corporate law outline

8/12/2019 Corporate Law Outline

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Corporate Law Fall 2013 Outline Professor Fishman

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Contents

I. Agency – Sole Proprietorship .............................................................................................................. 11

a. Introduction .................................................................................................................................... 11

i. Firm that is Owned by a single individual and is not cast in a legal form that can be utilized only

by filing an organic document with the state under an authorizing statute ...................................... 11

b. Agency and Authority ..................................................................................................................... 11

i. Prcpl/Agnt Relationship .............................................................................................................. 11

ii. Prcpl Agency Problems ............................................................................................................... 11

iii. Morris Oil Co. v. Rainbow Oilfield Trucking Inc. (1987) – pg. 2 .................................................. 13

c. Agent’s Duty of Loyalty ................................................................................................................... 13

i. Agency Costs ............................................................................................................................... 13ii. Tarnowski v. Resop (1952) – pg. 18 ............................................................................................ 13

iii. Statutes, Rules, and Regulations ................................................................................................. 13

iv. Reading v. Attorney General (1951) – pg. 21 .............................................................................. 14

II. A Primer on Accounting and Finance .................................................................................................. 14

a. Introduction to Accounting and Financial Statements ................................................................... 14

i. Fundamental Equations .............................................................................................................. 14

III. Partnerships .................................................................................................................................... 14

a. What Constitutes a General Partnership ........................................................................................ 14

i. Definition .................................................................................................................................... 14

ii. Uniform Partnership Act (1914) pg. 30-31 of Statutory Supplement .................................... 14

iii. HILCO Property Services v. US (1996) – ph. 49 ........................................................................... 14

iv. Martin v. Peyton (1927) – pg. 49 ................................................................................................ 14

v. Lupien v. Malsbenden (1984) – pg. 53 ........................................................................................ 15

vi. Formation of Partnerships .......................................................................................................... 15

vii. Joint Ventures ......................................................................................................................... 15b. Legal Nature of a Partnership [Pg. 58-60 of Textbook] .................................................................. 15

c. The Ongoing Operation of Partnerships ......................................................................................... 15

i. Uniform Partnership Act pg. 34-35 of Statutory Supplement ............................................... 15

ii. Summers v. Dooley (1971) –pg. 60 of Textbook ......................................................................... 15

iii. Sanchez v. Saylor (2000) – pg. 62 of Textbook ........................................................................... 15



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iv. Management of Partnerships ..................................................................................................... 15

v. Indemnification and Contribution .............................................................................................. 15

d. The Authority of a Partner .............................................................................................................. 16

i. Uniform Partnership Act pg. 31-33 of Statutory Supplement ............................................... 16

ii. North Investment Company v. Milford Plaza Association (2001) – pg. 66 ................................. 16

iii. Actual vs. Apparent Authority ..................................................................................................... 16

e. Liability for Partnership Obligations (to Third Parties) ................................................................... 16

i. Uniform Partnership Act – pg. 31-34, 40 in statutory supplement ............................................ 16

ii. Partnership Liability – Agency principles applies ........................................................................ 16

f. Partnerships Interest and Partnership Property ............................................................................. 16

i. Partnership Property – partner’s right ........................................................................................ 16

g. The Partners Duty of Loyalty ........................................................................................................... 17

i. Meinhard v. Salmon (1928) – pg. 74 of textbook ....................................................................... 17

ii. Fiduciary Duties – partners are fiduciaries of each other & the partnership: ............................ 17

iii. General Partners are personally liable for debts of partnership ................................................ 17

iv. Nature of Liability ........................................................................................................................ 17

v. Extent of Liability ........................................................................................................................ 17

vi. Partnership Liability by Estoppel ................................................................................................. 17

h. Side Notes on partnerships ............................................................................................................. 17

i. Salary ........................................................................................................................................... 17

ii. Partner’s share of profits and Losses .......................................................................................... 18

i. Dissolution ...................................................................................................................................... 18

i. Dissolution (in general) ............................................................................................................... 18

ii. By Rightful Election ..................................................................................................................... 19

iii. By Judicial Decree and Wrongful Dissolution ............................................................................. 20

j. Limited Partnerships and Limited Liability Partnerships ................................................................ 20

i. Limited Partnerships ................................................................................................................... 20

ii. Limited Liability Partnerships ...................................................................................................... 20

IV. The Foundations of a Corporation .................................................................................................. 21

a. The Characteristics of the Corporation ........................................................................................... 21

i. Limited Liability ........................................................................................................................... 21

ii. Free Transferability of Ownership Interests ............................................................................... 21



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i. WHITEBOOK – Business Corp. Law [BSC] .................................................................................... 24

ii. The Legal Distribution of Power Between the Board and the Shareholders .............................. 24

c. Requisites for Valid Action by the Board ........................................................................................ 24


ii. Fogel v. U.S. Energy Systems (2007) – SEE HANDOUT # 3 .......................................................... 25

iii. Rules are set at 2 levels. – first to set out formalities for board action and second are

concerning the consequences for noncompliance with the first level rules ...................................... 25

d. Normal Requisites for Valid Shareholder Action ............................................................................ 25


ii. Notice of Meeting: ...................................................................................................................... 25

iii. Quorum ....................................................................................................................................... 25

iv. Voting .......................................................................................................................................... 25

e. Corporate Governance and the Rise of Institutional Shareholders ................................................ 26

i. Shareholder Voting ..................................................................................................................... 26

ii. Financial Institutions and Their Advisors .................................................................................... 26

f. Election of Directors ........................................................................................................................ 26


ii. Staggered (or “classified”) Boards .............................................................................................. 26

iii. Straight and Cumulative Voting .................................................................................................. 26

iv. Plurality Voting ............................................................................................................................ 26

v. Short Slates ................................................................................................................................. 27

g. Removal of Directors – BCL § 705-706 ............................................................................................ 27

i. Removal by the Shareholders ..................................................................................................... 27

ii. Removal by the Board ................................................................................................................. 27

iii. Removal by a Court ..................................................................................................................... 27

h. Requisites for Valid Action by Corporate Officers – BCL § 715 & § 716 ......................................... 27

i. Corporate Officers ....................................................................................................................... 27

i. Equitable Limits on the Board’s Legal Powers ................................................................................ 28

i. WHITE BOOK – BCL § 707-708 .................................................................................................... 28

ii. Condec Corp. v. Lunkenheimer Co. (1967) –pg. 170................................................................... 28

iii. Schnell v. Chris-Craft Industries, Inc. (1971) – pg. 171 ............................................................... 28

iv. Blasius Industries, Inc. v. Atlas Corp. (1988) – pg. 173 ............................................................... 28




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v. Business Judgment Rule .............................................................................................................. 28

j. The Role of the Bylaws in the Allocation of Power between the Board and the Shareholders ..... 28

i. WHITEBOOK BCL § 601 ............................................................................................................... 28

ii. CA, Inc. v. AFSCME Employees Pension Plan (2008) – pg. 184 ................................................... 28

k. Allocation of Power between the Board and the CEO .................................................................... 28

i. WHITEBOOK BCL § 715-716 ........................................................................................................ 28

ii. Managing Model of the Board .................................................................................................... 28

iii. Monitoring Model of the Board .................................................................................................. 28

VI. Shareholder Informational Rights and Proxy Voting ...................................................................... 28

a. Shareholder Information Rights Under State Law .......................................................................... 28

i. SEE HANDOUT # 4 ....................................................................................................................... 28

b. Inspection of Books and Records .................................................................................................... 28

i. WHITEBOOK BCL § 624 and § 1315 ............................................................................................ 28

ii. Saito v. McKesson HBCO, Inc. (2002) – pg. 224 .......................................................................... 28

iii. Shareholders’ Inspection Rights.................................................................................................. 28

c. Stockholder List in a Dematerialized World (textbook page 232-239) ........................................... 29

i. Concept Release on the US Proxy System .................................................................................. 29

d. Reporting under State Law ............................................................................................................. 29

i. WHITEBOOK – BCL §624(e) ......................................................................................................... 29

e. Overview of the SEC and the Securities Exchange Act ................................................................... 29

i. Textbook pages 240-242 ............................................................................................................. 29

ii. Statutory Supplement pg. 274-274 ............................................................................................. 29

f. Periodic Disclosure under the Securities Exchange Act (textbook page 243) ................................ 30

i. Addresses the information deficiencies in state law by imposing periodic reporting

requirements on corporations with a security registered under § 12. .............................................. 30

VII. The Proxy Rules ............................................................................................................................... 30

a. Securities Exchange Act .................................................................................................................. 30

i. §14(a) – pg. 279 of Statutory Supplement .................................................................................. 30

ii. §14(c) .......................................................................................................................................... 30

iii. §14(a)-1, §14(a)-2, §14(a)-6 --- pg. 293-300 & 303-308 of Statutory Supplement ..................... 30

b. Introduction .................................................................................................................................... 30

i. Definitions ................................................................................................................................... 30




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v. Arnold v. Browne (1972) – pg. 296 ............................................................................................. 35

vi. Slottow Fidelity Federal Bank v. American Casualty Co. (1993) – pg. 297 .................................. 35

vii. Radaszewski v. Telecom Corp. (1992) – pg. 297 ..................................................................... 35

viii. Berkey v. Third Ave. Ry. Co. (1926) – pg. 298 ......................................................................... 36

ix. Note on Variations among States in applying the Piercing The Veil Doctrine ............................ 36

x. Note on Direct Liability ............................................................................................................... 36

e. Equitable Subordination of Shareholder Claims ............................................................................. 36

i. Equitable Subordination ............................................................................................................. 36

ii. Comparison with Piercing ........................................................................................................... 36

IX. The Special Problems of Shareholders in Close Corporations ........................................................ 36

a. Introduction .................................................................................................................................... 36

i. Uniform Limited Liability Company Act ...................................................................................... 36

ii. Corporations are divided into three classes ............................................................................... 36

b. Voting Arrangements at the Shareholder Level.............................................................................. 37

i. Shareholder Voting Agreements ................................................................................................. 37

ii. Voting Trusts ............................................................................................................................... 37

iii. Classified Stock ............................................................................................................................ 38

c. Agreements Controlling Decisions that are within the Board’s Discretion .................................... 38

i. WHITEBOOK BCL §620, 715(b) .................................................................................................... 38

ii. McQuade v. Stoneham (1934) – pg. 320 .................................................................................... 38

iii. Clark v. Dodge (1936) – pg. 323 .................................................................................................. 38

iv. Galler v. Galler (1964) – pg. 324 ................................................................................................. 38

v. Adler v. Svingos (1981) – pg. 331 ................................................................................................ 38

d. Supermajority Voting and Quorum Requirements at the Shareholder and Board Levels ............. 38

i. WHITEBOOK BCL §608, 616-617, 705, 708, 709 ......................................................................... 38

ii. Sutton v. Sutton (1994) – pg. 332 ............................................................................................... 38

e. Fiduciary Obligations and Shareholders in Close Corporations ...................................................... 38

i. Donahue v. Rodd Electrotype Co. (1975)—pg. 336 .................................................................... 38

ii. Rosenthal v. Rosenthal (1988) – pg. 343 .................................................................................... 39

iii. Wilkes v. Springside Nursing Home, Inc. (1976) – pg. 344.......................................................... 39

iv. Zimmerman v. Bogoff (1988) – pg. 350 ...................................................................................... 39

v. Smith v. Atlantic Properties (1981) – pg. 350 ............................................................................. 39



