Bus Org OutlineSole Proprietor

Advantages (5)o No formalities, fees, paperwork, ecto Proprietor is his own boss – no approval required for business decisions - owner has complete

control of business not subject to risk of agent taking inappropriate risk o Free to trade anywhere without formalities or qualification

Foreign corporations need an agent for service so that you can be served in the jurisdiction in which they are doing business

Sole proprietor can do business anywhere without providing an agent within the jurisdiction

o Owner entitled to all constitutional privileges and immunities accorded to citizens All residents of US are entitled to do business in the US as a sole proprietor

o Not subject to as many regulatory and reporting requirements Only must file or zoning requirements, or other local operating laws

o Business may receive credit not only on it’s balance sheet, but also to the extent of the owner’s entire resources, including those outside the venture Gains and losses from the business included with any other personal gains and loses on individual’s tax return

Double tax does not apply Disadvantages (6)

o No one other than owner can act on behalf of the business unless he is an agento Proprietor remains fully liable for business debts, even if business is dissolved

unlimited personal liabilityo No continuity of business- dissolves when proprietor dies

Partnership – simplest business - UPA §6 - association of two or more persons to carry on as co-owners of a business for profit

o a partnership agreement is like a contract - partners are free to set any terms, so long as they are not illegal; UPA is just a default guideline, where a contract exists, its terms will control

o residual form of business- when people come together and run a business where they split profits, and they don’t do something to form another type of business (such as register a corporation), they have created a partnership, whether or not they so intend

Does not require written agreement – oral understanding that people will work together and split the proceeds will suffice to form partnership

Types of Partnership:o Partnership de jure – legal partnership o Partnership de Facto – not explicitly intended by partners, but satisfies the UPA definition of

partnership receipt of a share of net profits is prima facie evidence that he was a partner, unless that

money was paid in the form of wages; UPA §7(4) (Zajac v. Harris) Use of the same name, declarations of co-ownership, equal withdrawals from

joint accounts, and complete failure to attempt separate accounting indicates that a partnership did exist (Crawford v. State Bar)

o Partnership by estoppel – no partnership exists, but the actions of the parties involved in suggesting one to third parties estops them from arguing that it does not exist UPA §16

Evidence of a Parntership:o one holding position of trustee within the firm, but not becoming a partner, does not have any

liability for the firm (Martin v. Peyton)o To be considered a partnership, profits, in whatever form earned, must be the joint property of the

parties before division (Dority v. Driesel)o That parties act in concert to achieve some economic objective, while relevant, is not sufficient to

create a joint venture that qualifies as a partnership (Dority v. Driesel) UPA provisions:

o UPA §9 - Partnership theory - whenever one partner does anything in the scope of the partnership, the other partners are bound as he is their agent

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§9(2) - there must be express authority for acts of a partner which do not appear to be in the usual course of business, and no part of this statute would overrule the statute of frauds limitation that such express permission be in writing

o UPA §10 - only allows one partner to bind the others in sale of partnership realty where such action falls under “normal course of business” as described in §9(2)

o UPA §11 – partnership bound by admission of partner- an admission or representation made by any partner concerning partnership affairs within the scope of his authority as conferred by this act is evidence against the partnership

o UPA §13 - partnership is bound by partner’s wrongful acto UPA §14 – partnership is bound to make good the loss where: 1) partner acting within scope of

his apparent authority receives and misapplies money/property, and 2) partnership, in the course of business, receives money/property, which is misapplied by any partner while in partnership custody

o UPA §15 – all partners are joint and severally liable for the partnership’s debts apparent scope of partnership depends upon the conduct of the partners in presenting themselves to third persons and suggesting their authority as partners

A person dealing with a partnership is usually in no position to know of special agreements between the partners and can, therefore, not be charged with knowledge of agreements between partners absent specific notice

o UPA §8, §25 - Each partner does not have a separate share in the partnership’s assets, rather each has a claim to interest in the undivided partnership as a whole

o UPA §18 (can be opted out of) - rights and duties of the partners in relation to the partnership shall be determined subject to the following rules:

each partner will be paid (or will owe) equally upon liquidation of assets, subject to any agreements made between partners

no partner is entitled to be paid for the services that they contribute to the business (but they can agree to be paid)

at some law firms, some lawyers opt to become permanent associates (where they are guaranteed a salary) rather than becoming partners and gaining liability for the actions of all partners

UPA §18(e) - all partners have equal rights in the management of and conduct of the business

UPA §18(h) - any difference arising as to ordinary matters of the partnership may be decided by a majority of the partners, but no act in contravention with any agreement between partners can be done without the consent of all partners (can never have majority without unanimity in partnership of 2 - one cannot be majority)

Dissolution of Partnership:o when rightfully dissolved, all partners have equal rights to liquidated assetso when wrongfully dissolved, two types of partners

rightful partners (nonbreaching) can liquidate and recover their assets and damages can continue operation, paying wrongful partners for their shares and removing

future liability from wrongful partners wrongful partners (breaching)

if other partners chose not to continue business:o can liquidate the assets

if other partners do continue:o can receive value of his assets, less damage he owes the rightful

partnerso Dissolution Provisions in UPA:

UPA §29- change in the relation of the partners caused by any partner ceasing to be associated in carrying on the firm business

UPA §31 - causes of dissolution - provisions for dissolution can be opted out of by written agreement UPA §32 - Dissolution by Decree of Court UPA §33 - general effect of dissolution on authority of partner

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UPA §34 - Right of Partner to Contribution from co-partners after dissolution UPA §35 - Power of Partner to bind partnership to third persons after dissolution UPA §37 - Right to wind up - belongs to partner or partners who did not dissolve the partnership

wrongfully UPA §38 - rights of partners to application of partnership property partners reduce all assets of firm

to cash, then apply those to partnership’s liabilities to third parties, then distribute the remainder under §40

(1)where dissolution is caused not in violation of the partnership agreement, the assets should be liquidated to pay partnership liabilities, then distributed between partners

o where dissolution is caused wrongfully, breaching partner can receive only net amount of cash due to him from partnership

(2) - where dissolution caused by breach:o (a) non-breaching partner may liquidate as in (1) and recover damages for breach

against breaching partnero (b) non-breaching partner may maintain the business without the breaching partner,

providing a bond or cash for payment of breaching partner for his interests in the partnership. less any damages recoverable for breach, and indemnify breaching partner from any future liabilities of the partnership

o (c I) where business is not continued under (2b), breaching partner may exercise liquidation as under section (1), less damages owed to the other partners

o (c II) where business is continued under (2b), breaching partner may have his interest in the partnership ascertained and paid to him by cash or bond, and will be released from all existing liabilities of the partnership; BUT, value of the business good-will will not be considered in the value of the party’s interest

o UPA §19 - Partnership Books - right of inspection every partner shall, at all times, have access to and may inspect and copy the partnership books

o UPA §20 - duty of partners to disclose information - partners shall render on demand true and full information of all things affecting the partnership to any partner or the legal representative of any deceased/legally disabled partner

o UPA §21 - partner accountability as a fiduciaryo One partner cannot bring an action at law against a co-partner to recover an amount claimed by reason of

partnership transaction until there has been a final settlement (dissolution) of the partnership (common law rule) because:

a man cannot at the same time in the same suit, be both plaintiff and defendant it would be a waste of time to give a man a settlement which he might be compelled to refund upon

dissolution it would defeat the equitable right of other partners EXCEPTION - final accounting is not required before lawsuit where there are no outstanding

obligations of the partnership, and a legal decision would effect a final settlement between partners (Pilch v. Milkin)

o Since the partnership isn’t a distinct entity, property used by it can either be 1) contributed to/acquired by the firm as a capital, or 2) individual partner’s personal asset, loaned to the firm for its use

