Business Organizations- Rousseau

I. Introduction

A. Corporate Structure: 1. Profit Corporations

a.) Publicly Held Corporationsb.) “Closely-held” Corporations

2. Non-profit Corporations3. Public Corporations

a.) State-controlled public corporationsb.) Federally-controlled public corporations: (FDIC, Fanny May, etc…)

II. AGENCY LAWQui facit per alium, facit per se: He who acts through another acts himself.

A. Introduction:1. Agency law is designed to balance the rights and needs of persons in charge with those who work for them and with those who deal with those who work for them. The primary goal of Agency is efficient economic conduct. Agency law makes business more efficient; this division of labor allows everyone within the economic system to do what they do best. The drawback = interdependence.2. Agency Terms:

a.) Principals: the real or legal person(s) that governs and directs, and from whom the authority originates. The person acting or accomplishing some task with the assistance of another who consents to act for and on behalf of the person and subject to the person’s control. This person appoints the agent and gives the agent his authority, as well as controls the agent’s actions.

b.) Agents: the worker directed and controlled by the legal or real principal. This person accepts his agency from the principal and deals with the third party.

c.) Third Party: the person with whom the agent transacts business for the principal.NOTE: In privately owned businesses, a real person is often the principal, with all those working for and with the principal being his agents.3. Louisiana Agency Law: gradually, but certainly evolving toward common law agency principles.

a.) As of 1998, Louisiana no longer uses the term “agency.” Passed mandate laws. We call what is referred to everywhere else as agency, “representation.”

b.) La. C.C. Art. 2985; Representation.1

“A person may represent another person in legal relations as provided by law or juridical act. This is called representation.”

c.) La. C.C. Art. 2986; The authority of the representative.“ The authority of the representative may be conferred by law, by

contract, such as mandate or partnership, or by the unilateral juridical act of procuration.”

d.) La. C.C. Art. 2987; Procurations defined; person to whom addressed.

“A procuration is a unilateral juridical act by which a person, the principal, confers authority on another person, the representative, to represent the principal in legal relations.

The procuration may be addressed to the representative or to a person with whom the representative is authorized to represent the principal in legal relations.”

Not effective until the other person accepts. So, unilateral as used here just means simplistic.

e.) La. C.C. Art. 2988; Applicability of the rules of mandate.“A procuration is subject to the rules governing mandate to the

extent that the application of those rules is compatible with the nature of the procuration.”

f.) La. C.C. Art. 2989; Mandate defined.“A mandate is a contract by which a person, the principal, confers

authority on another person, the mandatary, to transact one or more affairs for the principal.”

Not called a representative because this term is used for procuration.

g.) The Principles of La. Representation:i. Principal is ALWAYS in control of the agent, regardless of a contract to the contrary.ii. Agency is always terminable at will. (with one exception) (also does not fit the general rules of contract). New law says that if the parties want the mandate to be irrevocable, they must agree and specify. We don’t know what the courts will do with this.iii. No recovery for termination of agency (also different from the general rules of contract where you get damages for breach).

h.) Agency Coupled with an Interest = “Mandate in rem suam”; these agreements are non-terminable and are exceptions to the general principle stated above.

i. Example: You tell your broker to buy stock. Broker is simply an agent,

you make the call and he buys for you. But, when you sign a margin

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agreement, the broker is a co-principal. The broker under a margin

agreement has the power to sell if you don’t meet the margin. This is an

example of agency coupled with an interest. (also called leverage).

4. Common Law Agency Principles: Restatement (2nd) of Agency § 7

a.) When an agent is acting accordance with the authority given by the principal, the agent is said to have the right to bind the principal.

i. third party can sue principal but not agent when the agent manifests his status.

b.) When the agent is acting without authority or even in direct contravention of instructions by the principal, and the law nevertheless imposes liability on the principal because of estoppel (Bekins case), apparent authority, unjust enrichment, detrimental reliance, the agent is said to have power to bind the principal.NOTE: The agent’s power to bind is broader than his right to bind the principal.

c.) Liability for undisclosed agency relationships: The third party can sue both the principal and the agent; while the principal can sue the third party even though his name was never mentioned by the agent in his transaction with the third party.

5.Types of Agency Arrangementsa.) With Actual Authority

i.) Expressed Authority: what the principal told the agent. There must be expressed authority when an act of

ownership is sought. Follows the “equal dignity rule”: If the document must be in writing, then the power of attorney must be in writing also. Some of these agreements must be in writing(land sales, mineral transactions, compromises), but not all.

ii.) Implied Authority: this authority is implied from a general grant of authority to the agent. This is real authority flowing directly from a grant of power by the principal to the agent. Art. 2995. Ex: I appoint you as my attorney. I don’t have to say that you have the authority to make motions and pleadings and conduct depositions. The powers that the attorney will undertake go under implied authority.

b.) Without authority, but the principal is still bound to the third party. The purposes of these doctrines are: (1.) Protection of the third party from the principal; (2.) Protection of the agent from a suit by the principal.

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i.) Apparent authorityii.) Estoppeliii.) Detrimental Reliance

(1) alternative theory to apparent authority(2) Breaux v. Schlumberg – third party recovers where an

agent without authority tells a third party that he has authority. But, a third party cannot always blindly rely upon the assertions of an agent. Focus is on what the agent said.

iv.) Inherent agency power(1) used where apparent authority is weak. (2) Criticized by commentators, but recognized by courts

v.) Emergency power:(1) example: guy who pulls in cotton from a fire wants to be

paidvi.) Unjust Enrichment and Negotiorum Gestio: in Louisiana, the elements are:

(1) no other remedy at law(2) one is enriched(3) one is harmed(4) example: lawyer is hurt in car wreck and a friend comes in and helps by filing briefs making motions, etc. The friend is not an agent because he is not appointed. Civil Code calls it mandate without authority.

6. Master; Servant; Independent Contractor.a.) Master: A master is a principal who employs an agent to perform services in his affairs and who controls or has the right to control the physical conduct of the other in the performance of the service.

i.) This is the concept behind “Respondeat Superior”: whereby the principal is responsible for the servant-agent’s torts.

b.) Servant: A servant is an agent employed by the master to perform service in his affairs whose physical conduct in the performance of the service is controlled or is subject to the control by the master. Note: a lawyer is a non-servant agent.c.) Independent Contractor: An Independent Contractor is a person who contracts with another to do something for him, but who is not controlled by the other not subject to the other’s right to control with respect to his physical conduct in the performance of the undertaking. He may or may not be an agent. An Independent Contractor relationship exists when:1. There’s a valid contract between the parties;2. The work being done is of an independent nature such that the contractor may employ non-exclusive means in accomplishing it;

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3. Contract calls for specific piecework as a unit to be done according to the I.R.’s own methods without being subject to the control of the P, except as to the result of the services to be done.4. There is a specific price for the overall undertaking; and5. Specific time duration is agreed upon & isn’t subject to termination at the will of either side without liability for breach.

Relationship: The agreement: Scope of Control:Agency: Principal/Agent The principal (P)

manifest consent that the agent (A) shall act on the P’s behalf. The A consents to act for P. Not necessary to have a contract.

The A is subject to the P’s control or right of control.

Master/Servant Employment by master of servant to perform services in master’s affairs. The Servant agrees; contract unnecessary.

The servant is subject to the master’s control or right of control of physical conduct or performance.

P / Indep. Contractor P contracts with I.R., who contractually agrees to do something for P.

I.R. is subject to P’s control but not subject to P’s control of physical conduct of performance.

Non-agency: Owner or employer/ I.R. Owner or employer contracts with I.R., who contractually agrees to do something specific for employer or owner.

I.R. is not subject to employer or owner’s control: contract provisions are determinative.

7. Disclosed; Partially disclosed; Undisclosed Principals:a.) If, at the time of a transaction conducted by an agent, the other party thereto has notice that the agent is acting for a principal and of the principal’s identity, the principal is a disclosed principal.

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b.) If the other party has notice that the agent is or may be acting for a principal but has no notice of the principal’s identity, the principal for whom the agent is acting is a partially disclosed principal.c.) If the other party has no notice that the agent is acting for a principal, the one for whom he acts is an undisclosed principal.

i.) NOTE: The undisclosed P is liable when he authorized A to act or when it is within the scope of the Agent’s employment. The undisclosed P can sue the third party; while the third party can sue the undisclosed P and the agent.