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vi. Merola v. Exergen Corp. (1996) – pg. 352 .................................................................................. 39

f. Restrictions on the Transferability of the Shares and Mandatory Sale Provisions ......................... 39

i. FBI Farms, Inc. v. Moore (2003) – pg. 355 .................................................................................. 39

ii. Gallagher v. Lambert ()-- TWEN .................................................................................................. 39

g. Dissolution for Deadlock or Oppression ......................................................................................... 39

i. WHITEBOOK BCL §1001-02, 1104,1104-a, 1111, 1118 ............................................................... 39

ii. Deadlock...................................................................................................................................... 39

iii. Oppression and Mandatory Buy Out .......................................................................................... 39

X. Limited Liability Companies ................................................................................................................ 39

a. Introduction .................................................................................................................................... 39

i. Uniform Limited Liability Company Act §101, 103, 201-203, 301-303, 404, 405, 408-409

[Statutory Supplements pg. 67, 69, 72, 74-77, 79-81 ......................................................................... 39

ii. LLCs are non-corporate entities that are created under statutes that combine elements of

corporation and partnership law ........................................................................................................ 39

iii. Formalities; Articles of Organization; Powers ............................................................................. 39

iv. Operating Agreements ................................................................................................................ 40

v. Management ............................................................................................................................... 40

vi. Voting by Members ..................................................................................................................... 40

vii. Authority ................................................................................................................................. 40

viii. Inspection of Books and Records ............................................................................................ 40

ix. Fiduciary Duties ........................................................................................................................... 40

x. Derivative Actions ....................................................................................................................... 40

xi. Distributions ................................................................................................................................ 40

xii. Members’ Interests ................................................................................................................. 41

xiii. Liability .................................................................................................................................... 41

xiv. Dissociation ............................................................................................................................. 41

b. Piercing the LLC Veil ........................................................................................................................ 41

i. Kaycee Land and Livestock v. Flahive (2002) – pg. 400 .............................................................. 41

c. Fiduciary Duties ............................................................................................................................... 41

i. Salm v. Feldstein (2005) – pg. 405 .............................................................................................. 41

ii. Vgs, Inc. v. Castiel (2000) – pg. 406 ............................................................................................. 41

iii. Gatz Props. LLC v. Auriga Capital Corp. () -- TWEN ..................................................................... 41




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d. Dissolution ...................................................................................................................................... 41

i. In the Matter of 1545 Ocean Avenue LLC () -- TWEN ................................................................. 41

XI. The Duty of Care and Duty to Act in Good Faith ............................................................................. 41

i. WHITEBOOK BCL §402(b), 717, 719, 720 .................................................................................... 41

b. The Duty of Care ............................................................................................................................. 41

i. The Basic Standard of Care ......................................................................................................... 41

ii. The Business Judgment Rule ....................................................................................................... 41

iii. The Duty to Monitor, Compliance Programs and Internal Controls ........................................... 42

iv. Liability Shields ............................................................................................................................ 42

c. Duty to Act in Good Faith ................................................................................................................ 43

i. In re the Walt Disney Company Derivative Litigation (2006) – pg. 479 ...................................... 43

ii. Stone v. Ritter (2006) – pg. 484 .................................................................................................. 43

XII. The Duty of Loyalty ......................................................................................................................... 43

a. Self Interest Transactions ................................................................................................................ 43

i. Gantler v. Stephen (2009) – pg. 486 ........................................................................................... 43

ii. Lewis v. SL & E, Inc. (1980) – pg. 496 .......................................................................................... 43

b. Statutory Approaches ..................................................................................................................... 43

i. WHITEBOOK BCL §713, 714 ........................................................................................................ 43

ii. Cookies Food Products v. Lakes Warehouse (1988) – pg. 513 ................................................... 43

c. Compensation and the Doctrine of Waste, and the Effect of Shareholder Ratification ................ 43

i. WHITEBOOK BCL §202(a)(10),(13), §712(a)(3), §714, §720 ....................................................... 43

ii. Compensation ............................................................................................................................. 43

iii. Ryan v. Gifford (2007) – pg. 527 ................................................................................................. 43

d. Corporate Opportunity Doctrine .................................................................................................... 43

i. Northeast Harbor Golf Club, Inc. v. Harris (1995) – pg. 537 ....................................................... 43

ii. In re Ebay, Inc. Shareholders Litigation (2004) – pg. 552 ........................................................... 43

e. Duties of Controlling Shareholders ................................................................................................. 43

i. WHITEBOOK BCL §903 ................................................................................................................ 43

ii. Zahn v. Transamerica Corporation (1947) – pg. 553 .................................................................. 43

iii. Sinclair Oil Corporation v. Levien (1971) – pg. 561 .................................................................... 43

iv. Kahn v. Lynch Communication Systems, Inc. (1994) – pg. 567 ................................................... 43

v. In re Trados Inc. Shareholders Litigation (2009) – pg. 579 ......................................................... 43



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f. Sale of Control ................................................................................................................................. 43

i. Zetlin v. Hanson Holdings, Inc. (1979) – pg. 587 ......................................................................... 43

ii. Perlman v. Feldman (1955) – pg. 591 [Contrast with DeBaun v First Western Bank & Trust Co]

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XIII. The Antifraud Provision: Section 10(b) and Rule 10(b)-5 ............................................................... 44

a. Introduction to Section 10(b) and Rule 10(b)-5 .............................................................................. 44

i. Securities Exchange Act – Statutory Supplement pg. 273 and 290 ............................................ 44

ii. The Wharf Limited v. United International Holdings, Inc. (2001) – pg. 609 ............................... 44

b. Elements of Standing and Scienter ................................................................................................. 44

i. The purchaser-seller requirement .............................................................................................. 44

ii. “in connection with” requirement .............................................................................................. 44

c. Duty to Speak .................................................................................................................................. 44

i. ........................................................................................................................................................... 44

d. Junction of Breaches of Fiduciary duty and Rule 10(b)-5 ............................................................... 44

i. Santa Fe Industries, Inc. v. Green (1977) – pg. 653 .................................................................... 44

XIV. Insider Trading ................................................................................................................................ 44

a. Common Law Background .............................................................................................................. 44

i. Majority Rule ............................................................................................................................... 44

ii. Special facts................................................................................................................................. 44

iii. Atrophy ....................................................................................................................................... 44

b. Federal Disclose or Abstain Requirement ....................................................................................... 44

i. Statutory Supplement ................................................................................................................. 44

ii. In the Matter of Cady, Roberts, & Co. (1961) – pg. 657 ............................................................. 44

iii. Securities and Exchange Commission v. Texas Gulf Sulphur Co. (1968) – pg. 658 ..................... 44

iv. Chiarelly v. United States (1980) – pg. 673 ................................................................................. 44

v. United States v. O’Hagan (1997) – pg. 680 ................................................................................. 44

vi. Dirks v. Securities and Exchange Commission (1983) – pg. 693 ................................................. 44

c. Liability for Short-Swing Trading Under Section 16(b) of the Securities Exchange Act .................. 44

i. Statutory Supplement ................................................................................................................. 44




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I. Agency – Sole Proprietorship

a. Introduction

i. Firm that is Owned by a single individual and is not cast in a legal form that can be

utilized only by filing an organic document with the state under an authorizing statute

b. Agency and Authority

i. Prcpl/Agnt Relationship

1. The employment by one Person (P) of another (A) to act on P’s behalfimplicates the law of agency

ii. Prcpl Agency Problems

1. Liability of Prcpl to 3rd

Party for Torts of an Agnt

a. Respondeat Superior or Vicarious Liability

i. Prcpl will be vicariously liable for torts committed by Agnt if:

1. Prcpl-Agnt relationship exists (ABC’s)

a. Assent – informal agreement between Prcpl

and Agnt

b. Benefit – Agnt’s conduct must be for Prcpl’s

benefit

c. Control – Prcpl must have the right to

control the Agnt by having the power to

supervise the manner of the Agnt’s

performance

2. The tort was committed by the Agnt within the

scope of that relationship

a. Conduct “of the kind” Agnt was hired to

perform – was the conduct within the job

description

b. Tort occur “on the job”

i. Frolic – a new independent journey

ii. Detour – a mere departure from an

assigned task – within the scope of

agency

c. Agnt intent to benefit the Prcpl – partialbenefit is enough for scope

3. Intentional Torts

a. Rule – Intentional torts are outside the

scope of agency UNLESS

i. Specifically authorized

ii. Natural from the nature of

employment (e.g. bouncers)

iii. Motivated by a desire to serve the

Prcpl (e.g. employee apprehends

shoplifter)

2. Liability of Prcpl to 3rd

Party for Contracts entered by an Agnt

a. Prcpl will be vicariously liable for contracts entered into by Agnt if:

i. A Prcpl-Agnt relationship exists

1. Note: Requires ABC (see above)

ii. The Prcpl authorized the Agnt to enter the contract (4 types)

1. Actual Express Authority

a. Written or Oral (conveyance of land must

always be written)

b. revocable (unless durable power of

attorney – i.e. a written expression of

authority to enter into a contract)



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2. Actual Implied Authority

a. Necessity – authority is necessary to

accomplish expressed tasks

b. Custom – customarily performed tasks

associated with the title or position

c. Prior Dealings – prior authorization to do it

3. Apparent Authoritya. Prcpl cloak + a 3

rd party relies

i. the Prcpl cloaked the Agnt with the

appearance of the authority and

the 3rd

party reasonably relied on

the appearance of the authority

ii. Secret Limiting Instruction – Agnt

has actual authority but Prcpl has

secretly limited that authority and

Agnt acts beyond the scope of the

limitation

iii. Lingering Apparent Authority –

actual authority has been

terminated and the Agnt continues

to act on Prcpls’ behalf anyway. 3rd

party continues to rely on Agnt’s

apparent authority until the 3rd

party is notified of the Agnt’s

termination

4. Ratification (knowledge + acceptance of benefits)

a. authority can be granted after the contract

has been entered into IF:

i. Prcpl has knowledge of all material

facts regarding the contract AND

ii. Prcpl adopts the contract by

expressly or impliedly accepting itsbenefits

iii. BUT (NY rule) ratification cannot

alter the contract (Prcpl must ratify

the entire contract)

iii. Note: Authorized Agnt NOT liable UNLESS undisclosed Prcpl

b. Rules of Liability on the Contrac

i. General Rules

1. If Agnt has no authority – the Prcpl is not liable

the Agnt is held liable

2. If Agnt has authority – the Prcpl is liable the Agnt

is not liable

ii. Undisclosed Exception Rule (NY Rule)

1. Generally: if Prcpl is disclosed (existence and identity

of the Prcpl is known to the 3rd

party) – the Prcpl is

liable Agnt is not liable

2. Exception: if Prcpl is partially disclosed (Prcpl’s

existence is known but identity is withheld) or

undisclosed (neither identity nor existence is

disclosed) both Prcpl and/or Agnt may be liable

a. 3rd

party can elect to sue either or both

Prcpl and Agnt




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b. NOTE: The type of Prcpl (disclosed, partially

disclosed or undisclosed is relevant ONLY

when you are considering whether the Agnt

is liable, NOT when discussing the Prcpl’s

liability)

3. Duties which Agnt owe to Prcpls

a. Dutiesi. Duty to exercise reasonable Care

ii. Duty to obey reasonable instructions (i.e. not break the law)

iii. Duty of loyalty

1. Self-dealing – Agnt cannot receive a benefit to the

detriment of the Prcpl

2. Usurping the Prcpl’s opportunity OR

3. Secret profits

b. Remedies

i. Prcpl may recover losses caused by breach, and may disgorge

profits made by the breaching Agnt

iii. Morris Oil Co. v. Rainbow Oilfield Trucking Inc. (1987) – pg. 2

1. Undisclosed Prcpl is liable notwithstanding an agreement between Prcpl & Agnt

that no Prcpl/Agnt relationship existed. Where P contracts with A, Retains

complete control over A’s actions, can’t avoid liability w/regard to a 3rd party

by contractual terms between P&A.

