Legit Cane Outline

8/3/2019 Legit Cane Outline

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CORPORATIONS OUTLINE ~ Cane

I.INTRODUCTION TO BUSINESS FORMS

CLASSIFICATION OF BUSINESS TWO CATEGORIES:1) Corporations

2) Unincorporated associations

CLASSIFICATION OF CORPORATIONS BY OWNERSHIPINTERESTS1. Closely held: one or a few owners

Unincorporated are usually here. Closely held elect to be corporations. There is no liquidity b/c there is no obvious place to sell, thus no market.

2. Publicly held/traded: hundreds or thousands of owners; open to public to purchase shares and sellshares either in the exchange or over-the-counter market like NASDAQ.

LIQUIDITY:selling the shares you bought for a publicly held business in exchange for

SOURCE OF LAW:STATUTES1. Uniform Partnership Act (UPA 1914): National conference of commissioners on Uniform state

law. There are still states that follow this.2. Uniform Partnership Acts (RUPA 1997): There are some states that use this act. And FL uses this

act. The revised.3. Uniform Limited Liability Company Act of 1996 (ULLCA)4. Model Business Corporation Act (MBCA): the book has the 1969 legal capitol and par value.

Traditional jurisdictions look to this.5. Financial provisions of the Model Business Corporation Act of 1969 (MBCA 1969)

The beginning of the uniform laws series there is a list of which states have the laws andwhich ones have put a variation on them. Annotations should tells how it differs.

If dealing with the uniform laws if you do not have any case law on point then you can

look to other states or the federal interpretation of that part of the act. The model act is themodelfor the rest, but not intended to be uniform.

AGENCY LAW

1.01 Agency defined: Fiduciary duty that arises when one person (the principal) manifestsconsent to another person (the agent,) that the agent shall act on the principals behalf, and subjectto the principals control and the agent consents so to act.

Fiduciary:o A relationship of trust and confidence.o Manifests consent through written or spoken words so person has notice.o Agent must act in the best interest of the principle. Never for the interest of the

agent.- Contrast fiduciary with contractual relationships, where

you only have the obligations of good faith and fairdealing (dont be a bad guy)

Good faith and fair dealing: is not the same as a fiduciary relationship, it only meansthat what I have agreed to do I have or will do. What is in the contract is what I have todo. No duty beyond that.


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Arms length: (commercial relationships) Neighbors black acre and white acre sellingcows to each other. Only limit is not affirmative misrepresentations. Caveat Emptor

Principalperson to whom a fiduciary duty is owed to.o Disclosed principle: 3rd party HAS notice that agent is acting for a principle and

HAS notice of principles identity.o Undisclosed principle: the 3rd party NO notice that the agent is acting for

principle.o Unidentified principle: the 3rd party HAS notice that agent is acting for principle

buthas NO notice of principles identityo Dual Agent: acts on behalf of more than one principle on the same transaction.

(Matts realtor example).o Co-Agent: two agents for same principle.

Notice: person has thru following1. Knows it2. Reason to know it3. Should know it

Agency is consensual, not contractual (no consideration). 1.03 Consent can be manifested through written words, spoken words or other conduct

(i.e., acquiescence is sufficient in some cases)

ACTUAL AUTHORITY AND APPARENT AUTHORITY

Actual authority: B/w the agent & principalAuthorityconcept that defines scope of the agency relationship

Power to bind principal is broader than agents authority to bind principal.How can you have power without authority?(a) Estoppel

(b) Inherent agency power

Actual authorityissue is whether agent reasonably believed he had authority to act on behalf ofprinciple.

Manifestation of consent from principal to agent whereby the agent reasonably believedthat the principle wishes the agent to act (reasonable person standard).May be express or impliedImplied authority relies on industry customOne form of implied authority is incidental authority (which includes things needed toeffectuate actual authority)

Apparent authorityissue is whether 3rd party reasonably believed agent had authority to act on

behalf of principle (b/w 3rd party and principle)Power to affect a principals legal relations with third parties held by an agent or other actorwhen a third party reasonably believes actor has authority to act on behalf of principal andThird partys belief MUST be reasonableBelief must also be traceable to principals manifestations

Example: Sole proprietor for a pet store. Alex is sent to the pet store and he wears a shirtwith the name on it to get supplies for the pet store. Apparent authority by way of the T-shirt.


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Example: Alex now goes to the radio store and now you would need actual authoritybecause apparent is not sufficient.

Cane goes out any gets note cards with agent for Trump but there are no words ormanifestations as to the principle. The principle never authorized the alleged agent to doanything. However if there is a continuous notice to the principle.

Respondeat SuperiorEmployer is subject to liability for torts committed by employees while acting in the scope oftheir employment.Independent Kors: not acting under employer and thus employers are not liable for the acts.

EstoppelVery similar to apparent authorityCompensates for loss caused by relianceWhile apparent authority requires affirmative manifestation, estoppel may follow mereinaction.

Actual and apparent authority may co-exist, but are terminated differently.

Apparent authority terminates when it is not reasonable for the 3rd party with whom theagent deals to believe that the agent acts with actual authority.

Actual authority terminates when the either party has notice of such termination.

CHOICE OF BUSINESS ENTITYWhat are the seven basic choices?

Sole proprietorshipone owner that is personally liable b/c there is no legal separation b/w ownerand business.

CorporationsC type (designation for tax purposes); default. Corporate existence begins uponthe filing of articles of incorporation.

CorporationsS type small business (federal tax election, special elections creates tax benefits)

PartnershipGeneral: two or more people who are co-owners of a business for profit; this is fragileb/c one person can leave anytime. Anytime there is a change in relation b/w or among thepartners the partnership has been dissolved. Personal liability involved.

PartnershipLimited: same as general, but with this you have limited liability for obligations thatexceed the assets of the general partnership. There is a general partner and a limited partner. Thegeneral partner usually is active where limited partner is silent (like giving $$). If silent partnerbecomes active then partner becomes liable.

While the limited partnership is a traditional business form, it has evolved to involve the use of a

corporationas the sole general partner of a limited partnership.

Limited Liability Companies (LLCS) (hybrid between corporations and partnership; all ownershave limited liability; liability is limited to amount you invest). No double taxation. UnderDelaware, this is a distinct entity and requires an attorney b/c it is analogous to a corporation.

One or more persons at beginning, now there may be a sole member LLC.Can either be member managed or manager managed.


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Limited Liability Partnership: same taxation and looks as a general partnership. But with theadvantage of limited liability. Here the partners are only liable for what they are doing and not forthe malpractice of the others within the partnership.

Limited liability limited partnership (LLLP): not in every state. LLP merges w/ an LP (has both

limited and general partners but all general partners have protection of LLP). Publicly held means that the public may buy the stock.

o You know what it is worth by looking in the paper.

Closely held: not held out to the public, and not able to find out the worth

LLP=UPA section 306 [pg 42]..

THEORIES OF CORPORATION

Incorporation results in the creation of a new legal entity, a fictitious person with its own obligations.A corporation is an entity independent of its shareholders.

Though corporation is recognized as a separate entity, it is not shielded with certain privileges extended toindividuals.

For example, a corporation has:no right to privacyno 5th Amendment privilege against self-incrimination

But a Corporation has:

First Amendment protection

Cannot have property taken without just compensation

Is protected from unreasonable search and seizures

Can plead double jeopardy Is entitled to due process

Entitled to equal protection.

Theoretically, a corporation consists of three layers/tiers:1. Shareholders, who are traditionally viewed as the ultimate owners of the

enterprise2. Board of Directorscomposed of managers of the corporations affairs3. Officersact for the corporation to implement the decisions of the

directors.A single individual can simultaneously be an officer, director, and a shareholder.

Liability and Piercing the Veil: Only the corporation is liable for corporate obligations.i. However, if a director, officer, shareholder acts fraudulently or negligently, he

can become personally liable to 3rd persons injured by that conduct.ii. If one is simply inefficient, neither A nor B will be personally liable for

creditors losses.


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a. In comes piercing the corporate veil! A court may pierce thecorporate veil and permit creditors of closely held corporations torecover directly from directors, officers, or shareholders.

b. Piercing the Corporate Veil refers to extreme situations where some orall shareholders will bepersonally liablefor corporations obligations.

Models of Business Organizations

1. Nexus of contracts modelargue the firm is not a single entity, but an aggregate of variousinputs acting together with the common goal of producing goods or services.

2. Contractual theory of corporation is in stark contrast to the legal concept of the corporation asan entity created by the state. The entity theory of the corp supports state intervention (thrudirect regulation or facilitation of shareholder litigation) in the corporation on the ground that thestate created the corporation by granting it a charter.

i. Contractual theory says that the corporation is founded in private contract,where the role of the state is limited to enforcing contracts. A state chartertherefore merely recognizes the existence of a nexus of contracts. Called acorporation. Each contract warrants the same legal and constitutional protectionsas other legally enforceable contracts.

