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Business Organizations Review Session

© 1999 John M. Thompson


November 29, 1999


Authority (express, implied, apparent)

            A.. high standard of fiduciary duty of agent to the principal


Uniform Partnership Act of 1994

            A.. basic pattern

                        1.. certain norms set out they are subject to alteration by agreement

                        2.. partnership - association of two or more persons to carry out business

for profit.  No intent needed

3.. no formalities required to establish a general partnership

4.. in the absence of an agreement each partner shares equally; decisions are made per capita, and by majority vote (except for exceptional matters which require 100%)

5.. in the absence of an agreement, sharing of profits is prima facie evidence of a partnership; profits and losses will be split equally (per capita - NOT in relation to capital that has been invested) CHECK

a.. can share profits and not be a partners (landlord/tenant, debtor, etc)

b.. if no agreement with respect to profits, the profits will be split equally (usually people have agreement as to profits)

6.. partner by estoppel - person held liable as a partner; must be an affirmative misrepresentation by the partner representing that they are a partner

a.. in very tiny amount of cases, when cost is almost nothing, no effort, the courts may imply consent to person representing themselves as a partner

                                    b.. reliance by creditor is necessary

7.. relationship of partners to third parties (creditors) - each partner an agent of the partnership, and any act of the partner that is carrying out business of partnership will bind the partnership

a.. not bound if no actual authority and third party has knowledge of it

b.. partners can restrict authority of other partners - must inform creditors though

                        8.. all partners liable jointly for obligations of partnership

            B.. how 1994 act handles notion of partner leaving partnership and dissolution

                        1.. these provisions new with respect to the old partnership act

                        2.. no question under new act that the partnership is an entity (was unclear


                                    a.. therefore is able to keep in existence even if the owners change

3.. dissociation - does not mean there is a dissolution of the partnership though

a.. partnership has the right to purchase the dissociating partner’s interest; court will set price if they can’t agree

                                    b.. how dissociation can occur:

                                                i.. judicial decree - partners bring it to court

                        4.. dissolution - always leads to a winding up under the new act

C.. limited partnership - two or more persons organized under limited partnership act, having at least one general and one limited partner

1.. limited partner prohibited from participating in the control of the business

2.. if a limited partner does participate in the control of the business he is liable:

a.. only to persons who have actual knowledge at the time of transaction

b.. AND reasonably believed that person to be a general partner at time of transaction

c.. AND that belief must be based on the conduct of the limited partner           

i.. certain activities will be deemed not to be participating in the control of the business

3.. escape valve to protect the limited partner where the party in good faith believed they had become a limited partner

a.. must act like a limited partner (no participation in control): not liable to third parties if: they file the certificate or get general partner to file

i.. will be liable if the transaction occurred before the filing and the creditor reasonably believed the partner was a general partner at the time of the transaction (creditor relied - reliance)

            D.. Limited Liability Partnerships

                        1.. may be employed in CA only by lawyers, accountants

                        2.. partnership is still liable for all conduct of partners

                        3.. individual partner is liable for torts they themselves have committed

                        4.. partners are not personally liable for another partner’s torts (and

contracts in CA)

            a.. primarily because partnerships becoming huge and people would be liable for partners they were not even connected with in different offices


II.. Corporations

      A.. mechanics

            1.. bylaws

      B.. promoters

            1.. cannot make secret profits

            2.. fiduciary obligation to the corporation itself

            3.. pre incorporation contracts with third parties

a.. still liable as individual because corporation does not exist yet (even is promoter says he is not)

b.. EXCEPTION - sure exception - have other side (third party) explicitly say “and we will not hold you liable individually”; a novation; can get at time agreement entered into or subsequent to entering into it

      C.. what happens if you have defective corporation

            1.. corporation by estoppel

                        a.. still used by CA - KNOW THIS ONE

                        b.. the participants that are treated as though they were

incorporated and therefore the people that are suing are estopped

                        c.. reverse of traditional kind of estoppel

            2.. defacto corporate doctrine (essentially dead)

