Minority Shareholder in Close Corp seek to achieve a certain degree of control by Shareholder agreement.

a)      Super Majority:  C wants to be 25% owner in a Corp (minority Shareholder) so wants to the Corp to put in AOI that BOD can bind only if 80% agree. This gives minority Shareholders an effective veto, even though they won’t be able to push their policies through.  (Danger:  if there’s a serious falling out between the majority & minority, it will totally paralyze the Corp.)

b)      Restrictions on Transferability of Stock:  since S/H in a close Corp have more power than in a public Corp, the S/H may want to prevent the transfer of shares unless approved.

(1)    General Rule:  Share transfer restrictions will be upheld as long as reasonable.

(a)    Unreasonable = put into the stock “this stock cannot be sold unless approved by Joe”

(b)    Reasonable = determined at the time the agreement is made.  Courts have held as reasonable:

(i)                  Right of first refusal – Shares offered to Corp, other S/H or both on same terms.

(ii)                First Option – Prohibit transfers unless shares has been offered to Corp at price fixed by some formula.

E.      Shareholder Derivative Suits:  Shareholder unhappy because BOD not vindicating certain rights.

1.       Reasons Shareholder may bring Derivative Action:

a)      BOD not following through where Shareholders thought they should make a collection against someone who owes Corp Money because he is a friend of BOD.

b)      BOD itself is acting improperly. (i.e. stealing from Corp.)

2.       Shareholder suit:  In a derivative suit, S/H is suing a behalf of Corp not on behalf of themselves.

3.       Uniqueness:

a)      Lawyer seeks out Client not other way around:  S/H doesn’t gain much in derivative suit so usually instigated by L to make money.  (Lawyer gets paid on contingency)

b)      Client is not active in litigation.  Once litigation as begun, the Shareholders don’t participate so they have no control (no input to Lawyers) because they only own small shares.

c)      Shareholders don’t have real large stake in the litigation.

4.       FRCP 23.1  Lawyers cannot settle w/o approval of court:

a)      3 elements necessary to bring derivative action

(1)    Contemporaneous Ownership: must own the shares already at the time the complained of action occurred.  Can’t buy litigation by noticing something that was done wrong, then running out and buying a single share.  (Except if shares were obtained by operation of law (i.e. inheritance) and person who had it earlier was owner at the time of the transaction.

(2)    Security for D: must put up cash/bond so if P lose, the costs put out by D will be paid for (except in Federal courts where this isn’t required.  However, if there is diversity, then federal law may look at state law and require it.)

(3)    Demand:  Demand on the BOD must be made 1st.

(a)    If claim of Shareholder is that the board must collect $ from a 3rd party, then Shareholder must have made a demand on the BOD before bringing the claim

(i)                  Since BOD is in charge of control & management, in this situation, derivative suit will be halted.

(b)    If claim is that BOD did something wrong, then may be able to avoid demand because it would be futile to ask BOD to sue themselves.

X.                 Insider Trading

A.     Definition: someone related to the Corp (directors, officers) is in a position to have inside info about how the Corp is doing, and what the Corp’s stock is or will be worth.  This person (“insider”) then buys stock (w/ an advantage over the seller) or sells (w/ an advantage over the buyer).  For this reason, duties and restrictions have been placed on the insider, both at CL and by the fed securities law. 


  1. CL:  Maj has held that directors and officers owed no special fiduciary duty to present or prospective S/H and could deal at arm’s length when buying/selling shares (they only had a duty to the Corp; no duty to disclose inside info which affected the volume of shares to the Shareholders).

1.       STRONG – Special Facts Doctrine:  Director cannot seek out a stockholder for the purpose of buying his shares w/o making disclosure of material facts he has that the stockholder doesn’t know.

a)      General Rule:  No fiduciary duty to Shareholders unless there are special facts.

b)      Here, there were special facts because the director, using inside info, sought out the minority Shareholders in the Corp to purposefully purchase their stock before the value increased.

2.       GOODWIN v. AGAZZIZIndirect Transactions:  Special Facts Doctrine not applied b/c the director purchased the S/H’s stock on the exchange, w/ no communication between them.  (There was no “seeking out”; the P decided voluntarily to sell & sold anonymously over the exchange.)

a)      General Rule:  Insiders do not have any fiduciary duty to their fellow Shareholders but they do have a fiduciary duty to the Corp itself.

3.       Material Information:  Information does not have to be certain.  If it would have an impact on a reasonable investor, then such information is Material and must be disclosed.