SARBANES OXLEY ACT

Created stricter guidelines to protect investors as a result of Arthur Anderson.

CHAPTER 2

THE PARTNERSHIP

A. THE NEED FOR A WRITTEN AGREEMENTA written agreement is not necessary to form a partnership but should have one.

ADVANTAGES TO A WRITTEN AGREEMENT

1) Avoids future disagreements about the arrangement.a. (i.e. conflict of interest) always inform them of the potential conflict of interest IN

WRITING disclosed advised and chosen not to. Clear about any previous contactwith other clients, must clarify who they represent.

b. If the corp is represented then the same attorney may not also represent any of theshareholders or the directors or the officers in their individual capacity.

2) Provable in court.a. No he said she said. Put an INTEGRATION clause. This represents the entire

agreement between these parties as to this transaction. Otherwise you open the doorto parol evidence.

3) May focus on potential trouble spots in the relationship that may go unnoticed in an oralagreement.

a. Taxes


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b. Meetings voting4) Provides proof to the IRS that a partnership exists, ensuring that the partners to allocate the

tax burdens among themselves.5) Upon death or retirement of a partner, UPA provides that the business is either disposed of

or the interest of the deceased partner is to be purchased by the other parties.a. Having such provisions in writing should protect spouses and others that may be

affected by the agreement.b. The amount of the business at the time of the death. No written agreement as to her

interests of the decedent.c. Purchase life insurance for the persons then that will pay them and their estates when

the die and the corporation would not have to pay by agreement.d. In the case of retirement: pay in installments. Monthly annually, interest, and what

will secure the interest, assets of the partnership.e. Use the form Exhibit A. and make it easily ascertainable so as to be able to actually

comply with the terms of the note.6) Where a partner lends property to the partnership,

a. Personal property of one of the shareholders or is it obtained as partnership property.b. Black white & gray acres but only gray is owned as and by the corporation, so only

gray can be touched by the corporation.7) Where real estate is to be contributed as partnership property or the agreement includes a

term of more than one year, a written agreement may be necessary to comply with thestatute of frauds.

8) Helpful to the attorney setting up the partnership, providing fewer reasons for amisunderstanding.

LIMITED LIABILITY PARTNERSHIP (LLP)

UPA 306 (c): An obligation of a partnership incurred while the partnership is a LLP is solelythe obligation of the partnership. A partners is not personally liable, directly or indirectly, by way of contribution or otherwise,

for such an obligation solely by reason of being or so acting as a partner.

MANAGEMENT

NATIONAL BISCUIT CO. V.STROUD 1959

All partners are jointly and severally liable for the acts and obligations of thepartnership.

All partners have equal rights in management even if sharing profits are unequal. UPA 18 P: Natl Biscuit sold bread to the grocery store even after one of the partners told them

they were not going to be personally responsible for the purchase of the bread anymore. To the damage of $171. 04. Court says that indeed Stroud is liable for the partnership.He

was acting in the scope of his business to order the bread. The partnership is the principle and the principle is the one who creates the authority.

Stroud has not created his own authority, since Stroud only owned of the partnershipand without any majority of the general partnership.

There was no agreement. Thus the authority was not destroyed by the act of the onepartner without a majority vote.


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9 unless no partner has no authority.

SMITH V.DIXON 1965- -In this case, the managing/general partner contracted to sell land to Defendant for

$200,000.- The partnership refused to close the sale because these other partners said they only

gave the general partner the authority to sell the land at $225,000.- The court held that one partner has the authority to sign for the partnership in

transferring land as long as that partner is operating with apparent authority. Here thecourt determined that the D was acting with apparent authority, which he did.

R: A partnership is bound by the acts of a partner when he acts within the scope or apparent scope

of his authority. UPA 11 (reasonable expectation standard).

R: Partnership agreement governs the relations b/w the partners. RUPA 103.

ROUSE V.POLLARD 1941 Law firm which was a partnership where one of the partners took it upon himself to invest for

one of his clients and then embezzle most of the money while representing to her. Little old

lady in tennis shoes. He is not acting within his authority. Issue: what is the scope of the law firm.

- All partners are jointly and severally liable 15 of the old Act.- Here the court said that receiving money and buying mortgages is not part of the

business (to do it at their discretion.)- They took judicial notice of how the practice of law is decided.

In this case the partner (an attorney) did not act within the scope of (law) partnershipwhen he embezzled money from a client and invested it, as the partnership was a lawfirm, not an investment firm

Each partner is authorized to act as the general agent for his co-partners in all matterscoming within the scope of the business of the firm,

All partners are responsible for the acts of each of their agents If the transaction is outside the partnership business, the other partners are not liable and

they are not bound by a statement of the partner who conducts such transaction that he isacting on behalf of the firm.

To hold partners for the fraudulent acts of a co-partner, the acts with which the fraud iscommitted must have been within the general scope of the partnership business.

R: UPA 11partners liable for anything done w/I scope of business.

ROACH V.MEAD 1986Is the general partner in practice? Is he responsible for the acts of the other partner?

In this case, the partner (an attorney) failed to advise client on the legal consequences of aloan.

The court held this was in the ordinary course of the business of the partnership and hislaw partner was vicariously liable for these negligent acts.

Partners are jointly and severally liable for the acts of copartners based on the principal-agent relationship between the partners and the partnership.


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This case is also concerned with Ethics and this practice of loaning: A lawyer shall not dothis in accordance with Model Rules of Professional conduct.

i. This doesnt mean that you can never do business with the client, but only withcertain safe guards. And make sure that your legal advice is not tainted and mustbe fair.

ii. None of this was done at the case at bar. Partners are jointly and severally liable for the tortious acts of other partners if they have

authorized those acts or if the wrongful acts are committed in the ordinary course of thebusiness of the partnership.

Notes (read in class)Model Rules of Professional Conduct, Rule 1.8A lawyer shall not enter into a business transaction with a client or knowingly acquire an ownership,possessory, security or other pecuniary interest adverse to a client unless:(1) The transaction and terms on which the lawyer acquires the interest are fair and reasonable to

the client and are fully disclosed and transmitted in writing to the client in a manner that canbe reasonably understood by the client.

(2) The client is given a reasonable opportunity to seek the advice of independent counsel in thetransaction; and

(3) The client consents in writing thereto.

UPA 17, 306 (b)Note 5: the argument was that this was outside the scope of the legal realm, because this legal malpractice insurance.

- They will attempt not to cover- Ct up held the summary judgment b/c there was no attorney client relationship as to the

personal loan.Note 6: In coming partners: UPA 17 IS liable for all obligations but the liability is only to be satisfiedout of partnership property. (the money you put forward to become a partner.)

306 (b). person admitted to a partnership is not personally liable for any partnership.

DUTIES OF PARTNERS TO EACH OTHER

Partners and co-adventures have a fiduciary relationship.

Joint Venture: partnership of limited term or scope.

MEINHARD V.SALMONWhen a partnership is offered a profitable lease, one partner accepts it for himself, prompting the other todemand participation.

R: IF NEGOTIATIONS BEGIN BEFORE AGENCY R/S IS TERMINATED, EACH PARTY IS ENTITLED THE

OPPORTUNITY TO PARTICIPATE.

PARTNERSHIP PROPERTYOfficial Comment to Subdivisions (1) and (2-B) of Section 25 of the Uniform PartnershipAct

Partners for partnership purposes can only use the physical property of a partnership. Interest inthe partnership is personalty. The transfer of interest of one partner is only the right to income.


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UPA 24 & 25 (1) Partners are co-owners of partnership property. UPA 25 (2-b) The right of a partner as co-owner in specific partnership property is not separately assignable.

Example: A and B are partners. A wants to assign all his rights in partnership property to C.He cannot do so without the consent of B because the rights of A in the property is to possess

the property for a partnership purpose; and because a partnership is voluntary and A cannotforce a partner on B without Bs consent.

PARTNERSHIP ACCOUNTING- The interests of partners are reflected in capital accounts.- Capital account: sets forth the partners ownership interest in the partnership.- RUPA 401: describes how each partners capital account is maintained.- Equation: that account equals: the (capital contributed by the partner) less (the amount of anydistributions to the partner) plus (the partners share of the profits) less (the partners share of thelosses).

- When a partnership is terminated, a partner with a negative capital account must pay thepartnership that amount. UPA (1997) 807b.

- Most partnerships also have a second set of books to record transactions for tax purposes.- Equity = AssetsLiabilities (net worth of a business = assetsliabilities)- Equity: ownership or net worth.- Balance sheet: most fundamental financial statement. Equity = Assetsliabilities.- Asset side is the left-hand side.- Liability/equity side is the right hand side.- Records a situation at one instant at a time, therefore every transaction potentially creates anew balance sheet when the transaction is recorded.

