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Baumer Outline


I.        Distinguishing Between Partnership and Corporation

A.      Liability

1.       Partnership

a)      Liability of a partner is limitless, where each partner is personally liable for all the debt of the Partnership.

b)      Personal liability, where partner could be stuck w/ 100% liability if he has “deep pockets.”

c)       Liability is NOT limited to initial investment (unlike a LLP)

2.       Corporation:

a)      Shareholders and Managers are not personally liable for corporate debts because a corporation is a separate entity.

(1)    Exception:  Piercing the Corporate Veil for Managers, Directors, Officers (but not Shareholders)

b)      Shareholders liability is limited to the initial investment in corporation – “Liability Shield” (They still stand to lose a small amount of money)

B.       Management & Control

1.       Partnership:  Each partner has equal powers in Management, and can effectively bind his co-partners to the Partnership business, unless the Partnership Agreement provides otherwise.

2.       Corporation:  Board of Directors elected by the Shareholders to make the decisions (centralized control)

a)      Shareholder have virtually no power over management decisions (except to select/remove directors)

b)      Shareholders cannot bind the Corporation.

C.      Transferability

1.       Partnership:

a)      A Partner cannot transfer a P interest w/o the unanimous consent of the other partners.

b)      Difficult to transfer P interest due to liability factor

c)       Dangerous due to general agency and liability of Partnerships (all partners are liable) – requires confidence in other partners.

2.       Corporation (publicly held):  Ownership is divided into shares (stock) that can be freely transferred.

D.      Continuous Existence

1.       Partnership:  Absent an agreement to the contrary, a P is dissolved upon the death, bankruptcy, or withdrawal of any partner.  (Except in California, of course)

2.       Corporation:  Unless specifically limited in the articles, a corporation exists perpetually, until dissolved in accordance w/ statute.

II.      General Partnerships

A.      Formation of a Partnership (is there a partnership)

1.       Uniform Partnership Act (UPA) § 15006

a)      Partnership = “association of 2 or more persons to carry on as co-owners a business for profit”

b)      General Characteristics of a Partnership

(1)    Sharing of Profits

(2)    Sharing Control

(3)    Participation in Management

(4)    Joint/Several Liability

c)       Hypothetical Illustration:  A is a mechanic and B contributes capital to buy and rebuild a car.  While rebuilding the car, it rolls off and injures C.  Is B liable?

(1)    Business:  Can be one transaction – Yes.

(2)    Co-Owners:  Are they co-owners or was it a loan?  If it was a loan, then under 15007, this alone is insufficient to form a partnership even if they share in the profits

(3)    Co-ownership hangs on the notion of management and control.  In the hypothetical, B had some control by deciding what car to buy.

2.       Need for a Written Agreement

a)      General Rule:  No written agreement needed to form a Partnership.

(1)    Required:  Intent to make an association for profit; no mutual consent is needed.  (They don’t even need to thing they are partners!)

(2)    Participation in the control of the enterprise tends to show intent of Partnership.

b)      UPA governs as the default provision

(1)    Some provisions are not subject to contrary agreement.

B.       Determining the Existence of a Partnership UPA § 15007

1.       Generally, Profit sharing alone is prima facie evidence that a person is a partner § 7(4)

a)      In KAUFMAN, the court found the existence of a Partnership even though KB had only small control because of the existence of shared profits.

b)      For Profit Control, Courts Examine:

(1)    Is there a sharing of profits?

(2)    If yes, is it an ordinary customary relationship for that type of relationship?

(a)    Yes = no partnership.

(b)    No =  probably a partnership because the focus is control.

2.       Exceptions (Not a partner when):

a)      Receipt of the profit-share is payment for debt, wages, rent, annuity, interest on loan where the amount varies with the profits of the business or consideration for sale.

b)      Joint Tenancy and Tenancy in Common do not automatically create a partnership (even if there is a sharing of profits) – the focus is control factor.

C.      Inadvertent Partnerships:  Even if the written agreement states that the parties will not be partners, a partnership may still exist.

1.       Intent – Courts will usually give weight to intent, but for formation of partnership all that is needed is §6.

2.       Control – Court looks to see if D has enough control to be a Partner (i.e. veto, sharing profits)

a)      MARTIN – Here, even though D shared in profits and had veto power, the court did not find the existence of a partnership because his actions were only safeguards for the loan.

(1)    Where a person shares in profits, but delineates in agreement that he is not a partner and has no degree of control over Partnership decisions, Courts will be reluctant to find a Partnership because the control factor is the essence of Partnership (They will compare to the ordinary business community for customs.)

b)      Typical Safeguards for Lender-Debtor Relationship even though they may impact control:

(1)    Provision on the Use of Proceeds

(2)    Right to Inspect Books

(3)    Limited Ability of Borrower to Incur Additional Debt

(4)    Provision stating Change in CEO makes entire loan amount due and payable immediately

(5)    Limits on Distributions of Assets, Dividends, etc.

D.      Liability of General Partnerships (§13 – 16)

1.       § 13:  If a partner acts in the “Ordinary Course of Business” [ OR ] with permission of other partners and causes injury, then the entire Partnership is liable.  (And so is the partner who screwed up!)

2.       § 14: Liability for Partners, misapplication of money or property

3.       § 15:  Partners are Liable Jointly & Severally.  Personal Liability of Partners is Limitless

4.       General Liability Theories:

a)      Common Law – Aggregate of members, each partner has to be sued individually.

b)      UPA  - An association to some degree, yet also a separate entity (i.e. Separate entity in property ownership and an Aggregate for Taxes)

E.       Sharing of Profits and Losses (§18) – Absent contrary Agreement

1.       § 18(a):  Each partner shall be repaid his contributions, and share equally in the profits; and each must contribute towards the losses sustained by the Partnership according to his share in the profits.

a)      Equal Rights to per capita share of profits regardless of contribution to partnership.

b)      Absent Specific Agreement, Losses are split in the same proportion as the profits.

c)       No partner is entitled to remuneration for services, unless there is a winding up of Partnership affairs - § 18(f)  {Partners may want negotiate for salary in writing}

2.       RICHERT – Joint Logging Venture Case

a)      Since there was no contrary agreement, UPA controls apply.  Court found that when Partnership ends, the capital contributions of each General Partner must first be repaid before profits may be distributed.  Then, Profits, Losses and Dividends may be divided according to the UPA or Partnership Agreement.

b)      Hypothetical Illustration:  R & H agree to form a Partnership and R invests cash into the Partnership and the Partnership buys timber.  The Cash Investment by R is an expense of the Partnership.

3.       Determining Profits & Losses pursuant to § 18(a)

a)      Ending the Business


Partner A

Partner B

Partner C

Capital Account




Profit Share %




Profit/Loss = 60




b)      Not Ending, but Suffering a Loss


Partner A

Partner B

Partner C

Capital Account




Profit Share %




Profit/Loss = -10K




c)       Agreement as to Profits, no Agreement as to Losses:  § 18(a) states that if there is no agreement as to apportionment of losses, than losses are distributed in same proportion as profit.


Partner A

Partner B

Partner C

Capital Account




Profit Share %




Profit/Loss = -300K

100k (from B & C)



d)      No Agreement as to profits:  § 18(a) states both profits & losses are shared equally


Partner A

Partner B

Partner C

Capital Account




Profit Share %




Profit/Loss = -10K




4.       Effect on 3rd Party Creditors

a)      Any partnership agreements between the partners does not affect 3rd Party rights.  All partners are still Jointly & Severally Liable.

b)      Hypothetical Illustration:  A & B have a Partnership Agreement.  B invests 0, gets 50% of profits and 0% of loses.  The Agreement is only effective between the partners, so B would be just as liable as A.  However, B can sue A under the agreement.

F.       Fiduciary Relationship of Partners.

1.       General Rule:  Co-partners owe to one another, while the enterprise continues, the duty of the finest loyalty.

2.       MEINHARD v. SALMON – S Breached Fiduciary Duty by accepting a new lease agreement.  Since S was given the opportunity for the lease agreement the via Partnership, S had the duty to disclose it to his partners.

3.       Scope of Partnership:  Defining the scope of the Partnership business will make it much easier to define the fiduciary obligations.  (because this allows the court to ask if the Partnership business gave way to the opportunity).  Courts may still use a subjective view of equity if there is a dispute.

a)      Hypothetical Illustration 1: A manages apt. building.  A finds another building for sale and decides to buy & manage it for himself.  A invites B to invest and B does.  2 years later, A gets other investors to purchase another building.  Did A breach fiduciary duty to B by not giving B an opportunity to invest? –Yes.

b)      Hypothetical Illustration 2: Real Estate Broker A asks B to join in investing in property and fixing it up for re-sale.  This was A’s business in the past. 2 years later, A starts another Partnership for the same arrangement. breach fiduciary duty to B by not giving B an opportunity to invest? – No, B has notice of A conducting this type of arrangement.

c)       Analysis: In Hypo 2, the expectations of B would be that A would have similar ventures since that was A‘s Business (not so in #1).  Some Courts have held that in Hypo 2, B should understand that A would have other ventures so no breach of fiduciary duty.