Definition of partnership property - UPA §8 - (1) all property originally brought into the partnership stock or subsequently acquired by purchase or otherwise, on account of the partnership, is partnership property; (2) unless contrary intention appears, property acquired with partnership funds is partnership property; (3) any estate in real property may be acquired in the partnership name is partnership property

where one partner is acting as an agent of the other under UPA §9, statute of fraud’s writing requirement does not apply

o UPA §24 - three property interests of each partner: (1) rights in specific partnership property (see §25 = rights to property - cannot be claimed by individual creditors, upon death, goes to remaining partners, ect.); (2) interest in the partnership (see §26 = share of profits and surplus); (3) right to participate in management of the firmo UPA §25 - nature of a partner’s right in specific partnership property - a partner is co-owner with the other

partners of specific partnership property holding as a tenant in partnership

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(2)(d) - on death of partner, right in specific partnership property vests in surviving partners, who have no right to access the partnership property except for partnership purposes

(2)(e) - partner’s right to specific partnership property is not subject to dower, curesy, or allowances to widows, heirs, or next of kin

o UPA §26 - nature of partner’s interest in partnership - partner’s interest in the partnership is his share of the profits and surplus, which is his personal property “good will” should, absent any agreement, be seen as a firm asset under UPA §9(3)(b)

o individual partners may not withdraw their share of firm assets while the firm continues to exist one result of partners holding an undivided interest in firm assets is that individual creditors cannot

levy upon and sell in execution the individual’s interest in firm assets property of partnership is like tenancy by the entirety - cannot be severed as long as the legal

relationship exists partners do not have a divisible interest in the property

o Partnership Duration death of a limited partner does not automatically lead to dissolution partnership under UPA §29, if

partner is silent, or where agreement specifies otherwise (opt out in partnership agreement, court order, directed by will, agreement of executor)

under §31, partners are free to define the duration of their partnership for a term, for a task, or at will Under §31, if the partnership agreement provides for the distribution of partnership property,

the rights of the partners are governed by the agreement rather than by UPA (165) partners always have the POWER to dissolve, but the RIGHT to dissolve is dependant upon the terms

of the partnership agreement and §38 any partner has the power to dissolve a partnership at any time, even if such dissolution is in

contravention of the partnership agreement; however where a partner exercises the power to dissolve the partnership without the right to do so, he

must suffer the penalties UPA §30 - dissolution does not terminate a partnership… it continues until the winding up of the

partnership affairs is complete winding up activities include: assignment of partnership property to repay partnership debt,

disposition of partnership property, maintenance of action for damages on behalf of the partnership, execution of renewal notes after death of partner

UPA §40 - Rules for Distribution first, determine what the assets are second, pay in this order:

o secured creditors - have lien on assetso general creditors - don’t have guarantee of repayment (employees have claim after

tax liens)o pay partners their loanso pay partners capitalo pay partners profits

if dissolution did not violate partnership agreement or UPA §31,: UPA §30 - partnership is dissolved but not terminated. the firm continues until winding

up of partnership affairs is completed UPA §37 - right to wind up affairs belongs to surviving partner(s) when dissolution

resulted from death of a partner, or to all partners who have not wrongfully dissolved UPA §38(1) - grants every partner the right to have partnership property sold and

reduced to cash UPA §40 - in absence of agreement to the contrary, determines manner in which

partnership assets will be marshaled with respect to third party liability claims If one or more former partners desire to continue firm’s business,

UPA §41 - there is a right to continue business without settlement of accounts only in event of expulsion or wrongful dissolution

UPA §42 - retired/deceased estate stands in position of creditor with immediate claim to partnership under §26, but can elect to renounce interest on that amount in favor of a continuing stream of income as an investor

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If aggrieved partners do not desire to continue the business UPA §37 - non-breaching partners have right to liquidate and exclude breaching

partner UPA §38(2)(a) - non-breaching partners have right to have partnership property

applied to discharge liabilities to third parties and receive surplus in cash, and have a cause of action against breaching partner(s)

UPA §40 - breaching party has right to liquidation and dispersal of assets, less their liability in damages for breach

if the aggrieved partners desire to continue business UPA §38- aggrieve partners have cause of action for damages caused by breach, and if

they wish to continue business, they may do so after paying breaching party for fair interest and releasing him for present and future liabilities of the business

UPA §41(3) indicates that when any partner retires/dies, and the business is continued with the consent of the retired partner/administrator of deceased partner, but without assignment of his right to partnership property, the continuing partnership business shall be liable as if such assignment had been made

Agency – consensual relationship between two persons whereby the principal, upon whose behalf acts are to be performed, agrees to accept another person as a legal extension

o Types of agents: Servant agent – someone who is both directed in his assignment and under the principal’s

physical dominion in performing his assignment Non-servant agent – principal may give assignments, but she exercises no actual or potential

physical control over the performance of those assignments o All agents owe a fiduciary responsibility to their principals, so they must seek the principal’s

advantage in their actions, not their owno Agency may generate both tort and contract liability for the principalo Fidelity and Faithlessness

agent bears no liability when principal breaches a contract made by an agent acting in the scope of real authority

Even where no real authority exists, principal may be bound to third party by apparent authority, in which case the agent is liable to the injured principal (principal’s action arises in the law of trusts)

The liability of a faithless agent can be avoided, terminated, or reduced by a breach of contract by the principal, his contributory fault, or his failure to mitigate damages – Andrews v. Hastings Mut. Ins.

Where apparent authority cannot be established to obligate the principal, the faithless agent generally becomes personally liable for all of the terms of the contract

Authority – agent’s ability to deliver the principal’s liability in contracto express authority - the power which a principal has conferred directly upon an agent to take legally

binding action on his behalfo Implied authority – power conferred by the principal upon the agent from the principal’s

manifestations of consent to third persons by formal or informal writings or spoken word principal gives agent authority to take an action which requires authority to do another thing

o Apparent authority – manifestation of consent for agent to take some action based on appearance, generated by authority with which the principal has invested the agent to take some other action

action of principal/failure to act creates idea for reasonable third party that agent authority exists

Apparent authority only required to be understood by a reasonable person (not one “conversant in the business practices and customs)

Apparent authority cannot be established by the agent’s own acts or declarationso Authority by estoppel – power created when a principal allows an agent to act with apparent authority

despite his lack there of action of principal has caused third party to change position based on belief that authority

exists

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principal, by words or conduct, leads third party to believe that agent has authority to do something which he does not have authority to do

o Liability after the fact Authority by estoppel – principal becomes subject to liability of faithless agent when he

carelessly permits third party to believe in agent’s authority leading to a change in that party’s position based on the belief

Generally only reparation damages are awarded (not expectation interest) Authority by ratification – exists where principal is guilt of knowingly accepting what he

realized to be the fruits of an unauthorized contract May be the express action of betrayed principal not wishing to contest third party’s

claim, or may be implied from the conduct to the principal Very low threshold requirements to find implied ratification – sometime acceptance

of the benefits alone sufficeso When principal learns of unauthorized action by an agent, he must

immediately either ratify it or repudiate it Quasi-authority – relationship where ignorant/innocent principal is responsible to third party

for contract made by faithless agent because principal has received unjust enrichment as a result of the contract

if principal becomes unjustly enriched by agent’s actions, principal becomes responsible for agent’s actions

o Principal held responsible for (tort) actions of agent under Respondeat - the master is liable for the torts of his servant which were committed in the course of employment liability will induce principal to greater care in administering his business and agents, which

will benefit the public he who gains the benefits of an agent’s acts should also bear the burdens

o where the principal and third party are both innocent, the law implies the cost on the person that could have prevented the loss (principal - and principle can, theoretically, sue agent for breach of fiduciary duty, although agent generally is insolvent at that point)