- Thebottom lineof a balance sheet is not itself a meaningful figure, because transactions suchas a bank loan that do not affect the real worth of the business to the owners may increase ordecrease it.

- Profit and loss statement/income statementcan be created for a business for one day of

operation.- It is a right-hand entry on the balance sheet.- Income = RevenuesExpenses- Gross profit: total sales- Net profit: salesexpenses

Balance sheet v. Income statement:-- Balance sheet: shows the status of a business at a particular instant in time.

-- The basic document which all financial statements are constructed-- Income statement: describes the results of operations over some period of time-daily, monthly,

quarterly, or annually.-- It provides the bridge between the balance sheet at the beginning of the period and the

balance sheet at the end of the period.

Four concepts offinancial accounting:1. Assumes the business is an entity.2. All entries are in terms of dollars.- Both tangible and intangible property are shown on the balance sheet either at historical cost orfair market value. (Ex. Land and rights to a patent)-- Some assets such as a salesperson good with clients is not reflected on the balance sheet.-- A liability in the balance sheet sense is a recognized debt or obligation to someone else.


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3. A balance sheet must balance.(The sum of the left must be the same as the sum of the right.)

4. Double entry bookkeeping: Every transaction entered into by a business must be recorded inat least two ways if the balance sheet is to continue to balance. (It is the cornerstone of modern

accounting)

Cash flow accounting:-- considers only transactions that involve dollars in and dollars out, whereas traditional accounting

includes some expenses that do not reduce the amount of available cash of the business.-- Most businesses prepare cash flow financial statements for internal purposes and to make sure that

there will be cash available when foreseeable payments come due.

PARTNERSHIP DISSOLUTION

Steps to ending a partnership:

1 Dissolution2 Winding up3 Termination of partnership

Dissolution: DOES NOT IMMEDIATELY TERMINATE THE PARTNERSHIP. A change in the legal relationship caused by any partner ceasing to be associated in the carryingon of the business. UPA (1914) 29 Refers to a change in personal relationships among partners within the partnership and hasnothing to do with the disposition of assets or closing down or selling the business.

CHAPTER THREE

The Limited Partnership and Federal Income TaxationThe Internal Revenue Code recognizes two distinct methods of taxing business income:(a) Corporate Income taxationdescribed in Subchapters C and S of the Internal Revenue

Code(b) Partnership Income taxationdescribed in Subchapter K of the Internal Revenue Code

CORPORATE TAX RATES:Marginal tax rate is applicable to a corporation with exactly $75,000 of income is 34% because that isthe rate applicable to each additional dollar of taxable income the corporation earns over $75,000 and upto $100,000.

Effective tax rateis 18% since a corporations tax bill on exactly $75,000 of taxable income is $13,750(15% of $50,000 plus 25% of $25,000).

FEDERAL TAXATION

The fundamental difference in the tax treatment of partnerships and corporations is that a corporation istaxed as a separate entity with its own tax rate, whereas the partnership is taxed as an extension of theindividual.There is an element of double taxation in the corporate form if the corporation pays dividends. Thecorporate earnings are taxed to the corporation, and when the diminished earnings are distributed individends, they are treated as income in the hands of the shareholders, and taxed again.

Pass through(applies to S and Partnerships): pass through corporate level and goes straight toshareholders/partners.


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- SCORPORATION:o A.k.a. taxed as a partnership or electing partnership taxationo Only a single tax on corporate income is imposed on individual income tax rates at the

shareholder level.o The income is taxable to the shareholder whether or not the income is actually

distributed.o To be eligible, a corporation must meet the following conditions on the date of election,

in order to be for a S corporation:o Has corporate characteristics of limited liability and centralization of management.

It must be a domestic corporation It must NOT be part of an affiliated group of corporations It must have no more than 75 shareholders Each shareholder must be an individual citizen not a non-resident alien It may have only one class of stock outstanding (preferred not allowed), except

that classes of common stock differing only in voting rights is OK

CCORPORATIONA C corporation can minimize the disadvantages by reducing the substantial tax at the corporate levelthrough the payment of salaries, rent, or interest to the shareholders. If reasonable, such payments aredeductible as ordinary and necessary business expenses.

A factor favoring corporate tax treatment is the availability of tax-free employee fringe benefits forshareholders that are employees of the corporations. Such benefits include medical insurance, lifeinsurance and so forth.

Capital Gain is taxed at a lower rate (20%) if held for more than one year like stock.

KCORPORATION Pass through applies Its income or loss is reported on proprietors income tax return. Not a separate taxable entity Partnership must file an information return showing income & expenses Partners are taxed on each individuals share.

E.g. Draws are not included in the amount allocated for income calculations. If A, B, C owna business that made $300k and each got $100k and each drew $10k. The amount taxed is the$100k.


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PROPRIETORSHIPS

Proprietorships, businesses wholly owned by a single individual, are not a separatetaxable entity. Its income is reported on the proprietors personal income tax return.

The taxation of unincorporated business forms, such as general and limitedpartnerships and limited liability companies, is set forth in Chapter K of the InternalRevenue Code.

The partnership itself does not pay tax; rather it allocates the income or loss of thepartnership among the individual partners in accordance with the partnershipagreement. Each partner then includes in his or her personal income tax return, theamount allocated.

LIMITED PARTNERSHIPS WITH CORPORATE GENERAL PARTNERS:A limited partnership with a corporation as the sole general partner creates a totally different kind ofentity than the traditional limited partnership.

No individual is personally liable for the firms debt.

Most of the capital is provided by passive investors who have no right to participate inmanagement.

Control of the limited partnership is vested solely in the hands of the corporate general partner.

IN RE USACAFES LPLITIGATIONCourt of Chancery of Delaware (1991)

Metsa bought almost all of the assets of USACafes LP. The unit holders of USA cafes wants aconstructive trust declared on certain funds and damages to the class of unit holders resultingfrom the sale.

USA CAFES is the general partner: and few acting as the officers and directors

The Ps claim that the Ds sold the company for too little because they got incentives on the sideand thus breached their fiduciary duty to the unit holders.

P is suing D on the theory of breach of fiduciary duty.

The Ds claim they owe no such fiduciary duty to the Unit holders as directors only the GeneralPartner would owe such a duty and they were acting as directors at the time of the sale.

UP UNTIl now there was no case law as to the LPs and the duty owed.

This court then looks to the law of trusts. And finds.

However the court holds that they were acting personally as the Gen Partner and thus didowe a duty to the limited partners or unit holders.

Thos in control of the corporate general partner they owe some duty to the limited partners. Cause the loss bear the burden if the Wiles caused the loss they breached their fiduciary duty

and thus should be personally responsible for the damages.

P wins the motion and the Ds motion to dismiss is denied.

o WHEN retained to represent someone in this situation you make sure that it is clear whoyou are representing, A as a general partner of B corp or LP.

o Limited partnerships would originally have a human but now it is most likely a fictitiousperson a.k.a the corporate


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SIX CHARACTERISTICS IN A PURECORPORATION:1. Associates2. An objective to carry on a business and divide the gains there from3. Continuity of life

4. Centralization of management5. Liability for corporate debts limited to corporate property6. Free transferability of interest

* A Partnership will be treated as an association taxable as a corporation if it more merely resembles acorporation than a partnership

CHAPTER FOUR

LIMITED LIABILITY COMPANIES

An LLC is an entity designed to be taxed as a partnership while offering the owners the limitedliability that shareholders of a corporation enjoy.

Compared with a S corporation, an LLC may be better because it is not subject to thelimitations of Subchapter S (75 or fewer shareholders, one class of stock, etc.)

Compared with a limited partnerships, an LLC may be better because it does not require thatthere be at least one general partner that is personally liable for the partnerships obligation; nomember need be personally liable for the obligations under an LLC,

Although LLCs are governed by statute, the statute provides that members can adopt operatingagreements that will control.

Best understood in terms of four general characteristics:(a) Limited liability(b) Partnership tax features(c) Ability to choose between centralized and direct member management chameleon management.(d) Creditorprotection provisions

Management of an LLC is presumed to be by all members (unless specified in the articles)Management by members must follow these rules:(a) Majority vote is required to approve most decisions and(b) Each member is an agent of the LLC (meaning: LLC may be bound by the acts of any member)(c) Management rights are transferred ONLY with the consent of ALL members(d) Disassociation of an LLC member by resignation, death, retirement, generally causes the

dissolution of the LLC.

ELF ATOCHEM NORTH AMERICA,INC. V.JAFFARI AND MALEK LLC

Malek LLC was formed as a LLC in Delaware by filing a certificate of formation but with limitedarticles of governance.

Then Elf Malek INC. and Jafarri entered into the agreement setting forth detailed provisions for

the governance of Malek LLC which is not a signatory to the agreement. Arbitration clause and a forum selection clause.