8. Agency relationships distinguished from other relationships.Agency is the fiduciary relationship created by mutual consent of

principal and agent in which the agent agrees to action primarily on behalf of and for the benefit of the principal subject to the principal’s control.a.) Party providing benefit is a fiduciary but isn’t subject to control:

i.) Trustee – Beneficiaryii.) Administrator (Executor) – Heirsiii.) Tutor – Minoriv.) Corporate Director – Corporation

b.) Party providing benefits isn’t a fiduciary & isn’t subject to control:i.) Lessor – Lessee

Control is the determining factor for determining if an agency agreement exists between parties who generally are not considered to be in that relationship.

ii.) Bailor – Baileeiii.) Creditor – Debtor

A controlling creditor runs risks of becoming a principal. See Cargill, 309 N.W.2d 285.

iv.) Escrow Holder – Parties to the escrow agreementv.) Sellers – Buyers

9. Agency Relationship defined: “the fiduciary relation which results from the manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and consent by the other so to act.” §1.

a.) Three elements of Agency: (agency law is sui generis).i.) Consent of the Principal and Agentii.) Control of the Agent by the Principaliii.) Agent’s action on behalf of the principal

b.) Agency is consensual, but it is not contractual in essence. Rousseau: The relationship of principal and agent doesn’t fit neatly into a contractual relationship.c.) Control of the agent by the principal.

i.) Principal must exert some meaningful control over the agent; but the control need not be all embracing or present at each moment.

ii.) As between the P and the A, the A’s consent to the P’s control is an essential element.

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ii.) From an evidentiary point of view, control can be used to prove the existence of an agency relationship where it has not been formally pronounced.d.) Agent’s acting on behalf of the Principal:

i.) LSA CC Art. 2991; Interest served.The contract of mandate may serve the exclusive or the

common interest of the principal, the mandatary, or a third person.10. Distinctive Doctrines:

a.) Vicarious Tort Liability of the Principal: Respondeat Superiori.) Urbeso v. Bryan (La. 4th Cir.1991) Facts: alleged that the sheriff was vicariously liable because

Bryan towed vehicles as an employee/agent for the Sheriff’s Office. also alleged that the sheriff was negligent because he permitted his agent to be uninsured. The sheriff chose Bryan’s company to do its towing; they had to answer when the sheriff requested a tow; the sheriff’s office determined the charges imposed for towing; the sheriff determined the location to which the towed vehicle was to be towed. The sheriff argued that the contract said that Bryan was an IR; Bryan handled all of the “hook-up” details on the job; social security was not withheld from his checks; Bryan owned the tow-truck, not the sheriff.

Holding: Remanded to the lower courts, finding that summary judgment was inappropriate and Bryan might be an agent for the sheriff, who may be liable for Bryan.

b.) Apparent Authority: An equitable doctrine under which the principal is liable to good faith third parties for the unauthorized acts of an agent under circumstances in which the principal has made a sufficient manifestation or indication that the agent does have authority upon which the third party can reasonably rely.

i.) For the doctrine of apparent authority to apply:1. The apparent principal must act to manifest the agent’s ostensible authority to an innocent third party.2. The manifestation must reach the third party.3. The third party must be reasonably caused to believe that the apparent principal has authorized the agent to act for her/him.4. The third party is thus caused to act or not act to his/her detriment.

ii.) Generally, the Civil law does not subscribe to the doctrine of apparent authority, but Louisiana has cases that reference apparent authority, and rely on it to resolve disputes. iii.) Rousseau Question: Where does La. get apparent authority from? Article 3021 captures apparent authority. Basically the same as common law.

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iv.) Sometimes there is a duty for the third party to inquire into the agent’s authority, but it is a fact sensitive determination.

A. What happens when you don’t have actual authority, but the agent does something & the third party thinks the principal is responsible?

1. Ratification = “affirmance by person of prior act did not bind him but was done or professedly done on his account, whereby the act, as some or all persons is given effect as if originally authorized by him.” Found in thirty articles in the restatement of agency (82-104).

a. This applies if the principal likes what the agent has done.b. In order to ratify, the agent must have been a true agent.c. Failure to repudiate may manifest the consent of the Principal to be a

party to the transaction and retention of benefits can constitute affirmance.2. Elements of Ratification:

a. There must be some unauthorized act by someone purporting to act as the principal’s agent.

b. At the time of the unauthorized act the principal must have existed with capacity to act.

c. The principal must objectively affirm (consent) the unauthorized act, based on full knowledge of the facts pertaining thereto.

i. The principal must accept the whole deal.ii. The acceptance must take place before the third party withdraws

the offer.3. Effects of Ratification

a. Liability of the principal and the third party to the contract, or the principal’s liability for the agent’s tort or act.

b. The liability dates back to the time of the original unauthorized act of the agent, Except:

i. When the situation has so materially changed that it would be inequitable to hold the third party accountable; or

ii. When rights of other parties would be affected because the third party has taken action without knowing of ratification.

c. The agent, upon ratification, is neither liable to the principal nor is the agent liable to the third party.

i. However, if the principal ratifies the agent’s tort or wrongful act the agent is not liable to the principal but remains liable in tort to an injured third party.

d. Ex: Stock broker is told to buy 1,000 shares. Broker buys 10,000. If buyer waits to see how it does, then the stock goes well, then tells the broker that he ratifies. There are two theories that try to bring in equity:

i. if there is a changed circumstance, the third party can refuse. ii. It can be seen as a counter offer.

e. ratification is actual authority.

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B. What happens when the agent acts without authority & the principal doesn’t want to ratify, but the court uses a legal doctrine to hold the principal responsible- Power to bind by operation of law.

NOTE: Agency power is the power to bind the principal even though the agent has no right to bind because of lack of authority or ratification.

Apparent Authority = Legal responsibility of the principal because he has made some manifestation which put the agent in the position to induce third parties to believe and reasonably rely upon the agent’s authority to act, even where such authority does not exist. (See La. C.C. Art. 3021).

Interstate Electric Co. v. Frank Adam Electric Co. Facts: The manufacturer (P) had a long-standing agreement with a regional distributor (A1) under which A1 would accept orders on behalf of P from third parties. Then P fired A1 and hired a new agent (A2), and told the new agent that he must submit all orders to P for approval and P would then accept orders in direct dealing with the third party. A2 chose to accept without submitting the third party’s offer to the P, and the P later rejected the offer.Issue: Whether the P is bound by A2’s actions in derogation of their agreement?Holding: Yes; The P should have notified the third party that there was no longer authority for the agent to accept orders without P approval. Because of the past course of dealing and conduct between the parties, the P was responsible for the new A’s actions with the third party.

Boulos v. Morrison (La. 1987) Facts: Plaintiffs dealt with Mike at a store. Mike failed to deliver on the deal and the plaintiffs sued the store on the theory that Mike was an agent of the store. The owner and the manager testified that Mike was not an employee, but was just “hangin’ around” the store. Mike was not allowed to go behind the counter, operate the cash register, or write up an official sales slip. Mike was simply paid a 5% commission for any business he brought to the store. He was not authorized to have a business card, and the fact that he had one was denied by the defendants. The plaintiffs were “sophisticated” business people who had dealt in jewelry sales before.Issue: Whether plaintiffs carried their burden of proving that Mike had apparent authority, on which they reasonably relied, to act on behalf of the store?Holding: No; under the “clearly erroneous” standard applicable when reviewing a trial court’s factual findings, the plaintiffs have not met their burden.Rationale: (1.) The plaintiffs failed to prove that the actions of the owner and manager manifested an intent to make Mike an agent. (2.) The facts and circumstances should have caused the plaintiffs to question Mike’s authority and good faith. (3.) The crucial factor is plaintiffs’ failure to prove that they reasonably relied upon Mike’s purported authority.

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Rule: a third party has the duty to inquire into the nature and extent of an agent’s power.

Independent Fire Insurance Co. v. Able Moving and Storage Co. (La. 1995)Facts: Mary Hebert planned to move some furniture. She looked in the telephone directory and saw a familiar name, Bekins. The ad was designated and purchased by Bekins. At the bottom of the add, printed in small type, was the name Able Moving and Storage. Mary could not read the small print and thought the entire add was for Bekins. When she called the number, nothing indicated that she had reached Able’s office. She made the check out and it was endorsed to Bekins. When the movers got there, their shirts, caps, and vans said Bekins. One of the movers lit a cigarette and caught her house on fire. When Hebert sued Bekins, she found out that Able went bankrupt. Bekins had interstate moving authority and Able had only intrastate. Issue: Can a national moving company have liability for a fire caused by its insolvent agent?Holding: Mary Hebert reasonably believed she was dealing with Bekins rather than Able, creating liability under the doctrine of apparent authority. Rationale: Bekins and Able had a full service agency contract. This is one type of mandate in Art. 2986. court looked to § 8 of the Restatement of Agency which defines apparent authority as the power to affect the legal relations of another person by transactions with third persons, professedly as agent for the other, arising from and in accordance with the other’s manifestations to such third persons. Here, Able had actual authority from Bekins, and also had apparent authority manifested by Bekins’s advertising and Able’s use of Bekins’s name. When the apparent scope of an agent’s authority is relied upon by innocent third persons to their detriment, the principal is liable. Here, the principal published and paid for an advertisement which gave the erroneous impressions that third parties actually dealing with Able were dealing with Bekins.