Entrepreneur Theory – respondeat superior properly places cost on principal because such cost is a business liability which must be accounted for (like a breakage cost for a principal in the restaurant business)

Allows burden of tort to be allocated to all purchasers of principal’s services, as a cost of the business, so that those who benefit from the actions of the agent also must pay for his torts- spreads the cost to many users, rather than burdening a single individual Results in allocation of loss which is fair and reasonable

differences between general partnership and limited partnershipo §1 - partners not liable for partnership liabilitieso §20 - death of general partner = dissolution of partnershipo §21 - estate of limited partner has all of the rights of the limited partner, so partner’s death doesn’t

dissolve the partnership if the limited partner was the sole limited partners, than the partnership becomes general

rather than limited o Limitations to which sections can be opted out of - CANNOT opt out of ULPA §7 (changing

limited partner to general partner for exerting control) Weil v. Diversified Properties (319 F.Supp. 778)

ULPA §7 is for the benefit of creditors, not general partnerso §303- things that might look like exercising control, but actually aren’t because the general partner

is acting as an agent in a representative capacity, not in his personal capacityo §12- you can be both a general and a limited partner in the same partnershipo depends on how you act toward each creditoro §15 - limited partner can take a share of profits, so long as the company remains solvent (enough

money remains in the company for the liabilities to be paid)o §17 - liability of a limited partner to partnershipo §20 and 21 - death, insanity, retirement, unless opted out of, dissolves the partnershipo §29 -

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o UPA §17 - Goldman Sachs lawsuit joint venture - partners must specify who owns what out of the products produced

o partnerships more common than joint ventures because they are much less complicated limited partnership- two or more people doing business together

o people can shield their liability, but give up control of the business general partnership- two or more people doing business together

o maintain control, but have full personal liability neither partnership is ideal, but people didn’t want to incorporate because they wanted to avoid unfavorable

taxeso also, don’t want to have to put together annual report or file 10-k or 10-q disclosureso also, must file certificate of corporation and pay associated fees

JOINT VENTURE relationship between joint venturerers is a fiduciary one - generally governed by UPA - right to share in

profits, to share losses, and to exert some control over the businesso joint venturers are agents of one another within the scope of the venture

LIMITED PARTNERSHIP purpose of limited partnership - to allow partners to contribute capital as creditors, and receive a share of

profits from the company rather than interest (212) limited partnership is crated by statutory law; in the absence of compliance with an enabling act, it cannot

be created or maintained o three sets of guidelines govern the limited partnership

1916 Act - originally established concept of limited partnership; still important because: basis for statutory revisions substantial number of states adopting revised act have continued to apply the

UPLA to partnerships formed prior to the effective date of the revision provides foundation upon which nearly all decisional law in this area rests

1976 Act - attempted to make revisions to clarify questionable tax issues 1985 Amendments to the 1976 Act - originally was going to be a separate act, but

confusion of a new act so quickly after the 1976 one led to Amendments being made instead of a new Act passed - sought to modernize, improve, and establish more uniformity in the law of limited partnerships

UPLA §1 defines limited partnership as a partnership formed under the provisions of §2, having one or more general partners AND one or more limited partners

o limited partner like general partner except he must file a certificate and refrain from participation in the conduct of the business

failure to meet these requirements results in status as general partner participation in limited partnership allows limited partners to take the tax-deductions due

to loss on their personal tax returns (which might be beneficial if they have extensive income in other areas) where as they would be prevented from doing this if they had invested in a corporation because a corp. is a separate entity for tax purposes fulfills quest for tax minimization

o §41-407 of D.C.Code indicates that a limited partner shall not become liable as a general partner unless he takes part in control of the business

o §7 is intended to provide protection for creditors against a business, not to general partners against limited partners

so long as the partnership continues, general partner is in a relationship of trust with limited partners and he may not invoke the provisions of the Act to enlarge the liability of his partners

in times of severe crisis all partners become actively interested in an effort to keep the enterprise afloat and abnormal problems will arise that are not under the reach of day to day matters

LLP (Limited Liability Partnership) like a combination of partnership and corporation - all partners have limited liability and all have right to

manage partnership directly LLC (Limited Liability COMPANY) - allowed by state statute

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is an LLC actually just a partnership or corporation, or is it just treated that way for tax purposes? owners of an LLC are called “members”

o all members and managers of LLC have limited liability without loss of flexibility no member of an LLC is required to have unlimited liability

o Unless the articles of organization or operating agreement provide otherwise, management of an LLC is vested in the members in proportion to their ownership interest in the company

LLC organized with “articles of organization” LLC can be either:

o member managed (default organization, unless articles specify otherwise)o manager managed (potentially convertible into a corporation)

LLC is taxed as a partnership by IRS as default (or can elect to be otherwise taxed) benefits of LLC over corporation:

o no general meeting requirement, o no loss of owner power to board of directors, o no double taxation

Disadvantages of LLCo many states impose a franchise tax on LLCs (still much less than corporate tax, though)o relatively new classification - not well developed or consistent in law

investment contract - contract in which 1) money is invested 2) in a common enterprise 3)with profits to come solely from the efforts of others

o includes LLC with management groups [any LLC where all members do not manage]o LLC where all members manage is called a “member managed LLC”

just like a general partnership- every member is an agent of the entity and can control management

o where articles of LLC have provision vesting management in managers only managers are agents of the entity; the non-manager members cannot control actions

of LLC, although all still have limited liability therefore, LLC can both be and not be a security, depending upon whether it is member managed (not

security b/c not investment contract) or manager managed (yes security b/c it is an investment contract)

CORPORATION what are the different fiduciary duties? law recognizes corporation as an entity separate from shareholders, officers, and directors can own

property, assert legal rights, and has potential of perpetual duration directors (142) (AT LEAST one required, generally more chosen)

o board of directors consists of: inside directors (normally includes CEO), provide informational link between corp. and

other directors; develop business plans and policies, AND outside directors (majority- usually employed by other firms), oversee board

disinterested and independento duties: make major policy decisions, appoint and monitor officers, and determine when/if dividend

distribution occurs control all corporate legal powers powers must be exercised collectively by majority rule - no individual has general agency

power to act on behalf of the corporationo receive incentives, such as ownership shares, to ensure aligned financial interest with

shareholders, to whom they have a legal fiduciary duty, and salary for performance of duty- do not get share of company income

o business judgment rule - judicial presumption that directors acted properly; indicates deference given to directors by courts and regulators

consists of decision making and oversight if not protected, courts scrutinize and look for overall fairness to corp. and shareholders Shlensky v. Wrigley (238)

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will not interfere w/ honest business judgment unless there is fraud, illegality, or conflict of interest.  Will not require directors to forego their decision/judgment b/c of the decisions/judgment of other companies’ directors

Joy v. North (300) BJR ≠ apply in cases 1) where Corp decision lacks a business purpose, 2) is

tainted by conflict of interest, 3) is egregious, OR 4) results from obvious + prolonged failure to exercise oversight/supervision

officers (143) (only Corporate Secretary legally required)o responsible for day-to-day operations (with director oversight)

act as agents of the corporation o recent federal law regulates officers

Sarbanes-Oxley Act (2002)- requires CEO and CFO to certify financial reportso receive salary for their duties, not profit share

shareholders o provide capital and elect directors (bear greater risk, but residual profit beneficiaries/claimants)o three main duties: vote, sell, and sueo collectively have power to elect annually the corporation’s directors and approve fundamental

changes in governing rules/structure; individually, shareholders have very little power amendments to articles of incorporation can only be initiated by the directors (and

directors chair and control the agenda of shareholder meetings), so shareholders cannot take action without their approval

shareholders may amend bylaws on their owno shares are fungible property- freely transferable; purchaser receives all voting power and rights

possessed by the seller limited liability to all shareholderso opting out - both MBCA and DGCL place limitations on ability to opt

