985-796-8607SPRING 2002

ROUSSEAUI. AgencyAn independent contractor may or not be an agent. If the independent contractor is an

agent he is considered a Non-Servant.A Non-Servant acts on the behalf of the agent, but are not subject to the agent's control. In

agency, it is the will of the principal that determines and controls outcomes. In a non-agency relationship, it is the contract that determines the outcome.

In Non-Servant the contract provisions are determinative of the relationship.There are both General and Special agents. - general agents are authorized to conduct a series of transactions.- Special agents are authorized to conduct a single transaction.- Apparent authority is more likely to be applied to general agents.

Disclosed Principal: the 3rd Party knows that the person w/ whom he is transacting is a mandatory, and knows the identity of the principal.

Partially Disclosed Principal: the 3rd Party knows that the person is a mandatory but not the principal.

Undisclosed Principal: the 3rd party does not know that the person is a mandatory and, thus, does not know that there is a principal.

There is a fiduciary relationship between the parties.For there to be a fiduciary relationship, there is a need for control.

For instance, a controlling creditor runs the risk of becoming a principal if they gain too much control.

For there to be agency there must be:1) Consent of the principal and the agent.2) Control of the agent by the principal3) Agent's acting on behalf of principal.

As far as "control," it need not be all encompassing, but must at least have the ability to direct the actions of the agent in some meaningful way, or at a minimum, have the right to determine the purpose or outcome of the agency.

Urbeso v. BryanThe Ct. decides whether or not there is a employee / employer relationship between the

parties. The P's car was damaged when it was getting towed by a towing company that was hired by the St. Bernard Sheriff's Dept. In determining if there was a fiduciary relationship they must determine if there was control by the employer. It is not "whether he did exercise control." It is whether "he had the right to exercise control." In looking at the relationship they looked at:

-the towing company was obligated to respond-he had to put the car where the sheriff wanted it versus-he was not under any employer type of relationship-there was no physical control

The sheriff's Dept. allowed the company to tow cars despite the fact that they were not insured to do so.

The court found that there was a fiduciary relationship between the parties and reversed a summary judgement which had found to the contrary.

Apparent Authority of Mandatory: The principal is liable for the unauthorized acts of a mandatory under circumstances in which the principal has made a sufficient manifestation or indication that the agent does have authority upon which a third party can reasonably rely.

Ratification: an affirmance by a person of a prior act which does not bind him but which is done or professedly done on his account, whereby the act, as some or all persons, is given effect as if originally authorized by him.

The affirmation is effective when it is made not when it is communicated; unless, the 3rd party changes his mind not knowing of the ratifications.

Affirmance may be made by silence. (a failure to repudiate can be a ratification).The principal must have had capacity at the time.The ratification cannot be selective. It must be accepted as a whole, or not at all.

The effect is the same as that would have resulted from an authorization: liability of the principal and the 3rd party to the contract, or the principal's liability for the agent's tort or act.

What are the different powers that a 3 rd party can use to bind a principal: 1) Apparent Authority,2) Estoppel,3) Detrimental Reliance,4) Inherent agency power,5) Emergency power,6) Unjust enrichment (actio de in em verso) and management of the affairs of others

w/o authority (Negotiorum Gestio)

Apparent Authority: principals are bound under AA b/c they have put their agents in a position to induce 3rd parties to believe and reasonably rely upon the agent's authority to act, even where such authority does not exist.

For AA to apply:1) The principal must act to manifest the agent's ostensible authority to an innocent

3rd party.2) The manifestation must reach the 3rd party.3) The 3rd party must reasonably believe.4) The 3rd party must be caused to act or not act to his detriment.

The manifestation can be made: directly to the 3rd party, to the community, by the principal clothing the agent w/ the indicia of ownership or authority.

The burden of proving apparent authority is on the party relying thereon.Boulos v. Morrison

Applies apparent authority. "a 3rd person cannot blindly rely upon the assertions of an agent. He has a duty to inquire into the nature and extent of the agent's power." The guy was able to go into the back office. i.e. He was given access. Must look at all the factors, but the guy still has a responsibility to investigate if there is any question regarding the authority.

Independent Fire Ins. Co. v. Able Moving and Storage Co., Inc.The P hired Able to move their furniture. The movers burned her house down w/ a

cigarette. They had advertised as being Bekins movers. They showed up in a Bekins truck, and in Bekins uniform. The check was written out to Bekins. The Ct ruled that she had relied upon the name as being Bekins that it was the national Bekins company. Bekins had actual authority on the use of the name and apparent authority b/c of the use of the name by Able. The main issue was the reliance issue which was usually the "name" was not normally enough; However, in this case it was judged to be.Change in position is not as important with tort liability as it is with contract liability.

The articles:Representation2985: a person may represent another person in legal relations as provided by law or by

juridical act. This is called representation. 2986: The authority of a rep may be conferred by law, by contract (such as procuration or

mandate), or by unilateral contract.

2987: Procuration is a unilateral juridical act by a person, the principal, confers authority on another person, the representative, to represent the principal in legal relations.

The procuration may be addressed to the representative or to a person w/ whom the rep is authorized to represent the principal in legal relations.

Comment: it differs from mandate in that mandate is a K while procuration is a unilateral juridical act. Thus, the recipient of the procuration is not bound to do anything.

2988: a procuration is subject to the rules governing mandate to the extent that the application of those rules is compatible w/ the nature of the procuration.

Once the recipient accepts the procuration, it seems clear that there is some form of K is formed and thus he will have some obligations.

Procuration should usually be regarded as a type of precursor to mandate. It is best classified as an offer to a K of mandate.

MandateSection 1: General Principles.2989: mandate is a K by which a person, the principal, confers authority on another person,

the mandatory, to transact one or more affairs of the principal.-in drafting this article they left out the words, "and in his name." Thus, they adopted

the concept of the undisclosed mandatory.-an affair can be a juridical or material act, thus, the authority of a mandatory can be

much greater than that of a procurator.2990: if the law of mandate does not have a provision the laws of conventional obligations

applies.-this governs the object of the mandate.

2991: the K of mandate may serve the exclusive or the common interest of the principal, the mandatory, or a 3rd person.

-in all cases the good faith of the mandatory is required, but, there is no conflict if the mandatory serves to gain from the K in some fashion.

2992: The K of mandate may be either onerous or gratuitous. It is gratuitous in the absence of contrary agreement.

-if the K is gratuitous, then the mandatory still is obligated to perform the mandate, however, according to 3002, the amount of damages may be reduced.

2993: The K of mandate is not required to be in any particular form. Never the less it must be in at least the level of form required for the action which the mandate is expected to perform.

-"equal dignity" rule

2994: The principal may confer on the mandatory general authority to do whatever is appropriate under the circumstances.

-this article confirms that there is possible such a thing as a general mandate.

2995: the mandatory has authority to do things which are incidental to the performance of the mandate.

-This shows that the mandatory has implied authority to perform necessary acts in the fulfillment of the authorized mandate.

2996: If the mandate were to alienate, or encumber a thing he must be given express authorization to do it. But the thing to be sold does not need to be specifically described in the mandate.

2997: Express Authority is needed to:1) Make a donation2) Acc. or Ren. a succession3) K a loan, acknowledge or remission a debt, or become a surety.

4) Make promissory notes and negotiable instruments5) Agree to a compromise or arbitration6) Make health care decisions

-Express does not mean in writing.-These things make a distinction b/t actions that are as an agent and those acting as an

owner. So, an attorney can file suit but cannot settle. Its nature would be too close to an assumption of ownership.

2998: A mandatory cannot K with himself unless he is authorized to do so by the principal.2999: A person who is of limited capacity can act as a mandatory, however, his obligations

are governed by that stated in the code regarding people of limited capacity.3000: If a person is a mandatory for both the principal and the person who is to be the 3rd

party, then he must disclose this to both parties.Section 2: Obligations of the Principal and the Mandatory to Each Other(mandatory to the principal)3001: the mandatory is obligated to fulfill the mandate he has accepted with prudence and

diligence. He is responsible for any loss that the principal sustains as a result of his failure to fulfill the mandate.

3002: if the mandate is gratuitous the amount of loss for which he is liable may be reduced by the court.

3003: The mandatory is obligated to keep the principal informed about his performance and immediately notify upon his completion of the mandate.

3004: The mandatory is obligated to restore to the principal that which he has received as a result of the mandate. He may, however, retain enough property of the principal to pay for the mandatory's expenses and remuneration.

3005: The mandatory must pay the principal interest on the value of the property of the principal which he used for his own use.

3006: The mandatory is required to fulfill the mandate himself unless he authorized to appoint a substitute, or unless unforeseen circumstances make using a substitute necessary.

3007: If the mandatory is permitted to appoint a substitute, he is only liable if he does not use diligence in the selection of the substitute.

If he is not permitted to appoint a sub, he will be liable, regardless of the circumstances.

-the mandatory and the substitute should probably be liable in solido, so comparative fault should apply b/t the 2.

3008: If the mandatory exceeds his authority and causes a loss to the principal he is liable to the principal, but the principal is not liable to the mandatory for any loss he suffers as a result.

3009: Multiple mandatories are not solidarily liable unless the mandate provides otherwise. (principal to the mandatory)3010: the principal is bound to the mandatory to perform the obligations that the mandatory

contracts that are within the limits of his authority. He is not bound to the mandatory to perform any obligations that the mandatory contracts outside of the mandatory's authority, unless, the principal ratifies that K.

-The principal is primarily bound to the 3rd party with whom the mandatory has contracted.

3011: The mandatory has acted within his authority even if his fulfillment is more advantageous to the principal than was authorized.

3012: The principal is bound to pay the mandatory for his expenses and for his remuneration even if the mandatory fails to fulfill the mandate so long as it was not by the mandatory's fault.

3013: The principal is bound to compensate the mandatory for any losses which the

mandatory suffers as a result of the mandate so long as the mandatory is not the cause for the loss.

3014: The principal owes the mandatory interest on whatever expenditure the mandatory has paid in the performance of the mandate from the date that the expense was incurred.

3015: Multiple principals for a common affair are solidarily bound to the mandatory.-compare to 3009, which makes a contradictory statement regarding mandatories.

Section 3. Obligation of the Principal, the Madatory, and 3rd Persons to Each Other.(Mandatory to 3rd Persons)3016: A mandatory who contracts in the name of the principal and within the limits of his

authority does not bind himself personally to the performance of the K.-This article recognizes disclosed mandate, and principal.

3017: A mandatory who contracts in his own name without disclosing his status as a mandatory binds himself personally for the performance of the K.

-This article recognizes the concept of the undisclosed mandate.

3018: If the mandatory discloses his status but not that of the principal, he binds himself personally to the performance of the K, but ceases to be bound when the principal is disclosed.

-disclosed mandatory, undisclosed principal. When the principal is revealed, the mandatory's obligations is the same as the mandatory in a 3016 type mandate.

3019: A mandatory who exceeds his authority is bound personally to the 3rd party with whom he contracts unless the 3rd party knew that he was exceeding his authority or unless the principal ratifies the K.

(Principal and 3rd Party to Each Other)(Principal to 3rd Party)3020: The principal is bound to the 3rd party to perform the obligation which the mandatory

contracts within the limits of the mandatory's authority.-This is regardless of whether the principal is disclosed or undisclosed.

3021: Putative MandatoryOne who causes a 3rd person to believe that another person is his mandatory is bound

to the 3rd person who is in good faith contracts with the putative mandatory.-This introduces Apparent Authority into the Code. It is based only on the 3rd parties good

faith. It makes no mention of any reliance, so it is more similar to "strict agency" than it is to an "estoppel" theory.

(3rd party to Principal)3022: A 3rd party who K's with a disclosed or undisclosed mandatory obligates himself

personally to the performance of the K.3023: The 3rd party is bound personally to the undisclosed principal to perform the K,

unless the obligation is strictly personal or a right that is non-assignable.Section 4. Termination of the Mandate and the Authority of the Mandatory.3024: In addition for the causes of termination of a K under the laws of conventional

obligations, both the mandate and the mandatory terminate upon the death of the principal or the mandatory, interdiction of the mandatory, or qualification of the curator after the interdiction of the principal.

-Power, coupled with an interest, will prevent a termination by the mandatory.

3025: The principal can terminate a mandate at any time unless he has made an agreement to the contrary.

3026: Unless there is a contrary agreement the principals incapacity will not terminate the

mandate. This includes even when he should be considered incapable of revoking the mandate.

-Article 3024 provides that in this type of situation the mandate is terminated when the principal's curator is qualified. This acts to create an interim period b/t interdiction and the appointment of a curator.

3027: A person who is entitled to rely on the Public Records can rely on such regarding powers of attorney until the revocation of such is recorded in the Public Records.

3028: The 3rd persons with whom the mandatory is authorized to K must be notified that the mandate has been terminated. Otherwise, the obligations which the mandatory forms are enforceable a/g the principal.

3029: The mandate terminates when the mandatory notifies the principal of his resignation or renunciation.

-If the termination causes injury to the principal, it can be governed by the rules of conventional obligations. It can be reduced if it is a gratuitous mandate. This also follows the "power coupled with an interest" theory.

3030: If the mandatory has undertaken a mandate and the principal dies, he is bound to fulfill the undertaking if delay would cause an injury.

3031: If the mandatory does not know that his mandate has ended and the 3rd party is in good faith, the K is enforceable.

3032: The mandatory is bound to account for his performance to the principal upon termination of the mandate unless expressly dispensed with.

II Types of Business Associations1. Sole Proprietorships

Capital Outlay is smallPersonally liable for all debtsDifficult to raise capital, transfer, or sellBased largely on human capital, andTaxed individually on income

2. Ordinary PartnershipsIt is a legal entity that is separate and apart from its members and owners.There is a requirement that there be an agreement b/t the partners to assign determine

there efforts and to collaborate at mutual risk. This would be a Partnership Agreement.

The contract does not need to be in writing unless it is to own immovable property.Each partner has unlimited individual liability.Each of the following is split b/t the partners:

Equal authorityEach is an agent for the partnershipEach partner is jointly and severally liable.

-It doesn't matter if they approved the action, partners are strictly liable.Agreements can be made toward the continuation of the partnership should one of the

members die.There is a clear distinction b/t a partner's cessation of membership and the termination of

the entity. Termination occurs by the unanimous consent of the partners, by a judgement of termination, and by the bankruptcy of the entity.

A partner can sell his interest in the partnership but the transferee does not thereby become a partner. Rather, the transferor remains the partner subject to the financial deal with the transferee.

Partners files the tax return but partners are all taxed individually (The partnership acts as a Pass-Through Entity or (flow-through entity)).

3. Limited Partnerships (Partnerships in Commendam)

Consist of General Partners who:Have the rights, powers, and obligations of partners

And Limited Partners who:Have no personal liability beyond the amount contributed to the partnership unless

he:Participates in the management and control of the ordinary affairs of the businessOr, holds himself out as a general partner.If the limited partner allows his name to be used as if a general partner, a 3rd party

can sue as if he was a general partner without any specific proof of reliance thereon.The failure to comply with the statutory obligations of becoming a Limited Partnership will

result in the Limited Partners being treated as General Partners of the business.4. Registered Limited Liability Partnerships

This type of partnership needs to register with the Secretary of State and pay a fee.Partners are not individually liable for the liabilities or obligations of the partnership

arising from: errors, omissions, negligence, incompetence, malfeasance, or willful or inadvertent misconduct committed in the course of the partnership business by another partner, agent, or representative of the partnership.

Partners remain personally liable for their verile share of all other types of debts of the partnership such as contracts, contractual warranties, etc.

Each partner is always liable for his own torts.This is also a "flow through" entity for tax purposes.

5. Limited Liability Companies (LLC)Must be filed with the Secretary of State.Partners enjoy general limited personal liability for any LLC debt or liability whether

arising in tort, contract, or otherwise.They are still liable personally for their own torts or personal guarantees.Members can participate in the management of the business without jeopardizing their

limited liability status.The LLC can conduct business, own property, etc as its own entity.An operating agreement is not a requirement of an LLC. It can even be an oral

agreement.The Tax status is "check the box" to determine whether to be considered a "flow through

entity" or to be treated as a corporation. 6. "S" Corporations

There is a requirement that the proper filing be made with the Secretary of State.Articles of Incorporation, an initial report, and an affidavit signed by the agent for

process accepting appointment as the registered agent.Must have at least one shareholder, a board of directors, a president, and one other

officer.It may have by-laws.Shareholders will generally have Limited Liability.Corporations have perpetual existence.Have "flow through" taxation.

To be considered such the shareholders must meet Federal tax regulations:U.S. Citizens< 35 shareholders (It's now 75 members, but he hasn't changed it in his book)Only one class of shareholders is allowed, except for differences in voting rights.

-"S" corporations are generally "close" corporations. A close corporation is one which has special limitations on the transferability of shares.

7. "C" CorporationsGenerally are publicly traded corporations, and/because will not qualify to be an "S"

corporation because of the U.S. treasury restrictions on such.There are no restrictions on the transferability on the trading of stock.There can be unlimited numbers of classes of stock holders.

This form has the greatest stability of all of the business forms which exist.They are taxed under the general corporation taxation format. Thus, the profits of the

corporation are taxed, and the dividends of the corporation are taxed a/g the shareholders. This creates "double taxation" of the profits generated by the corporation.

III. PartnershipsChapter 1. General principals2801: A partnership is a Juridical Person, Distinct from its partners. It is created by a

Contract between 2 or more persons to combine their efforts or resources in determined proportions and to collaborate at mutual risk for their common profit or benefit.

-Mere co-ownership does not mean that there is a partnership because there is no consent.-The parties can K to have the amounts of the above in different proportions.

2802: The K of partnership is governed by the rules of conventional obligations in all matters that are not otherwise provided in this title.

2803: Each party participates equally in profits, benefits, and losses, unless the partners agree otherwise. The same applies to the distribution of assets, but unless otherwise agreed separately, contributions to capital are returned to each according to the contribution made.

-An agreement to apportion the risk will not affect the rights of 3rd parties.

2804: An agreement which states that only one of the following is to be in a certain proportion then that proportion applies to the other categories:

Profits, benefits, losses, or distributions other than capital contributions.2805: A partnership is not required to adopt a name which includes the name of a partner;

However, if no name is chosen, then it will operate in the name of all of its partners.2806: A partnership can own immovable property, but the partnership must be established

by a writing at the time of the acquisition. If it is not in existence at the time of the acquisition, then the title to the property is

vested in the individual partners, and is to be treated by 3rd parties as such.2807: Unless the parties have agreed otherwise,

Unanimity is required to:Amend the partnership agreement,Admit new partners, Terminate the partnership, orPermit a partner to withdraw without just cause if the partnership has been

constituted for a term.Majority is required to:

Make decisions affecting the Management or Operation.Chapter 2. Obligations and Rights of Partners Toward Each Other and Toward the Partnership2808: Each partner owes the partnership all that he has agreed to contribute to it.2809: A partner owes a fiduciary duty to the partnership and to his partners. If he conducts

activity contrary to that duty and prejudicial to the partnership, on the behalf of himself or a 3rd party, he is accountable to the partnership for any profit.

-To recover under this theory, the partner must be allowed to recoup his investment in the activity or the partnership must contribute its share of the investment.

2810: Neither 2808 nor 2809 prejudice other rights granted by law to recover damages or to obtain injunctive relief in appropriate cases.

-This article allows the partnership to recover from any damages which the partner caused. Thus, the partnership is not limited to the profits the partner received.

2811: A partner can also be a creditor to the partnership.

2812: A partner can share his interest in a partnership with a 3rd party without the consent of the other partners, but he cannot make that person a partner. Also, That partner will be responsible for any losses which that person causes to the partnership.

2813: A partner has the right to look at the books and records of the partnership. Any agreement to the contrary is null.

He has this right so long as it does not interfere with the operation of the business or the right of another to do the same.

Chapter 3. Relations of the Partnership and the Partners with Third Persons2814: A partner is a mandatory of the partnership for all matters in the ordinary course of its

business. However, this does not apply to the selling, etc of immovables.A provision to the contrary does not affect 3rd parties who in good faith K with that partner.

2815: A provision that a partner is not to participate in the losses does not affect 3rd parties.

2816: An obligation which the partner K's binds the partnership if it benefits by the transaction or if the transaction would be made in the ordinary course of the business. If the partnership is so bound it can also enforce the contract.

-this would keep the partnership from isolating a loss with one partner from the rest of the partnership after he has taken on an obligation for the benefit of the partnership.

2817: Creditors must first look to the partnership for the debts of the partnership. The partners are only secondarily liable.

-solidary liability is no longer available to creditors unless done so by agreement. They are imputed to be liable only for their virile share.

Chapter 4. Cessation of MembershipSection 1. Causes of Cessation

2818: A partner ceases to be a member of a partnership upon his:death,being granted an order for relief by bankruptcy,interest in the partnership being seized and not released as in 2819,expulsion from the partnership,withdrawal from the partnership, orin accordance with the K.

2819: A partner ceases to be a partner if his interest is seized and not released for 30 days.

2820: A partner can be expelled from the partnership for just cause by a majority vote of the partners.

2821: Partnerships for a term can be withdrawn from without consent, if the partner has just cause resulting from another partner's failure to perform an obligation.

2822: Partnerships without a term can be withdrawn from without consent at any time. But, he must give a reasonable notice and at a time that would not be unfavorable to the partnership.

-If he doesn't give reasonable notice he can be liable for damages.

Section 2. Effect of Cessation of Membership and the Rights of the Former Partrner2823: The Former Partner, his successors, or the seizing creditor is entitled to an amount

equal to the value of the share that the former partner had at the time membership ceased.

2824: The person in 2823 is entitled to interest on that value from the date that the membership ceased.

2825: If there is no contrary agreement the person in 2823 is entitled to seek a judicial determination of the amount.

Chapter 5. Termination of the PartnershipSection 1. Causes of Termination

2826: A partnership is terminated by:unanimous consent,judgement of termination,bankruptcy under chapter 7,reduction of membership to one,attainment or impossibility of attainment of the object of the partnership.

Or, in accordance with the provisions of the K of partnership.A partnership in commendam is terminated by:

The loss of a general partner unless:The other general partners consent to continue the partnership, orThe limited partners agree in writing to continue the partnership, appoint a new

general partner, and within 90 days of the event.(Continuation)2827: If the contract ends because its term expires, the object is attained, or a resolutory

condition is attained, the partnership can be continued expressly or impliedly.If the object is no longer attainable, the partnership can be continued for a different

object.If a new term is not agreed upon, the partnership continues without a term.

2828: When the partnership terminates, the business of the partnership ends except for purposes of liquidation.If it is terminated because the membership drops to one, the remaining member may continue the partnership but will owe the former partners the value of their shares as of the time of the termination of the partnership. They have the right to demand security.

Section 2. Effects of Termination of Partnership and Rights of Former Partners 2829: A change in the number or identity of partners does not terminate the partnership

unless the membership is reduced to one.2830: When the partnership terminates the authority of the partners as agents ceases. If a

partner in good faith, and not realizing that the partnership has terminated, K's, he binds the entire partnership as if it still existed.

2831: The termination of the partnership, for any reason, does not affect the rights of 3rd parties in good faith who transacts business with a partner or mandatory of the former partnership.

Chapter 6. Dissolution, Liquidation, and Division of Assets2832: The creditors of the partnership must be paid in preference to the creditors of the

partners. 2833: Division of the partnership assets.

Secured creditorsUnsecured creditors who are not partnersUnsecured creditors who are partnersCapital contributions to the partnersSurplus to the partners based on their interests.

2834: Unless otherwise stated the rules of liquidation of a partnership are the same as that to liquidate a corporation.

A partnership retains its juridical personality for the purpose of liquidation. 2835: The liquidation is not final until all of the assets have been used to satisfy its debts

and the surplus distributed to the partners.Chapter 7. Partnerships In Commendam (Limited Partnerships)2836: The provisions of the other chapters apply to Partnerships In Commendam so long as

they are consistent with the provisions of this chapter.

2837: A Partnerships In Commendam consists of one or more general partners who have the rights, powers, and obligations of a partner and limited partners (partners in commendam) whose powers, rights, and obligations are defined in this chapter.

2838: To be a partnership in commendam, the name of the company must show that it is such or that it is a limited partnership, and must not imply a name of a limited partner as a general partner.

2839: If he permits the use of his name to be used in the business dealings so that it implies that he is a general partner, he shall be liable as such.

If it is used without his permission, he is liable only if he knew or should have known it was being used and if he did not take reasonable steps to prevent such a use.

If the name of the company includes the name of another with the same name as the limited partner, he will not be liable because its use does not imply that he is a general partner.

2840: A limited partner must make a contribution to the partnership. The contribution must be made for a specific contribution and state the value or method of calculating the value of the contribution. There must be a time when the contribution is to be made by. The limited partner's liability is limited to his contribution and can be compelled to make that contribution by specific performance.

2841: To become a limited partnership, the partnership make a written contract of partnership and must file it with the Secretary of State. Until that time the limited partners will be liable as if they were general partners.

2842: A limited partner cannot receive any capital or undistributed profits if to do so would render that partnership insolvent. If he does so, he can be compelled to return the amount that he received by the partners, or by the creditors of the partnership.

2843: a limited partner does not have the authority to bind the partnership, participate in the management of the partnership, or to conduct business with 3rd parties on the behalf of the partnership.

2844: A limited partner is not liable for the obligations of the partnership unless: He is also a general partner of the partnership, orHe participates in the control of the business.

If based on his control of the business, he is liable to persons who transact with the partnership who reasonably believe that, based on his conduct, that the limited partner is a general partner.

He is not participating in the control of the business simply by:1) Being a contractor, agent, or employee of the partnership or a

general partner.2) Being an employee, officer, director, or shareholder of a

general partner that is a corporation.Being a member or manager of a general partner that is an LLC.

3) Consulting with or advising a general partner.4) Acting as a surety or making one or more obligations with the

partnership.5) Pursuing a derivative action in the right of the partnership.6) Requesting or attending a meeting of partners.7) Proposing, approving, or disapproving, by voting of one of the

following matters:a) The continuation, dissolution, termination, or

liquidation of the partnership.b) The transfer, sale, etc of any or all of the assets of

the partnership.c) The taking on of debt by the partnership other than

in the regular course of business.d) A change in the name.

e) The admission, expulsion, or withdrawal of a general partner.

f) The ", ", "" "" limited partner.g) A transaction involving a conflict of interest between

the general partners and those of the partnership or limited partners.h) An amendment to the contract of partnership.i) Exercising any right or powers permitted to limited

partners that the contract of partnership states in writing to be subject to the approval or disapproval of the limited partners.

8) Liquidating the partnership.9) Exercising any right or powers permitted to limited partners in

this chapter.

-Ex. A is a limited partner, but is also president. This does not mean that he automatically loses limited liability. But, he must present that when he acts as president that he is not acting in any other function.

-The LLC would allow the partners to manage all that they want without losing their limited status. This is why it is preferred today.

Title 9. Chapter 3. Registered Limited Liability Partnerships§3431: A. A partner of a RLLP shall not be liable for the liabilities and obligations of the

partnership arising from:Errors, omissions, negligence, incompetence, malfeasance, or willful or intentional misconductCommitted in the course of the partnership business byAnother partner, or a representative of the partnership.

B. The person does not lose his right against the partner who commits fraud or any breach of his professional duty. The RLLP also does not lose its right against that person for any fraud practiced upon it by that partner.

C. Subsection A does not affect the liability of a partner for any other cause than those specified in subsection A.

D. Subsection A does not affect the liability of the partnership assets for any partnership liabilities and obligations.

E. A partner of an RLLP who would be excluded from liability based on Subsection A would not be a proper party to a lawsuit by or against the RLLP to enforce liabilities or obligations listed in Subsection A.

-The partners remain liable for any contracts, or contractual warranties that the partnership makes.

-This article is not intended to protect the RLLP's assets from suit. -B keeps the partner's liability for things such as fraud, breach of professional duty or other

negligent or wrongful acts according to the LA Bar Journal article.

§3432. To become an RLLP, the partnership must file with the Sec of State an application stating:

The Name, address, number of partners, statement about business.Shall be executed on the behalf of a majority of the partners.Shall be filed with $100 fee and the registration needs to be renewed once a year

with the same fee payable.§3433. The name shall contain "registered limited liability partnership" or "L.L.P" at the end

of its name.§3434. A partner does not have to return assets to the partnership to satisfy a debt of the

partnership based on a liability or obligation based on Subsection A. Except to the extent of Chapter 12 of Title IV of Book III (presumably fraud)

§3435. If the RLLP fails to renew its RLLP status with the Sec of State, it will become a regular partnership and the provisions of this chapter will no longer apply.

Elements to consider in a partnership agreement:1) Put it in writing.2) Record it.3) Name.4) Set up contributions to be paid by each.5) Profit sharing6) Loss sharing7) Control sharing.8) What are the duties of the parties.9) Loans10) Restrictions on Sales of Interests.11) Changes in Partners.12) Termination13) Liquidation14) Accounting Method15) Fiscal Year16) Amendment of agreement17) Notice provision18) Severability.