1. In summary, apparent authority requires two things:a. a representation by the principal and b. detrimental reliance by a third party.

2. Distinguished from Boulos because there, the Ps did not convince the trial court that the principals manifested apparent authority to their claimed agent or that Ps reasonably relied on that purported authority.

3. See notes in supplement page 112.

Title XV: Representation and Mandate.

CHAPTER 1. REPRESENTATION

La. C.C. Art. 2985: Representation.A person may represent another person in legal relations as provided by law or by juridical act.

This is called representation.

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Comments:Representation is used to convey the same meaning as the word “agency” in

common law systems.

La. C.C. Art. 2986: The authority of the representative.The authority of the representative may be conferred (1) by law, (2) by contract, such as

mandate or partnership, or (3) by the unilateral juridical act of procuration.Comments:

The word “mandate” applies exclusively to contracts of mandate whereby a person called principal, authorizes another person, called mandatary, to transact an affair on behalf of the principal.

La. C.C. Art. 2987: Procuration defined; person to whom addressed.A procuration is a unilateral juridical act by which a person, the principal, confers

authority on another person, the representative, to represent the principal in legal relations.

The procuration may be addressed to the representative or to a person with whom the representative is authorized to represent the principal in legal relations.Comments:

The civilian term “procuration” is used instead of the colloquial term “power of attorney,” which is a common law term of art.

A procuration is a unilateral juridical act that confers on the representative authority to represent the principal in legal relations. It differs from a contract of mandate which is a “contract” that confers on the mandatory authority to transact one or more affairs for the principal.

The procuration is not required to be in a particular form. Nevertheless, where the law prescribes a certain form for the authorized act, a procuration authorizing the act must be in the same form.

La. C.C. Art. 2988: Applicability of the rules of mandate.A procuration is subject to the rules governing mandate to the extent that the

application of those rules is compatible with the nature of the procuration.

CHAPTER 2. MANDATE

Section One: General Principles

La. C.C. Art. 2989: Mandate defined.A mandate is a contract by which a person, the principal, confers authority on

another person, the mandatary, to transact one or more affairs for the principal.Comments:

A mandate is a contract; a procuration is a unilateral juridical act.1) Common law says, however, that agency is not a contract.

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2) Contract law really only governs the contract of hire.

La. C.C. Art. 2990: Applicability of the rules governing obligations.In all matters for which no special provision is made in this Title, the contract of

mandate is governed by the Titles of "Obligations in General" and "Conventional Obligations or Contracts."

La. C.C. Art. 2991: Interest Served.The contract of mandate may serve the exclusive or the common interest of the

principal, the mandatary, or a third person.

La. C.C. Art. 2992: Onerous or gratuitous contract.The contract of mandate may be either onerous or gratuitous. It is gratuitous in

the absence of contrary agreement.

La. C.C. Art. 2993: Form.The contract of mandate is not required to be in any particular form.

Nevertheless, when the law prescribes a certain form for an act, a mandate authorizing the act must be in that form.Comments:

Ex: The law requires that a donation be made by authentic act. Therefore, a mandate authorizing the mandatory to made a donation must be made by authentic act.

La. C.C. Art. 2994: General Authority.The principal may confer on the mandatary general authority to do whatever is

appropriate under the circumstances.1) This is implied authority in Louisiana

La. C.C. Art. 2995: Incidental, necessary, or professional acts.The mandatary may perform all acts that are incidental to or necessary for the

performance of the mandate.The authority granted to a mandatary to perform an act that is an ordinary part of

his profession or calling, or an act that follows from the nature of his profession or calling, need not be specified.

La. C.C. Art. 2996: Authority to alienate, acquire, encumber, or lease.The authority to alienate, acquire, encumber, or lease a thing must be given

expressly. Neither the property nor its location need be specifically described.

La. C.C. Art. 2997: Express authority required.Authority also must be given expressly to:

(1) Make an inter vivos donation.(2) Accept or renounce a succession.(3) Contract a loan, acknowledge or make remission of a debt, or become a surety.

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(4) Draw or endorse promissory notes and negotiable instruments.(5) Enter into a compromise or refer a matter to arbitration.(6) Make health care decisions, such as surgery, medical expenses, nursing home residency, and medication.

a. Ex: If the contract of mandate states, “you shall be the manager of our store,” this is actual authority. Also implied authority because he had the right to buy and sell specific goods. But, if the manager goes to the bank and tries to borrow money to buy the merchandise, they cannot do this because it requires express authority.

La. C.C. Art. 2998: Contracting with one’s self.A mandatary who represents the principal as the other contracting party may not

contract with himself unless he is authorized by the principal, or, in making such contract, he is merely fulfilling a duty to the principal.

La. C.C. Art. 2999: Person of limited capacity.A person of limited capacity may act as a mandatary for matters for which he is

capable of contracting. In such a case, the rights of the principal against the mandatary are subject to the rules governing the obligations of persons of limited capacity.

La. C.C. Art. 3000: Mandatary of both parties.A person may be the mandatary of two or more parties, such as a buyer and a

seller, for the purpose of transacting one or more affairs involving all of them. In such a case, the mandatary must disclose to each party that he also represents the other.

Section Two: Relations between the Principal and the Mandatary.

La. C.C. Art. 3001: Mandatary’s duty of performance; standard of care.The mandatary is bound to fulfill with prudence and diligence the mandate he has

accepted. He is responsible to the principal for the loss that the principal sustains as a result of the mandatary's failure to perform.

La. C.C. Art. 3002: Gratuitous mandate; liability of a mandatary.When the mandate is gratuitous, the court may reduce the amount of loss for

which the mandatary is liable.

La. C.C. Art. 3003: Obligation to provide information.At the request of the principal, or when the circumstances so require, the

mandatary is bound to provide information and render an account of his performance of the mandate. The mandatary is bound to notify the principal, without delay, of the fulfillment of the mandate.

La. C.C. Art. 3004: Obligation to deliver; right of retention.

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The mandatary is bound to deliver to the principal everything he received by virtue of the mandate, including things he received unduly.

The mandatary may retain in his possession sufficient property of the principal to pay the mandatary's expenses and remuneration.

La. C.C. Art. 3005: Interest on money used by mandatary.The mandatary owes interest, from the date used, on sums of money of the

principal that the mandatary applies to his own use.

La. C.C. Art. 3006: Fulfillment of the mandate by the mandatary.In the absence of contrary agreement, the mandatary is bound to fulfill the

mandate himself.Nevertheless, if the interests of the principal so require, when unforeseen

circumstances prevent the mandatary from performing his duties and he is unable to communicate with the principal, the mandatary may appoint a substitute.

La. C.C. Art. 3007: Mandatary’s liability for acts of the substitute.When the mandatary is authorized to appoint a substitute, he is answerable to

the principal for the acts of the substitute only if he fails to exercise diligence in selecting the substitute or in giving instructions.

When not authorized to appoint a substitute, the mandatary is answerable to the principal for the acts of the substitute as if the mandatary had performed the mandate himself.

In all cases, the principal has recourse against the substitute.

La. C.C. Art. 3008: Liability for acts beyond authority; ratification.If the mandatary exceeds his authority, he is answerable to the principal for

resulting loss that the principal sustains.The principal is not answerable to the mandatary for loss that the mandatary

sustains because of acts that exceed his authority unless the principal ratifies those acts.

La. C.C. Art. 3009: Liability of multiple mandataries.Multiple mandataries are not solidarily liable to their common principal, unless the

mandate provides otherwise. La. C.C. Art. 3010: Performance of obligations contracted by the mandatary.

The principal is bound to the mandatary to perform the obligations that the mandatary contracted within the limits of his authority. The principal is also bound to the mandatary for obligations contracted by the mandatary after the termination of the mandate if at the time of contracting the mandatary did not know that the mandate had terminated.

The principal is not bound to the mandatary to perform the obligations that the mandatary contracted which exceed the limits of the mandatary's authority unless the

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principal ratifies those acts.

La. C.C. Art. 3011: Advantageous performance despite divergence from authorityThe mandatary acts within the limits of his authority even when he fulfills his

duties in a manner more advantageous to the principal than was authorized.

La. C.C. Art. 3012: Reimbursement of expenses and remuneration.The principal is bound to reimburse the mandatary for the expenses and charges

he has incurred and to pay him the remuneration to which he is entitled.The principal is bound to reimburse and pay the mandatary even though without

the mandatary's fault the purpose of the mandate was not accomplished.Comment:

Indeed, the mandatary may be entitled to remuneration not only under the terms of the mandate, but also in accordance with usages, customary law, or even under the law of enrichment without cause.