4.       UPA § 21

a)      § 21 Fiduciary Duty:  Partners must account to the Partnership for any benefits & profits received, and hold as trustee for it any profits derived by him w/o consent of the other partners.

(1)    General Partner takes Cash from Partnership, gambles and wins:  Partner must share winnings with Partnership unless he had consent.

(2)    General Partner takes Cash from Partnership, gambles and loses:  Too bad, losses aren’t shared with Partnership.

b)      BASSAN – General Partner sold property to the Partnership at FMV, not to the detriment of the Partnership but without explicit approval of all partners.  Narrow view:  One can’t profit from ANY transaction as a partner unless one has specific express consent of the other partners even if the result is a windfall to the other partners.

c)       §19 Partnership Books:  Partnership Books shall be kept at the Partnership’s place of business and they can be inspected by the partners at any time.

d)      § 20 Disclosure:  General Partner must disclose true and full info on demand to other General Partners, of all things affecting the Partnership

e)      § 22:  Partners right to formal accounting exist if he’s wrongfully excluded, it’s terms of agreement, § 21, or just and reasonable under the circumstances.

5.       Revised UPA (not the applicable law in California) & Fiduciary Duty – Fiduciary Duty is divided into 2 types:

a)      Duty of Loyalty – duty not to compete with the enterprise—once cannot get in conflict with one’s own enterprise without proper approval.

(1)    The Act provides that the duty of loyalty is non-waivable provision, but can be altered if not manifestly unreasonable.

(2)    Duty provides 1) that other General Partner have the right to find out what benefit you’ve gotten and 2) can’t get benefit w/o express permission of other partners.

(3)    A General Partner cannot deal w/ a party who has an adverse relationship to Partnership.

b)      Duty of Care:  Addresses the question of negligence, according to what standards one’s measured to if one’s careful enough.

G.      Partnership Property

1.       UPA – Treats Partnership as an aggregation of individuals

a)      Revised UPA treats Partnership as an entity so each General Partner isn’t a co-owner of Partnership property, rather, the property is owned by the Partnership itself.  The only transferable interest under this view is the ability to receive profits.

2.       3 Property Rights of a Partner (§ 24)

a)      Rights in Specific Partnership Property (can’t assign w/o consent of Partners)

b)      Right to Participate in Management:  (can’t assign w/o consent of Partners)

c)       “Interest” in the Partnership (Can be assigned w/o consent of Partners)

3.       Partner’s Interest in the Partnership and Conveyance of (§§ 26-27)

a)      Hypothetical Illustration:  A & B have a Partnership & each invest equally.  After 5 years, A wants to move and divest.

b)      What is A’s interest in the Partnership?  § 26 – The right to receive profits and surplus, which is treated as personal property and can be taxed.

c)       Can A sell his interest to C? §18(g) –yes if other General Partners consent.

d)      If A doesn’t have consent of other General Partners is there anything A can sell to C?  §27 – w/o consent of other partners, the only right A can sell to C is A’s “interest” in the Partnership.  C’s (Assignee) rights upon assignment – (under §27):  C doesn’t get the right to participate in the management, inspect books, etc. (unless he has partners‘ consent).  He only has rights to the profits.

(1)    If all C receives is the “interest” in the property, he doesn’t become personally liable for losses.

(2)    A still retains management and property rights.

4.       Rights in specific P property (§25):  The partner is co-owner with the other partners of specific Partnership property holding as a tenant in partnership, but tenancy is subject to contrary agreement.  When there is a dissolution, assignee can get an accounting.

a)      Hypothetical Illustration: A owns 1/3 interest in the Partnership and there are 3 computers.

b)      Can A take 1 computer home?

(1)    Personal Use:  No, A cannot use property for personal use w/o partner’s consent (§26(2)(a))

(2)    Partnership Use:  Yes, if for Partnership business because partners have an equal right w/ other partners to possess property for Partnership purposes.  §25(2)(a)

c)       Can A sell 1 computer?

(1)    No, A cannot sell unless he has consent of the partners – to sell/dispose (assign) property, a General Partner needs consent of all partners §26(2)(b)

(2)    Note: Because of agency authority, if it appears that A had the right to sell and an innocent buyer buys it from A, A can transfer good title.  However, if A really didn’t have the right to sell, the other General Partners can sue A.

5.       Creditors Rights in Property § 25 (c),  §28

a)      Hypothetical Illustration:  A has a court order against her to pay child support.  A doesn’t pay.  As’ spouse gets a judgment for the amount.

b)      Can judgement be satisfied by A’s share of Partnership Property?  NO, personal creditors of a single partner cannot reach Partnership property (General Partner’s right in property is not subject to the judgment.)

c)       What can the creditor do? (§28)

(1)    Remedy:  Charging Order (A creditor may get a lien against the Partnership Interest so they are entitled to profits.)

(2)    If the lien doesn’t satisfy the creditor, the court may order a Foreclosure sale of interest in Partnership & the creditor can buy A’s interest in the Partnership using the debt as a “credit bid”.

(3)    If this is a Partnership at will, any partner including a creditor can cause dissolution of the Partnership and Liquidation of assets so the Creditor would then want a Foreclosure.

(4)    Because of this threat, it is a big incentive to the remaining General Partners to pay the debt or get someone else to buy out the creditor’s interest, so the creditor is paid.

6.       Property “Contributed” to the Partnership (§ 8)

a)      All property originally bought into Partnership or subsequently purchased or otherwise on Account of the Partnership is “Partnership Property”.  §8 (1)

b)      Intention:  Unless there is a contrary intention, property acquired with Partnership funds = Partnership Property.

(1)    CYRUS:  brothers enter into a Partnership for a Tourist Camp.  C1 moves on C2’s request and provided labor, C2 provided a 60 acre tract.  Partnership later acquired a 40 acre tract in C2’s name.  After 10 years, C1 dies and widow sues claiming both tracts are Partnership property.

(a)    Intent:  Court found that even though C2 purchased the land before the Partnership Existed, since improvements, taxes, etc., was paid out of the partnership funds, it was partnership property. C2 also expressed in letters to C1 intent for C1 to be ½ owner of the property.

(b)    Title:  Court found, that though the title of the 40 acres in C2’s name, it was not conclusive.  C2 acquired the property with Partnership funds so it was Partnership Property.

(c)    Economic Consequence:  Court examined the economic consequences of what the Partners were doing—C1 wouldn’t have put in 10 years of work if he wasn’t going to get anything out of the partnership.

(2)    Fact Change:  C1 dies when cabin is only ½ built, and had only moved in 4 months prior.  However, the property had increased in value.  Even though C1 & C2 had the same intent as in CYRUS, here, C1 had hardly done any works o the property is probably not Partnership Property yet.  (The court will still examine economic consequences)

(3)    Hypothetical Illustration: B, C, D, E all own ¼ of electronic manufacturing partnership.  The Partnership is set up in a warehouse owned by B.  Years later, they decide to sell the Partnership for $2 million.  Warehouse was worth $10k originally, but has increased to $100k now.  How is the $100k split?

(a)    First, is the property part of B’s capital account or was B’s intent to contribute it to the Partnership?

(i)      If it was not contributed tot he Partnership, then B gets the property back (it doesn’t got to the buyer) even though it’s value has increased due to the Partnership.

(ii)    If it was contributed to the Partnership, B only gets $10k more, the other $90k is split 4 ways.

c)       Factors determining if the property was “contributed” (intent.

(1)    Title:  Did B retain title or was it in Partnership Name?  (not conclusive)

(2)    Economic Consequences:  Was there improvements made and who paid?

(3)    Taxes:  Who paid property taxes?

d)      Revised UPA:  States that intention of the parties determine what’s contributed, but adds:

(1)    If Property is in the Partnership name, then it IS Partnership property

(2)    If the property is in 1 or 2 names of the General Partners & once transferred it is in the Partnership’s name, then it is Partnership property.

(3)    Property Purchased w/ Partnership Funds = Partnership property

(4)    Property Acquired in the name of an individual w/o mention of the Partnership and w/o use of the Partnership funds IS NOT Partnership property even if used in the Partnership business.

H.      Ability of a Partner to Bind the Partnership (Authority)

1.       Agency Law (Incorporated into the UPA): Whether an agent can bind a principal depends on the type of authority the agent has.

a)      Actual Authority:  This is EXPLICIT, principal asks agent to be his agent and the agent agrees.

