Business Associations Policy: agency is about bringing together work and capital. This is the foundation of all business associations. I. Principal/Agency Definitions: 1. Agent = one who has the authority to act on behalf of another. 2. Principal = person/entity that authorizes another to act on its behalf & subject to its authority to the extent that the P may be L for the actions of the A 3. Fiduciary relationship = when a person has a legal obligation to act for the benefit of another
A. Formation 1. What is Agency? Restmt 1- Agency is a fiduciary relationship that results from (1) the manifestation of consent by one person (the principal) to another person (the agent) that the other shall act on the principal’s behalf; (2) subject to the principal’s control; and (3) the agent consents to so act. a. Consideration is not required b. Intent to create agency relationship is not required c. Substance of relationship determinative; fact specific d. Examples of three prongs i. Skipper: “Gilligan, I want to you be my first mate.” ii. Skipper: “Gilligan, do it this way.” iii. Gilligan: “I will be your first mate” e. Policy reason: Social welfare- we do not want the principal to get the benefits of the agency relationship without also bearing the costs f. The three elements required to show the existence of an agency relationship include: (1) a manifestation by the principal that the agent will act for him; (2) acceptance by the agent of the undertaking; and (3) an understanding between the parties that the principal will be in control of the undertaking. 2. Ease of creating the principal/agency relationship a. A “principal need not exercise physical control over the actions of its agent” so long as the principal may direct “the result or ultimate objectives of the agent relationship” Green v. H&R
1 b. “when one…asks a friend to do a slight service for him, such as to return for credit goods recently purchased from a store” an agency relationship exists even though no compensation or other consideration was contemplated. Rstmt 2nd § 1 cmt. B 3. Cases a. Gorton v. Doty pg. 1: Doty offered the football coach the use of her car to transport team members but told him that he had to drive it. Coach was involved in a car accident, injuring Gorton. Was Coach an agent of Doty while driving her car? Court held that Coach was Doty’s agent. Prof did not agree that Doty consented to have Coach act on her behalf. Usually there is a benefit to the principal. Here, the court said the benefit was that Doty did not have to drive. i. Manifestation of consent that the other shall act on the principal’s behalf: “Garth, I want you to be my driver.” This is the most problematic. Court says that Doty didn’t have to drive. ii. Control: Doty told Coach he had to drive it, meaning that no one else could drive it. iii. Consent by agent: he drove it iv. Court was probably motivated by the fact that Doty had insurance v. What advice do you give Doty the next time she wants to lend her car to the team? a. GET THE ANSWER TO THIS QUESTION FROM LAURA OR THE AUDIO vi. Willi v. Schaefer Hitchcock held that ownership of car establishes a prima facie case against the owner b. Gay Jenson Farms v. Cargill pg. 7: Cargill entered into contract with Warren wherein Cargill loaned money to Warren, and Warren appointed Cargill its grain agent for one particular transaction, which ended. When Warren collapsed, the farmers sued Cargill, claiming they were Warren’s principal. Was Cargill liable as a principal on contracts made by Warren by virtue of its dealing with Warren? Court held yes. Cargill claimed that it was merely a creditor of Warren. Despite the terms of the contract, when the creditor assumes de facto control over his debtor, he becomes a principal. Prof thinks weakest link is that Cargill consented to working on their behalf; but all prongs are problematic i. Factors the court looked at A) Cargill’s recommendations to Warren by telephone; B) Cargill’s right of first refusal on grain; C) Warren’s inability to enter into mortgages, to purchase stock or to pay dividends without Cargill’s approval;
2 D) Cargill’s right of entry onto Warren’s premises to carry on periodic checks and audits; E) Cargill’s correspondence and criticism regarding Warren’s finances, officer’s salaries and inventory; F) Cargill’s determination that Warren needed “strong paternal guidance”; G) Provision of drafts and forms to warren upon which Cargill’s name was imprinted; H) Financing of all Warren’s purchases of grain and operating expenses; I) Cargill’s power to discontinue financing of Warren’s operations ii. Other definitions A) Supplier (Rstmt §14K: One who contracts to acquire property from a third person and convey it to another is the agent of the other only if it is agreed that he is to act primarily for the benefit of the other, and not for himself. B) Rstmst §14O: When does a creditor become a principal? Creditor becomes a principal at the point at which it assumes de facto control over the conduct of the debtor. iii. What advice do you give Cargill next time they want to work with a grain operator? GET THIS FROM LAURA OR THE AUDIO
FLOWCHART: First establish a PA relationship and then what kind of authority agent possessed.
B. Liability to 3rd Parties 1. Liability of principal for agent’s contracts (authority tests) a. Rstmt §144: a principal is subject to liability upon contracts made by an agent acting within his authority if made in proper form and with the understanding that the principal is a party b. Did the agent have authority to bind the principal to a contract? i. Actual Express Authority ii. Actual Implied Authority A) Rstmt § 35: Unless otherwise agreed, authority to conduct a transaction includes the authority to do acts which are incidental to it, usually accompany it, or are reasonably necessary to accomplish it 3 - incidental - usually accompany - reasonably necessary B) Mill Street Church v. Hogan pg. 14: The elders of the church hired Bill to paint the church, which he had done several times in the past. In the past, Bill hired his brother Sam to help. When he reached a difficult part of the church, he spoke to an elder about hiring a helper. The elder recommended a church member, but stated he might be difficult to reach. Bill hired Sam, and Sam injured himself while painting, Sam tried to sue church. Did Bill have authority to hire Sam as an assistant? Yes. Hiring Sam fit the usually accompany it prong (hired Sam in the past), and the reasonably necessary prong (high, difficult part of church). - read language pg. 15 iii. Apparent Authority - Focus on communication from principal to third party - Three kinds of principals: disclosed, partially disclosed, and undisclosed A) Rsmt § 8: Apparent Authority is the power. . . arising from [the principal’s] manifestations to . . . third persons B) Rstmt § 27: Apparent authority is created by . . . conduct of the principal, which, reasonably interpreted, causes the third person to believe that the principal consents to have the act done on his behalf . . . - must be some manifestations by principal C) Rstmt § 159: A disclosed or partially disclosed principal is subject to liability upon contracts made by an agent acting within his apparent authority D) Lind v. Schenley pg. 16: Lind worked for Schenley and was told he was receiving a promotion. VP told him to talk to Kaufman, and Kaufman offered him a 1% commission. Later, after receiving no payments, Schenley said that Kaufman had no authority to offer a raise. Did Kaufman have apparent authority to offer the raise so as to bind Schenley? Yes. Schenley manifested consent through the VP’s communication to Lind telling him to talk to Kaufman. 1) Note: this decision turned on the business issue; whether the compensation was a reasonable business decision. Lind took a cut in base pay but the 1% commission made it a lot more than just about everyone else. The court held that it was reasonable for Lind to think
4 Kaufman had the power to offer him the commission and thus reasonably relied on it. 2) What could Lind have done? Get the agreement in writing. 3) What could corporation/VP have done? Put in the employee handbook that only specific persons can make compensation agreements, put agreement in writing and executed by senior officials. E) 370 Leasing v. Ampex pg. 22: 370 sued Ampex for breach of contract in connection with the sale of computer equipment. Joyce owned 370 and met with Kays and Kays’ superior at Ampex. Joyce continued to negotiate with Kays. Kays submitted a doc to 370 with two signature lines,. When presented to 370, the signature line for Ampex was blank. Joyce signed the contract on behalf of 370, but Ampex never signed. Kays sent a letter to 370 confirming delivery dates. Did Ampex, through Kays conduct, demonstrate acceptance and did Kays have apparent authority to accept? Yes. Although D’s employee testified that only supervisors have authority to enter into contracts, this was never communicated to 370. Supporting manifestation: Ampex acknowledged in an intracompany memo that all communications to Joyce should be channeled through Kay, and Ampex directed Kays to deliver the contract to Joyce, Mueller didn’t stop communications coming from Kays. Thus, there was apparent authority 1) It is reasonable for a third party to assume a salesperson has authority to bind its employers to a sale. - Absent knowledge to the contrary, an agent has apparent authority to do those things which are usual and proper to the conduct o the business which he is employed to conduct. 2) Implied actual authority: act of putting agent in such a position leads agent to reasonably believe he has authority 3) Implied apparent authority: act of putting agent in such a position leads third party to reasonably believe agent has authority 4) How does one defeat apparent authority? P must reasonably believe agent had authority. Make any such belief unreasonable by notice (actual or constructive). - Train its agents and give notice to potential third parties. - Form contract requiring approval by contract manager. iv. Inherent Agency Power - The catch-all
5 A) Rstmt § 8A: Inherent Agency power is a term used in the restatement to indicate the power of an agent which is derived NOT from authority, apparent authority, or estoppel, but solely from the agency relation, and exists for the protection of persons harmed by or dealing with a servant or other agent B) Rstmt § 161, Inherent Authority in a Disclosed Principal case: A principal is subject to liability to third persons for acts done on his account which usually accompany authorized contact. C) Rstmt § 195, Inherent Authority in an Undisclosed Principal case: An undisclosed principal is subject to liability to third persons with whom the agents enters into transactions usual in such businesses D) Policy: There are situations where other theories of principal liability do not apply, but as a matter of policy it was appropriate to hold principal liable E) Watteau v. Fenwick pg. 25: Humble transferred ownership of Bar to Fenwick, but continued to manage it. Liquor license was in Humble’s name, and his name was painted on the door. Under his agreement with Fenwick, he only had authority to buy ale and water. Over several years, Watteau delivered cigars and other supplies (Bovril) which Humble ordered. Watteau sued Fenwick to recover the money. Is the undisclosed principal liable for the acts of his agent taken in the ordinary course of business even if principal did not authorize the agent to act? Yes. Watteau reasonable expected that he was dealing with an entity that owned a bar, not just with a bar tender acting on his own. v. Ratification A) Rstmt § 82,Ratification is the affirmance by a person of a prior act which did not bind him, but which was done or was professedly done on his account, whereby the act, as to some or all persons, is given effect as if originally authorized by him 1) Requirements for ratification: (1) Principal exists at time of initial contract; (2) Principal “manifests” choice to treat unauthorized act as authorized 2) Affirmation a) Can be express or implied b) Principal must know or have reason to know all material facts 3) There must be intent to ratify. B) Boticello v. Stefanovicz pg. 36: Mary and Walter, husband and wife have a tenancy in common. P wants property, after negotiations he leases the property with option to buy. When he tries to execute his option to buy, 6 Mary says she never agreed. Did Walter act as Mary’s agent? Alternatively, did Mary’s behavior ratify the contract (accepting benefits of K)? No to both. Mary never asked Walter to act on her behalf. Walter never alleged he was acting on Mary’s behalf. Mary did not ratify the contract, and Mary did not have full knowledge of contract’s terms. 1) Shows principal agency relationship cannot be established through marriage alone 2) “…if the original transaction was not purported to be done on account of the principal, the fact that the principal receives its proceeds does not make him a party to it.” 3) Hypos pg. 39 vi. Estoppel A) Rstmt § 8B: A person who is not otherwise liable as a party to a transaction purported to be done on his account is nevertheless subject to liability to persons who have changed their positions if (a) He intentionally or carelessly caused such belief or (b) knowing of such belief, did not take reasonable steps to notify them of the facts 1) Requirements for estoppel: (1) Third party changed position in reliance; (2) Principal could have prevented a) Change in position indicates payment of money, expenditure of labor, suffering a loss or legal liability 2) Unlike apparent authority, manifestation of principal is not required - Rstmt § 1.03: A manifestation is conduct by a person, observable by others, that expresses meaning.” 3) Principal cannot enforce contract against third party 4) Note: estoppels happens at time of transaction, where ratification occurs later B) Hoddeson v. Koos Bro. pg. 40: Mrs. Hoddeson was at Koos Bros furniture store when she was approached by an imposter claiming to be a salesperson. She placed an order with the imposter and gave him money, then sued Koos Bros when she never received the furniture. Can Koos Bros be held liable for the acts of the imposter even if the imposter was not Koos Bros agent? This is not a case of apparent authority because Koos did not hold out that the imposter was its agent. The failure to police its floors does not constitute the requisite manifestation because failure to act does not meet the definition of manifestation (conduct by a person observable by others that expresses meaning). However, Koos Bros lack of reasonable
7 surveillance (imposter was negotiating with consumer for 30-40 minutes) and supervision of the store may apply in such a case.