La. C.C. Art. 3013: Compensation for loss sustained by the mandatary.The principal is bound to compensate the mandatary for loss the mandatary

sustains as a result of the mandate, but not for loss caused by the fault of the mandatary.

La. C.C. Art. 3014: Interest on sums expended by the mandatary.The principal owes interest from the date of the expenditure on sums expended

by the mandatary in performance of the mandate.

La. C.C. Art. 3015: Liability of several principals.Multiple principals for an affair common to them are solidarily bound to their

mandatary. Section Three: Relations between the Principal, Mandatary, and Third Persons.

Subsection A: Relations between the Mandatary and Third Persons.

La. C.C. Art. 3016: Disclosed mandate and principle.A mandatary who contracts in the name of the principal within the limits of his

authority does not bind himself personally for the performance of the contract.Comments:

When a mandatary enters into a contract with a third person in the name of a principal and within the limits of his authority, the contract binds the principal to the third person and the third person to the principal. The mandatary does not bind himself personally

La. C.C. Art. 3017: Undisclosed mandate. A mandatary who contracts in his own name without disclosing his status as a

mandatary binds himself personally for the performance of the contract.

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La. C.C. Art. 3018: Disclosed mandate; undisclosed principal.A mandatary who enters into a contract and discloses his status as a mandatary,

though not his principal, binds himself personally for the performance of the contract. The mandatary ceases to be bound when the principal is disclosed.

La. C.C. Art. 3019: Liability when authority is exceeded.A mandatary who exceeds his authority is personally bound to the third person

with whom he contracts, unless that person knew at the time the contract was made that the mandatary had exceeded his authority or unless the principal ratifies the contract.

Subsection B: Relations between the Principal and Third Persons.

La. C.C. Art. 3020: Obligations of the principal to third persons.The principal is bound to perform the contract that the mandatary, acting within

the limits of his authority, makes with a third person.

La. C.C. Art. 3021: Putative Mandatary.One who causes a third person to believe that another person is his mandatary is

bound to the third person who in good faith contracts with the putative mandatary.

La. C.C. Art. 3022: Disclosed mandate or principal; third person bound.A third person with whom a mandatary contracts in the name of the principal, or

in his own name as mandatary, is bound to the principal for the performance of the contract.

La. C.C. Art. 3023: Undisclosed mandate of principal; obligations of third party.A third person with whom a mandatary contracts without disclosing his status or

the identity of the principal is bound to the principal for the performance of the contract unless the obligation is strictly personal or the right non- assignable. The third person may raise all defenses that may be asserted against the mandatary or the principal.Comments:

An undisclosed principal may demand performance of the contract from the third party with whom the mandatary contracted unless the obligation is strictly personal or the right unassignable.

Section Four: Termination of Mandate and of authority of the Mandatary.

La. C.C. Art. 3024: Termination of the mandate and the mandate’s authority.In addition to causes of termination of contracts under the Titles governing

"Obligations in General" and "Conventional Obligations or Contracts," both the mandate and the authority of the mandatary terminate upon the:

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(1) Death of the principal or of the mandatary.(2) Interdiction of the mandatary.(3) Qualification of the curator after the interdiction of the principal.

The curator must be appointed after a principal is interdicted, but before the mandate is terminated.

La. C.C. Art. 3025: Termination by the principal.The principal may terminate the mandate and the authority of the mandatary at

any time. A mandate in the interest of the principal, and also of the mandatary or of a third party, may be irrevocable, if the parties so agree, for as long as the object of the contract may require.

This flies in the face of all agency law. At common law, agency was terminable at will because it is a fiduciary relationship. A principal should not be bound to keep the agent or vice versa if the parties lose faith in the other. The only exception was agency coupled with an interest.

La. C.C. Art. 3026: Incapacity of the principal.In the absence of contrary agreement, neither the contract nor the authority of

the mandatary is terminated by the principal's incapacity, disability, or other condition that makes an express revocation of the mandate impossible or impractical.

La. C.C. Art. 3027: Reliance on public records.Until filed for recordation, a revocation or modification of a recorded mandate is

ineffective as to the persons entitled to rely upon the public records. McDuffie v. Walker.

La. C.C. Art. 3028: Rights of third persons without notice of revocation.The principal must notify third persons with whom the mandatary was authorized

to contract of the revocation of the mandate or of the mandatary's authority. If the principal fails to do so, he is bound to perform the obligations that the mandatary has undertaken.

La. C.C. Art. 3029: Termination by the mandatary.The mandate and the authority of the mandatary terminate when he notifies the

principal of his resignation or renunciation of his authority. Comments:

This provision is applicable even if a mandate is given for a specified period of time.

In the case of a gratuitous mandate, the court may reduce the amount of loss for which the mandatary is liable.

La. C.C. Art. 3030: Acts of the mandatary after the principal’s death.The mandatary is bound to complete an undertaking he had commenced at the

time of the principal's death if delay would cause injury.

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This is contrary to common law which holds that death terminates mandate.

La. C.C. Art. 3031: Contracts made after termination of the mandate’s authority.If the mandatary does not know that the mandate or his authority has terminated

and enters into a contract with a third person who is in good faith, the contract is enforceable.

La. C.C. Art. 3032: Obligation to account.Upon termination of the mandate, unless this obligation has been expressly

dispensed with, the mandatary is bound to account for his performance to the principal.

Tedesco Case (La. 1995) (distinction between apparent authority and estoppel)Facts: Bank with five lots hired real estate agent sell lot numbers 2 and 3. President authorized agents in writing to sell lots 4 and 5. The agent sold these lots, yet the board of directors of the bank said that they never authorized the sale. Ps demanded specific performance.Issue: Whether the doctrine of apparent authority is applicable in a case involving a contract to sell immovable property.Holding: The court held that apparent authority does not apply to real estate sales. Agency by estoppel applies if the third party changed position. Rationale: Court recognizes that apparent authority is not expressly provided for by La. code or statutes, but it is an important concept to the law of agency. Apparent authority operates only when it is reasonable to believe the agent is authorized and the third person actually believes this. Agency by estoppel is based on tort principles of preventing loss by an innocent person. The third person not only must show reliance on the conduct of the principal, but also must show such a change of position on his part that it would be unjust to allow the principal to deny the agency. Just as testimonial proof cannot be used to prove the sale of immovable property (or the agreement to sell such property), testimonial proof cannot be used to prove the agent's authority to execute the contract, whether that authority was actual or apparent. Nevertheless, the principal may be estopped from asserting the defense of lack of written authority if the third person can show a change of position in reliance on the representation.

Here, Ps cannot recover under apparent authority because the principal gave no written authorization to sell. Ps cannot recover under estoppel because they did not change their position.

III. MAJOR TYPES OF BUSINESS ASSOCIATIONS

Agency law goes through all types of businesses. To decide which form of business to use, get a team consisting of attorney, CPA, bank officer, insurance agent, to determine the best course for your client. For each business, know mandatory rules, default rules, and what rules can be contracted to.

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OUTLINE OF BUSINESS ISSUES TO KEEP IN MIND

1. What kind of entity2. Name and form problems

a. example of name problem: cannot include the name of a limited partner in the partnership name.

b. example of form problem: not filing limited partnership with Secretary of State3. Law (what is the default rule)4. The agreement5. Ownership and Control Issues6. Sharing of profits7. Sharing of losses8. Capital Investment9. Creditor’s Rights

a. Example: a creditor has no right to hold membership in an LLC10. Information Rights

a. Example: does a partner have the right to information, does the principal11. Fiduciary Duties12. Sale of Interests

a. Example: in a closely held corporation, may have to offer your interest to the other shareholders first.

13. Causes of Cessationa. How do you get out?b. What are the effects?

14. Termination15. Winding Up

A. Sole Proprietorships 1. Easiest to form2. Least government intervention3. Need:

a. License from cityb. File with the IRS to get FICAc. File with Department of Labor

4. No separate tax return5. Personal liability for debts.6. Death, retirement, bankruptcy of owner may terminate it.

B. Ordinary Partnerships1. In LA, a juridical person, separate and distinct from its partners.

Elements:a. Created by contract between two or more persons.b. to combine resources or effortsc. determined proportionsd. collaborate

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e. mutual risk (time or money)f. for profits

2. Continues to exist even if there is a complete change in the persons of the partnership by substitution of new partners.