Regulationso State Statute (two most used statutes for incorporation)

MBCA (model business corporation act) and DGCL (Delaware general corporation law) internal affairs doctrine - court applies laws of state of incorporation

o federal law- ie Securities Exchange Act of 1934o listing standards for national stock exchanges (self-regulating organizations)

Formation - the articles of incorporation (MBCA §2.01-2.06; DGCL §101-102)o MBCA §2.01 - Incorporators - one or more persons may act as incorporator by delivering articles

of incorporation to secretary of state for filing o MBCA §2.02 - Articles of Incorporation

must include: corporation name satisfying §4.01, number of shares corporation is authorized to issue, street address of initial registered office and name of initial registered agent name and address of each incorporator

may include: provisions not inconsistent with the law regarding: incorporation purpose;

management and regulating of affairs; definition/limit/regulation of powers of corp, directors, and stockholders; par value of shares; imposition of personal liability on shareholders to specified extend and conditions;

any provision that is required or permitted to be set forth in bylaws provision limiting/eliminating liability of directors or shareholders except in

specific cases provision permitting/obligating indemnification of directors for liability, except

in specific cases need not set forth any of the corporate powers enumerated in this act

o MBCA §2.03 - Incorporation - unless effective delayed date is specified, corporation exists when articles are filed; Secretary of State’s filing of articles is conclusive proof that incorporators satisfied all conditions, except that in a proceeding state can cancel or revoke incorporation

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o MBCA §2.04 - Liability for Pre-incorporation Transactions - all persons purporting to act on behalf of corporation, knowing no incorporation exists, are jointly and severely liable for all liabilities created when so acting

appropriate to impose liability only upon persons who act on be half of corporation knowing that no corporation exists

o MBCA §2.05 - Organization of Corporation - after incorporation, if initial directors are named in articles, they shall hold an organizational meeting to

complete organization by appointing officers, adopting bylaws, and carrying out any other necessary business;

if initial directors are not named, at call of majority of incorporators, meeting shall be held to 1) elect directors and complete organization of incorporation, or 2) elect directors who shall then complete organization

organizational meeting need not be held where required actions are taken as evidenced by written consent signed by each incorporator

o MBCA §2.06 - Bylaws - incorporators or directors shall adopt initial bylaws for corporation, which may contain any provision managing business and affairs that is not inconsistent with law or articles

Types of stock (MBCA §6.01; DGCL §151)o one corp. may have several types/classes of shares, each with different rights under the articles of

incorporation there must be a class with authority to elect directors and exercise shareholder voting

rights, and a class that entitles the bearer to receive the corporation’s net assets upon dissolution; shares that have both rights are “common shares”

all shares in a given class are fungible- have identical rights, preferences, and limitations preferred shares often have dividend/liquidation preference over common shares, but also

have limited/no voting rights Voting

o state created default rules may be changed in shareholders’ agreements, arts. of incorp. or bylaws articles are public documents that can be changed only by directors and shareholders;

bylaws are private documents and can often be changed by directors alone o Straight Voting (MBCA §8.04, 7.21, 7.28; DGCL §141(d), 212(a), 214, 216)

default method -1 vote/share; number of directors specified in initial articles or bylaws; each shareholder can cast their number of votes for the number of positions available

shareholder with 51% interest controls 100% of the board seatso Cumulative voting

shareholder casts total votes = number of his shares X number of positions to be filled cans spread votes between as many or few candidates as desired to elect board members, a shareholder must have more than SX/(D+1) shares, where S is

the total number of shares voting, D is the number of directors being elected, and X is the number of directors elected by the votes

o Class Voting corporation may divide shares into classes, allowing each class to select a specified

number of directors dual-class voting - divides shareholders into two classes and gives one class

disproportionate voting power compared to their capital contribution allows original founders to protect control of the corporation when going public

o Classified Board with Staggered Terms - Adaptability v. Stability (MBCA §8.06, DGCL §141(d)) default - election of directors annually corporations may adopt longer and/or staggered terms to ensure that corporation will

always have experienced directors in office more stockholder meetings (more years) are required to replace entire board

limits shareholders’ ability to quickly name new directors where provision for staggered terms is in bylaws instead of articles of

incorporation, shareholders more easily return to defaulto record date determines who receives dividends and who is qualified to vote

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shareholder meeting requirements:o DGCL §228 - any action required to be taken at an annual or special meeting may be taken

without a meeting, without prior notice, and without a vote, if consent in writing is signed my not less than the minimum number of votes necessary to authorize such action at a meeting at which all voting shareholders were present

o DCGL §211 Immutable rule - annual meeting must be held voting can be held by written agreement, but annual meeting must occur

removal of directors and other midstream private ordering o shareholders today can remove directors with or without cause by a majority vote (162)

under MBCA §8.08, no restriction on shareholders power to remove directors if corporation provides for staggered terms, but,

if corporation has cumulative voting, shareholders cannot remove director if the votes cast against removal would have been enough to elect that director, or

if director is elected by particular class of shareholders, he can be removed only by a majority vote of that class, even if the majority of all shareholders favors removal (163)

under DGCL § 141(k), members of staggered boards cannot be removed except for cause, but shareholders may remove even protected directors for cause, and majority retains ability to change the default rules and thereby permit removal in any of these situations by amending the articles (163)

o at common law, directors had a vested right to serve out their full term, so shareholders could remove directors only for good cause

o where all holders of voting stock vote together, they do not form a “voting group” as contemplated in section (b),

o a charter or bylaw provision which purports to alter statutory principle must be positive, explicit, clear, and readily understandable, expressing the stockholders’ desire

Business Judgment Rule - presumption that in making a business decision, directors acted on an informed basis, in good faith, and in the honest belief that their actions were in the best interests of the company (310)

o directors have a duty of care to inform himself of relevant information in order to make decisions on behalf of the company

standard of care is predicated upon concept of gross negligence - should be used to determine whether business decision reached by board of directors was an informed one

o corporate directors owe stockholders fiduciary duty to disclose all facts germain to the transaction at issue with complete candor all information such as a reasonable stockholder would consider important in deciding whether to sell or retain stock

o §141(e) amended to allow directors to rely on opinions of corporate officers, even if not made in “report” form

o two part process to overcome business judgment assumption: (321) plaintiff’s burden of proving directors acted without requisite care or loyalty defendants then have burden of proving that transaction was intrinsically or entirely fair

to the corporation two elements to fairness: (322)

o fair dealing - when transaction timed, how initiated, structured, negotiated, disclosed to directors, and how director and stockholder approval was obtained

o fair price - economic and financial considerations which effect intrinsic/inherent value of company’s stock: assets, market value, earnings, future prospects, ect.