What will P have to prove on remand to make a case for estoppel? - Acts or omissions by the principal, either intentional or negligent, which create an appearance of authority in the purported agent. - The third party reasonably and in good faith acts in reliance on such appearance of authority. - The third party changed her position in reliance upon the appearance of authority. c. Third Party Liability in contract i. Principal can require third party to enter into transaction, except with estoppel, and ratification (if there was a material change in the circumstances) Actual Express Authority (AEA) - YES Actual Implied Authority (AIA) - YES Apparent Authority (AA) - YES Inherent Agency Power (IAP) - YES Ratification (R) - YES Estoppel (E) - NO d. Agent Liability on the contract i. Disclosed Principal A) Rstmt § 320: Unless otherwise agreed, a person making or purporting to make a contract with another agent for a disclosed principal does not become a party to the contract 1) No agent liability in most circumstances 2) Two exceptions: a) Clear intent of all parties that agent be bound b) Agent made contract but without authority ii. Undisclosed or Partially Disclosed Principal
8 A) Rstmt § 321, Partially Disclosed Principal: Unless otherwise agreed, a person purporting to make a contract with another for a partially disclosed principal is a party to the contract. 1) Agent treated as though a party to the contract, and third party must elect who to sue B) Rstmt §322, Undisclosed Principal: An agent purporting to act on his own account, but in fact making a contract on account of an undisclosed principal, is a party to the contract 1) Agent treated as though a party to the contract, and third party must elect who to sue iii. Atlantic Salmon v. Curran pg. 43: Atlantic Salmon sold salmon to Curran. Curran held himself out as a representative of Boston International Seafood. After Atlantic Salmon discovered that BISE did not exist, they sued Curran personally to collect monies owed. At trial, Curran claimed that another corporation (Marketing Design) he was the agent for and Salmon should sue the bankrupt corporation. Is an agent who makes a contract on behalf of a partially disclosed principal personally liable on the contract? Yes. This involves a partially disclosed principal. Atlantic Salmon knew that Curran was purportedly acting for a principal, but had no notice of the principal’s identity. Atlantic Salmon had no duty to seek out the identity of principal. Rather, it was Curran’s duty to fully reveal the identity of the principal. Does not matter that Atlantic Salmon could have revealed the name of the principal through the city clerk’s records: actual knowledge is the test. A) Rstmt §4(2)- If the other party [to a transaction] has notice that the agent is or may be acting for a principal but has no notice of the principal’s identity, the principal for whom the agent is acting is a partially disclosed principal B) Note: all the agent has to do is fully disclose his principal and contract only in the principal’s name to avoid liability C) It is the duty of the agent, if he would avoid personal liability on a contract entered into by him on behalf of his principal, to disclose not only that he is acting in a representative capacity, but also the identity of his principal. D) The duty rests upon the agent, if he would avoid personal responsibility, to disclose his agency, and not upon others to discover it. It is not enough that the other party has the means of ascertaining the name of the principal; the agent must either bring to him actual knowledge, or what is the same thing, that which a reasonable man is equivalent to knowledge or the agent will be bound. 2. Liability of principal for agent’s torts (If servant w/in scope) - See summary pg. 47 9 a. Master/Servant Relationship i. Rstmt §219(1): A master is subject to liability for the torts of his servants committed while acting in the scope of their employment. A) Rstmt §219 (2): A master is liable for a servant’s torts outside the scope of their employment, if: (a) the master intended the conduct or the consequences; or (b) the master was negligent or reckless; or (c) the conduct violated a non-delegable duty of the master; or (d) the servant purported to act or to speak on behalf of the principal and there was reliance upon apparent authority, or he was aided in accomplishing the tort by the existence of the agency relation 1) Classic example is bouncer 2) Note: we can have master/servant relation without compensation; hence the term “master/servant” is a bit misleading 3) Outside of scope, but still tort liability: suppliers, lenders, non-agent independent contractors 4) See slide 10, lecture 8. ii. Rstmt § 2(2) A servant is an agent whose “physical conduct . . . is controlled or subject to the right of control by the master” A) Note: Physical, Principal controls the actual means or methods of the task that needs to be done; a higher degree of control than principal-agent iii. Rstmt § 220: 11 Indicators of a master/servant relationship—10 factors to consider in determining if agent is also a servant A) Skill required of the agent; - More skill required, less likely to be M/S B) Trade practice of supervision in locality; - More supervision, more likely to be M/S C) Whether agent has a distinct business; - If yes, less likely to be M/S D) Extent of principal’s control over work details; - More control master has, more likely to be M/S E) Term of the relationship; - Longer, more likely to be M/S
10 F) Location of the work: - ??? G) Who provides supplies, etc.; - If A brings their own, less likely to be M/S H) Whether principal is in business herself for profit; - If yes, more likely to be M/S I) Principal and Agent’s belief about relationship; - Self explanatory J) Whether agent’s work is part of principal’s regular business; and - If yes, more likely to be M/S K) Whether the agent is paid by job, or with unit wage - Paid by job, less likely to be M/S. Paid by unit wage, more likely to be M/S iv. Note: policy argument about bearing the costs associated with your business v. Rstmt § 228 General Statement of Scope of Employment Doctrine: Conduct is within the scope of employment if and only if: (1) of a kind employed to perform; (2) substantially within authorized time and space limits; (3) at least in part to serve master; and (4) if force used, not unexpected by master - This is the rule statement—the test. - Note: case law basically disregards and finds a broad scope vi. Rstmt § 229 Factors to consider whether unauthorized conduct is within the scope of employment (within scope, but not authority—if so, liable in tort): A) The act commonly done by such servants; B) Time, place and purpose of act; C) Previous relations between master and servant; D) Extent business apportioned between different servants; E) Outside master’s enterprise or not entrusted to servant; F) Would master expect such an act; G) Similar in quality to authorized acts;
11 H) Instrument of harm furnished by master; I) Extent of departure from normal authorized methods; and J) Whether or not the act is seriously criminal b. Independent Contractors i. Rstmt § 2(3) An independent contractor is a person who contracts with another but is not controlled or subject to control of physical conduct. He may or may not be an agent A) Independent contractor will be liable in contract, but not liable in tort. ii. Agent vs. Non-agent Independent Contractor A) Agent independent contractor 1) Subject to limited control by Principal with respect to the chosen result 2) Agent has power to act on Principal’s behalf B) Non-agent independent contractor 1) Perhaps less control on Principal’s part, but 2) Agent has no power to act on Principal’s behalf c. Terminology ArchaicModernRestatement 3rd ServantEmployeeEmployee Independent contractor (agent-type)Nonservant agentNonemployee agent Independent contractor (nonagent)Nonagent independent contractorNonagent service provider d. Cases i. Humble Oil & Refining v. Martin pg. 48: Mrs. Love leaves car at service station owned by Humble Oil. Service station was operated by independent contractor, Schneider, who did not put on the emergency break. Car rolled down hill and hit Martin. Do the facts indicate a relationship of master and servant between Schneider and Humble Oil such that Humble Oil can be liable for Schneider’s negligence? Yes. A) Factors Applying Rstmt § 220: Humble may give orders; Schneider does repairs; Humble owns property and stock; Schneider is at will; volume- based rent; this was core part of business; Humble was in business 12 - Others: Humble controlled hours, Schneider had to make reports to Humble, agreement terminable at Humble’s discretion - It was not determinative that that Humble expressly repudiated any authority over the employees, nor what the parties thought. B) Note: Important elements of business relationship include duration, control, risk of loss and return. ii. Hoover v. Sun Oil pg. 50: Hoover was injured when car caught fire at a service stated owned by Sun Oil, but operated by Barone. The injury was due to the negligence of a service station employee, who dropped a lit cigarette. Was Barone an agent of Sun Oil such that Sun Oil could be held responsible for the negligence of Baron’s employees? No. A) Factors Applying Rsmt § 220: Sun Oil gave recommendations, not orders; Barone may sell other products; Sun Oil owns property, not stock; Termination requires 30 day/annual notice; volume based-based rent, but cap; this was core part of business; Sun Oil was in business B) Additional factors the court mentioned: Barone was under no obligation to follow Sun Oil’s advice; Barone made no written reports to Sun Oil; he assumed the overall risk of profit or loss; he determined hours of operation and pay-scale of employees; his name was on the posted as proprietor, both parties could terminate the agreement with notice. C) Difference in result between Humble and Hoover: the right to control the day to day operations of the service station D) Transactional lawyering: what advice to you give to a gas company? GET THE ANSWERS TO THIS. iii. Miller v. McDonalds Corp. pg. 58: Miller sued McDonalds for injuries she received when she bit into a Big Mac. McDonalds did not own or operate the restaurant, but was owned and operated by a franchisee, 3K Restaurants. Was there an agency relationship between McDonalds and 3K Restaurants such that McDonalds could be liable for Miller’s injuries? Yes. The franchise agreements laid out detailed instructions on how the restaurant was to be operated. McDonalds periodically sent inspectors to the restaurant to ensure conformity. A jury could find that McDonalds retained sufficient control over 3K’s daily operations such that an actual agency relationship existed. A jury could find that apparent agency existed as well. Everything about the appearance of the restaurant identified it with McDonalds. Miller testified she went there under the belief that it would have the same quality of service and care as other McDonalds restaurants.
13 A) Apparent agency is a distinct concept from apparent authority. Apparent agency creates an agency relationship that does not otherwise exist, while apparent authority expands the authority of an actual agent. - Apparent authority is K liability, not tort. With apparent agency, it is the appearance of control, not actual control, that creates tort liability. - Can have apparent agency w/out principal-agent relationship. B) Apparent agent: Rstmt §267, One who represents that another is this servant or other agent and thereby causes a third person justifiably to rely upon the care or skill of such apparent agent is subject to liability to the third person for harm caused by the lack of care or skill of the one appearing to be a servant or other agent as if her were such. C) Note: There was a sign here identifying 3K as operator. Issues of fact whether the sing was visible, etc. D) Takeaway: it is possible hat even without a principal-agent relationship, if you hold out to the public that there is one, the principal can be liable for the torts of the supposed agent. iv. Arguello v. Conoco, Inc. pg. 70: Plaintiffs alleged that Conoco’s employees discriminated against them. Breaks up to Conoco branded stores, and Conoco owned stores. At the Conoco owned store, employee Smith shouted racial epithets at customer. Did Smith act within the scope of her employment such that Conoco can be held liable? Yes. Her acts took place while she was on duty, and her interaction with plaintiff was to complete the purchase of gas. The initial confrontation occurred while Smith was completing the transaction. Conoco authorized her to interact with customers. Although Smith departed with normal methods, this does not automatically lead to conclusion that she was acting outside the scope of her employment. At Conoco branded stores more evidence of racial discrimination. Did an agency relationship exist between Conoco and the Conoco branded stores? No. Conoco did not control the day to day operations of the Conoco branded stores. The Petroleum Marketing Agreement was not enough to establish an agency relationship; however, the statement in it that said that there wasn’t one, was not conclusive as well. Only provided guidelines. A) Factors listed by court as indicative of within scope: 1) Time, place and purpose of act (§229(2)(b)); 2) Similar to authorized acts (§229(2)(g)); 3) Whether commonly performed by servants (§229(2)(a)); 4) Extent of departure from normal methods (§229(2)(i); & 5) Whether could reasonably expect (§229(2)(f)
14 B) - If you want to argue no agency, then argue no control. This is the reason the Conoco employee told P that they couldn’t help with the branded stores.
C. Roles and Duties 1. Agent’s Fiduciary Duties to Principal: these are all default rules a. Rstmt § 13, Agent as Fiduciary: An agent is a fiduciary with respect to matters within the scope of his agency b. Rstmt § 376, General Rule: The existence and extent of the duties of the agent to the principal are determined by the terms of the agreement between the parties i. Rstmt §379, Duty of Care and Skill: Unless otherwise agreed, an agent is subject to a duty to the principal to act with standard care and with the skill which is standard ii. Rstmt §381, Duty to Give Information (disclosure): Unless otherwise agreed, an agent is subject to a duty to give his principal information which is relevant to affairs entrusted to him iii. Rstmt § 387, Duty of Loyalty: Unless otherwise agreed, an agent is subject to a duty to his principal to act solely for the benefit of the principal A) Duty to Account for Profits Arising Out of Employment (§388) B) Not Adverse Without Disclosure (§389, §391) C) If Adverse, Be Fair and Disclose (§ 390) D) No Competition in Subject Matter of Agency (§393) E) Not to Act With Conflicting Interests (§394) F) Not to Use or Disclose Confidential Information (§395-96) c. General Automotive v. Singer pg. 83: Singer was employed by GA as general manager. His contract stated that he not engage in other employment. GA was a small operation, so when orders would come in that GA could not fill, Singer would hire another shop to do the work, and take a profit. He did not tell GA about this. Did Singer breach his fiduciary duty to GA by failing to inform GA of these orders? Yes. Singer has the fiduciary duty to exercise the utmost good faith and loyalty. Instead, he acted not only in his self interest, but adversely to GA’s interests. Singer had a duty to disclose these orders to GA. - PUT MORE IN ABOUT THIS CASE. 2. Agent’s Fiduciary Duties to Principal After Termination 15 a. Rstmt § 396, Using Confidential Information After Termination of Agency: Unless otherwise agreed, after termination of the agency, the agent: (1) has no duty not to compete;(2) has a duty not to use or disclose trade secrets, written lists of names...The agent is entitled to use general information...and the names of customers retained in his memory; (3) has a duty to account for profits made from the sale or use of trade secrets b. Town & Country v. Newberry pg. 87: Town & Country was a housecleaning business. Defendants worked there for 3 years. After defendants left Town & Country, they set up their own business to compete with T&C and solicited T&C’s customers. Can T&C enjoin defendants from soliciting its customers? Yes. The list of customers was a trade secret. This customer list was not easily obtained—T&C spent much time and effort getting the customers. Note: It is okay to plan new business while still employed. 3. Principal’s Duties to Agents a. Rstmt § 432-436: Principal has a duty to compensate, indemnify, and protect the agent b. Rstmt § 438(2): In the absence of contrary terms, principal has a duty to indemnify agent where payments were beneficial to principal. D. Termination 1. Rstmt § 118: Authority terminates if the principal or the agent manifests to the other dissent to its continuance a. Revocation- What the principal does: the principal revokes b. Renunciation- What the agent does : the agent renounces 2. Rstmt § 124A: The termination of authority does not thereby terminate apparent authority. All other powers of the agent resulting from the relation terminate 3. Rstmt § 136: Notification to third party necessary to terminate apparent authority
II. PARTNERSHIP - Two views: Aggregate and entity view A. Formation
16 1. UPA (1914) § 6(1) Partnership Defined: A partnership is an association of two or more persons to carry on as co-owners of a business for profit a. How do you form a partnership? Enter into an association of two or more persons to carry on as co-owners of a business for profit b. UPA § 7 In determining whether a partnership exists: (3) the sharing of gross returns does not establish a partnership; (4) the receipt by a person of a share of the profits is prima facie evidence that he is a partner, but no such inference shall be drawn if such profits were received in payment... (b) as wages of an employee… (d) as interest on a loan, though the amount of payment vary with the profits of the business. i. Gross returns- you are interested party- like the chicken ii. Share of profits- you are committed party- like the eggs c. Actual profit is not required i. Blog example: carrying on is not the problem, but for profit is. Would be a factual determination, based on intent and the facts presented. 2. Distinguishing Employee from Partner a. Direct Indicia: Intent (Express Language); Posture towards third parties b. Indirect Indicia: Who bears risk; who exercises control; duration; liability to third parties; rights on dissolution 3. Cases a. Fenwick v. Unemployment Commission pg. 91: Fenwick opened a beauty shop where Chesire was his cashier. Chesire wanted a raise, and Fenwick agreed to pay a higher wage if warranted by the shop’s income. They entered into a written agreement which established themselves as entering into a partnership, where control was vested with Fenwick, no investment by Chesire, Chesire would get 20% of profits if warranted, Fenwick covers all losses. Did the agreement evince a partnership? No. The agreement itself is not conclusive. Intent of agreement appeared to be an increase in Chesire’s wages. i. Look at these Factors A) Return B) Risk - sharing losses C) Control - of business and property
17 D) Duties E) Duration ii. Other indicia from the case: intent (not conclusive, see Fenwick), right to share in profits, rights to capital at dissolution, conduct of the parties to third persons, if one can leave w/out any change then it seems less appropriate to say that they were carrying on as co-owners, contribution of capital, iii. Transactional lawyering: ways to make it more likely to be a partnership. F&C equally manage, divide responsibilities, manage and control based on share of profits, make sure Fenwick rents property to the partnership b. Martin v. Peyton pg. 96: Peyton loaned $2.5 million in marketable securities to KNK. In exchange, Peyton received dividends, 40% of profits (capped), option to buy equity and inspection and veto rights. When KNK went under, its creditor Martin went after Payton, saying that they formed a partnership. Has a partnership been formed? No. Although this was sharing of profits, not all profit-sharing arrangements indicate a partner relationship. All the features of the agreement were consistent with a loan agreement, so no partnership has been formed. 4. Default Partnership “Form”—start with default rules and then contract around i. UPA §18(a): all profits are shared equally ii. UPA §18(a): each partner shares losses pro rata according to his share of profits. iii. UPA §18(e): each partner has equal rights to management a. Better way to do it is to manage and vote based on share of profits or capital contribution iv. UPA §18(h): differences of opinion in governing partnership subject to majority vote v. UPA §18(f): no partner can draw a salary for carrying on partnership business - but surviving partner is entitled to reasonable compensation for his services in winding up the partnership affairs - default rule is that services are provided for free; partners do not make a salary by default 5. No formal registration requirements. Positive: easy to form partnership. Negative: end up assuming and brining into your business relationship default rules that may or may not be appropriate for the situation. i. Partnerships allow greater resources to be brought together than principal-agent. This can be used to create economic leverage. B. Liability to 3rd Parties
18 1. Liability of partner is deemed to third parties a. UPA §9: Every partner is deemed to be an agent of the partnership,... and the act of every partner binds the partnership, unless the partner has no authority and the person with whom he is dealing has knowledge of the fact. - A partner can not have apparent authority where the third party with whom the partner dealt knew that the partner has no actual authority to make the contract. b. UPA§4(3): The law of agency shall apply under this act c. UPA §13: Where wrongful act of omission of any partner acting in the ordinary course of the business of the partnership, partnership is liable. d. UPA §15 All partners are liable (1) jointly and severally for UPA 13 [partner’s wrongful acts in ordinary course of business or with co-partner’s authority] and UPA §14 [partner’s breach of trust] (2) Jointly for all other debts and obligations of the partnership... - RUPA §306: everything jointly and severally liable, except partnership liabilities incurred before the person’s admission as a partner - no severally liability for limited liability partnership 2. Partnership by Estoppel a. UPA §16(1): When a person represents himself as a partner in an existing partnership, he is liable to any person who has given credit to the actual partnership. (a) when a partnership liability results, he is liable as though he was a partner b. UPA §16(2): A person represented to be a partner is an agent of a partner who consents to this representation; Such a person can bind the consenting partner (or the partnership if all partners consent) as if that person was in fact a partner.