3. History under common law: see outline page 62 for complete comparison of the three.a. UPA (Uniform Partnership Act)

1) No entity2) But, recognizes that the partnership has assets that should

be used to pay partnership creditors before individual creditors. Called tenancy and partnership.

b. RUPA (Revised Uniform Partnership Act)1) Adopted by ½ of states2) Juridical person theory, same as LA

4. In all partnerships, there is personal liability.C. Limited Partnerships (Partnership in Commendam) – an entity consisting of

one or more general partners who have the rights, powers, and obligations of partners, and one or more partners in commendam who have no personal liability beyond the amount contributed to or agreed to be contributed to the partnership.1. Limited liability of a partner depends upon:

a. filing for registry with the Secretary of State the articles which set out the partner’s limited liability status. Failure to properly comply means that partner loses limited partner status.1) Unlike the Registered LLP, this entity only pays the filing fee once.

b. Limited partner also loses status if he participates in the management or control of the ordinary affairs of the business.

c. Partner loses limited status if he holds himself out as a general partner and the person transacting business reasonably believed that the limited partner was a general partner.1) If the limited partner allows his name to used in the business

as if a general partner, a third party does not have to show specific proof of reliance to recover.

2. Flow through entity for tax purposes3. Contract must be in writing.

D. Registered Limited Liability Partnerships1. If the proper registration requirements with the Secretary of State are

followed, along with a filing fee of $100 per year, the partners are not individually liable for the liabilities or obligations of the partnership entity arising from errors, omissions, negligence, incompetence, malfeasance, or willful or inadvertent misconduct committed in the course of the business by another partner, agent, or representative of the partnership. La. Rev. Stat. 9:3431.

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a. Filing requirements: application stating name of partnership, address of principal office, number of partners, and brief statement of the type of business. Registration valid for one year. § 3432.

b. the name shall contain the words “registered limited liability partnership” or the abbreviation LLP. §3433

2. Partners remain individually liable for their virile share of all other types of debts of the partnership such as contracts, contractual warranties, etc. Id.

3. Each partner is personally liable for his own torts4. A flow through entity for tax purposes

E. Limited Liability Companies1. Limited liability of the members, like a corporation

a. no personal liability for any debt, in tort, contract, or otherwise1) Unlike the registered LLP, members of the LLC do not have

personal liability for contract debt by heads.b. Members are personally liable for their own torts or personal

guarantees.2. Less formal internal structure, like a partnership3. Does not pay tax at the entity level, like a partnership. Income flows

through to members. “Check the box” provisions4. Need two documents:

a. articles of organization1) name2) Purpose (or the “any lawful business purpose” clause)3) Fee 4) More information can be included, but not madatory

b. Initial report1) address of the registered office2) name and addresses of registered agents3) name and addresses of those who will manage the LLC’s

business4) affidavit of acknowledgement and acceptance signed by

each registered agent of the LLC.5. Members may elect to have an operating agreement (this is optional though)

a. Not filedb. but, default rules will apply without it.c. can be oral

F. “S” Corporations 1. designed for the small company2. limited number of shareholders (75)3. Only one class of shares4. Non-resident alien cannot be a shareholder5. Special rules for undistributed profits6. no taxation at entity level, flow through entity 7. File with Secretary of State

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a. articles of incorporationb. initial reportc. affidavit signed by the agent for service of process accepting

appointment as a registered agent.G. “C” Corporations

IV. LOUISIANA PARTNERSHIP LAW (La. CC Arts. 2801- 44; 3431- 35; & 3401 – 08)A. LA C.C. Art. 2801: A partnership is a juridical person, distinct from its partners,

created by a contract between two or more persons to combine their efforts or resources in determined proportions and to collaborate at mutual risk for their common profit or commercial benefit.

Trustees and succession representatives, in their capacities as such, and unincorporated associations may be partners.Comments:

Serious implications to the juridical person distinction: for instance, if you sue the partners but not the partnership, your suit will be dismissed.

The contract does not have to be in writing unless the partnership owns real property.

LA C.C. Art. 2802: The contract of partnership is governed by the provisions in the Title: Of Conventional Obligations, in all matters that are not otherwise provided for by this Title.

LA C.C. Art. 2803: Each partner participates equally in profits, commercial benefits, and losses of the partnership, unless the partners have agreed otherwise. The same rule applies to the distribution of assets, but in the absence of contrary agreement, contributions to capital are restored to each partner according to the contribution made. (Default rule).

LA C.C. Art. 2804: If a partnership agreement establishes the extent of participation by partners in only one category of either profits, commercial benefits, losses, or the distribution of assets other than capital contributions, partners participate to that extent in each category unless the agreement itself or the nature of the participation indicates the partners intended otherwise.

LA C.C. Art. 2805: A partnership may adopt a name with or without the inclusion of the names of any of the partners. If no name is adopted, the business must be conducted in the name of all the partners

LA C.C. Art. 2806: An immovable acquired in the name of a partnership is owned by the partnership if, at the time of acquisition, the contract of partnership was in writing. If the contract of partnership was not in writing at the time of acquisition, the immovable is owned by the partners.

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As to third parties, the individual partners shall be deemed to own immovable property acquired in the name of the partnership until the contract of partnership is filed for registry with the Secretary of State as provided by law.

LA C.C. Art. 2807: Unless otherwise agreed, unanimity is required to amend the partnership agreement, to admit new partners, to terminate the partnership, or to permit a partner to withdraw without just cause if the partnership has been constituted for a term.

Decisions affecting the management or operation of a partnership must be made by a majority of the partners, but the parties may stipulate otherwise.

LA C.C. Art. 2808: Each partner owes the partnership all that he has agreed to contribute to it. If they don’t pay, the partnership or a creditor can bring suit.

LA C.C. Art. 2809: A partner owes a fiduciary duty to the partnership and to his partners. He may not conduct any activity, for himself or on behalf of a third person, that is contrary to his fiduciary duty and is prejudicial to the partnership. If he does so, he must account to the partnership and to his partners for the resulting profits

LA C.C. Art. 2810: The provisions of Articles 2808 and 2809 do not prejudice other rights granted by law to recover damages or to obtain injunctive relief in appropriate cases

LA C.C. Art. 2811: A partner who acts in good faith for the partnership may be a creditor of the partnership for sums he disburses, obligations he incurs, and losses he sustains thereby.

LA C.C. Art. 2812: A partner may share his interest in the partnership with a third person without the consent of his partners, but he cannot make him a member of the partnership. He is responsible for damage to the partnership caused by the third person as though he caused it himself.

Comment: Hard to determine the worth of one partner’s interest. Could put a price in the

partnership agreement.LA C.C. Art. 2813: A partner may inform himself of the business

activities of the partnership and may consult its books and records, even if he has been excluded from management. A contrary agreement is null.

He may not exercise his right in a manner that unduly interferes with the operations of the partnership or prevents other partners from exercising their rights in this regard.

LA C.C. Art. 2814: A partner is a mandatary of the partnership for all matters in the ordinary course of its business other than the alienation, lease, or encumbrance of its immovables. A provision that a partner is not a mandatary does not affect third persons who in good faith transact business with the partner. Except as provided in the articles of partnership, any person

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authorized to execute a mortgage or security agreement on behalf of a partnership shall, for purposes of executory process, have authority to execute a confession of judgment in the act of mortgage or security agreement without execution of the articles of

partnership by authentic act.LA C.C. Art. 2815: A provision that a partner shall not participate

in losses does not affect third persons.LA C.C. Art. 2816: An obligation contracted for the partnership by

a partner in his own name binds the partnership if the partnership benefits by the transaction or the transaction involves matters in the ordinary course of its business. If the partnership is so bound, it can enforce the contract in its own name

LA C.C. Art. 2817: A partnership as principal obligor is primarily liable for its debts. A partner is bound for his virile share of the debts of the partnership but may plead discussion of the assets of the partnership.

LA C.C. Art. 2818: A partner ceases to be a member of a partnership upon: his death or interdiction; his being granted an order for relief under Chapter 7 of the Bankruptcy Code; his interest in the partnership being seized and not released as provided in Article 2819; his expulsion from the partnership; or his withdrawal from the partnership.

A partner also ceases to be a member of a partnership in accordance with the provisions of the contract of partnership.

LA C.C. Art. 2819: A partner ceases to be a member of a partnership if his interest in the partnership is seized under a writ of execution and is not released within thirty days. The cessation is retroactive to the date of seizure.

LA C.C. Art. 2820: A partnership may expel a partner for just cause. Unless otherwise provided in the partnership agreement, a majority of the partners must agree on the expulsion.

LA C.C. Art. 2821: If a partnership has been constituted for a term, a partner may withdraw without the consent of his partners prior to the expiration of the term provided he has just cause arising out of the failure of another partner to perform an obligation.

LA C.C. Art. 2822: If a partnership has been constituted without a term, a partner may withdraw from the partnership without the consent of his partners at any time, provided he gives reasonable notice in good faith at a time that is not unfavorable to the partnership.

LA C.C. Art. 2823: The former partner, his successors, or the seizing creditor is entitled to an amount equal to the value that

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the share of the former partner had at the time membership ceased.