Elf alleged that Jafarri breached his fiduciary duty to the LLC by making it insolvent and filedsuit in Deleware.

R: Directors of a CGP stand in fiduciary r/s w/ limited partners.


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Elf put a million bucks in and Jafarri.

INTERNAL affairs rule states that Elf wants to be in Delaware b/c they are concerned that thecourt imposes a fiduciary duty.

o ISSUES: are they bound by the agreemento Is the arbitration clause valid.

Court looked to contract principles and found that two entities should be able to contract and the

arbitration clause should thus be valid. Like partnership law. Which means that they have abroad authority to contract. ELF wants to be able to not contract away the jurisdiction.

You should stick to Delaware because of the Internal affairs rule:

Legislature says this should be interpreted as broad like partnership law.o UPA RUPA: there are limits to what you can contract away. IE you may not completely

contract away the duty of loyalty you may limit the duty of loyalty to a reasonable limit.o R: Court will give deference to a member agreement that falls outside provisions of

statute, so long as it is reasonable.

POORE V.FOX HOLLOW ENTERPRISESR: An LLC requires representation by legal counsel in court proceedings.

Mr. Cambell wrote a brief for Fox Hollow.

This is more like corporation b/c members represent shareholders (artificial entity) than like apartnership when partners are not distinct.

Check the BOX:

May elect the S corporation treatment under the check the box in order to have pass throughtreatment while avoiding the complexities of subchapter K

Asset protection: you dont have to organize the LLC to be for profit:

You dont have to be a profit making enterprise

You have protection from creditors. To the extent of a charging order. Ie the owing of thevacation house.

Create a Single Member LLC SMLLC: then you cant touch the vacation home. When does a Limited Liability get pierced and when doesnt it? No case law on point as of now.

CHAPTER 6

THE FORMATION OF A CLOSELY HELD CORPORATION

A. Where To IncorporateSelection of a state to incorporate in involves two factors:

1) Cost of incorporation2) Advantages and disadvantages available under the state's laws of incorporation

Most practical is to incorporate in the jurisdiction where most business activities will take place- DE is the most popular outside jurisdiction

- If the corp. is incorporated in Delaware but wants to do business in FL then the corporationshave to get qualification and must put filings with the sec of state in Fl thus providing a wayto sue in FL. IF you are not qualified to do business may mean that you cannot maintain alawsuit in the state.


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- if the corp is closely held and its business is to be conducted largely or entirely within asingle state, local incorporation is preferred

- Delaware is a closely-knit legal community.- Normally unless you are going public then there is no specific reason to go to DE to

incorporate. Makes sense to incorporate in the state that you plan on doing business.- BUT Delaware has a sophisticated chancery business court!.

B. How To Incorporate: file art of incorp with the secretary of state and pay filing fee =corporation begins to exist.

In Florida: SunBIZ.org Forms that you can use to modify the corporation. Look up corporations Forms to amend the articles of incorporation Find articles of merge

Issues to be addressed: Whether substantive provisions should be placed in the articles of

incorporation, the bylaws, or a shareholders agreement Modern trend is to limit the articles of incorporation to provisions that are

required by law to appear in that public document while all other substantiveprovisions are placed in documents that are not filed of public record

but placing things in the public records gives legal notice to the world formal requirements for filing documents found in MBCA Section 1.20-1.26

Page 95 of the supplement tells you how

Chapter 1 forms the backbone of the Floridas laws.o Fees, filing requirements Dates and times and effectiveness.o 1.29o Look to 1.4 for definitions.

I. Corp Namesa. 4.01 Names:

i. Corp. name must be distinguishable upon the records of the Sec. of Statefrom other corp names

1. If your client comes in wanting to use the work gator in the name.Not available: Palm probably not.

2. Just because the sec of state allows the name does not protect againsta lawsuit by someone of a similar name under the intellectualproperty laws.

ii. Purpose of corp name regulation is to prevent unfair competitioniii. A corp may conduct business under an assumed or fictitious name to the

same extent that an individual may...test for the lawfulness of doing businessunder an assumed or fictitious name is that it is proper to do if the purpose isnot to defraud. The fictitious names are governed in another statute.

iv. 3.02 automatically grant every corp perpetual duration and succession in itscorp name, unless the Articles of Incorp provide otherwise.


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Exam Q: May a corp serves as an incorporator: YES! According to MBCA 2.01states that one or more personsand person is defined as an individual or entity and1.40 subsection defines that to be a corporation.

Preemptive rights and cumulative voting: statue says that you must put that rightin the articles. When the statute says where to put it whether it be the articles or the

bylawsthen you must do so! That which you put in the articles is a matter of public

record. That which you put in the bylaws is not public record.II. 2.02 Articles of Incorporation: Must versus May

a. The name for the corporationb. 6.01: The number of shares and type of shares (common/preferred) that it is

authorized to issue: this total number of shares may not exceed this number except byamendment to the articles. I.e. going public.

i. IE authorized to issue 200 shares of common stock par value of $1.00 pershare. You have A B C D as owners who have a prescription of shares perowner (here they have equal shares). 10 shares each. And are authorized toABCD and are outstanding

1. What is the number of shared authorized? 100 what is the numberissues and outstanding? 40 and are so because they are voting shares.

2. Each of ABCD has a of the shares. This board of directors canonly issue up to 100. What if they want to authorize 40 to E. Thenthere are 80 shared outstanding and issued THUS diluting theownership percentage. Now the ABCD only own 1/8 of the interest

ii. They authorize 1,000 shares and ABCD all have 10 shares. And E has 400shares. SO the percentage interest ABCD is 10/440. thus DILUTED! Thenumber of shares authorized also sets the limit which is the ultimate limit ofthe dilution of the ownership interest.

iii. You cant issue more shares unless you authorize more shares throughamendment to the articles of incorporation.

1. If you want to create different classes of sharesi.e. voting and nonvoting or preferred stock, or preference on liquidation or non

preference. You must describe them in the articles.2. i.e. stating series A preferred, par value, has liquidation preference of

$100 per share, and has a preference on dividends of $10 per sharecumulatively. You must describe them and not just state that thereare 1000 shares of preferred. Must be in the articles.

3. BLANK check provision: BOD can write into art of incorp amountof stock they are willing to sell to investor for an incentive. They areflexible to come up with what that venture capitalist wants if they aregoing to invest in the company.

4. 6.03 issuedc. Street address of corps registered office & name of its initial registered agent at that

office

d. Name and address of each incorporator.III. Purposes:

a. 3.01: not required to include purpose class unless limited.


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b. Corp. may list multiple purposes without any limitation on the number of purposesspecified and without any obligation that the corp actually pursue all the purposescontained in the articles

c. Several reasons why want a narrow purpose:i. Some types of corp may be engaged in businesses subject to state regulation

that permits incorp under general business statutes but requires limitations on

corp activitiesii. Founders may be uncomfortable with the complete lack of useful info about

the purpose of the corp permitted by the MBCA, preferring that somedescription of the principal business of the corp appear in the articles ofincorp

iii. In closely held corp, a limited purposes clause may be used where one ormore persons interested in the corp wish to restrict the lines of business thecorp may enter

III. Powers 3.02 Must distinguish between powers and purposes within the articles of incorporation Easiest way to do this is to precede each statement with the phrase to engage in the business of

when stating purposes. It is not necessary to make any reference to corporate powers in the Art. Of Incorp.

CHAPTER 5

Registered office and registered agent1. All about service of process.2. Having both a registered office and agent ensures that every corp has publicly stated

a current place where it may be found for purposes of service of process, tax notices,etc.

3. Agent must give written consent for a change.4. Solve the problem by making an attorney the registered agent so that he can receive

all important documents and deal with them accordingly

5. Bylaws of a corporation constitute the internal set of operating rules for thecorporation

1. Prepared by an attorney overseeing the formation of the corp2. Can someone resign? Yes but must also file it with the sec of state

and replace someone newPrepare the bylaws

i. WHERE AND WHEN the annual meetingii. What are the office positions going to be

iii. BY-laws are able to be amended by the board

DECLINE OF THE DOCTRINE OF ULTRA VIRES: ONLY IMPORTANT ON THE BAR EXAM

a. Beyond the powers: An act performed w/o the powers orpurposes of thecorporationit lacked power to do the act or enter into a K.

b. Traditional CL: was a defense.


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c. Modern: no defense: art of incorp usu., authorize corp to undertake any legal action, theultra vires doctrine has limited significance & is in decline.

d. Pursuant to law or its articles of incorporatione. When a corporation does act or enters into a contract beyond the scope of its charter, it is

not necessarily illegal and it is not necessarily void INSTEAD its voidable.f. The legislature would then have to enact a statute to over come this problem.