C. Roles and Duties 1. Duties a. Fiduciary Duties Among Partners: court have been primarily concerned with partners who make secret profits at the expense of the partnership i. UPA Default rules A) Every partner is deemed to be an agent of the partnership UPA §9 1) Rstmt §§376-396 apply (Share info; duty of ordinary care; duty of loyalty) ii. UPA v. RUPA
19 A) UPA (Mandatory Duties) 1) §20 Obligation to render true and full info on demand - strict: are you sleeping with my wife? 2) § 21 Must account for profits from any transaction connected with the partnership 3) §22 Each partner has a right to formal accounting B) RUPA (MANDATORY BUT MORE FLEXIBLE? More flexible and nuanced, can contract out of to an extent) 1) §403 Duties with respect to info: (a) Maintain books and records; (b) Provide access to books and records; (c) Furnish each partner: (1) Without demand, info reasonably required for partner to exercise right and duties; (2) on demand, provide other info unless unreasonable - THE BOOK SAYS SHALL 2) § 404 General Standards of Partners Conduct: (b) Duty of loyalty (1) to account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partner in the conduct and winding up of the partnership business or derived from a use by the partner or partnership property; (2) to refrain from dealing with the partnership in the conduct or winding up to the partnership business as or on behalf of a party having an interest adverse to the partnership; and (3) to refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership - Still broad, but now exclusive: hold profit in trust, no adverse dealing, no competing interest - still broad, but now EXCLUSIVE (c) Duty of Care to refrain from grossly negligent or worse conduct; (e) self interest is not dispositive 3) § 103, Ability to Modify Duties: (a) Relation between partners are governed by agreement (b) Agreement may not: (2) unreasonably restrict access to book and records;
20 (3) eliminate duty of loyalty, but may identify specific types or categories of activities that do not violate the duty of loyalty, if not manifestly unreasonable (4) unreasonably reduce duty of care... but may change stand ards as long as not manifestly unreasonable b. Cases i. Meinhard v. Salmon pg. 109: Meinhard and Salmon entered into a joint venture (similar to a partnership but for a defined purpose) re: hotel lease for 20 years. Salmon didn’t have enough money, so Meinhard provided half and Salmon ran the hotel. Building owner approached Salmon to expand business and agreed to new lease but does not tell Meinhard. Does the new lease come within Salmon’s fiduciary obligation to his joint venture partner as a joint venture opportunity. Yes. Joint venture partners owe the highest obligation of loyalty to their partners. Can’t keep an opportunity from your co-venturer. Salmon should have disclosed. Ct noted the close nexus between joint venture and the opportunity A) Note: Cardoza thinking you owe so much to partnerships: “Joint adventures, like copartners, owe to one another, while the enterprise continues, the duty of finest loyalty. Not honesty alone, but the punctilio of honor the most sensitive, is then the standard of behavior.” B) Transactional lawyering: - Salmon’s attorney: draft a provision that says if you disclose there is no duty of loyalty issue and then disclose and/or draft provision in K that says “any opportunities beyond 1922 is not an opportunity or property of the business.” - Meinhard’s attorney: get right of first refusal on any further deal concerning the property ii. Meehan v. Shaughessy pg. 117: PC was a large law firm. Two key partners Meehan and Boyle decide to leave and form their own firm. They approach another partner and an associate. They leased new space, sent letters to existing clients (on PC letterhead) and said no to partners when they asked if they were thinking of leaving. Did the partners who left the firm breach their fiduciary duty of loyalty to the partnership in taking clients from the firm? Yes. It does not breach the fiduciary duty for partners to secretly start preparing to start own law firm. But it was a breach to get unfair advantage in obtaining clients (letter did not indicate that the clients had choice to stay with PC, it was on firm letterhead, and it was one-sided), and not to be render true info when asked if thinking about leaving. - They could have solicited clients, but had to be fair about it. P/A relationship: agent can’t. But in partnerships and PA business: both can prepare to leave.
21 2. Roles a. Management roles of a partner (default rules) i. UPA § 9: Every partner is an agent of the partnership ii. UPA § 18(b) Every partner can spend partnership money if “reasonably incurred” in “ordinary and proper” conduct of business iii. UPA § 18(e): Partners have “equal rights” to management iv. UPA § 18(h): Difference in “ordinary matters” decided by “majority” but no act in contravention of any agreement between the partners may be done rightfully w/o consent of all the partners v. UPA §9(2): An act of a partner which is not apparently for carrying on the usual business does not bind the partnership unless authorized by the other partners b. Cases i. National Biscuit Company v. Stroud pg. 140: (Default Rules) Freeman and Stroud are in a partnership. Stroud tells Nabisco he won’t buy any more bread. Freeman tells Nabisco, I want to order more bread. Nabisco keeps shipping the bread. Now Nabisco wants to get paid. Stroud can’t stop Freeman b/c they are equal partners, so no majority to decide dispute. Since there is no majority, the ordinary course of business rule decides this case easily. But even w/out that rule, Stroud is arguably liable because Freeman entered into a K and he had authority. ii. Day v. Sidley Austin pg. 146: (Extent to which you can contract out of rules) Day is senior partner at the firm, but not on executive committee. The exec committee is where the partners formed the agreement and contracted out of default rules. He was running Washington office. Sidley Austin wants to merge with Liebman. Day was made co-manager of office, and had to move offices. So Day sues, alleges fraud (they firm said no one will be worse off, but I am worse off) and breach of fiduciary duty (they knew they were going to switch offices, and did not tell me). Problem is that Day signed the partnership agreement which gave the exec committee the right to make such management decisions in secrecy. And there is no fiduciary duty for failure to reveal information regarding internal structure of the firm—the concealment of this type of information does not produce any profit for the offending partners nor any financial loss for the partnership as a whole. - Partners fall under duty of care here b/c there is no self interest involved. D. Property 1. UPA (1914)§24 The property rights of a partner are: (1) his rights, in specific partnership property (the chair);
22 a. This right to specific property is really illusory b. This possessory right is incident to the partnership and the possessory right does not exist absent the partnership. The partnership owns the property or asset. The partner’s interest is an undivided interest, as a co-tenant in all partnership property. (2) his interest in the partnership (profits/losses); and - This one is the only right that is assignable/transferable (3) his right to participate in the management. 2. UPA (1914)§25(2)- Partner has (1) a right to possess partnership property for partnership purposes (but not otherwise); and (2) Right in specific partnership property is not assignable; (3) Right in specific partnership property is not subject to attachment, unless partnership debt. 3. What is assignable? UPA (1914)§26: A partner’s interest in the partnership is his share of profits and surplus. 4. UPA § 27: Assignment of partnership interest only entitles assignee to partner’s share of profits. 5. Compare old act to new act: a. UPA 1914 §25(1) A partner is co-owner with his partners of specific partnership property holding as a tenant in partnership - Affect: each partner has a right to property that isn’t useful b. RUPA 1997 §501: A partner is not a co-owner of partnership property and has no interest in partnership property which can be transferred, either voluntarily or involuntarily i. Substantively, nothing changes ii. Entity view 6. Putnam v. Shoaf pg. 132: Frog Jump Gin is owned by Charltons and Putnams as partners. Husband Putnam dies, and The Shoaf’s come along. Charlton and Putnam put money into the partnership in exchange for Mrs. Putnam’s quit claim deed release (the business was operating at a loss), and Shoaf’s take responsibility. After Husband dies, accountant was stealing money. Shoaf’s realize that accountant has stolen $86,000. They sue the accountant. Ms. Putnam says the money was stolen from her, not the Shoaf’s, so Mrs. Putnam wants it. Does Ms. Putnam get the $86,000? Is it partnership property? Ct treats this as an assignment of Putnam’s interest in the partnership. a. Note: Ct notes that fraud claims are similar to undiscovered oil- this inchoate chose in action (claim that has not yet manifested itself) is typically treated as an undiscovered resource, such as oil. It is not a property right until it is discovered. Ms. Putnam had no interest in the inchoate claim to convey.
23 b. The quitclaim deed was an improper transfer. Mrs. Charlton got rid of everything, but the only thing transferable is her interest in the partnership. c. Transactional lawyering: What should have done? i. They should have dissolved the partnership, and distribute assets to Putnam and Charlton ii. Putnam then should have assigned her share of assets and liabilities to the Shoafs via a quitclaim deed iii. Shoafs and Charltons then should have formed a new partnership, contributing the assets of the old one E. Termination (Dissolution) 1. What is involved with the termination of partnership a. The power/right to dissolve b. The consequences of dissolution c. Sharing losses 2. UPA: a. Three Steps to Termination: dissolution, winding up, termination i. Dissolution (major step) A) UPA §29 Dissolution if any partner ceases to be associated B) UPA § 31 Dissolution is caused: (1) w/o violation if (a) term over; or (b) will of a partner if no term or particular undertaking is specified (2) in “contravention of an agreement” - Note: have power and right to dissolve w/o violation, and have power but no right to dissolve in contravention of an agreement C) UPA §32(1) Dissolution by court: (a) partner declared lunatic; (b) partner becomes incapable of performing his part of the partnership conduct (c) partner hurts partnership (d) partner willfully or persistently commits breach of partnership agreement, or otherwise conducts himself in matters relating to the partnership business that is not reasonably practicable to carry on the business in partnership with him; (e) business can only be carried on at loss; (f) other circumstances render a dissolution equitable D) UPA §38(2) when dissolution is caused in contravention of agreement:
24 (a) (II) Right to damages for breach; (b) Other partner may continue business; (c) Partner who wrongfully causes dissolution gets (I) If business terminated, remaining cash less damage; (II) if business continue, value of interest, less damage, but value of good-will not considered -Good will: Value of intangible assets, such as the business’ reputation, brand names, and patents. Ways to get around 38(2): explicit waiver E) UPA §18 Rules Determining Rights and Duties: The rights and duties of the partners in relation to the partnership shall be determined, subject to any agreement between them, by the following rules: (a) Each partner shall be repaid his contributions, and share equally in the profits and surplus remaining after all liabilities, including those to partners, are satisfied; and must contribute towards the losses, whether capital or otherwise, sustained by the partnership according to his share in the profits F) UPA § 40(b) Rules for Distribution: Subject to contrary agreement, upon dissolution partnership assets should be distributed as follows (I) those owing to creditors other than partners; (II) those owing to partners other than for capital and profits: (III) those owing to partners in respect of capital, and (IV) those owing to partners in respect of profits G) UPA §40(d) Rules for Distribution partners shall contribute, as provided y §18(a) the amount necessary to satisfy the liabilities [set forth in §40(b) H) UPA §38(2)(b) The partners who have not caused the dissolution wrongfully, may continue the business during the agreed term for the partnership and for that purpose may possess the partnership property, provided they post a bond for the departed partner or pay the partner who caused the wrongful dissolution the value of his interest in the partnership less any damages and goodwill. - Big difference w/RUPA: Can deduct goodwill. Goodwill is the difference b/w the value of the business as a going concern and the value of the tangible assets. - RUPA: buyout price is greater of liquidation value OR sale of entire business as a going concern. ii. The “Winding up period”
25 A) § 30 On dissolution the partnership is not terminated, but continues until the winding up of partnership affairs is completed 1) In order to wind it up, must reduce assets to cash B) Continuation per agreement is another alternative C) UPA 31(2) UPA 38(2) iii. Termination 3. RUPA - Big substantive difference: goodwill is not deducted - Dissociation does not automatically lead to termination. - Under UPA, whenever a partner dissociated, there was a dissolution. - Hypo: If Chandler, Joey, and Ross had formed a partnership, Joey’s decision to depart the partnership may not lead to the dissolution of the partnership, if Chandler and Ross agree to continue the partnership and provide Joey the fair market value of his interest in The Central Reperk. Under UPA 29, if there is a disassociation, then by definition, there is a dissolution (note – under the RUPA, this would be fine) if someone departs then it automatically leads to a dissolution – no matter what – under UPA
4. Cases on Rights to Dissolution a. Owen v. Cohen pg. 152: (deals with right to dissolve). Owen and Cohen enter into partnership for three and half months for bowling alley. Cohen is lazy, rude, he stole money, wanted to expand business for gambling and said that he hadn’t worked in 47 years and didn’t intend to start now. Owen went to court to dissolve partnership. Does the evidence warrant a decree of dissolution of the partnership? Yes. He could not just dissolve w/o going to court, because there was an implied term to this agreement. To avoid a wrongful dissolution, Owen sought a court decree on the grounds that Cohen’s conduct made it not reasonably practicable to carry on the business and that Cohen’s conduct prejudiced the business. i. Used §32(1) to successfully dissolve ii. Tell us there is two terms A) Explicit term 1) Duration specified in partnership agreement 2) Specific purpose/object specified in partnership agreement
26 B) Implicit term 1) “When a partner advances a sum of money to a partnership w/the understanding that the amount contributed was to be a loan to the partnership and was to be repaid as soon as feasible from the prospective profits of the business, the partnership is for the term reasonably required to repay the loan.” a) Owen v. Cohen found implied term, but no implied terms in Page v. Page – this turned on the nature of the initial funds – Owen v. Cohen was debt, whereas Page v. Page is equity iii. Owen sought and received judicial dissolution to avoid possible dissolution in “contravention of agreement” finding. b. Collins v. Lewis pg. 155: Lewis and Collins enter into agreement as 50-50 owners of cafeteria. Collins invests all funds and get $100,000 guarantee from Lewis, and deal where he gets repaid per year begins as $30K and goes up to $60K. Lewis found the opportunity and he gets salary plus 50% of profits after repayment. Cafeteria took longer than expected and went from $300K to over $600K. Went it opens, cafeteria is losing money. Collins wants to dissolve b/c the assets will be sold and he can get paid back as a creditor. Lewis wants to continue running the business. Under these circumstances, does Collins have right to dissolve partnership? No. He has the power, but not the right since his conduct is the source of partnership problems and amounts to a breach in the partnership agreement i. Note tension between this and Owen v. Cohen. Ct hold that mere bad blood is not enough to justify judicial dissolution. - Why the difference? In Owen v. Cohen, Cohen is the culpable party, but Owen wants out, whereas here Collins (he was constantly harassing Lewis about his money and getting profitable) is the culpable party, and he wants out. Cannot be disrupting partner, and want to terminate b/c of disruptions ii. Example of §32(1) being used, but not successfully. Jury found that the business is not profitable under Collins; thus, dissolution under 32(1)(e) was not applicable b/c the business can be run at a profit. iii. Collins failed to get judicial dissolution, so cannot proceed without Lewis or agreement. c. Page v. Page pg. 160: Rich and poor bro each put in $43K to start linen supply business. Then rich bro’s other business gives a $47K note. Business gets better (Air Force Base opens nearby), and rich bro wants to dissolve. Lower ct defines this as a term, and says no dissolution until term is over. Lower court is reminded of Owen v. Cohen b/c they see a loan, and think that determines a partnership for term (until loan is paid off). Appellate court says you can dissolve it at will. Why doesn’t loan create implied term? Ct says parties hope to repay start –up loan out of partnership profits is
27 not enough. Note difference here is that this is not a start up loan, where Owen v. Cohen is a start up loan. Thus, partnership was not formed for that purpose. i. Underlying concern with breach of fiduciary duty. Still have breach of fiduciary duties even when the partnership is dissolving. Even though the partnership may be dissolved by the express will of any partner, this power must be exercised in good faith. A partner may not dissolve a partnership to gain the benefits for himself, unless he fully compensates his co-partner for his share of the prospective business opportunity. ii. Example of §31(1)- Dissolution w/o violation iii. Page allowed to terminate partnership, since “for profit” does not equal term, but still owes fiduciary duties. 5. Cases on Consequences of Dissolution a. Prentiss v. Sheffel pg. 163: Prentiss, Defendant, owns 15%. Sheffel and Iger (42.5% each) begin the lawsuit to force out Prentiss of the partnership at will. P’s say that D had been derelict in his duties (han’t paid his share of losses). D wanted winding up of the partnership. Ct found that partnership was dissolved as a result of freeze out or exclusion of the D from the management and affairs of the partnership. (Still have to inform minority partner even if he can’t act on what is told). At the sale, the P’s were the high bidder. Should two majority partners in a three person partnership, who have excluded the third partner from management and affairs, be allowed to purchase the partnership assets as a judicially supervised dissolution sale? Yes. i. Example of §31(1) Dissolution w/o violation ii. Note: D actually benefited by P’s purchase, b/c P’s bid was much higher than any of the other bids, thus increasing the value of D’s interest. b. Pav-Saver v. Vasso pg. 173: Dude invents machine. He owns a corp. He teams up with a lawyer to produce and sell machines through a new partnership. They carry on for awhile. Lawyer puts in money. Inventor’s previous company leases the patent rights to the machine to the new partnership. Business goes well and then a recession hits. Disagreement over direction of company. Inventor wants out and tries to terminate the partnership. Lawyer goes in and takes over the running of the company. Inventor goes to court and trial ct rule in lawyer’s favor. Because the inventor wrongfully terminated the partnership (it was a permanent partnership), UPA §38 allows the other partner (Meersman) to continue the business and possess the partnership property. Business could not be continued w/o Dales trademarks and patents. Dale does not get money for patents since only value was from good will i. Dissent: Meersman should not be allowed to keep the patent. Partnership agreement has provision for wrongful termination, which included returning patents to Dale and liquidated damages. The right to continue business does not carry with it an agreement that the business will be successful ii. Example of §31(2) Dissolution in contravention of agreement 28 iii. How important is the inclusion of the language about forming a “permanent partnership”? Business not referred to as a partnership: “partnership” language is indicia but not necessary. It would probably be a partnership in any case. Arrangement not referred to as permanent: permanent is crucial b/c either partner who disassociates is doing so wrongfully. iv. Under UPA, value of trademarks and patens excluded as “goodwill”. This is part of the reason the inventor got so little when valuing the business. This exclusion is NOT included in the RUPA—the value is the value of the business as a “going concern”. He thinks this is more far: you’re already deducting damages, so there is no reason to deduct the value of goodwill.