LA C.C. Art. 2824: If a partnership continues to exist after the membership of a partner ceases, unless otherwise agreed, the partnership must pay in money the amount referred to in Article 2823 as soon as that amount is determined together with interest at the legal rate from the time membership ceases.

LA C.C. Art. 2825: If there is no agreement on the amount to be paid under Articles 2823 and 2824, any interested party may seek a judicial determination of the amount and a judgment ordering its payment.

LA C.C. Art. 2826: Unless continued as provided by law, a partnership is terminated by: the unanimous consent of its partners; a judgment of termination; the granting of an order for relief to the partnership under Chapter 7 of the Bankruptcy Code; [FN1] the reduction of its membership to one person; the expiration of its term; or the attainment of, or the impossibility of attainment of the object of the partnership.

A partnership also terminates in accordance with provisions of the contract of partnership.A partnership in commendam, however, terminates by the retirement from the partnership, or the death, interdiction, or dissolution, of the sole or any general partner unless the partnership is continued with the consent of the remaining general partners under a right to do so stated in the contract of partnership or if, within ninety days after such event, all the remaining partners agree in writing to continue the partnership and to the appointment of one or more general partners if necessary or desired.

LA C.C. Art. 2827: A partnership may be expressly or tacitly continued when its term expires or its object is attained, or when a resolutory condition of the contract of partnership is fulfilled. If the object becomes impossible, the partnership may be continued for a different object.

Unless otherwise agreed, a partnership that is expressly or tacitly continued has no term.

LA C.C. Art. 2828: When a partnership terminates, the business of the partnership ends except for purposes of liquidation.

If a partnership terminates because its membership is reduced to one person, that person is not bound to liquidate the partnership and may continue the business as a sole proprietor. If the person elects to continue the business, his former partners are entitled to amounts equal to the value of their shares as of time the partnership terminated, and they have the right to demand security for the payment of partnership debts.

LA C.C. Art. 2829: A change in the number or identity of partners does not terminate a partnership unless the number is reduced to one.

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LA C.C. Art. 2830: When a partnership terminates, the authority of the partners to act for it ceases, except with regard to acts necessary to liquidate its affairs.

Anything done in what would have been the usual course of business of the partnership by a partner acting in good faith, who is unaware that the partnership has terminated, binds the partnership as if it still existed.

LA C.C. Art. 2831: The termination of a partnership, for any reason, does not affect the rights of a third person in good faith who transacts business with a partner or a mandatary acting on behalf of the former partnership.

LA C.C. Art. 2832: The creditors of the partnership must be paid in preference to the creditors of the partners.

LA C.C. Art. 2833: The creditors of a partnership shall be paid in the following order of priority: secured creditors in accordance with their security rights; unsecured creditors who are not partners; unsecured creditors who are partners.

If any assets remain after the payment of all secured and unsecured creditors, the capital contributions shall be restored to the partners. Finally, any surplus shall be divided among the partners proportionally based on their respective interests in the partnership.

LA C.C. Art. 2834: In the absence of contrary agreement, a partnership is liquidated in the same manner and according to the same rules that govern the liquidation of corporations.

A partnership retains its juridical personality for the purpose of liquidation.LA C.C. Art. 2835: The liquidation of a partnership is not final until

all its assets have been collected and applied to its obligations and its remaining assets, if any, have been appropriately distributed to the partners.

La. Partnership in Commendam Articles

A. LA C.C. Art. 2836: The provisions of the other chapters of this Title apply to partnerships in commendam to the extent they are consistent with the provisions of this Chapter.

B. LA C.C. Art. 2837: A partnership in commendam consists of one or more general partners who have the powers, rights, and obligations of partners, and one or more partners in commendam, or limited partners, whose powers, rights, and obligations are defined in this Chapter.

C. LA C.C. Art. 2838: For the liability of a partner in commendam to be limited as to third parties, the partnership must have a name that appears in the contract of partnership; the name must include language that clearly identifies it as a partnership in commendam, such as language consisting of the words "limited partnership" or "partnership in commendam"; and the name must not imply that the partner in commendam is a general partner.

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D. LA C.C. Art. 2839(A): A partner in commendam becomes liable as a general partner if he permits his name to be used in business dealings of the partnership in a manner that implies he is a general partner.(B) If the name of a partner in commendam is used without his consent, he is liable as a general partner only if he knew or should have known of its use and did not take reasonable steps to prevent the use.(C) If the name of the partner in commendam is the same as that of a general partner or if it had been included in the name of a predecessor business entity or in the name of the partnership prior to the admission of the partner in commendam, its use does not imply that he is a general partner.

E. LA C.C. Art. 2840: A partner in commendam must agree to make a contribution to the partnership. The contribution may consist of money, things, or the performance of nonmanagerial services. The partnership agreement must describe the contribution and state either its agreed value or a method of determining it. The contract should also state the time or circumstances upon which the money or other things are to be delivered, or the services are to be performed, and if it fails to do so, payment is due on demand.A partner in commendam is liable for the obligations of the partnership only to the extent of the agreed contribution. If he does not make the contribution, or contributes only part of it, he is obligated to contribute money, or other things equal to the portion of the stated value that he has failed to satisfy. The court may award specific performance if appropriate.

F. LA C.C. Art. 2841: A contract of partnership in commendam must be in writing and filed for registry with the Secretary of State as provided by law. Until the contract is filed for registry, partners in commendam are liable to third parties in the same manner as general partners.

G. LA C.C. Art. 2842 A partner in commendam may not receive, directly or indirectly, any part of the capital or undistributed profits of the partnership if to do so would render the partnership insolvent. If he does so, he must restore the amount received together with interest at the legal rate.If the partnership or the partners do not force the partner in commendam to restore the amount received, the creditors may proceed directly against the partner in commendam to compel the restoration.

H. LA C.C. Art. 2843: A partner in commendam does not have the authority of a general partner to bind the partnership, to participate in the management or administration of the partnership, or to conduct any business with third parties on behalf of the partnership.

I. LA C.C. Art. 2844(A): A partner in commendam is not liable for the obligations of the partnership unless such partner is also a general partner or, in addition to the exercise of such partner's rights and powers as a partner, such partner participates in the control of the business. However, if the partner in commendam participates in the control of the business, such partner is liable only to persons who transact business with the partnership reasonably believing, based upon the partner in commendam's conduct, that the partner in commendam is a general partner.

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(B.) A partner in commendam does not participate in the control of the business within the meaning of Paragraph A of this Article solely by doing one or more of the following:(1) Being a contractor for or an agent or employee of the partnership or of a

general partner.(2) Being an employee, officer, director, or shareholder of a general partner that

is a corporation or a member or manager of a general partner that is a limited liability company.

(3) Consulting with and advising a general partner with respect to the business of the partnership.(4) Acting as surety for the partnership or guaranteeing or assuming one or more specific obligations of the partnership.(5) Taking any action required or permitted by law to bring or pursue a derivative action in the right of the partnership.(6) Requesting or attending a meeting of partners.(7) Proposing, approving, or disapproving, by voting or otherwise, one or more of the following matters:(a) The continuation, dissolution, termination, or liquidation of the partnership.(b) The alienation, exchange, lease, mortgage, pledge, or other transfer of all or substantially all of the assets of the partnership.(c) The incurrence of indebtedness by the partnership other than in the ordinary

course of its business.(d) A change in the nature of the business.(e) The admission, expulsion, or withdrawal of a general partner.(f) The admission, expulsion, or withdrawal of a partner in commendam.(g) A transaction involving an actual or potential conflict of interest between a

general partner and the partnership or the partners in commendam.(h) An amendment to the contract of partnership.(i) Matters related to the business of the partnership not otherwise enumerated in

this Paragraph, which the contract of partnership states in writing may be subject to the approval or disapproval of partners.

(8) Liquidating the partnership.(9) Exercising any right or power permitted to partners in commendam under this

Chapter and not specifically enumerated in this Paragraph.(C.) The enumeration in Paragraph B does not mean that the possession or exercise of

any other powers by a limited partner constitutes participation by such partner in the business of the partnership.

V. LITIGATION TO DETERMINE WHETHER A PARTNERSHIP EXISTS A. Two types of lawsuits in this area:

1. Inter se – partners disagree among themselves2. Third party – creditors say they are partners

B. In Louisiana, if they hold themselves out as partners, the court will hold them liable as partners. This is true even if the parties expressly deny that they are partners. In summary, the factors the La. courts look to:

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1. some kind of agreement or contract (can be oral)2. Intention of the parties 3. joint contribution of efforts or resources4. joint control as principals5. a community of goods which each participant has a proprietary interest in.6. risk sharing

a. There is no weight to the criteriab. Different courts stress different things.