4.       DIAMONDDuty to Corporation

a)      Due negative inside info (IBM’s raised the price for fixing PC’s will make Corp go downhill), the CEO sold Corp stock on the market before public discl. and the sale devalued the stock.

b)      The court held that it could not find a duty between the directors & the S/H (the buyer of the stock) but found wrong committed.  Therefore, the court held that a duty existed between the director and the corp.  Loss of reputation due to the director's acts was a breach of that duty.

c)      This is a minority opinion, rarely followed.

d)      Solution = Legislation (see below) where the buyer could have presumably sued the insiders under rule 10b-5.


  1. Securities Exchange Act of 1934 – Federal Regulation of Insiders:  Two section of the act deals w/ purchases and sales by insiders (Rule 10b-5 & §16)

1.       SEC Rule 10b-5 (Anti Fraud Provision) – It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of Interstate Commerce, or of the mails or of any facility of any national securities exchange

(1)    To employ any device, scheme or artifice to defraud,

(2)    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

(3)    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.

b)      Application:   10b-5 applies to cases regarding schemes to defraud, misrepresentation and non-disclosure in securities transactions.  The breach of a fiduciary duty when purchasing or selling stocks is a concern addressed by the statute.  The P must be a buyer or seller, and the D must have knowingly (possibly recklessly) made 1) a material misrepresentation or 2) non-disclosure which affected a securities transaction.

(1)    Purchase or sale may be of any Security:  Applies to all sales/purchases of any security, including debt securities (not limited to large or public corps)

(2)    Any Person:  10b-5 applies to any person, not just insiders.

(3)    Use of Any Means of Interstate Commerce:  This has been read very broadly.  Using Telephone lines where the lines are somehow connected interstate is sufficient.

(4)    In Connection w/ Purchase of Sale:

(a)    The P must have actually purchased or sold securities due to the deception to have standing.

(b)    BLUE CHIP STAMP:  Company had a prospectus that P claimed made negative implications because the Corp really didn’t want to sell it’s stock.  P claimed he relied on this & did not buy & now seeks relief under 10b-5.  SC said 10b-5 does not apply unless an actual sale/purchase is made. 

(c)    D doesn’t have to purchase or sell; it’s enough if his acts affect the market.  See press release in TEXAS GULF.

(5)    Material Requirement (Objective Standard):  What constitutes a material misstatement or omission for the purposes of 10b-5?

(a)    Test:  Would a reasonable investor consider it important in making his decision to buy or sell stock?

(b)    Materiality requires a balancing of the anticipated magnitude of the event (whether or not there is a deal yet) against the probability that the event will occur.

(6)    Remedies:

(a)    Private Right of Actions:  The courts have implied a private right of action although not explicitly stated in statute.  P may sue for injunction, damages, or recession. 

(b)    SEC Enforcement Actions

(c)    Criminal Action:

2.       Requirements added by the Courts for 10b-5 Violation:

a)      State of Mind – Scienter:  D must have made the false statement w/ an intent to defraud, manipulate, or deceive.  Negligence is insufficient, though some courts have held that reckless disregard is enough.

b)      Causation:  Misrepresentation must have caused the damage (withheld information must always be the cause)

(1)    Hypothetical Illustration:  Director of ABC calls D & tells him to buy shares of ABC because the Corp found a cure for cancer.  D buys shares from X.  Info turned out to be false, but the stock price increased anyway because ABC found oil.  Is D liable to X?  Does it matter that info D got wasn’t true?

(2)    2 Theories of Causation:  X must show that D’s info was the cause of the transaction AND the loss.

(a)    Transactional Causation:  Here, the info did cause the transaction whether it was true or not D bought because of the directors’ false info.

(b)    Loss Causation:  The cause of the loss to X had to do w/ something totally different (oil found ) then D’s info.

(3)    Private Cause of Action:  Must show both Transactional & Loss Causation.

(4)    10b-5 Violation:  Just needs to show that the info was a breach of fiduciary obligation.

c)      Reliance:  P must have relied on the misrepresentation when deciding whether to purchase or sell.  If P would have bought anyway, then no reliance (Primarily in private Causes of Action)

(1)    Face to Face Misrepresentation:  P must have relied on affirmative statement.  If there was an omission, then reliance is assumed if the omission is material.