a. Rule: He who controls another is Prcpl; he who is controlled by

another is Agnt of the other.

c. Agent’s Duty of Loyalty

i. Agency Costs

1. The Sum of:

a. Monitoring expenditures by the principal

b. Bonding expenditures by the agent

c. Residual loss

2. An agent of a corporation that takes an opportunity to benefit for himself

where the corporation should have benefited insteada. Agent must work for one principal, in the interest in the principal and

not the interest of oneself

ii. Tarnowski v. Resop (1952) – pg. 18

1. The agent has a duty of loyalty to the principal, and the principal can recover

any unauthorized profits made by the agent on the transaction. [Restatement

of Agency §407(2)] It makes no difference that the principal rescinds the

transaction and gets his money back, or even that he makes a profit.

a. Where the agent violates the duty of loyalty, the principal is entitled to

receive the value of what he put into the transaction plus any

damages caused as a result of the transaction. [Restatement of Agency

§407(1)]

b. (P tells A to investigate business opprty. A gets bought off, doesn’t

bother researching, and gives P bad advice. P sues a for damages and

for the amount a receive from 3rd party

i. The agent has a duty of loyalty to the principal, and the

principal can recover any unauthorized profits made by the

agent on the transaction. [Restatement of Agency §407(2)]

iii. Statutes, Rules, and Regulations

1. RS Agency § § 8.01 – 8.05 [Statute Book pg. 27]

a. 8.01: General Fiduciary Principal




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language saying that no partnership is intended conclusive. The entire

agreement will be looked at in making this determination. Notwithstanding the

appearance of control over an organization, where all of the features of the

agreement between the parties are consistent with a loan agreement, no

partnership has been formed.

v. Lupien v. Malsbenden (1984) – pg. 53

1. Δ’s financial interest in a business, combined with his participation in its day-to-day business made him a partner even if the partners considered themselves

creditor and borrower. (Δ had invested $85,000 in the kit car segment of York’s

business. Δ characterized this investment as a no-interest loan. Much of the

loan took the form of day-to-day payments for kits and other parts, equipment,

and the salary of at least one employee. Repayments of principal were due on

the sale of kits rather than at fixed times. Δ opened the business daily, order

parts, and sold business assets.)

vi. Formation of Partnerships

1. No formalities required – no filing necessary

2. Sharing of Profits – parties continue money or services in return for share of

the profits, if any, is a prima facie evidence of a general partnership

3. Four Element test

a. Four Part test to determine whether or not there is a partnership

when there is no express agreement

i. An agreement to share profits,

ii. an agreement to share losses,

iii. a mutual right of control or management of the business, and

iv. Community of interest in the venture

b. UPC does not require the loss-sharing or the control elements

i. Mutual Right of Control and Loss-Sharing are evidence of a

partnership but NOT a requirement of one

vii. Joint Ventures

1. Note: Joint ventures and partnerships are very similar

a. JVs are sometimes subject to partnership rules in court proceedings

b. “special rules” are also sometimes invoked to enable certainprocedures in JVs that are not allowed in partnerships

b. Legal Nature of a Partnership [Pg. 58-60 of Textbook]

c. The Ongoing Operation of Partnerships

i. Uniform Partnership Act pg. 34-35 of Statutory Supplement

1. § 18 Rules Determining Rights and Duties of Partners

2. § 19 Partnership Books

3. § 20 Duty of Partners to render Information

ii. Summers v. Dooley (1971) –pg. 60 of Textbook

1. In a two person partnership, one partner cannot, over objection of the other

partner, take action that will bind the partnership. Where equal partners exist

(i.e., partners have equal rights in conduct of the affairs of the partnership),

then differences on business matters must be decided by a majority of the

partners.

iii. Sanchez v. Saylor (2000) – pg. 62 of Textbook

iv. Management of Partnerships

1. absent an agreement, the default rule is that each partner is entitled to EQUAL

control (doesn’t matter how much money they contributed)

v. Indemnification and Contribution

1. Each partner is only liable for his share of partnership obligations.

a. I.e. if one partner pays off a whole debt, he can collect the other

partner’s share of the debt directly



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2. Obligation to indemnify a partner is a partnership liability

3. Obligation to make contribution is a liability of a partner

d. The Authority of a Partner

i. Uniform Partnership Act pg. 31-33 of Statutory Supplement

1. § 9 Partner Agent of Partnership as a Partnership Business

2. § 10 Conveyance of Real Property of the Partnership

3. § 11 Partnership Bound by admission of Partner4. § 12 Partnership Charged with Knowledge of or Notice to partner

5. § 13 Partnership Bound by Partner’s Wrongful Act

6. § 14 Partnership Bound by Partner’s Breach of Trust

ii. North Investment Company v. Milford Plaza Association (2001) – pg. 66

iii. Actual vs. Apparent Authority

1. Actual

a. Each partner is an agent of the partnership for the purpose of its

business

2. Apparent

a. Acts for carrying on in the ordinary course business of kind carried on

by the partnership

e. Liability for Partnership Obligations (to Third Parties)

i. Uniform Partnership Act – pg. 31-34, 40 in statutory supplement

1. § 9 Partner Agent of Partnership as to Partnership Business

2. §13 Partnership Bound by Partner’s Wrongful Act

3. §14 Partnership Bound by Partner’s Breach of Trust

4. §15 Nature of Partner’s Liability

5. §16 Partner by Estoppel

a. Partnership liability by estoppel – one who represents to a 3rd

party

that a partnership exists will be liable as if a partnership exists (fact

pattern: Liability – formation issue – liability by estoppel)

6. §17 Liability of Incoming Partner

7. § 36 Effect of Dissolution on Partner’s Existing Liability

ii. Partnership Liability – Agency principles applies

1. General Partners are agents of the partnership for carrying on usualpartnership business

2. Partnership is bound by torts committed by partners in scope of partnership

business

3. Partnership is bound by contract’s entered into by partners with actual or

apparent authority

f. Partnerships Interest and Partnership Property

i. Partnership Property – partner’s right

1. Specific partnership assets – no single partner may transfer those assets to

another

a. E.g. Land, leases, or equipment owned by the partnership

2. Share of profits & surplus – partners share of profits Is personal property

owned, as personal property, by each individual partner (can be transferred

freely)

3. Share in management (i.e. right to vote) – owned only by the partnership; thus

no individual partner may transfer his share in the management to another

(not liquid)

a. Absent an Agreement, the default rule is that each partner is entitled

to EQUAL control (doesn’t matter how much money each partner

contributed)




17

4. Conflict between specific partnership assets & personal property – depends on

whose money was used to buy the property; if partnership money was used,

it’s partnership property, & vice versa

g. The Partners Duty of Loyalty

i. Meinhard v. Salmon (1928) – pg. 74 of textbook

1. Δ's fiduciary obligation to his joint venture partner as a joint venture

"opportunity"? Joint venture partners have the highest obligation of loyalty totheir partners. This includes an obligation not to usurp opportunities that are

incidents of the joint venture. The duty is even higher of a managing co-

adventurer. There was a close nexus between the joint venture and the

opportunity that was brought to the manager of the joint venture, since the

opportunity was essentially an extension and enlargement of the subject

matter of the existing venture.

ii. Fiduciary Duties – partners are fiduciaries of each other & the partnership:

1. Duty of loyalty

a. Partners may never engage in self-dealing

b. No usurping partnership opportunities; and

c. No secret profits

2. Action for account (NY RULE) – the only form of action that can be filed by the

partnership against its own partners and between partners

a. Partnership may

i. Recover losses caused by a partner’s breach

ii. Disgorge profits made by the breaching partner & put those

profits into a constructive trust for the partnership’s benefit

b. Between partners – an equitable proceeding whereby liabilities

between each partner & the partnership are converted into liabilities

between the partners individuals (an action lies to recover the balance

due any partner)

iii. General Partners are personally liable for debts of partnership

1. Incoming partner’s liability – generally, an incoming partner is NOT liable for

prior, pre-existing debts/obligations; except for any contributions to the

partnership may be used for any purpose (including satisfying priordebts/obligations)

2. Outgoing Partner’s liability – retains liability on future debts/obligations UNTIL

notice of withdrawal has been given to all known, & potential creditors

a. But liability for future debt/obligations are terminated upon death of

the outgoing partner

iv. Nature of Liability

1. Joint & Several Liability (one or more partners may be sued) – for torts and

breaches of trust

2. Joint Liability (all partners must be sued) – for all other debts and obligations

v. Extent of Liability

1. Each partner is personally and individually liable for entire amount of

partnership debts & obligations, and for partnership

vi. Partnership Liability by Estoppel

1. One who represents to a 3rd

party that a partnership exists will be liable as if a

partnership exists

a. I.e. Fact Pattern Liability – formation issue – liability by estoppel

h. Side Notes on partnerships

i. Salary

1. Absent an agreement, partners get NO salary (doesn’t matter how many hours

they work)



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a. EXCEPTION: Partners get compensation for helping “wind up” the

partnership Business

ii. Partner’s share of profits and Losses

1. Absent an agreement

a. Profits are shared equally

b. Losses are shared like profits

i. Dissolutioni. Dissolution (in general)

1. Definitions

a. Dissolution – ANY material change in the partnership, including by

i. Withdrawal

ii. Death of any single partner

b. Winding Up – The period between dissolution & termination in which

the remaining partners liquidate the partnership’s assets to satisfy the

partnership’s creditors

c. Termination – the real end

2. Notice of dissolution

a. Proper notice – to terminate the apparent authority of partners to

bind the partnership after dissolution (personal notice and/or

publication notice)

b. Failure to notice – binds partners personally to 3rd

parties who, while

unaware of the dissolution, extended credit to the partnership

3. Compensation and Liability for Winding Up

a. Compensation – partners who help wind-up receive compensation

(exception to compensation rules)

b. Partnership’s liability for winding up

i. Old business – partnership/partners retain liability on all

transactions entered into wind up partnership

ii. New Business – partnership/partners retains liability on all

transactions UNTIL notice of dissolution is given to all known

& potential creditors

4. Priority of distributiona. Each level must be fully satisfied before beginning the next level in this

order:

i. Outside creditors Any creditors other than a partner (i.e.

trade creditors) must be paid first

ii. Inside creditors partners who have loaned money to the

partnership must be fully repaid

iii. Capital contributions by partners – partnership owes the

full repayment of capital to its partners

iv. Profits & Surplus if any, absent an agreement, partners

paid equally

b. RULE: each partners must be repaid his/her

i. Loans AND capital contributions PLUS either that partner’s

share of the profits or MINUS that parter’s share of the losses

1. Example One (w/ surplus) liquidated assets $1M

to distribute; if partnership owes 600k to trade

creditors, partnership loaned 100k from A and B

made capital contributions of 200k?

a. Outside creditors must be paid full 600k

b. A is an inside creditor and should be paid

100k




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c. B must be repaid the 200k he contributed

to capital

d. Absent an agreement surplus of 100k is

then split between A & B equally

2. Example Two (w/ loss) Liquidated asset of $700k

to distribute; if partnership owes 600k, to trade

creditors, partnership loaned 100k from A, and Bmade capital contributions from 200k?

a. Outside creditors must be paid full 600k

b. A is an inside creditor and should be paid

100k

c. Partnership still owes capital contributions

of 200k to B

d. Each partner owes back 100k (200k/2) so

that the partnership can repay B

ii. By Rightful Election

1. Uniform Partnership Act Sections

a. § 29: Dissolution Defined

b. § 30: Partnership not Terminated by Dissolution

c. § 31(a): Causes of Dissolution (w/o violation of an agreement)

d. § 38(1): Rights of Partners to Application of Partnership Property

e. § 40: Rules for Distribution

2. Girard Bank v. Haley (1975) - pg. 79 termination of partnerships/at-will

Nature of Partnerships

a. If a partnership agreement does not specify that the partnership will

be for a particular term, an at-will dissolution of the partnership does

not violate that agreement.

b. Furthermore, a partner’s expression of her intention to dissolve the

partnership effects a dissolution even if it is in contravention of the

partnership agreement. If the dissolution does in fact breach the

agreement, the aggrieved partners may seek damages and, in some

circumstances, may continue the partnership’s business for theremainder of the agreed-upon term

3. Disotell v. Stiltner (2004) – pg. 79

4. McCormick v. Brevig (2004) – pg. 80

5. Page v. Page (1961) – pg. 85 Partnership for a term or at will?

a. Where there is no agreement to continue a partnership for a specified

term, the relationship is at will and can be terminated notwithstanding

the fact that the business has only recently become profitable, as long

as the termination is in good faith.

b. D testified that there were no understandings about continuation for a

term, or until money was paid back, and that another partnership that

P and D were in expressly provided for a term. Some cases do hold

that the partnership shall continue for a term necessary to repay debt,

but only where there is evidence showing this intention. If P is acting

in bad faith in seeking dissolution, then he may be violating his

fiduciary duty as a partner. Dissolution must be in good faith. State

law provides for damages in that case. A separate action could

determine this issue. But a partner at will is not bound to remain in a

partnership just because it is profitable.

