Fried Corps Outline

8/3/2019 Fried Corps Outline

1/93

.Agency and Partnershipa. The Law of Enterprise Organizationb. Acting through Others: The Law of Agencyc. The Problem of Joint Ownership: The Law of Partnership

I. The Corporate Forma. The Corporate Formb. Debt, Equity, and Economic Valuec. The Protection of Creditors

II.Normal Governancea. Normal Governance: The Voting Systemi. Class Voting

ii. Shareholder Proposalsb. Normal Governance: The Duty of Carec. Conflict Transactions: The Duty of Loyalty

i. Effect of approval by a disinterested partyd. Executive Compensatione. Shareholder Lawsuits

i. Demand Refused/Excused Summaryii. Special Litigation Committees

V.Extraordinary Governancea. Transactions in Control

i. Tender Offersb. Fundamental Transactions: Mergers and Acquisitions

i. Statutory mergersii. Asset acquisition

iii. Compulsory Share Exchangeiv. Triangular Mergersv. Summary of Voting & Appraisal Rights

vi. Appraisal Decision Treevii. Duty of Loyalty in Controlled Mergers

c. Public Contests for Corporate Controli. Unocal

ii. Poison Pilliii. Revlon

V. Federal Regulation of Trading in the Corporations Securitiesi. Trading in the Corporations Securities

ii. fRule 16iii. 10b5 elements

.Agency and PartnershipThe Law of Enterprise Organization

a. The Law of Enterprise Organizationi. Three Basic Goals of Corporate Law

1. Facilitating relationships among the owners of the corporation (shareholders)2. Facilitating the relationship between shareholders and the managers of the corporation3. Facilitating contracting between shareholders and other stakeholders in the business (creditor

a. To a much lesser extent than the other goalsii. Tools

1. Transaction Cost Economicsa. Coase, Williamsonb. when there are costs to transacting, owners of various resources will contract in order to

reduce costs and share efficiency gains


2/93

c. firm as a "nexus of contracts"d. particularly useful for how corporate law is doing with goals 1 & 3

2. Agency Cost Theorya. Jensen & Mecklingb. managers (agents) may make uneconomic decisions for the firm that are in personal inter

of managers but hurt shareholders (principals)c. generally about goal 2 (rltnshp btw owners & managers)d. also implicated in goals 1 & 3

i. situations of dominant/controlling shareholder that has power normally held by managused to make decisions not in best interest of firm and/or other shareholders

ii. goal 3: worried about shareholders who control firm indirectly through board makingdecisions w/creditors $$ that are only good for indirectly controlling shareholders

e. Three kinds of agency costsi. Monitoring

ii. Bonding - costs agents incur in limiting ability to hurt principal/ensure reliability & loyato principal

1. example: restrictions on stock trading by executivesiii. Residual

1. most serious costsiii. The Objective of Corporate Law: Increase welfare through economically efficient arrangements

1. Types of Efficiencya. Pareto efficiency - where no one can be made better off without making someone worse o

i. severely limits the possibility of welfare-improving tradesii. assumes that the original distribution of assets is legitimate

b. Kaldor-Hicks efficiency - transaction/move produces total gains sufficient to compensate athose who suffered any loss (net gains bigger than net losses)i. doesn't rely on losers actually being compensated

ii. still assumes initial wealth distribution is legitiii. more workable than Pareto, generally accepted among corporate law scholars as the

proper definition of "efficiency"c. all moves that are pareto efficient are Kaldor-Hicks efficient, but NOT vice versa

i. pareto is tiny subset of Kaldor Hicks2. Puzzle: courts rarely use language of efficiency to justify decisions

a. but when they talk about "fairness"/moral reasoning in opinions, do so in terms of "fairneto shareholders, which often means the efficient course bc of fiduciary duty

3. Jonas hypotheticala. Costs of apt & hotel

i. if it costs a firm $70,000 to rent apt (preferred by Jonas), $19,300 for hotel, cost to firm oapt is $50,700

ii. when Jonas is full owner, these costs are the same for him as to the firmiii. when Jonas is 10% owner, cost to him of apt is $7000, cost of hotel is $1930, so cost to h

is $5070b. What will he do with given benefit to him of apti. if incremental benefit of apt is $100,000

1. 100% owner = apt2. 10% owner = apt

ii. if incremental benefit of apt is $10,0001. 100% owner = hotel2. 10% owner = apt

iii. problems of agency cost arise when incremental benefit of apt is btw $50,700 & $5,0701. in this range, it is not Kaldor-Hicks efficient for Jonas to take apt, but he mightanyway bc it is efficient for him

2.

when its not the agent's money, not as careful with it


3/93

3. this would be a residual agency costActing through Others: The Law of Agency

b. Acting through Others: The Law of Agencyi. Definition: Restatement (Third) of Agency 1.01

1. Agency is the fiduciary relation that arises when one person (a principal) manifests assent toanother person (an agent) that the agent shall act on the principals behalf and subject to theprincipals control, and the agent manifests assent or otherwise consents so to act

ii. Agency Law1. agency relationship arises out of consent2. core of the agency relationship: Agent (A) can bind principal (P) to a third party (T)

a. this is its economic value in contract3. Background rules relevant to agency

a. Formationb. Terminationc. P's liability for A's authorized and unauthorized contracts, and for torts committed by Ad. A's duties to P

4. Formationa. Types of Agency

i. scope: special agents (limited to a single act or transaction) v. general agents (series of aor transactions)

ii. disclosure to T: P disclosed; P undisclosed; P partially disclosed (existence known butunidentified)

iii. right to control: employee/servant v. independent contractor5. Termination at will

a. agency relationships are not specifically enforceable, only monetary damages for violation6. Parties Conception Does Not Control

a. Jenson Farms Co. v. Cargill, Inc. (Minn. 1981) p18i. Principle: An agency relationship may be created through a circumstantial course of

dealing, even if the parties had no explicit agreement or did not intend such a relationshii. Facts: Warren operates grain elevator, buying grain from farmers and selling to buyers.

90% grain sold to Cargill, which also lent $$ to Warren to keep it running. It fails w/opaying farmers for some of the grain they'd bought. Farmers go after Cargill since Warredoesn't have $$

iii. Holding: Warren was acting as Cargill's agent, and is liable for its debtsiv. there was no express intent to form an agency relationshipv. Court defines elements of agency relationship as

1. restatement of agency defn2. manifestation of consent that one wants other act as agent, and that agent consento doing so

vi. Court: nine factors demonstrate Cargill's control over Warren1. question is how these factors are different than in a typical lender/borrowersituation

a.fact is that most of these factors would arise in most debtor/creditor relationshipb.those that are unique not as important bc Warren never implemented the

recommendations2. more unique features

a.constant recommendations by telephoneb.right of first refusal on the grainc.correspondence & criticism regarding finances, officers salaries, and inventoryd.Cargill determining Warren needed "strong paternal guidance"

3. standard featuresa.

inability to enter mortgages, purchase stock, or pay dividends w/o Cargill approv


4/93

b.right of entry onto premises for periodic checks and auditsc.Power to discontinue financing

vii. note: most creditors include a clause saying this is not an agency relationship, but thisprobably won't have a huge effect on outcome of court decisions

7. Liability in Contracta. Looking at principal's liability in contract to third parties when agent enters into contractsb. legal implications flow from the existence of an agency relationship

i. liability for debts accrued by agent, torts committed by the agent, agent owes duties toprincipal etc.

c. three types of agent authority that can lead to thisi. actual authority

1. Restatement (Third) 2.01 (p22): An agent acts with actual authority when, at thtime of taking action that has legal consequences for the principal, the agent reasonabelieves, in accordance with the principals manifestations to the agent, that theprincipal wishes the agent so to act2. Type of authority a reasonable person in A's position would believe they have baon P's conduct3. Includes implied and incidental authority 2.02 (1)

a.actions calculated to achieve the express act that has been authorized4. dependent on agent's perspective

ii. apparent authority1. Restatement (Third) 2.03: Apparent authority is the power held by an agent orother actor to affect a principals legal relations with third parties when a third partyreasonably believes the actor has authority to act on behalf of the principal and thatbelief is traceable to the principals manifestations2. authority that a reasonable third party would infer from the actions/statements 3. White v. Thomas (Ark. 1991) p22

a.Principle: "While the declarations of an alleged agent may be used to corroboratother evidence of the scope of agency, neither agency nor the extent of the agent'authority can be shown solely by his own declarations or actions in the absence othe party to be affected"

b.Facts: P (White) gives A (Simpson) authority to bid up to $250,000 for land, A bi$327,500. A realizes mistake, and sells part of land to T (Thomases), who ownadjacent house. P upset when he finds out, but closes on land purchase, but refusto sell portion of land to T. T sues P for specific performance.

c.Holding: Specific performance overturned bc agent had no apparent authorityd.no apparent authority bc P never made any direct or indirect representations to

T that A was authorized to selli. authority to buy does not lead to authority to sell

4. possibly an omission could lead to apparent authority, but if this is the case it ismore likely to work through the mechanism of estoppel

iii.