IV. Limited Liability CompaniesTitle 12. Chapter 22. Limited Liability Companies.Part I. Definitions§1301: Definitions

Part II. Formation§1302: The LLC can be organized for any lawful purpose. It can restrict itself to less than

any purpose.§1303: An LLC has the powers, rights, and privileges of a corporation organized under 12:1

and that provided for a partnership.It shall have perpetual existence, unless otherwise stated by the articles to be less.

§1304: It is formed as an LLC when it is filed or at its election on any specific date within 30 days of the filing with the sec of state.

The certificate of organization will show that it has been organized and exists of the time of the filing.

If the articles are filed within 5 days of their acknowledgement or execution, the filing date shall be retroactive to the date of the ack or ex.

§1305: What should be in the initial report of the articles of organization.§1306: The name shall include "limited liability company," "L.L.C.," or "L.C." It shall not

misrepresent what the company is limited by law or its article to do. It shall not purport to be a charity or nonprofit. The name shall be distinguishable from other companies.

§1307: The exclusive right to use a name can be registered by…and may be transferred.§1308: The company shall have a registered office in this state and a registered agent in this

state. It can be changed by the appropriate procedure and filing it with the sec of state. A registered agent can resign but must give notice to the sec of state and the LLC. The designation continues for both the office and the agent until notice and filings are made.

§1309: The articles must be amended when: the name is changed, the articles contain a false or erroneous statement, or the members desire to make any changes in the organization which is contrary to the articles.

§1310: There is also a process called a "certificate of correction" that can be used to make corrections to the articles or any other document which has been filed. The correction shall not make any changes to the articles which would have been unlawful at the time of filing the original document. It shall be filed with the Sec of

State and with any of the appropriate recorders of conveyances.Part III. Management and Management Rights of Members.§1311: Except as otherwise provided the LLC is to be managed by the members.§1312: The managers may or may not be members. The Articles may provide qualifications

to be a manager. The number of managers shall be specified. §1313: Unless otherwise provided, election of managers is initially by a plurality vote, and

managers can be removed by a majority vote, with or without cause, at a meeting called expressly for that purpose.

§1314: A member or manager:has a fiduciary duty to the LLC.In discharging his duty, is protected from liability in relying in good faith on the records of the LLC.

He is not acting in good faith if he has knowledge that makes reliance otherwise impermissible. Shall account to the LLC any benefit he has derived by him from any transaction connected with the conduct or winding up of the LLC or from any personal use by him of its property.

§1315: The articles or written operating agreement may:Eliminate or limit the liability of a member or members based on their membership.Provide for the indemnification of a member or members based on their membership.

But no provision can limit the liability of a member for liability based on their theft from the LLC or other unlawful acts.

§1316: Unless otherwise provided, the members shall have a single vote in all matters, and the decisions made by majority vote.

§1317: Unless otherwise provided, all members and managers are mandatories of the LLC or if a 3rd party reasonably believes him to be a mandatory.If it is stated in the written operating agreement and articles of organization that the person is not a mandatory, the 3rd party is deemed to have knowledge that the restriction exists. 3rd parties can rely on the certificate to establish membership that a person is a member.

§1318: Unless otherwise provided, single vote and majority decisions.Unless otherwise provided, a majority vote is req'd in the following matters:

1) Dissolution and winding up.2) Sale, etc of assets.3) Merger or consolidation.4) Incurrence of debt, other than in the normal course of business.5) Sale, etc of immovables.6) Amendment of the articles of organization or operating agreement.

No contract or transaction between LLC's and one or more of its members shall be void solely for the reason that he is a member with an interest.1) Because a manager or member was present in the meeting

that authorized the contract or transaction, or2) because his votes were counted for such a purpose

If the interest was disclosed, and his vote was not counted, orIf the interest was fair at the time of the authorization, approval, or ratification.

The interested party's vote counts to the extent needed to meet quorum.§1319: An LLC shall keep at its registered office:

1) Name and address of each member.2) Records that establish voting rights of its members.3) A copy of the articles of organization with the amendments.4) State & Federal tax returns.5) Written form of the operating agreement.6) Financial statements.

Unless otherwise provided, a member can do any of the following:1) Inspect and copy and records of the LLC upon reasonable request.2) Obtain from time to time: a copy of the tax returns, true and complete

information regarding the business and financial condition, or other information that is just and reasonable.

3) Demand a formal accounting of the LLC's affairs.Failure to provide the above will not make the LLC or any member liable.

§1320: Liability of managers, members, employees, or agents shall be determined solely and exclusively on the provisions of this chapter.

Unless otherwise provided, no member, manager, employee, or agent of an LLC shall be liable for any debt or obligation or liability of the LLC.

None of the above people are proper parties to a proceeding by or against an LLC.Nothing in this chapter limits a person's liability for fraud, breach of professional duty,

wrongful act, or negligence by such a person. Nor does it preclude the LLC's action against that person.

Part IV. Finance.§1321: The contributions of the partners can be in the form of cash, property, services, or a

promissory note or other obligation binding the person to make a contribution.§1322: A promise to contribute is not enforceable unless it is in writing and signed by the

member.If the person does not make his contribution, his interest can be seized by the LLC.

A creditor can force the contribution to be made.If the person does not make his contribution, the LLC can make a compromise

agreement if the compromise is approved with unanimous consent of the other members.

§1323: Unless otherwise provided, the profits and losses of the LLC shall be allocated equally among the members.

Part V. Distributions.§1324: A person is entitled to receive distributions from the LLC unless otherwise provided in

this chapter and to the extent that the operating agreement or authorized by the members.

Unless otherwise provided in writing, the distributions are to be made equally.§1325: If the LLC is for a term, a member may withdraw without consent if, his cause is that

another member has failed to perform an obligation.If the LLC is not for a term, a member can resign if he give 30 days notice.Unless otherwise provided, the member is entitled to the FMV of his interest at the time

of his withdrawal.§1326: Unless otherwise provided, no member is entitled to demand a distribution other than

cash, and no member can be compelled to accept a distribution in kind unless otherwise provided.

§1327: No distributions can be made if, after the distribution, the LLC will be unable to timely pay its debts, or if the liabilities will be greater than the assets, or if there are further restrictions on distributions contained in the articles or operating agreement.

In determining the accounting figures the officers can rely on the accountants figures if they are calculated under a reasonable accounting procedure.The assets can be calculated without depletion if desired, pre-paid and deferred assets are figured by what remains.If the terms of a debt require that it be paid only if solvent, etc that payment shall be considered a debt when calculating the liabilities of the LLC at that period. It shall be measured as of the date of the authorization if the distribution is made within 120 days of the authorization. If not, then as of the date of the distribution.

§1328: Each member or manager shall be liable jointly and severally for any amount that is distributed in excess of the above allowed amount. Each can sue the other to get the amount that they had to pay on their account for the return of distribution. The

action must be brought within 2 years from the date of the distribution. Part VI. Assignment of Membership Interests§1329: The membership interest in an LLC and does not constitute an interest in the

property of the LLC.§1330: Unless otherwise provided, an assignment of an interest in an LLC can be made. The

assignment does not make that person a member. It merely allows him to receive the distributions, share in the profits and losses, and receive other stuff from the LLC.

Unless otherwise provided, if the member's interest is seized or a lien placed thereupon, the member does not lose his membership interest.

The assignee shall have no liability as a member until he becomes a member.§1331: If a court makes a judgement against the member and enforces it against the

member's interest, the judgement creditor stands as an assignee. The member does not remove his exemption status.

§1332: Unless otherwise provided, the assignee shall not become a member unless by the unanimous consent of the other members in writing. The assignor shall continue as the member unless the assignee becomes a member.

If an assignee becomes a member he has the rights of a member and must fulfill the contributions and return of unlawful distributions as the member he replaces would have had to make; However, he is not liable for any liabilities that were unknown to the assignee at the time that he becomes a member.

Even if he does not become a member, he is liable for the contributions and the return of unlawful distributions made to the membership.

§1333: If a member dies his successor, executor, etc becomes an assignee of the member's interest in the LLC.

V. HamiltonChapter 1 - IntroductionA. The Subject in General -

B. The Statutues

C. The Role of Agency Law in Business Associations

D. Introduction to Business Forms

1. The Proprietorship

2. The General Partnership

3. The Limited Liability Partnership

4. The Traditional Limited Partnership

5. The Limited Partnership with a Corporate General Partner

6. The Limited Liability Limited Partnership

7. Limited Liability Companies

8. The Corporation

CHAPTER 2 - THE PARTNERSHIPA. The Need for a Written Agreement

A. Problems that arise out of partnership relationships:1. Partnership inter se = 2 partners argue that they never intended to

operate as a P2. Partnership creditors = 3rd party suing this business. If 3rd party

believed you are parties both are liable. 3. No partnership but estoppel may be involved. = litigation turns not on

whether there is a partnership but whether they hold themselves out as P and so are estopped from denying that they are P.

4. Policy situation = one claims P other denies and there is a policy against finding that there is a P

a. Woman & Man live together but not married. Woman has business (Renovation Co.) Man gets in business w/her (he helps her and gets paid). Then they break up. All profit is in her business account. He has no rights under community property b/c never married but he claims they are partners. Crt will generally say that it is against public policy to just create a P w/o agreement just b/c lived together or married.

Avoidance of tax regulation case = 2 companies form not for P but rather to avoid tax break. Can't make tax principle purpose of forming P.

B. Sharing of Profits and Lossesa. Common Profit and Mutual Risk

1. Each partner participates equally in profit, benefit and loss unless agree otherwise (2803)(virile share)

a. (2803)- participation in profits, benefits and loses are distributed equally unless agree otherwise.

b. (2804) - if you share 50% of profits you also share 50% of losses unless say otherwise.

c. CL = sharing of profits is a rebuttable presumption. d. LA only element to decide is if there is a P.(1) Employee says he is a partner b/c he gets piece of profits. LOOK to his

control level. 2. (2801)d - mutual risk

a. Does not prevent 1 or more partners from agreeing to protect other partners against loss. (2815)

(1) This agreement does not affect 3rd parties though. (2) Don't let your client sign a note for the P otherwise they will become

personally liable. b. Capital distributions

1. Each partner participates in distribution of assets equally, unless stated otherwise

2. Distributions to capital are restored to each partner according to contributions made unless stated otherwise. (2803)

a. (2803)cmtb - Partners are entitled to the restoration of their contributions to capital even when the restoration might result in an unequal distribution or be disproportionate to the sharing of profits.

b. in a partnership, capital = partnership capital while in a corporation, capital = shareholders equity

C. General1. P (2801)=

a. Juridical person b. distinct from its partnersc. created by contract (entity theory embraced)d. Between 2 or more persons

(1) if you have 2 or more people and 1 quits the partnership terminates unless agree otherwise

(2) How to make P more stable: (a) Have 2 LLC's as partners or 2 Corp. as partners

e. To combine their efforts or resources ($)(1) not necessary for both to put up $. One can put up sweat.

f. In determined proportions and collaborate(1) profits are divided equally (virile) unless agree otherwise

g. Mutual risk h. For common profit (commercial benefit)

(1) Generally covered by rules in obligations unless provided for specifically in P articles (2802)

i. Form(1) Oral agreements OK; does not have to be in writing. (2) Exception: P in COMMENDUM must be in writing

j. Types(1) Entity (Civil Law & RUPA) - legal organization separate and

apart from partners(2) Group (UPA) -Partnership is just a group of people working

together. (a) However when creditor lent money to them as a

business UPA came up w/ tenancy in Partnership = group partnership paid creditors as an entity

- the definition does not say anything about control. Prof. says control is significant. The definition does not say anything about community or sharing of goods.

2. Courts historically take the position that there is certain criteria for determining P

a. Consent (contract or intention)b. Sharing of profits (or commercial benefit)c. Sharing lossesd. Joint control as principalse. Community of goods.

(1) Darden v. Cox - Cox had a construction partner who wanted to retire. Generally if retire P terminates. What is the problem? (a) Have to divvy up capital. When P terminates

unrealized gains must be realized and taxes must be paid. So Cox made Darden a partner when other partner left and thus the P continued. Darden later wanted to terminate the P. Cox said you only get profits. Darden said no I get ½ of all capital & goods. Court went through 5 elements

· Consent· profit sharing· sharing of losses·Joint control· community goods

(b) consent (intention) i) look at how they file their tax returns. ii) was their anything in writingiii) business cardsiv) bank accounts

v) talk to suppliersvi) Did they register w/SOSvii) look at public records to see if registered anything as

P. (c) profit sharing(d) sharing losses

i) Sheridan v. Leguire - La. case deals w/agriculture problem. Guy owned land had cattle and hired boy to help raise the cattle. The boy was to share in the profits of cattle. When it came to divvy up profits, Rancher said you are not my partner b/c you didn't share in losses. a) Crt said they had consent, community of goods

(cattle), joint control, share in profits, share losses. b) Share losses = can = sharing in potential losses.

Don't need actual losses for P just potential losses. (e) Joint Control (as principals)(f) fishery business: need boat, captain to run ship, need

crew (shrimpers). Crew gets a share of the catch. 1/3 to crew, 1/3 to owner, 1/3 to captain. Crew injured himself and sued owner under Jones Act. Owner's defense: you are a partner not an employee.

a) H: there was profit and loss sharing but no joint control. Master of vessel is in control. If crew does not go along w/orders = mutiny (rebellion)

(g) Community of Goodsi) father and Mother accumulate $ and die and leave

their business (sole proprietorship) to daughter and son. Does that make daughter and son partners? H: No P b/c no consent to be partners. They are CO-OWNERS. MERE CO-OWNERSHIP „j P.

ii) If children inherit business (not already incorporated or an LLC) they should take that business and make it an LLC or corp to minimize their personal exposure.

iii) A & B want to get into business together and want to speculate in land. Bought $200K land. A puts up ½ B puts up ½ = co-ownership not P unless consented to be partners

D. WHO can be a partner?1. Trustees and succession representatives and

associations can be partners (2801)Notes

RICHERT v. HANDLY I (1957)

RICHERT v. HANDLY II (1958)

C. Law Firm Partnerships

1. The Economics of Law Firms

2. The Economices of Law Firms - The Twenty-first Century and Beyond

3. Retimement Policies in Law Firms

BANE V. FERGUSON

D. Limited Liability Partnerships

E. Management

NATIONAL BISCUIT Co. v. STROUD (1959)

SMITH v. DIXON (1965)

ROUSE v. POLLARD (1941)

ROACH v. MEAD (1986)

F. Duties of Partners to Each Othera. Obligations and Rights of Partners Toward each other and Toward the P

i. Capital Contributions = Each partner owes the partnership all that he has agreed to contribute to it (2808)

ii. Fiduciary Duty = a partner owes a fiduciary duty to the partnership and to his partners. (2809)

1. Partner may not conduct any activity for himself or on behalf of a 3rd person, that is contrary to his fiduciary duty and is prejudicial to the partnership.

2. If partner violates fiduciary duty to P, he must account to P and to his partners for his resulting profit.

iii. With (2808 & 2809) Rights of P against a partner are not limited to the recovery of profits resulting from a partners breach of his fiduciary duty. The P may recover damages from the partner for the harm it has suffered. (2810)

iv. Partner acting in gf for P may be a creditor (2811)1. Important to be a creditor b/c you get paid before divvying up capital.

v. Partner may share his interest in the P w/3rd person w/o consent of his partners (2812)1. Partner can't make the 3rd person a member of P2. He is responsible for damage to the P caused by the 3rd person as

though he caused it himselfvi. A partner may inform himself of the business activities of the P and may

consult its books and records, even if he has been excluded from management = MANDATORY PROVISION.

a. Relations of the P and the Partners w/3rd personsi. Partner is an agent of the P for all matters in the ordinary course of business.

(2814)1. Need special authority in alienation, lease, or encumbrance of its

immovables. 2. A provision that a partner is not a mandatary does not affect 3rd person

who in gf transact business w/the partner. ii. A provision that a P shall not participate in losses does not affect 3rd persons.

(2815)iii. An obligation contracted for the P by a partner in his own name binds the P if

the P benefits by the transaction or the transaction involves matters in the ordinary course of business. (2816)

iv. P is the principle obligor of partnership debt. If there is not enough assets in the P, then partners can be sued for virile share. A partner is bound for his virile share of P. 1. What happens when P1 puts up 90% of capital and gets 90% of profits

and P2 puts up 10% of capital and gets 10% of profits?a. P1 will only be liable for virile share (2 partners liability = 50%.

b. Cessation of Membershipi. Causes of Cessation

1. A partner ceases to be a member of Pa. upon his deathb. interdictionc. order or relief under Chapt. 7 personal bankruptcyd. his interest in P seized and not released under writ of execution

and not released w/in 30 days (2819)e. expulsion (kicked out)

i. a P may expel a partner for just cause. (2820)1. need majority agreement, unless otherwise

agreedii. if P for a term, a partner may w/draw w/o the consent

of his partners prior to the expiration of the term provided he has just cause arising out of the failure of another partner to perform an obligation (2821)

iii. if P w/o term, partner may w/draw from P w/o consent at any time, provide he gives reasonable notice in gf at a time that is not unfavorable to the P

f. withdrawalii. Effects of Cessation of Membership and Rights of the Former Partner

1. Rights of partner after w/drawal = the former partner, his successors, or the seizing creditor is entitled to an amount equal to the value that the share of the former partner had at the time membership ceased. (2823)

2. If the P continues to exist after the membership of a partner ceases, unless otherwise agreed, the P must pay in money the amount referred in (2823) as soon as that amount is determined together w/interest at the legal rate from the time membership ceases. (2824)a. if there is no agreement on the amount to be paid under 2823

or 2824, any interested party may seek a judicial determination of the amount and a judgment ordering its payment (2825)

MEINHARD v. SALMON (1928

G. Partnership PropertyE. Name (2805)

1. Can be anything P's agree on - can be trade name but can't have Corp in name ie. Home Health Services = OK, Home Health Corp „j OK

2. Doesn't have to have P's name in title3. Absent agreement, P's names = title of the P

F. Ownership of immovable (2806)1. Partnership can own immovable as an entity

only if is a written contract of partnership at the time of the acquisition.

a. If the contract of partnership is written but has not been filed w/the SOS, the contract of P is effective between the parties, but it is not effective toward 3rd persons.

2. If not written in articles then the immovable belongs to the partners

G. Decision Affecting the Partnership (2807)1. Unanimity is required (unless otherwise

agreed)a. to amend the P agreementb. To admit new partners c. To terminate the partnershipd. To permit a partner to w/draw w/o just cause

Notes on the Uniform Partniship ActH. Partnership AccountingI. Partnership Dissolution

c. Termination of Partnershipi. Causes of termination

1. Decrease to 1 personb. to avoid this, add a person before termination. c. a change in the number or identity of partners does not

terminate a P unless the number is reduced to 1

2. Unanimous consent of its partners3. Judgment of termination4. Chapt 7 bankruptcy5. Expiration of its term

a. what happens when continue P w/o knowing its term is up?i. (2827) a P may be expressly or tacitly continued. So

changes from P w/term to P w/o term. ii. if P w/o term, a partner may w/draw w/o consent of

partners at any time provided he gives reasonable notice in gf. (2822)

iii. if you have a term, partner can't just say I'm out, he must show just cause (2821)

iv. Attainment of or impossibility of attainment of object of P7. Terminates in accordance w/provisions of the contract of P

8. Winding up (liquidation)a. If a P terminates in L, the business of the P ends except for

purposes of liquidation. (2828)i. if a P terminates b/c its membership is reduced to 1

person that person is not bound to liquidate the P and may continue the business as a sole proprietor. 1. If the person elects to continue the business, his

former partners are entitled to amounts equal to the value of their shares as of the time the P terminated, and they have the right to demand security for the payment of debts

b. P = A, B, C. A retires. There will be an accounting (winding up) value of all assets and liabilities and A will get 1/3 of that. i. how does A's retirement effect prior creditors? Prior

creditors can sue A. ii. When you have cessation of partner, as a departing

partner insist that all debts are paid off or get an agreement of novation. 1. get departing partner off of the note.

a. b/c prior creditors all 3 partners are on debt.

2. How do you get retiring partner off note?a. departing partner might pay off his 1/3 or b. substitute collateral

3. If you don't get A off the note, the bank does not care that he retired.

iii. What about subsequent debts (suppliers) - A is retired but subsequent creditors come after A. What can you do?1. write a letter to creditors (suppliers) Put on notice2. Put letter in NP3. Take his name out of P filed w/SOS4. change name of P5. Send letter registered mail w/return /receipt.

a. Departing partner has future potential liability if he does not give adequate notice.

iv. In addition to notice what else would you do as a departing partner?

1. make the continuing partners give an indemnification or hold harmless agreement. a. "I agree to indemnify you in the event of

future creditor holding you liable and hold you harmless.

v. Call provisionvi. major creditor lends to P that says if 1 partner

leaves, P must pay off debt

ii. Effects of Termination of P and Rights of Former Partners1. When a P terminates, the authority of the partners to act for it ceases,

except w/ regard to acts necessary to liquidate its affairs. (2830)a. anything done in what would have been the usual course of

business of the P by a partner acting in gf, who is unaware that the P has terminated, binds the P as if it still existed.

2. Termination of a P, for any reason, does not affect the rights of 3rd persons in gf who transact business w/ a partner or a mandatary acting on behalf to he former P (2831)a. if the 3rd party was in gf, he will have a right of action against

the P and the person w/whom he made the transaction. b. the partner was acting on behalf of the P that had been

terminated.

d. Dissolution, Liquidation and Division of Assetsi. The creditors of the P must be paid in preference to the creditors of the

partners. (Liquidate in same way you liquidate corporation unless agree otherwise)1. Liquidator is appointed by court (usually is a partner); gets a fee.

2. Creditors of P shall be paid in following order of priority (2833)a. secured creditors in accordance w/security rights

i. Partner can be a secured creditorb. unsecured creditors who are not partnersc. unsecured creditors who are partners

i. If any asset remain after the payment of all secured and unsecured creditors, the capital contributions shall be restored to the partners.

ii. All surplus shall be divided among the partners proportionally based on their respective interests in the P.1.

3. A P retains its juridical personality for the purpose of liquidation4. Liquidation of P is not final until all assets have been collected and

applied to its obligations and its remaining assets, if any have been appropriately distributed to the partners. a. P continues to exist during winding up. b. UPA: death of 2 partners „j P (wind up entire P)c. RUPA - has changed that (1) the P entity will go out of business.

All assets divvied and all debts are paid. (2) when business continues but 1 or more partners leave = more complex winding up partners interest as opposed to winding up the entity.

- SOL to sue for nonpayment of loan is 5 years. Prescription: the underlying right does not terminate you just can't enforce it. Pre-emption: times runs out the underlying right is destroyed

e. Liability for debts i. LA - all partners are liable for their virile share unless agree otherwise.

1. P liable first and then look personally to the partners2. Should P have personal liability for partners

a. Prof says they shouldn't. What difference does it make to the state when they can just create and LLC.

RUPA/UPA - joint and several liability for debts of P. COLLINS v. LEWIS (1955).

CAUBLE v. HANDLER (1973).

ADAMS v. JARVIS (1964),

8182 MARYLAND ASSOC., LP v. SHEEHAN

MEEHAN v. SHAUGHNESSY (1989).

GELDER MEDICAL GROUP v. WEBBER (1977)

BOHATCH v. BUTLER & BINION

J. Inadvertent Partnerships

MARTIN v. PEYTON (1927). .

Important to have the spouse involved in signing the partnership agreement. What should have been done? Could have formed an llc or corporation to give ll status to creditor.SMITH v. KELLEY (1971).

YOUNG v. JONES (1992).

Chapter 3. The Limited Partnership and Federal Income TaxationA. Introduction

the most significant factor in forming a new business venture is the manner in which income or loss is taxed.

B. Federal Income Taxation: Basic PrinciplesFederal tax laws differentiate between corporations, partnership and individuals.(a) Corporate Tax RatesCorporations pay from 15% to an effective rate. Marginal rate - rate that changes when you

make 1$ over the benchmark.The tax structure for a corporation is progress.Example of regressive taxes is a sales tax. Everyone pays the same rate.A qualified personal service corporation is defined as a corporation whose activities

substantially all involve the performance of services in the fields of health, law, engineering, architecture, accountant, actuarial science, performing arts and substantially all of the stock is owned by present of former employees.

(b) Individual Tax Rates36% plus the state rate 6% in LA. If you are a shareholder in an S corp. or partnership, you pay on income even if you do not get the distribution.

(c) The Taxation of Capital Gains or LossesEssential Terms and Concepts

A. - Basis the investment the seller of the property has in the property. It is the cost or purchase price of the property paid or incurred by the seller in acquiring the property. A stepped up basis is the new basis in property inherited when someone dies, the basis increases to the fair market value. If acquired by gift the basis is the same as it was in the hands of the donor.B. -Adjusted basis - basis plus capital improvements minus depreciation, depletion, return on capital.

C. Amount realized is what you get when you sellD. Gain - selling amount less basis

(d) The Taxation of Partnerships and Corporations(1) Proprietorship - income reported on individual income tax return. 1040 Schedule C.(2) Uninincorported Business Forms - K1 - pass thru entities where you pass through

the tax treatment to the individual (3) C Corporation - (4) S Corp

(e) Business Tax Planning Strategies1-2- clients want you to minimize tax3 - focus on marginal rate4- business form, total liab. of bus and owners must be considered

C. Limited Partnerships With Corporate General PartnersULPA (1976)

IN RE USACAFES, L.P. LITIGATION (1991). Are the directors of a corporate general partner fiduciaries for the limited partnership? Yes. This problem comes up in trust law because modernly corporations may serve as trustees of express trusts. The directors and officers of a corporate trustee are certainly under a duty to the beneficiaries not to convert to their own use property of the trust administered by the corporation or to cause the corporation to misappropriate the property. Any officer who causes a breach of trust is liable to the beneficiary of the trust. Under these facts and by analogy these same principles can be applied to D. It is not necessary to attempt to delineate the full scope of duty that D owes P. Surely the duty not to use control over the partnership's property to advantage the corporate director at the expense of the partnership, as alleged here, is included in those duties owed by D to P. Motion denied. - This is a great decision. There was no precedent but there was precedent by analogy from well established principles of law in the trust field. The court applied those principles to the facts and decided that a dismissal was not warranted. However, the court did not go so far as to define the full nature of all duties owed as it was not asked to determine that issue.

Master Limited PartnershipKintner Regulations- to qualify must met six characteristics

D. Check the BoxThe IRS adopted new regulations call the Check the Box regulations. Basic principles:(1) an entity will be classified as a corporation for tax purposes if it is created under the statues that describe the corporation as incorporated as a corporation. Such entity must be taxed as a C corporation or an S corporation.(2) An entity that is not classified as a corporation and has at least two members can elect to be classified for tax purposes either as a corporation or as a partnership.

E. Limited Partnership in the Twenty-First Centuryf. Name

i. For the liability of a limited partner to be limited as to 3rd parties, the P name

1. Must include language that clearly identifies it as a P in commendama. ie "limited P" or "P in commendam"

2. And the name must not imply that the limited partner is a general partner.

ii. Consequences of Using the name of Limited Partner (LP)1. A LP becomes liable as a general partner if he permits his name to be

used in business dealings of the P in a manner that implies he is a general partner

2. If the name of the LP is used w/o his consent, he is liable as a general partner only if he knew or should have known of its use and did not take reasonable steps to prevent the use.

3. If the name of the LP is the same as that of a general partner or if it had been included in the name of a predecessor business entity or in the name of the P prior to the admission of the LP, its use does not imply that he is a general parnter.

g. Liability of LP == agreed contribution (2840) FORM REQUIREMENTS!!!i. A LP must agree to make a contribution to the P.

1. The contribution may consist of $, thinks, or services. 2. The P agreement must describe the contribution and state either its

agreed value or a method of determining it. 3. The contract should also state the time or circumstance upon which the

$ or other things are to be delivered, or the services are to be performed, and if it fails to do so, payment is due on demand.

ii. An LP is liable for the obligations of the P only to the extent of the agreed contribution. 1. If he does not make the contribution, or contributes only part of it, he is

obligated to contribute money, or other things equal to the portion of the stated value that he has failed to satisfy.