(2)    Affirmative Misstatement in Anonymous Market Transaction:

(a)    Fraud on the Market:  In a well-defined market (i.e. stock exchange) reliance on any public misrepresentation may be presumed based on the fraud on the market theory which creates a rebuttable presumption that P relied on D’s material misrepresentations.  (No affirmative reliance required because the market as a whole already relied on the misrepresentation by setting the price that was paid.)

(b)    BASIC v. LEVINSON:  Where P’s reliance on D’s misleading statement (denial of merger negotiations) was presumed for the purposes of a 10b-5 action, and D had the burden of rebutting this presumption (could be rebutted by showing that P independently purchased stock outside any market place info).

d)      Breach of Duty Required:  To violate 10b-5 insider must breach a duty owed to the Corp.

e)      Insiders – Duty of Disclosure or Abstain:  Corporate insiders who know material facts owe a duty of disclosure to the persons from whom they buy or to whom they sell.  They must disclose the inside info or abstain from trading.

(1)    SEC v. TEXAS GULF (Mineral Case)

(a)    D made a significant discovery of ore, but issued a press release downplaying their find.  The SEC brought action under 10b-5 against employees of D that bought stock prior to the full disclosure to the public concerning the discovery, and also sued D for the misleading press release. 

(b)    Held:  Violation of 10b-5 for insiders (employees) of a Corp, having inside info, which has not been disclosed to the public, to purchase the Corp’s securities w/o public disclosure of the material info.

(c)    Held:  The court found that the misleading press release was a violation of 10b-5 because the effect of the release caused the market price to be affected so it was “in connection with the purchase or sale of securities.”

(d)    The SEC requires full and complete disclosure when making a statement to the public.

(e)    Timing Required:  Market must have time to absorb any disclosure made before an insider can begin trading the stock.  The more complex the disclosure, the longer the waiting period.  Must wait until the news could have reasonably been expected to appear over media of widest circulation.

f)       Outsiders – No duty to Abstain:  A person who busy or sells a security, w/o disclosing material information about the security, and who has no relationship/fiduciary duty to the Corp or to the person w/ whom he deals (other side of the transaction) does not violate 10b-5.

(1)    CHIARELLA v. U.S. (Printer not Insider)

(a)    D, a printer, acquired takeover info while printing takeover bids.  Before the offer became public knowledge, D purchased stock in the target company w/o informing its Shareholder’s of his knowledge of the proposed takeover.

(b)    Held:  D could not be convicted on a failure to disclose his knowledge to the Shareholders or the target Corp. because he had no duty to disclose.

(i)                  Mere possession of important market info does not impose any duty to disclose it before trading.

(ii)                Duty arises from the relationship between the parties and not merely from one’s ability to acquire info due to his position in the market.

(c)    General Rule:  There must be a breach of fiduciary duty (existence of a relationship affording access to insider information intended to be available only for Corp. purpose) to the person on the other side of the transaction in order to violate 10b-5.  In this case, D owed no duty to the target co. or the acquiring Corp.

g)      Misappropriation Theory:  (Adopted in CHESTMAN & by Dissent in CHIARELLA, but SC is split on it.)  In situations where someone expends their own energy & puts together public info, they should be able to trade even if they somehow acquire non-public info.  But if he has stolen the information, he cannot trade even if he’s an outsider & has no fiduciary duty to the other side of the transaction.  Breach of fiduciary duty to the person it was stolen from is implied.

h)      Tips (Giving & Receiving Stock Tips)

(1)    General Rule:  A person receiving the tip assumes a fiduciary obligation to the Shareholders of a Corp not to trade on material, non-public info only when:

(a)    The insider has breached his fiduciary duty tot the Corp by disclosing confidential info to the receiver for some personal benefit; AND

(b)    The receiver of the tip knows or should know that there has been a breach (the tip receiver must be a “knowing confederate”)

(c)    Personal Benefit TestDIRKS:  VP of the Corp (tip giver) gave info to D (tip receiver) regarding the Corp producing fraudulent insurance policies.  D, a financial analyst, gave this info to his clients, whereby this clients sold their shares to the Corp.

(i)                  Where an insider breaches a duty by giving a tip depends in large part on whether he is exploiting the info for his own benefit.

(ii)                Here, absent personal benefit, there was no breach to the Shareholders by the insider.

(iii)               Since there was no breach by the insider, there is no derivative breach by D.

(iv)              The court also wanted to protect financial analysts, because they provide a valuable service to the public.