inherent authority/power1. dropped by third restatement but still alive in common law2. authority a court creates when there is no actual or apparent, but court thinks itwould be wrong to let the principal off the hook3. generally an agent can bind the principal (whether disclosed or undisclosed) to aunauthorized contract, if the agent would ordinarily have the power to enter such acontract and 3rdparty doesnt know that matters stand differently, Restatement (2nd

Agency 8A, 161, 1944. Third Restatement of Agency eliminates references to this concept

a. no section comparable to 8Ab.note says we don't need this concept bc it doesn't add anything when we have th

concepts of apparent, estoppel, and restitution


5/93

i. but unclear this is true, e.g. Gallantc.Estoppel to Deny Existence of Agency Relationship 2.05

i.A person who has not made a manifestation that an actor (supposed agenthas authority as an agent and who is not otherwise liable for the transactiis subject to liability to a third party who is justifiably induced to make adetrimental change in position because the transaction is believed to be othe persons account if:

ii.The person intentionally or carelessly caused such belief, oriii.Having notice of such belief and that it might induce others to change thei

positions, the person did not take reasonable steps to notify them of the fad.Restitution of Benefits 2.07

i. If a principal is unjustly enriched at the expense of another person by theaction of an agent or a person who appears to be an agent, the principal issubject to a claim for restitution by that person

5. Gallant Ins. v. Isaac(2000) p26a. Principle: A court looks to the agents direct and indirect manifestation and

determines whether the third party could have reasonably believed that the agenhad authority to conduct the act in question.

b.Facts: P sells car insurance to T through A. Policy states that any changes wouldhave to be authorized by P. On Dec. 2, T buys a new car, which A agrees to ensure

effective immediately w/o payment first. A and T agree that T will come in to fill opaperwork and pay on Dec. 5. On Dec 4, T gets into a car accident. On Dec. 5, Treports the accident and fills out paperwork as planned at A. P denies coverage foaccident bc A was not authorized to renew T's policy w/o payment w/oauthorization from P.

c.Holding: Court finds P must cover T bc A's approval of the policy occurred underinherent authority

i. no actual authority bc P directed A to get prior authorization before chanii.no apparent authority bc P never represented to T that A could renew w/o

authorizationiii. in fact, paperwork term says A does not have authority to bind principal

d.Factors leading to inherent authorityi. overall transaction was in ordinary course of business with the principal

ii.common practice to tell clients bound before payment, even if that waswrong

iii.principal did not take any steps to make sure consumers knew not bounduntil formalities complete

iv. even though they knew Thompson's common practicese.to avoid liability, P would have to try to put up more noticeable signage on this ru

i. but might not work if agent is still contradictingf.possible that we could impose liability through estoppel by showing Gallant

"carelessly" caused T's belief that agent had authority to bind coverage immediati. but if Gallant didn't know about it, this can't be shown

g.restitution probably doesn't really get her anywhereiv. Why the differences in outcome for White v. Gallant?

1. sophistication of the third parties2. sympathetic position of the principals3. repeat nature of transactions/transactions cost

a. with property transaction, not difficult for third party to check with principalsb.with insurance, much more of a mess for double checking insurance

8. Principals Liability in Torta. Restatement (3d) of Agency 2.04: Respondeat Superior - An employer is subject to liabili

for torts committed by employees while acting within the scope of their employment


6/93

i. Restatement 3rd Agency Law 7.04:Agents acting with actual authority1. A principal is subject to direct liability to a third party harmed by an agent acwithin the scope of actual authority. (or the behavior is later ratified Restatement Agency Law 7.03)

ii. Restatement 3rd Agency Law 7.051. A principal is liable is the harm was caused by the principals negligence in selecttraining, retaining, supervising, or otherwise controlling the agent.

iii. Restatement 3rd Agency Law 7.08:Agent Acts with Apparent Authority1. A principal is subject to vicarious liability for a tort committed by an agent wapparent authority, when the actions of the agent constitute the tort or enable the agto conceal its commission.

iv. 7.07 Employee Acting Within Scope of Employment1. Conduct of a servant is within the scope of employment when performing workassigned by the employer or engaging in a course of conduct subject to the employercontrol.2. An employees act is not within the scope of employment when it occurs within aindependent course of action not intended by the employee to serve any purpose of temployer.3. It is a question of fact, depending upon the extent of departure, whether or not anact, as performed in its setting of time and place, is so different in kind from that

authorized, or has so little relation to the employment, that it is not within its scope.4. Servant vs. Independent Contractor

a.An employee is an agent whose principal controls or has the right to control themanner and means of the agents performance of work, and

b.The idea is to determine control and whether or not the principal can prevent theharm caused by the agent.

c.The fact that the work is performed gratuitously does not relieve a principal ofliability.

b. Requirements for Principal Liabilityi. agent has to be an employee/servant, independent contractor is not enough

1. Distinction made based on who is in a position to take care to avoid accidentsii. act giving rise to tort must be w/in scope of employment

c. Bad incentives created by this schemei. more incentive to create more independent contractors, so even if value added by exerti

some measure of control, may decline to do so in order to lower risk of liabilityd. Gas station cases - is the oil company liable for incidents at service stations?

i. Liability:Humble Oil (Exxon) v. Martin (1949) p301. Facts: Humble leases station & equipment to Schneider, sells him oil & repairs caCustomer brings car, forgets parking brake & attendant didn't check, it rolls away anhits people2. Factors showing master/servant relationship

a.Humble paid sizeable operation billsb.Schneider required to do things directed by the companyc.little discretion residing in Schneiderd.lease agreement terminable at will by Humble

ii. No Liability: Hoover v. SunOil (Sunoco) (1965) p321. fire starts in back of car being refueled bc attendant is smoking2. Factors showing not enough control

a.Barone had a lot of discretion.b.Barone had a minimum and maximum rent in addition to profits.

i.Separates business interests, Barone has risk.c.He was allowed to sell competitors products.

i.Limits Suns ability to control and mandate.


7/93

d.He did not make reports to Sun.e.Determines his own hours of operation.f.He wasnt required to follow the advice of Sun.

iii. Why do gas stations set their businesses up this way, why do they want them brandedinstead of independent retailers?

1. creation of brand loyalty, since oil is more of a commodity2. but use franchisees bc want someone who's more invested in the business to run

a.management by central bureaucracy doesn't get the level of service you want3. franchise owners in the best position to monitor, but oil companies better able toafford damages when things do occur

iv. Variations in gas station arrangements1. Hours of operation

a.H/S: Companyb.S/B: Manager

2. Selling of productsa.H/S: company products onlyb.S/B: non company products also sold

3. Title to goodsa.H/S: Cb.S/B: M

4. Leasea.H/S: terminable at willb.S/B: terminable once annually

5. Renta.H/S: based at least in part on amount of products sold, C pays 75% operating cosb.S/B: M has overall profit/loss risk, but did get subsidies for competitiveness

6. Oversight/reportinga.H/S: C required periodic reportsb.S/B: no reports required

7. Most important factor probably risk of profit and loss/payment of utility billsa.Humble bearing large fraction of the costs, gives them stronger incentive to contr

the behavior, wouldn't give the $$ unless had some monitoring authority built inb.also the fact that the lease is terminable at will gives Schneider strong incentive t

do what Humble saysiii. The Governance of Agency (The Agents Duties)

1. The Nature of the Agents Fiduciary Relationshipa. Fiduciary duties Applied in Four Different Contexts

i. Agencyii. Trust

iii. Partnershipiv. Corporations

b. All duties laid out in Restatement (3d) of Agency Chp. 8 (supp35)c. Three main duties

i. Obedience, 8.09, duty to obey the principals commandsii. Care, 8.08, 8.10, duty to act in good faith, as one believes a reasonable person would a

in becoming informed and exercising an agency or fiduciary power (anti-negligence/malfeasance)

iii. Loyalty, 8.01, etc1. pervasive obligation always to exercise fiduciary power in a manner that the holof the power believes in good faith to be the best to advance the interest or purposthe beneficiary and not to exercise such power for personal benefit (acheating/nonfeasance)


8/93

2. An agent has a fiduciary duty to act loyally for the principals benefit inmatters connected with the agency relationship. 8.013. An agent has a duty not to acquire a material benefit from a third partyconnection with transactions conducted or other actions taken on behalf of principal or otherwise through the agents use of the agents position. 8.024. An agent has a duty not to deal with the principal as or on behalf of an adveparty in a transaction connected with the agency relationship. 8.03

a.The agentmay not compete with the principal or assist his competitors. 8.04iv. Legal power over property held by the fiduciary is held for the sole purpose of advanc

the aim of the relationship pursuant to which she came to control that property.1. Cant use property or confidential information for the agents own purposethose of a third party. 8.05

v. The fiduciary is bound to exercise her good-faith judgment in an effort to pursue, unfuture circumstances, the purpose established at the time of creation of the relationship

d. 8.06 creates a carveout if certain terms are satisfiedi. must be consent, disclosure, fair terms, good faith

ii. want the exception to the blanket rule in order to facilitate mutually beneficial transactiiii. so for prob. 1 on p35, when agent selling your house buys it at half the value of surround

houses, argue:1. lack of good faith, didn't disclose material facts, terms of the deal aren't fair

iv. why require disclosure in addition to fair terms?1. hard for courts to know exact amounts property could be sold for or when a pricunfair2. not enough protection for principal otherwise bc he couldn't always show a pricewas unfair, even if it was

v. all three cases related to this, the plaintiff wins1. shows courts take agent's duty of loyalty to principal very seriously