(1)    Implied Authority:  Based on Actual Authority.

(a)    When one has actual authority, one has sufficient implied authority to exercise the actual.

(b)    A asks B to b his agent to log land.  While doing so, B thinks the best way is to build a RR, so B contracts to build it.  Although A didn’t have Explicit Actual Authority for this, B has the implied authority.  Implied authority comes from the words, customs and relations of the parties.

b)      Apparent Authority: Principal held liable even if no actual authority exists.  Relationship is established with 3rd parties.  Principal “clothes” someone w/ what appears to be authority to act as his agent.  If the clothed party contracts with a 3rd party, the 3rd party is protected and can recover against the principal.

(1)    Reasonable Belief Required:  In BON AMI, the court found that even if other elements of apparent authority are present, the principal is not always bound because it must be something that can be reasonably believed by the 3rd party.  (i.e. If the VP tells umpire that he will earn $1mil/year, it is not reasonable for the umpire to believe.)

(2)    Look to Normal Business Practices:  In LIND LIQUOR CO., the Company clothed VP w/ apparent authority.  VP told P he could have 1% commission on sales.  Court found that even though commission would have made his salary = 4 times his supervisor (possibly an unreasonable belief), this type of commission is standard in normal business practice.

c)       Inherent Authority:  When dealing with an undisclosed principal who puts person in the position of apparent authority, then the principal is bound.

(1)    WATTEAU – H sold bar to D but H stayed on as D’s manager, had his name on the door, and took license in his name.  P sold to H, but H was specifically told by D he couldn’t buy these items.  P thought H had authority, sold to H, and then sued D for payment.

(a)    Actual Authority: Court found no actual authority because D specifically told H he couldn’t buy.

(b)    Implied Authority:  No Implied Authority because Implied stems from Actual.

(c)    Apparent Authority:  For Apparent Authority, D must clothe H to make P think H was D’s agent.  There was no Apparent Authority because P didn’t even know about D so he couldn’t have thought that H was D’s agent.

2.       UPA §0:  Partner as Agent of the Partnership

a)      General Rule:  Every partner is an agent of the Partnership, and his actions in carrying on the business in the usual way binds the Partnership §9 (1)

(1)    Exception:  Partners can protect themselves;  if no General Partner has actual authority, and this is communicated to a 3rd party, then the Partnership is not bound.

(2)    Where partners agree to restrict one partner’s authority to act in a particular manner, and the 3rd person has knowledge that restrict partner has not authority, the Partnership is not bound. § 9(1)

b)      Partner not conducting business w/in scope of Partnership business (not in the usual way) does not bind the Partnership. §9(2)

(1)    Exception:  Authorized by other General Partners (Actual Authority) – Does not have to be within the scope of Partnership, if one have actual authority based on agreement between partners.  (Therefore, the Partner may bind the Partnership)

(2)    A majority can change actual authority unless it’s an extraordinary matter that needs the consent of all.

c)       Hypothetical Illustration 1: A, B & C agree that none can make purchases in excess of $500 w/o consent of all.  C goes and buys $20K worth of dresses.  Is Partnership bound?

(1)    Here there is no actual authority, but Partnership is bound because they didn’t give notice to 3rd parties that C had no authority, so C acted w/ Apparent Authority.  Partnership could have protected themselves by letting 3rd parties know C had no Authority.  § 9(1)

(2)    What if C buys a Maserati & tells dealer he’s buying on behalf of Partnership.  Is Partnership bound?

(3)    Unless C had consent of all General Partners, Partnership is not bound because C was not acting w/in the scope of business (dresses).  §9(2)

d)      Revised UPA:  requires documents be filed with the secretary of state as a public record to notify public who has authority and lets 3rd party know what acts are in the ordinary course of business.  If 3rd party relies on the public record, the Partnership is bound.

I.        Rights of Partners in Management

1.       § 18(e):  all General Partners have equal rights in management and conduct of Partnership business unless contrary agreement exits.  A majority can restrict 1 partner’s authority unless it is in contravention of any agreement between partners in which there needs to be unanimous consent.

2.       § 18(h): Differences arising as to ordinary matters connected with the Partnership business can be decided by majority of General Partners, but need consent of all partners to act in contravention of agreement.

a)      Hypothetical Illustration:  A, B, C each are 1/3 General Partners in retail dress Partnership.  B loses confidence in C and wants to protect self against C incurring liability.  What are B’s options?

b)      B can ask A, B, & C to all agree that all 3 are needed for any business decisions, but C probably won't agree.

c)       §18 (h):  If the original agreement didn’t set out who does the buying, b can get A to agree with him & inform C that he no longer has the right to Contract.  B must then also give creditors notice of C’s lack of authority.

d)      C may assert that taking authority away from C is not an ordinary matter—it’s an extraordinary matter so the consent of all 3 would be needed.  (Ordinary matters can be decided by a majority, but to rightfully remove authority requires 100% consensus.)

3.       2 person Partnership (no majority)

a)      General Rule: 2 persons in a Partnership, if the binding act is the same type that the Partner has done in the past and one partner now tries to restrict the other partners power, courts will hold the other partner liable. (Majority is still required to restrict Authority)

b)      STROUD -   S & F were partners.  S told P that F can’t buy anymore.  F bought & §p sued S for payment.  The court held that the only way to change the authority of the partner is § 18 (majority), but since no partner can get a majority here, S is liable.

c)       Exception:  If one partner tries to alter the way something is done in the Partnership, the court will not allow the alteration due to no Majority. (Courts will not alter an existing way of doing business.)

d)      Hypothetical Illustration:

J.        Liability for Misrepresentation of Person as a Partner

1.       UPA § 15016:  One must either represent one’s self as being a partner when you aren’t, OR consent to another representing one as a partner when one isn’t.

a)      Reliance:  Creditor must rely upon the misrepresentation of a person being a General Partner for the person to be held liable.

b)      Public Manner:  Misrepresentation only needs to be made in a public manner.  It doesn’t matter how creditor finds out. Even if Misrepresentation is not made to a specific creditor, if he relies, he’s protected.

c)       There’s no reasonable obligation to negate someone else’s false statement that you are a partner.

(1)    Exception – If the misrepresentation has been made repeatedly and B knows others are relying on it & it would cost little or 0 for B to negate the claim that he’s a partner, then B is liable if he does not negate.

(2)    Hypothetical Illustration:  At a cocktail party, A tells B he just lent $20k to B’s Partnership.  B doesn’t have a Partnership & says nothing.  $0 cost to negate, therefore B is liable.

d)      Consent:  Silence is not consent.  Affirmative consent is required for one to be held liable.

(1)    If one knows he is being held out as a General Partner, but does nothing, he is not liable.  (i.e. if driving on a freeway and one sees a sign stating that “X (he) has joined our Partnership”, he will not be liable even if he does not act to correct the misrepresentation.)

(2)    If one didn’t know that he was being misrepresented as a partner, than he is not liable.

K.       Dissolution of Partnership

1.       UPA § 29:  Dissolution of a Partnership is the change in the relation of the General Partners caused by and General Partner ceasing to be associated in the carry on of the business.  (not the same as winding up.)

2.       UPA § 30:  On dissolution (legal happening) the Partnership is NOT TERMINATED,  but continues until the “winding up” of Partnership affairs is completed (liquidation)

3.       UPA § 31: Causes of Dissolution (Objective) – Court is not required to determine.

a)      Causes of Dissolution if No violation of Partnership agreement § 31(1)(a)-(d):  Lawful dissolution allows each General Partner the right to have assets liquidated and get his share in cash.

(1)    Dissolution w/o violation of agreement caused by:

(a)    End of definite term agreed upon.

(i)      PAGE court held “term can be until some event occurs, but on the facts of the case, it was a Partnership at will.  Court also held that there’s a fiduciary obligation not to dissolve the Partnership improperly.

(ii)    To satisfy the fiduciary obligation:  If one wants to dissolve then take over the business, one must treat fellow partners fairly and give fair compensation.

(b)    By express will of any General Partner, if it’s Partnership at will.

(c)    Express will of all General Partner’s (who haven’t assigned interest) when there’s a defined term.

(d)    By expulsion of any General Partner who acts in such a way that confers a power (by agreement) on the General Partner’s that expel him.

b)      Causes of Dissolution if in violation of Partnership agreement § 31(2):  Partner always has the power to cause dissolution but may not have the right (major repercussions).\

(1)    Express will of any General Partner, in contravention of Agreement.

c)       Other Causes § 31(3)-(7):

(1)    Any event making continuation illegal.

(2)    Death of a partner, unless all partners otherwise agree BEFORE such death (in writing) – In CA.

(3)    Bankruptcy of Partnership or any General Partner

(4)    Decree of Court under §32.