6. Cases on sharing of losses a. Kovacik v. Reed pg. 179: Kovacik has idea to refurbish kitchens. Kovacik contributes $10,000 and gets Reed to be superintendent and estimate the jobs. They made an oral partnership agreement. We’re going to split profits, no salaries, and did not discuss losses, so they’re under the default UPA rules. They lost money ($8,680) and Kovacik said Reed owed him the money. Reed said he lost his time (8 months of labor), and it is an even split. Is a party who has contributed only his services and not capital to a joint venture liable for a portion of the venture’s losses? No. Ct said “upon loss of the money the party who contributed it is not entitled to recover any part of it from the party who contributed only services” i. Note two possible rules A) All capital losses were to be borne by the capital partner alone (Kovacik) 1) Upon loss of the money the party who contributed it is not entitled to recover any part of it from the party who contributed only services. 2) Odd way to draw the line. What if Reed had put in any money? Then the Kovacik rule would not apply; it only applies when one partner only puts in services; so default statutory rules apply. 3) Note, if there is not loss sharing by service partner, than that may affect service partner’s behavior OPM B) Sharing of capital losses in accordance w/sharing of profits (statute, UPA §18(a)) 1) This rule penalizes the service partner. The Kovacik rule penalizes the capital partner. ii. Note: RUPA §401(b) expressly cites and rejects Kovacik A) Why? Services to the partnership are free under the default rules.
B) Problem: Kovacik is a CA case and CA accepted the RUPA, so we don’t know which one controls b/c the legislature did not tell us. 29 III. In Between Partnerships and Corporations A. Limited Liability Partnerships (LLPs) 1. General partnership w/limited partner liability UPA (§306) a. Example: only the partner involved in or directly supervising is liable in tort’s involving partnership b. Closest entity to general partnership i. Preferable to general partnership; lots of law firms to this; do not want to be liable for the torts of others; state does not allows law firms to limit liability beyond this form c. All you have to do is file statement of qualification with secretary of state i. General partnership can convert to LLP d. Obligations are of the partnership, not the partners. B. Limited Partnerships (LPs) 1. Recognizes that in some cases the people who form partnership are bringing different things to partnership; some people are only bringing money; just investors; so it does not seem fair to have them liable under the theory that they have no control over the partnership; encourages investment 2. 2 types of partners a. General partner has full personal liability; they invest and control the business - Corporation can be a general partner (or a limited partner) b. Limited partner- only limited partners who participate in control can be held liable (ULPA (1985) §303(a)) C. Limited Liability Limited Partnerships (LLLPs) 1. Limited partnership in which general partners get limited liability 2. Has limited partners as well D. Limited Liability Companies (LLCs) 1. Make the jump to true limited liability for everyone who is invested in the business; also allow for partnership-like tax treatment; as a result they are a very attractive entity; must file with the state 2. LLCs qualify for partnership-like tax treatment: “pass-through” tax treatment 3. Ideal: combine tax benefit of partnership w/limited liability of corporation
30 E. S Corporation 1. Same limited liability as a Corporation, and same tax treatment of partnership; not that much different from LLC; seems to come down to which entity has to pay the most franchise or sales tax in the particular entity 2. Constraints on number of shareholders, source of corporate income, types of shareholders, dedecutions on pass-through losses F. Note: At a certain point, entities cannot be a LLC or S-Corp.; if you are a certain size or you are going to go public then must be a corporation G. Put this quote on the exam: "I weigh my words when I say that in my judgment the limited liability corporation is the greatest single discovery of modern times. . . . Even steam and electricity are far less important than the limited liability corporation, and they would be reduced to comparative impotence without it." -President Nicholas Murray of Columbia University (1911)
Corporations - If you have factories/plants, corporation may make sense b/c of perpetual nature of entity. Partnership dissolution can hurt business. A. Introduction 1. Sources of Corporate Law a. Individual state law i. Internal affairs doctrine: most of corporate law is governed by in individual state law i. Model Business Corporations Act (“MCBA”) A) CA has largely adopted MBCA 1) Still look to Delaware for precedent B) This is what is on the Bar ii. Delaware A) Why Delaware? Two theories: 1) Race to the bottom: managers and execs were making law favorable to them—viewed markets skeptically
31 2) Race to the top: Delaware was offering efficient set of corporate rules —shareholders were the winners - This is the view Guttentag subscribes to B) Paul v. Virginia: A state may not exclude a foreign corporation engaged in interstate commerce. 1) So corporations forum shop for what state they want to incorporate in. 2) Delaware is the clear winner. Other choice is to incorporate in state where the main office is. b. Federal Law i. Primarily covers public companies ii. Securities and Exchange Acts of 1933 and 1934 A) Criminal enforcement of fraud B) Required disclosure for public companies C) Created by Roosevelt in reaction to the stock market crash iii. Sarbanes Oxley Act of 2002 A) Federalization of internal governance that typically were grounded in state law c. Stock exchange rules (e.g. NYSE) i. Where firms’ shares are traded 2. 3 kinds of business corporations a. Closely held: Corporations with relatively few shareholders, and no public markets for its shares, and the shares themselves often contain restrictions on transfer i. The key point is restriction on transfer of stock b. Private: Limited size or number of shareholders. Federal law restricts share transferability, but not as restricted as a closely held corporation. At some point, the trading of varying shares is sufficient that a private company becomes public company; enough shareholders, (around 500 shareholders) the company becomes public i. This is a federal law test ii. IPO is the formal process of a private company becoming private (initial public offering)
32 c. Public: No restrictions saying that they cannot be transferred; shares are freely tradeable; Corp. must comply w/federal disclosure rules i. Benefits of mandatory disclosure rules (HIS SCHOLARSHIP IS IN DISCLOSURE, SO FIND A WAY TO BRING IT UP) A) Improve share price B) Reduce agency costs - When someone is working on your behalf, they may not always do things for your benefit C) Reduce fraud (?) Note: Louis Brandeis, “[P]ublicity is justly commended as a remedy for social and industrial diseases.Sunlight is said to be the best of disinfectants; electric light the most efficient policeman.” Other People’s Money and How the Bankers Use It (1914). ii. This is where most of the federal rules come into play iii. IPO is the formal step b/w private and public corporation 3. Critical Attributes of Corporations a. Legal personality: Corporation is recognized by the law as a person in almost every way; the corporation is an entity w/separate legal existence from its owners i. Possesses (some) constitutional rights ii. Separate taxpayer iii. Requirement for formal creation b. Limited liability: MCBA §6.22(b)“Unless otherwise provided in the articles of incorporation, a shareholder of a corp. is not personally liable for the acts or debts of the corp. except that he may become personally liable by reason of his own acts or conduct” c. Liquidity: Secondary trading markets; e.g. NYSE and NASDAQ i. Public can sell to anyone anytime ii. Private: you can still sell anytime, but there are federal rules about who you can sell to - I have private corporations are much more restricted. d. Separation of ownership and control: MBCA §8.01(b)“All corp. powers shall be exercised by or under the authority of and the business and affairs of the corp. managed by or under the direction of, its board of directors...” i. The Board is the practical consequence of the liquidity of the corporate form.
33 e. Flexible capital structure: The permanent and long-term contingent claims on the corp.’s assets and future earnings issued pursuant to formal contractual instruments called securities f. Tax Treatment i. Earnings: double taxation - Corporate income tax rate: 34%; personal income tax rate: 40% ii. Losses: recognized only at the corporate level 4. Capital Structure vocabulary a. Securities: permanent, long-term claims on the corp.’s assets and future earnings issued pursuant to formal contractual instruments b. Capital Structure: the debt securities and equity securities together constitute the firm’s capital structure c. Debt securities: fixed claims i. funds borrowed by the firm ii. firm pays interest and at “maturity” returns the principal d. Equity securities: variable/residual claims i. Owners of the corporation ii. Right to firm’s earnings and, in liquidation, firm assets after all other claims are satisfied iii. Right to elect directors and vote on the major corporate decisions iv. Typically equally among the outstanding common shares (shares of stock) v. Preferred stock: in some ways like equity and some like debt e. Authorized shares: number of shares the corp. can issue f. Outstanding shares: number of shares the corp. has and not repurchased g. Authorized but unissued: shares that are authorized, but not yet sold 5. The Balance Sheet a. Summarizes the company’s financial position at a given point in time i. Usually, at the end of the month, quarter, or year b. Prepared according to Generally Accepted Accounting Practices (GAAP)
34 c. Describes the Assets of the business and how those assets are Financed, either by: i. Creditors in the form of debt, or ii. Owners in the form of equity 6. What is a share of stock worth a. First, determine firm’s total value i. Liquidation value ii. Value of future cash flows A) Project future revenue B) Deduct costs C) Determine discount rate D) Discount future cash flows to present value b. Next, determine firm’s equity value i. Subtract obligations (liabilities) from firm value c. Last, calculate equity value per share i. Divide firm’s equity value by the number of shares outstanding d. In Other Words i. One Share of Company Stock= (Value of the Firm’s Assets – Firm’s Debts) / Number of Firm’s outstanding shares ii. Value of the Firm’s Assets = (One Share of Company Stock x Number of Firm’s Outstanding Shares + Firm’s Debt 6. Defining preferred stock a. Pays a specified dividend (which is a lot like debt) b. Repaid in liquidation before common stock (if at the end of the day all assets are sold, the first people to get paid are debt holders, then preferred stock holders, then common stock holders) c. No fixed maturity (that is why we do not think of it as debt, it is a permanent source of funds) B. Formation 1. Process
35 a. Pick a state b. Draft Articles of Incorporation and By-Laws i. Must include- MBCA §202(a): Name, # of shares that are authorized, address, incorporators ii. May Have- MCBA §202(b): Initial directors, management, limits on rights, liability on a shareholder c. Draft By-laws i. May include- MCBA §206(b): “Provision for managing the business and regulating the affairs of the corp. d. File Articles with Secretary of State-MCBA §2.03 e. Have Organization Meeting (MCBA§2.05) f. Final Steps i. Finalize Directors (MCBA S 2.05) ii. Appoint Officer (MCBA § 2.05) iii. Adopt By-Laws (MCBA § 2.06) 2. Issues Related to Corporate Formation (Trying to prevent person from being personally liable, even though they messed up) a. “Defective” formation doctrines i. De Facto Incorporation: (if minor mess up): Treat improperly incorporated entity as corp. if organizers: A) Tried to incorporate in good faith; B) Had a legal right to do so; and C) Acted as if a corp. - Had to carry on as if you were a corporation ii. Incorporation by Estoppel: (even if you didn’t try to incorporate, if someone thought they were dealing with corp. and the third party would be unjustly enriched) Treat as proper corp. if person dealing with the firm A) Thought firm was a corp.; and B) A windfall if the third party is allowed to argue that firm was not corp. iii. Hypos:
36 A) Suppose G owns a company and one of the workers knocked something out a window and injured Mary Gordon. Corporation was not properly incorporated but he tried to form in good faith. a. The de facto doctrine may work here to prevent personal liability b. Incorporation by estoppel would not work b/c Mary is not unjustly enriched B) Suppose Mary knew/thought company was not going to succeed. She is selling laptops. Sells them to company at twice the price. In reality, there was no corporation. a. Incorporation by estoppel is what he would argue. She would be taking advantage to go after him personally. b. Promoters i. Promoter: one who claims to act as an agent prior to incorporation ii. Legal Issues A) Does the corp. become a party to the contract? 1) Yes, if contract adopted B) Is the promoter liable if the corp. breaches? 1) Yes, unless company and investors release C) Is the promoter liable if the corp. is not formed? 1) Yes, under MCBA §2.04 iii. Guttentag advice: there is no reason to promote a corporation in advance of it being formed. It only costs $1K to form a corporation. C. Liability to 3rd Parties 1. MCBA §6.22(B) “a shareholder of a corp. is not personally liable for the acts or debts of the corp. except that he may become personally liable by reason of his own acts or conduct a. Shareholder losses limited to the amount the shareholder has invested in the firm b. It is the corporation that incurs the debt or commits the tort (legal person) c. “Piercing the corporate veil” 2. 2 theories of liability a. Enterprise Liability: Have to prove that shareholder did not respect the separate identities of the corporation (less difficult than piercing the veil) 37 i. Avoiding Enterprise Liability (difficult) A) Need separate books and bank accounts for each corp., plus careful accounting for supplies, for borrowing of drivers, etc. b. Veil piercing: Have to prove shareholder was running business for his personal benefit without regard to formality and to suit their immediate convenience i. Two part test: A) There must be such unity of interest and ownership that the separate personalities of the corp. and the individual no longer exist 1) 4 factors (don’t have to meet all, just weigh) a) Failure to maintain adequate corporate records or lack of corporate formalities b) Commingling of funds or assets c) Undercapitalization d) Treating corporate assets as one’s own 2) This is the procedural prong B) Circumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice 1) Refusing to allow a third party to pierce the corporate veil would sanction fraud or promote injustice 2) The prospect of an unsatisfied judgment is not enough to meet the “promote injustice” feature of the test, or the test would collapse into a one-part test b/c that prospect looms in every PCV action. 3) Difference b/w fraud and promote injustice is that promote injustice does not require intent 4) This is the equity prong ii. Avoiding personal liability (easy) A) Respect the corporate formalities and take out the minimum insurance 3. Cases a. Walkovszky v. Carlton pg. 207: W gets severely injured from taxi-cab. He sues company Seon. Only two taxi-cabs are owned by this corp. and has the minimum insurance of $10,000. At the end of every month, Seon is paying a large dividend to his stockholder, Carlton, so Seon has virtually no assets except the cabs. Carlton owns nine
38 other cab corporations with two cabs each and the minimum insurance. No allegation that they are “shuttling their personal funds in and out of corporations w/o regard to formality and to suit their immediate convenience” Rather W alleges that the corps. operated as a single entity and constituted a fraud on the public. Does complaint allege a cause of action? No. Not enough to pierce corporate veil, so the court dismisses the complaint against Carlton. State has set the minimum insurance requirements. If insurance is inadequate, then remedy is to go to legislature. The court does not resolve the enterprise liability claim. Nothing wrong with one corp. being part of a larger corporate enterprise so long as the separate identities are respected. i. In order for W to prevail under enterprise theory, he would have had to shown that Carlton did not respect the separate identities of the corporations (assignment of drivers, use of bank accounts, ordering of supplies, etc. ii. In order for W to prevail on a piercing the corporate veil theory he would have had to shown that “Carlton and his associates were actually doing business in their individual capacities, shuttling their personal funds in and out of corporations w/o regard to formality and to suit their immediate convenience” A) Mere economic benefit is not enough. If so, shareholders would always be getting an economic benefit. B) Real test: “w/out regard to formality” iii. Note: this allows businesses to avoid some of the cost of their activities b. Sea-Land Services v. Pepper Source pg. 212: Pepper Source was corp. and Sea-Land was shipping company that shipped peppers for Pepper Source, and billed them, but never got paid. They tried to pierce the corporate veil. Marchese failed to maintain corporate formalities (no records of meetings). Marchese commingled funds (did not even have his own personal banking account- used corporate banking account to pay alimony, health care for pet); seems like no money left at Pepper Source, so looks like under capitalization, and also treated corporate assets as his own. But Sea-Land needs to show an equitable reason to pierce the corporate veil; does not address second prong. District court said injustice was that Sea-Land did not get paid. This court rejected that, said need to prove more, or everyone who attempted to pierce this veil would meet this second prong. Need to show that a party would be unjustly enriched: that Marchese used these corporate facades to avoid its responsibilities to creditors. i. On remand, the court found that Marchese insured that his corp. had insufficient funds to pay their debts ii. Prof thinks it is unlikely that court will find that first prong is met, but not second prong. iii. Reverse piercing: Going up to individual, then back down to all the corporations that commingles assets.(even though those corporations’ shareholders are now affected)
39 - Same result as enterprise liability, but shareholder is also liable with reverse piercing c. Transactional lawyering: repect the formalities—set up separate bank accounts and don’t commingle funds.