2. The Duty of Loyaltya. Tarnowski v. Resop (1952) p36

i. Principle 1: all profits made by an agent in the course of an agency belong to the princiwhether they are the fruits of performance or the violation of an agent duty.

ii. Principle 2: The right to recover profits made by the agent in the course of the agency inot affected by the fact that the principal, upon discovering a fraud, has rescinded thecontract and recovered that with which he parted.

iii. Facts: agent took $2000 secret commission from third party for having principal buy thiparty's jukebox business, agent deliberately lied to principal about business by inflatingapparent value. Plaintiff discovers this after making down payment, sues both sellers anagents. Plaintiff wins against sellers, who return almost entire down payment($9500/$11,000) and deal is voided.

iv. Holding: Plaintiff gets from agent the secret commission and all costs associated with faitransaction as damages (total of $5200)

v. Plaintiff is overcompensated for his losses after the addition of the $2000 commission1. useful for deterrence purposes

vi. important for agent to be responsible since difficult to detect the awarding of a secretcommission

1. chances of detection are low2. may think principal will just go after seller if transaction blows up

b. Trustsi. Established by settlor

ii. legal entity like corporation or partnership1. pool of assets held & administered by trustee for benefit of beneficiaries of the tr2. trustee and her creditors can't get hands on the assets of the trust3.

limited liability


9/93

a.creditors of the trust can't go after the beneficiariesiii. In re Gleeson (1954) p38

1. Principle: All profits a trust administrator gains from a trust must be accounted feven if there has been no breach of loyalty2. Facts: Mary Gleeson dies; Con Colbrook, a close friend and tenant is the executor trustee under her will, which benefits three children (1 is a ward). Lease for the landup soon after she dies, he is now in a conflict position because he is both trustee andtenant. After asking two competent children, stays on the land for another year,increasing payments by 67%, then finds tenant at the end of that year. Con files a sem

annual report, beneficiaries collectively object that he didn't account for his profits frthe land when he was the tenant3. Holding: Under 203, Con as trustee must account for profits, even if there hasn'been any breach

a.no evidence that what he did hurt anybody, and some reason to believe it helpedthem since he increased his rent, and if he had abandoned the tenancy, its possibthere wouldn't have been a replacement renter

4. Children probably sued bc the incompetent is represented by a guardian who isrequired to act in the best interest of the child and sue

iv. Why the stricter rule in trusts than in regular agency relationships for agent/trustee to dwith the principal?

1. trust is set up to protect people who are vulnerable, so the risk that something bawould be done is higher2. also principal is really the settlor, and often dead3. trusts typically not used to hold operating assets, usually cash & liquid investmenso likelihood of a deal that will increase welfare is very low

The Problem of Joint Ownership: The Law of Partnership

c. The Problem of Joint Ownership: The Law of Partnershipi. Why have joint ownership?

1. joint venture is a form of partnership, but focused on a single project, while joint partnership ismore open ended with more activities

a. all of the owners of a joint venture are considered principals, so all liable for the debts of thbusiness as if they were a single principali. also agents of each other

b. share equally in control as a default2. there's a limit to how much projects can be funded with debt

a. becomes too risky for investors after a certain pointb. also comes with interest payments, and a limit soon after starting on how much of these

businesses can affordc. bad incentives for the people who are borrowing

3. talent acquisition/retentionii. Agency conflicts among co-owners

1. Meinhard v. Salmon (Ny Sup. Ct. 1928) p47a. most important business law case, authored by Cardozob. Principle: very high standards will be applied in deciding whether one partners behavior

dealing with another partner violates the duty of loyaltyc. Facts: Meinhard & Salmon are joint venturers, Salmon manages, Meinhard supplies some o

capital & is passive. Salmon takes 20 year lease from Gerry to operate the hotel. Hotel ownknows only about Salmon, he gets 60% profit for first five years, then 50-50 for next 15.losses split equally. When first lease about to run out, different Gerry presents Salmonw/new opportunity: lease whole block for 80 yrs. Salmon accepts for his own corporationw/o informing or consulting Meinhard; Meinhard now suing for breach of loyalty bc he wa

a piece of the action


10/93

d. Holding: Salmon breached duty of loyalty, and Meinhard must be involved with the samecontrol/profit relationship as previously, though he must pay for his interest

e. Fiduciary duty at the very least was to give his partner equal chance to compete, since it cato him by virtue of his agencyi. had to present the information to Meinhard

ii. Possibility that he had to do more is left open, but not resolvedf.memorable/important paragraph "punctilio"

i. "Not honesty alone, but the punctilio of an honor the most sensitive, is then the standardbehavior" p49

2. Possible venture terms the parties might have thought about ex antea. Same Term Option

i. Meinhard participates in any new opportunity on the same terms as in the 20 year jointventure

ii. similar to Cardozo's actual remedyiii. Salmon might not like this if the rewards of a later venture will come about bc of his effo

so would reduce Salmon's initiative to look for other ventures if Meinhard will get half thprofits even w/o any work, and he might insist on greater level of profits for himself

iv. also a problem figuring out which new ventures are subject to this rule and which aren'tb. Competition/Renegotiation

i. Salmon must inform Meinhard, who is free to compete for, or renegotiate over, any newopportunity

ii. Cardozo suggests this is what Salmon's fiduciary duty requirediii. if there actually is competition over this lease, clear beneficiary is Gerry bc likely to get a

better price; whoever gets the opportunity will be the loser by paying morec. How Salmon did it

i. can keep the new opportunity or offer a piece to Meinhard, as he likesii. would have been better for Salmon ex post, but ex ante Meinhard might have required

higher percentage of profitsiii. might also cause Salmon to focus on the future at the neglect of the joint ventureiv. would also incur capital expenses at end of 20 year lease bc would only incur half the co

but would get all of the benefits, while Meinhard would be faced with unnecessary costswith no benefits

3. Suppose Cardozo's goal was to punish Salmon to make parties think about what to put ina. penalty/default rule - if you don't set it up, court will institute a rule that will make at least

one party unhappy so they'll think about these issues while contractingiii. Partnership Formation

1. same as joint venture, but not limited to a particular purpose2. does not need to be registered, exists in common law

a. courts can infer the existence from actions of the parties, even if one denies it3. UPA 6 Partnership Defined A partnership is an association of two or more persons to carry

as co-owners a business for profit

4.

UPA 7 Rules for Determining the Existence of a Partnershipa. profits prima faciae evidence of partnerships but not revenues bc profits indicates concernw/expenses as well and shows greater control/care of businessi. also true in RUPA 202(c) 2-3

5. Courts generally look ata. Profits

i. Allocation of riskii. Costs

b. Control over the Enterprisec. Intent

6. Vohland v. Sweet(1982) p52a. Principle 1: the parties conception of whether theres a partnership doesnt control


11/93

b. Principle 2: someone can be a partner even if they do not make a capital contribution to thbusiness, but instead contribute their talents

c. Facts: Sweet is gardener. When old owner dies and new takes over, Sweet paid 20% of netprofits of Vohland Nursery. No explicit agreement. Sweets 20% share is (erroneously) calcommission. In 1979, Sweet sues to dissolve partnership

d. $60,000 at stake, argument is that profits were used to build up the inventory, so Sweet isentitled to 20% of the available stock

e. Vohland argues this is a sole proprietorship, Sweet was paid on commissionf. Holding: provision of labor is enough to show partner, and that profits were used for

inventory, so he's entitled to his %g. Court notes that Net profits is prima facie evidence of a partnership UPA 7(4)

iv. Partnership Relations with Third Parties1. Relevant statutory provisions

a. Each partner is an agent of the partnership RUPA 301b. Acts in the ordinary course of business bind other partners RUPA 301(1)c. UPA 9: Partner Agent of Partnership as to Partnership Business Apparent Authority

i. (1) Every partner is an agent of the partnership, and the act of every partner for done incourse of the ordinary course of business of the partnership binds the partnership, unlethe partner has no authority to act for the partnership in the particular matter, and theperson with whom he is dealing has knowledge of the fact that he has no such authority

ii. (2) An act which is not for the ordinary course of business in the usual way does not binthe partnership unless authorized by the other partners.

iii. (3) Unless authorized by the other partners or unless they have abandoned the businessone or more but less than all the partners have no authority to:

1. (a) assign the partnership property in trust for creditors or on the assigneespromise to pay the debts of the partnership2. (b) dispose of the goodwill of the business3. (c) Do any other act which would make it impossible to carry on the ordinarybusiness of a partnership,4. Confess a Judgment,5. Submit a partnership claim or liability to arbitration or reference

iv. (4) No act of a partner in contravention of a restriction on authority shall bind thepartnership to persons having knowledge of the restriction.

d. UPA 11: Partnership Bound by Admission of Partneri. An admission or representation by any partner concerning partnership affairs within th

scope of his authority is evidence against the partnership.e. UPA 12: Partnership Charged with Knowledge of or Notice to Partner RUPA 102(f

i. Absent fraud committed by or with the consent of the partner, the partnership is chargeas having:

1. The notice given to any partner of anything relating to partnership affairs,2. The knowledge of the partner acting in a particular matter, and the knowledge ofany other partner who reasonably could and should have communicated it to the actpartner

f.UPA 13: Partnership Bound by Partners Wrongful Act RUPA 305(a)i. The partnership is liable for the acts or omissions of its partners that cause loss or injury

any person not a partner or for any penalty when:1. The partner is acting in the ordinary course of the business of the partnership, or2. With the authority of his co-partners.

g. UPA 14: Partnership Bound by Partners Breach of Trust RUPA 305(b)i. The partnership is bound to make good the loss:

1. Where one partner acting within the scope of his apparent authority receives moor property of a third person and misapplies it; and


12/93

2. Where the partnership in the course of its business receives money or property othird person and the money or property so received is misapplied by any partner whit is in the custody of the partnership.