(5)    Withdrawal of General Partner/Admission of new General Partner – unless otherwise agreed prior to act in writing.

4.       UPA §32 Decree of Dissolution (Subjective):  Effective only if a court decrees the dissolution.

a)      [Provided that the party requesting Dissolution is not the offending party] – A court may decree dissolution whenever:

(1)    General Partner is declared a lunatic of insane.

(2)    General Partner is incapable of performing his part in the Partnership contract.

(3)    General Partner has been guilty of conduct that prejudices the business.

(4)    General Partner commits breach of Partnership agreement (willful or persistent breach) – § 32(d)

(5)    Partnership can only be carried on at a loss.

(6)    Other circumstances that render dissolution equitable.

b)      COLLINS v. LEWIS – Cafeteria P

(1)    A court of equity will not grant a decree of dissolution when P’s own conduct gave rise to the dissolution.  P did not have “clean hands”.  P’s conduct prejudiced the business.  §32.

(2)    Here, P caused the business to carry on at a loss.

5.       UPA § 38 Rights of Partners upon Dissolution

a)      Not at fault General Partner can cause a liquidation at the dissolution.

b)      When Partner causes a dissolution in violation of Partnership agreement, he may not cause a liquidation of the assets.

(1)    Remaining General Partners may continue the business fort he rest of the term before they have to pay the violator his interest (just has to put up a bond for his interest) or they can pay him off.

(2)    Partner in contravention gets his share LESS damages and value of goodwill.

6.       UPA §37, 35, 42, Winding Up of Affairs

a)      § 37:  Each partner who has not wrongfully dissolved the Partnership, or legal rep of the last surviving partner has the right to “wind Up” unless otherwise agreed.

b)      § 41 “Continuing On”:  If the surviving General Partner has consent of the dead General Partner or rep of the dead General Partner, he can “continue on” rather than “wind up” the business.

c)       § 42 Rights of deceased General Partner against General Partner “Continuing On”:  If the General Partner continues on w/ consent (maybe implied consent), the deceased General Partner has the election to take the value of his interest at date of dissolution _ interest [OR] share of profits (dissolution is AFTER winding up ends).

d)      Hypothetical Illustration:  B & J are each ½ partners in Partnership. B dies 1/1/93—at time of death, B’s interest = $200k.  J continues to work until it closes on 5/1/93—value decreasing to a total of $300k.  How much is Window (W) entitled to?

(1)    Assuming there was no agreement to the contrary, death of B caused dissolution (§31)

(2)    B not at fault so W can force a liquidation. (§38)

(3)    If loss was incurred while “winding up”, W only gets $150k.

(4)    At the date of death, W can claim $200k (§42)

(5)    If W consents to “Carrying on” but states she is not responsible for risk or doesn’t consent at all, then she gets $200k + interest; or 200k + profit share from “winding up” ended.

III.    Limited Partnerships (LP)

A.      Definition:  A Limited Partnership (LP) is an association of 2 or more persons, of which, at least 1 is a General Partner and one is a Limited Partner (LP).

1.       The General Partner assumes management responsibilities and full personal liability for Partnership debts.

2.       A corporation may be a General Partner in a LP.

3.       The LP makes a contribution of cash, other property, or services rendered to the Partnership and obtains an interest in the Partnership in return – but is not active in management and has limited liability. (limited only to his investment)

4.       Old ULPA § 155XXX:  This was revised 10 years ago, but LP’s formed under this law were given opportunity to stay under old law or to bring the Partnership into requirements of the revised law.

5.       Revised ULPA § 156XXX:  Applies to any LP formed now or old LP brought into requirements

B.       Primary Reason for creating LP

1.       LP rather than General Partner:  LP liability is limited to the amount of investment (unless LP is labeled as a General Partner or is in “control”).

2.       LP rather than Corp:  Taxes—profits of a LP are taxed by each partner—not as an entity, and losses goes to each partners’ income tax calculation.  Corp. entities are taxed separately.

C.      Creation:  Must comply with certain formalities required by statute. (For a General Partnership, partners merely need to agree.  More is need for a LP)

1.       Filing:  Only requires 1 document; every jurisdiction requires a document be filed to put public on notice that there’s some Limited Partners.

2.       Revised UPA:  Requires 2 documents

a)      Bare bones disclosure.  (Name, General Partners/LP, % profits, Amt. Contributed)

b)      Agreement:  this may be oral if it can be proven.

D.      Liability

1.       Old ULPA § 155XXX: (never accepted in CA)

a)      Losing limited liability (§7):  LP can become liable as a General Partner if he takes part in the control of a business (no liability if there is no exercise of control).

b)      What constitutes taking part in control?  Unclear.  Voting on matters affecting the basic structure is not considered taking part in control.

c)       Hypothetical Illustration:  A is a General Partner in a SJ auto Partnership.  B is the LP.  B lives in LA, & works in another auto company.  A&B Partnership’s sales manager dies and B is asked to act as sales manager.  When Partnership is insolvent, is B liable as a General Partner because of his acting as sales manager?

(1)    Acting as employee DOES NOT equal control.

(2)    Ability to set sales price may indicate control.

(3)    Ability to hire employees & set wages may indicate control.

(4)    Ability to determine financing may indicate control.

(5)    HOLZMAN : LP’s collaborated w/ General Partners to decide wheat crops to plant and had planned to withdraw $ from Partnership.  Court found control existed.

(6)    If LP has impact by consulting w/ General Partner there may be control.

(7)    Right to vote if specified in cert. DOES NOT equal control.  §7 (b)

2.       Revised ULPA § 156XXX

a)      When a LP takes part in management & control of the business, he becomes liable as a General Partner. §32.

(1)    LP does not take part in control by any of the following:

(a)    Being a contractor, agent, or employee of the LP or transactional business w/ a General Partner.

(b)    Being an officer, director, or Shareholder of corporate General Partner.

(c)    Consulting or advising a General Partner (unless there’s a serious impact.)

(d)    Acting as a surety for the LP or the General Partners.

(e)    Voting or calling a meeting of the partners (CA believes in investor democracy)

(f)     Approving or disapproving an amendment.

(2)    If a limited partner participates in the control of the business w/o being named as a General Partner, that person may be held liable as a General Partner only to persons who transact business with the LP w/ actual knowledge of that partner’s participation in control [AND] with a reasonable belief that the partner is a General Partner based upon the LP’s conduct at the time of the transaction.

(a)    Old ULPA:  Doesn’t mater if creditor had knowledge or not, if LP participates in control, he’s liable.  This created a windfall to the creditor because he could hold the LP liable whether he had knowledge or not.  (The revised rule was created for protection.)

(3)    Hypothetical Illustration:  A = General Partner, B = LP.  A&B go to a bank for a loan.  Banker goes w/ A to the business and sees B doing things in the office and selecting inventory.  A tells banker B is a General Partner.  B is not aware that A held him out as a General Partner.  The Partnership becomes insolvent.  Is B liable to the bank as an LP?

(a)    Reasonable Belief:  B is not liable. It is not enough for the bank to reasonably believe B is a General Partner.  The reasonable belief must be on the basis of the conduct of B, not just reliance on A’s statement.

(b)    Conduct:  There is a High Standard for Conduct.  B must do something herself to say she’s a General Partner (actions alone are not enough) or allow someone else to say it w/o correcting.

E.       Liability if Erroneously Believed to be a LP

1.       Old ULPA - §15511:  If LP has contributed to the capital of the Partnership & believes he’s a LP, but is not because the documents were never filed, he is not liable as a General Partner if he promptly renounces his interests in profits as soon as he finds out he is not a LP.  Renouncing interest = need to forego future interest.

2.       Revised ULPA § 15633:

a)      Future Claims:  Not liable if certificate is filed promptly (does not have to renounce profits)

b)      Past Claims (Transactions occurring before Filing):  not liable unless the 3rd party reasonably believed he was a General Partner.

IV.    Limited Liability Partnerships (not available in CA)

A.      Definition:  Partnership is still absolutely liable for tortious conduct of any partner, & any partner is personally limitlessly liable for his own tortious conduct.  All partners are limitlessly liable for the Contract conduct of any partner, but a single partner is not liable for tortious conduct of another partner.

B.       Purpose:  Allows partner in Washington D.C. office to be liable for tortious conduct of partner in Nevada torts.

V.      Corporations (Generally)

A.      Definition:  A corporation is an entity that’s been created so it’s afforded legal protection.

B.       Creation:  Only the state has the ability to create a Corp.  It’s the prerogative of the jurisdiction to grant “Corporateness”.

C.      Limited Liability:  The people that invest (own) in a corporation have limited liability.  Creditors understand that any liability must be satisfied out of the assets of the Corp.