                        a.. needed certain elements

                        b.. most difficult was colorable attempt to comply with the statute

                        c.. most jurisdictions no longer follow this because too difficult

      D.. untra vires - beyond the powers

1.. in CA has been abolished between corporation and third parties (208); such as in contracts, usual course of business

2.. but shareholders may still raise ultra vires against own management (internal)

3.. the state can also tell a corporation not to do something because it is beyond its powers

            E.. management and control of corporations

                        1.. three level of organizations

a.. shareholders elect BOD; BOD elects officers that are supposed to execute the policy that is set by BOD

b.. does not always work this way because often officers are also directors

                                    c.. and officers do not always set policy

                        2.. corporations do 2 things that are essential:

                                    a.. separate ownership from management

                                    b.. centralize the management - just a few individuals

responsible for operations

                        3.. balancing of power between shareholders and management

                                    a.. CA very protective of shareholders

i.. shareholders may remove ALL directors without cause by simple majority vote

ii.. if the shareholders want to get rid of less than all of the directors, we have to be aware that if enough shares vote against removal, that would be sufficient to elect that director with cumulative voting, then you CANNOT get rid

of that director

a). this protects rights that are granted under cumulative voting

                        4.. how does BOD function?

a.. joint deliberation - decisions better made if all participants have an opportunity to say their opinion

i.. therefore, the number of directors that could carry a vote, if that number meets informally, that number cannot create binding corporate action; BOD cannot have informal meetings

ii.. therefore, in order to have a corporate meeting, you need NOTICE

                                          a).. formalities

b.. lots of collegiate atmosphere has been eroded because people want action quickly

            i.. can have a waiver of notice

                        a).. parties can do that before meeting, after meeting

ii.. can totally do away with the meeting if we have unanimous written consent

a).. agree in writing to motion and then you don’t have to have a meeting

b).. the corporation can be bound by apparent authority if someone does something without board approval but appears to be clothed in authority

                        5.. what is the function of shareholders?

a.. preemptive rights - right of shareholders to purchase subsequent issued shares in proportion of the shares they already have; can be written into AOI, but not required

i.. so they can maintain ownership percentage that they have in corporation

                                                ii.. only applicable to new shares that are sold for cash

a).. so shares issued not for cash, there are no preemptive rights that attach; this will erode original ownership percentages of shareholders

b).. permissive, can write them into the articles;

iii.. even if no preemptive rights, courts may stop inequitable sharing of additional shares

a).. usually if the shares are being sold beneath their true value

6.. control mechanisms that would affect voting power of particular number of shares

a.. cumulative voting - multiply number of shares by number of seats to be filled

                        i.. ONLY applicable in election of directors

                        ii.. promotes representation of minorities on the BOD

                        iii.. in CA: cumulative voting is mandatory for ALL CA

corporations with the exception of publicly held corporations

iv.. how can cumulative voting be thwarted?

            a).. decrease size of the board

            b).. stagger the terms of board of directors (in CA

CANNOT stagger boards in a regular corporation, unless amended in AOI to allow shorter terms (§301.5))

b.. pooling agreements - if shareholders agree in writing to vote a particular way (need not be signed by 100% of shareholders; any combination will work)

                                                i.. historically been held to be a valid agreement

                                                ii.. this sort of agreement is enforceable, even if we do not

have in connection with it an irrevocable proxy (opposite of Wringling Brothers Case where the ladies were not bound by agreement because they had no irrevocable proxy)

c.. irrevocable proxies - have to say the proxy is irrevocable, and must be given in certain situations:

                                                i.. long list

                                                ii.. catch all that says it will be irrevocable if it is to secure

the performance of some duty

            d.. voting trust - all jurisdictions; regulated by statute everywhere

                        i.. great concern about how long a voting trust can continue

                        ii.. in CA a voting trust can only last for 10 years at a time

                        iii.. title ownership is with trustee who must vote as is set

out in trust document           

iv.. trustees subject to very high fiduciary duties

e.. super majority requirements - some minority position wants to veto decisions and therefore the vote that is required to pass a resolution is increased to a super majority, that even the minority holder CAN veto a transaction

i.. CA very liberal in permitting super majority if written into AOI

ii.. vote requirement for directors meetings and quorum is okay

a).. but serious limitation in quorum for shareholders meeting (simple majority only; don’t want corporations to make it too hard to conduct business

b).. problem is that this increases possibility of deadlock

                                    f.. restrictions on transferability of shares

                                                i.. cannot put total restrictions on transferability

ii.. long standing tradition that people should be able to alienate  their property

                                    iii.. elements:

a).. most jurisdictions will prohibit mandatory consent from other shareholders because shareholders may unreasonably withhold their consent

                                                b).. if objective standards are used, might be valid

                                                            c).. on their face consent restrictions are not valid

                                                            d).. must be reasonable (if so, it will be alright)

                                                                        i).. example: right of first refusal is okay

g.. shareholder agreements - directors are supposed to be functioning independent from shareholders

i.. problem arises where shareholders agree not only to vote their stock a certain way, and when they become directors, that as directors they will do something

ii.. referred to attempting to sterilize the BOD (make the BOD ineffective)

iii.. in all jurisdictions, in order to have this kind of agreement enforced, you must have 100% agreement by the shareholders

a).. because this takes away statutory rights of the shareholders; so need all shareholders to agree to it

                                                iv.. in CA shareholder agreements are recognized:

                                                            a).. so CA created a statutory close corporation

i).. can get shareholders to enter into an agreement identified as a shareholder agreement (must have 100% shareholder approval); then the agreement will be valid no matter how they shareholders want to change the statutory norms

ii).. must say corporation in name, maximum of 35 shareholders, say “this is a close corporation”

iii).. termination of close corporation:

            1).. shareholders vote on it

            2).. if the agreement is lost, then can

say we want protection under common law at least

3).. most common way is for the maximum number of shareholders to be exceeded (by distributing shares to a bunch of people; number increases by operation of law)

4).. if an individual tries to sell stock that will give more shareholders than allowed is VOID

5).. any shareholder has standing to ask court to dissolve the close corp.

iv).. major benefits of close corporations: can rearrange AOI and can enter into shareholder agreements

            F.. dissolution

                        1.. voluntary dissolution - can just vote no courts needed

                        2.. involuntary dissolution

                                    a.. must get a court decree that the corporation is dissolved

i.. must have grounds for dissolution that are set out in statute

ii.. must have standing

a).. must be an appropriate party or number of shares (CA: at least half the directors, OR one third of the independent shares (eliminate shares owned by parties that are accused of fraud if this is the reason for dissolution; if close corporation, ANY shareholder can request dissolution)

b).. minority shareholders have NO standing (need at least one third of shares to get standing); hard for minority to get money out (different than a partnership - easier to get money out of a partnership if the partnership is dissolved)

b.. where 50% or less are moving for a dissolution, the shareholders have the right to buy out the shareholders for fair market value (determined by 3 court appointed appraisers) (section 2000)


            G.. fiduciary duties of officers and directors

                        1.. duty of care

                                    a.. statutory standard derived from case law

                                    b.. director must act in good faith in a manner that is the best

interest of corporation with such care as an ordinary prudent person would in similar circumstances (KNOW LANGUAGE)

                                                i.. not everyone is looked at the same; depends on specialty

                                                ii.. whether they are negligent or not

                                                iii.. duty of care includes reasonable inquiry

                                    c.. a very low standard of care

                                    d.. but more is being demanded of directors these days in takeover

context; did not have protection of business judgment rule because they were grossly negligent in approving buyout

i.. after this decision, CA (and many others) altered extent of financial damages against a director (204a10); can eliminate dollar damages against director for negligence in AOI

                        2.. duty of loyalty (of directors and officers)

                                    a.. two distinct areas where there is problem:

                                                i.. usurpation of corporate opportunity

a).. if opportunity brought to director or officer as an agent of the corporation, the opportunity must be offered first to corporation

b).. line of business test - if the opportunity was in the same line of business as corporation, director must first offer it to the corporation

c).. director cannot deal at arms length with their own corporation

ii.. where interested director transaction

a)..director has a financial interest in transaction

b).. shareholders can approve

c).. get independent BOD to approve (in CA you must also have a just and reasonable transaction as to the corporation - can’t know until you are in court); burden on party that is trying to say the transaction was not just and reasonable

d).. where shareholder is a mere director, just and reasonable does not come into play (where director does not have a financial interest just and reasonable does not come into play)

                        3.. business judgment rule - provides shield of personal liability for

directors; law recognizes that directors are supposed to act in good faith, be fair, etc.; must have elements:

            a.. decision has to be a deliberately focused decision

            b.. decision has to be in good faith

            c.. decision has to be disinterested

d.  no conflict of interest, fraud,


            e.. must be some rational basis for decision

4.. fiduciary obligations of controlling shareholders

            a.. review of cases

            b.. majority cannot use its control at the expense of the minority

            c.. majority has overriding duty of good faith and inherent fairness

5.. piercing the corporate veil - can obtain liability against owner of corporation; in rare cases can also go after sister corporations (very unusual)

a.. inadequate capitalization - usually applied at time of formation of corporation; not applied where there is adverse business and the corporation lost money (must have been at beginning); this is a very hard way to pierce veil - usually in conjunction with one of the other notions

            b.. mere instrumentality - corporation is not run with the objective

of making maximum profit, but being run in a way that would be beneficial to the owners

            c.. alter ego - owners themselves disregard the corporateness;

commingle funds; no shareholder meetings; these things done to the detriment of a third party

6.. equitable subordination (deep rock doctrine) - get creditor’s claims satisfied first if corporation is in bankruptcy


H.. regulation of proxy solicitation (14a of Securities Exchange Act of 1934)

1.. only applicable to listed corporations (NASDAQ, an exchange; $10 million in assets, 500 shareholders)

2.. 14a-9 - anti fraud rule - no solicitation is to be made containing a false or misleading statement OR omits to state a material fact which is necessary (same language in 10b-5 for purchase of securities)

            a.. private right of action - YES; come up as a class action

            b.. do NOT need to show that but for the misstatement or omission

caused each shareholder in the class to have voted differently

c.. material omission or misstatement; must show the solicitation was a necessary link in accomplishing what they wanted to do

3.. 14a-8 - shareholder proposal rule - management must include certain shareholder proposals in its proxy solicitation materials

                                    a.. do NOT have to include counter proposals

                                    b.. do NOT have to include proposals that would be against the law

                                    c.. do NOT have to include proposals that involve ordinary

business decisions

4.. 14a-7 - at shareholder’s cost, the corporation must either mail the proxy solicitation OR at the corporation’s option give a shareholder list to shareholder

                                    a.. great expense


            I.. Insider trading

1.. common law - directors and controlling shareholders had NO fiduciary obligation to other shareholders; however the special facts doctrine appeared - if an insider seeks out a shareholder to buy their shares, and a non material disclosure, then there is a breach of fiduciary obligation; called special facts

            a.. insiders could trade any way they wanted unless special facts

            b.. where insider sold shares, corporation HAS a claim against insider; corporation’s reptutation was damaged

            c.. fiduciary obligation did not fit very well; did not solve problem of insiders selling into market

2.. Rule 10b-5 - unlawful to make material false statement or omissions with connection of purchase or sale of securities

a.. must either disclose or abstain from trading (until market has reasonable time to evaluate the information)

b.. plaintiff must be a purchaser or seller

c.. insider expanded to include individuals who were given the confidential information in confidence (bankers, lawyers, etc.)