(2)    Hypo:  Tip giver must have breached fiduciary obligation for the tip receiver to be liable so if the tip giver goes to B (banker) and asks for a loan telling B they just had a mineral find, and B calls his broker to buy stock in the Tip Giver’s company, B is not liable because the Tip giver didn’t breach fiduciary duty by asking for a loan.

(a)    But, FN 14 in DIRKS says that if corp info is told to an underwriter, accountant, outsiders, etc., they may have a fiduciary duty to the S/H b/c they got non-public info only for corp purposes.  This duty only imposed if the Corp expects the outsider to keep disclosed non-public info secret and the relationship at least implies such a duty.

3.       Tender Offers – Rule 14e-3(a):  Rule promulgated by SEC that only applies to tender offers.  Upheld in CHESTMAN—if you have non-public material info you received from the party making the tender offer, party on the other side, or anyone who’s an agent of either side, then if you have this info about the tender offer, it is illegal to act.

4.       SEA § 16 (Short Swing Profits): C’s attempt to limit insider trading, wanted to make it unattractive for insiders to trade & make profit.

a)      § 16(b):  Officers, Directors, and More than 10% owners must pay to the Corp any profits they make within a 3 month period, from buying and selling stock. 

(1)    Only applies to “certain Corporations”: 16(b) only applies to publicly held corporations that:

(a)    Register on a national securities exchange; OR

(b)    Has both a minimum of $5 million in assets AND at least 500 Shareholders. 

(2)    Intent not required:  director can buy and be innocent then 4 months later, need to sell for heart transplant & he would still be subject to 16(b).

(3)    Only Applies to “Certain Insiders”: 16(b) applies only to officers, directors, and holders of more than 10% of a class of equity securities of the Corp.

(a)    Officers & Directors:

(i)                  One cannot avoid a 16(b) violation buy resigning.  (As long as he was an officer at the time of the purchase of stock)

(ii)                Deputization:  If X Corp asks one of it’s officers to be on the BOD of Y Corp, then X Corp makes a profit on Y stock, w/ in 6 mos, X may be liable under 16(b).

(b)    More than 10% Beneficial Owners:  must be such owners at both ends of the transaction for the purposes of 16(b).

(i)                  Reliance: Owner had 14%, then sold 4% and turned in the profits, then sold the other 9.99% and kept the profit.  USSC held this allowable because D must have more than 10% at the time of purchase AND at the time of sale to be subject to 16(b).

(ii)                MACKESSON: Court held that D must have > 10% at the time of the purchase that you want to match w/ the sale. Here, D wasn’t more than 10% at the time of the purchase so he could keep the profits.

(4)    Only applies to Equitable Securities.

b)      Enforcement of § 16(a):  Requires all officers, directors, more than 10% owners to file on public record when they purchase & sale securities.

c)      Determining “Profit” under 16(b):  Profit is computed by matching the lowest purchase price and the highest sale w/in the 6 month period, followed by the next lowest price and the next highest sale, and so on.  Only gains are counted and they are not offset by losses.



# of Shares

Stock Price

Jan 1




Feb 1




Mar 1




Jun 1




Solution:  300($50) – [200($10) +100(30) {from Jan1}] = $10,000 short swing profit


d)      Determining what constitutes a “sale” for 16(b) violation:

(1)    KERN:  O Corp wanted to acquire KERN, but K management did not agree.  O went to Shareholder’s & made tender offer & acquired 30% of stock (only stock at issue is the stock acquired after O became a 10% owner).  In the meantime, K approached T for a merger so K’s S/Hs would be come a small percentage of T & O and K could not take over.  Under the merger agreement K’s S/H would get preferred stock of T.  O negotiates an option w/ T for T to buy back stock O has in K, but says T can’t exercise option for at least 6 mos and 1 day after their tender offer (to K Shareholders) expires.  P’s here are claiming that at the time of the merger between T& K, O got preferred stock of T and this was a “sale”.

(2)     General Rule

(a)    In most situations, stock swap will be deemed a sale.

(b)    Here, the Court focused on policy & purpose of 16(b) as prohibiting insider trading & holds there’s no possibility of speculative abuse due to O’s >10% ownership because K wanted nothing to do w/ O so O couldn’t have any inside info.  Therefore, no sale.

(c)    16(b) usually applies to cash transactions, but may apply to mergers; if there’s a chance for speculative abuse, then it will be considered a sale and subject to 16(b)

XI.               Dissolution

A. Voluntary Dissolution - § 1900:  state law provides that if a certain percentage of the Shareholders agree then the court must order dissolution.