VI.    Formation of a Corporation

A.      How to Incorporate: Formality is required.  A document must be filed & accepted by the secretary of state.

1.       Certificate (Articles) of Incorporation (public record):  One or more persons may form a corporation by executing and filing AOI.  Existence of the Corp. begins upon filling CCC § 200

a)      Mandatory Provisions § 202

(1)    Name of Corp.

(2)    Purpose of Corp.

(3)    Address for Service of Process

(4)    # of authorized shares.

b)      Management control cannot alter the AOI by themselves and must obtain a s/h vote for approval.

2.       Organizational Meeting – After the filing, an organizational meeting occurs where:

a)      Board of Directors (BOD) are elected

b)      Bylaws (not public record) are passed. § 212

(1)    Bylaws contain:  duties of officers, Corp. Seal, # of officers, etc.

(2)    Management may alter bylaws w/o s/h approval.

B.       Obtaining Capital for Corporation – Selling Ownership Interests (Stock)

1.       Common Stock:  Every Corp. must have this.  It is residual ownership in the Corp.  Anything left in the Corp. belongs to common stockholders.

2.       Preferred Stock:  S/h have ownership of the Corp. but their rights are limited to the investment document they entered into.  Bylaws state the rights of preferred stockholders.  Any rights not given to Preferred Stockholders are left to the Common Stockholders.

3.       Debt:  Obligation of Corp. to repay.

a)      Corporate IOU’s – Corp borrows funds from the bank.

b)      Bonds

C.      Structure of Power

1.       Owners (s/h):  Own stock in the Corp., but not involved in Management.  S/h elect the BOD.

2.       BOD:  Directs & Manages the affairs of the Corp.  It elects officers.

3.       Officers:  Execute the Corp. and is employed by the board.

D.      Premature Commencement of Business

1.       Promoters:  Participate in formation of a new Corp., attract capital, sell idea of Corp., find talent.

a)      Fiduciary Duties:  Makes all the difference by how the transaction is structured.

(1)    Hypo 1:  S buys Real Estate for $125, sells to 3rd party for $200k (the FMV of the property).  Can S keep the $75k profit?  Yes, if it was an arms length transaction & there is no fraud or misrepresentation that P relies on.

(2)    Hypo 2:  S has a relationship w/ P.  S doesn’t tell P he owns Real Estate.  P asks S to be his agent for acquiring the Real Estate. –No, S cannot keep profit because S is P’s agent so he has a fiduciary duty to P & part of that duty is not to make secret profit in transaction w/your Principal.  It does not matter if the sale price = FMV.  However, if S discloses, then he can keep the $75k.

(3)    Hypo 3:P forms a corp. and has 100%stock.  He puts his family on BOD, and asks S to purchase Real Estate for the corp.  S doesn’t disclose.  Can S keep it secret?  No against Corp., because the Corp. is the principal;  Yes against P.

(4)    Hypo 4:  S forms a Corp.  S has the Corp sell P 100% stock for 200k.  S sells Real Estate to Corp. for $200k.  No—S cannot keep the profit because he’s a promoter for the Corp. and owes the Corp. a fiduciary duty.

(5)    Hypo 5:  S sells to P for $200k.  P forms Corp & contributes Real Estate in exchange for 100% stock. Can S keep the profit?  Yes because he is not an agent of P or a promoter of the Corp.

(6)    Hypo 6:  S forms a Corp, invests $200k in exchange for 100% stock.  S becomes president and family is BOD.  S sells land to Corp for $200k w/ full disclosure.  S sells his stock in Corp to P for $200k.  Can S keep profit from the previous sale of land? 

(a)    Split courts:  USSC found that fiduciary obligation is met as long as S makes a full disclosure to the Corp.

(b)    Massachusetts SC:  if the preconceived plan of financing & end result is to sell outside, then fiduciary duty does not end until whole financial scheme is over so S cannot keep the profit.

2.       Pre-Incorporation Contracts by the Promoter – promoter feels the need to enter into a contract for the Corp. before the Corp is formed.

a)      3rd Party v. Promoter – Generally, the Promoter is personally liable if he contracts w/ a 3rd party and the Corp. never formed or breaches contract, even if he makes it clear that he only wants to bind himself as an agent of the Corp because one cannot be an agent for non-existent principal.  (Corp doesn’t exist yet!)

(1)    Exception:  Novation – Agreement by 3rd party that they will only look to the Corp of liability and not the promoter.

b)      3rd Party v. New Corp – Generally, When Corp knows off the benefit they’re receiving (i.e. employee promoter contracts w/ shows up for work everyday) [OR] promoter is still in control of the Corp., then 3rd parties can enforce against the Corp after it’s formed even if Corp. doesn’t adopt the contract.

c)       New Corp v. 3rd Party

(1)    If 3rd party gets what they bargained for, the Corp can enforce the Contract.

(2)    SOUTHERN GULF – 3rd party contract w/ promoter to build a ship for the Corp.  3rd party wants out of contract & argues Corp was incorporated in a different place then they were originally told.  Court held that the Corp can enforce Contract because the 3rd party was searching for an “out” from the contract  once they realized they could make more profit on the transaction.

E.       Defective Incorporation – If the Corp failed to comply w/ statutory formalities for incorporation, 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 Corp (still alive in some Jx, but now mostly dead):   3 requirements

a)      Must be a statute under which one could have incorporated.

b)      Must have acted as if the entity were incorporated (i.e. hold out as pres., issue stock, put Corp name on the board)

c)       Must have made a colorable attempt in good faith to comply w/ Corp. statute – this is a difficult to satisfy because if it was easy to prove, than no one would incorporate.  Instead, they would simply claim a de facto corporation when a problem arises.

2.       Estoppel (doctrine alive in CA & other Jx):  The Corporation is not defacto, but the court holds that the attacking party is “estopped” to treat the entity as anything other than a Corp.

a)      Different from “normal” estoppel which protects P (D is estopped), here P is the one estopped from denying the existence of a corporation because the entity behaved as a Corp.

b)      P must have dealt w/ entity as if it were a Corp., in effect admitting it’s existence as such.

c)       P must have relied on credit of corporation, rather than that of officers or Shareholders.

d)      Hypothetical Illustration:  A, B, & C form a Corp.  L prepares the documents for incorporation, then ABC opens a bank account for the Corp., authorize leases, put up Corp. Name sign.  A signs a contract for cabinets.  The Corp goes insolvent.  S tries to collect $ and finds that the incorporation documents were never filed.  ABC thought they were.  S is estopped from claiming that the Corp. didn’t exist because S dealt w/ the Corp as a Corp. & relied on credit of the Corp., not the personal credit of A, B, or C.

e)      Investors in defective Corp:  In most Jx, courts will use estoppel doctrine to avoid liability for investors of corps who thought they were investing in a Corp but Corp was defectively incorporated, and who didn’t have anything to do w/ the business.

VII.  Powers of Corporations § 207, §208

A.      Common Law Doctrine of Ultra Vires:  Old doctrine meaning “beyond the powers”.  Corp. would enter into a contract for “X”.  Then if it didn’t like the contract, it would say that it did not have the power to make a Contract. 

B.       Common Law Ultra Vires Problems & Statutory Remedies.

1.       Charitable donations & contributions:  The question is “how can the Corp have the power to give these when their purpose is to maximize profits of Shareholder & what happens when Shareholder doesn’t agree w/ management choice of charity.

a)      SMITH v. BARLOW – Court found that the Corp could give charitable donations event though the Shareholder disagreed because of public interest.  So long as donation is not made indiscriminately or to a pet charity of the directors for personal rather than Corp. ends.

b)      Remedy – CCC § 207(e): All corporations are specifically authorized to make charitable contributions even if they don’t get a benefit.

c)       Exception:   Shareholders can restrict this power in the AOI.

2.       Corp attempts to become a General Partner in a Partnership.

a)      Problem here is that Shareholders have elected the BOD of the Corp, but if the Corp becomes a General Partner, other partners can hold the Corp liable.  Shareholder didn’t elect to have these other partners.

b)      Remedy - § 207 (h):  Gives Corp power to enter into a Partnership, whether or not it must share control.

3.       Pay Pensions – § 207(f):  Gives Corp. power to pay pensions, & carryout profit sharing, bonus plans, etc.

4.       Corporate Guarantees.  What happens when a parent Corp (owns 100% of 3 holding companies) borrows $ from bank for improvements & has 3 subsidiary companies’ guarantee the loan.  Parent co defaults & bank looks to subsidiary companies.  Sub companies will have their own creditors who will say parent co., had no power to make guarantee when subsidiary companies got no benefit of the loan. (all $ went to improve parent co)

a)      Remedy - §207(g):  Allows Corp to secure debt w/ assets of any of its’ franchises, property or income.