2. The court may award specific performance if appropriate.

h. Formi. Contract of P in commendam must be in writingii. Filed for registry w/SOS

1. Until the contract is filed for registry, partners in commendam are liable to 3rd parties in the same manner as general partners

i. Distributions to LPi. A LP may not receive directly or indirectly, any part of the capital or

undistributed profits of the P if to do so would render the P insolvent. 1. If he does so he must restore the amount received together w/interest

at the legal rate2. If the P or the partners do not force the LP to restore the amount

received, the creditors may proceed directly against the LP to compel restorationa. there are similar provisions w/corporation. Can't pay dividends if

it would render it insolvent.

j. LP restrictions on Management or Administration of the P (2843)i. A LP does not have the authority of a general partner

1. to bind the P, 2. to participate in the management or administration of the partnership

or 3. to conduct any business w/3rd parties on behalf of the P.

a. WHY? So 3rd parties won't think the limited P could be liable.

k. Liability of LP to 3rd parties (2844) i. A LP is not liable for the obligations of the P unless such partner is also a

general partner or such partner participates in the control of the business. (2832)1. However if the LP participates in the control of the business such

partner is liable only to persons who transact business w/the P reasonably believing, based upon the LP's conduct, that the LP is a general partner.

ii. A LP does not participate in the control of the business by doing 1 or more of the following1. Being a contractor for an agent or employee of the P or of a general P

a. ie. Corp is a general partner in P. X is LP in P and is manager at corporation that is a general partner in P

2. Being an employee, officer, director or SH of a general partner that is a corporation or a member or manager of a general partner that is a LLC

3. Consulting general partner w/respect to the business of P4. Taking any action required or permitted by law to bring or pursue a

derivative action in right of the Pa. can be against a Corporation that is a GP or against

management in favor of PIC5. Requesting or attending a meeting of partners6. Proposing, approving, or disapproving by voting or otherwise, one or

more of the following matters: a. the continuation, dissolution, termination or liquidation of the Pb. the alienation, exchange, lease, mortgage, pledge, or other

transfer of all substantially all of the assets of Pc. the incurrence of indebtedness by the P other than in the

ordinary course of its businesse. a change in the nature of the businessf. the admission, expulsion or w/drawal of a general partnerg. the admission, expulsion or w/drawal of a limited partnerh. a transaction involving an actual or potential conflict of interest

between a general partner and the P or the LP'si. An amendment to the contract of Pj. Matters related to the business of the P, which the contract of P

states in writing may be subject to the approval or disapproval of partners

7. Liquidating the P8. Exercising any right or power permitted to LP's

iii. Termination1. In commendam terminates by

a. retirement from the P b. death c. interdiction or d. dissolution of sole or general partner

i. P can be continued w/the consent of the remaining general partners under a right to do so stated in the contract of partnership or if, w/in 90 days after such event, all the remaining partners agree in writing to continue the P and to the appointment of 1 or more general partners if necessary

2. In commendum terminates bya. retirement from the P or b. death c. interdiction or d. dissolution of sole or general partner

i. P can be continued w/the consent of the remaining general partners under a right to do so stated in the contract of partnership or if, w/in 90 days after such event, all the remaining partners agree in writing to continue the P and to the appointment of 1 or more general partners if necessary

l. Recapi. Requirement for a PIC

1. Must be in writing2. Must be at least 1 GP and 1 LP3. Must indicate "limited" or "in commendum" (must clearly indicate int eh

name that it is a PIC) can't use a name that suggests limited partner is a GP.

4. Must be specific contribution by LPa. b/c it is basis of how much limited liability

5. Limited partner can not allow his/her name to be used as GP6. Limited partner must be passive investor (but see safe harbor (2844))7. Need name and address of entity of each partner. 8. Think a/b loss (Morris and Holmes say 1 partner may have to pay loss of

other P if other P can't hang)

ii. Elements to consider in P agreement1. Put in writing (doesn't have to be in writing)2. Record it w/SOS and mtg office (even though don't have to)3. Name of entity

a. if it has property interest in name, protect that w/copyright on trademark resister and make sure no other names like that out there

5. Contributionsa. what is each partner going to put up b. look to the future of potential failure

i. if X puts up $100K P wins the $100K. One way to protect your interest is to put up $20K buy a building for $80K and sublease it to P. Security device == you lose your $20K but you still have the $80K building. You may just be liable for debts of P but not $80K in cash. 1. under P law it is not required that all partners put

up $ can put up servicesc. Sharing of profits

i. salary1. if don't say anything, partner is not entitled to

salary2. if give him salary = expense

ii. bonus iii. profit allocation

d. Loss sharingi. stipulation that 1 partner will not bear losses is

ineffective against 3rd parties but is effective b/w the parties. So clarify 1. ordinary loss and2. capital loss

e. allocation of joint controli. who has what authority to do whatii. if you don't say anything then there are default rulesiii. each person has equal control

f. unanimous consent if alienate immovablei. might distinguish ordinary and fundamental

g. what can be done w/o approval of partneri. default: ordinary course of business.

h. Put down matters to be voted oni. What duties are assumed by partners

i. X put up $ii. Y works everyday.

1. create a budget. j. Loans

i. when a Partner loans money to the P will it change 1. capital2. debt3. security

k. Sale of interesti. regulations ii. restrictions

1. can't sell interest to business competition

l. Change in partnersi. when partner dies or incapacitated have provisions

dealing w/when have change of membership (ie. Kick out incapacitate partner)

m. Valuation formulan. when someone leaves. Otherwise must go to courto. Termination of P itselfp. Winding up/liquidating rather than judgeq. Accounting principlesr. fiscal years. method of amendment t. notice provision u. severability clause

i. LEGAL DOCUMENTATION §3401 - §3408i. 2 basic forms of legal documentation to register w/SOS

1. Private act duly acknowledged2. Authentic Act

a. It will be sent back to you if you send P act w/only signature of 2 parties.

b. must be duly acknowledged or authentic act

ii. SOS1. Who?

a. P does nto have to be in writing nor does it have to be filedb. PIC must file. . c. LLC must file. Doesn't exist til filed. d. Corporation must file. Doesn't exist til filed

2. 2 componentsa. paper in proper order

b. pay fee

iii. Filing §3402iv. Contract of P; required content §3403

1. Name and taxpayer id #2. Municipal address of principle place of business in state3. Name and municipal address of each partner (including PIC if any)

v. Registration; endorsement; issuance of certificate; effect §34051. When all fees are paid, SOS registers contract of P.

vi. Recorder of mtgs; filings §3406vii. Days of grace

1. P has 5 days of grace2. LLC has not days of grace, so must get it filed and get it back to be

effective

ii. REGISTERED LIMITED LIABILITY PARTNERSHIPa. Normally for attorneys & doctorsb. Flow through taxc. Insulation from tort liability arising out of the acts of other partners or partnership

representatives. i. Specifically, a partner in an RLLP is not individually liable for the damages of

the P arising from1. errors2. omissions3. negligence4. incompetence5. malfeasance

d. Partnership and the partner who is the tortfeasor are 100% liable for the torti. If A commits malpractice B&C are not liable for A's tort.

1. HOWEVER there are cases that say practice of law is under the jurisdiction of the SC so all should be liable for everyone's tort in Law practice - no matter what kind of organization you form.

2. More likely than not more than 1 partner will work on a case together. 3. Also crts say b/c B&C get they benefits of A's practice they should also

reap the costs. e. All partners are liable for contracts of each partner though

iii. S-Corp, P, v. LLCa. S-Corp

i. Limited # of peopleii. 1 class of stockiii. no resident or nonresident aliens.

b. Partnershipi. Personal liability of partner (either joint and severally or severally)ii. Flow through taxesiii. Not freely transferableiv. Not much continuity of existencev. Must have 2 or more partnersvi. In PIC limited partner can not manage

c. LLCi. no liability for member of LLCii. flow through taxesiii. Free transferability of interest iv. Much more continuity of existence. v. Can have 1 person membership

All members are limited partners and they can manage.

CHAPTER 4. LIMITED LIABILITY COMPANIES

A. Introduction1. LLC is a flow through entity (P); for tax purposes you just check the box2. Limited liability - members are not liable in LLC (Corp)

a. Even greater limited liability status in LLC then corp. b. Corporation you have piercing the corporate veil.

c. Some say co-mingling of assets in LLC can't = piercing corporate veil. Prof. says this is bullshit. You do have piercing the corp veil w/LLC too. Prof. says that when corp does not keep adequate records then you pierce corporate veil. Distinction w/LLC b/c LLC does not have many records. When no adequate records are kept it is impossible to tell the difference between corporate assets and owner assets.

3. All members can participate in management decisions while enjoying limited liability. 4. Continued existence even if members die or leave. (Corp)5. Can have 1 person membership

Relevant Statutesd. Purpose §1302

i. Don't have to state a specific purpose in AOI = just state a general purpose

e. Powers §1303i. Powers are not limited

f. Formation §1304i. 1 or more personsii. File AOI w/SOS (corp files papers w/SOS and recorder of mtgs)iii. Initial reportiv. File affidavit of agent of service of processv. Operating agreement requiredvi. File with SOS

1. Include:(a) Name of company including the term "LLC" or "LC"(b) articles of organization including the purpose of the company(c) application must be signed by a forming member accompanied by an

acknowledgement and an authentic act(d) initial report including: name and address of the LLC; notarized affidavit

of acknowledgment; name and address of the registered agen(e) fee

2. If you get a certificate back that is conclusive that you are an LLC. Attny should advice his client to wait to operate until receive certificate otherwise there may be a lot of malpractice suits.

g. Name §1306i. Name must be distinguishable from other names; In Corporation name must

not be deceptively similar to other names. ii. Reserve the name before you organize b/c someone else might have the name

and when you apply to SOS everything comes back to you. iii. Problem w/names that comes up w/Corporation law. iv. ACME repair Company Inc. is the name registered w/SOS but use trade name

ACME fast repair in everyday business. Creditor sues b/c thought he was doing business w/partner b/c Inc. was not in name. Prof says crt might say you had a

name and didn't use it so we are going to treat you as a Pv. Articles of Organization - §1305

1. Must be in English2. Shall be executed by at least person (who need not be a member or manager)3. AOO shall be acknowledged (authentic act) by the person or one of the

persons who signed the AOO4. Shall be filed w/SOS5. The AOO shall set forth:

a. Name of LLCb. Purpose formed.

vi. Initial Report §1305e1. Shall be signed by each person who signed AOI or by his agent2. Shall set forth the following:

a. location and address the registered office of LLCi. must distinguish registered officer from PPB.

b. name and address of each Registered agenti. must have at least 1 registered agent.

c. a notarized affidavit of acknowledgment and acceptance signed by each of its registered agents

d. names and addresses of the first managers. (If not yet decided must file a supplementary report)

vii. Affidavit of acceptance of agent for service of process1. Purpose: person go to to sue2. Sign affidavit b/c you could just put anyone's name down as agent

a. w/signature you have an affidavit (statement sworn before a notary) of a persons agency acceptance

viii. Operating Agreement1. Private agreement that need not be filed (analogous to P agreement)

a. any agreement written or oral (does not have to be in writing but it is advised that you put it in writing)i. REMEMBER: can't have oral PIC. Must be in writing and

file w/SOS. I want to be limited partner and only want to put up $100K. Although he wants to be limited partner its not b/c its not in writing.

2. What should be in the drafting of OA?a. Don't put anything about power unless you want to limit power. b. Voting

i. expelling a memberii. transferability of assets.iii. Issue units of beneficial interest or membership units for

every $ you put up. Then voting of each member is based on each unit of membership interest. 1. good for planning b/c if successful in future you

could give away some of those units c. Fiduciary duty

i. make clear what members are giving up to form LLC1. ie. What are the duties of a member who

specialized in R/E. Can he buy another building for himself

d. Transferability of ownershipi. do you want to limit transferabilityii. put it in AOI and OA.

1. puts people on noticee. Moral turpitude

i. sexual harassment, alcohol

f. Triggering eventsi. bankruptcy, death, interdiction, criminal conviction,

disabilityg. General Cause. h. Buy/Sell agreement

i. valuation formula1. how do yo come up w/a formula that fairly values

the LLCa. adjusted BVb. tri-parte appraiser

(9) Allocations - pre-agreed allocation of profit and loss to each partner/member;

(10) Shares of membership interest(11) Dissolution

9. Amendment of AOO - §13091. AOO must be amended when any of the following

occur:a. Change in the name of LLCb. False erroneous statement in AOOc. Members desire to make a change in any other statement in the AOO in order

to accurately represent their agreement. 10. Management and Voting

1. Management by members and by non-members §1311 and §1312

a. If you don't say anything about management in AOO the members will manage.

b. If you want members to appoint management, put it in the AOO. c. In AOO or OA may prescribe qualifications for managers. d. The number of managers shall be specified in or fixed in accordance w/AOO

or OA

2. Elections & removal of managers §1313a. elections of managers shall be by plurality voteb. any or all managers may be removed by a majority vote of members with

or without cause, at a special meeting expressly for that purposei. notice tells you what the special meeting if forii.notice time, place and purpose.

3. Duties of members and managers §1314a. A member as management or nonmember as management:

1. shall be deemed to stand in fiduciary dutyii. discharge duties in gf, diligence, care, judgment and skill which an

ordinary prudent person in a like position would exercise under similar circumstances and in a manner reasonably believed to be in best interest of LLC. (This statute if literally read says members owe fiduciary duty in all aspects of the business)

2. CAN WAIVE FIDUCIARY DUTY, if there is a provision in AOO

3. if waive fiduciary duty the members are not liable. iii. Also there is exculpatory clause of fiduciary duty

1. when member/manager makes a decision in gf and no conflict of interest; rationally believing its in best interest of company.

2. Someone doesn't come to meeting to vote. iv. Notwithstanding part A, a member/manager is not liable to LLC for $

damages unless he acted in grossly N manner (A talks about ordinary care)

1. grossly N manner - acts with reckless disregard or carelessness amounting to indifference.

2. ONLY get these protections if he doesn't have conflict of interest

v. ƒÀ in claiming breach of duty of care has burden of proving that member or manager is liable

Corporation = fiduciary dutyvi. SH don't ow fiduciary duty to corporationvii. Prof. says if members are passive investors shouldn't they be

analogized to corporation SH who have no fiduciary dutyb. Record Reliance Defense: A member/manger shall be fully protected in

relying in fg upon the records of the LLC when reasonably believes such reports are w/in such other person's professional or expert competence and which person is selected w/reasonable care by members, managers, any committee thereof, or any agent

c. Member/manager shall account to the LLC and hold as trustee for it any profit or benefit derived by him, w/o the informed consent of a majority of the uninterested members, in accordance w/12:1318(C), from any transaction connected w/the conduct or winding up of the LLC or from any personal use by him of its property

d. Limitation of Liability and indemnification of members and managers §13151. If member/manager does wrong , is sued, and is liable, company or

insurance may indemnify you (in AOO or OA) when a. breach of fiduciary dutyb. penalties, fines, expenses incurred b/c he is member.

i. DOES NOT INCLUDE intentional violation of a criminal law.

1. infers that if you violate criminal law unintentionally you could be indemnified

ii. Danger of indemnification; those who are responsible will do wrong things knowing the company will indemnify

e. Voting by managers §13161. (Unless agreed otherwise) If LLC has ore than one manager, each

manager shall be entitled to a single vote on all matters properly brought before the managers , and all decisions of the managers shall be made by majority vote of the managers

f.Agency power of managers or members §13171. Each manager (member or nonmember) is a mandatary of the LLC

for all matters in the ordinary course of its business NOT INCLUDING alienation, lease sale of immovables, unless agreed otherwise. UNLESS such person lacks authority to act for the LLC and the person w/whom he is dealing has knowledge of the fact that he lacks authority (unless agree otherwise)

a. NO Apparent Authority: persons dealing w/managers shall be deemed to have knowledge of restrictions on authority of such manager contained in written OA if the AOO contains a statement that such restrictions exist. (Constructive knowledge)

i. This is an attempt to do away w/Apparent authority. 1. So ƒÀ can't claim that he Principle member

emanated apparent authority and thus he relied.

If it is in AOO that member/manager has no authority, ƒÀ is put on notice

ii.Prof says might circumvent this rule w/equitable estoppel

a. Certifying official: persons dealing w/LLC may rely upon a certificate of any person name in the statement to establish the membership of any member, the authenticity of any records of LLC or the authority of any person to act on behalf of the LLC.

i. what happens when there is conflict in AOO and OA both saying manager has no authority but certifying official gives him authority to borrow $ = conflict

1. Prof. thinks the certifying official should trump.2. it could be fraud or it could be error. 3. you may be able to hold manager liable for

certifying authority when he shouldn'tii.what happens if bank knows that there is a limitation to

borrowing on public record but still allows certifying official to borrow? By law banks can rely on certifying official.

iii. How to cover your ass if you are contracting w/LLC:1. Look at public record of AOO2. Ask for OA (b/c its private), and 3. get a Certificate which provides:

a. who is managers,b. authenticity of managing agreement and c. who can sign agreement.

4. to cover your ass get all of managers to sign (or power of attny someone acting for them), then have them personally warrant that they have authority complete the transaction and have them certify that they will indemnify.

1. Who are the agents of Corp and LLCa. Corp:

i. Agents: officers (Pres./VP); Employeesii.management: directors; SH

b. LLCi. Agents: members/managers.

1. no distinction btwn passive investors (like SH in Corp) and active managers

g. Voting rights of members §1318 (default rule1. Each member can case 1 vote

a. All decisions of MEMBERS shall be by majority vote of the MEMBERS:

b. Majority vote of MEMBERS required to approve the following matters

i. dissolution and winding up of the LLCii.sale, exchange, lease, mtg, pledge or transfer of all or

substantially all of the assets of LLCiii. the merger or consolidation of the LLCiv. the incurrence of indebtedness by the LLC other than

in the ordinary course of businessv. The alienation, lease, or encumbrance of any

immovables of the LLCvi. An amendment to AOO or OA.

- Remember managers are elected by plurality- Managers are removed by majority

1. No contract between LLC and one of its members shall be void or voidable solely b/c the interested member/manager was present at or participated in the meeting which authorized the contract or b/c his vote was counted if:

a. the material facts as to his interest and to the contract was disclosed or known to the members, was approved by majority w/o counting the interested member or

b. the contract or transaction was fair to the LLC as of the time it was authorized, approved or ratified.

c. Interested members may be counted in determining the presence of quorum which authorized the transaction.

2. Prof: dangers of how LLC voting is set upa. the LLC does not have to have the formality requirements

associated w/meeting and minutes the corporation has (BOD meeting and minutes)

b. no notice, quorum or record requirements (put in OA)c. statute doesn't talk a/b vacancies. d. your voting is not tied to your financial stake unless you change

ite. agency law is still in effect.

h. Finance (§1321 - §1323)1. The statute does not mandate the contribution of capital.

a. Prof: its hard to find a mandatory contribution but b/c the statute talks a/b the form of capital, this might imply that contribution of capital is mandatory.

b. The contribution of a member to LLC may take the form of §1321

i. cash, ii.property, iii. service rendered or iv. promissory note orv. other binding obligation to contribute cash or

property

2. Prof.: I'd put up capital b/c what would happen if you later claim to be a member but never put up anything. They could argue that you did not comply w/the statute.

Morris & Holmes - it is implied that member should put up capital- P don't have to make a contribution to capital- Corporation: you must make a contribution to capital or give up the

capital. In corporate law you can't give a promissory note as a contribution to capital

i. Liability for contribution §13221. Must be in writing (oral promises to contribute to LLC are not allowed)

a. Suppose a person orally promises to put up $ but never does and company has accrued $100K in capital. It is possible that b/c he has not contributed, he may have to give back everything he has earned b/c §1321 implies that you must contribute capital.

2. OA does not have to be in writing but must be in writing if 1322(B) is going to apply.

a. If a member does not make the required contribution of property or services, he or his personal representative is obligated, to contribute cash equal to that portion of value of the state contribution which has not been made or forfeit his entire membership interest.

b. Unless otherwise agreed in OA, the obligation of member to make a contribution may be discharged by unanimous consent of members.

c. Death, disability or other reason does not discharge the debt unless agree otherwise

d. a Creditor of LLC who extends credit may enforce the note if company discharges the debt, by showing he relied on the note for payment.

- Hypo ABC enter into LLC. After a couple of weeks one partner says I will put up $10K if you let me out. The creditors do not care. Not withstanding such compromise, the creditors who extends and relies on the fact that all were responsible, all may be responsible for the debt.

i. However if creditor lent money after forfeiture of note he cannot enforce the note. After the forfeiture the creditor has no rights

ii.If extended credit before forfeiture, creditor must prove reliance.

1. what will happen is that the LLC will look at the situation of partner and compromise it w/o telling creditor thus forcing creditor to prove reliance

iii. To prove reliance, prove note due was on F/S1. to protect creditor in this situation make all

members guarantee the debt. Thus executor can't claim it has 1st right or members can't reliquish members debt to LLC.

iv. a succession representative can beat creditor out of right, so if succession rep gets to the right first then succession rep has to pay all creditors out of that

- ULLCA - creditor who extends credit can bring an action to enforce no matter when. More favorable to creditors

- LA written in favor of debtors,

3. Sharing of profits and losses §13231. Unless you say something in AOO & OA about profit/loss

distribution, it will be divided equally.a. The statute does not say that members have to contribute

capital but absent an agreement members share in losses equally (the statute talks about paying debts to 3rd parties but don't have to make capital contribution = discrepancy)

i. Prof: put in OA that each person bears his/her share of capital losses.

i. Rules against Distribution (§1324- §1328)1. If the company makes money, but there is no distribution the

members still have to pay taxes on the distribution. All members have to agree to distribution and they all may not agree. (Don't

have to have an operating agreement)2. Need authorization for interim distribution §1324 3. A withdrawing or resigning member is entitled to receive

distribution.a. LLC for a term - member may w/draw w/o the consent of other

members prior to the expiration of the term, needs just cause arising out of another member's failure to perform an obligation

b. LLC w/no term - member may w/draw upon not less than 30 days prior written notice filed w/SOS and delivered to each member

c. W/drawing members are paid FMV of member's interest. 1. very important in OA to outline FMV formula2. really should have some kind of buy/sell agreement

In a buy/sell agreement must have a (1) triggering event, a (2) cross purchase where other members by the interest. (3) method of determining an amount. (appraisal or for CPA firm, one years' billing) (4) provide a mode of payment, (5) provide a security agreement.

d. Restrictions against distribution in LLC(§1327) 1. No distribution may be made if

a. LLC could not pay debts in usual course of business; can't pay your debts as they accrue (bankruptcy in the equity sense)

i. Corporation definition of insolvency = inability of a corporation to pay its debts as they become due in the usual course of business.

b. Total assets are less then total liabilities (bankruptcy in the federal bankruptcy sense) (biting provision of preferred - must pay preferred members first) (balance sheet test)

c. Distribution would be contrary to any restrictions contained in the articles.

2. Restrictions against distributions in Corporation (dividends)a. The BOD may pay dividends out of surplus except when

i. Insolvent (equity insolvency)ii. Corporate assets exceed liability iii. biting provision of preferred

3. Protection on those who declare a dividend. a. Reasonable use of financial statements prepared on basis of

accounting practices. b. don't need to make allowance for depletion or amortization of

cost of assets Oil and gas when asset intended for sale in the ordinary or usual course of business with limited life, (such as a lease for a term of years or patents or Oil ad gas properties)

c. Proper allowances must be made for depreciation and depletion sustained and ascertained.

d. deferred assets and prepaid expenses shall be considered as assets only to the extent of amount thereof not amortized i. deferred asset = prepaid expense.

1. matching proper period income w/proper period expenses

ii. ie. If pre-pay insurance for 3 years worth $30K, amount must be reduced by $10K per year. 1. you can't write off $30K in the first year that is

improper matching. e. May include in the calculation of depletion in oil and gas =

drilling costs of oil and gas wells even if not successful = intangible costs = something you pay for but can't touch it. i. ie. Oil co. pays geologist $50K to look over patch =

intangible cost. Intangible cost can be depreciated. f. If don't have to pay P&I unless make pay distribution. Then

payment of P&I is not included in liability section. i. redemption or interest

1. give not to a member for his membership interest. When make a distribution must be solvent.

g. Accruali. $30K insurance. Company says you don't have to pay

insurance til the end of the 3rd year. 1st year you don't pay cash but accrue $10K . So decrease income accordingly. By process of accrual you pay less taxes.

4. Measuring effect of distributiona. effect of the distribution shall be measured as of the date upon

which the distribution is authorized (signing of payout) if the payment occurs w/in 120 days after the date of authorization or

b. distribution shall be measured as of the date upon which payment is made if it occurs more than 120 days after the authorization. i. if debt is payable w/in 120 days of authorization. Then

just look at the solvency as of the date of signing. ii. if debt is payable after 120 days you have to be solvent

when each payment is made in the future. Must gage solvency of LLC each time the note is due. Thus this debt is a subordinated position

5. Member has option in LA of letting himself out (unless says otherwise in OA)a. Uniform Act - member can only get out where death or

something that keeps member from performing. Then the LLC has the option of letting him out. i. So in LA creditor losses b/c debtor can let himself out.

6. HYPO: 3 people form LLC. Make a lot of money. What happens if a member dies? Heirs inherit but they can't vote. So people who are operating the LLC are going to take big salaries and fringe benefits. So always put in OA.

7. HYPO: guy wants to retire and OA says pay FMV of investment. Pay 10 year note. 5 years later LLC has problems. What are the retired members rights - past 120 days measured if you solvent at time of distribution. The not subordinated to all outside investors to solvency of LLC. a. How does retired member deal w/this? Make them get a bank

loan to pay you and then they can pay the loan back or get them to sign the back of the note (guarantee the note)

ei.

e. Liability upon wrongful distribution §13281. Only time member has to pay back the distribution is when the member

has been negligent or knowingly (intentionally) wrong. They are liable

to LLCa. Corporation: illegal dividend, officers and directors are

personally liable. They are liable to corporation, or SH or creditors or both

2. 2 statute of limitation for bringing suit for wrongful distribution. a. Assignment of membership Interest

i. There is no right of w/drawal 1. In Corp. can sell interest to another SH

ii. If sell interest in LLC to 3rd party, they are only assignee. They get no voting interest. §13301. Assignee only receives distributions, share in profits and losses similar

to assignor. NO VOTING RIGHTS until he is admitted by unanimous consent of members. Until assignee becomes member assignor will continue to be member.

2. Until become a member, assign had no liability as a member solely as a result of such assignment

3. When assignee becomes member, also shall be liable for any obligations of his assignor to make contributions and to return distributions received in violation. However, the assignee shall not be obligated for liabilities unknown to the assignee at the time that he became a member

4. Member who dies, or is incompetent his membership ceases and the member's executor, administrator, guardian shall be treated as an assignee of such member's interest in the LLC. a. if a member is a corp and is dissolved, the member's

membership ceases and the members legal rep shall be assignee.

iii. To get around this: 1. in OA put rights of assignees of decedents heirs. 2. put a buy-out clause. Upon certain events the members will buy out.

iv. Creditor can get individual members interest but shall only have the rights of an assigne of the membership interest. This is cheap piece of property

b. Dissolutioni. Dissolved when:

1. Occurrence of events specified in AOO or OA2. Consent of members3. Entry of decree of judicial dissolution.

a. on application by r for member, any crt may decree dissolution of LLC when it is not reasonably practicable to carry on the business in conformity with the AOO or OA

ii. Winding up §13361. pay all debts2. What's left

a. members and former members to pay liabilities for distributionsb. members and former members to pay return of their capital

contributions. 3. Must give notice of dissolution so creditors can make claims

4. Advanced Orthopedic - 1 member put up capital for another. When it came time for dissolution, the guy who had not paid said he put up his time and labor. That needs to be in writing. Crt said you didnt contribute anything either

1. Balance Sheet a. Sources of Assets

b. Outside = liabilitiesc. Inside = Owners equity (LLC = members capital; P = partnership capital; Corp =

shareholders equity)1. Surplus

a. earned surplus (accumulation of profits)b. Capital surplus

i. Paid in capital (sale of stock )ii. re-evaluation (arises out of re-evaluating assets)iii. donated

2. Capital Stocka. common stockb. preferred stock

Notes: LLC Statutes promulgated in 1996. Must form/draft it correctly or it collapses. Action is in the operating agreement. Are you going to favor the corp. model or partnerhsip model?

- Believe it will one day replace the partnership.

Notes - 190Don't want to be an llc if purpose if to organize assets and go public. Too many issues with SEC with filing. If anticipate co will make a lot of money, you may want to be a c corp. since there is a lower tax rate. If you anticipate that you will operate several years at a loss, you probably want to be an s corp. so that the losses flow up to ind. and offset any ind. taxes.B. The Uniform Limited Liability Company Act (not covered)

C. Contractual Aspects of Limited Liability Companies

ELF ATOCHEM NORTH AMERICA, INC. V JAFFARI AND MALEK LLCCharacter of llc was the contracted purpose. Companies are going to arbitrationD. Characteristics of an LLC

POORE v. FOX HOLLOW ENTERPRISES

E. Limited Liability Companies and "Check the Box"

F. LLC as Asset Protection DevicesVacation Home Strategy -

CHAPTER FIVE - THE DEVELOPMENT OF CORPORATION LAW IN THE UNITED STATES

CORPORATIONS- Every state has its own corporations law - statutory (25 states follow the model

corporation law)- La Corp law is 100% Common law. More like Delaware. (Dividend section is exactly like Delaware- most conservative corp. law is California - protects SH and creditors- most liberal corp law is Delaware protects directors and officers - Somewhere in the middles is Illinois - follows the uniform model act- A/b 300 corporations in the world control the economics of the world (primarily males -

few minorities)

THE CORPORATION - AN OVERVIEW (1)Corporation Definition

a legal person by which business firms can enter into contracts, own property , sue in court and be sued.

Creature of law - a legal artifice; state enabling statutesThere are many gaps left by statutes and persons are filled by

judicial normsOther gaps == involving info for SH are filled by federal securities

law. Investment vehicle for the pooling of money and labor.

Money capital - SH and creditorsHuman capital - executive sand employees.

both money and labor(human) capital expect a return of their investment thus there are conflicts of interest

Review notes on page 8.Review LLC Law and read from page 10 to page 70.