C. At common law, the UPA and RUPA define partnership as an association of two or more persons to carry on as co-owners a business for profit, whether or not the persons intend to form a partnership. § 202 of RUPA: The association of two or more persons to carry on as co-owners a business for profits forms a partnership, whether or not the persons intended to form a partnership. In summary, the Common law approach emphasizes co-ownership, control, intent , and profit sharing. Gives safe harbors: A person who receives a share of the profits of a business is presumed to be a partner in a business, unless the payments were received in payment:1. of a debt2. of services as an independent contractor or of wages to an employee3. of rent4. of an annuity to a beneficiary or retired partner5. of interest, even if that amount varies with the profits of the business6. for the sale of the goodwill of a business.In fact, these are the relationships people claim exist when trying to avoid partnership classification.

D. Suggested litigation categories with dominant factors:1. In the inter se case, the primary inquiry should be the intention of the

parties and joint control as principals. a. Intention can be shown from how they label themselves, their

contracts, and how they share profits.2. In the third party tort suit, the dominant factors should be joint control,

profit sharing, and risk allocation.3. In the third party contract suit: profit sharing, control, and joint ownership.4. In procedural matters, the court should find a partnership where there is

control, joint ownership, or profit sharing and where a full fair hearing can be given while avoiding a multiplicity of suits.

5. In tax avoidance cases, the intention or motive should be dominant6. in the case of a creditor of a partnership seeking to be made a partner, the

key element is extent and duration of control over the partnership debtor.E. Discovery should be employed to determine:

1. who makes business decisions, who has a right to veto, who signs the checks

2. written agreements among participants.3. contributions of capital by each participant4. recorded title to property

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5. tax returns6. bank account information7. license applications8. insurance policies9. advertisements10. other suits against the entity11. acts of ownership.

F. Cajun Electric Power v. McNamara (La. 1st Cir. 1984)Facts: GSU and S&W enter into a contract for the construction of a nuclear power plant. GSU and Cajun agreed that Cajun would become a 30% owner, and executed an agreement that Cajun would pay the costs of construction retroactively. Cajun contended that, as an electric cooperative, it was statutorily exempt from sales and use tax, and claimed an exemption for all construction materials purchased. Cajun claimed that S&W was a purchasing agent.Issue: Was S&W a purchasing agent for Cajun, thus statutorily exempt from sales and use tax?Holding: S&W was an agent for Cajun, but neither were exempt from tax because they were a joint venture, not a coop.Rationale: Joint venture is the same as a partnership for a specific task. When Cajun and GSU signed the agreement, a joint venture was formed, it does not matter that their contract specifically denies that they are a joint venture. The language of the statute shows that coops only were to be exempt from tax. The exemption cannot hold where the coop changes form into a joint venture. Thus, Cajun is responsible for 30% of the taxes.

G. Thibaut v. Thibaut (La. 1st Cir. 1972)Facts: Some members of a partnership saw that the business was coming to an end. So they took the name, customer list, accounts receivable, employees, and assets and tried to form a new company without the other partners. Holding: This was in violation of the fiduciary duty that each partner owes to the other.Rationale: Fiduciary duty entails a high degree of trust and responsibility. When the Ds here took tangible assets and violated the going concern of the business, they violated their fiduciary duty. 1. RUPA allows a partner to contract away all fiduciary duties except for

good faith and fair dealing. Ex: partners allow one of the other partners to conduct future activities without them. Then the non-participating ones will not be personally liable if the venture fails.

IV. Corporations Law.

1. CORPORATION LAW IN GENERAL

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A. "CORPORATION" DEFINEDa.) A corporation is a type of legal institution or process that defines

relationships among people. It provides:(1) limited liability for its owners;(2) perpetual existence independent of its owners;(3) centralization of management in persons who need not be owners; and (4) free transferability of ownership interests.

b.) These characteristics may be modified to a significant extent by agreements among the participants. Several different theories have been developed to describe the corporate relationship:

i.) Entity or “Person” theory

A corporation can be envisioned as an artificial, fictitious entity created for the purpose of conducting a business. This theory was first enunciated in Dartmouth College v. Woodward (1819).

a. The artificial entity has the power to conduct its business entirely in its own name.

b. The artificial entity is formed by a grant of authority by a government agency.

c. The artificial entity must be generally recognized as such by persons dealing with the corporation, including the creating state, the United States, and private citizens.

d. However, courts may refuse to follow the artificial entity analysis to its logical conclusions, if it leads to fraudulent or significantly unfair consequences, frustration of clearly defined public policies, or other undesirable results.

e. The owners of the entity are the "shareholders," the managers are the "directors," and the persons carrying out the policies of the managers are the officers."

f. Corporation has no “purely personal” protections afforded to individuals, such as:

i.) 5th Amendment self-incrimination privilege;ii.) Right to privacy;

g. Corporation does have:i.) Rt. to Freedom of speech;ii.) Protection a/g uncompensated takings;

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iii.) Protection from unreasonable S&S;iv.) No “double jeopardy”; andv.) Due Process and Equal Protection.

ii.) Concession Theory

A second theory of corporateness is that a corporation is a "grant" or "concession" from the state. The theory is based on the role of the state in the formation of the corporation.

iii.) Contract Theory

A third theory of corporateness is that the charter of a corporation represents a contract (a) between the state and the corporation, or (b) between the corporation and its shareholders, or (c) among the shareholders themselves.

This theory is most likely to surface today in disputes between different classes of shareholders, or in disputes in which one class of shareholders claims that the class is being discriminated against in some way.

iv.) “Nexus of contracts“ theory

A fourth theory of corporateness is a "nexus of contracts." This theory, formulated by Judge Posner at the Chicago School of Ethics, is utilized by economists for analytic purposes. Rejects the notion that the shareholders are the ultimate owners of the corporation and treats them instead as contractual providers of capital in anticipation of receiving a desired return.

The corporate managers by contract provide for all the requirements of the corporation for capital, services, and goods. A corporation, therefore, is a "nexus of contracts."

a. Under this theory, state corporation statutes only provide standard rules suitable for the average corporation which may be modified as desired by contract.

b. The economist's concept of a "contract" differs from the legal definition in that it includes non-consensual rational economic relationships.

NOTE: Rousseau says that the problem with this theory is that the “nexus of contracts” is a fiction: the shareholders are not really protected by a contractual arrangement; the real protection is the “fiduciary duty”

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v.) Process Theories

Scholars have also suggested that a corporation may be viewed as a process by which various inputs of capital, services, and raw materials are combined to produce desirable products. It may also be viewed as a form of private governance for persons involved in a business.

B. CONSTITUTIONAL INCIDENTS OF THE CORPORATE "PERSONALITY"

A corporation is viewed as a "person" entitled to some but not all of the constitutional protections available to individuals. For example, a corporation is not a citizen of a state or of the United States for purposes of the privileges and immunities clause, but has constitutional rights of free speech; it does not have a privilege against self incrimination, but is protected against deprivations of property without due process of law and is entitled to equal protection of the law.

C. SOURCES OF LAW

The law of corporations is derived from several sources.

1. State Incorporation Statutes

Every state has a general incorporation statute. Two sources of statutes have been particularly influential in modernizing and liberalizing the state statutes. Louisiana’s Corporations Law in modeled after the MBCA (1984):

a. The Model Business Corporation Act (1984) prepared and maintained by the Committee on Corporate Laws of the Section on Corporation Banking, and Business Law of the American Bar Association; and

b. The Delaware General Corporation Law (GCL).

2. State Common Law Principles

1. Has declined in importance due to increased statutory regulation, but still relevant in the area of duties of directors & officers.

3. Federal Statutes

- Securities Acts of '33 & '34.

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- Other laws relating to publicly held corporations: Investment Company Act, National Securities Markets Improvement Act, etc..

4. Federal Common Law

- The U. S. Supreme Court has stated on numerous occasions that there is no general federal common law of corporations. Kamen v. Kemper Financial.

D. FUNCTIONAL CLASSIFICATION OF CORPORATIONS

The basic distinction underlying much of the law of corporations is between the closely held corporation and the publicly held corporation.

1. Definition of a Closely Held Corporation

A closely held corporation

a. Has a few shareholders, all or most of whom are usually active in the management of the business;

b. Has no public market for its shares;

c. Has never registered a public distribution of shares under the federal or state securities acts.

2. Definition of a Publicly Held Corporation

A publicly held corporation is a corporation with most of the following attributes:

a. Its shares are held by members of the general public and there is a public market for its shares;

b. It is subject to reporting and disclosure requirements under the securities acts and has made one or more registered public offerings under the Securities Act of 1933.

3. Significance of a Public Market for Shares

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The presence of a public market for shares is the most important difference between a closely held and a publicly held corporation. In a closely held corporation minority shareholders may be "locked in" to an unsalable asset. In contrast, in a publicly held corporation an investor has power to "enter" or "exit" through the public market for shares.