2. Rights of Partnership Creditorsa. UPA 15: PRs jointly and severally liable on partnership torts; jointly liable on P'ship

contractsb. RUPA 306: PRs jointly and severally liable on partnership torts & contracts

i. BUT partnership assets must be exhausted before pursuing personal assets (307(d))c. bottom line is if you're a general partner, you're exposed

3. Three Aspects of Creditors Rightsa. Whom can creditors pursue? Who is a partner?b. When can an ex-partner escape partnership debts?c. How do partnership creditors fare in competition with personal creditors for assets when

partnership and its partners are all bankrupt (common scenario)?4. Partnership by Estoppel

a. Somewhat analogous to apparent authority doctrineb. will be personally liable for partnership debts even if not really a partner IF

i. a person represents himself as being a partner in an enterprise (or consents to othersmaking the representation)

ii. AND a third party reasonably relies on the representation (actual reliance required) anddoes business with the enterprise

c. Note on reliancei. UPA 16(1) lang says this applies only when someone gives credit to the partnership

ii. But RUPA 308 expands to all transactions, and this has been followed even in UPA cont5. Third Party Claims Against Retiring/Departing Partners

a. Baseline is liability exposure for partners who leave partnershipb. But UPA 36 provides several ways to escape further risk associated with the partnership

i. (1) The dissolution of the partnership does not of itself discharge the existing liability ofany partner

ii. (2) By agreement between the creditor, the departing partner, and the remaining partnRemaining partners can agree to assume the existing obligations of the dissolvedpartnership.

1. Such agreement may be inferred from the course of dealing between the creditorhaving knowledge of the dissolution and the person or partners continuing thebusiness.

iii. (3) Where a person agrees to assume the existing obligations of a dissolved partnership(remaining partners), the partners whose liability has been assumed are discharged fromthe liability of a creditor who, knowing about the agreement, consents to a materialalteration in the nature or time of payment of such obligations.

1. Usually applies to the release of a departing partner when a creditor renegotiatesold debt with the remaining partners.

2.

The Material Alteration Exception: A withdrawing partner can be released frpartnership debts if the creditors and partners renegotiate. Material alteration is thnature or time of payment of obligations might discharge liability. UPA 36(2)-(3) aRUPA 703.

c. If a partner withdraws, the partner remains liable on the debts that accrued while he was partner.(may have to cough up his personal assets to pay creditors). Partners in this situatare at risk yet without control.

6. Third Party Claims Against Partnership Propertya. The partnership creates a segregated pool of assets that partners can only get their hands

by dissolving the partnership.b. UPA 25: speaks about joint ownership but is constructed to act entity property of the

partnership rather than of the individual partners


13/93

i. critical feature is that individual partners have virtually no power to dispose of partnersproperty, thus transforming this property into de facto business property.

ii. (2) a partner cannot possess or assign rights in partnership property, a partners heirscannot inherit it, and a partners creditors cannot attach or execute upon it.

c. Though partners dont own partnership property, they do have a transferrable rightin thshare in the partnership profits and partnership distributions. UPA 26, 27; RUPA 503,504i. BUT UPA 27 (2) assignee of profit interest has no right to participate in management o

the partnership or access to the accounting

ii. RUPA 504 and UPA 28 permit individual creditors of partners to obtain a chargingorder, which is a lien on the partners transferrable interest that is subject to foreclosurunless it is redeemed by repayments of the debt.

7. Claims of Partnership Creditors to Partners Individual Propertya. Partnership assets must be exhausted before creditors can go after individual assetsb. Creditors of individual partners can't reach partnership assets before partnership creditorc. Partnership creditors and Individual creditors have equal priority access to individual

property , Bankruptcy Act of 1978 723 (c), RUPA 8-7 (a)v. Partnership Governance and Authority

1. Default Rule any dispute about ordinary matters of the firm will be decided by majority vote, buany acts outside the ordinary course of business or in contravention of the partnership agreem

must be done unanimously. UPA 18(h); RUPA 401(j)2. National Biscuit v. Stroud(p61)

a. Rule: One partner in a 2-partner partnership is not a majority for purposes of making firmdecisions within the ordinary course of business.

b. Facts: Stroud and Freeman are partners in Strouds Food Center (SFC). Stroud tells Nabische he personally would not be responsible for any bread delivered to SFC after Feb. 6th.Nabisco nevertheless delivers bread after Feb. 6th, worth $171.04, to SFC at the request ofFreeman. Partnership dissolves on Feb. 25th.

c. Holding: Stroud is liable for the bread because his decision was not a majority decision andFreeman, therefore, could bind the partnership on an ordinary matter connected with thepartnership business.

d. If there had been 3 partners, and two voted against it, theyd have to notify Nabisco in ordto not be bound by the 3rdpartners orders

e. Crane on Partnership: The partnership being a going concern, activities within the scope the business should not be limited, save by the expressed will of the majority deciding adisputed question; half of the members are not a majority

3. UPA 18(h) Any difference arising as to ordinary matters may be decided by a majority; but noin contravention of any agreement between the partners may be done rightfully w/o the consenof all partners (RUPA 301)

vi. Partnership Dissolution & Disassociation1. Under UPA

a. Dissolution 29: any change of partnership relations, e.g., the exit of a partnerb. Winding up 37: orderly liquidation and settlement of partnership affairsc. Termination 30: partnership ceases entirely at the end of winding upd. These definitions make partnerships unstable

2. Under RUPAa. Disassociation 601: a partner leaves but the partnership continues, e.g., pursuant to

agreementi. Provision gives all the ways in which disassociation may happen

b. Dissolution: 801: the onset of liquidating of partnership assets and winding up its affairsc. Solves UPAs instability problems

3. Dissolution summary


14/93

a. An exiting partner does not get wind-up rights if the partnership agreement specifiesotherwise (Adams v. Jarvis)i. RUPA 701(b): Disassociating partner who doesnt insist on wind-up rights gets the

higher of the liquidation or gowing concern ratesb. If partner is kicked out of the partnership

i. Under UPA could not get going concern value or insist on wind-up rightsii. Under RUPA are entitled to a claim on going concern value, minus the damages you caus

c. When parties dont specify, default rule is partnership at will; anyone can dissolve at any t(Page)

i. BUT: Fiduciary relationship tempers purely opportunistic dissolution (Page)d. When winding up, it is more fair to sell the business and payoff in cash rather than dividinthe assets (Dreifuerst)

e. Appraisal Alternative: Have an appraisal of the business and pay the withdrawing partnerpro rata sharei. Avoids the need to actually sell the business

ii. Full sale is usually better than appraisal b/c it includes the market value (real market teiii. BUT appraisal may sometimes be better:

1. Sale of business has high transaction costs2. Tiny businesses may not have a liquid asset market3. Often, the only interested buyers are your ex-partners who wont pay a fair price

4. The Ability of partners to opt out of statutory wind-up in a partnership at willa. Adams v. Jarvis p65

i. Rule: If the partnership agreement provides for continuation, sets forth a method of paythe withdrawing partner his agreed share, does not jeopardize the rights of creditors, thagreement is enforceable (under the UPA)

ii. Rule: One does not get wind-up rights if the partnership agreement specifies otherwise(UPA 38)

iii. Facts: Dr. Adams withdraws from three-doctor partnership; contends that his withdrawconstitutes a dissolution that requires a winding up. Partnership Agreement sayswithdrawal of a partner will not terminate the partnership (contract 15). in this event, 1/3 profits based on date of year partner withdraws, and certain other specified rights, i

contradiction to UPA language of winding up with remaining cash distributediv. Lower court history: Trial court finds this is a dissolution so it must be wound up and h

gets 1/3 of the accounts receivablev. Rationale: if UPA provision were interpreted strictly, there would be too much instabili

not everyone is sophisticated enough to draft contract exactly rightvi. Court looks at UPA 38(1) - saying unless otherwise agreed, ptship paroperty can be

applied to discharge liabilies and net out in cash1. UPA 38 applies only unless otherwise agreed: UPA 38 contemplates adiscontinuance of the day-to-day business when one partner leaves, but does not forother methods of winding up

vii. key phrase in agreement is that the partnership shall not terminate in the event ofwithdrawal, but defines withdrawal as not dissolving, so chicken and egg with the UPAprovision

1. should have said the withdrawal will not lead to a wind-up/termination5. Mode of liquidation in a statutory wind-up

a. Dreifuerst v. Dreifurstp69i. Rule: the UPA does not allow in-kind distribution of partnership assets unless there is a

agreement to do soii. Rule: if at least one partner wants a sale, and there's no agreement to the contrary, ther

will be a sale


15/93

iii. Facts: three brothers in at-will partnership that's winding up, one brother wants assetssold and proceeds used to pay off creditors & divide btw them. trial court instead divideassets in kind, giving one mill to two brother, second mill to the other brother

iv. Holding: assets must be sold off and proceeds dividedv. Rationale: cash sale creates a pot creditors can reach, distributed property harder to rea

to satisfy debts, also sale is best method of establishing true value of assets, ensuring afairer distribution, statute itself seems to contemplate a sale rather than distribution inkind

vi. Precedent Rinke v. Rinke allowed in-kind distribution only when there were no creditorb. UPA 38(1): When dissolution is caused in any way, except in contravention of thepartnership agreement, each partner, as against his co-partners . . , unless otherwise

agreed, may have the partnership property applied to discharge its liabilities, and the surpapplied topay in cashthe net amount owing to the respective partners.