Corporation BasicsFive Basic Attributes of a corporation

- Independent, Separate, and perpetual existence- Centralized management- Ownership interest tied to residual earnings and assets- Tranferability of ownerships' interests- Limited liability for all participants

Independent, Separate, and perpetual existenceIt is an entity distinct from those who contribute capital (sh

and creditors) and those who manageThe corporation owns the assets of a company and is liable

for any business debtsIf ever SH dies in a Corp it continuesIf every partner dies in a partnership then it is over

Centralized managementBOD manages and supervises the business but delegates

power to officers who act and bind the corporationBOD is subject to fiduciary dutiesSH have limited role and power to initiate change == they

have voting power to elect directors and approve fundamental changes

Ownership interest tied to excess earnings and assetsCreditors (bank lenders, bondholders, trade creditors,

employees) are first in line and receive a return based on their contract.

SH are last in line and receive dividends as declared by discretion of BOD.

Creditors have priority and SH left-over claimants in event of liquidation

Free Transferability of ownerships' interestsHard to get out of LLCnot so easy to get out of closely held CorpEasy to get out of publicly traded Corp (stock market)

Liquidity of mkts is what makes American economic system so strong. It rewards economic productivity and punishes inefficiency & laziness. Rewards businesses that can provide better, more efficient services.

Limited liability for all participantsInsiders (Directors, officers, SH and lenders) are not

personally liable to outsiders on corporate obligations and risk only their personal investment However Directors and executives usually have

a fiduciary duty to SH and the entitySH don't owe any duty to other SH == they can sell

stock. However majority SH may have a fiduciary duty.

Outsiders (contract creditors and tort victims) bear the risk of corporate insolvency.

partnerships have a fiduciary duty to investorsLLC some instances there are fiduciary duty

passive vs active investor

Keep in mind, closely held corporations may be exposed to different risks== SH can agree to manage the business, to pay themselves dividends, and to limit their ability to transfer stock. In some circumstances courts may hold SH personally liable for corporate debts beyond their investment or lenders may require SH to personally guarantee the corporations debt obligations

Corporate law and LLC law is statutory.

Corporate participantsmany players - SH, managers, lenders, customers, employees, gov't

employees are well represented where there are unions national labor relations act protects unions

Corporate law sets up mandatory, permissible and default rulesCorporate law focuses on relationships between SH and managersOutside relationships w/ creditors, suppliers customers, employees,

government authorities are usually subject to legal norms that treat the corporation as a personcontract laws, debtor-creditor, antitrust, labor and tax

Theory of the FirmSH and Managers == conflicting interests

Once SH invest Managers may become lazy; nd may be reluctant to take business risks that threaten job security.

SH may not want earnings re-invested in the business, may want to take high return risks,

Corporate law allocates risks between SH and managers in an attempt to minimize SH-manager conflicts and to maximize the firms overall success. Sometimes legal intervention is too costly, so corporate law

leaves the risk to SH ie. Business judgment rule == judicially created

gives directors broad discretion to run business w/o judicial second-guessing

In other contexts corporate law regulates conflictsSH must vote on BOD's decision to merge

Contractarian view - The corporation is a device organized by law. The SH can protect itself by contract. Corporate law should not interfere w/the bargain but rather enforce the bargain. Corporate law is like a series of contracts dealing w/relationship btwn investors and managers.Prof: is there really any way to create a contract between the SH and the manager? NoThe Corp. (like a contract) is a device recognized by law to

organize specialized business activityMkt is efficient ==thus managers can't exploit controlManagers can't exploit control b/c mkt constraints align

interestsCorp law should interfere & enforce bargainsJudges should intervene w/caution == only fill gaps in

bargainsHigh leverage is good b/c managers who face high debt will

invest wisely otherwise they will go bankrupt and lose their job == makes business more efficient.

Traditionalist view - Corporation is a creature of law SH unsophisticated. Judges should enforce managers fiduciary duty. corporation is a creature of law; no real bargaining occursmanagers use control to exploit SHSH can be exploited b/c they are unsophisticated or

uninformedCapital mkts are not always efficient acting slowly and

unevenly to discipline poor managersCorporate law should mandate rules to promote fairness and

efficiencyJudges should actively enforce managers fiduciary duties to

SHHigh leverage is bad. == weekend fiduciary duty will drive

investors away.

Leverage - using other peoples money to make money. Increases the potential for profit but punishes the inability to cover. The bondholder always gets the same return (10% interest payments per month) However if the company invests that debt properly the SH could get increasing appreciation. ie. Borrow $50K to buy $50K worth of land. Payback 10% interest in 1 year. In 1 year the property value goes up to $100K so you made 40% w/leverage.

Sources of Corporate LawSources of Corporate Law

U.S. ConstitutionState Constitution lawState statutes - general corporation lawfederal statutesjurisprudencearticles of incorporation

BylawsResolutions of BODImplied powersContracts

2 trends in Corporate LawState law - less regulation and more management discretion

Delaware - write your own ticket let managers do what they want. (Mature jurisprudence and sophisticated judiciary)

Federal law - more regulation b/c state laws failedSecurities Act 1933Securities Exchange Act 1934Sherman-Anti-trust ActClayton ActInterstate Commerce ActFederal Trade CommisionNational Relations BoardFederal Powers CommissionFAA

Historical Sketch of the Corporation2 major trends

- restraint- liberalismrestraint

1800's Congress created Interstate commerce Commission created to regulate RR monopolies

1890 and 1916 Congress passed antitrust legislation to combat consolidations of corporate economic power

Sherman ActClayton Act1900's blue sky lawsdeal w/ fraud in the sale of corp. securities 1930's Congress passed series of securities laws aimed at

abusive management practices in interstate stock mkts

1933 securities act1934 securities act

Liberalization1800's state corporation statutes enacted to attract

corporate revenues some states amended their statutes to:lift limits on the amount of capital that a

corporation could raise, to permit corporate ownership of other

corporations,to increase flexibility of managementDelaware was the front runner

Modern State Business Corporation StatutesBasic state corporate statutes

How to form a corporationthe financial rights of SH

the governance powers of SH, directors and officersThe transferability rights of SHLimited liability of SHStructural changes such as charter amendments, mergers

and dissolution

- Some statutory terms are mandatory (annual election of directors and SH voting on mergers; some are default terms (removal of directors w/o cause, majority voting on mergers)

- Internal Affairs Rule - the law of the state of incorporation governs all SH-manager matters in multi-state corporations

- No two state corp statutes are identical but there has been a trend to greater uniformity and modernization

· 1950 ABA committee on corporate law published first model bus. Corp Act - served as basis for 36 states· 1984 ABA reorganized and rewrote the model act = Model Business Corporation Act (MBCA). As of 1996 19 states have enacted statutes based on the 1984 MBCA· Louisiana followed the old model act that goes way back with a traditional view of corporate finance

Role of Judge Made Lawmost important judicial gap-filling involves fiduciary duties of

directors, officers and controlling SH.

ALI Principles of Corporate GovernanceAmerican Law Institutes (ALI) long-term project to describe and

unify the basic standards of corporate governance and structure, particularly in those areas not addressed by state statues = Principles of Corporate Governance (began in 1977 finished in 1993).

Some crts embrace portions of ALI principles, others given them little attention, others have completely rejected them.

Federal LawThere is no federal corporation statuteBut federal law adds a significant layer of regulation

Securities Act of 1933 - corporation disclosure requirements when raising capital in public markets - debt or equity. To prevent the fraud that occurred in the 1920's.

Securities and Exchange Act of 1934 - corporations whose stock is public are subject to periodic reporting and proxy voting requirements. Also regulates the trading of securities in public and private markets, including the use of material, nonpublic corporate information to buy and sell stock (insider trading)

Corporation as a Constitutional Entity

- For commercial purposes state and federal law largely respects the corporation as a person. But there are many noncommercial context in

which the law does not treat the corporation as a natural person ie. intestacy, adoption, political voting

Broad Commercial Rights - the constitutional status of the corporation varies depending on the constitutional right at issue. It is a person only for some purposes (primarily those protecting commercial interests)Commerce Clause - corporations are protected against state

restrictions that burden interstate commerceDue Process (property interests) - corporate property is

protected against governmental deprivation under DP 5th and 14th (takings clause)

Commercial Speech - Corporations have limited 1st amendment right to express themselves as to commercial matters - such as advertising

- One exception in the commercial interest analysis has been SC's refusal to treat the corporation as a citizen protected by the Privileges and Immunities clause. This allows states to regulate foreign corporations (those incorporated in another state) differently from its own domestic corporations.

Limited Noncommercial rightsself-incrimination - Corp can't claim 5th amendment privilege

against self-incrimination. (However if closely held ie. 1 person corporation -some

lower crts have suggested that self-incrimination clause may extend to that corporation.)

unreasonable searches and seizures - corporations have a limited 4th amendment right to be free from unreasonable searches & seizures. (But b/c business privacy is less compelling than personal privacy - the right is narrower than afforded to individuals)

due process (life and liberty) - Corporation is not a person for purposes of deprivation of life or liberty.

Political (non-commercial speech) - some free speech protection under 1st - SC held that a state can't forbid a corporation from expressing its views on a state referendum, even when the referendum does not materially affect the corporations business.

Notes from Class

LOUIS K LIGGETT CO. V. LEE (famous decision) by time opinion written, America was getting corrupt by big businesses. Allowed Rockefeller to control oilfields, retailers, etx. Caused Sherman act. He had a monopoly. NJ broke mold and did away with creditors and shareholders rights. Fear caused states to limit capital, scope. Delaware is so important because of the internal affairs doctrine.Comment, Law for sale: A study of Delaware Corporation Law of 1967. Reasons it is favorable to do business in Delaware.Distinguished judicial sectionSo many decisions on business, lawyers can read lawWrite your own ticket statuteReasonable cost

States have backed off the regulation responsibility and the federal government has stepped. There is now an idea of pushing regulation back to the state. The business of recording a charter in Delaware has become simple.Note 2 pages 220Page 227 RMA - a write your own ticket statute. Model Business Corporation Act Revision. Don't need a rule; it is your fiduciary duty. No state has adopted the entire MBCA, about 30 have taken bits and pieces. (232)Reasons for leaving Texas and Incorporating in Delaware. Stated reasons on page (234). Water down the requirements for converting shares, voting rights with regard to the class of stock, changing rights of shareholders. More difficult to oust mgr, Director liability, Page 236Although constitutionality in doubt, states sometimes require "internal affairs rule" that foreign courts should apply the law of the state of incorporation to issues relating to the internal affairs of the foreign corp.; some states require that if the principle place of business in the state, apply specific provisions of its statutes.Bayless Manning = Corporation statutes have basically nothing left to them. Like a towing skyscraper of rusted girders internally welded together and containing nothing but wind.Another example of fed gov. having to come in and straighten state law. Foreign corrupt Practices Act - international fraud; general dynamics fraud; prince bought gd plane instead of boeing, bribery. FCPA is an accounting practice to set up books and account for all business that they want to practice, including foreign related corps.Shareholders are not protected because there are no constituencies to protect them.Corporate Governance Project issues include: (a) The takeover movement, (b) articulation of the business judgment rule, (c) litigation committees, derivative action (d) executive compensationThe emphasis on state law should not be misinterpreted; there is a significant portion of law in federal origin.PSLRA

CHAPTER 6 THE FORMATION OF A CLOSELY HELD CORPORATION

A. Where to Incorporate1. A small or medium business should incorporate in its home state; this avoids double

franchise tax and personal jurisdiction associated w/ Delaware incorporation; once a corp is big/ interstate, it should incorporate in Delaware for its liberal laws. However Delaware has high franchise taxes and it is costly to defend suit there.

2. "Internal Affairs Doctrine" - state corp law of the state of incorporation, applies to corp disputes.

c. The law of the state of incorporation governs the relationships among the parties in the corporation (even if principle place of business is otherwise)== applies to situations such as:

i. shareholdersii. fiduciary duties of BODiii. procedures for corporate action

d. Calif challenges they by subjecting foreign corp to Calif law if 50% of the corporations business is in California

e. NY public policy of the state requiring certain provisions of NY law to apply

3. Qualification of Foreign Corporations(1) If incorporated in Delaware but want to do business in LA you have to qualify for a

Corporation in Louisiana (foreign Corp)i. file certified copy of its AOIii. pay filing feeiii. appoint local agent to receive service of process.

(2) A company whose interest business is only mail order need not qualify as a foreign corp.

(3) Penalties for doing business w/o being qualified(1) fines(2) treat business as

unincorporated and subject to personal liability

4. Why Delaware for National Business(1) flexibility of management

(1) allows managers to waive fiduciary duty

(2) Judges and attnys highly experienced in corp law matters

(3) large body of case law interprets Delaware statutesiv. Delaware legislature is a leader in corporate law reform

B. How to Incorporate- Forming a corporation:

· creates a public record of incorporation· binds the parties to the corporate law scheme of the incorporating state· it documents any additional optional terms the parties may wish to

specify - Significant questions to ask when forming a corporation

· What provisions must be in the articles of incorporations· What optional provisions should be in the articles

· In what state should the corporation be incorporated

3. Process of Incorporation- Some states corporation begins w/ filing articles of incorporation - Some states corporation begins when a state official issues a certificate of incorporation- Forming a corporation takes three essential steps

· preparing articles of incorporation· signing articles of incorporation by one or more incorporators· submitting the signed articles to the state's secretary of state for filing

4. What is in the Articles of Incorporation- Name of corporation- registered office and agent- capital structure of corporation- purpose and powers of the corporation- size/composition of BOD- optional provisions

a. name of corporation(a) complete name and must have reference to corporate status ie. Corporation,

incorporated or inc. (including non profit and limited liability companies)(b) the name must be "distinguishable upon the records" or must not be

"deceptively similar". Test: similar, deceptively similar, unfair competition.1. LA - must be distinguishable upon the records -(lighter burden) -

means each corporate name will be unique and easy to identify. LA 12:21, LA 12:22

(c) Many states allow businesses to reserve a corporate name for a fee during preincorporation (120days)

(d) In some states a corporation incorporated in another state (foreign corp) may register its name w/SOS to keep locals from using it.

1) LA 12:23 Corp name ; reservation of namea. must contain corporation, incorporated or limited or Co. (Can't have

Jones & Co. = partnership)b. no corp can contain phrase doing business as or d/b/ac. must be distinguishable d. back up provision 12:23(c) intellectual property law prohibits other from

using the namee. Must use English letters

b. registered office and agenti. articles must state the corporations address for service or process and for

sending official noticesii. often AOI must name a registered agent at that office whom process can be

servediii. Changes to registered officer or agent must be filed w/SOSiv. About a dozen states require publication of articles and filing with state official.

c. capital structure of the corporationi. specify the shares the corp will have authority to issueii. describe various classes of authorized shares, # of shares of each class,

privileges, rights, limitations and preferencesiii. Some states require a minimum amount of capital before corp commences

business (LA 12:26 minimum capital amount only if specified)d. purpose and powers of the corporation

i. AOI may state the corp's purpose and powers1. w/decline of ultra vires - purposes clause is far less important

ii. modern assumption - the corporation can engage in any lawful business. Unless you limit the powers, the corp can do anything.

iii. LA. 12:24B(2) - the AOI shall set forth in general terms the purpose or purposes for which the corp is formed or that its purpose is to engage in any lawful activity

e. size/composition of board of directorsi. most statutes have abandoned requirement that AOI name initial directors or

that articles specify the # of directors1. LA 12:25 names of directors are found in the initial report not AOI

(2) Do not put yourself (as an attorney) down as an initial director.f. optional provisions

i. voting provisions - greater than majority approval of certain actions (mergers, amendments)

ii. membership requirements - that directors be Sh or that SH be members of a certain profession

iii. management provisions - SH must approve certain matters normally entrusted to the board

5. LA - 12:24 Articles of IncorporationAOI must be: (Mandatory)(1) written in English

(2) signed by each incorporator or agent(3) acknowledged by someone who signed the articles or by authentic act

AOI must set forth (4) name of corp.

(5) in general terms, the purpose or purposes for which the corporation is to be formed or that its purpose is to engage in any lawful activity for which corporations may be formed

(6) duration - if other than perpetual(7) aggregate # of shares which corp shall have authority to issue(8) aggregate # of shares which the corp shall have authority to issue(9) par value of each share or statement that all shares are w/o part

(10) If shares divided into class must specify and any designation preferences, limitations and relative rights

(11) Full name and post office address of each incorporator

(12) Tax id # from IRS (but if you don't provide this it won't prevent the filing)

The AOI may also contain Optional/Permissive provisions 12:24Ca. preemptive rights - you have to put in AOI that SH have pre-emptive rights

otherwise they have NONE.[rules regarding issuance of SH that might dilute SH % ownership ]i. LA 12:72 SH preemptive rights. No preemptive to subscribe for

shares:1. which are to be issued for consideration other than cash2. which are to be issued to satisfy conversion or option rights 3. which are treasury shares4. issued pursuant to 12:49B(e)

b. powers or rts of the corp, directors, SH's or any class of SH'sc. redemption of dividend w/in certain timed. limiting the personal liability of a BOD or officer of corporation or shareholders

for $ damages for breach of fiduciary dutyi. breach of BOD or officer duty of loyaltyii. acts not in good faith or intentional misconduct or knowing violation of

lawiii. transaction BOD or officer got improper personal benefitiv. for liability under 12:92D unlawful dividend distribution or stock

redemptione. Any other provision including restricting transfer of shares

6. LA 12:25 Filing and recording articles and initial report; issuance and effect of certificate of incorporation; commencement of corporate existence

a. AOI must be acknowledged by incorporators duly acknowledged by notary or authentic act

b. To incorporate we needi. AOI (filed w/SOS)ii. initial report (filed w/SOS)iii. affidavit of service of processiv. fee payment

1. years ago AOI contained the names of directors today the initial report contains the names of directors

2. However if the first directors are not named in the initial report b/c they are not going to be appointed until the first meeting they a supplemental report setting forth their names and addresses signed by each incorporator shall be file w/SOS and for record.

c. A copy shall also be file for record in officer of recorder of mtgs in parish where corp is located

7. LA 12:25.1 Acquisition of immovable property prior to incorporation; retroactivity of corporate existencea. immovable property acquired before incorporation in the name of the

corporation shall have retroactive ownership once incorporated8. LA 12:26 Condition precedent to beginning business.

a. If articles state amount of paid-in capital with which the business will begin can't incur debts until amount of paid in capital has been paid in full. If articles don't say anything a/b putting up capital they you don't have to put up capital before begin incurring debts

9. LA 12:27 Expenses of Organization, reorganization and financinga. may pay reasonable organization expenses out of payment for shares w/o

impairing fully paid or non-accessable statutus of such shares10. La 12:28 Bylaws

11. Incorporatorsa. sign the AOI, and arrange for their filing. If articles do not name directors, the

incorporators select them at an organizational meeting. After incorporation, incorporators fade away and need not have any continuing interest in the company.

b. employees of Corporation Service Companies often serve as incorporators. c. Corporations may act as incorporators for companies (some states require

incorporators to be natural persons)

12. Filing Processa. Accept AOI for filing if

i. contain the minimal info required by statuteii. document is typed or printediii. sufficient copies are submittediv. appropriate fees and franchise taxes are paidv. the corporate name is distinguishable.

b. once filed AOI become public documents. Corp. existence can be confirmed in a number of ways:i. certificate of incorporation obtained from SOSii. receipt returned by SOS when AOI filediii. a copy of AOI w/original acknowledgment stampiv. certified copy of original AOI from SOS

(3) After AOI is filed -(1) prepare the corp bylaws(2) prepare the notice alling the meeting of the intial board of directors,

minutes, and waiver of notice, if necessary(3) obtain a corporate seal and minute book(4) obtain blank certificates for the share of stock, arrange for theri printing

and ensure that htey are properly issued(5) Arrange for the opening of the corp bank account(6) prepare employment contracts, voting trusts, shareholder agreements

(read statute), share transfer restrictions, and other arrangments(7) obtain taxpayer identification numbers, occupancy certifiates, and

other permits or consents for the operation of the business(8) Evaluate whether the corporation shold file an S Corp election,

assuming S Corp election is available

13. Organizational Meeting- Filing the AOI begins the corp existence but organization meeting creates the working structure == draws a scripta. elect directors (unless initial directors are named in AOI or initial report)b. approve bylawsc. elect officersd. adopt pre- incorporation promotors contracts (attny fee for setting up corp)e. designate a bank f. authorize the issuance of sharesg. set consideration for shares

14. Bylaws - prepared by an atty submitted before the organizational meeting

- Bylaws are not required to be filed but must be consistent w/ AOI == can elaborate on AOI.

a. function of each corporate officeb. voting c. when meetd. who calls meetinge. formalities of SH votef. qualification of directorsg. formation of BOD committeesh. transferring shares - limitations (put in AOI too)

C. The Decline of the Doctrine of Ultra Vires- used to invalidate corporate transactions beyond the powers stated in the AOI. However today it has limited relevance b/c now states allow corporations to authorize general purpose clauses and unlimited powers. If the corporation limited its powers in the AOI but went beyond those powers == the act is void = ultra vires doctrine1. Early common law

(a) early corp were formed to run capital intensive businesses such as RR == to attract investors in AOI they limited the scope of their business. SO if a transaction was beyond the corporations purposes or powers, either party could contract to disaffirm it.

2. Erosion of Doctrine(a) crts permitted voiding contract only if the contract was still executory (no

performance began)(b) crts began interpreting AOI purposes flexibly to authorize transactions

incidental to the business. (c) states passed enabling statutes authorizing general purposes clauses

3. Distinguishing Ultra Vires from Corporate DutiesNOT UV:

(a) fiduciary duty(b) failure to follow procedures(c) Dumping toxic wastes

4. What's Left w/UV(a) A corp purpose is to make $ for SH - Does a corp have power to give away its

profits through charityi. corp have implied powers to make charitable gifts that in the long run

may benefit the corp. ii. most state statutes specifically permit the corporation to make

charitable donations. 1. However gifts cannot be for unreasonable amount or purpose. 2. Generally if the gift is tax deductible it is reasonable (10%)

iii. IF the gift is beyond tax deductibility or is not tax deductible or is unrelated to corporate benefits it may be attacked as UV

(b) LA 12:41B(12) Corporation shall have the authority to make donations for the public welfare or for charitable, scientific, educational, or civic purposes.

5. LA 12:42 Ultra-Vires Doctrine(a) no act, conveyance, transfer shall be invalid by reason of the fact that

corporation was w/o capacity or power but may be asserted by (1) SH against corporation

(2) damages by corporation or SH in derivative suit against former officers or BOD for unauthorized action.

(3) Action by state AG to dissolve the Corporationiv. Must be brought while the act is still executory (before performance)

1. if bring after then have to prove the directors were N and this is hard to do

D. Premature Commencement of Business1. PromotersA. Before a business operation can be incorporated there are numerous contractual

agreements which must be formed to facilitate the formation of the business and the actual incorporation. Promoters are responsible for the enforcement of these contractual agreements and if there is limited liability during this period of incorporation.

B. Promoters take the initiative, directly or indirectly, to:(a) discover business opportunities for corps.(b) assemble management, labor, and capital(c) put plans into action to develop the corp.

(1) they are not necessarily the directors(2) Promoters, unlike incorporators have significant responsibilities in the

formation of the business and can be liable to outside creditors for:(a) Pre-incorporation contracts they sign before the business is incorporated,(b) Contracts they sign for a corporation that was not properly incorporated.

C. Promoters will also have fiduciary duties to not engage in self dealing with the corporation, and to the future shareholders during the capital-raising process.

D. To discover who is responsible for the pre-incorporation contracts:(a) The default rule is that the promoter is responsible. Otherwise, if a contract

agreement is formed:(1) Look to negotiated assumptions for intent of the promoter and the 3rd party.(2) Look at post-contractual actions of the " and the ".(3) Look at the corporation's actions (look for an affirmative action by the

corporation that the contract was intended as a novation). E. If the promoter misrepresents that the corporation is in existence, the promoter may be

liable because of the misrepresentation of the existence or of his misrepresentation of having proper authority.(a) Under premature commencement of a corp. (doing business in corp. name when

the corp. is not yet formed, and in a defective incorp), promoters enter into Ks in the name of the corp. "to be formed". These Ks show on their face that the corp. is not yet formed.

F. If the corporation adopts the contract of the promoter by an explicit or implied adoption or accepts the benefits of the contract, the promoter may be removed from liability and transferred to the corporations personality. This liability is a two way street. So if the promoter or the corporation is held to the contract, then, likewise, the 3rd party will be bound.

G. What may promoters be sued for:(a) if the promoter makes it clear that he is acting for a corp. to be formed (premature

commencement of a corp.) he may be liable for:(1) misrepresentation that the corp. is being formed(2) breach of promise to form the corp.(3) breach of warranty that the corp. would be formed

(b) if the promoter gives a third party the impression that he is acting for an existing corp. (when in fact it has not yet been formed; defective incorp) he is liable for either:(1) breach of implied warranty of the existence of the principle(2) breach of implied warranty of authority form the principle

H. Basis for a Promoter's liability:(a) breach of fiduciary duties, to present s/hs, to prospective s/hs, and to the corp.(b) failure to disclose duty to all parties of any transaction b/w themselves and the

corp.(c) non-disclosure of facts in securities sale to public; also penalties under the

Securities Exchange Act.I. How do promoters protect themselves from liability?

(a) deal with a non-recourse A; sing K on behlf of the corp and say that the promoter is not personally liabile

(b) sign as best efforts A;(c) attempt to sign as interim contracting party(d) be an additional contracting party(e) get the corp to acquiese to the K and thus relieve the promote of liability

J. Court mandates that perfect candor, full disclosure, good faith, and honesty are required of promoters and their dealing must be open and fair, w/ no undue advantage taken. A promoter who makes money is not frowned upon, it is the covert nature of the dealings that are forbidden.

2. Defective Incorportion

Robertson v. Levy

A. de jure corp - has strictly complied w/ all the mandatory conditions for incorp so that it is not defectively formed, thus, the corporate formation cannot be attacked by any

party, even the state (PCV may still be available).B. de facto corp - has been defectly incorp b/c it has not complied w/ all the

mandatory conditions for incorp to obtain de jure status; but it may have complied sufficiently to be given corporate status against third persons (but not against the state) if three requirements are met:(1) Must be a good faith effort to comply (2) There must be a statute under which they can incorporate.(3) They must operate under the corporate form

C. Corporation by Estoppel - a third party who relies on an innocent representation that the corp. is formed is estopped from denying the existence of the corp. to avoid a K b/c he accepted dealings on a corp. basis; the person erroneously, but honestly representing the existence of the corp. is permitted to escape liability while the person who relied on the representation is estopped form disputing the representation.

If they dealt with the company on a corporate basis, the Court will treat it as a corporation with limited liability.

If the person deceives another into believing that it is under the corporate structure, that person can be held liable. If on the other hand a person in good faith believes that the business was incorporated, that person will be treated as if the corporate structure existed.

Defective incorporation will not subject an inactive investor to liability. But, an active investor may have liability in the above type situations.

If the corporate status is revoked, a person who is not aware of the revocation will not be liable. If the corporation is reinstated, modern statutes provide that the reinstatement relates back to the date of administration dissolution as though the revocation had never taken place.

Even if registered liability was not available, the investors might seek recovery under the anti-fraud provisions of the federal securities laws, in particular §12(a)(2) and 10b-5.

CHAPTER 7 - DISREGARD OF THE CORPORATE ENTITYA. The common Law Doctrine of Piercing the Corporate Veil

1. (general Rule - cannot pierce the corp veil; PCV only applies to closely held corps; no PCV of publicly held corps; '93 shareholders are under no liability for a corporation.

2. PCV allows creditors to go thru the entity and hold the individual s/hs personally liable; PCV gives creditors a break by preventing fraud, injustice, and inequity; yet the power to pierce should approached cautiously because the party seeking to pierce has the burden of proof.

3. By piercing the corp veil, corp asks court to disregard limited liability of shs, BOD, etc and hold them personally liable for corps obligations.

Can you pierce corp veil of sub to get to parent. - NO -

Bartle v. Home Owners COOP (298)

RS 12:93 Corpa. A SH of corp organized after 1/1/29 shall not be liable personally for any debt or liability of the corporation.

b. When can a SH be liable for Corporation liability(1) Piercing corporate veil

(a) co-mingling of assets and can't distinguish between corporate assets and owner assets. Owner starts taking $ out of register and using it for his personal use. (b) Siphoning of assets - bled the corporate dry and end up bankrupt

(c) Under capitalized - not enough $ to start corp but you do anyway and go belly up(d) Decieving Creditors - fraud, misrepresentation(e) Failure of Corp formalities - no records

(2) Situation of PCV - must involve several factors(a) one person corp. (suspect)- (b) closely held corp. -(c) Has nothing to do with corp. shareholders(d) Involuntary creditor - tort case, easier to make tort case than contract case (e) Brother sister corp.(f) Parent Subsidiary(g) One business, multiple corps (taxi cabs)(h) One business fractured into many corps(i) K and Tort(j) Government regulated case; when will a statute allow the courts to ignore regulations and PVC(3) Factors to Determine when to PCV with regard to parent sub. Conclusion to disregard rest on several factors

(a) siphoning of funds, assets, or good deals by a director or s/h. It is very difficult to pierce the corp veil of parent corp.