711KINGS HIGHWAY CORP V.FIM'S MARINE REPAIR SERV.,INC1966 The art of incorp that D was in business of marine life. D entered into a 15-year

lease to build movie theater. Defaulted on payment. P sued. D raised ultra viresdefense alleging it was outside the scope of its charter.

Where as the common law stated that unless it was within the purview of thearticles, the Statue says that the doctrine of ultra vires is limited in its use.

Finally the second point made is that the defense may not be invoked as a swordin support of a cause fo action.

Modern trend: ultra vires is NOT a defense.The decline of the Ultra vires: look to 3.01 purposes: which states that no matterwhat.

Theodora Holding Corp. v. Henderson -- Charitable Contributions

Rule of law: a majority stockholder may cause a charitable contribution to be madeout of corporate funds if such charitable gift is within reasonable limits as to amountand purpose

The test applied in passing on the validity of any corp gift is that ofreasonablenessfrom IRS.

When a corp makes a gift of corporate property or funds, such transactions can raisean ultra vires issue.

Question is whether the gift is reasonably necessary to furthering a valid corp

objective

PREMATURE COMMENCEMENT OF BUSINESS

1. Promoters 2.04a. Promoter: a person who, acting alone or in conjunction with 1 or more persons, directly

or indirectly takes initiative in founding and organizing the business or enterprise of anissuer. Often referred to as the founder or organizer or an enterprise.

b. Owe significant fiduciary duties to other participants in the venturec. Boss Rule: A promoter though he may have assumed to act on behalf of projected

corp and not for himself, will be personally liable for the K unless other party

agreed to look to some other person or fund for payment.d. Adoption and ratification will not let the promoters initial obligation go away.e. Only time promoter is off the hook is when there is a novation in which there is a new K

with a new party.


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f. Corp is not liable for promoters K unless it expressly ratifies or adopts it.g. Newly formed corp can disaffirm Ks entered into by promoters based on theory that BOD

has not voted on it.2. Co-promoters

Fiduciary relationship exists between co-promoters.

3. Corporation itself Must be done after corp has come under the control of subsequent investors or

other persons

FOUR THEORIES: ABOUT AGREEMENTS PRE INCORPORATION

When a promoter makes an agreement with another on behalf of a corporation to be formed, thefollowing alternatives may represent the intent of the parties:

**A corporation not yet formed means promoter liability

1) Understanding that the other party made a revocable offer to the non-existent corp which willresult in a K if the corp is formed and accepts the offer prior to withdrawal.

- Revocable offer: does not mean a K not enforceable (no one bound)

2) Understanding that the 3d party is making an irrevocable offer for a limited time. Considerationto support the promise to keep the offer open can be found in an express or limited promise bythe promoter to organize the corporation and use his best efforts to cause it to accept the offer.

- There was a 3rd party, corp to be formed, and promoter- Revocable offer bw 3rd party and promoter (not enforceable)- Could also say there was a K to form the corp (irrevocable for a limited time)

3) May agree to a present K by which the promoter is bound, but with an agreement that his liabilityterminates if the corporation is formed and manifests its willingness to become a party. Therecan be no ratification by the newly formed corp, since it was not in existence when the agreementwas made.

- Between 3rd party and corp to be formed

Novation: when you substitute a party in a K. In order to have a novation, the other partymust agree.- If it was a novation, liability to the promoter ends, when new party becomes part of the K

4) May agree to a present K on which, even though the corp becomes a party, the promoter remainsliable either primarily or as surety for the performance of the corps obligation.

- Adoption Ratification- Promoter makes a K with the 3rd party, and the formed corporation adopts the K. -

irrevocable.- Corp adopts the K of promoter and 3rd party, but the promoter remains liable. (secondary,

like a subtenant).

Revocable offer: parties understand that promoter will not be liable and the corp will only be liable whenits formed. Condition precedent. May be quantum meriut.

Irrevocable offer: parties understand that the promoter is binding himself until the corporation is formed.


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Present contract by which the promoter is bound: NOVATION: substitution of a party entirely becauseit is a new contract. the third party has to agree to the substitution of liability. There can be no ratificationb/c the corp was not in existence at the time the agreement was made.

Present contract: both corp and promoter are liable.

PROPER EXECUTION:The name of the corporation BY ____ the name of the promoter

McArthur v. Times Printing Co

R: formal adoption or acceptance of a contract by a corporation Is not a requirement, but

acceptance may be inferred from acts or acquiescence on the part of the corporation or its

authorized agents

DEFECTIVE INCORPORATIONCorporationde Jure (at law): Corporation formed under law.

Corporationde facto (by fact): an appearance that corporation is formed.1.Requisites established by the Supreme Court to establish a de facto corporation.

1) Valid law under which such a corporation can be lawfullyorganized

2) An attempt to organize under that law.i. What is an attempt? You must try to file with the

secretary of state. It is more than just writing the art ofincorp. You must put them in the mail or send bycourier.

3) Actual doing business as a corporation.4) Good faith in claiming to be in, and, doing business.

Note: You can assert that you are a de facto corporation against anyone but the state.

Corporation by Estoppel: if a 3rd party deals with what it believes is a corporation, then the 3rd partywill be estopped from denying there is not a corporation. Usu., the person estopped is the person acting.

ROBERTSON V.LEVYR: officers and directors who attempt to act for a defectively formed corporation or prior to its

formation are jointly and severally liable for those acts

CANTOR V.SUNSHINE GREENERY,INC.R: one who deals with a de facto corporation as a corporation is estopped to deny its existence in

an attempt to hold those with whom he dealt personally liable on its contracts

CRANSON V.INTERNATIONAL BUSINESS MACHINES CORP.-Doctrine of estoppel: where the person seeking to hold the officer personally liable has contracted orotherwise dealt with the association as a corporation.


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ISSUE SPOTTER:If the person believes there is a corporation: De facto and estoppel:If the person is acting before then look to promoter liability.

CHAPTER 7DISREGARDING THE CORPORATE ENTITY


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BOD = board of directors, S/h = shareholders, BJR = bus judgment rule 22

COMMON LAW DOCTRINE OF PIERCING THE CORPORATE VEILA court may pierce the corporate veil and hold owners liable for corps debts. Piercing the Corporate Veilrefers to extreme situations where some or all shareholders will be personally liable for corporationsobligations.

TESTS TO PIERCE

Alter egoMere instrumentalityFraud illegality

Reasons topierce corporate veil:1. Prevent fraud, illegality, misrepresentation, or2. Achieve equity

Factors to consider for piercing corp veil:1. Undercapitalization (depends on nature of specific business)2. Failure to observe corp formalities (ex: if not holding meetings then one

person is really running corp and not really a corp)3. Non-payment dividends.4. Insolvency of a corporation.5. Siphoning of corporate funds by a dominant shareholder.6. Corporation is a faade of the dominant shareholder.

One of the key attributes of the corporate form is limited liability Cane - Piercing is the exception, not the rule. The rule is that corporations limit liability and theburden of proof is on the party trying to pierce.

DEWITT TRUCK BROKERS V.W.RAY FLEMMING FRUIT CO.(4THCIR.1976) In this case, the Dewitt is the shipping co., who is suing Flemming in their capacity as a creditor ofthe corporation. The Corporation was withholding the transportation costs and running it out of hisback pocket. Thus he was not treating the corporation as a separate entity. There was no meeting therewas no observation of corporate formalities. Court looks at equity and fairness to see if subsidiary is mere instrumentality or alter ego - theresno real separation between the person and the corporation. No fraud required. The corporation is notreally there, because it is just himself or his evil twin Skippy, there was no distinction between the two.

Factors of which courts may consider any number:a. Undercapitalization for purposes of corporate undertaking.

i. If you are running a business with less then what it takes torun the business. Doesnt mean sufficient assets to satisfyevery claim, but enough to run the business withexpectation of some liability.

b. Failure to observe corporate formalities.Evidence of treating it asa separate entity

c. Non-payment of dividends.d. Insolvency of debtor corporation at the time.e. Siphoning of funds of corporation by dominant stockholder. Merged

funds. Interchangeable between the individual and the corporation.f. Non-functioning of other officers and directors.g. Absence of corporate records.h. Element of injustice or fundamental unfairness required.


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i. The court will look to the circumstances, and not just to one singleelement to achieve their decision.

Note: Piercing is entirely a phenomenon of closely held corporations, and predominantly one-personcorporations. Here the Court found that this was just an alter ego and mere instrumentality.

BAATZ V.ARROW BAR (SD,1990)TORT CASE

Piercing is allowed to avoid injustices and inequitable consequences. This is the tort case.Concerning a car accident. The individuals are not held liable in the majority because it wouldproduce injustices and inequitable consequences of piercing the veil.Note: Courts are more likely to pierce in tort cases than in contract cases.