5.       Agreement w/ 3rd Parties

a)      Corp enters into a contract w/ a 3rd party that the 3rd party acquires rights under.  Corp now claims ultra vires to get out of it.

b)      Hypothetical Illustration:  AOI of Corp that makes widgets, says Corp can only sell in the U.S.  BOD starts selling in Mexico (exceeding its’ authority)

c)       Remedy: §208 Once 3rd party Gets an interest, he is protected.  It does not matter that the BOD exceed it’s own powers.

C.      § 207:  A Corp. shall have all the powers of a natural person in carrying out its business activities.

D.      Limiting Corporations Power § 202

1.       § 202(b):  Corp must put specific language in AOI stating that the Corp has power to engage in any business.  Corp must specifically limit the power if they want to do so;  it must say what you cannot do.

VIII.            Disregarding Corporateness (Courts are generally reluctant to Pierce the Corporate Veil)

A.      Piercing the Corporate Veil:  Even if the corporation has been properly formed, creditors may still seek to make the owners personally liable.

1.       General Rule:  Courts will Pierce the Corporate Veil whenever necessary to prevent fraud (tort) or to achieve equity (contract).

2.       General Rule for non-contract/tort:  It is rare that the court will PCV where all formalities are followed, there is sufficient assets, corporation is kept separate Corp is run for profit, regardless how much the Corp has tried to externalize the cost of running the business.

3.       Exception (Egregious case):  TX court case.  Court PCV even thought it followed formalities, because forming a separate Corp. to do “mountain blasting” above a town was outrageous.

4.       Incorporating to Escape Personal Liability:  Permitted by law.

B.       Grounds for Piercing the Corporate Veil.

1.       General Rule for PCV:  Act of the Corp must have mislead a 3rd party to their detriment by fraud, etc, to enter PCV.

2.       Inadequate Capitalization Test:  Applies if Corp. was organized w/o sufficient capital to meet obligations reasonably expected to arise.

a)      WALKOVSKY – Under capitalization is a major factor, but alone is not sufficient by itself to PCV.

b)      Inadequate Insurance:  Not sufficient grounds itself, or in combination w/ inadequate capitalization to pierce.

3.       Alter Ego Test (Corp is a mere alter ego of owners):  Applies when the individual owners themselves disregard the Corp. by ignoring Corp formalities.  Court will find that the Corp has been used by it’s owners as a mere “alter ego” because the owners themselves disregarded corporateness.  Must mislead 3rd party to their detriment.  Examples:

a)      Commingling of funds (personal & corporate) – i.e. owner used Corp funds for personal groceries & personal funds to help out the Corp.

b)      Corp records not maintained

c)       Lack of formalities, i.e., BOD meetings

d)      Corp serves as a mere agency or business conduit of owners

4.       Mere Instrumentality Test:  Generally applies where there is a parent & a subsidiary where owners use the subsidiary to benefit themselves, but not the Corp.  The Corp is not run in the best interest of the Corp so it’s a mere instrumentality of its owners.

a)      BARTLE v. HOME OWNERS CO-OP:  Although subsidiary (contract Corp_ was set up to make no profit for the parent Corp (wanted to build houses inexpensively) the court found that there was no fraud or inequality because the corps were kept separate at all times.

b)      Dissent:  Somehow this subsidiary is being operated in a way that is not in the best interest for the subsidiary.  Owners should not be able to benefit by acting detrimentally to the Corp.

5.       Contract v. Tort Creditor:

a)      Contract Creditor: by the nature of this situation, there is  some dealing between the parties so the chance are that one party could investigate whether the Corp. is undercapitalized, complying w/ formalities, etc., before they enter into a contract.   –Probably can’t get to the owner if his only act is sometimes paying with personal check and sometimes paying w/ corporate check.

b)      Tort Creditor:  Normally, at Tort Creditor is not in a position to choose the Corp as a tortfeasor.  In this instance, it doesn’t matter to tort victim how Corp kept it’s books etc. What matters is adequate capitalization and adequate insurance.

(1)    MINTON – organized Corp to operate a swimming pool, but had no $ in Corp when someone was injured.  Court pierced the Corp veil because of inadequate capitalization.

(2)    Enterprise Liability:  Different than piercing Corp veil because here one can get the entire enterprise, not the personal liability of the owner.

(3)    Hypothetical Illustration:  You get run down by a cab co. that has insufficient assets.  Cab co is owned by Corp X which also owns other cab companies.  Under enterprise liability, you could get the assets of X or other companies owned by X.  Arguments to support all one enterprise:

(a)    Common ownership of all the companies.

(b)    Back & forth between different back accounts of each co.

(c)    All corps have the same office, directors, dispatcher, mechanic, etc.

(4)    Agency Liability:  Argue that since X owns all the stock of the subsidiaries, they are it’s agent and X is the principal.  The problem with this argument is there’d never be limited liability because any P would claim that owners are principals & Corp is the agent.

C.      Equitable Subordination (Deep Rock Doctrine)

1.       Definition:  Equitable subordination occurs only in bankruptcy and is not PCV.  It occurs when the court subordinates a Shareholder’s loan to the debts owed by the Corp to other creditors.

2.       Hypothetical Illustration:  When established, Subsidiary sells 100% of its stock to Parent for $5k, then parent loans Subsidiary $50 million.  How can we get to assets of the parent if everything has been kept separate & formalities followed?

3.       Problem:  When the subsidiary goes bankrupt, all creditors must submit claims to see how much debtor actually owed.  In the hypo, parent loan is a debt and gets added to the other claims so there’ll be a miniscule amount left for other debtors.

4.       Solution – Equitable Subordination: If the company is large & would really need lots of capital, the court will find that $5k was insufficient and $50 million was arbitrarily called a loan, when it was actually meant as equity.  In this case, the court will subordinate the debt of the parent company so other debtors are paid first.  Reasons for Subordination:

a)      The shareholders loan was part of a capital structure which consisted of too high proportion of debt (hypo).  Shareholder wins either way – he only puts up a small capital & wins if the Corp succeeds, but still protected as a creditor if the Corp fails.

b)      Loan by Shareholder to Corp really meant as a contribution to capital (hypo).  (i.e. “loan” had no provision for interest, repayment or default.

c)       Claim that creditors had no prior warning.  (i.e. prior to bankruptcy, manager of Corp submits a bill for 3-4 years back wages)

d)      Shareholder engaged in transaction which unfairly hindered collection of creditor claims.

(1)    GANNETT CO. v. LARRY – Corp bought a solvent newspaper publisher then converted it to a supplier of newsprint to protect itself from a threatened shortage.  There was no shortage, new print market went bad, subsidiary folded.  Parents’ loans were subordinated to the other creditors because the parent operated the subsidiary in its own interest to the detriment of creditors.

IX.    Director/Shareholder Power

A.      Traditional Roles of Director & Shareholder – Right to Manage the Business & Affairs of Corp.

1.       General Rule § 300(a):  The right to manage the property & affairs of the corporation is vested in the BOD, not in the Shareholder unless otherwise provided by the AOI, by law or valid agreement.

2.       Fundamental Corporate Changes:  Certain important changes in the Corp require Shareholder approval (following BOD approval)

a)      Organic Changes:  i.e. mergers, dissolution, reducing capital, etc.

b)      Voluntary dissolution

c)       Election & removal of Directors

d)      Sale of significant portion of Corp assets

e)      Number of shares of stock to be authorized (must amend the AOI which requires approval of Shareholders)

f)        Amendment of AOI

3.       Standards for Shareholder approval

a)      § 152:  vote by the majority of outstanding shares (those entitled to vote)

b)      § 153:  vote by the majority of shares represented and voting at a meeting where quorum is present.

B.       Selling off of Assets – Powers of the BOD v. Shareholders (5 person BOD opposed to selling assets, but Shareholders want to sell.  What can Shareholders do?)

1.       Sale/Lease/Exchange of Property or Assets § 1001(a): 

a)      Approval of BOD is required so S/h cannot sell of 100% assets themselves.

b)      If the transaction is in the usual course of business, the BOD alone can act.  Otherwise, they would need approval of the s/h, but either way, BOD must approve.

2.       Power to Add More Directors:  Look at AOI or bylaws to find the max # of directors.

a)      § 212 Bylaws State the Maximum Number of Directors

(1)    § 211 Amending the Bylaws:  S/h can amend bylaws w/ approval f outstanding shares—BOD approval is not needed.

(2)    § 600 (d) Meeting to Amend the Bylaws:  BOD or members w/ no less than 10% voting rights at meetings.

(3)    § 601 (a) & (e) Notice Requirements:  Must give at least 10 days notice of meeting.

(4)    § 603 (a) & (d) Written Consent:    Action that can be taken at meeting can also be taken through written consent.  However, directors cannot be elected by written consent unless there is unanimous written consent by all S/h.

b)      AOI:  If Maximum # of directors is in AOI, S/h may want to amend AOI.