(b) grossly undercapitalizing a corp at inception and carrying too little insurance; "going thin"; creditors should check this before granting credit or should have obtained a personal guarantee; the undercapitalization must be "trifling"; tort creditors (those suing the corp in tort); failure to adequately capitalize a corp bring personal liability to the s/hs;.

DeWitt Truck Brokers v. W. Ray Flemming Fruit Co. (300) - Flemming, his wife, and his atty form a corp.; Flemming held 90% of stock; there was only one director who never did anything; no s/h meeting; corp. formalities were not followed; Flemming was the only director who had a say in management, and could receive a salary which was everything that the corp. could spare. Court finds Flemming is grossly undercapitalized and holds Flemming personally liable for corp. debts by PCV; one-man corp. is suspect and PCV likelihood is increased.

(c) co-mingling of funds; creates confusion for creditors;(d) fraud and misrepresentation; this is the most important factor(e) Enterprise Liability Doctrine - operational dominance; a parent corp of many

subsidiaries is liable for those subs; consider the control of the parent corp; failure to maintain a clear separation b/w corp affairs.

(f) running a corp at no profit; delegating all the profit to salaries or dividends(g) failure to observe corp formalities; such a BOD meetings and keeping minutes; is the

lack of formality causative of the injury; if not PCV is not likely; if so, PCV.Walkovsky v. Carlton - Walkovsky was hurt by a cab owned by Corp 2; Corp 1 owned corp 2 and several other corps that each owned a single cab carrying the minimum liability insurance; Walkovsky seeks to sue s/h of corp 2 and PCV to get at assets of Crop 1 claiming that all the corps are As of Crop 1; Cort says there is no cause for PCV; if the cabs were all owned by just one Corp, ther would still be no recovery from the s/hs; just because the assets of Corp 2 are insufficient to pay Walkovsky's bills is no reason to PCV; there was no fraud and there is nothing wrong w/ one corp being a part of larger corp enterprise.

(h) seizure of opportunity; of good deal for the parent corp instead of the sub

Note 2 (305): The rhetoric and reasoning in DeWitt is typical of many "piercing the corporate veil" cases: Long on rhetoric and contradictory general principles but short on reasoning. Courts state that the corporate entity is to be disregarded because the corporation is, for example a mere "alter ego." Note 3 (305): Piercing the corporate veil is entirely a phenomenon of closely held corporations, and predominately one-person corporations. There are no cases in which shareholders of a publicly held corporation were held liable. Piercing occurs only within corp groups or in close corporations with fewer than ten shareholders. Only those that take an active role in the corp are subject to liab.

Baatz v. Arrow Bar (309)Bar's assets will minimal v. owners. P tried to pierce corp. veil. Owners were not liab. Ct. grocery list in determining whether could pierce corp. veil.

1) fraudulent representations by corp directors2) undercapitalization3) failure to observe corp formalities4) absence of corp records5) payment by the corporation of individual obligations 6) use of the corp to promote fraud, injustices, or illegalities.

Note 1 (312): Tort cases involving the "piercing" doctrine have a different flavor than the contracts cases. A major consideration in determining whether the shareholders or the third party should bear the loss is whether the third party dealt voluntarily with the corporation or whether his is an involuntary creditor; typically a tort claimant. In a contract case, the plaintiff has usually dealt in some way with the corporation and should be aware that the corporation lacks substance. In the absence of some sort of deception, the creditor more or less assumed the risk of loss when he dealt with a "shell". In tort cases, there is usually no element of voluntary dealing, and the question is whether it is reasonable for businessmen to transfer a risk of loss or injury to members of a corporation that may be marginally financed. The issue of public policy raised by tort claims bear little relationship to the issues raised by a contract claim.

Note 2 (312) Statistics

Radaszewski v. Telecom Corp.

Watered stock - issuing stock of cap structure worth more than the company. If have insurance, you can have adequate capital.

Note 6 & 7 -(322): Minton v. Cavaney - Undercapitalization; The undercapitalization of a corp set up to run a swimming pool was sufficient grounds for holding a director personally liable when a young girl drowned.

Fletcher v. Atex (323)

Notes (327 - 328)1) Blumburgs theory is rejected - a parent corp with numerous subsidiaries should be viewed a sa single economic enterprise for liability and other purposes.4) Areas of control that are justified by economic or legal considerations

a) consolidated Income tax returnb) Routine legal services provided by parentc) Subsiduaries not permitted to borrow moneyd) Employees may be transferred form one sub to anothere) Cash concentration systems

Riggens v. Dixie, LA supreme ct case where piercing was not allowed.

B. Should the Piercing Doctrine Be Abolished?1. UFTA (Uniform Fraudulent Transfer Act)

a) It is illegal to deprive/defraud creditors of their rights to recoveryb) Three Scenarios of Illegal Fraudulent Transfers:

1) any transfer w/ the intent to defraud;2) any transfer where the debtor doesn't receive fair market value for the services

provided;3) any transfer for questionable value and threatens the debtor's ability to pay his

other debts as they become due, thus leaving the debtor insolvent.c) Disregarding limited liability in the case of a failed business would dampen the

incentie to invest or take rational business risks; however, imposing personal liability does protect reasonable creditor expectations;

d) Fraudulent transfer law depends on identifying specific transactions lacking fair market value; these specific transactions may be hard to find.

2. Both UFTA and corporate piercing doctrine create for corp. participants implicit duties to consider creditor's expectations and to place them ahead of their own expectations; Creditor claims are senior to shareholders. For PCV do not have to have a showing of fraud like the Fraud Act.

C. The Piercing Doctrine in Federal/State RelationsUnited States v. BestFoodsStark v. Flemming - Stark put all of her assets in a corp. and began to draw $400/month as

salary; she had set up the corp. in order to pay herself a salary and thus eventually be eligible for Social Security benefits. The salary left little to no return on the capital. Where corp. formalities have been observed, the form cannot be disregarded. Here all corp. formalities were complied w/ and thus the corp. must be treated as legitimate entity, regardless of the motive of Stark.

Roccograndi v. Unemployment Comp. Bd. Of Review

D. "Reverse" Piercing

Cargill, Inc. v. Hedge (Protecting the Family Farm)

Downward Piercing - parent corp is 100% owner of a sub corp; sub corp negligently injures and employee; employee can only recover worker comp under law; can attempt to sue the parent corp claiming that it and the sub corp are in fact only one entity.PVC - Creditor through corp to shareholders

Deep-Rock Doctrine- Equitable Subordination - insiders pay others and try to stand in line before some other creditors

1. Corp yield no personal liability to directors and officers; but due to equitable principles, inside creditors (secured shareholders) who are guilty of fraud or deception are placed last in the line for payment.

2. Guidelines: PCV factors used by court making individuals liable to creditors and insiders can assert their preferences; equity courts place inside creditors last in line.

Pepper v. Litton - Pepper sued a corp. for royalties due under a lease. Meanwhile, Litton, the only s/h of the corp. got a judgment against corp. for back salary; corp. was sold to meet this judgment and Litton bought the corp. and forced it to file bankruptcy. Litton then filed a claim in bankruptcy court for the amount of the judgment that the sale did not pay; by filing a wage claim, Litton tried to put himself ahead of the corps creditors because wage claims take precedent over creditor claims in bankruptcy. This case demonstrates the Deep Rock Doctrine. Bankruptcy courts are courts of equity. A director is a fiduciary and must work for the best interest of the corp. All transactions between the corp. and the director must be at arms length,

not matter how legal each step was the court could still act equitably and disallow the claim. The court refused the claim because the defendant attempted to defraud the other creditors; this his claim was subordinated.

Going Thin - when you take your investment out of the company in cash. Debt to Equity 2:1 if go beyond.

CHAPTER 8 FINANCIAL MATTERS AND THE CLOSELY HELD CORPORATIONA. Debt and Equity Capital

Means of Financing the Corporation: - Equity financing = issue stock. SH pay the corporation for their shares. Shares represent ownership interest in the company.

· SH have financial rts to dividends and liquidated corp. assets. · SH have voting rts to elect directors & important corporate transactions · SH have liquidity rights that enable them to sell their interests

- Debt financing = corporation borrows money from friends, family, banks or credit cards.. Long term bonds, Short term notes, inside and outside financing.

· Obligations are fixed by contract and can be issued to 3rd persons (outside debt/capital contributions) or Shareholders (inside debt/capital contributions)

· Repay debt plus interest· no voting rights or participation in earnings

- Corporate earnings = funds generated internally, retained earnings of the business. Largest source of financing.

Start up use equity, establish credit use debt, largest source of financing is corporate earnings

As an investor, there are 5 ways to invest in a corp depending on the risk willing to take:a) Maximum Return, minimum security - common stock, must payb) Preferred Stock - not a creditor, if you don't pay, he can't sue you.c) Hybrid security d) Debenture - promissory note w/ protective devices like an indebenture, but not secured e) Maximum Security, minimum return - Bonds

b) through e) are generally fixed return investments

Interest rate plays a huge factor in investment decisions:-feds fix interest rate that banks have to borrow money; rates also set by government influence - Greenspan

B. Types of Equity Securities1. Shares generally - the fountainhead of all equity securities is in the Articles of Incorporation (AOI)

(a) the clases or types of equity securities(b) # authorized for each class. (c) preferences, limitations, and relative rights of each class

- AIO empowers the board to issue equity = authorized. They are issued when sold to SH and outstanding when held by

(a) Treasury stock is authorized and issued but no longer outstanding.

2. Common and Preferred Shares- each class has same rights unless class divided into subclasses

- Generally AOI gives the BOD ability to fix rights and powers of series or class w/o SH action.

(1) common stock (a) represents the corporations residual (excess ) ownership interests - what is left over after all financial claims by creditors, bondholders and PS have been satisfied.

i) liquidation rights are the same == what's left after creditors, debtors, PS have been satisfied

(b) Dividends are not guaranteed. (c) Generally issued as straight Common Stock w/no conversion or redemption

principle(d) NYSE won't allow non-voting common stock

(2) Preferred stock (a) Hybrid btwn debt and CS(b) earns fixed dividends and is entitled to fixed liquidation rights(c) senior to CS as to dividends and liquidation rts but junior to debtholders and

creditors (d) paying dividends on PS is w/in BOD discretion and failure to pay is not a default

i) cumulative PS - allows PS holder to carry forward rights to receive dividend BOD does not declare in a given year

ii) partially cumulative - unpaid dividends accumulate only to the extent there were sufficient earnings in the year that was passed over

iii) Cumulative non-participating PS = most common(e) dividend preference is based on name of PS

i) ie. $10 PS = $10 per share each year before any dividends on CS are paid. ii) 15% PS means 15% of the PS's stated value or par value must be paid first .

(f) liquidation preference is usually a fixed price per share i) generally equal to stated or par value (though sometimes includes a premium)

that must be paid in liquidation before CS. (g) usually no voting rights

i) some state statutes give PS holders right to vote on significant transactions - mergers or amendments to articles.

(h) PS can have conversion rights(i) PS can allow for redemption at option of SH or corp

i) Call - company can try to redeem PS from SHa) why? If IR are low and thus debt is cheaper to finance company will buy

back the PS and then just finance through debt at a lower fixed rate. ii) Put - SH holds the redemption option where SH can require the corp to

buyback the stock. The corp. will secure its repurchase obligation by setting up a sinking fund into which the corporation sets aside earnings to redeem the stock and which may not be used to pay dividends or make other contributions

3. Special Rights of Publicly Traded Preferred Shares(1) Cummulative Dividend Rights: Paying dividends on preferred stock is w/in BOD

discretion and failure to pay is not a default. Preferred means preference in payment over common (5% preferred means that pay 5% on share which is generally $100.) but limited rights. Before pay common, must pay preferred. Generally cumulative preferred, but must look at contract to determine whether pay arrears.

(2) Voting: preferred generally does not vote, however, may be allowed to vote in election of directors

(3) Liquidation Preferences: usually a fixed price per share. Generally equal to stated or par value, In liquidation, pay bonds, debentures, creditors before common and

preferred stock holders.(4) Redemption Rights: Most preferred stock is redeemable. Usually have a call premium.

$107 instead of $100. (a) If IR are low, thus debt is cheaper to finance, company will buy back the PS and

then just finance through debt at a lower fixed rate.(5) Conversion Rights: Covertible Debentures: It gives a security position. If the co will not

do good then leave as is, but if the company does well, they convert.(6) Protective Provisions: may have protection such as sinking fund(7) Participating Preferred - entitled to the specified dividend and, after the common shares

receive a specified amount, they share with the common in additional distributions on some predetermined basis.

Classes of Preferred - each one at a different interest rate; can also issue blank shares where directors set out the contractual terms

4. Classes of Common Shares voting and non voting (NYSE won't allow non voting common stock)Common stock is a contract. The typical contract involves (1) the rt to vote; (2) the hope of dividends; (3) the right to information; (4) the hope of increased value in the stock itself; (5) the right to bring a derivative suit. Have the rt to vote for organic changes such are art. Of inc., bylaws, amendments; mergers;

etc.Negotiability - you have as a common share a ni. If you want to sell it you can.

Notes: (4) most state statutes also prohibit shares with an "upstream conversion" right, that is,

the right to convert common shares into preferred shares, or to convert eithr common or preferred shares into debt securities or interest.

(5) The MBCA permits the creation of all types of shares referred to in the previous paragraphs without restriction or limitation. Indeed, the MBCA goes even further in some respects, permitting for example, the creation of share that are redeemable at the option of a third person, eg. The holders of other classes of shares, or the creation of shares that are redeemable at a price "determined in the accordance with a designated formula or by reference to extrinsic data or events.

R.S. 12:51 Classes of SharesR.S. 12:71 Subscription for Shares

Don't have to have separate agreementMust be in writing and statutorily binding

C. Issuance of Shares: Herein of Subscriptions, Par Value and Watered Stock1. Share Subscriptions and Agreements to Purchase Securities

2. Authorization and Issuance of Common Shares Under the MBCA- Some share should be authorized in excess of what is proposed to be issued, even if ther is some additional tax cost.

3. Par Value and State Capital - - Whether investors paid enough depends on whether their stock has "par value or no par value" Par value must be paid to be fully paid and nonassessable

(1) Par Value = (a) artificial dollar figure assigned to shares and specified in the AOI. (b) Represents the minimum amount that must be paid

(c) purpose: modern corporation, legislatures and judges in the past grappled w/how to best protect investors and creditors from free-riding insiders who issued themselves stock at prices below those paid by outside investors. The solution was par value.

i) Creditors were told that assets that assets = to par could not be distributed to Sh (it's a cushion for creditors)

a) if par $1/share at 100 shares company can not distribute to SH assets if assets fall below $100

b) Par value goes into account called stated value. Excess goes into capital surplus account

Reasons for Par value: (1) amount for which shares would be issued to establish proportionality

(2) shows creditors amt. of corp contribution and provides company with assets; (3) lock in a permanent investment amount for secured and creditors and increases

confidence in the resale market.

What if sell stock below par? - What happens is the stated capital account reflects the par value of the stock issued even if the stock was issued below par. So creditors rely on the stated capital account when lending b/c supposedly the dividends will not be paid if capital is below the stated capital value == cushion for bankers. Liability theories for watered stock:

(a) statutory obligation theory - RS 12:52(a)i) LA 12:92(B) Liability of BOD and officers - BOD or director who knowingly or

w/o reasonable care consent to issuance in violation of this chapter liable jointly and severally to the corp and any person who suffers an y loss or damage as a result thereof

ii) LA 12:92(C) = BOD or officers who knowingly or w/lack of due care consented to overvalued issuance shall be liable personally jointly and severally to the corporation for the benefit of creditors or shareholders for any loss or damage arising thereof

iii) LA 12:93A - SH shall be liable for shares not fully paid for. Assignee or transferee of shares in good faith and w/knowledge that shares not fully paid for shall not be liable to the corporation or creditors

iv) LA 12:93C - Liability of subscribers and SH - if property or services taken in payment of the shares are grossly overvalued contrary to the provisions of this chapter, the SH who knowingly or w/o the exercise of reasonable care and iquiry consented thereto or voted in favor thereof shall be liable jointly ns severally to the corporation for the benefit of creditors or SH for any loss or damage arising therefrom

v) MBCA §25 requires the SH pay the corporation the full consideration for which such shares were to be issued.

(b) Trust fund theory - Stated capital was a trust fund for creditors. If the corp went bankrupt and SH had not paid full par value, creditors could compel SH who received watered stock to ante up the shortfall

(c) Holding out theory or Tort/Fraud Theory (Hospes)- The theory creates a rebuttable presumption that creditors rely on the corporations stated capital as an implied representation of the company's credit worthiness. Creditors can recover w/o showing a misrepresentation of stated capital or actual reliance on stated capital. ONLY creditors who extended credit after the watering of the stock and who did not know a/b it could recover.

Notes: 369(1) Bonus - nothing was paid for the stock(2) discount - issued for cash but less than par(3) watered shares - shares issued for property worth less than par.

Subscription agreements are not used because of the securities

Hanewald v. Bryan's Inc.

4. Eligible and Ineligible Consideration for Shares(1) To be fully paid and nonassessable stock must be issued for the proper kind of

consideration. (a) ie. typically statutes require that stock be issued for

i) money paid, ii) services performed or iii) tangible or intangible property actually receive.

(2) many statutes prohibit the use of unsecured promissory notes or promises of future services to pay for stock/.

(3) stock being issued for ineligible consideration leads to the stock being treated either voidable or as not being fully paid (not fully paid = liability = SH can be assessed for the shortfall as in the case of watered stock)

(4) LA 12:52 Issuance of shares; consideration(a) 12:52C - consideration shall be paid in cash, corporeal or incorporeal property, or

services actually rendered to the corporation, before the shares are issued. Upon payment of the consideration fixed thereof, such shares shall be considered as fully paid.

b) cash consideration for shares may not be paid by purchaser's note, secured or unsecured or uncertified check; and in case of delivery of such a note or check - the shares shall not be issued until the note or check has been paid in full.

Notes:

5. Par Value in Modern Practice Par value is arbitrary and once it is determined you can't sell below it. No-par stock -

many modern statutes permit shares to be issued w/no par. When stock is issued w/nopar, SH are liable to the corporation for which the shares were authorized to ve issued or specified in their subscription agreement. Liability may be asserted by SH on behalf of corp in a derivative action or by creditors in insolvency proceedings.

(1) Accounting Allocations to capital and surplus(a) Par value stock

i) Par value payment goes to Capital stock account (also called legal stock or stated capital)

ii) excess value over par goes to capital surplus account (also called capital in excess of legal capital) used to pay dividends

iii) LA 12:52 Issuance of shares; consideration - 3 possibilities for who fixes par:

a) incorporatorsb) BODc) SH can reserve themselvesd) Treasury stock are fixed by BOD

(b) No Par stocki) directors sell the stock and then allocate a fair value to the capital stock

account and what ever is left over goes into the capital surplus account. (Some directors allocate the amount that is going to go into the capital stock account before the stock goes to market) A

(c) LA 12:61 Allocation to capital and surplus, and increases and reductions thereof.

(d) LA 12:1E(1) - (3) Definitions(4) restate

Know page 377

Notes:

Ted Fiflis - There is not much protection for creditors as a result, rely on security interest or require limitations that provide that you cant pay any dividends until you cover the debt 3 times.

Torres v. Speiserpar only applies to initial issuance

D. Debt Financing (Incurement of debt through borrowing.)

1.Liabilities - Three ways to Debt Finance a Corp:A. Bonds, (secured)B. Debentures, (unsecured)C. Notes (secured or unsecured)

2. Shareholder Equity (internally generated funds thru business.A. Common StockB. Preferred StockC. Surplus

1. Earned - Retained Earnings or Undistributed Profits (profits less expenses)2. Capital Surplus

a. Paid in Capitalb. Revaluationc. Donatedd. Reduction

Idea of legal capital is that a certain $ is lock in and provides a cushion for preferred and debt.

1. The Concept of Leverage (382)Non tax advantages

A. no dilution of equity- a debt security represents the corporations promise to repay a loan made by the debt holder. The corporation is bound by contract to make payments of principal and interest on a fixed schedule. Corporations can borrow money in many ways

· issuing st commercial notes· making loans to SH· accepting bank lines of credit· taking trade creditors' extensions of credit· issuing debt securities traded in public debt markets

1. Debt Securities(1) include both st and lt debt obligations

(a) st - paid w/in 1 year = loans or notes to finance day-to-day operations of

the business(b) lt - often freely transferable and more permanent part of capital structure

to finance fixed assets; usually secured by specific corporate assetsi) examples = bonds and debentures

(2) debt securities do not have voting, redemption or conversion rights but it is possible to incorporate these rights.

(a) ie. Bonds are commonly convertible at holder's option into specified equity or redeemable at holder's option (put bonds).

Conversion rightsi) Downstream- bond to csii) upstream - PS to debentures or PS to bond

(b) Some statutes permit debt securities to have voting rights if authorized in the AOI.

i) LA 12:75H - Unless the AOI provide otherwise a corporation may confer upon holders of any bonds or debentures or other obligations the power to bot for directors or on other matters. Such power may be conferred by the BOD or SH

B. Leverage(1) using debt to finance the corporation creates leverage. Borrow $ from

someone else w/fixed interest rate & pay on maturity. Take what you borrow and invest it in something over and above the interest rate = Trading on the equity (but if don't produce the earnings you still have to pay the interest)

(a) means that debt financing is providing some of the capital. (b) High outside debt financing increases the potential for large returns (and

losses) on the insider's equity investment(c) B/c debt is fixed, high earnings will produce a high return on equity; low

earnings will do the opposite(2) THE EFFECT OF LEVERAGE IS MEANINGLESS IF THE DEBT IS HELD BY

INSIDERS(3) The overall return to insiders who hold debt and equity will be the businesses

return on investment (a) ROI = earnings before interest / total debt +total equity(total investment)

(4) Leverage also allows an equity investor to put up less money and still retain full management control of the business.

(a) HOWEVER greater leverage also increases the risk of loss for the debt investor b/c the equity cushion is proportionately thinner.

Leverage - using other peoples money to make money. Increases the potential for profit but punishes the inability to cover. The bondholder always gets the same return (10% interest payments per month) However if the company invests that debt properly the SH could get increasing appreciation. ie. Borrow $50K to buy $50K worth of land. Payback 10% interest in 1 year. In 1 year the property value goes up to $100K so you made 40% w/leverage.

Say for example x has land to sell $1000 per acre, 1000 acres. You buy it and one year later you sell for $2000 per acre. Make $1m dollars. Suppose we leverage and same guy who owns 1000 acres owns 5000 acres at $1000 acre ($5m) You want to buy it so you put up $1m and put up a note for $4m. One year later sell for $10m. What you get back is yours less pmt of loan and interest. Danger of leverage is that if you don't pay, landowner get property back and get keep deposit.

C. Security (Going Thin) - a highly leveraged company is said to be "thinly capitalized." No dilution of Equity. (instead of capitalizing with all stock, make some

stock and some debt.)1. Evaluated by examining a corp's debt/equity ratio (long term debt to equity

capital); debt can be composed of outside debt (regular creditors) and inside debt (s/h creditor; when s/hs put $ in, they receive both stock and a note); the advantage is to avoid double taxation on dividends while receiving a tax deduction on the interest; a corp undercapitalized for PCV purposes. Debt to equity ratio 2:1 okay. 4:1 IRS will pit is all a equity for tax purposes.

2. Tax Treatment of DebtTax Advantage

A. Interest Deduction - Interest payments by a corporation are tax deductible (dividend payments are not)

B. Return of Capital - a repayment of debt may be a tax-free return of capital (pay back debt w/o interest) rather than a taxable deduction;(1) IRS is not blind to this tax avoidance -- merely characterizing an investment as

debt is not enough. IRS will reclassify your debt as equity for tax purposes only. (a) IRS will start looking at you if debt to equity is 4or5 to 1. OK to be 2 or 3 to 1.

(2) The crts use a number of factors to distinguish real debt from equity masquerading as debt:

(a) is there a payment schedulei) D paid when due; E payment never due

(b) is the rate of return fixed or does it fluctuate i) D is fixed; equity fluctuates (variable payments is a sign of E)

(c) are payments made only from earningsi) D paid regardless of earnings; dividends on equity are paid from earnings

(d) do the investors also manage the companyi) inside debt is hard to characterize - will tend to be viewed as "at the risk of

the business." particularly when debt/equity is high (for every dollar in equity you have a ton of debt)

(e) is the corporation thinly capitalizedi) higher the debt/equity ratio, the more likely it is that some of the debt will

be recharacterized as equity.

(3) Tax effects of re-characterizing debt as equity(a) payments to the debtholder are not deductible by the corp. (b) payment of interest may be considered a taxable dividend payment

(4) Problem w/insider debt - company falls on hard times. The IRS will subordinate the insider debt first.

C. Ordinary Loss - if you cant pay debt back you try to write it off against your income. Sec. 1244. If you lose money on stock of closely held you can deduct it from your ordinary income.

3. Debt as a Planning DeviceDisadvantage of Debt

A. Payback/Payment Schedule - Corp has to pay debt back on time or go bankrupt:B. Loss of opportunity - when a corp incurs debt, it has less of a chance to borrow $ b/c its

assets are already backing existing debt; thus, b/c banks won't lend to corps already in debt, it has less opportunity to exploit new business.

Summary - Advantages and Disadvantages of Debta. Advantages - non-tax

(1) leverage

(2) no dilution of equity(3) can be secured

b. Advantages - tax(1) interest tax-deductible (dividend = double taxation)(2) return of capital (3) ordinary loss

(a) if you have CS it becomes capital lossc. Disadvantages

(1) must pay interest and principal on fixed basis(2) loss opportunities - if you already have big debt you can't get

more & take advantage of business opportunies.

E. Planning the Capital Structure for the Closely Held CorporationEx: A lends B $15k (A had $100k). B puts 15K in stock and gives it to A as security of loan. Loaned B $70K.

1. Debts Priority over Equitya. if corporation insolvent or dissolves creditors/debtholders are entitled to payment

before equity SH. So investors prefer to be debtholders

2. Choosing Debt-Equity Mix- Creating the proper capital structure for a company

a. Participation in profits(1) E participates in earnings ; D just receives fixed payments specified by contract

b. Control rights(1) D no voting rights; E has voting rights (can control management to avoid last in

line scenerio)c. Fixed payment

(1) D must be repaid; E depends on earningsd. Corporate level taxes

(1) D interest is tax deductible by the Corp.; Flow through S-corp SH are taxed on earnings even if not paid out

e. Leverage(1) greater debt = increase risk for equity and debt holders b/c � earnings could lead

to insolvencyf. Priority in insolvency and dissolution

(1) D and PS have priorityg. If the mix is weighted too heavily toward debt, the advantages of tax deductibility of

interest payments and debt's priority over equity may be jeopardized.

(1) Debt financing to a point might reduce the cost of capital for a firm. When debt is cheaper than equity a business would do better by issuing more debt than equity.

(2) A highly leveraged firm presents higher risks for equity investors who demand higher ROI

(3) Cheap debt is offset by expensive equity

h. However no debt = lots of assets and free cash = good target for takeover or good takeover aggressor.

3. Sources of financing a. outside = bond, debentureb. inside = PS, CS, surplus, RE, capital surplus, re-evaluation, donated, reduction

Notes on page 387 - General Rule: if I get stock and notes for securities, it is tax free. If tranfer and get cash, taxable. Sec 351.

F. Public Offerings

Thomas Lee Hazen -- If you want to sell stock you have to register with the SEC. 33 Act Required disclosure. Securities law has not been structurally endangered. Key is Sec. 5 which provides that before you sell sec. In interstate commerce must first register. A registration statement consist of 1) "prospectus" and 2) additional information that must be submitted.

1. Historya. 1929 2/3 value of the stock mkt evaporated. Caused a crisis in the banking

industry. Caused whole economy to be destroyed. 1/3 people had no jobs another 1/3 only wrked part-time. Over ½ of stock sold from 1920-1929 was virtually worthless. So passed the Security Act of 1933.

b. Regulation of securities approaches (*fed. Regulation through Sec. Acts)(1) regulate what is sold(2) *disclosure what ever you sell must make complete disclosure(3) *anti-fraud - you can sell what you want but if fraudulent you can be sued.(4) Negligence - if n then personally liable

2. Security Act of 1933 - deals w/the primary mkt - Mandates that investors receive comprehensive disclosure when corporation raises capital in public securities offerings. a. Before you sell stock to the public mkt

(1) must file registration certificate w/SEC, (2) signed by directors, attny, accountant, UW, issuer, brokers(3) those who sign are personally liable. (Purpose: decrease fraud)

3. Security Exchange Act of 1934 - a. deals w/Secondary mkt - SH selling to another SH - brokerage, stock mkt ,

secondary mkt, dealers, UWb. Applies to stock traded on stock exchange which have more than 500 SH and

$10MM in assets (1) Ongoing disclosure is required by public or reporting companies (2) purpose make trade on best current info

4. Blue Sky Laws - state laws that regulate security regulationa. Register & qualifyb. Registration by notification

(1) fed law does not preempt state law so you must comply w/bothc. Anti-fraud provisions

(1) if sell stock w/o proper disclosures then = fraud & criminal prosecutiond. Escrow system

(1) make promoters escrow all of their stock until business is up and running.e. Rule 10b(5) - most important corporate regulatory statue.