d.. tippees - liable if they know tippor is breaching fiduciary obligation and doing so for personal advantage

e.. possession of material non public information is not enough for 10b-5 liability

            i.. must have a duty to speak in order for their to be a fraud by nondisclosure

f.. in criminal enforcement actions, if information was obtained by someone outside the corporation through a breach of a duty, this would constitute a misappropriation and 10b-5 liability

g.. tender offeror liability (CHECK)  14e-3 - did not require a breach of duty for liability (O’Hagan case)

h.. in private causes of action, reliance is still somewhat necessary - at least in a face to face transaction; probably not needed in market transaction; courts will presume reliance if omission is material

i.. must still show causation for damages

i.. loss causation - non disclosed material information caused the stock price to change

            ii.. transactional causation

j.. scienter - must have the intent or at least reckless disregard; negligence not enough to support 10b-5 action

k.. Litigation Reform Act of 1995

            i.. to provide safe harbor for forward looking statements

if the information; must state the statements are mere estimates, judgments as to what is going to happen; then no 10b-5 liability

ii.. not applicable to tender offers or IPO’s

                        3.. 16(b) - involves insider’s trading in their own shares

                                    a.. applicable only to registered, reporting companies

                                    b.. involves only officers, directors, or more than 10% shareholders

                                    c.. RULE: any profits made in less than 6 months by those

statutory insiders belong to the corporation

d.. calculation of profits - compare sale and purchase at any time within 6 month period

e.. officer or director need be as such only at one end of the transaction

i.. BUT more than 10% shareholder must be such at BOTH time of purchase AND sale (stops people from selling enough to be just under a 10% shareholder at time of sale)

                                    f.. courts try to bring some policy in to 16(b) operation:

i.. in unorthodox transactions, buying and selling share NOT for cash (stock exchange, etc), courts can interpret what constitutes purchase and sale for 16(b)

a).. test: whether the transaction could lend itself to speculative abuse on inside information



J.. Limited Liability Company

            1.. fundamental aspects

                        a.. combines elements of partnership and corporation law

i.. all members (owners) have limited liability (like a corporation)

ii.. also can avoid double taxation (which occurs in taxation - get partnership type of taxation)

iii.. can set up internal management to look like corporation or partnership

b.. LLC may not be used to carry out professional activity (lawyers)

                                    c.. used often for joint ventures (not for public companies yet)

                                    d.. flexible in types of stocks, voting ability

                                    e.. must have at least 2 owners right now


II.. examination advice - 3 hour exam

            A.. read the question carefully

                        1.. respond to the particular inquiry being made

                        2.. multiple choice is on basis of particular fact so you need to make sure

you know all the facts

            B.. pace yourself - 3 hour exam

                        1.. don’t justify an answer by saying “true, unless….”

                        2.. if you do this you will probably want to say false instead

            C.. Some kinds of answers that do not receive credit:

                        1.. select the best, and say why “because A, B, C incorrect”

                        2.. don’t repeat the facts  - give the legal basis of your answer

                        3.. staggered boards benefit minority shareholders? FALSE

            D.. exam info

                        1.. 26 questions that require 33 answers

                        2.. exam is 3 hours


III.. review of sample questions

A.. Laura and Phil, owners of 50% of outstanding stock, Phil wants a dissolution, can Laura prevent it?

1.. Laura CAN prevent it buy using the forced buyout provision.  A fair value determined by the court

B.. Limited partnership purchasing inventory of RVs for a grand opening; things did not go well; limited partner then stepped in and participated in control of business; seller of RVs sues dealership; tries to get money from limited partner;  Is the limited partner liable for unpaid amount?

                        1.. RV international will NOT succeed -

                                    a.. must participate in control

                                    b.. must have some reliance - third party must be aware of the

control at the time of transaction

C.. Conflict of interest transaction; person sitting on two boards of directors;

1.. treat differently where there is a financial interest on part of the director, and where there is not (REVIEW THIS)

2.. ANSWER: none of above

3.. for each justification don’t write more than a sentence, unless answer is all or none of above.  Then explain why you did not choose each of the answers