6. Fiduciary/equitable limitations on the ability to force a dissolution of a partnershipa. Page v. Page p73

i. Like Meinhard v. Salmon in the factsii. Rule: A partnership may be dissolved by the express will of any partner when no definit

term or particular undertaking is specified. UPA 31(1)(b)iii. Rule: Partners may impliedly agree to continue in business until a certain sum of money

earned, Mervyn Investment v. Biberor until certain debts are paid Vangel v. Vangel

iv. Rule: Bad faith is irrelevant for determining if the partnership is for a term or at will,although still relevant in examining actions after dissolution

1. ???? is this true?v. Facts: Two brothers running laundry, both partners contribute $43,000 and Big P loans

another $47,000 through his wholly-owned company. Business loses $$ for awhile, and when it turns a corner Big P seeks to dissolve. Little P claims Big P is trying to take anopportunity for himself stemming from new Air Force base

vi. Lower court: Trial court finds that the partnership is for an implied term rather than at => Big P can't dissolve

vii. Holding: Partnership was at will and could thus be dissolved at any time, but Big P still hfiduciary duties towards little P like in Meinhard

viii. If Big P later appropriates an opportunity, will show wrongful dissolution leading todamages for Little P

7. Other Relevant statutory provisionsa. UPA 17: LIABILITY OF INCOMING PARTNER

i. The new person is liable for all the obligations of the partnership arising before hisadmission as though he had been a partner when such obligations incurred, except hisliability will only be satisfied out of the partnership property.

b. RUPA 804: PARTNER'S POWER TO BIND PARTNERSHIP AFTER DISSOLUTION.i. Subject to Section 805, a partnership is bound by a partner's act after dissolution that:

1. (1) is appropriate for winding up the partnership business; or2. (2) would have bound the partnership under Section 301 before dissolution, if thother party to the transaction did not have notice of the dissolution

vii. Limited Liability Modifications of the Partnership Form1. Means creditors can't go after personal assets of people in the partnership2. To get these forms, you must register entity with the state

a. provides notice to creditors and third parties that this liability is limited3. These non-corporate forms have proliferated bc corporate forms subject to double level of

taxation4. Limited Partnerships

a. arose in 1850sb. two types of partners

i. general partners subject to full liability


16/93

ii. limited partners give up control in the firm in return for limited liability1. Control Test no longer exists since the LP mustcompete with the LLP and LLC.2. ULPA 303: abandons the control test, a limited partner is not personally liablepartnership liabilities even if the limited partner participates in management andcontrol.

c. Generally governed by the Uniform Limited Partnership Act (ULPA) or the Revised UniforLimited Partnership Act (RULPA)

d. constraints on general partnersi. limited partners try to align incentives through compensation schemes (%)

ii. but there's also still fiduciary dutyiii. reputational concerns, need to raise additional capitale.

5. Limited Liability Partnershipsa. what exactly is limited varies from state to state

i. vicarious negligenceii. torts caused by other partners

iii. if protect from all liability, question whether that will be respected in other statesw/different statutes

6. Limited Liability Companiesa. avoids double taxationb. statutes first established in the mid-1970sc. initially, to not be double taxed, IRS applied 4 factor test to see if corporation

i. if you have 3, enough like corporation to be taxed like one1. lawyers would design agreements to fail 2/4 factors

a.restrictions on transferability & entity lifeii. the four factors

1. limited liability for owners2. management is centralized3. freely transferable ownerships interests4. entity continuity (indefinite) life

d. 4 factor test scrapped in 1997, IRS Reg. 7701-1 to 3i. allow all new unincorporated businesses to choose taxation as partnership or corporati

e. today, corporations usually preferred over this formi. much more case law with corporations than LLCS

ii. for many, issue of double tax doesn't arise bc they end up failingiii. if it goes public, will be taxed as a corp. no matter how its organized IRC 7704(a)iv. problem diminishing over time bc dividend tax rate has been low

1. 2003: Jobs and Growth Tax Relief Reconciliation Act reduces taxation of dividendto 15% through the end of 2008.2. 2005: Tax Increase Prevention and Reconciliation Act extends reduction throughthe end of 2010.3. 2009: Obama Administration plans to increase dividend tax rate to 20%, forhouseholds earnings more than $250,000.

I. The Corporate FormThe Corporate Form

a. The Corporate Formi. Introduction to the Corporate Form

1. Core Characteristics of the Corporate FormGeneral

PartnershipLimited

PartnershipLimitedLiability

Company

Corporation

Investor Ownership X X X X


17/93

Legal Personality X X X X

Limited Liability X X X

Transferable Status X X X

Centralized managementunder an elected board

X

a. Investor Ownershipb. Legal Personalityc. Limited Liabilityd. Transferable Sharese. Centralized Management under an Elected Board

2. Benefits of the Corporate Forma. Eliminates messy problems of personal liability

i. creditors rely only on business assetsii. although creditors may ask a company owner to cosign a loan to the corporation

personally, in order to contract around limited liabilityb. Allows investors to enter & exit the firm

i. all they have to do is buy or sell sharesc. Prevents minority investors from trying to hold up the firm by threatening to dissolve itd. Makes it easy for third parties who contract with the firm to know whom they are dealing

with as an authorized agenti. Board resolution provides all necessary assurance

3. Structural Features of Corporationsa. Holdings

i. closely held v. widely held shareholders1. small group can control in closely held2. in widely held control is dispersed

ii. Creation of a Fictional Legal Entity1. Structural Features of the Corporate Charter Marketplace

a.

US firms not constrained by HQ, place of business, or operational factors in choosingb. State of incorporation dictates which corporate law rules apply under "internal affairs"doctrine

c. states charge annual franchise taxesi. range from $10 flat fees to $100,000+

ii. dependent on different features such as income, assets, etc.d. Can reincorporate in a second state

i. create a new corporation in the new stateii. then do a tax-free merger of the existing corporation into the new one

iii. typical costs ~$70,000 in 2000iv. requires shareholder approval

e. half of all companies incorporated in Delaware, nowhere near as common for HQ state...i. corporate case law extremely extensiveii. dispute resolved promptly in specialized court not offered in other states

iii. believed to insulate directors from personal liabilityiv. courts often deferential to board directors in disputes w/other partiesv. Delaware v concerned about losing corps to other states

2. The Process of Incorporating Todaya. See RMBCA 2.01-2.04b. An individual called an incorporator signs the requisite documents and pays necessary fc. Incorporator drafts and signs a document called either the articles of incorporation (RMBC

or the certificate of incorporation (DGCL), colloquially called the charter


18/93

i. State the purpose and powers of the corporation and define all of its special features, wigreat flexibility being afforded to the designer of the firms legal structure

1. Purposes of the corporation are typically put forth in an extremely broad statemeii. Instead, Bylaws have the guts of the Corp, not the charter. (To change the bylaws, you o

need a vote by the board of directors ) See RMBCA 2.06d. After charter is duly executed it is filed with the designated public official, usually the

secretary of state.i. Filing also identifies the corporations principal office within the state, or if there is none

the name of the agent in the state upon whom process may be served

ii. A filing fee is due at this timee. In Delaware a corporations legal life begins with the filing of the charter (DGCL 106), inother states it may only begin when the secretary of state issues the charter

f.The first acts of a newly formed corporation are electing directors, adopting bylaws, andappointing officers which takes place at an organizational meeting

3. The Charter/Articles of Incorporationa. usually very sparseb. Name of Companyc. Addressd. Purpose (usually "any lawful act")e. capital structure

i. classes, number of common shares, rights of preferred shareholdersf.much more difficult to change than bylawsg. Amendment Process, DGCL 242(b)(1)

i. see list of possible amendments suppl. Page 220ii. Must be initiated by the BOARD, NOT shareholders

iii. Must be approved by an absolute majority of all outstanding voting shares or the majorirequired in the article to be changed, and a majority of the voting shares of each classentitled to vote.