(1) Dupuy - closely held co. Dupuy, brother, mother owned stock. Dupuy made fraudulent ideas to mother and brother and they sued him under Rule 10b(5)

5. Securities Act of 1933 Disclosure Mandatesa. Public Offerings - Issuers, Underwriters, Dealers, and Investors

(1) Public Distribution process = issuer (originator = individual or corporation) sells to UW (wholesaler) to dealers (retailer) to investor (consumer). Anyone involved in distribution process has SEC concerns.

(a) UW relationshipsi) firm - UW buys at fixed price from firm and then sells on the mkt.

Issuer knows what he is going to get.

ii) Best efforts - UW agrees to use his best efforts for the issuer. Issuer takes what the mkt gives.

iii) Agent - UW is an advisor or agent to issuer of when to go to Mkt at what price (retail broker) = normal channel

(b) when UW purchases from issuer for purpose of distribution = purpose is to control issuer. When control person sells he must register or show an exemption. The control becomes issuer. The person who sells becomes UW.

i) when the person who sells becomes an UW = when dealing w/control people = control person having unregistered securities when issuer registers piggy backs so doesn't also have to get registration

b. Registration and Mandated Disclosure - §5 Prohibitions(1) purpose of securities Act is full disclosure to investors in public offerings. (2) §5 requires the filing and dissemination of disclosure documents;

§5(a) prohibits the sale of any security using the mails or other interstate

means of communication unless:i) issuer has filed a disclosure document (registration statement)

w/ SEC and ii) the registration statement becomes effective

(b) requires that investors receive disclosure document known as prospectus forms the main part of the registration statement containing info a/b

i) the companyii) managementiii) securities being offerediv) purpose of the offering v) company's capital structurevi) financial performance

(3) Pre-Filing Period - issuer can't offer to sell securities or make any sales why? Purpose of §5 is to get to the effective date.

(4) Waiting period - triggered when filed registration. (a) SEC determining whether the company properly disclosed. (b) Company filed w/prospectus. On prospectus there is a red caption

"These securities are not validated by SEC = Red Herring= prospectus or preliminary prospectus

i) company can send red herring out to get people aware.ii) the price is not in red herringiii) there can be discussions among the UW - no sales thoughiv) Tombstone ads - no written offers but can advertise coming of

issuancev) no written offers - only oral offers - discussion to sell

(5) Effective Date(a) there can be sales accompanied by or preceded by a prospectus

i) accompanied - b/c the idea is the people have seen the red harring- so don't have to send official prospectus until after sale

(b) Price amendment filed day before effective date(c) any amendments to prospectus made as soon as known

7. Exemptions - Tempting the Breadth of §5 (p. 81)- Exempted from SEC registration and mandatory disclosure requirements are

- intrastate offerings (Rule 147) Know- nonpublic (private) offerings

- small offerings as defined by SEC (Reg D) Know- transactions in trading mkts· 1 SH sells to another SH - shares already registered

Registering securities is very expensive so good attny help clients to avoid the acts coverage. Keep in mind those transactions that are exempted from registration and disclosure requirements are still subject to ANTI- FRAUD provisions of Securities Act and Securities Exchange Act.

a. Intrastate Offerings (Rule 147)(1) SA exempts any offering made and sold only to residents w/in a single

state. The exemption is narrow:(a) issuer must reside and be doing business in the state of offering.

i) Resides in its state of incorporationii) "does business" in a state if its revenues, assets and principal

officer, as well as use of proceeds of the offering are principally in the state.

(b) the offering can be made only to in-state residents i) the exemption is lost if any sale or offer is made to an out of state

resident (even if doesn't result in sale)ii) exemption lost if in-state purchaser acting as conduit for outofstate

investor - issuer can't rely on representations of instate purchasers(c) The offering can't be part of a larger offering in which there are

out-of-state investors. (Rule 147) i) if 6 months before or after a company claims an instate exemption

as of Jan 1, 1999 then come w/registered offer 4 months later the same company comes out with a registered offer, the SEC might say the 2 offers are integrated b/c they are w/in 6 months of each other and thus not exempted.

ii) Resale to outstate prermitted after 9months after issuanceiii) issuers qualify if at least 80% of revenues, assets, proceeds are in

state

b. Nonpublic (private) offerings(1) no need for protection of Act b/c investors are well informed

(a) investors must be able to fend for themselves = qualified investors

i) SEC v. Ralston - Ralston sold unregistered stock to employees (stock clerk to managers). Many of the employees lacked ability to fend for themselves and so crt held Securities Act registration was required. Can't claim private exemption when people you give the stock to need protection of the Act. It is then a public offering and you must register with SEC.

(b) securities can't be resold to unqualified investorsi) exemption is lost if qualified purchasers turn around and resell the

securities to unqualified investors who can't fend for themselves. So securities sold in private placement = restricted securities.

(c) securities can be offered only to qualified investors i) The entire exemption is lost if a sale or offer is made to just one

unqualified investorc. Small offering exemptions (SEE HANDOUT)

(1) Reg D= under §3(b) of the SA, the SEC has authority to exempt offerings of less than $5MM

(a) Rule 504 - small offerings subject to state "blue sky" lawi) non public Co can sell up to $1MM in securities in any 12 month

year. ii) no limit on # or kinds of investorsiii) Issuer may use general advertising and solicitationiv) no restrictions on resales

(b) Rule 505 - medium sized offerings subject to SEC conditionsi) Non-reporting companies can sell up to $5MM in securities in 12-

month periodii) no general advertising or solicitation are permittediii) offering can be sold to an unlimited number of accredited investorsiv) can be no more than 35 accredited investorsv) all non accredited investors must receive specified written

disclosure and opportunity to ask questionsvi) Securities under Rule 505 become restricted

(c) Rule506 - private offerings subject to SEC safe-harbor conditions. i) any company can sell an unlimited amount of securities under same

conditions as rule 505 w/one added conditiona) if any sale is made to nonaccredited investors, each of these

investors must have sufficient knowledge and experience in business and financial matters so she can evaluate the merits and risks of the investment

ii) Rule 506 is a non-exclusive safe harbor; an offering that does not satisfy all the rules may still be exempt under §4(2)

(2) Reg A = exempts offerings by nonreporting companies of up to $5MM provided the issuer follows a simplified registration-type process

d. Exemption for post-distribution Market Trading ?????(1) ordinary trading transactions such as on stock exchanges or between

investors are exempt. Once securities are sold in the public mkt they no longer need regulation in secondary mkt.

(2) §4(1) exemption extends to any transaction to a person other than issuer, UW, or dealer (protects SH)

(a) hidden catches b/c of the way the Act defines UW:i) purchases shares from an issuer w/a view to their further

distributionii) offers or sells shares for an issuer in connection w/a distributioniii) purchases shares from a control person w/a view to further

distribution (Control person = person b/c of his position has access to confidential corp info and power to have Co. register shares under the SA)

iv) offers or sells shares for a control person in connection w/a distribution.

(b) §4(1) does not cover SH who owns restricted securities and resells them (c) sales by a control person into a public trading mkt w/assistance of

another persons , brokerage firm,= nonexempt transaction i) UW buys from issuer w/view to distribution = control person. B/c of

his position he has access to confidential info. ii) brokerage firm becomes a statuory UW

e. Rule 144 - safe harbor for secondary distributions. Restricted stock sold in secondary mkt(1) Rule 144 is exclusive means by which control persons can sell their stock

into public trading mkt w/o registration. (a) SEC rule 16b any officer, director, controlling SH who sells or buys w/in

6 month period owes profit to the corporation = 6 month rule of insider trading.

(2) secondary distributions and sales by control persons into public mkts are permitted w/o violating the registration requirements if each of the following are met:

(a) current public info a/b the issuer must be available(b) seller (if stock restricted) must have had held the securities for at least

1 year after they were purchasedi) control person who does not hold restricted shares is not subject to

the 1yr holding period. (c) securities must be sold through a broker w/ normal commission and

does not solicit orders(d) the seller must trickle the securities into the mkt -

i) no more than 1% of issuers outstanding securities or the average weekly trading volume (which ever is greater) sold in any 3months

(e) seller must give notice to SEC whenever more than 500 shares are sold or sales price exceeds $10K

(f) a noncontrol holder of restricted who has held them for more than 2 yrs may sell w/o condition

(g) Noncontrol holders of restricted securities who sell into a public trading mkt can either use rule 144 or argue that their shares come to rest and had not been acqired w/ a view of public distribution

8. Civil Liability under Securities Acta. Why civil liability

(1) investors can rescind their investment if there was any violation of the §5 registration and disclosure requirement = SA §12(a)1

(2) investors in a registered offering can recover any losses from specified participants if there are material misrepresentations in the registration statement = SA §11

(3) sellers in public offerings are liable for material misreps made in the prospectus or orally = SA § 12(a)(2)

b. Section 12(a)(1) - Rescission for Violations of §5 (registration and disclosure)(1) a purchaser may rescind the transaction and get money back w/interest

when the stock was offered or sold in violation of §5 registration and disclosure requirements

(2) imposes SL for violations of §5

c. Section 11 - Damages for Deceptive Registrations Statements(1) allows any purchaser to recover damages from issuer and others involved

in the distribution if registration statement contains falsehoods or ½ truths concerning any material fact (one that a reasonable investor would consider important in deciding to invest)

(2) §11 Creates liability scheme that includes- specific �s- due diligence defense- intricate formula's for computing damages- allocation of liability among �'s- tricky limitations period

(a� Who is liable?i) issuer (SL regardless of fault)ii) directors (whether or not signed registration statement)

iii) senior executives who signed the RSiv) UW of the offeringv) any expert whose opinion is used in the RS (ie. Lawyers, accounting

firm that audits FS)(b) due diligence defenses - insures complete disclosure

i) very few litigated cases impose liability under §11 instead most are settled

ii) due diligence = potential �'s investigation of the information contained in the registration statement and prospectus. The level of due diligence expected varies according to who prepared (or certified) the info. later attacked as false or misleading == expert or nonexpert. Whether the false info was certified by an expert = expertised portion and whether who looked over the expertised portion was an expert

iii) expertised portiona) CPA auditb) UWc) attny opinion a/b titled) nonexpert must have no reason to believe experts info is false

iv) nonexpertise portiona) co. plansb) doesn't have to go back and add numbers (unless he knows they

are cheating)c) nonexpert - after reasonable investigation must reasonably

believe the info to be true

(c) § 11 Expansion of CL fraud rules�� �'s are liable for material untruths or omissions - halftruths

are actionable silence is general not a defenseii) � need not prove �'s knowledge. Each � (except issuer) can

defend on �'s due diligence in checking registration statementiii) � need not show actual reliance on the untruths or omissions or

even have read the prospectus. �'s can defend if show � knew of untruth or omission

iv) � need not show causation -need not show misinfo caused the fall in value. � can defend by showing decrease in value was due to other factors

v) Damages limited to �'s total amount of offering even if damages were larger. UW only liable to amount of stock sold or helped sell

d. Section 12(a)(2) - Rescission for Misrepresentations (1) antifraud provision - allows people to sue for damages(2) purchasers in an offering may seek rescission from statutory sellers if

offering is carried out by means of a prospectus or oral communication that is materially false or misleading

(3) reliance and causation are not elements of the claim(4) sellers have defense if show purchaser knew of misstatement(5) �'s have a reasonable care defense if show they did not know (and

reasonably could not have known) of the misinformation(6) Scope of §12(a)(2)

(a) restricted by Gustafson v. Alloyd - sh of closely held corp sold all their shares to an outside investor group. The group claimed the sellers had misrepresented the company's financial position in the sale contract and sought rescission. H: the parties contract could not be a prospectus since it was not the statutory prospectus described by the

SA filed in a registered offering. i) the decision confused community regarding whether §12(a)(2)

extends to private placements using prospectus like offering circulars (does cover registered public offerings though)

(7) Statutory sellers (a) §12(a)(2) does not require privity. In addition to the actual seller who

passes title, those who actively solicit the purchaser (and who do so for gain) also can be held liable. Printer v. Dahl - collateral participants in a securities offering, such as lawyers and investment advisers, who assist in selling process risk becoming liable

Smith v. Gross - Definition of Securitya. All the prohibitions and liability of Securities Act turn on whether a transaction can be

classified as sale of a security. b. Security Definition

(1) stock, bonds, debentures, notes, transferable shares(2) evidence of indebtedness, investment contracts, certificate of interest in profit

sharing agreement. (3) borderline case turns on whether the scheme involves an investment

contract (= security) SEC v. WJ Howey test :(a) person invests money (b) in a common enterprise and (c) is led to expect profits(d) solely from the efforts of others

(4) clarification to the Howey test(a) can be other than money(b) must be a number of investors in a common pool (c) expected return must come from earnings and not merely additional

contributions(d) solely from efforts of others

i) investors are counting on others to manage an enterprise that will produce returns on their investment

(5) = investment contract = sale of security(a) investors purchase interest in rows of orange trees; seller handled

cultivation, harvesting and marketing(b) investors purchase earthworms and seller promised to buy back all

worms for guaranteed price and mkt to fishermen(c) investor purchased peice in pyramid scheme; seller promoted; investor

paid commission for each new person brought into scheme(d) investor bought beachfront condos; seller managed condo and pooled

rentalsi) in each case investors put $ into a scheme in which the

expected returns derived predominantly from efforts of others. The enticement was the return on investment created by others management and marketing efforts.

G. Issuance of Shares by Going Concern

1. Financial Rights of Equity Sharesa. The basic qualities of Equity

(1) dividends - discretion of BOD = cash, property, CS, PS, debt(2) financial rights on dissolution (liquidation rights) = distributions in

cash or kind by the corp. to SH based on an apportionment of assets on dissolution. AOI can specify amount to be paid

(3) voting rights - based on # of shares (election of BOD, approval of significant corp. transaction ie. amendment of AOI, creation of new class of stock, mergers, sale of corp assets

(4) conversion rights = Sh an option to convert their stock into another security of the corp

(a) downstream - debt to preferred stock(b) upstream - common to preferred stock

(5) redemption rights =(a) give SH an option to force a redemption by other SH (or repurchase by

corp) of the shares. Ideal to get redemption at capital gains rate(6) preemptive rights=(only thing covered in class

(a) allows Sh to acquire stock when corp issues new stock so that new stock does not dilute proportional interest.

(b) Preemptive right allows the SH to acquire enough shares at the issue price, to preserve his ownership interest

i) ie. SH owns 300 of 1000 shares outstanding = 30% ownership. Corp issues 200 more shares. A preemptive right lets the SH purchase 60 more shares to maintain 30% ownership

(c) Must be in the AOI or else there is no preemptive rights also put on face of certificate

(d) in the secondary issuance the existing shareholders has the preemptive right to buy a proportion share. Can opt out.

(e) RS 12:72(a) SH preemptive rights. No preemptive to subscribe for shares:

i) which are to be issued for consideration other than cashii) which are to be issued to satisfy conversion or option rights iii) which are treasury sharesiv) issued pursuant to 12:49B(e) (see rules)v) don't have them unless you prescribe for them

Stokes v. Continental Trust

Katzowitz v. Sidler

H. Distributions by a Closely Held Corporation

1. Transferring Assets to SHsa. when the corp. declares a dividend there is a potential conflict of interest between

the corps interest and the SHs interest; Corp wants assurance that no claimants who rank below them are paid before them.

b. corp can distribute its assets to SHs in variety of ways:(1) dividends(2) capital (or liquidating) distributions(3) stock redemptions(4) corp. repurchases

c. Dividends - periodic payments by the corp made in relation to past or current corp earnings to SHs in proportion to their share o/ship(1) declaration is made by the BOD(2) BOD protected by the BJR(3) May be paid in $, property, or corporate share(4) Stock dividend - pro rata distribution of additional shares among existing

SHs; gives them more shares(5) cash dividend - SHs obtain rights as creditors once the BOD declares

and they can't recind it; (stock dividends can)(6) Stock split outstanding share are converted into new and additional

shares; (2 for 1; 3:1); Most corp statutes allow BOD to declare its own stock split; = to stock dividend in that SH get additional shares w/o paying anything

(7) LA RS 47:62 - BoD may declare dividends to be paid in property, cash, stock out of surplus except when the corp is insolvent. When a dividend is paid out of capital surplus, notice must be given because it is not out of earnings.

(8) Nimble dividends - 12:63(9) RS 12:61

d. Redemption & Repurchase(1) corp can also distribute assets to SHs by acquiring outstanding shares

through redemption - a forced sale initiated by the corp(2) repurchase - voluntary buy-sell transaction b/w corp and shareholder(3) all corp statutes now recognize power of corp to repurchase its own shares(4) If you redeme a complete minority interest, the person who repurchases

his own stock gets a capital gain.(5) RS 12:55(6) cross purchase agreement - other shareholders buy your shares. - do this

because economic, insurance to buy stock when others died, premiums are not deductive, but if other dies, insurance to purchase stock is not taxable.

(7) compare cross purchase to redemption

Gottfried v. Gottfried

Dodge v. Ford Motor Co.

Wilderman v. Wilderman

Treasury is never an asset, it is a reduction in the amount of equity outstanding

Donahue v. Rodd Electotype

Notes: Have to let Directors show that what was done in the redemption had no business sense. Another ligitamate option was available not to harm the minority shareholder.

I. Legal Restrictions on Distributions - MBA -must be able to pay debts as they become due; cannot issue a dividend if it inhibits your ability to remain solvent. Must pay dividends out of earned surplus.

1. the effect of a corp. distribution is to transfer assets from the corp to SHs; this jeopardizes Cs claims; Cs want to limit distribution to SHs, MBCA - evaluated the lawfulness of distributions.

2. to protect Cs who may be counting on corp. Assets to satisfy their claims against the corp, corp law imposes a variety of rules for when distributions are legally authorized:a. Equity Insolvency Test -

(1) all corp statutes forbid distributions that would render the corp unable to pay its debts as they become due in the ordinary course of biz.

(2) test is concerned w/ liquidity - the ability of the corp to pay its bills(3) reflects what concerns Cs - that the biz will not have enough assets after a

distribution to pay its debts;(4) stock dividends not subject to test because they do not involve the transfer

of $ or corp property; stock dividends can be made when corp is insolvent.b. Balance sheet tests - nearly all corp statutes impose a system of accounting

rules to decide when distributions are legally authorized.c. RS 12:63 - Equity - stated capital = surplus (RS 12.1)

RS 12:63(b) - 24month rule.

J. Non-Model Act Statutes1. BOD were once strictly liable for approving an illegal Distribution2. Modern statutes - impose liability on directors who assent to an illegal distribution only if

they did not act in good faith; liability is to the corp.3. Under some statutes, some SHs who receive an illegal distribution may be liable to the

corp, along w/ BODs, if the SHs knew the distribution was illegal; it may be a fraudulent conveyance allowing Cs to recover from SHs directlya. Pure Insolvency Testb. "earned Surplus" Dividend Statutesc. "Impairment of Capital" Dividend Statutesd. Distributions of Capital Surplus

Missed Tues April 9

Know 61,62,63,71-79

Voting trust problem

Thursday 4/11

12:11212:31See Shareholder Governance Rule12:12112:8112:73B who can call a special meeting

Read rules:

R v. Dresser. Directors fired a didrector and shareholders said take him back and we and we want to remove some of the other directors for cause. Shareholders have a rt to remove a director for cause, the director has to have due process. How do you do this when everything is done by proxy system.

State Level Information Rights RS 12:102B

If you are a listed company, there is more inforamtion that you have to provide12:103D

12:8212:121(e)12:121(g)12:81(all)12:82(f) read in conjunction w/ 81D

The quarum shall be all directors

CHAPTER 9. MANAGEMENT AND COTROL OF

CORPORATIONSHAREHOLDERS' ROLE IN CORPORATE GOVERNANCE (BAR EXAM**)(6)

1. Blackstone described corporation as a little republic1. Shareholders = electorate - vote annually to elect BOD. Don't

participate in managing everyday affairs. Protected by voting rights, litigation rights and liquidity rights.

2. BOD = legislative organ - all corp powers flows from board. Act on behalf of Corp. = fiduciary duty to corp and SH

3. Officers = bureaucracy - day to day management answerable to BOD4. LA 12:815. LA 12:82

2. Purpose of SH voting 1. Elect directors2. Limited right to initiate changes = people w/power to vote don't have

power to initiate3. Vote tied w/SH ownership rts.4. Voting sham b/c proxy cards == Sh have no knowledge & officer run5. Wall Street Rule - don't like management then sell

3. Shareholder voting in Public Corporations1. SH participation in election of directors is far less fulsome than

the model assumes. SH are mostly passive b/c vote their proxies for the slate of directors and transactions proposed by incumbent managers.

2. Proxy process(1) to solicit proxies, management send to SH at

corporate expense a voting package containing an annual report, proxy disclosure document, proxy card and return envelope.

(2) beneficial owners - shares are owned on the books by a nominee

(3) under SEC rules, the corp must disseminate proxy materials either to the record owners or beneficial owners who do not object to having nominees furnish names and addresses . (1) if corp believes record holder is nominee it

must send enough so all beneficial owners are forwarded voting material

(4) Most SH complete the proxy cards and vote as recommended by management

(5) State law permits any SH to nominate her own slate of directors or propose SH resolution, effort futile w/o solicited proxies

3. History of public SH voting(1) In response to voter lack of control, Congress created

SEC in 1934 to (among other things) promote a fed regulatory regime for proxy voting.

(2) 1950-60's SH did little but vote as managment asked(3) 1970's SH just sell shares if not satisfied “Wall street rule”(4) 1980's SH power to exit and sell shares - boom of takeovers(5) 1990's institutional investor = majority SH that has more

incentive to be informed a/b management. (1) institutional investors - financial

intermediaries that hold large pools of investments

for beneficiaries = 39% of largest US companies have institutional ownership of 70% or more

4. Voting incentives for Public SH(1) Insurgent if loses absorbs the full costs of the contest

and can't seek contribution from other SH or the corp. If wins, able to obtain reimbursement from the firm but any gains she creates will be shared w/all SH == personal rewards are according to Shares owned.

(2) institutional investors have a large stake in individual companies(1) larger shareholding make activism worth the

effort(2) institutional investors can't easily exercise the wall street

rule and sell stock b/c selling of large blocks of stock drags down the mkt price

(3) 1990's insurgent success rate +50% (80's 30%; 60-70's 16%)

4. SH Voting in Close Corporations1. SH lack public mkt 2. SH often rely on the corp as a source of livelihood and assume a far

more active role in the corporation governing

5. LA 12:75(C) - Voting of SH and bondholders1. A SH shall have right to cast his vote either in person or subject

to the following proxy (power of attny)(1) must be in writing(2) signed by SH(3) filed w/secretary at or before meeting(4) the authority of the holder of proxy to act is not revoked by

death of SH(5) proxy revocable at will (6) proxy valid unless successfully challenged before voting(7) when shares registered by 2 or more people 1 must sign(8) Sh may authorized another to act as proxy for him

(1) what happens if you go to bank and pledge stock - who has right to vote? If bank registers the securities they have right otherwise you retain.

6. LA 12:57E 1. Trustee voting ???2. Legal executor voting rights

7. LA 12:77 Record Date1. Record date is set for the purpose of determining Sh entitled to

notice of and to vote at a meeting. 2. Date must not be more than 60 days prior to the date on which the

action requiring the determination of SH shall be taken

2. VOTING STRUCTURE (7)1. Voting by SH is prescribed by

1. State statutes. 2. By laws3. AOI4. Directors5. Fed. Proxy Rules

2. Shareholder's Governance Role1. Election and Removal of Directors

(1) SH elect BOD at 1st SH meeting and thereafter annually

(2) SH can remove BOD for cause or w/o (depends on statute and AOI)

(3) LA 12:81 Directors - Election and Removal of(1) 12:81A - subject to bylaws and statute all

corp must be managed by BOD of no less than 1 person. If not fixed in AOI or bylaws # of directors shall be the # named in initial report or supp report. Unless provide otherwise directors hold office for 1 year and until their successor are chosen and qualified.

(2) 81C(4) - SH may remove director by vote of a majority of total voting power at a special meeting called for the purpose with or without cause

(3) 81C(3) - If have 3 directors and 1 is interdicted BOD by majority vote can fill te space provided the SH shall have the right to fill the vacancy

(4) 81C6(C) - meetings of the BOD may be initiated by chairman, president, majority of directors unless otherwise provide in AOI or bylaws

(5) If director is voted by a class of SH it must be removed by that same class.

(6) IF SH want to remove director, SH must call a special meeting. The special meeting shall be preceded by at least 2 days notice.

(7) CL directors can't vote by proxy b/c director has a fiduciary duty == cant delegate personal fiduciary duty. LA81E - allows director to vote by proxy but must be in AOI

(8) 81C6(b) - In LA if director comes to meeting but says he got no notice being a the meeting presumes notice.

(9) If we are at war w/someone don't have to give those foreigners notice

(10) *** EXAM - 81C(7)- Special meeting, gave notice and 5 of 9 showed up of the 5 if 3 voted for the provision it passes b/c 3 is majority of 5. Unless provided otherwise when quorum present when meeting commences majority shall bind. Must have at least quorum when votes are taken?????

(11) 81 C(10) BOD may hold a meeting by conference telephone or similar communication

(12) 81D - the AOI may provide that a particular class or series of shares or securities may elect directors

2. Approval of Corporate Transactions(1) Sh have limited powers to approve corp. transactions

initiated by BOD(1) fundamental corp. changes

1) SH can vote on amendments to AOI, mergers, sales fo substantially all corp. assets, voluntary dissolutions

(2) LA 12:31 Method of Amending articles generally1) 31B - amendment of AOI may be

adopted by a vote of at least 2/3 of voting power present (not less than a majority present 51%)

(3) LA 12: 112 Merger or consolidation procedure1) BOD shall enter in to agreement

merger2) The agreement must be approved by SH3) Directors can only initiate the merger not SH; SH

only can vote4) 112 C(2) The agreement must be approved by the

SH of each business corporation by vote of at least 2/3 of the voting power present, or by such larger or smaller vote (but not less than a majority) of the voting power present or of the total voting power as the articles may require

(4) LA 12:121 Voluntary transfer of corporate assets1) Authorization by 2/3 SH (w/not less

than majority present)

3. Initiation of Corporate Change1. Sh have narrow power to initiate

(1) Amend and repeal bylaws. (1) Usually if BOD shaes this power to amend

bylaws this is coterminous w/SH(2) LA 12:28 Bylaws

1) BOD may alter bylaws subject to SH adoption.

2) SH can initiate meeting to change bylaws????(2) Amendment of AOI

(1) most statutes vest this initiation w/BOD(2) LA12:31- LA 12:35 Amendment and Restatement

of Articles(3) non-binding recommendations

(1) SH can make nonbinding recommendations a/b governance structures and management of corp including matters exclusively to BOD.

(2) in public corp such recommendations = shareholder proposals under SEC rule 14a-81) Auer v. Dressel - SH could

recommend that Pres. be reinstated even though recommendation had no binding effect on BOD

(4) LA 12:73B Shareholders meeting(1) Special meeting of SH may be called by

president or BOD and upon written request of any SH holding 1/5=20% (or lesser fixed by AOI or bylaws adopted by SH) of total voting power

4. Information Rights1. Financial Reports2. Inspection of corporate books and records3. LA 12:102 Annual Report

(1) 102B - Corp once in every calendar year upon the written request of any SH of record, deliver to the SH or mail a report of B/S showing stated capital, captal surplus and earned surplus

4. LA 12:103 Corporate Record; rights of SH to inspect(1) 103D - at least 5 days written notice any SH who has

been the holder of record of at least 5 % of the outstanding shares of any class of a corporation for at least 6 months shall have the right to examine, in person or by agent or attorney at any reasonable time, any and all of the records and accounts of the corporation. (1) if corporation objects then go to crt and have

a hearing. Crt usually allows the SH to see those records and SH can hire an agent (CPA) to look at the records.

(2) SH can inspect and make copies. (3) SH can combine votes to get 5%

5. Enforcement of SH rights1. S can enforce their voting powers and info rights in a direct

action against the Corp or directors.