FIDUCIARY DUTIES Business Judgment Rule - judicial presumption that directors have met duty of loyalty, care, and good faith

o requires high burden of evidence to prove breach generally, fraud, illegality, or conflict of interest required to overcome BJR - simple

waste/mismanagement not sufficient Shlensky (lights on Wrigley Field)

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o breach of any fiduciary duty sufficient to rebut BJR presumption, in which case directors are liable unless they prove transaction was fair

o primary purpose of a corp. is to make profit for shareholders, so directors are obligated to act in furtherance of this goal Dodge

Duty of Loyalty - (general duty = act in best interests of corporation)o 1) duty not to take corporate opportunitieso 2) duty to avoid conflict of interesto Corporate Opportunity Doctrine - where corporate fiduciary cannot serve both self and

corporation at same time, must serve corporation; three potential tests, most use ALI, DE uses Guth

Guth/line of business - based on facts of situation; where director faces opp. that corp. 1) is in a financial position to take, 2) is in the corporation’s line of business, 3) is of practical advantage to the corp., and 4) the corp. has reasonable interest/expectancy in,

he may not seize the opportunity Dufree fairness test - unfair for director to take advantage of opp. where corp. interests

require protection ALI test - director/senior official may not take corp. opp. unless:

1) opp. is first offered to corp. and disclosure of conflict of interest is made, 2) opportunity is rejected by corporation, AND 3) such rejection is either:

o fair to corporationo approved in advance, after disclosure, by disinterested directors, oro approved in advance or ratified by disinterested shareholders and isn’t

waste Corp. Opp. exists where:

o 1) director is aware of it a) in connection with performance as director, leading him to

believe it was intended to be offered to corp. b) through use of corp. info/property where he believes

resulting opp. would be of interest to corp.o 2) opp. is to engage in business activity director knows is closely

related to business corp. is engaged in or expects to engage in where duty comes to director independently/individually, failure to present opportunity

doesn’t necessarily amount to usurpation, but disclosure = safe harbor (if he doesn’t present it, and the opp. was a corp. opp., he is liable) Broz

o Conflict of Interest (§144) no conflicting interest transaction void or voidable solely by reason of conflict, if: (includes candor requirement - must disclose all material facts)

1) authorized by majority of disinterest directors, or 2) approved in good faith by shareholders, or 3) is fair to the corp. at the time of the transaction

o interested director - 1) party to the transaction, 2) has a business/financial/familial relation that would affect judgment, 3) has a material pecuniary interest in transaction, 4) is subject to controlling influence that could affect decision ultimately, director is unable to exercise independent judgment on the matter

o for director compensation issue, two prong test used to uphold its validity (not subject to BJR): benefit - must be identifiable to the corp. value - must be in reasonable relation to expected benefit plan must include safeguards to ensure value is received ; value assumed to be adequate

Duty of Care - breach is rare; director conduct must have been egregious o statutory exculpation provisions relive director liability for breach of duty of care (doesn’t extend

to breach of duty of loyalty or acts done in bad faith, however)o 1) decision making

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so long as directors act in good faith, not liable for any losses suffered by unfortunate outcomes Joy v. North

directors not liable for anything less than gross negligence hindsight litigation detrimental to corporation because of chilling effect on risk

taking decision must be rationally made with all of the information reasonably available in order

for the protection of the business judgment rule to be applied Van Gorkom for shareholder ratification of director action, duty of candor to supply

shareholders with all germane facts Van Gorkom §141(e) allows directors to rely on reports of officers, even when not reports

o 2) oversight §102(b)(7) (combination of duty of care and good faith) director has obligation to manage/monitor/oversee actions of those within the company to

prevent corp. liability exposure Caremark breach = unconsidered failure to act where due attention would have prevented loss must have in place system of reporting/information to reasonably inform directors of

corporate compliance w/ law and business performance Casemark Duty of Good Faith/Fair Dealing - sometimes it’s own duty, sometimes implicit in Duty of Care

o sustained, systematic failure of board to exercise oversight establishes breach of good faith Caremark

o Disney case (Brehm v. Eisner) - bad faith = deliberate/indifferent failure to act in the face of a duty to act

§141(d) - safe harbor for directors; §144(c) and §144(e) Indemnification/Insurance statutes - issue is whether good faith is involved - you don’t have to prevail on

the merits of the case, so long as the questioned action was in good faith, insurance will kick in MBCA §§8.50-8.59; DGCL §§102(b)(1), 145

o purpose of such provisions to protect against directors’ overuse of caution in performing duties and refusal to serve as directors at all

o however, specifically exclude uninsurable acts such as willful misconduct, dishonest acts, and receipt of improper personal benefits

o good faith ( a requirement under §141) may be generally assumed by corp. bylaws for purpose of insurance indemnification under (a) and (b) Owens Corning

officer oversight - **know how to kick officers out and what you need to file to do so

DERIVATIVE ACTION shareholder has right to bring action against corporation/directors where directors would not/should not

bring action on behalf of the company (ie in the case that they would be defendants in the case)o 7th Amendment gives them right to jury trial

dual parts of a derivative action: (368)o 1) action against corporation for failing to bring specified suito 2) action on behalf of the corporation for harm identical to that which the corporation failed to

bring derivative actions universally require that the shareholders give the board a demand, outlining the cause of

action, and giving them 90 days to bring suit; after which time, the shareholder may state a cause of action against board for wrongful refusal, alleging board did not act independently

o demand excused where futile futile where plaintiff can plead with particularity that directors are not disinterested or independent, and the action is not protected by the business duty rule

Aronson rule - demand is futile where: 1) directors are not disinterested and independent, and 2) the challenged transaction is not otherwise protected by the BJR

potential personal liability of all directors, without more, not sufficient to prove interest plaintiff must allege particularized facts indicating corp. conduct demonstrating

wishes/interest of the controlling individual in order to show control exists Aronson in order to prove interest for first prong of Aronson test, must show that: In Re Limited

1) financial interest in the transaction, 2) motivated by desire to remain on board (entrenchment), or

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3) directors were controlled by someone with a direct interest in the transaction **court must apply subjective, actual person test for each director’s involvement

o MBCA requires universal demand (no futility exception)o MBCA allows interested board to delegate authority to decide to disinterested committee in order

for demand decision to remain protected by BJRo Zapata - DE allows appointment of disinterested committee where committee moves to dismiss

suit based on written record of investigation that suit is detrimental to corp. court must apply 2 step inquiry:

1) committee acted independently/in good faith after reasonable investigation in recommending suit be dropped, and

2) court finds dropping suit to be appropriate in its own reasonable business judgment in order to satisfy “well pleaded complaint” shareholders must have access to company books/records,

which, under §220, they theoretically do, but generally actually don’tPROXIES

three meanings of proxyo legal relationship/arrangement under which one person is allowed to vote for anothero the person or entity given the power to voteo the document that evidences the relationship

5 activities trigger federal disclosure requirements:o issuing securitieso periodic reporting (under §13 - 10-K’s, 10-Q’s, 8-K’s) - applies to companies registered on

national exchange and under §12 (500+ shareholders AND at least $10,000,000 in assets)o proxy solicitations (§14(a)) - applies to companies registered on national exchange and under §12

(500+ shareholders AND at least $10,000,000 in assets)o tender offerso insider trading

purpose of disclosure requirements is to help shareholders make informed decisions Disclosure requirement 14(a) includes implicit assumption that shareholders will be able to make use of information provided in

proxy solicitations in order to vote in corporate elections based on premise that shareholder voting could work so long as investors had enough information and procedural protections did not attempt to regulate stockholder choices

o Rule 14a-3 - requires proxy statement with time, date, and place of meeting, revocability of proxy, solicitor’s name and funding source, and name/basic info of director candidates to be included with proxy solicitation

proxy statements by management for annual meeting must include annual report o Rule 14a-4 - regulates form of proxy documento Rule 14a-5 - regulates form of proxy statemento Rule 14a-9 - catch all prohibition of false/misleading statementso Rule 14a-7 shareholder communication requires company to either give you a list of other

shareholders names/addresses. or to mail the proxy for you (but you pay costs) if provided with shareholder list- shareholder must use for proper business purpose -

can’t use as mailing list for something else Conservative Caucus proper purpose - reasonably related to shareholder’s interest as stockholder

o burden is on directors to show improper purpose where shareholders bring action for corp. wrong-doing, must have held stock at

time of wrong-doing in order to access corp. records, except where earlier activities are reasonably related to the issue

o Rule 14a-8 - qualifying shareholder may require corp. to include her proxy statement/proposal in corp. material - may not exceed 500 words

qualifying shareholder = $2,000 market value or 1% of share; must have held stock for at least 1 year, and through date of meeting; only 1 proposal/shareholder/year

must be appropriate subject matter must not have too many words

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must be qualifying shareholder §14a-8(i) - ways corp. can get around including shareholder proposal:

(5) - “economically irrelevant” info can be excluded if issue does not amount to 5% total assets, net sales, and gross sales, or is otherwise significantly related to business (relation doesn’t have to be economic Lovenheim v. Iroquois Brand)

(7) - “ordinary business” proposals are excludable, determined case-by-case No Action Letter - letter from SEC that it will not bring enforcement action against corp.

if it does not include a specific proposalo purpose of 14a-2b is exception to allow shareholders to solicit from a small number of people so

that he does not have to bear the cost of a full proxyo look at 14a-12 - rule that people rely on today when there is going to be a proxy battleo most important rule- 14a-3 - Disclosure Requirements

even if shareholder has winning proposal, the directors may (and generally do) ignore creates no obligation to act

Sarbanes-Oxley requires CEO and CFO to certify 10-Q’s Business Roundtable - SEC’s authority limited to disclosure requirements can’t enforce 1 vote/share

o §14(a) assumes that shareholders will be able to use info provided in proxy statemento under Rule 14a-9, plaintiff must show 1) misrepresentation/omission of material fact, 2) scienter,

and 3) resulting damage TSC Industries - definition of material fact requiring disclosure to shareholders - a “substantial likelihood

that a reasonable shareholder would consider it important in deciding how to vote”o significant propensity to effect voting process - alter total mix of info availableo §

Virginia Bankshares - director/officer’s statement of belief/purpose can be important material fact, but plaintiff must prove that the belief stated was not the insider’s true belief/purpose

Mills where full disclosure not made, no need to prove how people would actually have voted with the different information, so long as change in votes could have made a difference; no scienter requirement - negligence is sufficient for cause of action under 14a-9

causes of action against corporation:o §12 of 1933 private right of actiono §16 of the 1934 provides a derivative cause of actiono §21 provides cause of action for SECo §32 provides criminal liability for violation of SEAo §14a provides implicit private cause of action, in order to guarantee shareholder interests

§9, §16, §18 - cause of action for private partieso §18 - false and misleading statements in any application/report/document filed pursuant to the title

or its rules/regulationso private parties have right under §27 to bring suit for violation of §14(a), and that right of action

extends to both derivative and direct causes State Causes of action - under breach of fiduciary duty

Stoneridge - whether third party participants in filing forms (lawyers, bankers, ect) can be held responsible for false statements made on the forms

o all Enron class-action plaintiffs are awaiting decision can potentially recover $, then, since Enron went bankrupt, but the law/accounting/bank firms are still viable

o ****know what happened in this case**** (Oct. 10, supreme court)o could the lawyers just draft an indemnification clause? if the company

is defunct, it will not be able to indemnify the firms, because it is bankrupt

cannot limit liability against social policy - can’t limit liability as to third party’s not parties to the agreement (such as stockholders)

MERGERS

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Friendly Mergers:o Board of Directors of each corporation must adopt a plan of merger specifying terms must

provide notice of plan and obtain shareholder approval must submit approved/certified plan to state corporations commissioner to make it effective friendly merger generally requires simple majority of all shares outstanding

o reasons why friendly transactions occur assets of combined corporations produce economies of scale synergistic gains current CEO may be nearing retirement don’t want to leave the company without a

CEO and other company may have a good CEO managing team may anticipate personal benefits (ie lucrative employment contracts

breach of fiduciary duty?) reduce taxes

o dissenter’s rights - protective device for shareholders opposed - right for cash purchase at “fair value”

o cash-out merger - use of cash as consideration in merger; often majority shareholders receive surviving company equity while minority shareholders receive the cash-value of their shares, eliminating their interest in the surviving company

o generally any form of consideration is acceptable for canceled shares: new shares, cash, notes, combo

o Key assumptions of shareholder participation in merger: shareholders can make informed decision to approve or reject merger

participation of shareholders in decision making process adds value for corporations and shareholders

management will be able to provide sufficient, digestible, unbiased information for an informed decision on the merger

shareholder participation will not be unduly burdensome for corporationso Business Purpose Test - transaction leading to cash-out merger must serve a valid corporate

business purpose and not be solely to freeze out minority owners Singer - required controlling shareholders to prove valid business purpose Weinberger overruled business purpose rule

o entire fairness test - where director sits on both sides of a merger, conflict between self-interest and fiduciary duty to minority holders, so he must prove, considering the totality of the circumstances, transaction was fair to minority Coggins (Patriots)

director has burden of preponderance of evidence to show fairness; plaintiff must allege specific acts of fraud/misconduct to demonstrate unfairness in challenge of cash-out merger Weinberger

Guth test - requires officer/director to 1) affirmatively protect corporate interests, AND 2) refrain from causing injury to corporation

Fair Dealing Standard - two aspects of fairness (must be considered as a whole, not bifurcated)

1) fair dealing - duty of candor - timing, structure, initiation, negotiation, disclosure…

2) fair price - all relevant factors to economic and financial considerations Hostile Takeovers

o potential acquirer who wants to seek control without board approval; two ways: 1) tender offer - make offer to buy sufficient shares to take control of board

13(d)(1) reporting requirement for acquiring >5% of shares 2) proxy - can seek proxy support of existing shareholders under Rule 14a-8

o tender offer [see pg. 1020 of text]- made to shareholders of a publicly held offer in exchange for cash

considered hostile b/c buyer goes directly to shareholders over objection of target board tender offers should be regulated b/c:

danger of “prisoner’s dilemma” (have to sell now or receive “junk bonds” after everyone else sells out) for shareholders

“winner’s curse” whoever pay’s highest bid generally pays too much

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o William’s Act - requires tender offer to be open for 20 days, best price rule, pro rata purchase, must disclose identity, source, funding, and purpose of take over - eliminates the prisoner’s dilemma

***see Rule 14e-1a, §14(d)(6), §14(d)(7), §14(d)(5)o Board Defense Mechanisms:

directors cause corp. to re-purchase own stock - Cheff v. Mathes directors must show: 1) good faith, and 2) reasonable investigation into purchase must demonstrate reasonable grounds for belief in threat to corporate policy directors must NOT have acted to solely/primarily to perpetuate office Unocal adds requirement that response must be proportionate/reasonable in

relation to threat posed AND directors must act in the best interests of the corporation/stockholders

BJR applies to board’s adoption of defensive mechanism where: Unocalo 1) good faith/reasonable investigation leads to belief in threat, ando 2) response reasonable in relation to threat o decision is informed if not grossly negligent