iv. A class is entitled to vote either under the articles of incorporation or if the change woulseriously affect the shares 242(b)(2) suppl. P.221

v. Some states allow appraisal rights, Delaware doesnt4. Corporate Bylaws contents

a. Can be amended by Board or directly by shareholdersi. In Delaware shareholders can ALWAYS amend on their own initiative, this right cannot

contracted away DGCL 109(b)ii. The charter may confer the power to amend the bylaws on the board in addition to

shareholders but not in lieu of them. DGCL 1091. The fiduciary duty of loyalty may invalidate an abuse of the power to modify andinvalidate bylaws

b. May contain any provision not inconsistent with law or charter DCGL 109(b)c. Generally, fix the operating rules for the governance of the corporation

i. Ex: the existence and responsibilities of corporate officers, functioning of the board andcommittee structure, annual meeting date or formula for calculating it

ii. Stockholdersiii. Board of Directorsiv. Committeesv. Officers

vi. Stockvii. Indemnification

viii. Miscellaneousd. Lawyers role comes in at figuring out financial division btw the parties

iii. Key Benefits of the Corporate Form (Easterbrook & Fischel)1. Benefits of Limited Liability


19/93

a. Reduces need to monitor agents (managers)i. you have less $$ at risk, so lower cost threshold for benefit

b. Reduces need to monitor other shareholdersi. with full liability, if other shareholders have less $$ than you, it increases your chance of

having to payc. Makes shares fungible

i. with full liability, value of the share is dependent in part on your wealth and wealth ofothers

ii. which also facilitates takeovers (?)d. facilitates diversificationi. with full liability, minimize exposure by holding only one companye. Enlists creditors in monitoring managers

i. bc creditors bear some downside riskii. will charge higher interest rate to compensate

2. Benefits of Transferable Sharesa. Permits takeovers -> disciplines managementb. allows shareholders to exit w/o disrupting businessc. bc of LL, shares are fungible -> facilitates active stock markets, increasing liquidity

iv. Effects on Torts of Limited Liability1. Limited liability includes too much investment in risky industries bc the businesses &

shareholders don't internalize all the costs2. Corporation may be involved in a socially desirable business but shareholders don't have mean

to pressure the managers to take adequate precautions bc they won't bear full cost of the injury3. Limits company size to uneconomic scale

a. makes sense to do 10 companies w/1 drill each rather than 10 drills in one company bc ifthere's an accident, don't want victim to be able to take all the assets, but rather only one

b. inefficient for operation, but makes sense from the companies liability perspectivev. Centralized Management

1. Legal Construction of the Boarda. DGCL 141(a): The business and affairs of every corporation organized under this chapte

shall be managed by or under the direction of a board of directors

i. Automatic Self-Cleansing Filter Syndicate Co., Ltd. v. Sunninghame (1906) p1031. Rule: Board members are not required by duty to follow the wishes of a major

shareholder, but rather the wishes of all of the shareholders as a group

2. Facts: McDiarmid and friends own 55% of ASCF. ASCF charter vests control inboard, subject to regulations by "extraordinary resolution" of 75% of shareholders.McDiarmid and friends bring such a resolution to sell the company's assets; resolutiofails 55% to 45%. McDiarmid then asks the court to order the board to sell the assets3. Holding: majority shareholders cant overrule the board4. Why was the company set up this way to be difficult to overrule the board?

a.organizers were affiliated with the boardb.in order to protect minority investors who own less than 50% shares

i.investors need protection from each otherii. The board is not the agent of the shareholders.

iii. The board is a quasi principal: it can act independent of what the shareholders want to div. We rely heavily on their expertisev. Though the shareholders by a majority vote can vote in new directors.

b. Boards Powersi. Power to appoint, compensate, and remove officers,

ii. Power to delegate authority to subcommittees of the board,iii. Power to amend the companys bylaws,iv. Exclusive power to initiate and approve certain extraordinary corporate actions

1.

Amendment to the articles of incorporation


20/93

2. Mergers3. Sales of all assets4. Dissolutions

v. Power to make all major business decisions1. Products company will offer2. Product prices3. Wages will pay4. Financing agreements will enter into

c. Structure of the Boardi. By default all members of the board are annually elected for one year terms.ii. Corporation statutes generally permit corporate charters to create staggered (classified

boards, in which the directors are divided up into classes that stand for election inconsecutive years. In Delaware there can be up to three, DGCL 141(d)

iii. The Charter may provide for board seats to be elected by certain classes of shareholdersiv. The board has inherent power to establish standing committees and may delegate

responsibilities to them1. Matters that, by statute, require board action cannot be delegated to a committeefinal action.

d. Formality in Board Operationsi. Governance power resides in the board of directors, not in the individual directors

ii. The bylaws indicate what constitutes a quorum and proper notice of meetings1. Statutes usually provide minimums See 141(b)

iii. Directors act as a board only at board meetings and by majority1. Some states allow members to give their unanimous written consent to thecorporate action in question w/o an in-person meeting DGCL 141(f)

iv. Meeting formally helps alleviate manipulation of board decisionsv. Cannot give proxy to others

2. Corporate Officers: Agents of the Corporationa. Corporate officers, unlike directors, are unquestionable agents of the corporation and

therefore subject to the fiduciary duty of agentsb. Jennings v. Pittsburgh Mercantile Co. (Pa. 1964) p110

i. Principle: Without more, a single director is not considered to have the authority of full board,

ii. Facts: Mercantile is a publicly-held corporation w/400 shareholders, 9 directors, and athree-member executive committee of directors. Egmore (VP and Treasurer, corporateofficer, and director), along with Stern (financial consultant) instruct Jennings to solicitoffers for a sale and leaseback of its property. Egmore tells Jennings that the execcommittee has the power to accept and offer, and eventually does so through Stern, butboard rejects and Jennings sues for his commission. Mercantile argues Egmore didn't haauthority for the deal, and so Mercantile isn't bound. jennings argues Mercantile is bounthrough apparent authority of Egmore

iii. Holding: for Mercantile bc no apparent authority; there must have been a representationthe principal, but here its just Egmore

iv. Rationale: allowing recovery would undercut the ability of boards to control their agentDebt, Equity, and Economic Value

b. Debt, Equity, and Economic Valuei. Capital Structure

1. Types of Corporation Cash Flow (junior to senior claims)a. Common stock

i. carries right to vote in election of directorsii. must be at least one class

iii. most ubiquitous form of stock


21/93

b. Preferred stocki. comes with liquidation preference entitled to be paid a certain amount b4 common hold

get anything at dissolutionii. specified dividend; no requirement to pay, but can't pay anything to common sharehold

b4 theseiii. can be thought of as a soft & flexible form of debt (but still classed as equity)

c. Subordinated debti. contractually subordinated to the claims of other debt holders

d. Debt (or notes)i. entitled to whatever remains after collateral used up to pay secured claimse. Secured Debti. backed by collateral; holders have a priority claim to this value

ii. Basic Valuation: Future & Present Values1. FV=PV(1+r)n PV=FV/(1+r)n r=(FV/PV)1/n - 1

a. Where FV is future value; PV is present value; r is annual interest rate or discount rate; n inumber of years

b. Note: As r increases, PV decreases2. examples p121

a. Net present value problems p122i. What is the net present value of borrowing $10,000 at an 8.5% interest rate, and repayin

it in a year, given the same discount rates?1. r=7% NPV=$10,000 -$10,140.19 = -$140.19

a.ie only take the loan if your future cash flows will be above $140.19 (?)2. r=8.5% NPV = $10,000-$10,000=0

iii. Two Stories about Risk Aversion1. Declining marginal utility of wealth

a. if money is worth more the less you have, losses give more pain than identical gains bringpleasure

2. OR Variable outcomes inflict large transaction costs3. Risk Premium: amount of extra $$ you must receive to accept a larger risk4. Two ways to value risk

a. two step methodi. conceptually correct

ii. find the certainty equivalent (CE) in future $$ of the payout, thereby incorporating risk asmaller numerator

iii. then, discount the CE by the risk free discount rate (ie the market interest rate on 1 yr Tbill)

b. single step methodi. more commonly used

ii. increase the discount rate, thereby incorporating risk as a larger denominator. Specificadiscount by (rf(risk free rate) + risk premium)

5. Three conceptually distinct operations in calculating risk in deciding whether to extend loan (1a. calculates the EV of the payment it is promised

i. ie adjusts for loss of EV arising from the hotel's risk of defaultb. adjusts the EV downward to reflect the intrinsic unpleasantness of the risk of default

i. ie to reflect its risk aversionc. it discounts to adjust for the time value of money

i. the bank does 2 & 3 simultaneously by using the 8.5% discount rate. It could do all threesimultaneously by using an even higher discount rate, say, 14% or so

6. Systematic and Unsystematic Riska. Diversification - when some of your investments negatively correlated w/other investmen

decreases the amount of risk


22/93

b. If it is going to be a big one-shot exposure, then you worry a lot; but if there are a bunch oflittle exposure, then the worry is less; this is the point ofdiversification

c. Systematic risk is risk that cannot be diversified away; this will be the only risk bumped bydiscount rate

iv. Valuing Assets: Discounted Cash Flow analysis1. price per share x number of shares = estimated value of business2. reliant on efficient capital markets hypothesis

a. share price reflects all available information about performance of firmb. best available estimate of the true value of the companyc. not clear this is necessarily true thoughi. someone who would pay higher runs out of capital

ii. purchase based on guessing how other people will behave laterd. but taken seriously bc know has to be right to some extent, if not entirely