6. What SH can not do?1. can't act on the ordinary business and affairs of the Co.2. can't decide on marketing or production strategies3. can't bind the Co contractually4. can't select and remove officers even for cause5. can't fix employee compensation 6. can't set dividend polices 7. can't compel or overturn BOD decisions unless BOD failed to comply

w/statute or breached fiduciary duty7. Mechanics of SH Meetings

1. Annual and Special Meetings and Notice(1) Usually bylaws specify timing of of annual meeting(2) all corporate statutes require an annual meeting (3) Special meetings must be called by BOD, president, SH who hold

requisite number of shares or whatever authorized in Bylaws or AOI

(4) SH entitled to vote must be given notice of annual and special meetings(1) record date - only SH of record who own

shares as of record date are entitled to notice or vote(5) Contents of notice

(1) time and location of meeting(2) notice of special meetings must specify purpose of the

meeting(6) Timing of notice

(1) must arrive in time for SH to consider the matters which they will vote

(7) Defective notice

(1) SH can waive notice before, at or after meeting

(2) if notice is defective and not waived the meeting is invalid

(8) LA 12:73 Shareholder's meeting(1) 2 types of SH meeting:(2) annual - provided for in bylaws and notice requirement

is relaxed(3) special

1) extraordinary purpose1) amending articles2) removing directors

2) notice: need special detail of time and

2. Quorum(1) for an action to be valid there must be quorum

(usually = majority of shares entitled to vote. ) (2) Once there is a quorum at a meeting most statutes provide that

it can't be broke if a SH faction walks out in middle LA???(3) LA 12:74 Quorum

(1) Why? Designed to create representative group

(2) can amend quorum requirement except that in no event shall a quorum consist of less than 1/4 of total voting power

3. Appearance in Person or by Proxy(1) if by proxy must be in writing and signed(2) LA 12:75 Proxy voting

(1) 75C - SH has right to cast vote in person or proxy

(2) 75C(3) - Proxy is revocable at will

4. Voting at SH's Meetings(1) 1 sh/1vote(2) Beneficial owners can tell record owner how to vote(3) CL - statutes do not permit subsidiary to vote for parent, if

subsidiary holds majority of vote of SH(1) LA12:75 voting of SH and bondholders

(4) Majority vote(1) for most actions an absolute majority of

shares entitle to be voted must be voted in favor of a proposal. Abstentions and no shows count as votes against the proposal (abstentions of shares represented at the meeting count as votes against the proposal, but shares not represented are neutral

(2) MBCA abstentions are neutral(3) LA12:75

5. Action by Consent(1) SH can act w/o a meeting by giving their written

consent. (2) in Delaware - consent need only min. # of SH

(3) LA 12:76 consent(1) 76A need consent in writing of all SH having

voting power on the particular question unless AOI provide otherwise

8. Election of Directors1. Qualifications and Number of Directors

(1) LA 12:81A - not less than 1 director, elected for year unless provide otherwise.

(2) 81C - qualifications may be prescribed by AOI, bylaws or statute2. Voting Methods

(1) straight (2) cumulative

(1) Takes the candidates w/the highest number of votes

(2) 3 directors= ABC. A has 200 shares * 3 = 600. B has 100 shares * 3 = 300. B wants to elect all of his 300 shares to himself so A can't elect B out if A wants to elect himself to office as well. A = 301, B = 300, C = 299

(3) LA 12:75B if corporation wants cumulative voting but must be provided in AOI

(3) Staggered board(4) Class voting

(1) articles can specify that certain classes of stock elect their own directors.

(2) LA 12:29 SH agreements1) any provision regulating the affairs

of a corp or rights and liabilities of SH, not required to be set forth in AOI, may be set forth in an agreement among all of the SH who would be entitled to vote on the provisions if proposed as an amendment.

2) SH can agree or set SH in classes where class A can elect class A directors and class B can elect Class B directors.

(3) LA 12:81D directors - if you want your director position protected - in bylaws can require certain class of shares to elect directors.

(4) LA 12:82F Officers and agents - Articles may provide that only SH or only a particular class of directors may elect certain or all of the officers, in which even officers so elected may be removed without cause only by the SH or directors empowered to elect there successors

(5) Holdovers - director holds office until a successor is elected and qualified.

(6) Enforcement - SH may bring direct action for failure to seat properly elected director candidates. And can sue for notice, quorum and voting rule violations

3. Removal of Directors(1) LA 12:81C - Unless provided in bylaws or AOI

1) office of director vacant if dies or resigns

2) BOD may declare vacant the office of director

1) if interdicted2) bankrupt3) incapacitated by illness4) ceases to have qualifications required by

bylaws(2) 81C(4) SH by vote of majority of total voting power

may remove from office director with or without cause director is entitled to due process (notice of why)(1) CL only can remove w/cause

(3) Removal under cumulative voting(1) prevents the majority from circumventing

minority representation. (4) Filling vacancies.

(1) Who votes when vacancy -BOD?, SH?

3. JUDICIAL PROTECTION OF VOTING RIGHTS (8)1. Generally the courts want to protect the rights of majority to run the

corporation. 2. 3. Rules Against SH Opportunism

1. Vote Buying (1) Can you buy someones vote? It is illegal to outright

buy votes but Can buy votes but have burden of showing business reason for purchase. The transaction also must(1) ensure disclosure(2) not harm SH (3) be free from fraud

(4) Schreiber - Del crt said this arrangement was legal b/c did to disenfranchise SH, there was a business motive.

(2) LA 12:78 Voting trusts - form voting trusts = method of getting control of the company

(3) Irrevocable proxy - most courts allow

2. Payment and Reimbursement of Voting Expenses(1) insurgents who solicit proxy don't get paid back

expenses for the solicitation. However they can get reimbursed if they win.

4. Judicial Review of Management Entrenchment1. Board oversees voting procedures, location, date, calling special

meetings and establishes corporate voting agenda, nominating state candidates and setting size of board. (1) When there is an insrgent from outside, Courts give

directors more deference2. Manipulation of Voting Process

(1) BOD cannot advance annual meeting if it would burden insurgents pending a proxy contest

(2) BOD can't hurt insurgents but do not have to aid them

3. Interference w/Voting Opportunities(1) Suppose BOD concerned a/b a close vote. BOD can

try to issue new shares and sell voter on their side. BOD can't do this to dilute threatening insurgents

(2) Poison Pill (p. 634)(3) Shark repellant - super majority voting 70%. Staggering

voting BOD so insurgent can't get control

4. Deviations from One-Share/One-Vote(1) SEC passed a REG = 1 vote per SH - crt ruled SEC did

not have authority. Then Congress stepped in == if you don't want to be heavily regulated you must voluntarily have 1SH/1Vote

4. FEDERAL REGULATION OF PROXY VOTING (9)1. Federal Proxy Regulation - An Overview

1. Congress tried to create SH democracy by creating proxy voting forcing corporation to give out information.

2. SEC requires disclosure of all relevant info before you can solicit their proxy.

3. SEC says proxy must be in certain form. SH can make proposal at company expense.

2. Reach of SEC Proxy Rules1. Public Corporations - Registered Companies under the

Exchange Act(1) what triggers application of proxy rule

(1) Listed company - securities listed on National stock exchange or

(2) over the counter company w/greater than $10MM assets and at least 500 equity SH.

2. Definition of Proxy Solicitation(1) request of someone's vote

3. Mandatory Disclosure When Proxies Not Solicited(1) pre solicitation communication by nonmanagers does

not trigger proxy rule but once you ask them to sign that proxy card - the proxy rule kicks in.

(2) 3. Formal Requirements of SEC Proxy Rules

1. Mandatory Disclosure in Proxy Statement 2. Form of Proxy Card3. Filing and Distribution of Proxy Statement4. Antifraud Prohibitions5. Exemptions from Proxy Rules

4. Shareholder Initiatives1. SH have the right to vote but have difficulty getting information

and communicating to each other. (1) information flow is managed by SEC by proxy flow(2) There are impediments to SH initiatives

(1) resources to communicate(2) inability to share risks

(3) SEC tries to get over these impediments by implementing Rule 14a-7(1) effort to give SH the recordholder list(2) corporation can assist w/communication but at SH

expense

2. Common Carrier Obligation under Rule 14a-7(1) Don't give SH the list of record holders, instead

corporation puts letter together and the SH just pays for the mailing. Corp rarely gives out record holder list

3. SH proposal under Rule 14a-8 -(1) SH on their own initiative can propose certain proper

proposals(2) SH can propose their own resolutions through company financed

proxy at company's expense(1) allows SH to make proposal

1) SH proposal is SH recommendation or requirement that the company and/or its BOD take action , which SH intends to present at a meeting of company SH.

2) Proposal should state as clearly as possible the course of action SH believes that the company should follow.

(3) 1997 SEC amended proxy rules(1) any SH who has owned 1% or $2000 worth of

a company's shares for at least 1 year 1) must submit proposal in a timely

fashion so the company can decide whether the proposal will be heard (if company says no there will be an SEC hearing)

(2) proposal max 500 words. published at company's expense.

(3) Proper proposal1) proposal inconsistent w/centralized

management 2) must be proper subject under state law

(4) Medical Committee for Human rights v. Cracker Barrell - 3 proposals that interfere w/managements proxy solicitation. (1) proposal can not be against a management

proposal(2) if it is duplicative proposal already shot down - waiting

period(3) proposals that are illegal deceptive or confused

5. PROXY FRAUD (10)

1. Implied Private Action1. A search of proxy rules shows that there are no litigious

remedies for violation of proxy rules. Fed securities law does not explicitly provide for private enforcement of its proxy rules.

2. The Sec. Exchange Act simply prohibits proxy solicitations that do not comply w/SEC rules. SEC rule against proxy fraud prohibits any proxy solicitation containing any statement which is false or misleading w/respect to any material fact. Although 21(d) of the Exchange Act authorizes the SEC to enforce rules in court, there is no explicit authority for a SH to seek relief for proxy fraud

3. Traditional State Remedies

- Each theory of liability has its pitfalls(1) State law of deceit - SH can sue those by showing

(1) fraudulently misrepresentation of material facts

(2) knowledge of falsity(3) which SH rely to their detriment(4) reliance was cause of injury

(2) Corporate fiduciary duties(1) SH can sue directors who breach duty of care

and loyalty through derivative action1) must overcome procedural

requirements as demand on BOD, security of bond for expenses, potential BOD dismissal

4. Borak's Implication of Federal Action(1) Borak - SH has an implied C/A to challenge company

transaction for violation of SEC antifraud proxy solicitation rules(1) implies a remedy for §14(a) could be inferred

under §27 of Exchange Act. The provision gives federal district court exclusive jurisdiction over actions to enforce any liability or duty created under the exchange act

(2) Borak also pointed to §14(a)'s legislative history indicating that congressional purpose to protect investors from proxy abuses inferred that Congress must have intended to supplement SEC enforcement w/private action

(3) STILL GOOD LAW(2) Cort v. Ash - limited the implied C/A theory test:

(1) did congress intend an implied remedy(2) is there an available state remedy

2. Federal Action for Proxy Fraud1. Nature of Action

(1) Proxy fraud action implied by Borak is a federal action so Sh can avoid procedural challenges of a fiduciary challenge under state law such as: the business judgment rule, liability exoneration provisions

(2) Under Borak a private proxy fraud action can be brought either in SH own name (as a class action) or in a derivative suit on behalf of the corporation.

2. Elements of Action(1) misrepresentation or omission regarding

material fact(2) Statements of opinions, motives or reasons

(1) CL did not make actionable statements of opinion, motive or reasons

(2) The opinion must mislead the BOD's true beliefs and must mislead a/b the SM of the statement, as the value of shares in a merger Virginia Bancshares

(3) Materiality(1) TSC Industries v. Northway - an omitted

material fact is one which there is a substantial likelihood that a reasonable SH would consider it important in deciding how to vote

1) the information must significantly alter the total mix of info available .

(2) Texas Gulf Sulfur - exploring for minerals in Canada & there were sinking holes & got back nothing but one day discovered a rich deposit of gold, silver and lead. When company makes investment for benefit of company its OK but when trade stock on insider info that info must be disclosed

(4) Culpability(1) negligence is enough (2) the party need not know the misrepresentation was false

(5) Reliance(1) reliance is not necessary where the info is

material(2) materiality implies reliance

(6) Causation(1) the challenged transaction must have

caused harm to the SH = loss causation (merger price was less than what shares were worth) and

(2) the proxy solicitation must be an essential link to the accomplishment of the transaction = transaction causation (There can be no recovery if the transaction did not depend on the SH vote ie Mills the transaction causation existed since a proxy solicitation of minority SH holding 46% of the company's stock was essential to getting the necessary 2/3 approval for the merger.

(7) Prospective or retrospective relief(1) relief can be prospective or retrospective

(8) Attorneys fees(1) SC endorsed the award of attny fees even

before a final remedy to SH who successfully prosecute proxy fraud b/c SH 's in proxy fraud are producing a benefit for the body of SH's. Mills

3. State Action for Proxy Fraud1. Although no state statutory law defines the info public a SH must

receive == State crts have developed a body of caselaw that prohibits false and misleading statements in any management communication w/public SH - whether in proxy solicitation, tender offers, notice of a SH meeting or notice of merger. (1) Delaware has a complete candor rule.

(1) Lynch v. Vickers - imposes on management a complete candor duty borrowed from anti-fraud materiality standard rules of fed. proxy regs (was the director completely candid when distributed proxy)

(2) Federal rules don't look at fiduciary duty of director, however in a state action you can look at the fiduciary duty.

(3) In Del the SH can use the complete candor rule to successfully challenge mergers, reorganizations and charter amendments

(2) Liability is premised on false or misleading info that a reasonable SH would consider important in deciding whether to vote == challenging SH need not show that the alleged

info would have changed the outcome of the SH vote; it is enough that the challenged disclosure was material

6. FIDUCIARY DUTIES AND INTRODUCTION (11)- Fiduciary duty = duties of care and loyalty owed by those who control the company to the corporation. Directors, officers and controlling shareholders are obligated to act in the corporation's best interest, principally for the benefit of shareholders1. The Corporate Fiduciary - A Unique Relationship

1. Analogy to Partnership(1) in a closely held corporation the directors

are considered partners & thus have a special fiduciary duty among each other

2. Management discretion(1) corporation separates risk-taking of investors and

decision making of specialized managers. (1) While management need discretion to

efficiently carry out their management roles, (2) suggests that there should be judicial abstention ==

what do judges know about corporations. 1) Dodge v. Ford - Ford's decision to

discontinue the $10MM dividend and rather invest in the company to reduce price of cars was faulted by the court as an abuse of discretion and the court ordered the special dividend. The crt said if you want to be charitable you have to do it out of your own pocket. However, the court was faulted for second-guessing the most successful management. Real reason Ford did not want to give the dividend was b/c Dodge was a majority SH and the dividend would give them competitive edge.

2) a company can't accumulate an unwarranted amount of profits w/o having a business reason. IRS can place a penalty tax but tax is easy to avoid if you can show that you are holding the money for business investment

(3) management must also be held accountable. == so where there is management overreaching judicial system will intervene

3. Other constituency statutes(1) some states have recently enacted other constituency

statutes that permit, but do not require, directors to consider non-SH constituents, particularly in the context of a corporate takeover. (1) Some have praised them as signaling a new

era of corporate social responsibility; others have criticized them as a ruse for incumbent entrenchment. Some cases suggest directors can only take other constituents into account if rationally

related to promoting SH interests.(2) Yet others suggest directors have significant latitude to

consider corporate policy beyond immediate SH returns when responding to takeover threats

2. To whom a fiduciary duty is Owed1. Corporate officers, senior executives and majority share holders

have the same fiduciary duty as directors(1) in general persons retained by the corporation do

not have fiduciary duties ie. attorney. However attny can be liable for tortuous aiding and abetting of the majority's breach

2. Directors owe a fiduciary duty to the SH but they do not owe a fiduciary duty to creditors, employees, community. (1) However some cases indicate that when the

corporation is on the brink of insolvency, the BOD's role shifts from the risk-taker in favor of the SH to the asset preserver, risk evader in favor of creditors.

3. Fiduciary Duties of Care, Loyalty and to obey- Duty of Care- Duty of Loyalty- Duty to obey1. Duty of Care

(1) attentiveness and prudence of managers in performing their decision making and supervisory functions. Must exercise informed judgment w/minimum skill and attentiveness

(2) Business judgment rule presumes that directors (and officers) carry out their functions in good faith. Unless this presumption is overcome, courts abstain from second-guessing business decisions that flop.

(3) LA 12:91 Relation of directors and officers to corporation and SH. (1) officers and directors shall be deemed to

stand in a fiduciary relation to the corporation and its SH's, and shall discharge the duties of their respective positions in good faith and with that diligence, care, judgment and skill which ordinarily prudent men (business judgment rule) would exercise under similar circumstances in like positions.

(2) however a director or offficer shall not be held personally liable to the corporation or the SH thereof for monetary damages unless the director or officer acted in a grossly N manner as defined in Subsection B of this Section or engaged in conduct which demonstrates a greater disregard of the duty of care than gross N, including but not limited to intentional tortuous conduct or intentional breach of duty of loyalty.

(4) LA 12:95 Actions for Fraud

(1) Nothing in this chapter shall be construed as in derogation of any rights which any person may by law have against a promoter, subscriber, SH, director or officer, or corporation, b/c of any fraud practiced upon him by any of such persons or the corporation, or in derogation of any right which the corporation may have because of any fraud practiced upon it by any of these persons.

2. Duty of Loyalty(1) Prohibits fiduciary's from putting their own

interests ahead of the corporations. Corporate fiduciaries breach their duty of loyalty when they divert corporate assets, opportunities or information for personal gain(1) flagrant diversion - unauthorized stealing(2) Self-dealing - when fiduciary enters into a transaction

w/the corp. on unfair terms. (Parent company preferring itself at the expense of the minority)

(3) Executive compensation - when director or officer receives compensation that exceeds the fair value of his services

(4) Usurping corporate opportunity - When fiduciary seizes for herself a desirable business opportunity that the corporation likely would have taken and profited from

(5) Trading on inside information - when fiduciary knows of confidential corporate info such as target acquisition and buys target's stock. Texas Gulf Sulfur

(6) Selling out - accepting a bribe to sell company(7) Entrenchment -using corporate governance to protect

fiduciary's governance preventing SH from exercising control rights.

3. Duty to obey(1) AOI(2) Bylaws(3) Fed. law(4) State law

4. Controlling SH1. A shareholder does not owe a fiduciary duty to another SH but

controlling SH does have a fiduciary duty

5. Fiduciary Duty in Modern Public Corp1. Director/Senior Executive

(1) make policy decisions(2) ownership decisions (mergers)(3) oversight of management

(1) stock market punishes the director who doesn't do their duty; and reward by increase in stock value

6. Enforcing Fiduciary Duties1. Fiduciary duties are said to be owed to the corporation and not

to particular shareholders and must be enforced in the name of the corporation. So fiduciary breaches are usually challenged by shareholders in derivative litigation. (1) SH brings suit on behalf o Corp but for the benefit of

the Corp not the SH

7. DUTY OF CARE AND THE BUSINESS JUDGMENT RULE (12)- Judicial review of directors' performance of their decision-making and oversight functions revolves around the duty of care, which in turn is defined as the business judgment rule. - Business Judgment Rule - managers must have discretion so if they take a chance and lose they won't be held liable for the chance they took. Gives officers and directors the right to take a chance.

1. Standards of Care - General but Misleading, Guidance- in performing their functions, directors (and senior execs) are subject to both statutory and common law standards of care1. Standards of Care

(1) Statutory - many statutes codify the standards for directorial behavior(1) discharge duties in good faith(2) in manner reasonably believed to be in the Best

interest of the corporation and(3) informed in performing decision-making and oversight

functions w/the care that a person in like position would reasonably believe appropriate under the circumstances

(2) Common Law standards(1) in good faith(2) in honest belief that the action taken was in the best

interest of the company(3) on an informed basis

2. Facets of Duty of Care(1) Good faith

(1) honest(2) no conflicts of interest and (3) not approve or condone illegal activity.

(2) reasonable belief(1) substance of decision-making should be

related to furthering the corporations interest(3) reasonable care

(1) directors must have at least minimal levels of skill and expertise

(2) informed basis and ordinary care1) in making decisions involving the

procedures of decision-making and oversight. 2) in making decisions when monitoring and

supervising management.

3. Careless Directors Rarely Held Liable(1) Regarding duty of care there have only been a

handful of cases in which directors or officers have been held liable for mere mismanagement uncomplicated by

illegality, fraud or conflict of interest.

2. Business Judgment Rule1. Corporations have a division of interest. SH wants dividends and

increase stock value while directors consider paying dividends a squandering of corp. assets. But if they don't pay dividends stock value decreases. (1) express judicial hands off (except in egregious

carelessness cases)(2) rebuttable presumption that directors in performing their

functions are hones and well meaning2. Operation of Business Judgment Rule

(1) shields directors from personal liability and (2) insulates board decisions from review.

3. Justification for the Business Judgment Presumption(1) encourages risk-taking (2) avoids judicial meddling(3) encourages directors to serve by taking risks w/o fear of being

judged in hindsight(1) some commentators suggest that judiciary

should not intervene and rather the market will punish managers who perform poorly.

4. LA 12:91 Relation of directors and officers to corporation and SH. (Handout)

(1) officers and directors shall be deemed to stand in a fiduciary relation to the corporation and its SH's, and shall discharge the duties of their respective positions in good faith and with that diligence, care, judgment and skill which ordinarily prudent men (business judgment rule) would exercise under similar circumstances in like positions.

(2) however a director or offficer shall not be held personally liable to the corporation or the SH thereof for monetary damages unless the director or officer acted in a grossly N manner as defined in Subsection B of this Section or engaged in conduct which demonstrates a greater disregard of the duty of care than gross N, including but not limited to intentional tortuous conduct or intentional breach of duty of loyalty.

(3) Theriot v. Bourg - corporation owned oil and gas property and sugar cane property. Oil & gas had limited life so directors though they needed to get into new business such as aquaculture (raising fish) - planted fish and was destroyed twice once by a hurricane and once b/c someone let the water out. SH brought suit against directors for N investing in SH assets. BOD defense = business judgment rule. 1) Director not personally liable unless

acted in grossly N manner or intentionally or recklessly.

2) LA 12:91C (handout) - gross N = a director or officer who makes a business judgment in good faith fulfills the duty of diligence, care,

judgment and skill if the director:1) does not have conflict of

interest w/respect to the subject of the business judgment

2) is informed w/respect to the subject of the business judgment to the extent the director or officer reasonably believes to be appropriate under the circumstances

3) rationally believes that the business judgment is in best interests of the corporation and its SH.

5. Reliance Corollary - Delegation of Inquiry and Oversight Functions(1) an offshoot of the Business judgment rule(2) entitles directors to rely on info and advice from other directors,

officers and employees and outsider experts (attny, accountant)but at the same time they can't hide their heads in the sand and claim reliance if they have knowledge or suspicions that make reliance unwarranted. (1) a director who knows management

overstated earnings can't rely on an auditor's opinion that earnings were properly stated.

(2) additionally directors w/greater familiarity of corps business have greater duty to independently verify info.

(3) LA 12:92E Director shall be fully protected in relying in good faith upon.... expert but he must reasonably believe that the expert is competent

(4) a director can be attacked if they act (1) fraudulently (12:95)(2) grossly N or (3) intentional

3. Overcoming Business Judgment Presumption1. When a BOD decision is challenged the challenger has burden of

overcoming business judgment rule by proving2. Common law burden

(1) fraud, illegality or conflict of interest(2) lack of a rational business purpose or (3) gross N

3. Statutory MBC burden(1) acted not in good faith(2) director did not reasonably believe decision was in corp. best

interest(3) decision which director was not adequately informed(4) action resulting from the directors lack of objectivity or

independence(5) sustained failure to be informed(6) receipt of an improper financial benefit

4. KEEP IN MIND Louisiana allows corporations to eliminate personal liability of director if contained in AOI. (1) LA 12:24C(4) - The articles may contain a provision

eliminating or limiting the personal liability of a director of officer to the corporation or its shareholders for monetary damages for breach of fiduciary duty as a director or officer, provided that such provision shall not eliminate or limit liability of director or officer: (1) for breach of director's or officer's duty of

loyalty to corporation or SH(2) acts or omissions not in good faith or which involve

intentional misconduct or a knowing violation of law(3) Liability under 12:92(D) Unlawful distribution or (4) any transaction from which the director or officer derived

an improper personal benefit.

5. Not in Good Faith - Fraud, Illegality, or Conflict of Interest(1) Fraud

(1) director who mislead SH in connection w/SH voting

(2) director knowingly or recklessly misrepresents a material fact on which of which BOD relies to corporations detriment

(2) Conflict of interest(1) director personally interest in corp action b/c

he will receive a personal benefit == depends on fairness standard

(3) Illegality(1) director approves illegal behavior ie. bribes. (2) Miller v. At&T - Director forgave a $1.5MM debt from

Democratic National Committee and SH brought a derivative suit. H: Corp failure to collect the debt could be actionable if the directors had no legitimate business justification aside from illegally currying political favor. An illegal purpose can't be a rational business purpose.

6. Irrational Decisions - Waste(1) presumption of BJR can be overcome if the action of

the directors lacked a rational business purpose. Rational purpose test:(1) director shielded from liability under BJR as

long as judgment was not 1) improvident beyond explanation2) removed from the realm of reason.

(2) Seldom found(3) Good faith action just must be so imprudent

1) ie. Board approves a transaction which the company receives no benefit = issuance of stock w/o consideration or use of corporate funds to discharge personal obligations

2) Litwin v. Allen - historically directors that have been found liable are directors of S&L and

banks. Bank director took a risky investment of call agreement that did not pan out. H: so improvident, so risky so unusual and unnecessary to be contrary to fundamental conceptions of prudent banking practice

7. Gross Negligence(1) LA has adopted Gross N standard(2) Trans Union (Smith v. Van Gorkom) - CEO approved merger for

random number. SH brought suit b/c directors did not inform themselves - they simply relied on the presidents word. H: BOD should not have relied on CEO's word. Crts second guessing boardroom procedures has been harshly criticized.

8. Inattention(1) Courts are reluctant to hold directors liable for not

paying attention to management but are more likely to be held liable for management abuses

(2) Monitoring illegality - directors knowing or suspecting management abuse have a duty to monitor managements illegality

4. Remedies for Breaching the Duty of care1. Personal Liability of Directors

(1) if director voted for the action or failed to object he may be jointly and severally liable for all damage proximately cause to the corp

(2) some crts require the challenger to show the director's action proximately caused damage to the corp.

2. Enjoining Flawed Decision

5. Limitations of Directors Liability1. Charter Options

(1) permit state charters to limit directors personal liability

2. Heightened Standard of Liability(1) directors liable only on showing of gross N ro

recklessnes3. Liability Caps4. Effect of Exculpation Clause

8. DUTY OF LOYALTY - SELF-DEALING TRANSACTIONS (13)1. LA 12:84 Interested directors; quorum

1. When you have an interested director the transaction is not void or voidable if:(1) the material facts of his interest were known to the

BOD and the contract was then approved w/o interested party vote or

(2) the material facts as to his interest were disclosed to SH entitled to vote and the contract was approved in gf by SH or

(3) the contract was fair as to the corporation as of the time it was authorized, approved by Bod, committee or SH.

2. Nature of Self-Dealing1. Direct and Indirect Self-Interest

(1) direct

(1) selling piece of property owned by director to the corporation

(2) loans to and from corporation (3) furnishing services by a nonmanagement director

(corporations outside attny, accountant, investment banker sits on the board)

(2) indirect (1) director gets his close relative to work for the

company but the relative never goes to work(2) transaction w/entity that director has a significant

financial interest(3) transaction btwn companies w/interlocking directors

3. Judicial Suspicion of Self-Dealing Transaction

1. Substantive and Procedural Tests- Human nature tells us that fiduciary will advance his own interest and Group dynamics lead the other directors to identify w/their colleagues

(1) Substantive focus = whether the transactions terms and measure whether the interested director advanced her interests at the expense of the corporation

(2) Procedural focus = focuses on the board's decision making process and measures the independence of disinterested directors.

(1) Fairness plus board validation 1) crt upheld self-dealing if the

transaction was fair on the merits and approved by majority of disinterested directors

(2) substantive fairness1) crts upheld self-dealing if crt

determined the transaction was fair on its merits. Approval by disinterested board was not necessary

(3) disinterested board approval1) crts upheld self dealing if

disinterested directors approved the transaction

(4) shareholder ratification1) crts have upheld self dealing if

disinterested SH approved the transaction

2. Burden of proof(1) challenger must show existence of conflicting interest

and then must show transactions validity by board or SH approval and/or fairness

3. No Business Judgment presumption(1) self-dealing transactions rebut the BJP. However BJP

protects from personal liability disinterested directors who approved the self-dealing transaction in good faith

4. Self-Dealing by Officers and Senior Executives -(1) same standard as directors but may be even more

harsh b/c are expected to devote themselves primarily if not exclusively to the corporation.

4. Remedies for Self-Dealing1. General Remedy - Rescission2. Exceptions to Rescission

(1) Corporation may be entitled to damages if rescission remedy won't work b/c (1) 3rd party will not rescind then hold the

directors personally liable. (2) property sold

(2) if was a corporate opportunity forgone by corp - director my have to account for profits made in the deal

9. EXECUTIVE COMPENSATION (14)1. Forms of Executive Compensation

1. salaries and bonuses(1) any salary over $1MM is not tax deductible

2. Stock plans(1) stock grant(2) stock option(3) phantom stock plans and stock appreciation rights = stock

option w/o the option just and accounting entry(4) pension plans(5) perks, fringe benefits, (car, expenses, accts, homes, corp apts)

2. Judicial Review1. Dilemma of Executive Compensation

(1) what doe a judge know a/b what an executive is worth.

2. Compensation Must Be Authorized(1) by board

3. Disinterested Approval Avoids Fairness Review(1) informed, disinterested group almost totally isolates

the compensation from judicial review4. Prevailing Standard - Waste

(1) If executive compensation is approved by disinterested directors, the court invokes presumptions of the business judgement. The challenger must show either that the board was grossly uninformed or that the compensation was a waste of corporate assets - no relation to the value of the services given.