6. Partnership Breakup under RUPA (more complex than the UPA)

a. Nomenclature – to begin with nomenclature, RUPA continues to use

the terms “Dissolution”, “winding up”, and “termination” but adds in



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the term of “Dissociation” to describe the termination of a person’s

status as a partner

b. Events of Dissociation – pg. 89 and 90 in text

iii. By Judicial Decree and Wrongful Dissolution

1. UPA Sections

a. § 31(2): Causes of Dissolution (breaking a contract between partners)

b. § 32: Dissolution by Decree of Courtc. § 38(2): Rights of Partners to Application of Partnership Property

(when an agreement has been broken)

2. Drashner v. Sorenson (1954) – pg. 92

a. Where a partner neglects the business and makes it reasonably

impracticable to carry on the business as partners [See UPA §38(2)] A

court may terminate the partnership.

b. State law allows the court, as a penalty for wrongfully causing

dissolution of the partnership, to refuse to consider goodwill in valuing

the business, although most of the original value of $7,500 paid for the

business was for goodwill.

3. Note on Wrongful Dissolution (pg. 96 of Text)

a. Drashner v. Sorenson illustrates the consequences of a wrongful

dissolution (damages against the partner, valuation of a partner

[minus goodwill], and continuation of a partnership w/o a partner)

j. Limited Partnerships and Limited Liability Partnerships

i. Limited Partnerships

1. General vs. Limited

a. General Partners – liable for all debt/obligations

i. But, may exercise substantial control

b. Limited Partners – not liable beyond contribution

i. But limited control, must pay full consideration

2. Formation of Limited Partners

a. WHITEBOOK pg. 786-787 & 789-790

i. §303

ii. § 4033. Liability of Limited partners

a. Gateway Potato Sales v. G.B. Investment Co. (1991) – pg. 98

4. Fiduciary Obligations

a. Gotham Partners v. Hallwood (2002) – pg. 108

ii. Limited Liability Partnerships

1. Defined

a. Members of LLC, who are owners, are NOT liable for all

debt/obligations

2. § 3.02 – Limited “Tort” Liability in LLPs

a. Negligence or other misconduct by a co-partner or other

agent/employee of the firm not liable under Delaware

3. § 3.03 – Limited Liability for All Types of Claims

a. Liability is limited for all partnership debts and obligation

b. A partner is not personally liable, directly or indirectly, for partnership

obligations --- eliminate vicarious liability for all types of claims while

preserving partners’ liability for their own misconduct

4. § 3.04 – Partners’ Direct Liability

a. Does not relieve owners from liability for their own misconduct

i. Limited liability only means that owners are not, solely as

owners, vicariously liable for the firm’s debts




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IV. The Foundations of a Corporation

a. The Characteristics of the Corporation

i. Limited Liability

1. Shareholders are (normally) not personally liable for corporate obligations

2. Managers are also not personally liable AS LONG AS they act on the

corporation’s behalf, within their authority

ii. Free Transferability of Ownership Interests1. Publicly held corporations Shares of stock are usually freely transferrable

2. Partnership interests cannot be transferred without the consent of ALL the

partners unless otherwise agreed

iii. Continuity of Existence

1. Corporations Usually continuous, unless a shorter term is specified in the

certificate of incorporation

2. Partnerships usually limited terms, and are easily dissolved

iv. Centralized Management

1. Publicly held corporations power to manage the business is legally vested in

the board of directors (in practice, it is normally exercised by the corporations

executives [i.e. CEOs, CFO, etc.]

2. Partnerships all partners have a right to participate in the conduct of the

business unless it’s previously agreed otherwise

v. Entity Status

1. Corporation it is a legal person or entity – can exercise power and have

rights in its own name [i.e. it can sue & be sued, can own real & personal

property]

2. Partnership

a. States that follow the Uniform Partnership Act are NOT deemed to

have entity status

b. States that follow the Revised UPA ARE deemed to have entity

status

b. Architecture of Corporate Law

i. Traditional Conflicts

1. Typically involve self-interested transactions between managers and theircorporations

ii. Positional Conflicts

1. Involve actions by managers to maintain and enhance their positions

iii. Four Major Modules

1. State Statutory Law

a. Allows corporations to be organized

b. Provides corporations with various endowments

c. Facilitates corporate transactions

2. Judge-Made Law

a. Set the level of care required of officers and directors

b. Regulates traditional conflicts of interest

c. Gives content to remedial structures to protection shareholders rights

and resolve shareholder claims

3. Federal Law (i.e. Securities Acts and Sarbanes Oxley)

a. Regulations certain traditional conflicts directly through rules on

insider trading and regulations positional conflicts of interest indirectly

through rules that govern the proxy voting systems and through

regulation of the flow of information concerning management’s

performance

4. Private Ordering *“soft law”+ – stock exchange rules for listed companies



22

a. Regulate positional conflicts directly, by requiring an independent

board and committees to monitor the corporation’s executive

iv. Which State’s Law Governs a Corporation’s Internal Affairs

1. A corporation’s internal affairs may be governed by four different legal

modules, often state law will be the most important

2. Normal Rule the law of the state’s incorporation will govern the

corporation’s internal affairsa. HOWEVER some states [i.e. NY and California] have adopted

provisions in their corporate statues under which designated sections

of the statues are applicable to the internal affairs of certain

corporations incorporated in another state

c. Selecting State of Incorporation [textbook pages 122-128]

i. A corporation that will have only a few owners will usually be incorporated locally (i.e. in

the state that the corporation will have its principal place of business)

ii. States may impose a franchise tax on the corporation for the privilege of incorporation,

even if the corporation does little or no business in the states

1. Elements of the “doing-business” tax and franchise tax may overlap

iii. Publicly held corporations different things are considered,

1. See handout – “To Delaware with Love”

d. Organizing the Corporation

i. WHITEBOOK – Business Corporate Law Statutes [BSC]

1. § 201: Corporate Purposes and Powers

2. Article 4 – Formation of Corporations

a. § 401: Incorporators

b. § 402: Certificate of Incorporation; Contents

c. § 403: Certificate of Incorporation; Effect

d. § 404: Organization Meeting

3. Article 6 - Shareholders

a. § 601: By-laws

b. § 615(c): Written Consent of shareholders, subscribers or

incorporators without a meeting [Notice]

e. The Basic Types of Financial Securities [textbook pages 131-135]i. Brief Explanation [pg. 131-133

1. Common Stock

a. Shares of common stock are conceived as ownership or equity

interests in the corporation

i. Has no fixed claim on the corporation

2. Preferred Stock

a. A hybrid that combines the ownership element of common stock and

the senior nature of debt

i. Does not promise a repayment of the original investment

3. Convertibles, Classified Stock, and Derivatives

a. Preferred stock and bonds can sometimes be converted into common

stock

b. Different classes of stock have their own rights and privileges

c. New types of securities can be derived from common stock

ii. Introduction to Types of Debt and Debt Covenants

1. Defined

a. Debt – a fixed claim against the corporation for principal and interest

2. Major Types of Corporate Debt

a. Trade Debt

i. Amount that a corporation owes for purchased goods or

services that have not yet been paid for at any point of time.




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1. It appears on the balance sheet as accounts payable

b. Bank Debt

i. Any loans that were used for finance the business

1. It appears on the balance sheet under loans payable

c. Bonds and Debentures

i. Promises, embodied in an instrument, to repay amounts that

the firm has borrowed on a long-term basis, typically byselling the bonds on the general market or on some special

market

d. Notes

i. Legally recognized the same as bonds/debentures

ii. Typically notes are ten years or less where debentures are

ten years or more

f. The Classical Ultra Vires Doctrine [Textbook page 151-154]

i. Classical Ultra Vires Doctrine

1. Corporation is regarded as a fictitious person endowed with life and capacity

only insofar as provided in its charter. Transactions outside that sphere are

characterized by the courts as Ultra Vires (beyond the corporation’s powers –

and therefore unenforceable)

a. Original purpose is to protect the public or the state from

unsanctioned corporate activity

ii. Powers and Purposes

1. Questions of Ultra Vires Doctrine merged to create the “powers and purposes”

clause of a corporation’s certificate

a. Whether the corporation acted beyond its purposes (engaged in a

type of business activity not permitted under its certificate)

b. Whether the corporation had exercised a power not specified in its

certificate

iii. Recurring Problems

1. The power of a corporation to guarantee a third party’s debts

a. Used to be an issue but Present Day statutes address this problem by

explicitly empowering corporations to make guaranteesiv. Limitations on the Ultra Vires Doctrine

1. Implied or incidental powers based on the corporation’s primary business

2. Cannot be used to reverse completed transactions or as a defense to tort

and/or criminal liability

3. If the corporation doesn’t carry out its side of the contract after another party

has already completed their portion, performing party sues for

nonperformance

a. Majority rule – nonperforming party I estopped from using the Ultra

Vires defense

b. Minority rule (federal rule) -- performing party can recover in

restitution for the value of any benefit conferred

4. Unanimous shareholder approval barred the ultra vires defense unless

creditors would be injured

5. Laundry list of power are conferred on every corporation even without

enumeration in the certificate by allowing “any lawful business”

6. Modern statutes adopted provisions that almost abolish the ultra vires

doctrine. Similar statutes have been adopted in all but a few states

g. The Objective and Conduct of the Corporation

i. WHITEBOOK Business Corp. Law [BSC]

1. § 202(a)(12): General Powers



24

a. To make donations, irrespective of corporate benefit, for the public

welfare or for community fund, hospital, charitable, educational,

scientific, civic or similar purposes, and in time of war or other

national emergency in aid thereof.