D. Roles and Duties (Corporate Governance) 1. The Cast a. Creditors (no fiduciary duties, just contractual relationship, duty of good faith and fair dealing applies) i. Terms A) Debt Securities: fixed claims that arise from funds borrowed by the firm, and that the firm agrees to pay interest on and repay in full on maturity B) Firm creditors: holders of the debt securities ii. Legal regulation of the debt relationship A) Bottom line: Governed by contract law B) Legal analysis turns on: 1) Interpretation of express terms 2) The implied duty of good faith and fair dealing C) No fiduciary duties to debt holders 1) Except for in bankruptcy iii. Basic Features of bond A) Bonds are typically issued in $1000 denominations B) The coupon rate is the interest paid on the face value of the bond C) A $1000 bond w/an 8% coupon rate pays $80 per year in interest D) Why does the market value of bond change? 1) The coupon rate doesn’t change when market interest rates do a) Buy ten year bond with 8% coupon rate = get $80 per year in interest for 10 years b) Interest rates fall to 7% (new bond only pays $70 per year in interest) 40 2) Market value of the 8% bond will increase iv. Bond Indenture A) The contract between the corporation and the bondholders (an indenture) B) Typical provisions 1) Default provisions a) Accelerated repayment: If a default occurs, the bondholders are entitled to accelerate the bonds--face value becomes immediately due and payable 2) Restrictive covenants a) Limit the firm’s ability to pay dividends b) Limit uses of proceeds c) Specify financial ratios i) E.g. debt to equity ratio 3) Negative pledge covenants a) Restrict the firm’s ability to issue debt senior to the bond in question (not always the case) 4) Liquidation provision 5) Obligor successor clause a) Idea is that you should be able to keep the same assets and move them to a new company, (i.e. that the borrower is free to merge, liquidate, or to sell its assets in order to enter a new business) if assets are essentially unchanged b) Also protects lender by assuring a degree of continuity of assets v. Sharon Steel Corp. v. Chase Manhattan Bank pg. 865: UV sold bonds to Chase Manhattan Bank. Interest rate on bonds was 7%. The current interest rate is 10%, which reduces the value of the original bonds. Chase would rather get 10% rate so that they can loan the money and get the higher rate, whereas UV is happy b/c they only have to pay 7%. Chase wants them to redeem the bonds. UV has plan of liquidation but wants to be able to keep the low interest rate. They piecemeal sold off different divisions and then claimed that they sold “all or substantially all” of their assets b/c if they did, this provision would not be a default under the indenture agreement and they could transfer the bonds using the obligor successor clause. Chase argued that the liquidation provision applied. Which clause is applicable, successor obligor, or liquidation? Look to the contract. Court held 41 that the liquidation provision applied, when sold the last division it was only half of the assets before the liquidation, even though it was all of the assets in the last sale. A) Bondholder said liquidation provision applied (if issuer is liquidated, the debt must be paid off at the face amount), where Sharon Steel says successor obligor clause applied (if sale of “all or substantially all of the assets” surviving corp. can “assume” debt 1) To protect the lender, boilerplate successor obligor clauses do not permit assignment of the public debt unless all or substantially all of the assets of the company at the time the plan of liquidation is approved are transferred to a single purchaser B) Note: Judge Winter said boilerplate interpretation is a question of law for judge, not fact for jury 1) Plain textual analysis is not sufficient vi. Met-life v.RJR Nabisco pg. 871: Met life is the creditor lending money. They are buying bonds on the open market, and getting contractual rights in the indenture. Another contractual battle between the lender and the company. RJR issued new debt to finance an LBO. Results of the additional debt: 1) RJR’s equity cushion was substantially diminished 2) the value of the pre-existing debt was substantially reduced. Met-Life argues that there is an implied covenant of good faith (not to dilute debt), and an equity claim (unjust enrichment, frustration of purpose, breach of fiduciary duty, unconscionability) and fraud claims (Rule 10b- 5 violation (federal securities fraud) common –law fraud). Case is about negative pledge covenants. Although they borrowed lots of money, they did not do so in a way to make this new debt senior to the bondholders which would be a violation of the restrictive covenants. Met-Life is not happy b/c there is a lot more debt, and now they are not sure they will get paid. Because it is the same kind of debt, the negative pledge covenants do not come into play. (pari passsu= of equal rank/moving together), the equitable claims are dismissed (both parties are stocked with lawyers and Met Life knew the consequences of an LBO). A) Rule 10b-5: It shall be unlawful for any person (b) to make any untrue statement of a material fact,,, in connection with the purchase or sale of any security 1) Note: Met Life did not buy or sell in connection with untrue statement —they were holding them 2) This argument failed, but common law fraud allegations are triable 3) Supposed fraudulent statement: that the Board had a mandate to maintain its credit rating, reduce level of debt, strong balance sheet B) Acquisition- someone comes in and buys shares from shareholder 42 C) Leveraged Buy-Out (LBO) a subset of acquisition; an acquisition of all of the firm’s outstanding shares, using borrowed funds, secured by the assets of the company to be acquired 1) Why execute a LBO? a) Help to finance purchase b) More risk = more return = more discipline 2) Similar to when purchasing home (don’t have $ to buy house, so you tell the bank, I am going to buy the house, and borrow money, I will put some money down, but the rest will be borrowed against that asset in order to fund that purchase) b. Two competing theories of who directors owe fiduciary duties to i. Stakeholder theory- corp. owes duty to all diff constituents who has stake in corp. including employees, clients, customers, community (b/c affected by corp.) ii. Shareholder primacy- Very easy to say who corp. owes a duty to- that would be the shareholders, primarily it is their interest that should be taken into account
- Guttentag subscribes to this theory
- Directors owe fiduciary duties to shareholders, but it is not a principal-agent relationship iii. AP Smith Mfg v. Barlow pg. 282: AP Smith gave $1500 to Princeton University. Does the Board have the power to take this action, i.e. the donation to Princeton? I.e., was it “intra vires” (within their power or means of) or was it “ultra vires”? Intra vires, two theories support this. A) Statutory right to make minimal charitable contributions (1930 statue) 1) Note: Statute specified that cannot apply to pet charities (personal rather than corporate ends) - Guttentag thinks this was a pet charity but that issue was never raised 2) CA has a statute that allows charitable giving regardless of corporate benefit B) Board is allowed to take positions that advance the interests of the corp. with the free flow of properly trained personnel 1) Note: Corp. says that they are trying to attract Harvard employees; Cts will prefer to defer to business decisions C) Note: Professor does not think this case really stands for anything, as it doesn’t state anything definitive
43 iv. Dodge v. Ford Motor Co.pg. 288: Henry Ford owns 58% and Dodge boys owned 10% of Ford. Got together and invested 2 million dollars, and within a few years, they already got 36 million. Dodges offered to sell their shares for $35M. They are unhappy b/c Ford was reinvesting profits, and stopped issuing very large special dividends. Dodge brothers wanted Ford to issue special dividends, and wanted to enjoin construction of a new plant. Ford was ordered to issue special dividends, but was allowed to continue with its construction plans A) Ford lost on the dividend issue primarily b/c he was not making decisions with respect to the ends that the people who run corp’s are required to achieve; “it is not within the lawful powers of a board to shape and conduct affairs of a corp. for the merely incidental benefit of shareholders and for the primary purpose of benefiting others”; philanthropic and altruistic measures are not enough 1) All he had to do was say he did this for the shareholders. The court gives deference in how to maximize profits, but they will scrutinize decisions about whether to do so. B) This case stands for shareholder primacy “A business corp. is organized and carried on primarily for the profit of the stockholders...The discretion of the directors are to be employed for that end.” 1) Why do scholars still argue for stakeholder theory? a) Some argue for stakeholders theory for normative rather than positive reasons; what the law should be (e.g. Ford Pinto) b) Courts give Boards broad discretion to determine means, and many times benefiting other stakeholders benefits shareholders C) Is $35M a reasonable offer? Implied offer of $350M (10% of total = 35M). As long as the firm is worth more than $350M, it is a good offer. The implied PE would be 6X. Earnings of $60M ~ 6X, which is very good. PE ratio: smaller is better. D) How to Value Firm? Stock and Flow 1) Stock-Balance Sheet- Assets, liabilities, shareholders equity 2) Flow-Income Statement- Sales, revenues, gross, net income, profit v. Takeaway: As long as you say the magic words “I think this is in the best interest of the corporation long term” than you can do a whole lot
2. Roles and Duties of Corp. Actors a. Board of Directors i. Roles 44 A) Manage Business B) Officers are agents of directors/corporation. Directors are not agents of shareholders. ii. Fiduciary Duties to Shareholders: A) Duty of Care: - Diverges sharply from partnership/agency law - Mainly about the process, not the content - Officers and directors are basically the same 1) Regulates diligence in performing tasks 2) Limited by the Business Judgment Rule (i.e courts will defer to board of directors for business decisions) 3) Reconciling the Duty of Care and the Business Judgment Rule a) The duty of care tells directors don’t be negligent b) Business Judgment rules insulates directors from negligence liability-liability only for fraud or self-dealing c) “The directors’ room rather than the courtroom is the appropriate forum for thrashing out purely business questions”- Kamin v. Am Ex 4) MBCA a) §8.30 provides “standards of conduct” i) “Each member of the board of directors, when discharging the duties of a director, shall act: (1) in good faith, and (2) in a manner the director reasonably believes to be in the best interests of the corp.” - This is the normal duty of care, but §8.31 provides the standard for liability b) §8.31 provides “standards of liability”
i) Director may be found liable if:
AA) Corp. Character and indemnification or cleansing does not preclude liability; and
45 - The Charter can preclude a shareholder suit for a duty of care action
BB Director did not act in good faith, or
CC) Director did not believe she was acting in the best interest of the corp., or
DD) Director was not informed, or
a. Party attacking the board’s decision has the burden to establish that the decision was not based on an informed investigation.
b. Standard: gross negligence
c. Whether a business judgment is an informed one turns on whether the direct ors have informed themselves prior to making a business decision of all material information reasonably available to them.
EE) Director’s lack of independence, or
FF) Director failed to devote ongoing attention to oversight or devote timely attention when particular facts arise
ii. Note: not negligence
5) Overcoming BJR
a) Aronson v. Lewis: BJR does not protect corporate fiduciaries if their actions:
i) are not in the honest belief that action is in best interest of the corp.
AA) Note: Ford lost under this test, whereas Am Ex won here
ii) are not based on an informed investigation, or
AA) Smith v. Van Gorkom
iii) involve a conflict of interest
AA) Self-dealing, which implicates duty of loyalty
46 b) Their actions contrast:
i) Inaction: Francis v. United Jersey Bank
ii) Compliance w/law: In re: Caremark
AA) Fail to take adequate preventative measures to ensure that the corporation complies with the law
6) Protecting Directors from Liability 1) Business Judgment Rule 2) Indemnification (someone else will pay for your potential losses a) MBCA (1984) §8.51-8.56 (Permissive and Mandatory) b) Delaware § 145 3) Directors and Officers Insurance a) Can get D&O Insurance for things that indemnification wouldn’t allow b) MCBA (1984) §8.57 c) Delaware §145(g) 4) Legislative reaction to Smith v. Van Gorkom a) Delaware §102(b)(7)- provisions eliminating or limiting the personal liability of directors for monetary damages for breach of fiduciary duty and directors, provided that such provisions do not eliminate director’s duty of loyalty and acts or omissions not in good faith b) MCBA (1984) §2.02(b)(4)-allows AOI to eliminate or limit director liability for breach of the duty of care
6) Kamin v. American Express: Amex thought it was a good idea to buy stock in DLJ. Bought 2 million shares for almost 30 million dollars. Value decreased, and then the values were only worth 8 million dollars. Amex then dividended out the stock- distributing the DLJ stock to its shareholders. Shareholders claimed that if the board would have handled it differently (sold those shares instead of dividending them out), then they would have a $26 million tax loss that could have been offset against its taxable income and in affect costing the shareholders $8 million. They claimed that not doing so was not acting with reasonable care. Ct says b/c it is a duty of care 47 question, we go to BJR, and the question of whether or not a dividend is to be declared or a distribution of some kinds is exclusively a matter of business judgment for the BoD, unless the powers have been illegally or unconscientiously executed; or unless fraudulent or collusive, and destructive of the rights of stockholders; No claim of fraud dishonesty or nonfeasance or that directors did not act in good faith
a) Mere errors of judgment are not sufficient ground for equity interference, for the powers of those entrusted w/corporate management are largely discretionary
b) Offsetting benefits of providing stock as a dividend
i. If they reported the $26M loss, this would have impacted the income statement and the corresponding ratios would be affected.