The Protection of Creditors

c. The Protection of Creditorsi. more of these in Europe; US is more debtor-friendly, so more relaxed take

ii. How Shareholders can hurt Creditors1. Misrepresentations2. Removing assets

iii. Summary of Legal Strategies for Protecting Creditors (complementary, not exclusive)1. Mandatory Disclosure

a. not done in US for nonpublic corporationsb. federal securities law imposes extensive obligations on public companiesc. pros: transactions cost savingsd. cons: potential confidentiality costs (info to competitors)

2. Capital Regulationa. distribution constraints

i. done in US, but in such a way that its almost meaninglessb. minimum capital requirements

i. not done in USc. capital maintenance requirements

3. Equitable/Fiduciary Constraintsa. Director Liabilityb. Creditor/Shareholder Liability: Fraudulent Conveyancec. Shareholder Liability: Equitable Subordination & Piercing the Corporate Veil

iv. Capital Regulation1. Net Assets/Shareholder Equity Accounts

a. This category is fundamental to regulation, but is not a constraint in and of itselfb. this is the category on the balance sheet that makes assets=liabilities

i. assets - liabilities = net assetsii. liabilities + net assets = assets

c. made up of three componentsi. stated capital (not available for distributions)

1. determined by "par value" stated on stock, can choose whatever amount you wan2. stated capital = par value/share * # of shares3. if stock is no par, board must set aside a discretionary part of sale price DGCL 15

ii. capital surplus1. difference btw sales price and retained earnings

iii. retained earnings (two categories = "surplus")1. available for distribution, but havent yet been distributed

d. The equity remaining in the corporation undistributed to the shareholders must be at leasthe stated capital


23/93

2. Distribution Constraintsa. New York Bus Corp. Law 510 (capital surplus test)

i. can only pay distributions out of surplus (510(b))ii. and distributions cant render firm insolvent.

iii. NOTE: NYBCL 516a4 allows board to transfer funds out of stated capital into surplus ifauthorized by shareholders.

b. DGCL 170(a)(nimble dividend test)i. may pay dividends out of (A) capital surplus + retained earnings

ii. OR (B) if no surplus, net profits in current and/or preceding fiscal year. (the greater)iii. NOTE: DGCL 244(a)(4) allows board to transfer funds out of stated capital into surplufor no par stock.iv. Rationale for this test is a desire to reward companies that have been growing

c. Cal. Corp. Code 500(modified retained earnings test)i. may pay dividends out of (A) retained earnings ( 500a) or (B) out of assets (500b1), i

ratio of assets to liabilitiesremains at least 1.25, and CA>=CL (500b2)d. RMBCA 6.40(c)

i. may not pay dividends if1. cant pay debts as they come due ( 6.40c1)2. OR assets would be less than liabilities plus the preferential claims of preferredshareholders ( 6.40c2)

ii. BUT: board may meet the assettest using a fair valuation or other method that isreasonable in the circumstances ( 6.40(d)).

3. Minimum capital requirementsa. not used in the US, in decline elsewhereb. even if you have one, if there's no maintenance requirement, can take capital out later so i

can get dissipatedi. but maintenance requirements are very strict, bc this rule is always binding, and the cap

$$ can't be distributed as shares or in business operationsc. prevents some people with limited resources from starting socially desirable businessesd. Capital Maintenance rules

i. Pros: greater security for creditorsii. Cons: if you require minimum capital, may have capitals that are forced to liquidate

prematurely when they would have become profitable laterv. Standard-Based Duties

1. Director Liabilitya. Attempts to change director incentives so theyll consider interests of creditorsb. Accomplished through UFTA, statutory restrictions on payments, some common lawc. Credit Lyonnais Bank Nederland v. Pathe Communications Corp. (Delaware 1991)

i. Rule: When near insolvency, board cannot consider SH welfare alone but should alsoconsider the welfare of the community of interests constituting the corp.

ii. Facts: The corp. began to go under. The board was presented with several offers that cogive various results depending on whether they litigated and, if so, whether they won/lo

iii. Reasoning: The possibility of insolvency skews incentives, exposing creditors to the riskopportunistic behavior. Creditors would be in favor of accepting a settlement offer as loas it was more than what the corp. owed to the creditors (so the creditors could get all thmoney back). But, the SH would not want to accept a settlement offer barely above thatamount b/c then after the corp. paid its debts they would be left with practically nothingSH have diversified portfolios and so are more willing to accept the risk of litigationbecause the payout might be bigger (in which case they get $), but if the corp. loses theydont individually lose very much, while the creditors get screwed

iv. But remember this case is not majority rule2. Fraudulent Conveyances & UFTA 4


24/93


25/93

b.some soft misrepresentation6. if company had limped along for 5 years instead of going under right away,probably would have gone the other way

a.would have suggested capitalized enough & given creditors time to get used to necorporate structure

b. Piercing the Veili. allows one or more creditors to go after one or more shareholders of the corporation to

satisfy debts company can't payii. doctrine is a mess, most jurisdictions have different tests

iii. generally tests consist of two components1. evidence of "lack of separateness"a.e.g., shareholder domination, thin capitalization, no formalities/co-mingling of

assets2. unfair or inequitable conduct

a.wildcard as to what counts for thisiv. probably no piercing

1. against public corporations2. against passive shareholders3. against minority shareholders4. if all formalities are observed and nothing "funny" with the accounts

v. Formulations of the test1. Lowendahl test (NY): veil-piercing requires (1) complete shareholder dominatiof the corporation; and (2) corporate wrongdoing that proximately causes creditorinjury2. Van Dorn test(7th Cir. - applied in Sea Land):

a.(1) such unity of interest and ownership that the separate personalities of thecorporation and the individual [or other corporation] no longer exist. Look to:

i. Failure to maintain adequate corporate records or corporate formalitiesii.Comingling of funds or assets

iii. Undercapitalizationiv. One corporation treating the assets of another corporation as its own

b.and (2) circumstances must be such that adherence to the fiction of separatecorporate existence would sanction a fraud or promote injustice

3. Laya test (applied in Kinney Shoe)a.(1) unity of interest and ownership such that the separate personalities of the

corporation and the individual shareholder no longer exist; and (2) would aninequitable result occur if the acts were treated as those of the corporation alone

b.BUT says (3) if defendant can show plaintiff assumed the risk, no veil piercingvi. Summary of the Piercing Cases

1.vii. Sea-land Services, Inc. v. The Pepper Source (7th Cir. 1991) p152

1. involves reverse piercing - going after other corporations owned by the one you'generally be piercing against


26/93

a.with regular piercing, you could only get the equity of larger owner's othercorporations, but reverse piercing means going in and taking a position equal to tcreditors of the other corporation, not the subordinated equity status it would gefrom taking the owner's position

b.problem with this practice is that it hurts the creditors of the other corporations2. Principle: Mere failure to have your claim paid does not constitute injustice suto allow veil piercing3. Facts: Sea-Land wins a judgment against Pepper Source, but before the paymentbecame due, Pepper lost all its assets it was dissolved for failure to pay taxes. Pepp

is one of many corps owned by Marchese. Sea-Land wants to pierce the veil to get toMarchese, and then reverse-pierce to get to his other corps.4. Lower court: Van Dorn test satisfied, this promoted injustice5. Holding: First prong of unity of interest is met, but remanded to District todetermine second prong6. Subsequent history: District said there was injustice bc Marchese had committedtax fraud and lied to Sea-Land, 7th cir affirms

viii. Kinney Shoe v. Polan (4th Cir. 1991) p1571. Rule 1: Third prong of the Laya test is permissive, not mandatory2. Rule 2: when nothing is put into a company, it provides no protection of otherassets

3. Rule 3: Undercapitalization and a lack of corporate formalities is enough topierce4. Facts: Deft Polan has two companies: Industrial (no assets) and Polan, Inc. (assetKinney gives Industrial a sublease of its plant in Dec. 1984, Industrial gives sublease Polan @ 1/2 rent; both subleases signed by Polan himself. trying to shield assets inPolan, Inc. from Kinney in case Industrial defaults. Other than the Kinney sublease,Industrial had no assets, income, or bank account; it issued no stock certificates b/cnothing was ever paid into it. The first rental payment to Kinney was paid out ofPolans personal funds, and no further payments were made. Kinney obtains judgmeagainst Industrial for $166K in unpaid rent, then sues Polan individually to collect5. Lower court: finds for Polan finding that Kinney had assumed the risk under thethird prong of the test (Kinney should have known about Industrial'sundercapitalization)6. Holding: for Kinney, saying third prong of "risk assumption" not applicable here7. Application of first two prongs is different than Sea-land/Van Dorn bc doesn'trequire injury beyond lack of repayment8. How 4th circuit addresses third prong

a.only supposed to apply to financial institutionsb.when its clear the "owner" was just creating a shell, third prong doesn't apply

vi. Veil-piercing for involuntary creditors1. Walkovszky v. Carlton (NY 1966) p161

a. Principle: Undercapitalization alone is not enough to pierce as long as the minimumlegal capitalization requirements are met and formalities followed

b. Facts: Walkovszky struck by a cab owned by Seon Corp and seeks to hold major shareholdCarlton personally liable. turns out each corporation has two cabs, no assets, and minimuminsurance. Plaintiff alleges comingling of funds btw the cab companies, unity of services, etBut no comingling of personal and business funds for Carlton

c. Holding: Court of Appeals dismisses the complaint for failure to state a claim, with leave tofile amended complaint

d. Where are the sources of cash in the corporation?i. insurance - but can probably only get the insurance $$ from the one cab that hit him

ii. cabs themselves - but heavily mortgaged so can't get muchiii. medallions - given by the city, but they're judgment proof