2. § 717: Duty of Directors

ii. ALI Principles of Corporate Governance – SEE HANDOUT #2

1. § 2.01: The Objective and Conduct of the Corporation2. § 6.02: Action of Directors that has the Foreseeable effect of Blocking

Unsolicited Tender Offers

iii. Interests Other than Maximzation of Shareholders’ Wealth

1. Dodge v. Ford Motor Co. (1919) – pg. 156

2. A.P. Smith Mfg. Co. v. Barlow (1953) – pg. 158

3. Note on the Conduct of the Corporation

a. Almost every state has adopted statutory provisions similar to

Delaware’s corporate contribution statute. A Limit of reasonableness

is implied

i. “Donations should be reasonable in amount in the light of the

corporation’s financial condition…” *textbook page 163+

b. There is very little direct authority on the permissibility of taking

ethical considerations into account in framing corporate action where

doing so might not enhance profits.

V. The Legal Structure of the Publicly Held Corporation

i. The power and the roles of the Board, the Shareholders, and the Executives in the

governance of publicly held corporations

b. Legal Distribution of Power Between the Board and the Shareholders, and Equitable Limits on the

Board’s Legal Power

i. WHITEBOOK – Business Corp. Law [BSC]

1. § 601: The By-Laws

2. § 602(b): Meetings of Shareholders

a. Held annually for the election of directors

3. § 701: Board of Directors

4. § 702: Number of Directors5. § 703: Election and Term of the Directors

6. § 704: Classification of Directors

7. § 705:Newly Created Directorship and Vacancies

8. § 706: Removal of Directors

9. § 712: Executive Committee and Other Committees

10. § 715: Officers

11. § 716: Removal of Officers

12. § 801: Right to Amend Certificate of Incorporation

13. § 803: Authorization of Amendment or change

14. § 804: Class Voting on Amendment

15. § 903: Authorization by Shareholders

16. § 909: Sale, Lease, Exchange or Other Disposition of Assets

ii. The Legal Distribution of Power Between the Board and the Shareholders

1. Charlestown Boot & Shoe Co. v. Dunsmore (1880) – pg. 168

2. People ex Rel. Manice v. Powell (1911) – pg. 169

c. Requisites for Valid Action by the Board


1. § 707: Quorum of Directors

2. § 708: Action by the Board

3. § 709: Greater Requirement as to Quorum and Vote of Directors

4. § 710: Place and Time of Meetings of the Board




25

5. § 711: Notice of Meetings of the Board

6. § 712: Executive Committee and Other Committees

ii. Fogel v. U.S. Energy Systems (2007) – SEE HANDOUT # 3

iii. Rules are set at 2 levels. – first to set out formalities for board action and second are

concerning the consequences for noncompliance with the first level rules

1. Level One -- Governing rules

a. Meetingsb. Notice

c. Quorum

d. Voting

2. Level Two – Consequences of Noncompliance

a. Unanimous Explicit Although Informal Approval

b. Explicit Approval by a Majority of the Directors Coupled with

Acquiescence by Remaining Directors

c. Majority Approval or Acquiescence

d. Unanimous Written Consent

d. Normal Requisites for Valid Shareholder Action


1. § 602: Meetings of Shareholders

2. § 603: Special Meeting for Election of Directors

3. § 604: Fixing Record Date

4. § 605: Notice of Meetings of Shareholders

5. § 606: Waivers of Notice

6. § 607: List of Shareholders at Meetings

7. § 608: Quorum of Shareholders

8. § 609: Proxies

9. § 612: Qualification Voters

10. § 613: Limitations on Right to Vote

11. § 614: Vote of Shareholders

12. § 615: Written Consent of Shareholders, Subscribers, or Incorporators without

a Meeting

13. § 616: Greater Requirement as to quorum and Vote of Shareholders14. § 617: Voting by Class or Classes of Shares

ii. Notice of Meeting:

1. Normally take action at annual or special meeting, but can also act with written

consent (if certain conditions are met)

iii. Quorum

1. A majority of the shares entitled to vote is necessary for a quorum unless the

certificate of incorporation sets a higher/lower figure.

a. Most statutes have a minimum requirement of one-third of shares

entitled to vote to set a quorum

iv. Voting

1. Ordinary Matters

a. Most statutes require that a majority of the shareholders agree for

shareholder action on ordinary matters

2. Fundamental Changes

a. An amendment of the certificate of incorporation, merger, sale of

substantially all assets, and dissolution, often require approval by a

majority, or sometimes 2/3rd

s vote

3. Written Consent [textbook page 141]

a. Most statutes allow that shareholders can act by written consent,

without a meetings, if certain conditions are met

i. Conditions vary from state to state



26

1. I.e. --- The model code requires a majority vote as

long articles of incorporation may allow it

e. Corporate Governance and the Rise of Institutional Shareholders

i. Shareholder Voting

1. WHITEBOOK – Business Corp. Law [BSC]

a. § 618: Cumulative Voting

b. § 704: Classification of Directorsc. § 706(c): Removal of Directors – with or without cause

2. Empty Voting and Record Date(s)

a. Record Date – on or around the date that notice of the meeting was

given in order to determine which shareholders are entitled to vote at

the meetings

i. Only record shareholders on the record date are entitled to

vote at that particular meeting

1. Used to prevent discrepancies when record holders

change after notice has already been given meaning

the new holder would not have received proper

notice – this would prevent them from voting bc

they missed the “record date” and prevent people

from giving empty votes (i.e. votes from the old

holders that no longer matter)

ii. Financial Institutions and Their Advisors

1. Note on the role of shareholders under modern corporate practice

a. {self-study section – see text pages 194-204}

f. Election of Directors


1. § 614(a): Vote of Shareholders

a. Directors shall be elected by plurality of the votes (unless stated

otherwise)

2. § 618: Cumulative Voting

3. § 703: Election and term of Directors

4. § 704: Classifications of Directorsii. Staggered (or “classified”) Boards

1. A board that is divided into two or more classes, each of which is elected

separately for staggered terms

a. I.e. – staggered board has 3 classes, with 3 directors in each class, and

all nine board members would serve 3 year terms. Each year only 3 of

the 9 members would be up for election

iii. Straight and Cumulative Voting

1. Straight Voting: one vote per number of shares that she holds

a. Example: A owned 100 Shares of X. X’s board is made up of 7 directors

and all directors are up for election and there are 2 competing slates

of seven candidates

i. Under straight voting, A can cast a total of 700 votes (7

directors *100 shares) but no more than 100 votes to any

given nominee

2. Cumulative Voting: a shareholder can distribute the votes any way she pleases

a. Example: A has 700 votes available. A can cast 350 votes each to her

two candidates

iv. Plurality Voting

1. The most votes




27

v. Short Slates

1. A slate of candidates for less than all, and usually less than a majority, of the

directors to be elected

g. Removal of Directors – BCL § 705-706

i. Removal by the Shareholders

1. Shareholders can remove a director for cause even in the absence of a statute

that so provides2. Shareholders CANNOT remove a director without cause in the absence of

specific authority to do so under the statute, the certificate of incorporation, or

the by-laws

ii. Removal by the Board

1. In the absence of a statute, the board cannot remove a direct either with or

without cause

a. It is unsure whether or not the certificate of incorporation can change

this

b. Some states allow boards to remove a board member for specific

reasons (i.e. convictions of a felony)

iii. Removal by a Court

1. Cases are divided on whether courts can remove a director with or without

cause

a. Some statutes allow courts to remove board members for specific

reasons i.e. fraudulent or dishonest acts

i. This normally requires a petition requesting the removal by a

designated percentage of the shareholders (normally 10%)

h. Requisites for Valid Action by Corporate Officers – BCL § 715 & § 716

i. Corporate Officers

1. President

a. Modern rule is that the president has apparent authority to bind the

corporation to contracts that are made in the usual and regular course

of business, but does not have apparent authority to bind the

corporation to contracts of an extraordinary nature

2. Chief Executive Officera. Top officer, usually also holds the title of chairman of the board,

president or both

3. Chief Operating Officer

a. Usually second in command of publicly held corporations

i. Little to no law on apparent authority of a COO. Question as

to whether apparent authority of a president applies to COOs

too

4. Chairman of the Board

a. Job varies from corporation to corporation

b. No case law on apparent authority

5. Chief Financial Officer

a. Usually the number 3 executive

b. Corporate finance and typically managing risks and expenses

6. Vice-President

a. Not much case law on apparent authority of vice presidents

b. Normally a “fancy” title without added specialties

7. Secretary

a. Has apparent authority to certify the records of the corporation,

including resolutions of the board

8. Treasurer

a. Almost no apparent authority



28

9. Closely Held Corporations

a. President exercises absolute authority over the corporation’s affairs

and the board has never questioned, altered, or rejected his decisions,

the president will have extremely wide actual and apparent authority.

10. Ratification

a. If an officer lacks both actual and apparent authority the corporation

may be bound by her act of entering into a transaction on thecorporation’s behalf if the board later ratifies the officer’s act.

11. Schoonejongen v. Curtiss Wright Corp. (1998) – pg. 151

i. Equitable Limits on the Board’s Legal Powers

i. WHITE BOOK – BCL § 707-708

ii. Condec Corp. v. Lunkenheimer Co. (1967) –pg. 170

iii. Schnell v. Chris-Craft Industries, Inc. (1971) – pg. 171

iv. Blasius Industries, Inc. v. Atlas Corp. (1988) – pg. 173

v. Business Judgment Rule

1. Officers, directors, managers, and other agents of a corporation are immune

from liability to the corporation for loss incurred in corporate transactions that

are within their authority and power to make when sufficient evidence

demonstrates that the transactions were made in Good Faith.

j. The Role of the Bylaws in the Allocation of Power between the Board and the Shareholders

i. WHITEBOOK BCL § 601

ii. CA, Inc. v. AFSCME Employees Pension Plan (2008) – pg. 184

k. Allocation of Power between the Board and the CEO

i. WHITEBOOK BCL § 715-716

ii. Managing Model of the Board

1. Traditional model

a. The board manages the business of the corporation

2. Modern Model

a. The executives manage the business

b. Central figure is NOT the board but the CEO

iii. Monitoring Model of the Board

1. The function of the board in publicly held corporations are toa. select, regularly evaluate, fix the compensation of, and where

appropriate, replace the senior executives;

b. to monitor the conduct of the corporation’s business to evaluate

whether the business is being properly managed; and

c. approve major corporate plans and policies formulated by the

corporation’s executives

2. This model is widely accepted in publicly held corporations and is being used in

most corporations

VI. Shareholder Informational Rights and Proxy Voting

a. Shareholder Information Rights Under State Law

i. SEE HANDOUT # 4

b. Inspection of Books and Records

i. WHITEBOOK BCL § 624 and § 1315

ii. Saito v. McKesson HBCO, Inc. (2002) – pg. 224

iii. Shareholders’ Inspection Rights

1. “No fishing” – The credible Basis Requirement

a. Credible basis can be shown through documents, logic, testimony or

otherwise that there is a legitimate wrongdoing

2. Common Law – Interpretation of the Statutes

a. A shareholder acting in good faith for the purpose of advancing the

interests of the corporation and protecting his own interest as a




29

stockholder has a right to examine the corporate books and records at

reasonable times

i. Shareholder has the burden of alleging and proving good faith

and proper purpose

3. “Proper Purpose”

a. Courts have deemed the following proper

i. To determine the financial condition of the corporationii. To ascertain the value of the petitioner’s shares

iii. To obtain a mailing list for the solicitation of proxies from

shareholders

b. A purpose is proper even though it yields no benefit to the corporation

c. Deemed improper

i. To seek access to gain information that will be used in a

competing enterprise

4. Mixed Purposes

a. Multiple purposes that are either proper or not proper

i. Once it is determined that a shareholder has a proper

primary purpose, any secondary purpose or ulterior motive

that the stockholder might have is irrelevant

5. Pillsbury v. Honeywell (1971) – pg. 231

6. Stockholder Lists

a. As a practical matter, the courts are more willing to grant access to

stockholder lists and the like than to grant access to otherwise

confidential financial and business information (i.e. internal data and

contracts)

c. Stockholder List in a Dematerialized World (textbook page 232-239)

i. Concept Release on the US Proxy System

1. The current Proxy Distribution and Voting Process

a. Types of Share Ownership and Voting Rights

i. Registered Owners

ii. Beneficial Owners

b. The Process of Soliciting Proxiesi. Distributing Proxy Materials to registered Owners

ii. Distributing Proxy Materials to Beneficial Owners

1. The Depository Trust Company

2. Securities Intermediaries: Broker-Dealers and Banks

c. Proxy Voting Process

d. The Roles of Third Parties in the Proxy Process

i. Transfer agents

ii. Proxy Service Providers

iii. Proxy Solicitors

iv. Vote Tabulators

v. Proxy Advisory Firms

d. Reporting under State Law

i. WHITEBOOK – BCL §624(e)

1. Books and Records; right of inspection, prima facie evidence

a. Upon written request by the shareholder, the corporation will send

the records within reasonable time

e. Overview of the SEC and the Securities Exchange Act

i. Textbook pages 240-242

ii. Statutory Supplement pg. 274-274

1. Securities Exchange Act

a. Section 12: Registration Requirement for Securities



30

i. § 12(a), (b), and (g)

f. Periodic Disclosure under the Securities Exchange Act (textbook page 243)

i. Addresses the information deficiencies in state law by imposing periodic reporting

requirements on corporations with a security registered under § 12.