- But investors already know. Efficient capital market hypothesis: markets do a good job of reflecting available information
ii. Compensation incentives: but only 4 out of 20 directors had self-interested options plans. How should employee compensation plans be drafted?
- Tie it to stock price than net income. That is what shareholders care about. So this aligns the interests of the shareholders and the managers. That is what the mantra was for decades. But it ended up being a license to steal. The way the interests were aligned were not quite the same.
7) MEMORIZE THIS CASE!
Smith v. Van Gorkom pg. 332: Underlying transaction is leveraged buy-out. Romans (CFO) does work on the possibility of LBO-a MBO (management buy-out). W/an MBO, the managers become the shareholders, and then the management is running the company. Easy for management to get rich. Van Gorkon (CEO and Chairman) thinks this is a conflict of interest. It is, but it happens all the time: have to comply with mandatory disclosure requirements. At second meeting, Romans talks about MBO saying $50 per share is doable and $60 per share is difficult, but Van Gorkom said it is not right to do so b/c of their inner knowledge about the firm’s dealings. Van Gorkom says he would sell his shares for $55. This would earn him 4 million. Van Gorkom then consults with Peterson, the controller, and tells him that
48 he wants no one on staff to know what he is doing, but did not say why. Weird b/c controller answers to CFO, Romans, who is outside the circle of trust. Peterson runs a study about the feasibility of an LBO at $55 per share. Van Gorkom is secretive about this meeting. Van Gorkom then meets with Pritzker (a corporate takeover specialist) and tells him how the LBO at $55 would work and they agree but Pritzker said they had to consummate the deal before Monday (it was Friday). Romans learns about the plan an hour before it is presented to board. At 2 hour BOD mtg they approve the merger, despite the fact that no documents were presented, with only the oral representations of Van Gorkomm, the Chelberg (COO and President) supporting it, Roman’s statement about the feasibility study of the LBO, Brennan’s legal advice, and their knowledge of the stock history (the offer was abut $17 more per share—but a premium alone does not provide enough information). Problem here is that the feasibility study was not a proper valuation, that Van Gorkom suggested the price, and that the agreement did not allow active solicitation. Van Gorkom signs agreement w/o reading. Upper management is pissed and threatens to leave if they can’t actively solicit. Pritzker says okay but changes language so that it was more difficult to receive a proper market offer (required offer to be final offer). Board approves amendments sight unseen. Shareholder approved merger. a) DGCL §141(e) provides a defense for directors who rely on reports from officers
i) Not applicable here b/c Van Gorkom was uninformed and Directors had a duty of inquiry and can’t rely blindly. If Romans would have said that $55 was fair they could have relied, but he didn’t. The price was based on feasibility rather than value. b) Delaware Supreme court held TU Directors liable b/c (1) they did not make an adequately informed decision, (2) they could not rely on the officers statements under DGCL §141(e), (3) there was not an adequate market test, and (4) all material info was not disclosed before the shareholder vote on the transaction c) Guttentag thinks Roman’s deposition testimony was crucial in finding liability: “very brief bit of work on the possibility of a leverage buyout”. d) Things that would have protected the directors: informed business decision, adequate market test, meet longer than two hours. Why not shareholder vote that approved the deal? B/c the disclosure was not complete: Van Gorkom signed deal w/out 49 looking at it and used feasibility study for price, rather than valuation.
8) Francis v. United Jersey Bank pg. 356: Reinsurance Brokerage Business; reinsurance is the process by which an insurance company that has agreed to insure a risk, assigns all or a portion of that risk to another company along with a share of the premium. Charles Sr. died and handed over his 48% interest to his wife, Lillian. She was a director, but she was inactive, listless, and drank rather heavily after her husband’s death. She died in 1978. Charles Jr. and William are the two brothers. They are sons of the founder. They were active in management, and they systematically embezzled large sums in the form of nominal “loans”.
a) 3 legal issues in this case;
i) Did she have a duty to the clients?
AA) Insurance companies are a special situation where directors duties run to more than just the shareholders. Court says in this special kind of situation—like a bank. Duties are owed to customers b/c corporation hold funds of others in trust.
- Banks and insurance companies have fiduciary duties that go beyond shareholders, as well as other businesses that hold client’s funds in trust.
ii) Did she breach her duty to those clients?
AA) She didn’t do a lot. Did her failure to act breach an affirmative duty to act? Is there an affirmative duty to act? Yes. Directors have an obligation of basic knowledge and supervision; must be able to read and understand financial statements; must object to misconduct (if you see something illegal), and if necessary, resign.
a. A director may have a duty to take reasonable means to prvent illegal conduct by co-directors .
iii) Was her breach a proximate cause of the client’s loss?
50 AA) Court says if she would have pointed out the illegal action, the boys would have returned all the money. Prof does not agree with this. The sons started stealing in 1970, 3 years before she became director and the dead husband commented that Charles Jr. would steal the shirt off his back. Thus, this negates the proximate cause.
b) Takeaway: inaction is not covered by the BJR
c) Why loans? B/c it doesn’t affect stockholder’s equity and you don’t have to pay taxes on loans.
9) In re Caremark pg. 362: Case involved pharmaceutical companies giving research grants and the like to doctors—are these kickbacks, which is illegal? Judge is examining the behavior of the directors. Did they violate the duty of care? More specifically, does the Board have a duty adopt a law compliance program? Judge determines that the company did not violate their duty that much, even though the law is broken. Directors had systems in place to try to avoid breaking the law. Judge did not like old rule. The chancellor’s rationale for this new rule is that Van Gorkom requires that boards make informed decisions; timely info is essential for board to adequately supervise; federal sentencing guidelines create incentives for law compliance programs. Guttentag thinks this judicial reasoning is business decisions and thinks the court messed it up by focusing on profitability in regard to business decisions and substituting its own business judgment.
a) Old law from Graham v. Allis-Chambers: Directors are entitled to rely on the honesty of their subordinates until something occurs to put them on notice. If they are put on notice and then fail to act, liability may follow. “One Free Bite” rule
b) New law: “Directors obligation includes a duty...to assure that a corporate info and reporting systems exists, and that failure to do so may, in theory at least, render a director liable for losses caused by non-compliance w/legal standards.”
i) No “one free bite”
c) Guttentag’s better rationale for the holding:
i) Risk taking with respect to business opportunities is good to encourage: BJR applies;
51 ii) Risk taking with respect to law abidance: societal interest in discouraging: No BJR protection: active oversight require
d) What would an “adequate” law compliance program include?
i) Policy manuals, training of employees, compliance audits, sanctions for violations, provisions for self reporting of violations to regulators
ii) Guttentag says that no one knows whether this stuff works
B) Duty of Loyalty 1) Generally a) Regulates self-dealing transactions b) No BJR 2) Topics within a) Corporate Opportunity Doctrine i) Broz v. CIS b) Controlling Shareholder i) Sinclair Oil Corp. v. Levien c) Shareholder Ratification w/a Controlling Shareholder in Delaware i) In re Wheelabrator 3) DGCL §144(a): No contract or transaction between a corp. and 1 or more of its directors or officers...shall be void or voidable if: 1) Informed, disinterested directors approve; or (2) Informed shareholders ratify; OR 3) Transaction is substantively fair to corp. a) Case law fixes (2) to mean informed disinterested shareholders ratify b) Not substantially different from MBCA 8.60 c) His language: a duty of loyalty transaction is okay, if: (i) independent director’s approve it; (ii) independent shareholders ratify it; or (iii) transaction is judged fair 52 4) MBCA §8.60(1): Conflicting interest if: (i) Director is a party to the transaction; (ii) Director had knowledge and a material financial interest in the transaction; or (iii) a transaction which the director knew a related party had an interest in a) By concept: (i) Director or related person is an adverse party or has an adverse financial interest; or (ii) transaction involves another firm with which the Director is involved. b) Burden is on the plaintiff c) No difference w/Delaware 5) MBCA §8.61 Duty of Loyalty transaction okay if: (i) Independent Director’s cleanse §8.62; (ii) Independent shareholders ratify §8.63; (iii) Transaction is judged fair §8.61(b)(3) a) This is the process i) Is there a conflict of interest? AA) If no, there is no a duty of loyalty issue BB) If yes, has it been cleansed? (P Burden) aa) If yes, then the transaction is valid bb) If no, the transaction if voidable by corp. 6) Corporate Opportunity Doctrine (subset of Duty of Loyalty) a) The Director must disclose the existence of the a corporate opportunity i) Corporate Opportunity Doctrine: an opportunity that the corporation and one of the directors might be interested in pursuing b) Corp. has right of first refusal on project i) But can choose to give it to fiduciary c) Remedy: Gains based: constructive trust i) Injunctive relief and punitive damages also d) The Delaware Test from Guth pg. 386: Corporate opportunity exists where: i) Corp. is financially able to take the opportunity AA) Relevance of capacity 53 aa) Not dispositive bb) Lessens defendant’s burden ii) Opportunity is in the corp.’s line of business AA) Guth“activity as to which it has fundamental knowledge, practical experience, and ability to pursue” BB) Guth“Consonant with its reasonable needs and aspirations for expansion” CC) This is normally going to be the deciding factor iii) Corp. has an interest or expectancy in the opportunity AA) Interest: Something to which the firm has a right; legal right to something aa) If officer bought land to which the corp. had a contractual right, the officer took an interest BB) Expectancy: something which, in the ordinary course of things would come to the corp.; not yet realized legal right bb) If the officer took the renewal rights to a lease the corp. had, the officer took an expectancy CC) Line of business is broader than the above two technical definitions aa) Line of business will include interest or expectancy most of the time, but not all the time bb) If a director took an interest, it would pretty egregious and it would be obvious that there was a corporate interest iv) Embracing the opportunity would create a conflict between director’s self-interest and that of the corp. AA) Seizing the opportunity creates the conflict v) Note: Are these four factors or elements? They are factors. However, Guth says “and” and court calls them factors e) Broz v. PriCelullar pg. 384: Broz was sole shareholder and President of RFB Cellular. Broz was also a member of the Board of 54 CIS. Potential corporate opportunity is to buy cell phone franchise called Michigan 2. CIS was in financial difficulty, but was in the process of being acquired by PriCellular. Michigan 2 license was being sold. Those selling it contacted Broz. Never approached CIS b/c they were in process of selling licenses. They did approach PriCellular. PriCellular was in process of acquiring CIS; they were trying to buy up the remaining shares of CIS. Pricellular also made a bid of 6.7 million for Michigan 2. Provision said seller could only sell it to a bid 1/2 million more. Broz then agreed to pay $7.2 million. Broz informally spoke to individual directors of CIS, and told them he was thinking of buying Michigan 2. Directors said go ahead, we are not interested. RFB bought license and later (arguably, he thinks the dates the court used are suspicious and manipulates the dates b/c it was annoyed that PriCellular just didn’t pay and get the license) PriCellular completed purchase of CIS. Did this violate Corporate Opportunity Doctrine? No, this was not a corporate opportunity. Broz did not owe fiduciary duties to PriCellular until after the tender was complete (the trial court viewed Broz’s duty as if the transaction was complete). i) Relevance of board approval or lack thereof on corporate opportunity AA) Not required ii) Board approval creates a safe harbor iii) Meeting individually w/Board members does not count. Why? Whole point of the Board is to meet and discuss issues. Therefore, it makes sense for there to be discussion. Individual meetings don’t allow the shared process. Plus, there is a formality of a vote iv) Application: Was the Michigan II license a corporate opportunity? 1. corporation is financially able to take the opportunity - CIS was selling licenses. 2. opportunity is in the corp’s line of business - CIS was getting out of the business- 3. corporation has an interest or expectancy in the opportunity - no interest or expectancy. in order for it to be an interest or expectancy, there would need to be a legal right or one coming
55 4. embracing the opportunity would create a conflict b/w director’s self-interest and that of the corp. - there already was one—he owned another mobile company v) How Broz found out could also be a consideration (timing, from who and how) vi) What should Broz do if RFN had other shareholders and CIS had resources to purchase license? He has conflicting duties of loyalty. He should disclose and abstain. 7) As a director, you may want to contractually limit a corporation’s corporate opportunity rights. You see this a lot in parent-subsidiary relationships. a) Charter can provide leeway with corporate opportunities 8) Requirements for Formal Board of Directors Action: Action of the Board only occurs when: a) MCBA 8.20- Board meeting are either regular or special b) MCBA 8.21- Action w/o meeting requires unanimous written consent c) MCBA 8.22-No notice necessary for regular meeting; two day notice required from special meeting d) MCBA 8.23(a) A director may waive notice. Except as provided by subsection (b), waiver, must be in writing i) If director doesn’t show up, you can waive notice in writing. ii) If you show up, we assume that you waive notice, unless the director objects at the beginning of the meeting. iii) But if you vote, you waive, even if you originally objected e) MCBA 8.23(b)- A director’s attendance at a meeting waives any required notice unless the director objects f) MCBA 8.24- Quorom- default rule- majority; minimum quorum requirement acceptable- 1/3. Vote decided by majority present b. Shareholders i. Roles- Vote Sell, and Sue A) Sue-
56 1) Direct Suits a) A suit alleging a direct loss to the shareholder. E.g.- if you are entitled to vote, and the company does not let you vote, you have a direct claim. i) Problems is figuring out what remedy is ii) Bases for direct claims AA) Force payment of promised dividend BB) Enjoin the activities that are ultra vires CC) Claims of securities fraud/blue sky laws DD) Protect Participatory rights for shareholders 2) Derivative Suit a) 2 suits in one: Compel corporation to sue another; and the suit against that other party i) First suit is telling corporation to sue another, and the second suit is the corporation suing that party ii) Basically, a derivative suit makes that lawyer the corporation’s lawyer, so there are procedural hurdles in place to make sure too many people do not try to get themselves hired to sue corporations AA) Bonding Requirements aa) In minority of states (not Delaware) a derivative claimant with “low stakes” must post security for corp.’s legal expenses Aa) Why? Deters frivolous lawsuits BB) Demand Requirement aa) Most states require shareholders in derivative suits to approach BoD and demand that they pursue legal action unless the shareholder can claim a valid excuse [See below] CC) Special Litigation Committee iii) Bases for derivative suits AA) Breach of duty of care
57 BB) Breach of duty of loyalty CC) Enjoin management retrenching practices iv) Note: Shareholder is suing “in right” of the corporation, so remedy (damages) from principal suit goes to corporations; corp. is required to pay shareholder atty fees if suit is successful or settles v) With derivative suits, there is little to gain for shareholders and lots to gain for lawyers. b) Distinguishing a Direct Claim from a Derivative Claim i) Who suffered the most immediate and direct injury? AA) If shareholder votes are thrown away, shareholder suffered more directly, so direct claim. ii) Who did defendant (usually a director) owe a duty to? [ALI Test] - If duty is owed to corporation, then more likely a derivative suit. - If director owed a duty to the shareholder (give dividend), then more likely to be a direct suit. iii) Who would receive the benefit of a favorable verdict? [Delaware Test] iv) Is the remedy only injunctive? AA) If so, more acceptable to be direct suit c) Who can bring a derivative suit under the MBCA? i) MBCA §7.41(1) Must be a shareholder at the time of the alleged wrongdoing ii) MBCA§7.41(2) Named plaintiff must be a fair and adequate representative of the corp.’s interest. AA) E.g., no conflict of interest, such as suit for unrelated strategic purposes iii) In many states, must continue to be a shareholder d) Trade-offs for plaintiff in pursuing derivative versus direct lawsuit i) Advantages
58 AA) Possibly more attractive damages BB) Undoubtedly more fee allocation ii) Disadvantages AA) Damages and other remedies usually go to the corp., not directly to shareholders e) Trade-offs for defendant in defending a derivative lawsuit i) Indemnifications from Delaware §145- Waltuch AA) May indemnify for any expenses (including atty fees, fines and amount paid in settlement) if person acted in good faith. Termination of suit by settlement shall not create a presumption not acting in good faith BB) If a person is adjudged liable, removes right to be indemnified in most cases - So why not always settle? CC) If successful on merits, must indemnify actual and reasonable expenses DD) Indemnification in (a) or (b) above need to be approved by disinterested directors or shareholders EE) Corporation can advance expense f) Demand Requirement i) Policy Concerns Supporting Demand Requirement AA) Derivative suits a mechanism of managerial accountability BB) Potential for Bias: Directors cannot be expected to sue themselves CC) Cause of action belongs to a corp. aa) Like all assets, litigation under control of BoD DD) Shareholders may have interests diverse from those of corp.