1.       Definition:  Any Corp may elect voluntarily to wind-up and dissolve by the vote of Shareholders holding shares representing 50% or more of the voting power.”

2.       Don’t need to go to court as long as 50% or more agree to dissolve.

3.       If minority wants dissolution, then must go to court for petition.

A.     Involuntary Dissolution - § 1800:  On petition of a Shareholder and on certain conditions, the court may order the Corp to dissolve.

1.       Must have Standing - § 1800(a)

a)      One-half or more of the directors in office.

b)      The Shareholders representing not less than 33 1/3% of:

(1)    Outstanding Shares [OR]

(2)    Outstanding Common Shares [OR]

(3)    Equity of the Corp.

(4)    See Exception Below.

2.       Grounds for Dissolution

a)      Corp has abandoned business for more than 1 year.

b)      Even numbers of directors are equally divided and cannot agree resulting in disadvantage to business or property and the Shareholders are so divided that they cannot elect a BOD consisting of an uneven number of directors.  This is the notion that there must be economic adversity even if also have an equally divided board & divided Shareholders.

c)      The Shareholders are so deadlocked that business can no longer run at an advantage or Shareholders have failed at 2 consecutive annual meetings to elect successors to BOD whose terms have expired.  (Also need economic adversity here or Shareholders cannot elect.)

d)      Those in control are guilty of fraud, mismanagement, abuse of authority, or waste of Corp property.  (Here, 1/3 isn’t needed for standing)

e)      In close corps, liquidation is reasonably necessary to protect interest of Shareholders.

3.       Economically Viable Corp: Having an economically viable Corp won’t stop dissolution but has a big impact.

a)      RADDUM:  Falling out between 50% owners of Corp.  Court wouldn’t allow dissolution because during the period of turmoil, the Corp was making lots of $$$.

b)      Economic Adversity:    not enough for dissolution usually must also show some other grounds (i.e. deadlock)

B.     Avoiding Dissolution - § 2000:  Subject to contrary provision, the S/Hs with at least 50% of the votes can dissolution of the Corp by purchasing for cash, the shares owned by those who want dissolution.

1.       Example:  A owns 50%, B owns 40%, C owns 10%

a)      A may cause voluntary dissolution because 50% is sufficient.

b)      B cannot cause voluntary dissolution due to only having 40%.  Assuming B can show economic adversity for involuntary solution, A &C can block B by coercing B to sell his shares under § 2000.

2.       Buy Out Price:  If they can’t agree on a price that those against dissolution will pay to get the shares, then § 2000 allows the court o appoint 3 independent appraisers to determine a fair value of stock.  B is then obligated to accept that price.

Limited Liability Corporations

I.   §1700 (enacted 1994)

  1. Company not Corporation:  Statute disallows use of the word “Corp” or “Inc.” in the name.

B.  Melds Corp code & Partnership Code.

II.                 Characteristics

1.       Limited Liability for all owners

2.       Owners = “Members” (not Shareholders)

3.       Personal Assets: Not available to creditors

4.       Taxation:  There’s assurance of no double taxation; taxed same as a Partnership & profits & losses are passed to owners directly.

a)      Distinguish Corporation:  In Corp, the profit is taxed to the Corp as an entity, then after tax funds may go to Shareholders as dividends and are taxed again.

b)      Distinguish Subchapter S Corp:  Taxed like a Partnership, but they’re very restricted & limited.  (Must have less than 35 Shareholders and could only have one class of stock, etc.)

5.       Doesn’t matter how many members in LLC, and doesn’t matter whether member is foreign or domestic.

6.       At least 2 people required.

7.       Flexibility of Management:  Similar to a Partnership, can arrange in any way.

III.               Formation

1.       Filing:  Short Document called “Articles of Organization” must be filed w/ secretary of state

2.       Operating Agreement:  must be signed by 100% of members & this is very flexible.  Internal Governance can be arranged in anyway.

IV.              Duration:  Not perpetual—duration must be fixed.

A.     Transferability – One can assign his membership, but assignee gets no managerial control unless 100% members agree or it is allowed in AOO.  So only transfer economic interests w/ rights to management.

B.     Dissolution

1.       Voluntary:  Majority of members can have voluntary dissolution unless otherwise stated in AOO.

2.       Judicial Decree:  Any member can ask court for dissolution and in some cases, courts can order it.

3.       Coerced buy-out:  similar to § 2000, court can force party wanting dissolution to accept cash rather than dissolution.