1. 10-K – Annually

2. 10-Q – Quarterly

VII. The Proxy Rulesa. Securities Exchange Act

i. §14(a) – pg. 279 of Statutory Supplement

ii. §14(c)

1. Governs disclosure during proxy contests, when various parties might solicit an

investor's vote on a corporate action or to vote for certain board members.

The Exchange Act requires that disclosure materials be filed with the SEC.

iii. §14(a)-1, §14(a)-2, §14(a)-6 --- pg. 293-300 & 303-308 of Statutory Supplement

b. Introduction

i. Definitions

1. Proxy Bolder: A person authorized to vote shares on a shareholder’s behalf

2. Proxy/Form of Proxy/Proxy Form: the written instrument in which such a

authorization is embodied

3. Proxy Solicitation: the process by which shareholders are asked to give their

proxies

4. Proxy Statement: a written statement sent to shareholders as a means of proxy

solicitation

5. Proxy Materials: the proxy statement and form of proxy

ii. Overview of Proxy Rules

1. Background:

a. Proxy voting is the dominant mode of shareholder decision making in

publicly held corporations.

i. Shareholders are often geographically dispersed making it

difficult for them to all meet up at one central location.

ii. Shareholders typically only have a few shares in comparison

to the total number available…physical attendance of everyshareholder would be a waste of their time, money , and

energy

b. Proxy Solicitation is The process of systematically contacting

shareholders and urging them to execute and return proxy forms that

authorize named proxy holders to cast the shareholder’s vote, either

in a manner designated in the proxy form or according to the proxy

holder’s discretion

c. After fraudulent solicitations became notorious and widespread,

Congress enacted §14(a) of the Securities and Exchange Act

i. §14 has no effect on private conduct – its only effect was to

authorize the SEC to promulgate rules that will govern private

conduct that are now referred to as Proxy Rules.

2. Format Requirements

a. One of the purposes of Proxy Rules is to regulate the form or

presentation the ballot (proxy) itself.

i. The proxy’s format is addressed in Rules 14a-4 and 14a-5

which require that the proxy

1. be in bold face type,

2. identified as a proxy,




31

3. that there be a box for the proxy giver t express

approval, disapproval, or abstention with respect to

EACH matter to be voted upon

4. that the proxy giver to withhold approval for voting

for a nominee

5. that any request for discretionary authority to vote

may be sought only with respect to matters thesolicitor did not have notice of at least 45 days

before the date the proxy materials were sent in the

prior year’s annual meeting

6. all written materials be at least 10-point roman type

b. Rule 14-4(d) – short slate provision [pg. 245 of text]

i. Facilitates efforts to oppose management’s dominance of the

election of directors

3. Anti-bullying

a. Requires separate voting on matters that are not related in order to

prevent shareholders from being bullied into a vote

i. Prior to anti-bullying clause, in order to obtain approval of an

unpopular matter it would be included within a more popular

proposal – can NO longer do this

ii. Note: Management can continue to condition separately

voted on proposals so that neither becomes effective without

the approval of the other

4. Mandated Disclosure

a. Another purpose of the proxy rules is to require full disclosure in

connection with transactions that shareholders are being asked to

approve (such as mergers, certificate amendments, or election of

directors)

i. Rule 14(a)-3 provides that no solicitation of proxies that is

subject to the proxy rules shall be made unless the person

being solicited is “concurrently furnished or has previously

been furnished with a written proxy statement containing theinf ormation specified in Schedule 14A”

1. Schedule 14A details the information that must be

furnished when specified types of transactions are to

be acted upon by the shareholder

b. When proxies for the election of directors are solicited on behalf of a

corporation that is subject to the Proxy Rules, the corporation must

send an Annual Report to its shareholders (in advance or concurrently

with the proxy statement)

c. If a corporation’s stock is registered under section 12, and the

corporation proposes to take an action that requires shareholder

approval, or to hold an annual meeting at which directors are to be

elected, then even if the corporation is not soliciting proxies it must

distribute essentially the same information that would be required if it

was soliciting proxies

5. Filing with SEC

a. Rule 14a-6 governs that filing of proxy materials with the SEC. In broad

overview, the preliminary proxy statement and the ballot (“form of

proxy”) must be filed with the EC 10 days before the definitive copies

of these materials are expected to be sent or given to shareholders

6. Coverage



32

a. Rule 14a-2 provides that the proxy rules “apply to every solicitation of

a proxy with respect to securities registered pursuant to section 12 of

the act” subject to certain exceptions

i. Exceptions

1. Rule 14a-1(l)(2) lists several acts that are excluded

a. I.e. authorizes instances in which it does not

constitute a solicitation for the securityholder to announce his intent to vote in a

certain manner

2. Rule 14a-2(b)(2) excludes from most proxy

requirements a security holder’s communication

directed to ten or fewer persons

a. Doesn’t apply to the anti-misrepresentation

rule of 14a-9

3. Rule 14a-2(b)(1) excludes from most of the proxy

rules communications by a person who is not

seeking a proxy authority

a. Doesn’t apply to anti-fraud rule

7. Access to the Body of Shareholders

a. Rule 14a-7 and Rule 14a-8 provide mechanisms through which

shareholders can communicate with each other

c. Shareholders Access

i. Securities Exchange Act

1. Rules 14a-8 – pg. 311-316 of Statutory Supplement

ii. Dissident’s Access Provisions *Rule 14a-7]

1. Provides a means for a shareholder who wishes to solicit proxies to gain access

to her fellow stockholders.

a. This provision requires that the company shall in response to a request

by a record or beneficial holder either provide a list of stockholder or

circulate the requesting holder’s materials

i. This rule ONLY applies if the company has or intents itself to

engage in a proxy solicitation and the company has theoption of either providing the list or mailing the requesting

security holder’s materials

iii. Shareholder Proposals Under Rule 14a-8

1. The rule permits a shareholder initiated proposal to be included on

management’s proxy statement, provided the proposing shareholder has been

a beneficial owner of one percent or $2000 of the company’s voting shares for

at least one year

2. Rule also sets grounds to exclude the proposal

a. The proposal is not a proper subject for shareholder action under law

b. The proposal relates to operations which account for less than 5% of

the firm’s total assets, net earnings and sales

c. The proposal deals with a matter relating to the company’s ordinary

business

3. In order for the company to exclude the proposal, it must submit a statement

of the reasons why to the SEC staff.

a. If the SEC agrees, they send a “no action” letter – a letter stating that if

the shareholder proposal is omitted, no action will be taken by the SEC

b. If the SEC disagrees, the letter briefly states its disagreement with the

issuer’s opinion that the proposal can be omitted

i. It is still called a no action letter when the SEC disagrees even

though the SEC is likely to lead to an SEC enforcement action




33

iv. Lovenheim v. Iroquois Brands, Ltd., () – TWEN Case

v. Rule 14a-11

1. Provides shareholders and shareholder groups who collectively have held

investment and voting power of at least 3% of the voting power of a company’s

securities continuously for 3 years the right to have nominees on the

company’s ballot. The right extends to a maximum of 25% of the entire board

(or a minimum of one director)d. Material Misleading Proxies and Rule 14a-9

i. Securities Exchange Act Rule 14a-9 – pg. 316-317 of Statutory Supplement

ii. J.J. Case Co. v. Borak (1964) – pg. 256

iii. Cort v. Ash (1975) –pg. 256

iv. Mills v. Electric Auto-Lite Co. (1970) – pg. 257

1. Note on Further Proceedings in Mills v. Electric Auto

a. v. Note on Materiality

1. TSC Industries Inc. v. Northway, Inc. (1976) – pg. 262

VIII. Personal Liability in a Corporate Context

i. Restatement 3rd

of Agency § 6.04 [Statutory Supplement pg. 23]

b. Pre-incorporation Transactions by Promoters

i. A promoter is a person who transforms an idea into an enterprise by bringing together

persons and assets, and overseeing the steps required to bring the enterprise into

existence

1. Normally enters into pre-incorporation contracts for the benefit of a

corporation that has not yet been formed.

ii. Liability of the promoter

1. The general rule is that when a promoter makes a contract for the benefit of a

proposed corporation, the promoter is personally liable on the contract, and

remains liable even after the corporation is formed.

a. Exception – if the party who contracted with the promoter knew that

the corporation was not in existence at the time o the contract and

nevertheless agreed to look solely to the corporation for performance

i. In such cases, the promoter is NOT a party to the contract2. Goodman v. Darden, Doman & Stafford Assocs. (1983) – pg. 275

iii. Liability of the Corporation

1. A corporation that is formed after a promoter has been entered into a contract

on its behalf is not bound by the contract, without more

a. The corporation was not in existence when the contract was made and

therefore did not authorize the promoter to enter into the contract on

its behalf

b. HOWEVER – after the corporation has been formed it may become

bound in one of several ways

i. Ratification

ii. Adoption

iii. Novation

iv. Proposition made t the promoters is a continuing offer to be

accepted or rejected by the corporation when it comes into

being and upon acceptance becomes an original contract

c. Consequences of Defective Incorporation

i. Note

1. Sometimes there is a defect in the process of forming a corporation

a. Example: the certificate of incorporation may fail to include a required

provision in proper form or may be improperly filed

2. Issue is what is the effect on the defect on the corporation’s status



34

a. Usually means the corporation is put in terms of De Jure, De Facto,

Estoppel, or not at all.