(1)    § 902 Amending AOI:  Needs approval of both the BOD & S/H.

3.       Power to fill BOD if new slots open

a)      § 305 Filling Vacancies of the Board:  BOD has first hot at filling vacancies.

b)      § 305 Filling Vacancies created by Removal:  S/h get first shot at filling these types.

4.       Shareholder Removal of Director During Term

a)      Removal for Cause § 304:  Director may be removed for abuse of authority or fraudulent act if at least 10% of the outstanding shares bring suit in Superior Court.

b)      Removal w/o Cause § 303:  Any or all directors may be removed w/o cause if approved by the majority of outstanding shares.

5.       Voluntary Dissolution §1900(a):  If a certain percentage of the s/h agree, court must order a dissolution.

a)      “Any Corp may elect to voluntarily to wind-up and dissolve by the vote of s/h holding shares representing 50% or more of the voting power.”

b)      § 1900(b):  BOD can dissolve Corp due to 1) bankruptcy, 2) Corp has disposed of all its assets and has not conducted business for 5 years, 3) Corp has issued no shares.

C.      Directors’ Power to Take Corporate Action

1.       Formal Aspects of Board Action:  The board must act as a board, by resolution or vote at a properly called meeting, at which there is a quorum, in order for an action by the BOD to be valid.  Valid action typically – meeting of the BOD.  (Must also follow statutory formalities).

a)      Corp Acts through Authorization of the BOD

b)      Director’s Act is a valid Act of Corp.

2.       Binding Agreements

a)      Quorum Requirements § 307(7):  Before a meeting can commence, a quorum is needed.  The majority of the authorized # of directors constitutes a quorum.

b)      Calling Meeting § 307(1):  A meeting of BOD can be called by the chairman, President, VP, 2 directors, or secretary.

c)       Notice Requirement for Meetings § 307(2):  notice doesn’t have to specify the purpose of the meeting.

(1)    Regular Meetings: may be held w/o notice if time & place is fixed by the bylaws.

(2)    Special Meetings: 

(a)    Need 48 hours notice if by personal delivery, telephone, or telegraph.

(b)    4 days notice by mail (notice starts at the moment the letter is placed into the mailbox; irrelevant whether or not received - § 118)

(3)    AOI & bylaws cannot dispense with notice.

d)      Wavier of Notice § 307(3):  If a quorum cannot be attained, any member of the BOD can:

(1)    Sign a waiver of notice before the meeting is held.

(2)    Approve the minutes of the meeting after the fact.

(3)    Sign a waiver to not receiving notice after the fact. –There is a big gamble to getting waivers after the fact because they may not agree with the action taken.

e)      Protesting Notice:  If all BOD are present at the meeting, it still might not be sufficient for notice, because if they protest prior lack of notice, then they aren’t counted as “receiving notice.”

3.       Action taken w/o holding a meeting:

4.       Executive Committees § 311:  BOD can elect an executive committee to act on behalf of the board when the BOD is not there.

a)      Executive committees have the same authority of the BOD except they may not act on important matters such as:

(1)    Dividend Payments

(2)    Amendment/Repeal of Bylaws

(3)    Filing Vacancies on BOD

(4)    Area where s/h approval is also required.

(5)    Appointment of other committees of he board.

5.       Binding Action even if Notice isn’t perfect

a)      Courts will enforce where s/h are also directors.

b)      Courts will enforce where 2 of 3 directors sign lease then tell 3rd director who acquiesces after the fact.

c)       Apparent Authority:  President or VP may bind Corp even if they have no actual authority.

X.      Duties of Directors, Officers and other Insiders

A.      Duty of Care:  Directors occupy a fiduciary relationship to the management of the Corp and must exercise the care of ordinary prudent persons under similar circumstances (duty not to be negligent.)

1.       § 309 Duty of Care (not to be negligent):  Director must perform duties in good faith in best interest of the Corp and to the s/h and w/ such care including reasonable inquiry as an ordinary prudent person in like position would use under similar circumstances.

a)      Standard of Care Required of Director is Low:  There’s no duty to go down into Corp and ferret out everything that could go wrong. Unless there’s a red flag, it is sufficient to do reasonable inquiry.

b)      Ordinary Prudent Person:  Just Ordinary Person doesn’t need expertise—could be a non-business person using common sense.

c)       In a like position:  Obligation of care changes w/ respect to complexity & size of Corp.  When trying to make a director not negligent, it depends greatly on the nature of the Corp – ALLIS-CHALMERS (larger corps have larger duty)

d)      Under Similar Circumstances:  Duty of care varies for specific person depending on their experience, training & expertise.

e)      Reasonable Inquiry:

(1)    Keep Current

(2)    Explore Suspicious Circumstances

(3)    No duty to Micro Manage.

(4)    Kodak hypo (price fixing in one division of Company):  If director saw change in prices, he would be under obligation to ask about it and make reasonable inquiry in order to satisfy duty of care.

(5)    If Corp had history of price fixing charges, instituting surveillance system or making employees sign promise to not engage, it would satisfy reasonable inquiry unless there was other red flags.

f)        Hypothetical Illustration:  Kodak directors alleged to be negligent in duty of care (lower level officer caught in criminal act of price fixing).

(1)    Should Directors be held liable?  No

(2)    It is unreasonable to assume directors will oversee what was happening five levels down in the hierarchy.

(3)    Generally, directors will not be held negligent when size & complexity of Corp is large, for happenings in the lower levels.

(4)    Exception:  Directors may be liable if there were red flags and didn’t’ make reasonable inquiry.

2.       § 309(b) Reliance on Reports:  Director may rely on internal employee opinion & outside opinions of professionals, provided there’s no red flag that gives reason for further inquiry.

a)      Hypothetical Illustration: Does a Director of DuPont (operating a nuke plant) have to make reasonable inquiry when reports given to him say “everything is fine?

b)      Director may not be held negligence, since he may rely on expert reports.

3.       SMITH v. VAN GORKOM – Gross Negligence of Directors in Cash-Out merger.

a)      Held:  Court found directors personally liable despite Business Judgment Rule because of their gross negligence.  (signed document at cocktail party, called meeting w/o prior notice, etc.)

b)      Rationale for Director’s Gross Negligence:

(1)    No independent study made to determine intrinsic value of company (didn’t get fairness opinion from outside source).

(2)    Directors didn’t read the agreement.  (no one ha opportunity to actually read a written agreement)

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

4.       Legal Remedies after SMITH:  No one wanted to be a director because of potential liability so legislature passed statutes limiting the directors’ liability.

a)      § 204(a)(10): S/h can place in AOI, a provision totally eliminating or limiting the liability of a director in monetary (shareholder derivative actions only) derivative actions except:

(1)    S/h can’t limit liability for intentional misconduct.

(2)    S/h can’t limit liability for acts director believed not in best interests of the Corp.

b)      § 317 Indemnification:

(1)    Against 3rd parties:  Corp can indemnify director of expenses involved & judgment director must pay provided that he acted in good faith, and in a manner he believed was in the best interests of Corp.

(2)    In S/h derivative suits:  Can only indemnify for expenses of litigation.

(3)    § 317(1) Insurance:  Corp can buy insurance for non-deliberate negligent action of a director.

B.       Duty of Loyalty:  Directors are held as part of their fiduciary relationship with the Corp., to the duty of loyalty in all dealings w/ the Corp.  This means that the director must place the interests of the Corp above their own personal gain in situations of conflict of interest.

1.       Obligation to S/h (Present State of Law):  Directors must look out primarily for the s/h so there's no legally enforceable obligation to the creditors or bond holders.

a)      No obligation to creditors/bondholders:  Corp entered into transaction that made it less likely for bondholders to be paid.  The court found that if you’re a creditor, you must look to your own diligence, check on person you’re extending credit to & if you think there might be a problem, you must deal with it in the Contract. (i.e. Write into bond that any additional debt of the Corp is subordinated to bondholders.)

b)      Possible obligation to members (spa hypo): Directors can Close Spa or try ad campaign w/ 5% chance of success to attract new members. Common person off the street isn’t charged w/ checking out finances of the Corp like a creditor is.

2.       Business Dealings with Corp.:  Conflict of interest arises whenever a Corp. contracts directly w/ one of its officers or directors, or w/ a company in which the director is financially interested.  To be valid, such transaction must be properly authorized, all pertinent facts must be disclosed, and the transaction must be fair.

a)      Introduction

(1)    Common Law:  Transaction was void due to conflict of interest.