Voluntary Creditor Doctrine - in a contract case, there is the opportunity to look into the credit of acorporation or bargain for personal guarantee. In tort, such opportunity for the plaintiff/creditor/victim toprotect themselves.

RADASZEWSKI V.TELECOM CORP.(8THCIR.1992)=A tort victim may not pierce the veil of a sub to reach the parents assets when the sub has liability insuranceadequate enough to cover victims injury, when sub is otherwise insolvent, regardless of whether victim canrecover under insurance.

Choice of Law is determinative because different states have different tests for piercing. Federal courts,throughErie, will apply state law.

FLETCHER V.ATEX,INC.(2NDCIR.1995)In order to hold a parent corp liable for its subsidiarys conduct under thealter ego theory, the P hasthe burden to prove that:

1. The parent and subsidiary operated as a single economic entity and2. That an overall element of injustice or unfairness is present.

Note that fraud is not a required element!

THE PIERCING DOCTRINE IN FEDERAL/STATE RELATIONS

UNITED STATES V.BESTFOODS (S.CT.1998)DIRECT LIABILITY The fact that a parent corporation affects the operation of the business of the subsidiary is notenough. There must be a domination and control of the subsidiary. Here, you need specific control of the subsidiary and not just general control for normal piercing

Control Test:2. Active involvement3. Actually exercised control over the subsidiary immediately responsible of the acti

STARK V.FLEMMING (9THCIR.1960)social security benefits --nothing useful.

ROCCOGRANDI V.UNEMPLOYMENT COMP.BD. OF REVIEW (1962) If youre self-employed, you cant lay yourself off. Court will ignore the existence of your

corporation. The Superior court corporate entity may be ignored when determining that as a matter of

public policy they had the control to lay themselves off and they had the power to not laythemselves off.

REVERSEPIERCING

The owners of the incorporation desire the veil to be pierced and want to be individuals.


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CARGILL,INC. V.HEDGE (MN,1985)BANKRUPTCY HOMESTEAD EXEMPTION.Factors the court considered:

A. Degree of identity between individual and his/her corporation.B. Extent to which corporation is an alter ego.C. Whether others, such as creditor or other shareholders, would be harmed by

the pierce.D. Policy reasons. Ex: furtherance of homestead exemption.

HYPO:A, B, C, D Corps are in the business of construction. Fred is an employee of D corporation and was injuredby the crane that was not owned by D corporation. Workers compensation means that I cannot sue myemployer for tort, I must work within the workers compensation statutes. If Fred was injured by the craneowed by D corp and was an employee of D corp she would be limited. But if A corporation (which is allrelated to B C D) Is the one that owned the crane, then she should be able to sue A in tort, and not in workerscompensation.Reverse veil piecing fits into this because we represent A corporation and its affiliates. We want to say thatABCD are all one big happy family and thus make all the corporations the same thus workers comp applies.

PEPPER V.LITTON (S.CT.1939)Pepper is a 3

rdparty. Litton is the sole shareholder of Dixie. Litton paid himself for back pay, he

did that b/c he knew that creditors were coming after that debt. As a result, the back pay made the corpinsolvent.

A. Deep Rock Doctrine - a dominant-controlling shareholder will have his claim against thecorporation subordinated if he abused his position to make his claim come ahead of other creditors.Its a matter of equity. Equitable subordination of controlling s/hs claim.B. The test is a violation of fair play and good conscience; a breach of fiduciary standards ofconduct owed to your corporation, its stockholders, and creditors.

Florida Veil Piercing

DANIA JAI-ALAI PALACE,INC. V.SYKES (FL,1984)Alter ego & mere instrumentality adopted. Supreme ct said that it is not alter ego.Fraud -----improper conduct ------alter ego.For purposes of pleading in complaint, in Florida to pierce the corp veil you must allege improper conduct.Problem: No set definition for improper conduct. If you dont plead it, then it is dismissed.Piercing may be granted if you prove Improper Conduct, on part of parent. Its conduct worse than in thealter ego test, but better than fraud.

CHAPTER 8

FINANCIAL MATTERS AND THE CLOSELY HELD CORPORATION


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DEBT AND EQUITY CAPITAL

BONDS VERSUS PROMISSORY NOTES.

What makes bonds more & less valuable? Pricing of bonds depends on risk involved. Bond rates onbased on how solvent and steady the company is. Risk is built into price of bond in form of interest.

JUNK BONDS (HIGH RISK, HIGH YIELD, HIGH INTEREST)

CAPITAL MAY BE OBTAINED BY:1. Borrowing funds (from friends or banks)2. Capital contributions (from owners or persons who wish to remain inactiveoutside investors)3.Retaining earnings of the business (rather than distributing them to owners)

Debt: must at some point be paid back; interest is paid periodically, and its repayment is not dependent onthe earnings of the business.

Equity Capital is composed of contributions by:1. The original entrepreneur(s)2. Other investors in exchange for ownership interests3. Retained interests

Blue Sky Laws: State statutes that regulate the sales of securities within the specific state. Applicablewhenever a business seeks funds a.k.a. capital from 3rd partiesno limit as to amount.

TYPES OF EQUITY SECURITIES

Common shares: represent residual ownership interest; they get whatever is left over after creditors,

bondholders, and preferred s/hs are paid. They generally have voting rights but not dividends.

Preferred shares: hybrid b/w debt and common stock. It has a preference on dividend versus liquidation.Traditionally not sold publicly, thus preferred stockholders would want conversion rights in articles of aclosely held in order to convert their preferred to common if corp goes public.

Three types of preferred dividends/shares:1. Cumulative preferred: if dividends not paid in year 1 they rollover into year 2.2. Non-cumulative preferred: if no dividends paid in year 1, too bad.3. Partially cumulative: depends on financial status of corp.

Debt Financing Equity Financing

Contractual r/s involving promissory notes orbonds that involve a promise to repay theinvestors loan at a certain rate of interest.Exception: bankruptcy but you can get a

charging order and

Buying stock.

Risk is low b/c its a contractual r/s andguaranteed your $$ back.

Risk is high.

Reward is lower for bonds b/c its a fixedamount & interest rate.

Reward is higher b/c value of interest goesup.

Law and contracts protect bondholders. Stockholders are protected by fiduciary r/s.


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Ex: if dividends not paid in year 1 and corp had adequate earnings to pay in year 1,then it rolls over into year 2.

NOTE: if you have preferred stock, corp CANNOT elect to be an S corp.

Participation Rights: if corp pays out dividends to preferred and common and there is surplus in dividends,

then preferred and common share.Non-participating: entitled to specified amount for dividend and liquidation and nothing else.

Shares: (defined in MBCA 1.40(21) as the units into which the ownership interests in a business aredivided)

There may be different classes of shares They may have different preferences, They may have different limitations and relative rights. There may only be one class issued and they may be called:

1) Common shares,2) Capital shares,3) Shares, or4) Stock.

All shares w/in a single class must have identical rights.Various designations and rights of shares must be set forth in the art of incorp (MBCA 6.01).

USHOUSING FOUNDATION,INC. V.FORMAN,421US837: enumerates the rights of Common Shareholders:1. Right to receive dividends2. Negotiability3. Ability to be pledged or hypothecated4. Capacity to increase in value and5. Voting rights in proportion to the number of shares

owned.

Redemptionrights: corporation has the power to redeem or call back the preferred shares at any time at afixed price when corporation anticipates that dividends on preferred may become more expensive than otherforms of financing.

The fixed price is usually set by the art. of incorp., or typically more than the liquidation preference.Redemption can usually only be exercised after a specific amount of time. Ex: If the corporation calls back the stock and the stockholder has a $100 liquidation preference, thefixed price of the redemption would probably be $105 + any unpaid cumulative dividends. If thestockholder refuses, the corp will simply put the $105 in a bank and refuse to recognize the stockcertificate.

Classes of common shares (MBCA 6.01)Classes of common shares are usually referenced alphabetically, i.e., Class A common shares, or bydescription, i.e., nonvoting common shares.

ISSUANCE OF SHARES: HEREIN OF SUBSCRIPTIONS, PAR VALUE AND WATERED STOCKShared subscriptions and agreements to purchase securities (MBCA 6.20)

Historically, subscription agreements were utilized to raise capital for a new corporation. Subscription agreements: occurs when persons agree to purchase a specified number of sharescontingent upon a specified number of capital being raised. Now, we use (mostly) Contractual Agreements to purchase securities.


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AUTHORIZATION AND ISSUANCE OF COMMON SHARES UNDER THE MBCA Prices for shares must be the same for, say A and B shares ifthey are to be treated equally, butthe # of shares and corresponding price may be set at any level.

PAR VALUE AND STATED CAPITALPar value: represents amount that must be paid for shares so that they are issued as fully paid.