b. This becomes an issue when a third party seeks to hold the would-be

shareholders personally liable on the ground that corporate status was

not attained and therefore neither was limited liability

ii. De Jure Corporation

1. A corporation that is organized in compliance with the requirements of therelevant statute (substantial compliance is normally enough too)

a. Status cannot be attacked either by private parties or by the state in a

quo warranto proceeding

iii. De Facto Corporation

1. Is said to exist when the steps taken to incorporate the enterprise were

insufficient to result in a de jure corporation with respect to a challenge by the

state in a quo warranto proceeding, but were sufficient to treat the enterprise

as a corporation with respect to third parties

iv. Estoppel

1. Overview

a. In many cases where courts have found that the corporation does not

fall under de jure or de facto, the courts have held that a third party

who has dealt with an enterprise on the basis that it is a corporation is

estopped from denying the enterprise’s corporate status, as are the

corporation and its shareholders

b. Estoppel theory is made up of several sets of rules as listed below

2. Denial of Corporation Status by the Would-be Shareholders

a. An enterprise engages in a transaction with a third party. At the time

of the transaction, the owners claim that the enterprise is a

corporation. Later, the third party brings suit against the purported

corporation and the enterprise and its owners deny that the

enterprise is a corporation [this is a true estoppel case if the third

party relied on the owner’s statements+

3. Technical Contexts

a. Occurs when the question of a corporate status is raised in a technical,procedural context

i. Example: In a suit brought by a would-be corporation, the

defendant may seek to raise the defense that the plaintiff is

not really and corporation and therefore cannot sue in a

corporation’s name. Estoppel is used by the courts to ignore

the claims of the defendants

4. Liability of Would-be Shareholders [most important]

a. When a third party who has dealt with an enterprise on the basis that

it is a corporation seeks to impose personal liability on the would-be

shareholders, who in turn defend on the ground that the third person,

having dealt with the enterprise as a corporation before, is estopped

to deny that the enterprise has corporate status

i. Different from the de facto theory

1. Third party has dealt with the enterprise as a

corporation before

2. Would be shareholders would not need to resort to

the estoppel theory if they could establish that their

business had de facto corporate status

v. Who May be Held Liable

1. If a would-be corporation is neither a de jure corporation, a de facto

corporation, or a corporation by estoppel, the courts have divided on which




35

would-be shareholders may be held personally liable for debts incurred in the

corporation’s name

a. Older decisions imposed personal liability on all of the would-be

shareholders

i. On the theory that if the enterprise is not a corporation it

must be a partnership making all shareholders general

partnersii. Modern theory imposes personal liability only against those

owners who actively participated in the management of the

business

1. The owners that actively participated are held

personally reliable as if they were partners where

the others were passive investors which are not

liable

vi. McChesney, Doctrinal analysis and Statistical Modeling in law (1993) – pg. 281

1. Three requirements for application of the de facto corporation doctrine

a. A statute in existence by which incorporation was legally possible;

b. A “colorable” attempt to comply with the statute;

i. Note: an attempt to file the articles of incorporation has

frequently been sufficient as the necessary attempt as

statutory compliance even if it was not successful

c. [and] Some actual use or exercise of corporate privileges

d. Limited Liability and Its Exceptions

i. Introductory Note on Limited Liability

ii. Fletcher v. Atex, Inc. (1995) – pg. 283

1. Note: Courts have generally declined to find alter ego liability based on a

parent corporation’s use of a cash management system -- This case illustrates

the high burden a plaintiff must overcome to pierce the corporate veil.

iii. Walkovszky v. Carlton (1966) – pg. 289

1. Note on further proceedings in Walkovszky v. Carlton

iv. Minton v. Cavaney (1961) – pg. 294

v. Arnold v. Browne (1972) – pg. 296vi. Slottow Fidelity Federal Bank v. American Casualty Co. (1993) – pg. 297

vii. Radaszewski v. Telecom Corp. (1992) – pg. 297

1. The fact that a corp. does not have sufficient $ to pay claim doesn’t mean that

it’s undercapitalized. O/w, the only thing needed to pierce would be to make

claim in excess of corp’s capital. Also, where co purchases insurance to cover

liabilities, cannot pierce the veil on the ground that insurer later became

insolvent. (PIERCING THE VEIL FOR JURISDICTION PURPOSES.)

a. Generally, a person injured by the conduct of a corporation or one of

its employees can only look to the assets of the employee or of the

employer corporation for recovery. The shareholders of the

corporation (including a parent corporation) are not liable.

b. There is an exception where the law allows a plaintiff to pierce the veil

of the subsidiary to make a parent-shareholder liable. Under Missouri

law, in a tort case, you must show three things:

i. Control beyond stock control; i.e., complete domination of

finances, policy, and business practice, w/ regard to

transaction under attack so that the subsidiary had no mind

of its own;

ii. Control must be used by the Δ to commit a fraud or wrong of

some kind (i.e., there is a breach of a duty to plaintiff); and



36

iii. The control and breach of duty must proximately cause the

injury to the plaintiff

viii. Berkey v. Third Ave. Ry. Co. (1926) – pg. 298

ix. Note on Variations among States in applying the Piercing The Veil Doctrine

1. Although the tests announced by the courts for piercing the corporation veil

are often similar from state to state, the manner in which those tests are

applied may vary considerably across jurisdictionsx. Note on Direct Liability

1. Closely related to piecing-the-veil is parent-subsidiary context are cases in

which a parent is sought to be held directly liable as a primary wrongdoer, on

the ground that the parent directed the subsidiary’s operations, or some

relevant portion of those operations and wrongs were committed in the course

of those directed operations

e. Equitable Subordination of Shareholder Claims

i. Equitable Subordination

1. Under the doctrine of equitable subordination, when a corporation is in

bankruptcy, debt claims that a controlling shareholder has against the

corporation may be subordinated to the claims of other persons, including the

claims of preferred shareholders, on various equitable grounds

a. Doctrine of equitable subordination is often called “deep rock”

doctrine

ii. Comparison with Piercing

1. It simply takes an investment already made, and denies it the status of a

creditor’s claim on a parity with outside creditors, whereas imposing liability

for corporate debts undermines the essential premise of limited liability – that

a shareholder’s risk is limited to the amount of his investment

a. Courts find it fair to subordinate a controlling person’s claim based on

lesser evidence of misuse of the corporate form than what is required

to impose affirmative personal liability for all corporate obligations

IX. The Special Problems of Shareholders in Close Corporations

a. Introduction

i. Uniform Limited Liability Company Act1. § 101, 103, 201-203, 301-303, 404, 405, 408-409

a. Statutory Supplement pg. 67,69, 72, 74-77, & 79-81

ii. Corporations are divided into three classes

1. Publicly Held Corporations [typically have a large number of shareholders]

2. Private Corporations [shares are not publicly traded, although they may have

more than a small number of shareholders]

3. Close Corporations [a subset of private corporations

a. Have a small number of shareholders

b. Typically characterized by owner-management

c. Resemble partnerships and sometimes referred to as incorporated

partnerships

d. Legally viewed and treated a publicly held corporations rather than

partnerships

4. Note on legislative strategies toward the Close Corporation

i. Note: derived from Delaware, NY, and the Model Act

b. Unified Strategies

i. To make no special provisions for close corporations but to

modify traditional statutory norms so that they will meet the

needs of close corporations although applicable to publicly

held corporations as well.

c. The New York and the Model Act Strategies




37

i. To follow the unified approach up to a point but to add one

or two important provisions that are applicable only to those

corporations that satisfy certain criteria

1. I.e. allowing certain kinds of shareholder agreements

for close corporations that are not allowed in

publicly held corporations

d. Statutory Close Corporationsi. Follows the unified approach up to a point but adds an

integrated set of provisions that are explicitly made

applicable only to corporations that both satisfy certain

criteria and formally elect statutory close corporation status

ii. Significance of statutory close corporations

1. The data shows that only a tiny fraction of newly

formed corporations elect to become statutory close

corporations

e. Note on non-electing corporations

i. When a close corporation don’t opt in to be a statutory close

corporation does not prevent the courts from applying the

laws

b. Voting Arrangements at the Shareholder Level

i. Shareholder Voting Agreements

1. WHITEBOOK BCL §609 and §620

2. Ringling Bros-Barnum & Bailey Combined Shows v. Ringling (1947) – pg. 308

a. Where one party refuses to vote in accordance with an enforceable

agreement these votes should not be counted

3. Note on Shareholder Voting Agreements and Irrevocable Proxies

a. Contracts among shareholders concerning the manner in which their

shares will be voted (usually known as voting or pooling agreements)

are classified as one of two types

i. Type 1 – the parties agree in advance on the exact way in

which they will vote their share during the term of the

contractii. Type 2 – the parties do not agree in advance on the exact way

in which they will vote their shares but instead agree that

during the term of the contract they will vote their shares as

a unit, in a way to be decided by agreement, ballot, or other

means.

ii. Voting Trusts

1. WHITE BOOK BCL §617

2. In General

a. A voting trust is a device by which shareholders separate the voting

rights in, and the legal title to, their shares from the beneficial

ownership of the shares.

3. Validity

a. Majority of courts have declared voting trusts to be valid or held that

the plaintiff was not in a position to attack them

b. Statutes both explicitly validate voting trusts and regulate their

creation and their content

i. For example

1. Maximum time period (10 years)

2. Agreement must be filed with the corporation

4. Overlap of Voting Trusts and Shareholders’ Voting Agreements



38

a. Voting trusts may sometimes be used to allocate voting control in

other than a pro rata manner or to preserve the solidarity of a faction

consisting of less than all the shareholders.

iii. Classified Stock

1. WHITEBOOK BCL §617

2. Note

a. One of the most simplest and most effective ways of assuring that allthe participants or that particular minority shareholders will have

representation on the board of directors is to set up two or more

classes of stock, provide that each class is to vote for and elect a

specified number or a stated percentage of the directors and then

issue each class or a majority of shares in each class to a different

shareholder or faction of shareholders

c. Agreements Controlling Decisions that are within the Board’s Discretion

i. WHITEBOOK BCL §620, 715(b)

ii. McQuade v. Stoneham (1934) – pg. 320

1. Shareholders may not agree among themselves how they will act as directors in

managing the affairs of the corporation. Shareholders may not agree to control

the directors in the exercise of their independent judgment. Such agreements

violate public policy. S/Hs may combine to elect directors, but they must let the

directors manage the business, which includes election of officers.

a. Commentary. It’s OK to ally as S/Hs; but corp dirs. must oversee corp.

for benefit of S/Hs

iii. Clark v. Dodge (1936) – pg. 323

iv. Galler v. Galler (1964) – pg. 324

1. Where substantially all of the shareholders of a close corporation enter a

shareholders’ agreement that provides for actions to be taken by the

corporation, the court will sustain such an agreement although it deviates from

state corporation law practice.

a. Courts have allowed close corporations to deviate from corp. norms to

give bus. Effect to intentions of the parties. Here substantially all of

the shareholders of the corporation entered the agreement. Theagreement did not injure creditors, other shareholders, or the public.