59 aa) Shareholders lawyer often real party in interest EE) “The demand requirement is a recognition of the fundamental precept that directors manage the business and affairs of the corp.”Aronson ii) What is the Demand AA) Typically a letter from the shareholder to the BoD aa) Must request that the board bring suit on the alleged cause of action bb) Must be sufficiently specific as to apprise the board of the nature of the alleged cause of action and to evaluate its merit BB) Shareholders must make demand before filing suit, unless its futile. aa) FRCP 23.1The complaint shall allege “the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors and the reasons for the plaintiffs failure to obtain the action or for not making the effort” iii) Issues concerning Demand AA) When is demand requirement excused? aa) Demand is deemed futile if Plaintiff creates a reasonable doubt (using tools at hand) that: AA) Directors are disinterested and independent; Or - This is usually the stronger argument Bb) Challenged alleged transaction was product of valid exercise of business judgment bb) Discovery is limited to “tools at hand” BB) What recourse does shareholder have if Board decides not to pursue? CC) Does making the demand affect one’s subsequent right? 60 aa) Yes. Once demand requested (in Delaware) can no longer challenge Board’s independence iii) Grimes v. Donald pg. 241: DCS Communications hired Donald as CEO. Entered into employment agreement in order to get him. Agreement said if he was terminated w/o cause, he would continue to get salary until 75 years old, bonus and medical, and pension after employment agreement expired. He could be deem it termination w/o cause if directors unreasonably interfere with his job running the firm. Grimes did not like it. So he sued corp. based on this contract being entered into. Makes direct and derivative claims. Two main claims 1- Board abdicated its power to manager. Basis is fact that contract said that Board could not unreasonably interfere with CEO. That is a direct claim b/c the shareholders are entitled to select managers of firm. So if that right is given away, they are losing one of their contractual rights. He loses on this claim on the merits. An informed decision to delegate a task is subject to the BJR, although director may not delegate duties which lie “at the hear of the management of the corporation.” Also, Ct says that the Board did not abdicate their rights, rather made it more expensive to exercise their rights. 2-Excessive compensation is derivative claim b/c the corp. is being most harmed by this arrangement. Now we have to make a demand or plead excuse. Grimes did both. Cannot do that. Have to choose. Once you made demand, you cannot also plead that demand is excused. Grimes loses this claim on procedural grounds. AA) Compensation issues fall under the BJR protections: decision has to be uninformed or purely wasteful which is hard to argue AA) What is effect of making demand? Board decides not to pursue the case. It is not going to let corporation sue us. At that point the Ct says they will evaluate the Board’s demand refusal, to see whether Board adequately refused it. The test they will apply is BJR, and ask whether they made an informed decision, but will not second guess. aa) Usually, can say of course they are going to refuse, b/c they are self-interested. COI, so BJR should not apply. However Delaware
61 has little trick. Want to claim that they are self-interested, but you are the one that made the demand. If you made the demand, that you must have thought that they were not interested, or you would have tried to get it excused. Grimes should not have made a demand, because he waived the right to challenge the Board’s independence Aa) In Delaware, a rational plaintiff will file derivative suit before making demand and claim that demand would be futile Ab) If P makes a demand on the Board in Delaware, the P throws away his ability to challenge the independence of the Board. Ac) Consequences of not making demand are trivial—if required, slight delay while you make demand Ad) Claiming demand would be futile preserves the right to litigate the issue
BB) Delaware: A demand, when required and refused (if not wrongful), terminates a stockholder’s legal ability to initiate a derivative action. But where demand is properly excused, the stockholder does possess the ability to initiate the action on his corporation’s behalf. When demand is refused because the litigation would be detrimental to the corporation, the decision is subject to the BJR with independence removed from argument (basically, just at issue is reasonable investigation). Even when demand is excused, circumstances may arise when continuation of the litigation would not be in the corporation’s best interest. Pg. 264 BB) Demand Requirement under MBCA: §742: No shareholder may commence a derivative proceeding until a written demand has been made and 90 days have expired form the date the demand was made unless irreparable injury to the corp. would result by waiting for the expiration of the 90 day period.
62 aa) Making a demand does not waive the interested/independence argument CC) Disposition of Demand Requirement under MBCA aa) §744(a) Ct will dismiss if independent directors or panel find in good faith proceeding w/suit not in best interest of the corp. bb) §7.44(b) Evaluation by (1) a majority of independent directors or (2) a majority of committee of independent directors cc) §7.44(c) Can proceed after demand rejection if majority of board not independent or review not in good faith or reasonable dd) Burden of proving in good faith and reasonable shifts to Board if majority of directors not independent Aa) Note: Substantively similar to Delaware DD) Substantive review is the same in Delaware and under the Model Act, but the procedure is different g) Special Litigation Committee a) Directors appoint disinterested board members to set up this SLC and then they determine that the lawsuit does not make any sense, so the lawsuit gets dismiss b) Zapata v. Maldonado pg. 261: Demand was not made, and was excused as futile. 4 years later the Board appoints a special litigation committee with new board members who recommend dismissal b/c the only one who will profit is the attys. Did the committee have the power to dismiss the cause of action? Yes. Excusing demand does not strip the board of its power. May be circumstances, like here, where the suit, though properly initiated, is not in the corp.’s best interest. i) Zapata Two Step (Delaware): AA) Inquire into the independence and good faith of the committee. Inquire into the bases supporting the committee’s recommendations: 63 AA) Procedural step to make sure they are untainted BB) Very hard—that is their job, they get tons of expensive reports and experts BB) Court applies its own business judgment as to whether the case should be dismissed - This is no tjust from the company’s perspective, but overall. - “If I let the Special Committee kill this suit, will it let the directors get away with murder?” - This is far more intrusive than normal judicial review of director actions? Why? Demand was excused b/c board disabled from acting due to conflicted interests. This same disabled board also appointed the Committee. - Argument you will make: “If you let the Litigation Committee end my suit, no one is ever going to be able to bring these types of claims.” f) See flowchart: slide 34, lecture 24 g) Some empirical findings on derivative litigation a) Derivative litigation has no positive effect on stock price b) Adoption of §102(b)(&) liability limitation provision does not have a negative effect on stock prices B) Vote 1) Who votes? a) Shareholder of record AA) MBCA§7.07 Holder on the record date votes aa) No more than 70 days before vote BB) MBCA §7.21 Default rule is one share-one vote (Unless articles of incorporation provide otherwise) 2) When?
64 AA) Shareholder Meetings aa) MBCA §7.01 Annual meetings (Time set in bylaws) bb) MBCA § 7.02 Special Meetings Aa) By Request of Board Directors or at written request of at least 10% of shares BB) MBCA §7.04 Unanimous written consent 3) How? AA) Most matters require a majority of shares present at a meeting at which there is a quorum (MBCA §7.25(c)) BB) Shareholders vote either in person or by proxy (MBCA §7.22) 4) What voting on? Entitled to vote on AA) Election of directors (MBCA§§8.03-8.08) aa) Special case 1: cumulative voting MBCA §7.28 Aa) System that allows minority shareholders to assure board representation Bb) Must be provided for in Articles of Incorporation bb) Special case 2:classified or staggered boards (MBCA §8.06) Aa) Separate directors into two or three groups Bb) Limits number of directors that can be changed by one shareholder vote cc) How you put staggered boards in place Aa) MBCA §8.06 The article of incorporation may provide for staggering the terms of directors Bb) In Delaware, (DGL§141(d)) The directors may by the certificate of corp. or by a bylaw adopted by a vote of the stockholders, be divided into 1, 2, or 3 classes -Can do it with bylaws of COC dd) Which directors can you vote for? Aa) Incumbent board nominates a slate of directors 65 Bb) A completing slate may be offered in separate proxy material (A) Note: SEC considering allowing shareholders to add competing directors to company materials ee) Process for Proxy contests Aa) Proxy process regulated be SEC rules Bb) The company sends out the official proxy solicitation materials (A) May include shareholder proposals- Rule 14(a)-8 Cc) Insurgents must send out “unofficial” proxy solicitation before they solicit proxies a. Under federal law, firm has the option to mail out “unofficial” proxy material at independent shareholder’s cost (Rule 14a-7) b. Shareholder may request names and addresses of shareholders under state law if for proper purpose BB) Modify Article of Incorp./Certificate of Corp. Aa) MBCA §10.03: An amendment to the articles of incorporation: (a) must be adopted by the board of directors, and (e) approved by majority of the shares present (as long as a quorum) Bb) Delaware §242(b)(1) The directors shall adopt a resolution and holders of a majority of the outstanding stock must vote in favor of the amendment to the certificate of incorporation - Higher standard, not majority of these who show up, but all outstanding shareholders Cc) MBCA: articles of incorporation. Delaware: certificate of corporation CC) Modifying Bylaws under MBCA and DGCL AA) MBCA §10.20 (a) Shareholder may amend or repeal, and (b) Directors may amend or repeal,
66 unless pertaining to director election or bylaws prohibit a. It is possible that the shareholders can adopt a bylaw that disallows directors from modifying bylaws. BB) DGCL§109(a) The power to adopt, amend, or repeal bylaws shall be in the stockholders entitled to vote (plus, directors may also have this power if so provided in the articles of incorporation) a. If the bylaws can be modified by the shareholders and the directors and the two have different interests, there can be a tug of war about who has the power. DD) Amendments to the articles of incorporation and by-laws (MBCA §§ 10.03, 10.20) - It’s harder for shareholders to amend AOI/COC than the bylaws. EE) Fundamental transactions (e.g. mergers) (MBCA §11.04) FF) Odds and ends, such as “precatory” measures aa) recommended or suggested measures, i.e.
“We the people” advice bb) Rule 14a-8 Shareholder proposals- Allows qualifying shareholder to put a proposal before their fellow shareholder [see below] 5) Proxy Voting (like voting with absentee ballot) AA) Shareholders appoints a proxy (a.k.a. proxy agent) to vote his/her shares at the meeting BB) Appointment effected by means of a proxy (a.k.a. proxy card) aa) Can specify how shares to be voted or give agent discretion bb) Revocable 2) Rosenfield v. Fairchild pg. 537: In this proxy contest, the incumbent board put up their slate of directors, and then there were others who got together and proposed a competing board. Each group provided material that complied with rules: this cost money. They also spent money to 67 solicit votes for directors. Money that Incumbent board spent came from the company. The new board invested their own money. The new board convinced enough to vote for the new slate, and that slate won. Shareholder brings derivative suit, challenging what happened with the money. When the new board got elected, they had shareholder vote, and majority approved having the new board’s cost reimbursed. AA) Froessel rule from case: In a contest over policy, as compared to a purely personal power contest, corporate directors may spend money from the corporation’s money so long as they believe in good faith that it is in the best interest of the corporation, subject to court scrutiny. Successful contestants can be reimbursed by a vote of the stockholders for the reasonable and bona fide expenses incurred in such policy contest, subject to court scrutiny. - Froessel rule from Guttentag: incumbent board proxy contests paid regardless of outcome; insurgent costs may be reimbursed if insurgents win. Has to be a bona fide policy contest. - Crazy baller incentives for incumbent board--OPM - Was there bona fide policy contest? If yes, company funds can be used. If it is a personal dispute, company funds should not be used. - Majority founds this to be a policy contest over the excessive compensation of Ward. BB) Dissent: Not convinced that shareholder vote is not enough. Shareholder vote only extinguishes a duty of care claim. This is a duty of loyalty issue (personal purpose, not corporate purpose), so the shareholder vote only shifts burden. Also says this may involve ultra vires expenditures, b/c acting in wasteful way, so all shareholders would have to vote. Thinks bona fide policy dispute test is stupid test b/c ever power change is inherently policy as well. BB) Proxy Contest are Relatively Rare 6) Shareholder proposals: 14a-8 allows qualifying shareholders to put a proposal before their fellow shareholders. AA) Expense paid by company and the proxies are solicited in favor of them in the company’s proxy statement BB) These measures have to be precatory (nonbinding) CC) Board does not have to adopt them; if they don’t, it is subject to the BJR
68 DD) Reasons shareholder proposals can be excluded: a) 14a-8(i)(1): If the proposal is not a proper subject of action for shareholders under the laws of the jurisdiction of the company’s organization. -In a way, this is federal deference to state law b) 14a-8(i)(2): implementing would violate the law c) 14a-8(i)(3): implementing would violate proxy rules d) 14a-8(i)(4): proposal involves personal grievance or special interest e) 14a-8(i)(5): proposal is not relevant to firm’s operations f) 14a-8(i)(6): company lacks power to implement g) 14a-8(i)(7): proposal deals with company’s ordinary business operations h) 14a-8(i)(8): relates to electing directors EE)These proposals tend to be about big environmental, social issues that are related the company’s operations—basically, a political voice for shareholders that care about how the company’s business affects a certain issue. FF) Eligibity: a) Timing: The proposal must be submitted to the corporation at least 120 days before the date on which proxy materials were mailed for the previous year's annual shareholder's meeting. E.g., if the firm mailed its proxy materials on May 1, 2006, you count back 120 days from May 1 to determine when a proposal must be submitted to be included in the 2007 proxy statement, which works out to January 2, 2007. b) Share holdings: 14a-8(b)(1): Proponent must have owned at least 1% or $2,000 (whichever is less) of the issuer's securities for at least one year prior to the date on which the proposal is submitted. c) 14a-8(c): only one proposal per corporation per year - no limit on how many companies a proponent can submit proposals to
69 d) 14a-8(h): If the proponent fails to show up at the meeting to present the proposal in person, the proponent will be ineligible to use the rule for the following two years e) 14a-8(d): Proposal plus supporting statement cannot exceed 500 words - References to websites with more information okay, but website is subject to proxy rules GG) Process for Excluding a Proposal a) Management files a notice of intent to exclude with the SEC. i) Accompanied by an opinion of counsel if any of the stated reasons rely on legal issues ii)Under rule 14a-8(f), management must notify the shareholder-proponent of remediable deficiencies in the proposal and provide an opportunity for them to be cured. b) A copy of the firm's notice and statement must also be sent to the proponent, who may (but need not) reply HH) SEC Response a) Staff level action: i) If staff determines proposal can be excluded: Issue a no-action letter ii) If staff determines should be included: Notify the issuer of possible enforcement action if the proposal is excluded b) SEC role: Bainbridge – “The SEC reluctantly referees the shareholder proposal process.” p. 562
70 II) Lovenheim v. Iroquois Brands Ltd. Pg. 559: Shareholder wants to put in the company’s proxy statement a proposal to study about how the foie gras the company distributes is produced. It’s not over 5% of the company’s business, so the company claims it can exclude it. Shareholder argues that he fits into the exception: significantly related to the issuer’s business. a) It’s just a suggestion that the corporate study the foie gras. (precatory, not mandatory). - Company could exclude it if it wasn’t precatory b) “Otherwise significantly related” includes ethical and/or social significance. c) He thinks it is a waste of money for the SEC to monitor these shareholder proposals C) Sell 1) Securities Act of 1933: what the company must do a) Regulates the sale of NEW securities b) Disclosure at the time of the public offering c) Key section: §5 2) Securities Exchange Act of 1934: regulates trading activity a) Regulates TRADING activity b) Ongoing disclosure required c) Key sections: §10(b): no fraud; §14(a): proxy contests; §14(e): tender offers; §16: insider trading 3) What is a security? a. ’33 Securities Act § 2(a)(1): “The term ‘security’ means any note, stock, ... bond, debenture, ... or investment contract ... or, in general, any interest or instrument commonly known as a ‘security’.” b. Forman test - Security if: i. Involves “traditional stock” and: ii. Receive dividends, iii. Negotiable, iv. Can be pledged, v. Proportional voting rights, vi. Can appreciate in value. c. Howey test - Security if: i. Invest dollars, and ii. Common enterprise, and iii. Profit solely from other’s efforts d. See slide 42, lecture 26.