Poison Pill - Moran - where used as a preventive measure, rather than in response to direct threat, does not prevent protection of BJR

lock-up provisions, no-shop provisions, cancellation fee - Revlon where sale/bust-up is inevitable, directors’ Unocal requirement (to act in best

interests of corp.) creates duty to get best price possible Unocal/Revlon [enhanced scrutiny test] created framework that directors’ responsibility

is to act in best interests of shareholders/corporation means getting best price where sale is inevitable

directors’ duty to manage business and affairs of corporation obliges them to charter course in best interests of corporation without regard to a fixed future time point, so not under any duty, per se, to maximize shareholder value in the short-term, where company will survive Paramount

o generally 2 circumstances which implicate Revlon duties: 1) corporation initiates active bidding process 2) in response to bidder’s officer, target abandons long-term

strategy and accepts break-up as inevitable o if board’s reaction to hostile tender constitutes only defense response,

not abandonment of corp.’s continued existence, Revlon not triggered o directors may use open-ended/flexible criteria where determining threat

posed by take-over bid - not limited to financially inadequateo directors do not have to maximize shareholder profit unless clearly no

basis to sustain corporate strategy Paramount in sale/change of control transaction (Revlon duty invoked), board subject to

enhanced scrutiny, before application of BJR, mandated by: Viacomo threatened diminution of current stockholders’ voting powero fact that asset belonging to public stockholders (control premium) is

being sold and may never be available againo traditional concerns for actions which impair/impede stockholder

voting rights key features of enhanced scrutiny test are judicial determination of: Viacom

o a) adequacy of decision-making process on which decision is basedo b) reasonableness of the directors’ action in light of circumstances

**hallmark is reasonableness - not perfection in hindsight extends Revlon rule to all pending sales of control, not just break-up standard

voting contest - Schnell v. Chris-Craft - application of BJR inappropriate where board acts for primary purpose of impeding/interfering with effectiveness of shareholder vote

situation requires enhanced scrutiny and directors bear heavy burden of demonstrating compelling justification for their actions

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Blasius standard - requires heightened scrutiny where board acts with primary purpose of interfering/impeding shareholder franchise and shareholders did not have full and fair opportunity to vote

o board must first demonstrate compelling justification for action as condition precedent to judicial consideration of reasonableness and proportionality

preclusive/coercive defensive mechanisms - Omnicare to the extent a merger contract requires directors to act/not act in violation of

their fiduciary duty to minority shareholders, it is invalid/unenforceable pages 762-765 - DEFINITIONS of terms

o front end loaded tender offer - consideration for tender offer (to get controlling interest) worth more than consideration in second-step merger

o greenmail- target goes out and repurchases it’s own shares bidder wasn’t really trying to take over the company in the first place, it just wanted the company to buy the shares back at a premium

o bidder/raider - acquiring partyo bust-up takeover - seeks to break up target and sell it in pieceso junk bonds - bonds that are higher risk, therefore bear a higher interest rateo target - company sought to be acquiredo white knight - second bedder, thought to be friendlyo white squire - friendly party who acquires large block of stock, but not controlo Arbs/Arbitragers - regular market participants seeking to make money by short-term purchaseso golden parachute/tin parachute - ease descent of former managemento termination fee - offered to white knight as incentive to continue bidding against raider, where

outcome is uncertaino stalking horse - white knight used to bid up the price so raider must pay a premiumo lock-up option - gives whit knight right to purchase most valuable assets (crown jewels)

make other bids unlikely b/c key assets now promised to white knighto poison pill - stock right/warrant issued to potential target’s shareholders prior to takeover;

unusable until hostile acquisition, at which point holders can redeem for price well above market or for acquiring company stock at reduced price after merger; generally written to exclude shares held by acquiring company

flip-in plan - allows shareholder to buy more shares in target company flip-over plan - gives shareholders contractual right to purchase shares in the acquiring

companyo Recapitalizations and leveraged buyouts by management (LBO’s and MBO’s) - rearranged

financial package offered by target management to shareholders offering immediate cash payout for their shares, often financed by huge borrowing by corporation

o shark repellent amendment/porcupine provision s - in corporate charter/bylaws (address 2nd step): super majority amendments - raise vote required to approve merger fair price amendments - require payment of high “fair price” for 2nd tier stock purchase staggered board amendments - extends time required to replace entire board dual-class capitalization - provides management control insulation beyond shares by

multiplying votes/share of management stock

PIERCING THE CORPORATE VEIL/ALLOCATING RISK piercing veil is judicially created remedy for situations where corp. not operated as separate entity, so not

entitled to such treatment - applies to injustice, fundamental unfairness, or inequityo court more likely to pierce to reach corp. than individuals, and unlikely to pierce publicly corps. o more likely to pierce in tort cases than contract cases b/c opportunity for bargainingo equitable subordination - less sever than piercing veil - subordinates secured loans of insiders to

unsecured loans of third parties, where appropriate for equityo equitable cushion - capital stock - # of shares outstanding * par value - reserved for payment of

corporation debt/liabilities - un-reachable by shareholders

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Contract Cases:o corporation separate identity/shareholder limited liability should not be maintained where such

division would accomplish fraudulent purpose, create a constructive fraud, or defeat a strong equitable claim Consumer Co-op

Piercing more likely in closely-held corp. b/c directors, shareholders, and officers usually same

o fraud/misrepresentation are most important factors in contracts piercing cases - can’t bargain theseo alter ego theory/instrumentality rule : (case specific/not bright line) Consumer Co-Op v. Olsen

1) complete dominion by individuals, so that corporate entity has no “separate mind” at time of transaction (considers adherence to corporate formalities, adequate capital…)(company is just a shell company)

2) control used for fraud, violation of statutory/legal duty, or other dishonest/unjust act, AND

3) control proximately caused injuryo actual fraud not required for piercing where justice/equity require piercing (KC Roofing)

where defendant uses corp. for unfair/inequitable purpose, veil should be pierced Tort Cases:

o proper to pierce veil where individuals where dominating force behind corporation, so proximately caused damage Western Nook (negligent blasting operation)

o factors to consider in determining if individual is dominating force behind corp. (Baatz- bar): fraudulent representation by corporate directors/misrepresentation undercapitalization failure to observe corporate formalities absence of corporate records payment by corporation of individual obligations use of corporation to promote fraud/injustice/illegal activities

do same factors/alter ego theory apply to both contracts and tort cases? o proper to pierce the veil of LLC where

1) unity of interest and ownership exists between individual and corporation, such that separateness of corporation and individual has ceased

2) continued adherence to fiction of separate entity would cause fraud or injustice Legally defective allocation of risk:

o reasons corporation may not be in existence: 1) not yet formed, or 2) dissolved (by voluntary action of directors/shareholders, involuntary action of administrative decree, or involuntary action of judicial decree)

no corporation = cannot be agent = individual actions not protected by agency law corporation NOT bound by/party to contract made while legally non-existent, unless

contract subsequently adopted by corporation (expressly or implicitly) how individual is bound depends whether he tried to contract around personal liability

o where attempt made to avoid personal liability, but ambiguous contract resulted, 1) contract construed against those who drew it, and 2) rational/probable interpretation preferred

three results for individual when contract made when corp. didn’t exist: RKO-Stanley Warner Theaters, Inc (promoter made contract on for non-existent corp.)