The duration of the agreement is until the death of Π. This period is

not too long. The purpose of the agreement (maintenance of the

widow) is proper. The provision for a dividend is valid since a base

surplus is required to be maintained.

v. Adler v. Svingos (1981) – pg. 331

d. Supermajority Voting and Quorum Requirements at the Shareholder and Board Levels

i. WHITEBOOK BCL §608, 616-617, 705, 708, 709

ii. Sutton v. Sutton (1994) – pg. 332

e. Fiduciary Obligations and Shareholders in Close Corporations

i. Donahue v. Rodd Electrotype Co. (1975)—pg. 336

1. When the controlling majority of a close corporation causes the corporation to

purchase some of its shares from the controlling majority, it must offer this

same opportunity to the minority to sell a pro rata portion of its shares at an

identical price.

a. Freeze-outs by majority shareholders controlling close corporations

(majority withholds dividends or other corporate benefits from

minority shareholder, forcing her to sell at an inadequate price) are

illegal. In a close corporation, shareholders owe each other the same

strict fiduciary duty that partners do. This is a higher standard than




39

shareholders and directors in regular corporations owe to the

corporation in discharge of their duties.

ii. Rosenthal v. Rosenthal (1988) – pg. 343

iii. Wilkes v. Springside Nursing Home, Inc. (1976) – pg. 344

iv. Zimmerman v. Bogoff (1988) – pg. 350

v. Smith v. Atlantic Properties (1981) – pg. 350

vi. Merola v. Exergen Corp. (1996) – pg. 352f. Restrictions on the Transferability of the Shares and Mandatory Sale Provisions

i. FBI Farms, Inc. v. Moore (2003) – pg. 355

ii. Gallagher v. Lambert ()-- TWEN

g. Dissolution for Deadlock or Oppression

i. WHITEBOOK BCL §1001-02, 1104,1104-a, 1111, 1118

ii. Deadlock

1. Wollman v. Littman (1970) – pg. 371

2. Note on Dissolution for Deadlock

a. A number of statutes provide for involuntary dissolution on a showing

of deadlock. A few of the statutes define deadlock in terms of an

equally divided board or body of shareholders, but most are phrased

broadly enough to include deadlock brought about by super-majority

or veto arrangements

b. The deadlock statutes are generally interpreted to make dissolution

discretionary even when deadlock is shown to exist and the courts

have been reluctant to order dissolution of a profitable corporation on

the ground of deadlock

i. Profitability is not a bar to dissolution for deadlock

iii. Oppression and Mandatory Buy Out

1. Matter of Kemp & Beatley, Inc. (1984) – pg. 374

2. Meiselman v. Meiselman (1983) – pg. 380

3. Note on Evolving Expectations

a. In Meiselman, the court stated that what constitutes a shareholder’s

reasonable expectations can change over time

4. Note on Duties of Care and Loyalty in Close Corporationsa. Two legal safeguards for minority shareholders in publicly held

corporations are the duties of care and loyalty imposed by law on

corporate directors and officers

i. Normally provide insufficient protection in close corporations

5. McCallum v. Rosen’s Diversified, Inc. (1998) – pg. 384

6. Muellenberg v. Bikon Corp. (1996) – pg. 387

7. Kelley v. Axelsson (1997) – pg. 388

X. Limited Liability Companies

a. Introduction

i. Uniform Limited Liability Company Act §101, 103, 201-203, 301-303, 404, 405, 408-409

[Statutory Supplements pg. 67, 69, 72, 74-77, 79-81

ii. LLCs are non-corporate entities that are created under statutes that combine elements

of corporation and partnership law

1. Under corporate law, the owners “members” of LLCs have limited liability.

Under partnership law, an LLC has great freedom to structure its internal

governance by agreement

iii. Formalities; Articles of Organization; Powers

1. An LLC is formed by filing articles of organization in a designated state office

(usually the office of the secretary of state). The statutes all allow LLCs to be

formed by a single person



40

a. Articles include: Name of the business, the address of its prinicpal

place of business, name and address of its agent for service of process

i. Some require: the purpose of the LLC, if it’s going to be

manager-managed and if so the managers name, if it’s going

to be member-managed the name of the members, and the

duration of the LLC or the latest date on which it is to

dissolve,iv. Operating Agreements

1. An LLC articles of organization are usually very sketchy. The operating

agreement is an agreement among the LLCs members concerning the conduct

of its affairs

v. Management

1. Most statutes provide that the LLC is to be managed by its members. A few

statutes provide that unless otherwise agreed an LLC is to be managed by

managers who may need to be members

vi. Voting by Members

1. Just over half of the statutes provide that unless otherwise agreed, members

vote per capital (one vote per member)

2. The remaining statutes provide that unless otherwise agreed, members vote

pro rata (by financial interest)

3. Some statutes require a unanimous vote for certain actions

a. Such as an amendment of the articles or the operating agreement

vii. Authority

1. Member-Managed

a. Each member has power to bind the LLC for any act that is for

apparently carrying on the business in the usual way or ordinary

course

2. Manager-Managed

a. Only the managers have apparent authority to bind the firm

3. Delaware Statute

a. Unless otherwise provided each member and manager has the

authority to bind the LLCi. Must be provided in the company agreement otherwise

viii. Inspection of Books and Records

1. Statutes generally provide that members are entitled to access the books and

record

a. Many require a proper purpose

ix. Fiduciary Duties

1. Duties of managers and member is not specified in statutes

a. Some specify the duty of care elements ,

b. Some provide that a manager will be liable for gross negligence, bad

faith, recklessness, or equivalent conduct

x. Derivative Actions

1. Most of the statutes explicitly permit members of LLCs to bring derivative

actions on the LLCs behalf

2. Courts are likely to permit them even if a statute does not explicitly permit such

actions

xi. Distributions

1. Most LLC statutes that address the issue of distributions provide that unless

otherwise agreed, distributions to members are to be made pro rata according

to the members’ contributions

a. Absent an agreement distributions are to be made on a per capita

basis




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xii. Members’ Interests

1. A member has financial rights and may also have governance rights

a. Financial rights – include a right to receive distributions

b. Governance rights – to participate in management, to vote on certain

issues, and to be supplied with information

xiii. Liability

1. Provide that members and managers are not liable for LLC debts, obligations,and other liabilities

a. Members may become liable if the conditions for piercing the veil of

an LLC are satisfied

xiv. Dissociation

1. Statutes vary considerably in their treatment of dissociation (the termination of

a member’s interest in an LLC other than my the member’s voluntary transfer

of her interest)

b. Piercing the LLC Veil

i. Kaycee Land and Livestock v. Flahive (2002) – pg. 400

c. Fiduciary Duties

i. Salm v. Feldstein (2005) – pg. 405

ii. Vgs, Inc. v. Castiel (2000) – pg. 406

iii. Gatz Props. LLC v. Auriga Capital Corp. () -- TWEN

d. Dissolution

i. In the Matter of 1545 Ocean Avenue LLC () -- TWEN

XI. The Duty of Care and Duty to Act in Good Faith

i. WHITEBOOK BCL §402(b), 717, 719, 720

b. The Duty of Care

i. The Basic Standard of Care

1. Francis v. United Jersey Bank (1981) – pg. 420

2. Aronson v. Lewis (1984) – pg. 432

a. Where state law requires that demand on the directors be made prior

to bringing a shareholder’s derivative suit such a demand be excused

where it is futile: i.e.,

i. all directors were named as defendants and they participatedin the wrongs;

ii. Δ Fink picked and controlled all directors; and

iii. to bring this action, the defendant directors would have to

have the corporation sue themselves.

b. The test is: Based on the particularized facts alleged, is there a

reasonable doubt that (i) the directors were disinterested and

independent, and (ii) the challenged transaction was the product of a

valid exercise of business judgment.

c. A general claim that Fink controls the board and owns 47% of the

stock does not support a claim that the directors lack independence. P

must allege particularized facts showing the control and showing that

entering the contract was a breach of good faith or shows control.

d. A bare claim that defendants would have to sue themselves is also not

enough. Particular facts again must be alleged showing lack of director

independence or failure to adhere to standards of the business

judgment rule.

ii. The Business Judgment Rule

1. Kamin v. American Express Co. (1976) – pg. 433

2. Smith v. Van Gorkom (1985) – pg. 439

a. The business judgment rule presumes that directors act on an

informed basis, in good faith, and in an honest belief that their actions



42

are for the good of the company. Plaintiffs must rebut this

presumption. There is no fraud here, or bad faith. The issue is whether

the directors informed themselves properly. All reasonably material

information available must be looked at prior to a decision. This is a

duty of care. And the directors are liable if they were grossly negligent

in failing to inform themselves.

b. The directors were grossly negligent in the way they acted in the firstboard meeting that approved the merger: They did not know about

Van Gorkom’s role, and they did not gather information on the

intrinsic value of the company. Receiving a premium price over market

is not enough evidence of intrinsic value.

c. An outside opinion is not always necessary, but here there was not

even an opinion given by inside management. The Van Gorkom

opinion of value could be relied on had it been based on sound

factors; it was not and the board members did not check it. The post-

September market test of value was insufficient to confirm the

reasonableness of the board’s decision.

d. Although the 10 board members knew the company well and had

outstanding business experience, this was not enough to base a

finding that they reached an informed decision.

e. There is no real evidence of what the outside lawyer said, and as he

refused to testify, Ds cannot rely on the fact that they based their acts

on his opinion.

f. The actions taken by the board to review the proposal on October 9,

1980, and on January 26, 1981, did not cure the defects in the

September 20 meeting.

g. All directors take a unified position, so all are being treated the same

way.

h. The shareholder vote accepting the offer does not clear Ds because it

was not based on full information.

iii. The Duty to Monitor, Compliance Programs and Internal Controls

1. In re Caremark International Inc. Derivative Litigation (1996) – pg. 457a. Outcome: Settlement agreement approved on the ground that,

despite the weakness of plaintiffs’ claims against the defendants,

individual members of the corporation’s board of directors, the

settlement was an adequate, reasonable, and beneficial outcome for

all parties.

iv. Liability Shields

1. WHITEBOOK BCL § 726 – Statutory Supplement

2. Emerald Partners v. Berlin (1999) – pg. 470

3. Malpiede v. Townson (2001) – pg. 471




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c. Duty to Act in Good Faith

i. In re the Walt Disney Company Derivative Litigation (2006) – pg. 479

ii. Stone v. Ritter (2006) – pg. 484

XII. The Duty of Loyalty

a. Self Interest Transactions

i. Gantler v. Stephen (2009) – pg. 486

ii. Lewis v. SL & E, Inc. (1980) – pg. 496b. Statutory Approaches

i. WHITEBOOK BCL §713, 714

ii. Cookies Food Products v. Lakes Warehouse (1988) – pg. 513

c. Compensation and the Doctrine of Waste, and the Effect of Shareholder Ratification

i. WHITEBOOK BCL §202(a)(10),(13), §712(a)(3), §714, §720

ii. Compensation

1. Structure of executive compensation

2. Short term components of compensation

3. Long term components of compensation

4. Restricted stock

5. Stock options

6. Long term incentive plans

iii. Ryan v. Gifford (2007) – pg. 527

d. Corporate Opportunity Doctrine

i. Northeast Harbor Golf Club, Inc. v. Harris (1995) – pg. 537

ii. In re Ebay, Inc. Shareholders Litigation (2004) – pg. 552

e. Duties of Controlling Shareholders

i. WHITEBOOK BCL §903

ii. Zahn v. Transamerica Corporation (1947) – pg. 553

iii. Sinclair Oil Corporation v. Levien (1971) – pg. 561

1. Where there is self-dealing, the intrinsic fairness test must be applied, which

puts the burden on the majority shareholder to show that the transaction with

the subsidiary was objectively fair.

2. On the dividend issue there was no self-dealing (since the parent did not

receive something from the subsidiary to the exclusion or detriment of theminority shareholders; they shared pro rata in the dividend distributions). On

the expansion issue, D did not usurp any opportunities that would normally

have gone to the subsidiary. Thus, the business judgment rule applies; the

court will not disturb a transaction under this rule unless there is a showing of

gross overreaching, which there was not.

3. Note. This case is confused. The court should have decided on one standard to

apply in situations of transactions where the majority controls the corporation.

If the standard is the intrinsic unfairness test, then one element is self-dealing.

Where it is absent, there is no violation.

iv. Kahn v. Lynch Communication Systems, Inc. (1994) – pg. 567

v. In re Trados Inc. Shareholders Litigation (2009) – pg. 579

f. Sale of Control

i. Zetlin v. Hanson Holdings, Inc. (1979) – pg. 587

ii. Perlman v. Feldman (1955) – pg. 591 [Contrast with DeBaun v First Western Bank &

Trust Co]

1. A majority shareholder owes a duty to the minority shareholders to investigate

an individual and not to sell to him if they reasonably should know he will loot

the corporation.

a. Δ knew of Mattison’s numerous financial failures and that Mattison

could not meet his obligations to pay for the corporation without

using its assets.

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