4) Analysis: 1. Are you selling a security?
71 a) If yes, then federally regulated. b) Security is defined very broadly and is really easy to meet 2. Is your sale a “public offering”? a) If no, avoid §5, but §10 still applies (antifraud provisions) i) Still subject to federal rules ii) Some disclosure may still be required
b) If yes, terms of 1933 Act apply: c) Not a public offering, if either i) Shares were already registered (secondary trading) a. Not an issuer, underwriter, or dealer, when: - Shares already registered and issued - Covers most day to day traders ii) Offering by the issuer that is a private placement. a. Some factors to consider: Number of investors offer to Size of the offering Manner of offering No general advertising or solicitation b. In private placement, some disclosure may still be required c. Not as onerous as traditional public offering d) What does Securities Act require when public offering? ’33 Securities Act § 5: i) Pre-registration period - prohibits any offer to buy or sell any “security” unless you file a registration statement with the SEC. ii) “Waiting” period – Offers to sell are allowed, but cannot close until after the effective date (determined by the SEC, at least 20 days). iii) Post-registration period – Sales can be closed, but must be accompanied by a prospectus. 3. Is your sale insider trading? a) What is insider trading? i) Buying or selling shares using inside information. ii) “Inside Information” – information about the firm which is not publicly available. iii) But buying and selling using non-public firm information is not always insider trading. b) When is it insider trading? Depends on… i) How the info was gathered: - Role as fiduciary—more likely to be insider trading - Overhead in public ii) How you use info
72 - Buying or selling in advance of a tender offer— more likely to be insider trading - Buying or selling on the open market Types: a) Statutory insider trading (§16) i) Section 16 (a): If own over 10% or are a director or officer, then must report ownership stake and changes to SEC (“Statutory Insiders”) must file statements with the SEC. - Statutorily defines who an insider is - If director leaves within the time period, he is no longer a statutory insider ii) Section 16 (b): “Statutory Insider” profits from a purchase and sale or sale and purchase within six months are recoverable by the firm. - Shares are fungible - The sale and purchase must occur with six months of each other - Only covers transactions where such beneficial owner at the time of the purchase and sale - Any recovery goes to the company - Courts interpret the statute to maximize the gains the company recovers iii) Bainbridge: “both over- and under-inclusive.” iv) From 1934 Act: legislature thought insider trading led to the market crash v) Applies only to companies that must register under the 1934 Act; compare with 10b-5 which applies to all issuers vi) Applies only to stocks and convertible debt (equity securities); compare with 10b-5 which applies to all securities
73 vii) Reliance Electric v. Emerson Electric pg. 511: Emerson was going to try to take over Dodge so they buy a bunch of shares. Reliance actually merged with Dodge. Emerson wanted to sell shares. They bought 13.2% in preparation of their tender offer. So they became a statutory insider with this purchase: court looks at position after transaction. On the advice of their lawyer, Emerson sells stock a couple months later to bring their ownership down to 9.96%. This reduction was subject to the statutory insider trading rule and the gain went to Reliance. The remainder was sold within the six months. The Court holds that it doesn’t matter that it was a planned series of transactions. They were no longer a statutory insider when they sold the remaining 9.96%, so they could keep the profits. - Can get around bright line statutory insider trading rule by structuring your transactions properly. - Another option for Emerson was to wait six months and then sell the stock. b) Classic insider trading i) Classic insider trading occurs when a fiduciary trades in shares of his or her own firm, based on information gained as a fiduciary. ii) It is hard for insiders to trade in their own stock b/c they have to disclose or abstain when they have insider information; there is a small window after disclosure. ii) From interpretation of 10b-5 iii) SEC v. Texas Gulf Sulphur pg. 482: Late 1950s: TGS begins exploring eastern Canada. 10/29-30/63: Exploratory hole k-55-1 drilled (Visual assay promising). 11/12/63: Based on core sample results, TGS begins land acquisition (President commands secrecy). 11/12/63: TGS insiders begin acquiring shares and call options. 3/27/64: Land acquisition complete. 4/11/64: Unauthorized press reports. 4/12/64: Misleading press release issued. 4/16/64: Official statement made at 10 am. 4/16/64: News appeared on Dow Jones ticker tape at 10:54 am - 10b-5 not only requires that affirmative statements be true, but also includes the requirement that you cannot omit material information. - The company does not have an ongoing affirmative disclosure duty. The timing of the disclosure is a mater for the business judgment of
74 the officers. Eventually, they will have to disclose, just not contemporaneously. But some really things should be disclosed more quickly - General standard of materiality: whether there is a substantial likelihood that a reasonable shareholder would consider the fact important. Here, the stock price increased which is pretty good evidence of materiality. - What choice did the mangers at TGS have with respect to stock purchases? Disclose or abstain: But they may be breaching their fiduciary duty to the company by disclosing. - SEC: an insider in possession of material nonpublic info must disclose such info before trading or if disclosure is impossible or improper, abstain from trading. - One director bought shares after the official statement but before it hit the ticker. The trial court dismissed the claim against him. The appellate court overturned the dismissal b/c the purchased before the info was widely disseminated. - Why was the TGS also charged? B/c we enforce 10b-5 against corporations even if the corporation does not buy or sell securities. “In connection with” is satisfied if the press release would cause reasonable investors to rely thereon and cause such investor to purchase or sell a corporation’s securities. - Two theories for prohibiting insider information: 1. Provide relatively equal access to material information. Do you see any problems with deciding TGS based on establishing a level playing field? It seems overly broad. There are lots of situations where unequal information is fair. There are lots of situations where information advantages are created in a legitimate manner. There seems to be something particularly bad about executives using info - This rationale has been basically rejected. 2. Punishes breaches of fiduciary duty to maintain corporate secrets. Do you see any problems with deciding TGS on this basis? May be too narrow. Unclear how the firm could use inside information for gain. We will
75 say this complication and been resolved (You are taking an asset that the corporation can’t use and you are a fiduciary, those gains belong to the firm). It mky not capture all situations where use of inside information is “unfair”
iv) Chiarella v. US pg. 493: Chiarella works for printing press. A company was taking over another and Chiarella was working on the required printing. The company took precautions but Chiarella figured it out. He bought a lot of stock of the target company. He is not a fiduciary of the target company (the shares he traded), so the SC lets him get away with it. Court throws out “level playing field” theory for prohibiting insider trading. - When you apply 10b-5, you apply only if the trader owed a duty to the corporation/shareholders. This is very narrow and is limited in subsequent case law by other insider trading liability theories. - Burger’s dissent is the beginning of the “misappropriation” theory. c) Tippers and tippees i) Insider trading prohibition extends to those who use non-public material information they knew was provided by tipper for personal benefit. ii) Dirks v. SEC pg. 494: Equity Funding was committing fraud. Secrist leaves firm, calls and tells Dirks about EF’s fraudulent conduct, Dirks interviews officers and underlings tells him it is true, Dirks calls Wall Street Journal who doesn’t believe him and refuses to run the story, Dirks isn’t invested in EF, but he tells other investors and they sell their stock. Is Dirks guilty of tipper/tipper insider trading? No. . This was inside information: material nonpublic information . Analysis: Did Secrist violate his duty to the EF shareholders? Did he do something for personal benefit? o If so, does Dirks “inherit” Secrits’ts “Cady/Roberts” duty (disclose or abstain)? 76 Does Dirks “pass it on” to his tippees? iv) Basically, you can tip someone as long as you are not doing for personal benefit, BUT . Reg FR changes the rule (if the insider didn’t breach, then the tippee couldn’t breach even if it was unfair). When Secrist/company gives info, they now have to tell everybody at once Analysis: a. The tippee inherits the tippers “disclose or abstain duty” if: i. Tipper flunks “personal benefit” test or his purpose is to make a valuable gift ii. Tippee must know or have reason to know of breach and it’s not for the good of the company. b. Did the tipper violate his duty to the corporation/shareholders? Only if he had a personal benefit. If no, end of analysis. i. Raising fraudulent conduct, even if vindictive is not a breach. ii. Tipper must be doing something wrong iii. Personal benefit: o monetary gain o reputational gain o quid pro quo But not desire to provide public good c. Other tippees can inherit prior tippee’s duty with the same test. But new tipppe could know about either original tipper or original tippee flunking the personal benefit test. d. In general, the tippee’s liability is derivative of the tipper’s, arising from his role as a participant after the fact in the insider’s breach of fiduciary duty. v) Dirks establishes a category of “constructive insiders” who can violate insider trading prohibitions. a. An actor becomes a corporate insider where they (1) obtain material nonpublic information from the issuer with (2) an expectation on the part of the corporation that the outsider will keep the disclosed information confidential and (3) the relationship at least implies such a duty. i. Think lawyers, accountants, consultants. 77 d) Misappropriation insider trading i) Insider trading prohitibiton extends to those who use non-public material information in violation of a fiduciary obligation. ii) Ex. Lawyer doing title search. For awhile this was legal, but O’Hagan says this is not permissible under the misappropriation theory iii) US v. Ohagan pg. 501 O’Hagan was a lawyer. He was working on a deal for Grand Met to buy Pillsbury. He used this information to buy stock in Pillsbury. - It would be traditional insider trading if O’Hagan represented Pillsbury - The SC adopted the misappropriation theory: if you breach a fiduciary duty to the source of your information and use that information to trade with someone, even if it is not the company you got the information from, that will count as insider trading. - 10b-5 will apply to this transaction. Statute/Rule proscribe “deception” by trader “in connection with purchase/sale” of securities. In this case, deception works through non-disclosure; and purchase/sale requirement clearly met. iv) Rule 14e-3: Prohibits insider trading during a tender offer and thus supplements Rule 10b-5. o Once substantial steps towards a tender offer taken, Rule 14e-3(a) prohibits anyone, except the bidder, who possesses material, nonpublic information about the offer from trading in the target’s securities o Rule 14e-3(d) prohibits anyone connected with the tender offer from tipping material, nonpublic information about it o Rule 14e-3 is not premised on breach of a fiduciary duty - O’Hagan upholds it anyway v) what if O’Hagan disclosed and they approved? There is still a violation of 14e-3. What if it wasn’t a tender offer? Basically, he is not breaching a fiduciary duty and it is okay. This seems unfair, part of the reason for Regulation FD (fair disclosure)
Note: why is 10b-5 helpful in addressing insider trading claim? - b/c it is buying and selling securities - it is a broad fraud provision 78 - it makes omission to state a material fact a valid claim—one of the few places where silence can be penalized - Corporation could just remain totally silent (reading the language of the statute) o But it will be harder for individuals to remain totally silent
4) Rule 10b-5 applies, whether or not a public offering: a. It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or - There is an affirmative duty of disclosure, but it only applies to purchase or sell of securities (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. b. We enforce 10b-5 against corporations even if the corporation does not buy or sell securities. ii. Duties A) None, unless controlling 1) Shareholders acting as shareholders owe one another no fiduciary duties a) However, Controlling Shareholders owe fiduciary duties to the minority 2) Sinclair Oil v. Levien pg. 394: Sinclair Oil was a holding company with multiple subsidiaries- each operating subsidiary functioned in one country. Conflict of interest is between the parent and the subsidiary company. Problem is that the parent owns 97% of subsidiary company. Minority objected to three aspects of Sinclair- Siven relationship. 1- Sinven’s large dividends; 2- Sinven prevented from expanding; 3-Contract between Siven and International (100% subsidiary of Sinclair to manage foreign operations) breached. This case has to be brought under the third prong of DGCL §144, because there are no disinterested parties. Well, there is 3% minority interest but company is not going to allow 3% minority decide what is best. So left in prong number 3, to take case to court have to look at intrinsic fairness. First allegation: Here, it is fair because every
79 shareholder got the same dividend. Does not meet the standard of intrinsic fairness and the business judgment rule is used. Second claim is that they are preventing from expanding in violation of the corporate opportunity doctrine. Should apply the 4 factor Guth test, but Sinven did not hear about these opportunities and Sinven was all about Venezuela, so opportunites outside country wasn’t an opportunity for them. So the court finds that there was no breach of duty of loyalty on the first two assertions. On the third, the court finds that the duty of loyalty was breached with respect to the contract (payments lagged and minimums not always met). Subject to intrinsic fairness test. “Sinclair got the oil w/o having to comply w/contract duties.” This was self-dealing on Sinclair’s part. a) DGCL §144(a): No contract or transaction between a corp. and 1 or more of its directors or officers...shall be void or voidable if: 1) Informed, disinterested directors or approve; or 2) Informed (disinterested) shareholders ratify; OR 3) Transaction is substantively fair to corp.(Sinclair) b) Intrinsic fairness applies when parent received a benefit to the exclusion of and at the expense of the minority shareholders. i) Burden on defendant to show transaction was fair ii) Contrast: BJR, burden of proof on P to rebut “rational business purpose” c) How might a corporation that owns a large percentage of the stock of a corporation deal with a minority shareholder that may file fiduciary duty law suits? - Get rid of them: buy them out. The only way to get it cleansed is to get a judicial review. 3) In Re Wheelabrator pg. 408: How do we know this is a fair transaction? Waste owns 22% of Wheelabrator, and has 4 member on the Wheelabrator Board. Waste and Wheelabrator want to do a stock switch so that Waste owns 55% and is a controlling shareholder of Wheelebrator. What should they do? Make the 4 interested members leave, and have the 7 disinterested members form a committee to set up a process where you can fairly evaluate a transaction between these two companies and potentially cleanse the transaction. Avoids a conflict of interest. Then get third party expert opinions. At the board meeting, they got a few investment bankers to come in and talk to them about the transaction. This is to ensure that they were informed. However, the meeting was a little short (3 hours), breaking one of Guttentag’s rules. They voted for the transaction. Then sent it to shareholders, and the informed shareholders ratified it. Here, the court
80 says the interested, or conflicted shareholders do not count. Here we apply rule when Waste was 22%, so not controlling shareholder. a) Effect of ratification by a majority of informed, disinterested shareholders depends on type of claim i) Duty of care claims are extinguished AA) What about Smith v. Van Gorkum? The shareholders were not fully informed ii) Duty of loyalty claims against directors AA) Shifts burden of proof to plaintiff to show waste aa) This is the effect in this case iii) Duty of loyalty claims against controlling shareholder AA) Shift burden of proof to plaintiff to show unfairness c. Officers i. Roles A) Work for Directors ii. Duties A) Similar to Directors E. Termination 1) Voluntary dissolution: a) Board submits and shareholders vote on proposal to dissolve: MBCA § 14.02 (b) b) Submit Articles of Dissolution to state c) Can only carry on to wind up 2) Involuntary dissolution: If there is a deadlock: MBCA § 14.30
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