27/93

e. Rationale: assets being moved between companies not enough to pierce the veil,complainant needs to show in complaint that $$ were being funneled for Carltons personaconvenience & w/o observing formalities

f.Keating dissent says if you haven't adequately capitalized for typical risks, we will pierce, evif you have required insurancei. But this creates uncertainty; says we'll determine afterwards how much capital should b

thereii. pushes out relatively successful owners with sufficient resources to have coverage, and

with cab industry run by people with no assets who aren't deterred by veil piercing

2. Successor Liability for Torts (when corporation has dissolved)a. DGCL 278 & 282: shareholders remain liable pro rata on their liquidating dividend for thyears

b. RMBCA 14.07: same, provided the corporation publishes notice of its dissolutionc. Successor Corporation Liability: product line test in some jurisdictions

i. may hold acquiror liable if it buys the dissolved corporation's business intact and continto manufacture same product

ii. any sophisticated buyer who buys business as a going concern will contract forindemnification for tort liability or pay less

iii. so only way for shareholder to escape long-term liability through dissolution is to sacrifthe going-concern value of the business and keep only the piecemeal liquidation value

II.NORMAL GOVERNANCENormal Governance: The Voting System

a. Normal Governance: The Voting Systemi. Basic Features: The Role and Limits of Shareholder Voting

1. Shareholders vote on three kinds of matters:a. election of directors;b. organic or fundamental changes, e.g., mergers, sales of all assets, corporate dissolution

charter amendmentsc. shareholder resolutions

2. Registered shares: each share has a holder of record, which facilitates getting in touch with thultimate beneficial holder (unlike bearer system in France & Germany).

3. Proxy system:if you cant attend the annual shareholder meeting (ASM), you can still vote byfinding a representative (proxy) who goes to the meeting and votes on your behalf.

4. State law mandatory rules: all state statutes except one require an annual meeting for electiodirectors; quorum requirements.

5. State law default rules: all state statute statutes permit special meetings and action by writtenconsent, though default varies.

6. Shareholder Meetings and Alternativesa. What can be voted on at annual meetings

i. The election of the boardii. The adoption, amendment and repeal of by-laws

iii. The removal of directorsiv. The adoption of shareholder resolutions that may ratify board actions or request the bo

to take certain actionsb. Special meetings

i. Usually the only way shareholders can take action between annual meetingsii. DGCL 211d allows board to call, or anybody authorized by charter or bylaws

iii. RMBCA 7.02 allows board or somewhere between 0-25% shareholders (contractually 10% default) to call a special meeting

c. Action by written consenti. DGCL 228: unless charter provides otherwise, 50% +1 of shares can act at any time to

any action that could be taken at a meeting of shareholders through signed written cons


28/93

ii. RMBCA 7.04(a) requires unanimous written consent7. Cumulative Voting

a. each shareholder gets votes equal to number of shares owned x number of seats to be filleb. Improves likelihood of minority representation on the board, bc they can all pool their vot

and win one candidate, whereas w/straight voting theyd be defeated on each c. Ex: Family Corp. has 300 shares outstanding; A owns 199 shares and B owns 101 shares.

Family Corp. has a three-person board elected to annual terms.i. Straight Voting: A would win each seat 199 to 101.

ii. Cumulative Voting: B casts 303 shares all for one candidate => guaranteed to get one seaon the board, because As 597 votes cannot be divided three ways so that all three aregreater than 303.

ii. Electing and Removing Directors1. Every corporation must have:

a. A board of directors, even if the board has only a single member. DGCL 141(a)b. At least one class of voting stock

i. In the absence of any customization in the charter, each share of stock has exactly one vDGCL 212(a)

ii. The right to appoint the board of directors is more valuable to common stock investorsthan any other class of investors, since many others receive periodic payments or cancontract for additional rights.

c. Annualelection of directors DGCL 211(b) (doesnt mean must elect all at once)2. Corporate law facilitates the election of directors by creating a flexible framework for holding t

annual meeting of shareholdersa. State statutes fix a minimum and maximum notice period (e.g. 10-60 days DGCL 222(b))b. Quorum requirement for the general meeting

i. Set in the charter or bylaws but may not be less than one third. DGCL 216c. Shareholders who are registered as of the record date are legally entitled to vote at the

meeting (e.g. DGCL 211(c))i. 10-60 days before the meeting DGCL 213(a)

3. Staggered Boards: Boards whose directors are elected at different timesa. (1/3 elected at board meeting each year, each serving a 3 yr term) DGCL 141(d)b. Also called classified boardc. Cannot remove a director from a classified board except for cause DGCL 141(k)(1)d. Implication: An outsider cant take control of a board at the annual meeting; must go thro

at least 2 cyclese. MA has mandatory classified boardsf.How these inhibit takeovers:

i. Delay problem: takes at least one year and as long as two years to gain board control.ii. Two election problem: no ability for a hostile bidder to get an up-or-down vote on its b

at a single point in timeiii. Firm offer problem: firm offer eliminates the need for the target shareholders to asses

how well the bidder would run the firm, but making a firm offer effectively gives targetshareholders a (free) put option for their shares for the duration of the bid

4. Charter Provisionsa. Shareholders cannot amend the charter without the boards consentb. Shareholders CAN amend the bylaws under DGCL 109 even if the Board objectsc. Amend bylaws to Increase the size of the board

i. BUT DGCL 223(a) says the Board of Directors can fill any vacancies on the boardii. Shareholders may amend the bylaws to provide that the shareholders, rather than the

Board of Directors fills the vacanciesd. Shareholders may amend the bylaws to remove the classified board, then remove director

without cause


29/93

e. For best protection: Boards should put anti-takeover devices into Charter, which SHs cannunilaterally change

5. State law in all jurisdictions generally bars directors from removing their fellow directors, forcause or otherwise, in the absence of express shareholder authorization

a. But Shareholders can contract around the majority voting rules6. DGCL 141(k) Any director or the entire board can be removed with or without cause by the

holders of a majority of the shares then entitled to vote at an election of directors, except thefollowing

a. (i) Unless the certificate of incorporation otherwise provides, in the case of a corporatiwhose board is classified. Shareholders may affect such removal only for cause; or

b. (ii) In the case of a corporation having cumulative voting, if less than the entire board is toremoved, no director can be removed without cause if the votes castagainsthis removalwould be sufficient to elect him.

iii. Proxy Voting and its Costs1. Because shareholders are unlikely to actually attend shareholder meetings, board and its office

are permitted to collect voting authority from the shareholders in the form of proxiesa. See DGCL 212(b) and (c) (supp205)

2. Proxies are revocable unless the holder has contracted for the proxy as a means to protect a leinterest or property, such as an interest in the shares themselves. DGCL 212e

3. Federal law governs the solicitation and exercise of proxies under 14 of the 34 Act4. Reimbursement rules can differ on at least three dimensions:

a. Amount: reimburse all, part, or nothing?b. Conditionality: do you need to win to be reimbursed?c. Bias: favor incumbents, insurgents, or neither?

5. Rosenfeld v. Fairchild Engine & Airplane Co. (NY 1955 p179)a. Froessel Rule: Management can be reimbursed for any reasonable business expen

incurred during a proxy contest, and insurgents can be reimbursed if successfu

expenses ratified by shareholders

b. Facts: During proxy context, incumbents spent $106,000 and reimbursed themselves frthe company treasury. Spent $28,000 for which they were not reimbursed because twere voted out. The Insurgent reimbursed the incumbents the $28,000 and reimbur

themselves. SH ratified insurgents reimbursement. One stockholder brings derivative acseeking return of all reimbursements to the corporate treasury.

c. Holding: Reimbursement of incumbents & insurgents proxy expenses were reasonabled. In practice, rule biased for management bc they can always show some business neede. If its established that incumbents spent funds for personal power/gain and not for the g

of the company, no reimbursement6. Choice of bias in rule affects how much gain there must be to the company before insurgents

run a proxy contest


30/93

a.b. So under this rubric, value enhancing transfers will always be prevented from happening

i. But transfers are most likely to go through under Super Froessel ruleClass Voting

iv. Class Voting1. When a majority of the votes in every class of stock that is entitled to vote must approve a

transaction (DGCL 216 [4])a. Can also be made more than the majority in bylaws

2. This assures that transactions are fair not only to shareholders in the aggregate but that it is fai(or does not disadvantage) shareholders in subgroups. See RMBCA 10.04, 11.04(f)

3. Class voting also gives classes a veto right which could be abused or used opportunistically.4. Because investors are usually sophisticated, the differences in t

Documents

Fried Corps Outline