1) may take on offer on behalf of proposed corporation, which upon formation of corporation, becomes a contract

2) make a contract binding at the time of formation on individual personally, with understanding/stipulation that at formation of corporation he shall be relieved of liability

3) may bind himself personally without more, and look to proposed company, when formed, for indemnity

o where no attempt was made to avoid personal liability, all persons who act as corporation without certificate of incorporation are jointly and severally liable for subsequent debts/liabilities

“assume to act as corporation” includes those who actively participate in policy and operation of organization (not limited to actual signer) - not strict investors Timberline

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o corporation by estoppel - one who recognized the organization as a corporation cannot escape liability by claiming that the organization technically does not meet the corporation requirements

courts willing to recognize corporations by estoppel where defendant seeks to escape liability by contending that plaintiff is no lawful corp., less willing to do so where defendant seeks to escape liability by contending that debtor corporation, rather than himself individually, should be liable b/c plaintiff recognized its existance Timberline

ultra vires - an act that a corporation is unauthorized to do by its articles or the statutes that regulate it

INSIDER TRADING §10(b) makes it unlawful for any person to use interstate commerce (including a securities exchange) to

employ any deceptive/manipulative device (fraud/deceit) in sale/purchase of securities in contravention of the rules created by the SEC for the protection of public interest and investors

o violation of §10(b) requires: 1) material misrepresentation, 2) scinter/recklessness, 3) reliance on the representation, AND 4) damages caused by the representation

o purpose of §10(b) ensure fairness in securities trading Texas Gulf Sulphur (ore deposit discovery) Rule 10b-5 - unlawful to use interstate commerce to: a) employ any device/scheme/artifice to defraud, or

b) make untrue statement/omission of material fact necessary for statements made not to be misleading, or c) to operate fraud/deceit on any person, in connection with the purchase/sale of any security

classic insider trading fraud: individuals who are/get info from traditional insiderso insider - one who has a statutory fiduciary duty to disclose under state lawo applies to officers, directors, permanent insiders, and temporary insiders such as attorneys

breach of relationship of trust/confidenceo insider has duty to abstain or disclose material info, arising from: (Cady, Roberts)

1) relationship afforded insider access to info intended only for corporate purposes, not personal benefit, and

2) unfair to take advantage of info, knowing it’s unavailable to those with whom dealingo basic test of materiality: whether a reasonable person would attach importance to the

information in determining his choice of action in the transactions in question TGS any fact which reasonably might affect value of corporation’s stock TGS importance attached to fact by those who knew it is important indication of materiality

o disclosure must be in manner sufficient to insure availability to investing public - use media of widest circulation TGS

o Individual not an insider/fiduciary has no duty/obligation to abstain/disclose Chiarella (printer) non-disclosure liability premised upon relationship of trust and confidence individual’s use of info/silence is not fraud (as required by Rule 10b-5) if no duty exists

o Stoneridge - §10(b) only applies to those who actually engage in the fraud, so Rule 10b-5 extends only to those who actually make the fraudulent statement; others may only aid and abet

anyone who does use manipulative device/make misstatement can be liable, including lawyers, bankers, accountants, ect.

o Central Bank produced three governing principles: 1) private plaintiff may not bring a 10b-5 suit against party for actions not actually

prohibited by §10b (this includes 10b-5(a)-(c)) 2) a device or contrivance is not deceptive absent some misstatement or failure to

disclose by one who has a duty to disclose 3) the term “manipulative” has limited meaning - transactions to prevent the market price

of a security from reflecting the market’s true value of that security no private right exists for aiding/abetting tort claims

o special facts doctrine - ordinary insider relationship does not create duty to disclose, but knowledge of special material facts pertaining to potential transaction creates such duty

tippee liability/constructive insiderso constructive insider - receives info from corp./insider for proper purpose, but uses improperlyo Dirks - tippee has assumes derivative fiduciary duty to abstain/disclose where 1) info obtained

from insider who breached fiduciary duty in disclosing info (tippee inherits fiduciary duty from insider), and 2) trader knew or should have known of the breach

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test whether breach occurred - whether insider benefited from disclosure insiders may not use inside info for personal gain (whether they are trading stock themselves, or creating valuable relationship by providing info to others); this is a question of fact

Regulation FD - prohibits company and its senior officials from privately disclosing any material, non-public information to analysts and institutional investors Siebel Systems (CEO comments at private event)

o issuer must make public information disclosed to market professionals Siebel where private disclosure is intentional, public disclosure must be simultaneous, where

inadvertent, must be prompt (as soon as reasonably practical; < 24 hours after senior officer learns of disclosure) Siebel

Likely material info includes: earnings info; mergers/acquisitions/tender offers/ joint ventures/change in

assets; new products/discoveries/developments; changes in control/ management; changes in auditors; events regarding issuer’s securities; bankruptcies/receiverships

misappropriation - when individual breaches duty owed to source of information (not to traders); must satisfy §10(b) with both duty and breach (duty to source, breach by using info in securities trade) O’Hagan

o fraud results from unauthorized use of informationo to avoid misappropriation liability, must inform source of use of info, then no breacho §14(e) was added to SEA by Williams Act, in order to prevent fraud in tender offerso Rule 14e-3 disclose/abstain duty for anyone with material info about tender offer who knows/has

reason to know: 1) info is non-public, and 2) info came, directly or indirectly, from offering party, issuer of securities involved, or any agent of the offering party Carpenter/O’Hagan

does not require that trader owes pre-existing fiduciary duty to respect the confidentiality of the information designed to prevent fraudulent trading on material, nonpublic info about tender offers b/c duty of confidentially generally exists, but hard to prove - strict liability

o misappropriation duty applies to relationships of discretionary authority - one person must rely on another to act for his best interests; doesn’t generally exist between family members, but does with: attorney/client; executor/heir; guardian/ward; principal/agent; trustee/trust beneficiary; senior corporate official/shareholder, ect.

o in response to anticipated dissent objection in O’Hagan, Ginsberg includes two safeguards: violation must be willful (intentional/with knowledge) individual must have knowledge of §10(b) and Rule 10b-5

have to return profits, but won’t go to jail if safeguards not satisfiedo duty exists between trader and source, so §20 creates cause of action between traders

§16(a) - required disclosure of becoming an insider/insider tradeso Sarbanes-Oxley requires beneficial exchange to be filed within 2 days (§16(a)(2)(B)

§16(b) requires officers, directors, and 10% shareholders to disgorge profits on purchase/sale in 6-monthso 10% owner = beneficial owner; Rule 16a-8 extends beneficial owner to include trustee of trust for

trustee’s immediate familyo “officer” only includes policy making officerso strict liability provision - applies to all 6-month profits, regardless of intent

officer/director only has to be insider at buy OR sell; BO must be insider at BOTHo four ways to calculate profits to be disgorged: Smolowe

1) FIFO (first in, first out); 2) averaging; 3) tracing (matching the dates on the certificates actually exchanged); 4) LIHO (lowest in, highest out)** court chooses (4)

o deputization - possible for an entity, such as partnership or corporation, to incur §16(b) liability as a “director” by deputizing an individual to sit on the board on behalf of the entity Martin Marietta

facts test - consider 1) indication of management’s intent/belief, 2) requirement of board approval for individual to become outside director, 3) existence of other acts of deputization by company

insider trading actions generally brought under §10 rather than §16 because §10 has fewer restrictions:o §10 allows plaintiffs to be anyone who engages/dissuaded from engaging in sale b/c of defendant;

§16 plaintiff must be corporation, brought by any shareholder of the corp.’s stock; SEC has no enforcement authority under §16

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§16 plaintiff only must own 1) security in 2) the issuer Gollusto §10 defendant - anyone with duty to disclose; §16 defendant - officer, director, 10% shareholdero §16 doesn’t apply unless company is a §12 corporation; §10 has no such requiremento §10 may provide penalty of jail or treble damages; §16 does not

study notes: stocks and bond definitions memorize all §14/Rule 14 provision piercing the veil - maybe subprime? Switzer 590…

Duty of Loyalty conflicting interest transactions corporate opportunity doctrine line of business test (ALI test) BJR

Unocal sets up basic test, Revlon Rule adds that judicial scrutiny is going to be the main test

Enron lawyers - should have acted as gatekeeper “Enron, lawyers, fiduciary duty, current law suits”lawyers representing directors in case shouldn’t be able to collect that amount of money - *** lawyers that actually worked for Enron - weren’t all in house counsel, so should have known and acted as

gate-keepers want to pierce the veil based on fiduciary duty

Proxy Memorize the 14a’s!!!!

§141 v. §142 (officers’ powers v. directors’ powers§101, §102 (requirements for arts. of incorp)§151- how to determine what shares to issue

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