Par value is a may in RMBCA 2.02(b)(2)(iv). Par value does not apply to re-sale only applies to issuance. MBCA (1969) 54(d), 15 (second sentence), 18, 21. Par value is whatever amount is designated by the drafter could be one mill, one cent, etc. If you issue stock for less than par value then you are liable for difference for what he paid forit and what the par value actually is. Watered Stock: stock issued for less than par value.

o Two issues:1. Non-cash consideration given for stock

i. BOD gets deference, absent fraud, to accept but hasfiduciary duty to assure that property is equivalent toshares issued.

2. Stock issued for less than par value for cashinstant liability. Reasons in Florida to have the par value nominal, or low is because of the MBCA state in addition tothe documentary stamps that must be put on all documents. The Doc stamp tax is based on the parvalue. If you dont put a par value on the corp, then it is the documents transactional value. Thou shall not issue less then their par value. Thou shall not issue for illegal consideration. Thou shall not hurt creditors to advance interest of s/hs and s/hs economically. 45(MBCA) talks about dividends. You cant pay dividends to s/hs if creditors would benegatively affected by it.

HANEWALD v. BRYANS INCR: A shareholder may be held personally liable to his corporate creditors to the extent that his stockhas not been paid for. MBCA 25. Purpose is to protect the public and those dealing with the corporation.

The shareholder is liable to the extent of the difference between the par value and the amountactually paid and to such an extent only as may be necessary for the satisfaction of the creditors claim. Shareholders loan is a debt and not an asset of the corporation. Here the corporation

repaid a loan to the shareholders before its operations were abandoned, the loan cannotbe considered a capital contribution.

Traditional Rules1. Insolvency: look at what money you have, types of assets, what money you owe, and when the debts

are due. When you are looking at balance sheet for purposes of declaring and paying a dividend &when corp is repurchasing shares from its own s/hs (s. 6). You cannot pay out a dividend to s/h indetriment of creditors. A, B, C & D are s/hs.You may not pay or declare dividends if it makes corp insolvent.

2. Surplus Lesser: you can only re-purchase and/or you can only pay dividend out of therestricted/unrestricted surplus.

2 DefinitionsStated capital: # of shares x par valueCapital surplus: difference in amount paid per share minus par value (x) # of shares.Earned Surplus: the aggregation of income from all profit and loss s/ts going back to the time the corpwas organized (i.e. amount of $$ corp has made since its inception).


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New ruleEx: Insolvency by looking at Balance SheetAssets LiabilitiesCash ($500) Account payable (A/P) - $100Building ($500) Note due in 2050 -- $400

EquityStated Capital10 shares @ $1 per shareSurplus -- $490

______________________________$1000 $1000

500 cash100 A/P = 400.Surplus is 490Surplus is total assetstotal liabilitiesstated capital.

Take lesser of two, which is the 400. So corp can only spend up to 400.1stpart of test to make determination if corp will go insolvent:

What are the liquid assets and what are current liabilities?

Modern Rule Distributions 6.40P.123, 106

s. 1.40(6) defn of distribution1) Insolvency Test liquid assets (-) accounts payable = gives you surplus.And2) Modified balance sheetTest: total assets(total liabilities + preference) = equity.FN in balance sheet will tell you if there is a preferred class and what the preference per share is.

Always take the lesser of the two no matter what test you apply: traditional & new.

TORRES v. SPEISERThere was a resale of stock in exchange for future services as consideration.R: Watered stock only arises in connection w/ original issuance & any subsequent re-sale is NOT

governed by the par value.

R: Liability for watered stock arises from initial issuance of stock in a NEW corp for less than par

value.

45: The BOD may declare and pay dividends, EXCEPT if that payment would create insolvency, asstated in 2(n).

Assets: General R: for the purpose of insolvency:Is there a sufficient amount of cash such that ifI pay the dividend may I still be able to pay my creditors, so that I am not favoring shareholders overcreditors.

Treasury shares: MBCA 2(h)

If you double the amount of shares then you should half the par value:Stock split means that the # of shares issued and out increases but the proportional amount of shared hasremained the same. It just changes the number of slices in the pie.The real reason as opposed to the legal capitol.. IT happened in the public market place, for psychologicalreasons. 2 for one split where if your shares were worth 100 you would reduce the cost per share to 50 and


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you now own 2 thus you havent changed what you own. Thus psychologically it is a good thing for yourshareholders. But what happens is that it might increase about a buck.Reverse Stock Split: you now have half as many shares. The assets and liabilities have not changed. Thepie is just split into smaller pieces. On the equity side you either create surplus when you dont change thepar value. By monkeying around with the number of shares you increase the surplus. THE importance is thedividend or the repurchase, and the surplus would be more! The most common reason is that the stock is

trading too low! So psychologically the reverse split so that for every two shares you now have 1 share and ittrades at 20 bucks a share.

DEBT FINANCING Debenture is an unsecuredcorporate obligation. Bond issecuredby a lien or mortgage on corporate property. Traditionally, debentures and bonds were payable to bearer and the interest was kept track of by wayof interest coupons, which were attached to the debt security. The owner would clip, or cut off thecoupon and submit it to the corporation for payment. A registered bond is one that has been registered in the name of a specific individual.

Why a corporation does debt as a manner of financing.

THECONCEPT OF LEVERAGE Leverage: Debt owed to third persons is leverage when you earn more than the cost of borrowing. Leverage = other peoples money; earn more than cost of borrowing. So if its costing 8 percent toborrow and you can take that money and earn 15 percent, that is where you get leverage from. Past abreak even point. Leverage is favorable to the borrower when the borrower is able to earn more on the borrowedcapital than the cost of the borrowing.

TAX TREATMENT OF DEBT A loan by a shareholder to his corp. reduces the double tax problem of a C corp. Interest on debt is tax deductible. Risk of business formulation = contributors of capital undertake the risk because of the potentialreturn in the form of profits and enhanced value on their underlying investment. If the IRS reclassifies the debt as equity then it is no longer deductible because it is now seen as adividend. If you are a creditor and you use your position as a director (like in pepper) you would have aninsubordination, which is not good!

DEBT AS A PLANNING DEVICE Subordinating equity concept is the same as the deep rock doctrine at a state level.

Debt/Equity Ratio: Problems: (1) If you have a lot of debt over equity, IRS may reallocate back to equityside. This means interest you thought was being paid will become dividends subject to tax and it is notdeductible. Varies depending on type of business you have. (2) Amount of insider debt to insider equityhow much do s/hs of corporation own as creditors.

If high ratio then there is a problem under deep rock doctrine.

PLANNING THE CAPITAL STRUCTURE FOR THE CLOSELY HELD CORPORATIONQuestions to ask when approached by a client for purposes of the capital structure:

1. Will the structure stand up when later faced with disagreements? I.e., a legal attack?2. Will the structure provide the desired result, i.e., the client should be aware that the directors may

choose to forego dividends on the preferred stock if they so choose?3. Is the desired tax treatment available; C or S corp.?


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4. Unexpected liabilities?5. Clients financial contributions reasonably protected?

NOTE: watered stock issuing for less than par or improper or illegal consideration.1. The stock is issued for future consideration thus it is watered stock

Problems on page 387Watered stock: Issued at less than par value & no future consideration allowed.

Securities Act regulation: Prior to 1933 no securities laws.The regulation was governed by the stateregulation of the sale of stock called the BLUE SKY LAWS (securities law in every state). Both systems stillexist. Must deal with these problems on both levels. 1933 Act: how you may lawfully sell securities. Key toAct is s. 5 that says: thou shall register. Registration is required unless there is an exemption.

Underwriters: investment bankers; they buy the stock from corporation and sell it to public.

Public Offerings

Securities involve state and fed laws

Going PublicNegatives of going public:

1. Cost is high2. Regulation3. What was private is now public4. Quarterly financial statements are required so the world could see how its doing.

- You have a company, and the company wants to get money (could get from bank, but wants a certainamount of capital) and wants to build another factory (company 2)

- Comp 1 goes to the underwriter (investment banker)- Figured out it needs 75 million for IPO. Underwriter forms asyndicate to say that there are enough

people who would want to buy stock.- Public distribution: process of getting stock from issuer to public. Underwriter prices the stock!- The co and counsel with underwriterregistration statement (will be filed with SEC)- Piggy-backing registration: when closely held corp is thinking of going public instead of selling entire

stock to underwriter, s/hs will keep some for themselves and just give underwriter share of profit.

1) Pre-fileQuiet periodpre-filingb/c you do not want to predispose people to buy

2) File (waiting period)You filethen you are in the waiting period, b/c you are waiting for the SEC to give you comments

3) EffectiveSEC will declare your registration effective

- can do this by prospectus

UnderwritersThe person/organization that acquires shares for resale or who arranges the direct sale of shares by the issuer.

1. Usually a firm commitment


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- Means that on the day you go effective that the underwriter will be you the co real money then up tothem to sell the stock thru the distribution channelthe syndicate. They usually take a mark up of15%.