5. Fair and Reasonable Compensation (more relevant to closely held corp)(1) when compensation is not approves so as to avoid

fairness review, judicial scrutiny is substantial(1) relation of compensation to qualifications,

ability, responsibility, and time(2) complexity revenues earnings profits and prospects(3) likelihood incentive compensation would fulfill its

objectives(4) comparable to peer companies

3. Directors Compensation1. Fees2. Paid up to $100K per year 3. Compensation for outside services (attny that sits on board)

(1) treated as self-dealing transactions subject to fairness review

4. Market Pressure1. If you pay too much people will sell stock2. Congress revised tax laws to disallow corporate deductions for executive

compensation to COE and 4 highest paid executives in excess of $1MM. (1) an exception is made for performance goals (SEC IRC

§162M)(1) determined by compensation committee of

outside directors and(2) approved by SH after disclosure of material terms and(3) certified by the compensation committee

3. SEC Reg SK = SEC greatly expanded amount of info. exec must give regarding executive compensation

10. INDEMNIFICATION AND INSURANCE (15)1. The law gives directors protection

1. Business judgment rule 2. Liability exculpation - put in articles of incorporation director not liable

for fiduciary duty3. Indemnification - if director sued he can be indemnified by corp

2. LA 12:83 Indemnification of officers, directors, employees, and agents; insurance

Permissive. A(1) A corporation may indemnify officer, director, employee...

1. if he acted in good faith and in a manner he reasonably believed to be in the best interest of the company.

2. A(2) no indemnification if liable for willful or intentional misconduct in the performance of his duty unless the court determines despite the adjudication but in view of all the circumstances that he is fairly and reasonably entitled to indemnity for such expenses

3. A(3) termination of any suit by judgment , order, settlement shall not itself create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the BI of the corporation

4. D. Expenses incurred in defending such action may be paid by the corporation in advance of final disposition

Mandatory B5. to the extent that a director, officer, employee or agent of a

corporation has been successful on the merits or otherwise in defense of any such action, suit or proceeding, or in defense of any claim, issue or matter therein, he shall be indemnified against expenses (including attny fees) actually and reasonably incurred by him in connection therewith

3. Indemnification1. corporation either promises by contract or by law or statutory

mandate in which director attny fees and damages is paid for by corp(1) open-ended indemnification - undermines the

directors responsibility

2. sources of indemnification

(1) contract (insurance)(2) bylaw(3) statutory (look at what is mandatory and what is permissive(4) AOI

3. Mandatory indemnification(1) mandatory = successful defense upon the merts or

otherwise.(2) or otherwise = mandatory in the event of procedural success

(1) ie. Statute of limitations, lack of standing(3) A director is not deemed successful if the

claim is settled out of court(4) Indemnification to the extent successful

(1) some statues allow indemnification for parts of a suit that successfully vindicated

(2) Waltuch v. ContiCommodity Services (Delaware) - company paid to settle lawsuit when director was charged w/conspiracy to corner the silver mrkt

4. Permissive indemnification(1) Third party action -

(1) a director must be deserving to be entitled to indemnification in an action brought by a third party ie. when EPA sues for illegal dumping or investors claim securities fraud

(2) indemnification criteria1) director acted in good faith2) reasonably believed her actions were in the

corporations best interests3) had no reasonable cause to believe that her

actions were unlawful(3) coverage

1) may be indemnified for reasonable litigation expense and any personal liability arising from a court judgment, an out-of-court settlement or the imposition of fines or penalties

(4) Procedures1) statutes specify who may determine

whether the director meets criteria for permissive indemnification1) SH2) Committee3) independent legal counsel4) court

(5) Actions by or on behalf of the corporation1) most statutes do not allow the

corporation to indemnify a director “adjudged liable” to the corporation if the action is brought by the corporation itself or by SH in a derivative action on behalf of the corp.

1) allowing indemnification would create a culpable director would pay the corporation in one had and the corporation would reimburse the director w/the other

2) Nonetheless, the corporation can indemnify a director who settles a suit by or on behalf of the corporation for her litigation expenses if she meets the criteria for permissive indemnification

(6) Court ordered indemnification1) some statues allow a court to order

indemnification

5. Advancement of Litigation Expenses(1) Some corporation allow advancement of litigation

expenses

6. Exclusivity of Statutory indemnification(1) Indemnification pursuant to the AOI, bylaws or an

agreement is permitted only to the extent consistent w/the statute

7. Indemnification of non-drivers(1) In general the corp may indemnify nondirector

officers, employees, and agents to the same extent as directors. Indemnification of officers is mandatory to same extent as directors

4. Insurance- Corporate statues permit companies to buy insurance for itself to fund it own indemnification for directors

1. Insurance Covering Corporation's Obligations(1) company self insures or purchases insurance from an

outside company

2. Insurance Covering Liability of Directors and Officers(1) D&O insurance - corporation pays premium and

insurance company defends. Policies typically exclude:(1) improper personal benefits(2) actions in bad faith(3) illegal compensation (4) libel or slander(5) knowing violations of law and(6) other willful misconduct(7) many policies also exclude coverage for fines and

penalties regardless of executive intentions.

11. CORPORATE OPPORTUNITIES AND UNFAIR COMPETITION (16)1. Unfair competition - same idea w/agency law. Agency can't see an idea

and put it his pocket if he is working to advance the company's principle interest. 1. Outside opportunities offer managers a means to diversify their

own human investment, a flat prohibition against outside business

activity might well lead many managers to shun the corporate form

2. Corporate Opportunity Doctrine (COD)1. COD = subset of the duty of loyalty = balances the corporation

expansion potential and managers entrepreneurial interest = JUDGE MADE CONCEPT not statutory

2. Prohibition against Usurping Corporate Opportunities (1) a corp manager (director/executive) cannot usurp

corp opportunities for his own benefit unless the corp. consents (uninterested directors vote)

3. Remedies for Usurping a Corporate Opportunity (1) Liability for profits(2) liability for lost profits and damages to corporation(3) constructive trust on the new business

3. Definition of Corporate Opportunity1. What is a corporate opportunity? Underlying the definitions are 2

conflicting premises(1) corporate expansion

(1) the corporation expects managers to devote themselves to expanding the corporations business = maximize profitability

(2) manager entrepeneurialism(1) managers expect to have freedom to pursue

outside business interests.

2. Use of Diverted Corporate Assets(1) A fiduciary cannot develop a business opportunity by

using assets secretly diverted from the corp. (1) using company's hard assets - cash, property(2) the evil is not the opportunity for himself but rather that

he took something that belonged to the corporation to do it

3. Existing Corporate Interest - Expectancy Test(1) to measure the corporation's expansion potential. If

the corporation has an existing expectancy in a bus. opportunity , the manager must seek corporate consent before taking the opportunity.

(2) Expectancy need not rise to the level of an ownership interest (taking self advantage of merger opportunity) but rather can exist when manager misappropriates soft assets(1) uses secret processes of corp, good will,

customer lists, secret manufacturing process for his own business (applies to corporate confidentiality and trade secrets

4. Corporation's Existing Business - Line of Business Test(1) Measures the reach of the corporations expansion

potential(2) compare the new business w/corps existing operations

(1) if the new business is functionally related to the corporations existing or anticipated business may

= liability(2) functional relation exists if there is a competitive or

synergistic overlap that suggests that the corporation would have been interest in taking the opportunity itself

5. Eclectic Approaches(1) director becomes aware of in his corp capacity(2) director knows the outside party is offering to the corp(3) senior exec becomes aware through use of corp info(4) senior exec knows it is closely related to corp business

(1) executives = lineof business or expectancy (2) directors = expectancy

4. Corporate Consent and incapacity1. Voluntary Consent

(1) if you have disinterested board that consents better off(1) Burg v. Horn - managers of closely held R/E

business got tacit consent from co-SH to acquire other properties for themselves. H: OK b/c coSH knew from start that managers owned other R/E

2. Corporate Incapacity(1) Crt doesn't take kindly that corp. did not have money

b/c corp could always have borrowed the $(2) ALI principles

(1) mandates informed corporate rejection for the manager to take an opportunity free and clear1) manager must have offered it to the

corporation and disclosed his conflicting interest and

2) BOD or SH must have rejected it(2) offer/rejection safe-harbor is the only harbor

5. Competition w/the Corporation1. A manager who sets up competing business may be liable in

damages (manger need not share the competing business unless setting up the business usurped a corporate opportunity)

2. Other theories of liability(1) breach of contractual covenant not to compete(2) misappropriations of trade secrets(3) tortuous interference w/contractual relation

12. DUTIES OF CONTROLLING SHAREHOLDERS (17)1. Who Are Controlling Shareholders?

1. Controlling SH have a duty to minority SH2. What/WHo are controlling SH?

(1) 20% of public company(2) SEC says 10% of public company

2. Parent Subsidiary Dealings1. look at who serves on what BOD. Is parent BOD the same as

subsidiary. 2. Dealings w/Wholly Owned Subsidiaries

(1) parent can do whatever it wants3. Dealings w/partially Owned Subsidiaries

(1) problems/risk of abuse(1) dividends

1) sub declares dividend to a cash strapped parent at expense of internal expansion

2) sub adopts nodiv policy to force minority SH to sell to parent

(2) shared transactions1) sub issues shares to parent at less

than fair thus diluting the minorities shares(3) parent/subsidiary transaction

1) sub enters into contract w/P on terms unfavorable to S

(4) usurping opportunities1) P take bus opps from S

(2) Ordinary Business dealings(1) most crts view w/sympathy the argument

that a parent corp should be able to exercise control position

(2) Parent though is subject to a fairness review, if minority shows the parent has preferred itself at their expense

(3) Sinclair v. Levien - parent owned 97% of Sinven. P imposed on Sinven had high dividend policy. Minority can't complain b/c they got share of dividend policy like everyone else. 1) minority also claimed that Sinven's

nonenforcement of contract for sale of oil products to other Sinclair affiliates preferred the affiliates to Sinven's detriment. P had failed to show that nonenforcement was fair to subsidiary. Must show clear preferential discrimination act against subsidiary in favor of parent

(4) Jones v. Ahmanson - controlling SH can't use their control to their own benefit and not minority

(5) Zahn v. Transamerica - (6) Speed v. Transamerica -

3. Squeeze-Out Transactions - Eliminating Minority Interests1. Squeeze-Out Mechanics

(1) form another corporation and merge parent into X and only allow shares of subsidiary to be merged into X and X pays cash to the minority. Paying minority in cash doesn't allow them to participate in the merger

(2) Liquidation (3) Stock-Split

2. Business Purpose Test 3. Entire Fairness Test

4. Remedy in Squeeze Outs(1) La:131 Rights of SH dissenting from certain corporate

action (1) pay off a fair price = appraisal rights

(2) Del appraisal is exclusive remedy in squeeze out unless can show fraud

13. SHAREHOLDER LITIGATION (18)1. Nature of Derivative Litigation

1. Two Suits in One(1) individual sues a director (agent for the corporation)

on behalf of the corporation

2. All Recovery goes to the Corporation3. A successful gets all expenses and attny fees reimbursed4. 5. Derivative Suit Plaintiff is a Self Appointed Representative

(1) the /SH (w/her attn) chooses herself as a representative for the corporation.

2. Distinguishing between Derivative, Direct, and Class Action Suits1. Direct Suits

(1) SH sues in her personal capacity to enforce her rights as a SH

(2) Direct suits vindicate SH financial, liquidity and voting rights. Derivative suits enforce fiduciary duties of directors, officers, or controlling SH == duties owed to the corporation

(3) When a claim has both attributes the SH's pleading choice governs

(4) Examples of direct action.(1) enjoin ultra vires actions(2) compel payment of dividends declared but not distributed(3) to challenge fraud(4) challenge corporate restrictions on share transferability (5) to require the holding of a SH's meeting(6) compel inspection of SH lists or corporate books and

records(7) challenge the denial or dilution of SH lists or corporate

books and records(8) challenge the denial or dilution of voting rights such as

when substantially all the corporations assets are sold w/o SH approval

(9) compel dissolution of the corporation2. Claims w/Direct and Derivative Attributes3. Class Action - Direct Suits Brought by Representative

3. Procedural Restrictions on Derivative Litigation1. Distorted Incentives in Derivative Litigation2. Litigation Procedural Requirements3. Demand Requirement - Exhaustion of Internal Remedies4. Court Approval of Settlement - A Clean Solution

4. Derivative Litigation in Federal Courts1. Diversity Jurisdiction2. Federal Actions

5. Dismissal of Derivative Litigation - Finding a Corporate Voice1. Self Appointed Derivative Suit Plaintiff2. Unwieldy Body of Shareholders3. Board of Directors - Voice of Centralized Corporate Governance4. Special Litigation Committee

Notes from Class

10 million and 500 shareholders to be subject to proxy rulesSolicitation - can be subtle or can advertise in WSJ. SC said there is corp. freedom of speech and corp. law says can't solicit proxy votes. Request not to sign is a proxy. Proxy means power of attorney. Even when proxies are not solicited there are certain disclosures; Rule 14C-who is soliciting?- proxy card must be approved as to form-distribution of proxy statementAntifraudShareholder initiatives - 2 ways to view-you can get from company the names and address of shareholders. Common carrier rule. If you pay expenses, the company will send information out for you. 500 word rule. 1 - can't make management proposal, ie.who to do business with, can't ask company to elect someone, etc. Shareholders wanted DOW to quit manufacturing napalm. Shareholders trying to push certain agendas.

If you propose something and you lose, you can't come back and propose it again.Can' t proxy personal grievances. In summary the 500 word rule requires a shareholder to request feedback on something that is not a crackpot request. It is rare that a proxy will produce a change in management.

Proxy fraud - suppose you a shareholder and you get a fraudulent proxy statement. There is an implied rt of action to enforce the proxy rule and cts are free to fashion whatever remedy they see fit. (implied remedy).Nature of private rt of action - implied action- must be a misrepresentation or omission of facts.- has to be material- has to culpability (scienter)- shareholder has to rely, cts refer to materiality and if material, then the relied-causationWe have statutory provisions that provide for attorney's fees.

See Handout Question VI - Not on exam. Example of increase in value of property. Had a -$10k earned surplus (loss). Can you pay dividends out of Revaluated Surplus? First must restate par value to get rid of the loss then pay out of capital.

Corporate fiduciary duties - directors must be obedient, read art of inc. They are bound by that. Requires attorneys to inform the directors of what they must obey, contracts.They have a fiduciary duty, duty of loyaltyDuty of care12:26 -does not apply

12:92 (add)Protective devices for directors.

Provisions you can put in art. of inc. 12:83 12:24Breach of loyalty can not be eliminated for acts of omission not made in good faith (included above)

Defenses for actions against officers and directors1. Article exculpatory provision (corporate records defense) can say clause eliminates liability for gross negligence.

2. 12:92(e) records expert defense3. Business judgment rule4. Proximate cause -5. 12:94 - voted against6. 12:95 - fraud7. 12:96 - actions against officers and directorsOfficers have mostly been liable for negligence in bank cases

Breaches of duty of loyalty-self dealing

Nature of Self DealingAny of 3 ORThird is substantive fairness test. Basic fairness - you can go to trial on that.

Insider tradingEntrenchmentSelling out

Fidicuiary duty is violation of three - enterprise violation- ownership decisions-oversight - have a duty as director to watch over.Chicago school of thought is that market will get rid of directors.Fiduciary duties is closely held corp is analogous to fiduciary duty of partners

Duty of care-gross negligence- must be in good faith-failure to become informedMinimal care - not reasonableCareless directors are seldom held liable.

Business judgment rule basically is a hands off attitude. Defers to decisions of director. -BJR encourages risk taking. -It also avoids judicial medalling. -encourages directors to serve. Why take a chance if they will be punished for using their judgment.

How do you win a case against directors when plead BJR-fraud-lack of rational basis- gross negligence if don't have exculpatory clause in articles-self dealings - breach generally only if self dealing.

Lack of good faith shown by:-violation of the law.-conflict of interest-outright fraud -waste doctrine - long shot, waste is generally not found.

Transunion case Smith v. Van Garner - (in notes)

Duties of Directors and Officers1- Care2- Obedience

3- Loyaltya) Self-Dealingsb) Corp oppC) Fidiciary Duties of controlling s/hd) executive compensatione) selling outf) indemnificationG. Trading on inside info (10b5 and 16b)

Executive compensation2 kinds of pension plans-defined contribution plan -put part of salary away i.e., 10%. At retirement, you get what money accumulates to plus interest.-defined benefit plan - get actuary to look at each person and when hit retirement you get a certain amount.Stock optionsPerksDilemma is that people who are getting the money are the ones that make the decisions

Indemnification - want to attract top quality people to the company.

Certain things that a director would rely on as a defense = indemnification for cost and any thing relied on as a directorInsuranceBJRProvisions in art of inc.Proximate causationOur statute provides for expert advice and records defenseIndemnification by contract, by aoi, bylaws, statute 12:83, insurance (a separate insurance company will indemnify you) Best is ins. Co.Mandatory indemnity - director sues and winsPermissive indemnity - public policy. You can't indemnify people for violent crimes, bribery, criminal violation of securities laws, etc. It does not mean that you can indemnify of a crime that does not involve a willful and malicious intent.D&O insurance (see insurance in outline.) Exclusions1 - improper personal benefits2- actions in bad faith3- illegal compensation4 - slander5- knowing violation of laws

83(e)Contractual indemnity and bylaws say allowed to get into indemnity and statute and want broadest type of indemnity to statute, most by law. Want insurance contract.

Corporate opportunities (see outline)

Corporate expectancy test: what was offered and could be offered and director takes it, director is guilty of violating his fiduciary duty (see outline)Line of business test - Eclectic - 1) they become aware of offer by their office. 2) director should know offering to corp not to him. 3) if sr executive knows (ALI)Corporate incapacity -

Duties of controlling shareholders - The controlling shareholders owe a fiduciary duty to minority shareholders. Parent -sub situation - parent is controlling shareholder. (Sinclair v. Levene)Exclude minority is stock transactions (admission case - admission was a savings and loan, not publicly traded. Key is there was a preference given majority, as result minorities were able to sell at a preferential rate to sub.Zahn case - tabacco co had two classes of stock, A and B. Transamerica owned B stock. War was declared and tobacco went up. Controlling shares went up and so they sold, if directors would not have been owners of class A stock that they called, they would not have benefited from the increased value of the stock. Made Transamerica pay off B class shareholders.

There are ways to squeeze the minority out.1 - cash out merger.2 - liquidate and put assets in hands of major and they go on with another co.3 - stock splitAll 3 are subject to judicial scrutinyFirst apply the business purpose test. Then entire fairness test, was there a fair dealing or fair notice. If not use appraisal method. LA RS 12:31.

Right to dissent

Share transferability - every share of stock is a negotiable instrument - person who buys gets it free and clear of all defenses.

Rt of first refusal, buy/sell agreement, on face of stock (NI) interim steps of limitations. Can't be unreasonable like only members of family can buy the stock. It must be on certificate itself. When a restriction has to be on face of document.

If x sues A for a tort committed outside the course of employment, a partner in GP, x is a secondary creditor of the GP

If creditor of partner is suing a partner is suing the partner,

If matter ends up in fed bankruptcy court, partnership can be put in liquidation; partner can be put in liquidation, etc.In LA, we have a RLLP. Limit tort liability of all of the other liabilities limited to tort. All liabilities for contract debts, 2nd phase, completely exonerate each partner for contracts and torts.

LP means the old the other part or a GP, at least on GP. LLP - law firm, one gets sued for malpractice. Other partners are not liable for malpractice of tortfeaser. There are cases where supreme courts say we don't pay attention to LP, everyone pays, ptnrship pays.

Partnership problem Test -No indication of filing, looks like GP, intention to form an entity, sharing profits, sharing losses, one putting time, one put up money, community of goods. Partership, 3rd party creditor can hold him liable for 50% of debt. Draw contract, could have ptnrship contract, GP can incorp, everyone is limited, LLC, buy/sell agreement. Might assume it was recorded. No one simple answer.Equal dignity rule, ultimate contract and poa must be in writing. To file, you have to file, must file act and poa. For it to be effective, must file.(sale of ptnrship assets).

Concept of shelving stock - conglomerate that for example sells auto glass, they expanded by going into cities and buying locals in the business. File with sec, in reg. statement, make full

declaration, s-1 and tell sec you want to reg. stock and put a certain amount on the shelf. When you want to sell stock on the shelf, you just need to update with the SEC. Regulation D - response to sec to complaint that small bus can't afford to pay for registration. Have exemptions; sell to credited investors, and those that can fen for themselves. If you can't make an exemption, you are forced to pay the costs. Shelving will not be on exam.

Every question is an invitation for you to be creative and imaginative. Can contribute services for interest in ptnrship, can't do it for corporation.

At dissolution, in LA, 9000 would go to who put capital up because you get your capital back first. In common law it is different. If LLC, look to what is in contract and default rules apply. Could say that Harris would lend Jay the money, then lets take a mortgage on the cattle.

LLC v. S Corp Both flow thru entitiesLLC easier to meet in terms of membership. S Corp, one class of stock (simple small business) same dividends, exception, can have different voting rights, class A, B, C, can't have preferred and common, can't have non resident aliens. LLC does not have all of those rules. LLC is preferred by Lawyers, probably because lawyers are comfortable. In an S Corp, you can't sell your stock (?)

3. One element ratification, apparent authority, punitive agent, implied authority, detrimental reliance, estoppel, emergency power,

Exam, some essay, some identification questions, maybe some objective.

Dividends - Insolvency - inability to pay debts as they become due, or accrue. So if you have $10m real estate and $5m mortgage and taxes come due and don't have money so you want to mortgage to property, you are insolvent.Second, balance sheet insolvency, assets are less then liabilities, With regard to dividends, can't pay dividend if you are insolvent. You can pay dividends out of surplus, all kinds. Second fund is if you don't have any surplus, you can still pay dividend if you have made a profit in last fiscal year or this one as long as you are not insolvent after payment.

4/23/02 10b5

Buy/sell agreementsIn close corporation - have stock certificates, but don't want transferablity. One way to limit is to put a rt of first refusal, before any shares are sold to strangers they must first be offered to shareholders. Redemption or cross purchases (other shareholder buy shares v. Corp.)

What goes in a stock purchase agreement?1 - Need a triggering event like death, incapacity, lost license, etc.2- procedures3- set a price (appraiser should consider good will, instruction given to appraiser or use a formula like one years billings)4 - how do you pay

No limit on transferability is effective unless it appears on the certificate. If not on front should have see reverse for transferabilty "these shares may not be sold, transfered, etc, except in accordance of buy sell agreement." put option language. Otherwise have to prove that other party had actual knowledge.

Generally all share transferability is subject to fed sec. Laws.

Intrastate telephone, droping note in mail creates fed. Nexus such that have to follow 10b5. It applies to all for fraud and misrepresentation.

Remember that since stock is a neg. Instrument, it cannot be prohibited from transferrability. What is allowed is an intermediate step, buy/sell, rt of first remittance, etc.

33 Act deals with primary market. You have trading in securitiesPrimary market - issuer to publiceSecondary market - sales from shareholder to shareholder, governed by 34 act.34 ActProxy10b516bReporting - listed companies and co.s with $10m and 500 shareholdersExchanges regulated by this actStock brokers are regulated by this actOTCNASDAQSelling stock from inventory of broker firmEtrade

Controlling interest - controlling shares are worth more than regular share. When a group of controlling shareholders want to sell their shares, they can sell at a premium. Exceptions1- controllers have a fidicuary duty to the minority shareholders not to sell to looters.2- cannot recast the transaction - say someone comes to the board and wants to buy all the shares and bd says don't buy all, just buy ours3- premeium is so high they are sell something that is a secret. Some hidden value in an asset that belongs to the corp.

Perman v. Felman - felman was controlling shareholder of newport steal. Newport was a specialty mfg of steal. A group of 10 buyers of these specialty seals and bought pearlman shares for twice as much. Customers held price down during the war and they kept the profit. Ct said that because there was a sale, Perman had to devide his profits among the shareholders. They were going to loot. Sale of corp officers. When clean sale okay, but if opportunity to make money belongs to corp, can't.

Disclosure in sec. Markets.1- Have to look at the state law 103b2-state law came up short so fed disclosure rules apply3- fed disclosure requires periodic disclosreA-quarterly report, special repert, and annuallyB-registered co must keep records with sec and fraud rulesC- proxyD- tender offerE- directors' offerec and major shareholder must report all sales of their stock (rule 16(b))

Reporting today is under EDGAR - electronic data gathering and retrieval

Record keeping - Foreign Corrupt Practices act. - prohibit bribing officials of foreign governments. Routine small pmts are not a voilation

Exam 3 hours

SA questions:Some short answer questions

10b5 is always considered with other remedies, common law fraud,

(see chart) Insider trading summary

16b and 10b5 are efforts to put more teeth in common law16b - there must be a purcharse or sale of an equity security. Must copr be required to reg with sec. No,,,,,, 16b is only a registered co. Potential plaintifss is the target of the fraud. In 10b5 potential plaintiffs are the SEC. All other ps will ride on coat tail. A purchaser or a seller. Individual shareholders bring action, private attorneys, the attorneys get attorneys fees. Potential defendants - in common law fraud the purchaser or the seller. Under 10b5 there is a list, corp, o, d, controlling shareholders, tippers, and tippee (grandma).

Tippees Elements of actionScienter - state of mind that you know you are doing wrong.

PrivityRemedies

History of rule 10b5- Rule made by sec. It is a criminal statute. However there is a private rt of action. Cardon. S Corps have right to action under 10b5.

When have action - read statuteMust identify sale or purchse of sec.Identify deception or fraudCheck some jurisdictional nexusOther elements:In damage suit p must be the purchaser or the seller, burnbalm rule burnbalm v. Newport steal. In pearlman, minority shareholders did not get profit whenfelmen sold corps future profits. Ps filed suit because they believed taht D did not disclose. P could not sue because they were not a buyer or seller.

Central bank of Denver caseKnow 10b5 and 16bDuty and duty of disclosureSilence is duty of action when asked to speak.MaterailityCorp mismanagment is not 10b5ScienterReliane is assumed is materiality is proven.Defenses to 10b5 is statute of limitations. 1 year after the discovery or 3 years after the violationsRemeber state blue sky lay that you can look to.

10b5 insider tradingPresDirectorsControlling shareholders punative insidersAttorneysAccountantsHow can they use it.

Worry about the integrety of the stockmarket.

Theories of insider trading -FairnessIntegrity of marketBusiness property idea - misappropriation theory( if know corp will make a profit, the entire corp has a rt to know)

Texas Gulf Sulphur.

10b5 Comparison to State Law RemediesIn fed system there is no bond for cost. In state, loser pays so if you want to sue you have to put up a bondSee page 390 -

See outlinePrivate securities (PSLRA) made it difficult to bring class action. Relaiance and causation must be provied, what if in ommision case,Can you prove that you relied on what they did not tell you. See page 384 - read section

Disclose to market. Look at the industy - can find out what the chanels are to funnel information.

Chestman (390)

To deal with deadlocks you can impose a buy sell agreement

PUBLICLarge # of shareholdersSH don’t participateLarge market for the stockCLOSELY HELDSmall # of shareholdersSH more ActiveNo market for the stock

POOL (Voting under a SH agreement)A and B will consult on how to vote for the directorsIF A and B can’t agree they appoint a arbitrator – the arbitrator does not have proxy unless given it specifically in writing.LA a pool can only be good for 3 years

VOTING TRUSTSA and B can put stock in trustees nameA and B surernder stock to corp and new shares are issued to trusteesLA 15 years can be renewed for an additional 5 years

MULTIPLE CLASSES OF SHARES8181D - the AOI may provide that a particular class or series of shares or securities may elect directors82 F – Allows for classes of shares

BUY SELL AGREEMENTThis is the best control factor

Put transfer restriction on the face of the stock certificate ON EXAM

VOTING TRUSTSReal trust – No 15 year limitVoting Trusts – 15 year limit – trustee only has the right to vote and the other rights flow through to the beneficiary.

Transfer restrictions must be reasonableReasonable limitations-Right of first refusal-Buy/Sell Agreement

The challenge is to figure out the purchase priceYou must fall back on a formula – How do you set up one today that is good for years from now

Restriction on directors discretion

Creating classes of shares you will have deadlock – how do you dissolve these disputes?- Dissolution

1. Voluntary (Winding up or have the courts monitor the dissolution)2. InVoluntary – Everyone is not on board to dissolve

143 – The court may entertain a proceeding for involuntary dissolution under its supervision when it is insolvent under certain conditions listed in the statute.

- Creditors brings the suit to dissolve (Fed Bankruptcy Court) (State)Involuntary Usually because of 1. Misconduct2. BoD Deadlock3. SH Deadlock

IF no Buy Sell and no agreementInvoluntary DissolutionFiduciary challenge

You must plan for deadlocks

To deal with deadlocks short of dissolutionMEDIATIONTIE BRAKING SHARE (sometimes appointed by the court)

PartnershipCessation of membership1. Term – good cause2. Indef – notice3. Statutory buy out for mkt value4. Partnership agreement5. Death – heirs paid off6. Interdiction – pay off

LLC1305 – no term

1329 – assignment(all transfer = assignment = no vote)1333 Death = assignmentCreditor = Buy Out or Dissolution1332 – assignee becoming a member1325 – If LLC is for a term the member can only withdraw if he shows just cause arising out of another member to perform his obligation.