(2)    Modern Law:  Transaction is voidable.  Director may make transaction w/ corporation so long as he does not breach fiduciary duty (i.e. buy property w/ view of selling to the Corp at a profit).  If it ‘s fair price and fair contract to the Corp when entered into, it is okay for the director to make profit selling to the Corp.

b)      CCC § 310(a)

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

(2)    If a transaction occurs between Corp 1 & Corp 2, where Corp 1 director has a material financial interest in Corp 2, 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 1 & Corp 2 where Corp 1 director is also a director in Corp 2.  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.

(7)    Hypothetical § 310 Illustration:  Director owns $50k oven.  Corp wants to purchase oven.  Director knows oven will not perform to Corp’s requirement but sells anyway.  Director gives full disclosure of his financial interest & has BOD inspect oven even before purchase.  Is the sale voidable?  Yes.

(a)    Director has an affirmative obligation to not only make the BOD aware of his financial interest, but to also disclose all material (relevant) facts (oven will not perform to Corp’s requirements).

(b)    Director cannot deal at arm’s length w/ Corp and must disclose all material facts even if he wouldn’t have in dealing w/ a 3rd party.

3.       Corporate Opportunity Doctrine:  If a director gets an opportunity, he can exploit it himself, unless it’s a Corp opportunity, in which case, he must offer it first to the Corp.

a)      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 he 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.

b)      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, not sure fire protection—could still be a Corp opportunity because it is too easy for the director to use this as an 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.  ENERGY RESOURCE.

c)       Director of Multiple Corporations:  If Corp is director of multiple Corp’s & 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.

d)      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.

C.      Business Judgment Rule:  When a director acting in good faith commits an act or omission involving no fraud, illegality or conflict of interest, he will not be held personally liable for errors of judgement, unless clear & gross negligence is shown. (There must be a rational reason for his decision.)

1.       Prerequisites of Business Judgment Rule (BJR):  Must satisfy duty of care & duty of loyalty in order to get protection of BJR (i.e. if tried to gather all info they could then sat down & deliberated, then Duty of Care is satisfied, and no conflict of interest satisfies Duty of Loyalty)

2.       KAMIN v. AMEX – BOD took course of action that caused loss (distributed stock instead of selling at loss & taking tax break) but were not negligent so were protected by BJR (because they gathered information, got experts, focused & tried to decide) –they satisfied their duty of care.  Court brushed off issue of duty of loyalty saying conflict of 4 directors couldn’t influence the other 16.

3.       No protection of BRJ if conflict of interest (violates duty of loyalty)

XI.    Fiduciary Obligation of Controlling (Majority) S/H (owed to minority s/h)

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 Shareholders cannot cause the Corp to take action for the benefit of the Dominant Shareholders if the action taken is not in the best interest of the Corp.

a)      Hypothetical Illustration:  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 because 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 Shareholders, so that the dominant Shareholders 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 majority 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 there was nothing wrong with the liquidation of assets if you’re doing it to sell off for greater $$, but here, when all is concluded, the barge company is still continuing business so the whole goal of the transaction was just to squeeze out he minority.

3.       Full Disclosure Required Upon Corp Liquidation:  The majority Shareholders should fully disclose the material facts to the minority Shareholders, where upon the minority may have an equal opportunity to share in the profits.

a)      ZAHN v. TRANSAMERICA:  Majority Shareholders 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 a problem, under circumstances of nondisclosure, it becomes a breach of fiduciary duty because there was 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 minority

b)      General Rule:  Majority Shareholders cannot use the 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.

a)      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.

XII.  Insider Trading

A.      Definition:  The typical problem involves the situation where someone related to the Corp (directors, officers) is in a position to have inside information about how the Corp is doing, and hence, 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 Common Law and by the federal securities law. 

B.       Common Law:  Majority has held that directors and officers owed no special fiduciary duty to present or prospective Shareholders 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 specifically seek out a stockholder for the purpose of buying his shares w/o making disclosure of material facts he has that the stockholder cannot have.

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

b)      Here, there was 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 because the director purchased the Shareholder’s stock on the exchange, w/ no communication occurring 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)      In light of negative inside information (IBM’s increased the price for maintaining computers will make Corp go downhill), the CEO sold Corp stock over the exchange before public disclosure and the sale devalued the stock.

b)      The court held that it could not find a duty between the directors & the Shareholders (the buyer of the stock) but still recognized a wrong committed.  Therefore, the court held that a duty existed between the director and the corporation.  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.

C.      Securities Exchange Act of 1934 – Federal Regulation of Insiders:  Two section of the act deal 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.  Otherwise, ANYONE could claim, “I would have bought”.

(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 there is 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).

(c)    Hypothetical Illustration:   If P buys stock because his astrologer told him to, then later learns that the company had made false statements, he will not have a cause of action based on a theory of Fraud on the Market.

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)    Hypothetical Illustration:  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)    However, footnote 14 in DIRKS recognizes that if corporate info is legitimately revealed to an underwriter, accountant, outsiders, etc., they may have a fiduciary obligation to the Shareholders because they acquired non-public info only for corporate purposes.  This duty is only imposed if the Corp expects the outsider to kept he disclosed non-public info confidential 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 months, 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.

(1)    Hypothetical Illustration



# 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 Shareholder’s would be come a small percentage of T & O and K could not take over.  Under the merger agreement K’s Shareholders 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 months 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)

XIII.            Proxy Solicitation and Regulation – (Shareholders cannot be everywhere to vote, so the alternative is to elect a proxy.

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 & proscribed 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 Shareholder of sufficient information so Shareholders 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 whatever position they endorse.  (However, you can give management 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 case 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 merger and 46% minority claimed there was misrepresentation in proxy solicitation.  Court held that each and every P does not need to show that misrepresentation is what 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% majority didn’t need the vote of the 15% minority 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 Shareholders which is 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 business operations so management can exclude a Shareholder proposal that falls under this.

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)      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 corporation 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 Shareholders 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 soli9d answer on whether all acts of management should be reimbursed (i.e. take Shareholders’ to Bermuda to solicit proxy.)

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

XIV.            Shareholder Control of 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)       Example:  If there’s 5 candidates & 3  seats available & A owns 100shares, 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):  where each Shareholder may cast a number of votes equal to the number of directors to be elected multiplied by the number of shares he holds.  Shareholder may distribute his votes unequally over number 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 Shareholders of representation on the BOD.  Device for increasing Shareholder power in the publicly held Corp. 

c)       CA § 708:  Every Shareholder is entitled to 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 Shareholder 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:  Shareholders can remove directors w/o cause if they want to remove the entire board and start from scratch.  But Shareholder 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)        Minority Shareholder may try to increase # of BOD in order to keep his place on the board if cumulative voting is allowed because the more individuals that are being voted on the smaller percent of shares is needed to elect (fewer the board members, the more shares minority needs to elect one director w/ cumulative 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 Shareholder has every right in the world to combine with 1 or more other Shareholders 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 was unwilling to enforce the agreement because agreement 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 rea 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 funds to buy new airplanes.  Bank would not lend because of fear that HH would not use funds properly.  Bank agreed to lend provided that 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.      Shareholders Agreements:  Shareholder’s may seek through Shareholder 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 Shareholders can decide who they want to elect as directors.  (Rationale:  Directors are charged w/ fiduciary duties to the Corp, therefore the Shareholder agreement which restricts their actions is void.)

2.       MCQUADE – Minority Shareholder 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 Shareholder agreement that each group gets to vote for 2 of the 4 person 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.  At this time 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 whereby Shareholders may participate in the management of the business; impinges upon the BOD by limiting their decision making power due to prior agreement, but it must fit within 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 must say “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):  Shareholder agreement & close Corp status are terminated (left w/ nothing) if # of Shareholders in Corp becomes greater than max # stated in AOI unless it is written into the Shareholder agreement that the Corp loses close Corp status, the agreement will be enforced as much as possible under Common Law.

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 demand that the Corp puts 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 Shareholders in a close Corp have more power than in a public Corp, the Shareholders may desire to prevent the transfer of shares unless they approve of the transferee.

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

(a)    Unreasonable = put into the stock “this stock cannot e transferred unless approved by Prof. Baum”

(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 Shareholder 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 sues on behalf of Corp:  In a derivative suit, Shareholder is suing a behalf of Corp not on behalf of themselves.

3.       Uniqueness:

a)      Lawyer seeks out Client not other way around:  Shareholder doesn’t get much gain 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 brining 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.

XV.  Dissolution of Corporations

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.

B.       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)

C.      Avoiding Dissolution - § 2000:  Subject to contrary provision, the Shareholders with at least 50% of the voting power may avoid 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.

XVI.            Limited Liability Corporations

A.      New Law:  in CA 10/1/94

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

2.       Melds Corp code & Partnership Code.

B.       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.

C.      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.

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

E.       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.

F.       Dissolution

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

2.       Judicial Decree:  Any member can go to court and ask for dissolution and there’s certain reasons where courts can order the dissolution.

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