- the co gets what the co Ked for and the underwriter is on the hook.- The pricing of the security determined the day it offered.

2. Best Effort UnderwritingWhat we cant sell, you get back

If the IPO price is $25 dollar per share it means the co is being compensated on this price.If after effective price goes up to $75 per share. This does not go to the co, b/c it is in the market.The co is locked in at the IPO price for that stock.

The amount it goes up or down has nothing to do with the cothey dont care

The magic of going public is that you have created a new form of currencyOnce you (the corp) have gone public, you can use shares of stock that the company owns to buy thingsinstead of cash.

Blue Sky LawsState securities law.Focus disclosure and regulation of securities. Needed because people were selling anything up to the BlueSky.

Securities Act of 1933:First fed regulation dealing with securities laws.Deals w/ the sale and distribution of securities.

Securities Exchange Act: of 1934:Deals with how securities are traded after sale and distributionTWO VIEWS:

1. Full and Fair disclosure: Congress opted for disclosure because investors are adequately protectedif all of aspects of the securities being marketed are fully and fairly disclosed. All material facts w/omaterial omissions permit you to sell shares.

2. Merit regulation (paternalistic view): state looks at offering and decides whether its worth ofinvestment.

Fed acts do not necessarily preempt state securities laws.

Securities Act of 1933:- When you are going to disseminate securities publicly you have a document that must be filed with the

SEC(independent regulatory agency of the fed gov). Other part of this act is about fraud. Actionable in addition to failure to register. e.g. material omissions

General Rule: Federal Registration 5: Thou shall register (give SEC prospectus and other info)

- Requires registration of a public issue that is offered or sold through the use of anymeans or instrument of transportation or communication in interstate commerce of themails 0 includes phone, e-mail, fax.

- Prospectus: a document that contains the info essential to make an informed investmentdecision. Ex: financial information, senior mgmt, etc.

- You have to register unless an exemption applies.


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- Failure to register unintentionally (mala prohibitum): purchaser gets stock back plusinterest and subject to civil liability.

Exemptions 4(2): Private Placement: corp selling stock to make capital before it goes public. You dont

have to register.You do not have to register transactions not involving public offerings (Ralston Purina)

- In a private placement, the info never gets to professionals, because the potentialinvestors are educated enough to understand.- Guideline for the cts is whether or not the people in the private placement would

have the necessary expertise to make an informed decision. (e.g. top levelmanagement would, but not production line workers).

- Look at (1) who the offeree and (2) what info is available to offerees to make aninformed decision.

3(a)(11): Intrastate Offering:Exempts any security which is a part of an issue offered and sold only to persons residentwithin a single state, where the issuer of the security is a person resident and doing businessin, or if a corp, incorporated by and doing business within the state,

- Basically, a one state offering. An offer to a single non-resident destroys theexemption.

- Purchaser cannot act as aconduit to out of state investors in order to getexemption and issuer has a duty to inquire where purchaser resides.

- Even if there is a purely intrastate offering, this does not mean you are exemptunder state Blue Sky Laws.(So, you would also have to look at the state statutes to see if you are exempt fromregistering within the state.- If a corporation seeking to take advantage of the non-public offering exemption

inadvertently makes one offer to a person who needs the protection of the SecuritiesAct loses the exemption and full-scale registration is required.- Intrastate exemption is limited in FL, because everyone is from different places

- Rule 147 provides objective standards for determining when a person is considered aresident within a state, and the doing business within requirement that the businessshould be located within the state (and the principal business must be carried on there)and substantially all the proceeds of the offering must be put to use within the local area.

12: Failure to register gives purchaser right to tender back plus interest

SEC v Ralston Purina Co- Tried to encourage stock ownership among employees. They did not register bc they saidthey were not offering to the public as a whole. They said key employees. (Would havebeen ok for managers who had access to info and knowledgeable)

- Exemption to though shall not register is if not public- Financial analysts also gets prospectus. In a private placement, the info never gets toprofessional- Ct said this was not an exemption under non-public offering, so had to register.- If not registerget to sell back to co with interest.

An exemption from registration NEVER frees you from anti-fraud concerns under securities laws.


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The burden to prove all elements of the exemption is on the issuerIf no exemption, everyone who purchased can give back securities and get money with interest.

How the 33 act works:Sec 11 provisions creates liabilitySays that if the underwriter did not act withdue diligence to determine that there has been no misstatement

in the registration statement, they have liability.

- Can find filings under EDGAR (sec.com): best way to get original info on stock

Administration Rules Promulgated by the SECRegulation D -Rules Governing the Limited Offer and Sale of Securities Without Registration Under theSEC of 1933

- These are exemptions from 5 - thou shall register.- (More popular exemption - a series of safe harbor exemptions)- 3(b) of SEC act of 1933- SEC may promulgate rules as long as they are in the interest of the

investment protection. - 3(b) gives no exemptions, SEC does in the rules (b/c congress letthem decide what to exempt).

- Was to facilitate capital formation consistent with the protection of investors.230.504-506 are the operative provisions (the actual exemptions)

1. There is NEVER exemption from anti-fraud requirement (information is missing essentialmaterial).

2. Still have to worry about state Blue Sky laws

230.504 Exemption for Limited Offerings and Sales of Securities Not Exceeding $1,00,000- Aggregate offering price shall not exceed 1 million dollars sold within 12 months before start of and

during the offering of securities.- Must wait 6 months to avoid integration problem.- Governed by state rules.- What this rule is about is that the SEC says that these deals are too little for them to worry about, even if

interstate (can raise a million dollars without registering).- Still must comply with the state Blue Sky laws you are offering in. No investor CAP but could be if

doing a deal w/ another state.If you were doing a 504 deal in OH and ILL, would have to look at their Blue Sky Laws

9 mths504 504500,000 500,000

230.505 Exemption for Limited Offerings and Sales of Securities Not Exceeding $5,00,000- This is another 3(b) exemption- Aggregate offering pricecannot exceed $5,000,000 within 12 months before start of and during the

offering of securities.

- No more than 35 non-accredited investors (regular people & family members).- No cap on accredited investor (ex: institutional investors to millionaires).- Issuance of stock is Restricted securities: sold outside the registration process and must be held for

ONE year otherwise purchaser is considered an underwriter.- Quid pro quo: quid = dont have to register; quo = you are restricted.- Paragraph (c) also states that there are limitations on the manner of offering in that the issuer may not

offer or sell the securities by any form of general solicitation e.g. TV, magazine, newspaper, seminar

230.506 Exemption for Limited Offers and Sales Without regard to Dollar Amount of Offering


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PRIVATE OFFERINGS SUBJECT TO SEC SAFE HARBOR CONDITIONS.(This is the SEC Safe Harbor Rule for private placements under section 4 (2) of the act, and is the mostimportant part of Regulation D). You can buy and sell as much as you want!!

a) Must meet 501:Accredited investore.g. bank, natural person whose individual net worth with spouseexceeds $1,000,000, individual income in excess of $200,000 or joint income in excess of $300,000 in 2

most recent years, director, general partner, executive officer of the issuer, and 502 (a): Integration:Offers made 6 months before or after Regulation D will not be considered part of the Reg D offering solong as there are no other offers or sales of securities in the same or similar class.

b) No more than 35 purchasers.c) Each purchaser who is not an accredited investor must have knowledge and experience in financial and

business matters to evaluate the merits and risks of the prospective investment.

- Factors that should be considered in determining whether offers and sales should be integrated forpurposes of exemption under Regulation D:

Whether the sales are part of a single plan of financing, whether sales involve issuance of the sameclass of securities, whether the sales have been made at or about the same time, whether same type ofconsideration is received, whether the sales are made for the same general purpose.

Private Placement memorandum(Preparation of this is essential for anti fraud purposes under 504, 5, 6- Warn person of the risks. And for anti fraud requirements- Contains all the info required in Reg D and states you are offering a contains risk factors up front.- State in the memo that this is the only thing the purchaser should rely on.

If you sell a security under 505 or 506 of Regulation D (issued in connection with the rules or the act), itis deemed a restrictive security.

- This involves a holding period: You have to hold (not sell) for a minimum of 1 yr.- If you want freely traded security, you have to register- If getting restricted stock, you cannot sell for a yr. Might want to ask for more stock e.g. from Ford. (or

get them to register (which is unlikely)

Calculation on Number of Purchasers for 505 and 506The following purchasers are excluded:- relative, spouse or relative of the spouse of a purchaser who has the same principal residence- Any trust, estate, or corporation in which a person or those related to him have more than 50% interest- Any accredited investor (so can have more than 35 unaccredited investors)

What a Security is:Any note, bond, treasury stock, stock, debenture, evidence of indebtedness, certificate of interest orparticipation in any profit sh

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