4. Other Differences Between Closely Held and Publicly Held Corporations

Other important differences are: closely held corporations are usually managed by controlling shareholders while publicly held corporations are usually managed by professional managers with small shareholdings, and (2) there are few disclosure obligations for closely held corporations while publicly held corporations must operate in the "goldfish bowl" created by the disclosure obligations of the federal securities laws.

E. STATE COMPETITION FOR CORPORATIONS

Since the late Nineteenth Century, states have competed for businesses to incorporate under their state statutes. Today, the uncrowned winner of this competition is the state of Delaware.

1. Advantages of Incorporation Business

The incorporation business provides tax revenues for the state, fees for attorneys, corporation service companies, and local filing authorities.

2. Success of Delaware

More than half of all businesses & over one-third of all the corporations listed on the New York Stock Exchange are incorporated in Delaware. The Delaware Legislatures and the Delaware Supreme Court are therefore an important source of modern corporation law today.

3. Reasons for Success of Delaware

The popularity and primacy of the state of Delaware may be explained partially by history of permissiveness WRT corporate governance, partially by the continued efforts by the bar of that state to provide an effective, flexible, and

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modern body of corporate law, and partially by the familiarity of corporate lawyers around the country with the Delaware GCL. Major contributors to Delaware's primacy also are the existence of a sophisticated judiciary and sophisticated filing office that assures reasonable and knowledgeable decision making and dispute resolution.

a. There is "more" corporation case and statutory law in Delaware today than in any other state. As a result, there are fewer areas of uncertainty in Delaware corporation law than in the law of any other state, and corporation lawyers may plan transactions with a relatively high degree of certainty.

- NOTE: Louisiana has great uncertainty in its corporations law, because it abides by statutory changes to the corporate law and there is no significant body of case law dealing with the relatively new Corporations law.

b. The Delaware Chancery Court is a respected and sophisticated commercial court. Other states have created similar courts but none have been as successful as Delaware.

c. Delaware case law generally permits corporations to adopt defensive tactics to combat unwanted takeovers.

4. Economic Analysis of the Reasons for Delaware's Success

The earliest explanations of Delaware's success was that the Delaware GCL was unduly permissive and permitted management to operate without constraint and thus profit personally directly or indirectly. In this view, Delaware had won "the race for the bottom."

a. Economists pointed out that if this explanation were accurate, corporations that reincorporate in Delaware should suffer a loss in the value of their publicly traded shares under the efficient capital market hypothesis. Empirical investigations do not reveal such a loss.

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E. The Basic Characteristics of a Corporation.

1. Corporation Definition1. a legal person by which business firms can enter into contracts, own property ,

sue in court and be sued. 2. Creature of law - a legal artifice; state enabling statutes

(1) There are many gaps left by statutes and persons are filled by judicial norms

(2) Other gaps == involving info for SH are filled by federal securities law. 3. Investment vehicle for the pooling of money and labor.

(1) Money capital - SH and creditors(2) Human capital - executive sand employees.

(1) both money and labor(human) capital expect a return of their investment thus there are conflicts of interest

2. Corporation Basics1. Five Basic Attributes of a corporation

- Independent, Separate, and perpetual existence- Centralized management- Ownership interest tied to residual earnings and assets- Tranferability of ownerships’ interests- Limited liability for all participants

(1) Independent, Separate, and perpetual existence(1) It is an entity distinct from those who contribute capital (sh

and creditors) and those who manage(2) The corporation owns the assets of a company and is liable for

any business debts(3) If ever SH dies in a Corp it continues(4) If every partner dies in a partnership then it is over

(2) Centralized management(1) BOD manages and supervises the business but delegates

power to officers who act and bind the corporation(2) BOD is subject to fiduciary duties(3) SH have limited role and power to initiate change == they

have voting power to elect directors and approve fundamental changes

(3) Ownership interest tied to excess earnings and assets(1) Creditors (bank lenders, bondholders, trade creditors,

employees) are first in line and receive a return based on their contract.

(2) SH are last in line and receive dividends as declared by discretion of BOD.

(3) Creditors have priority and SH left-over claimants in event of liquidation

(4) Free Transferability of ownerships’ interests(1) Hard to get out of LLC(2) not so easy to get out of closely held Corp(3) Easy to get out of publicly traded Corp (stock market)(4) Liquidity of mkts is what makes American economic system

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so strong. It rewards economic productivity and punishes inefficiency & laziness. Rewards businesses that can provide better, more efficient services.

(5) Limited liability for all participants(1) Insiders (Directors, officers, SH and lenders) are not

personally liable to outsiders on corporate obligations and risk only their personal investment 1) However Directors and executives usually have a

fiduciary duty to SH and the entity(2) SH don’t owe any duty to other SH == they can sell stock.

However majority SH may have a fiduciary duty. (3) Outsiders (contract creditors and tort victims) bear the risk of

corporate insolvency. (4) partnerships have a fiduciary duty to investors(5) LLC some instances there are fiduciary duty

1) passive vs active investor

Keep in mind, closely held corporations may be exposed to different risks== SH can agree to manage the business, to pay themselves dividends, and to limit their ability to transfer stock. In some circumstances courts may hold SH personally liable for corporate debts beyond their investment or lenders may require SH to personally guarantee the corporations debt obligations

2. Corporate participants(1) many players - SH, managers, lenders, customers, employees, gov’t

(1) employees are well represented where there are unions 1) national labor relations act protects unions

(2) Corporate law sets up mandatory, permissible and default rules(3) Corporate law focuses on relationships between SH and managers(4) Outside relationships w/ creditors, suppliers customers, employees,

government authorities are usually subject to legal norms that treat the corporation as a person(1) contract laws, debtor-creditor, antitrust, labor and tax

G. MODERN BUSINESS ALTERNATIVES TO CORPORATIONS

Traditional alternative business forms for closely held businesses are the partnership and limited partnership. In the last decade a new business form, the limited liability company, has achieved wide acceptance. The LLC provides limited liability for members, flexibility in internal operation similar to that provided by partnerships, and partnership type tax treatment.

2. The Partnership.

A. The Need for a Written Agreement.

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Reasons for Writing a Partnership Agreement:

- May avoid future disagreements over what the arrangement actually was.

- A written agreement is readily proved in court while proof of an oral agreement may involve substantial factual controversy.

- A written agreement may focus attention on potential troublespots in the relationship which had laid dormant.

- IRS treatment of partnerships allows them to allocate tax burdens among themselves and this should be written out.

- Allows the partners to dictate what will happen to their shares in the partnership upon death or dissolution.

- Allow the parties to identify, & thereby, protect any assets or property they have contributed or loaned to the partnership.

- If real estate is contributed the transfer must be written, and the agreement would provide an adequate memorialization thereof.

- Good for attorney to place his suggestions and advice in concrete form in order to lessen confusion and risk of liability.

B. Sharing of Profits and Losses.

The following are ways to share the profits of the business:

1. Flat percentage based only on ownership interest.2. Payment of a partner salary3. Percentage basis, with the percentages recomputed each year on

the basis of the average amount invested in the business during the year by each partner.

4. Percentage basis, with the percentages recomputed each year on the basis of total income, the sales or billings by each partner, time devoted to the business, or on the basis of some other factor.

4. In large partnerships, the general partners may share a fixed percentage of 80% of the total income; with the remaining 20% distributed among the junior partners.

5. May choose not to provide a division arrangement in the partnership agreement, choosing instead, to work it out in a mutually acceptable manner each year.

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B. Sharing of Profits and Losses.

The following are ways to share the profits of the business:

1. Flat percentage based only on ownership interest.2. Payment of a partner salary3. Percentage basis, with the percentages recomputed each year on

the basis of the average amount invested in the business during the year by each partner.

4. Percentage basis, with the percentages recomputed each year on the basis of total income, the sales or billings by each partner, time devoted to the business, or on the basis of some other factor.

5. In large partnerships, the general partners may share a fixed percentage of 80% of the total income; with the remaining 20% distributed among the junior partners.

6. May choose not to provide a division arrangement in the partnership agreement, choosing instead, to work it out in a mutually acceptable manner each year.

The following are ways to compensate employees:1. Productivity and billable hours2. New business3. client liason4. practice economics5. management, administration, training, and supervision.6. marketing advancement.

Richert v. Handley (Wash. 1958)Facts: P alleged he entered agreement with D where P was to purchase timber and D was to log it. The two would share equally in profits and losses. The partnership suffered a loss. P had advanced $26,842 of capital and felt that he should get this back. The partnership agreement did not mention returns of capital.Holding: the P was entitled to a return of his capital. Since there was no agreement to the contrary, the UPA must control. Applying it to this case, D must reimburse P for the loss, including the capital contribution.

C. Limited Liability Partnerships (LLP’s)

The collapse of the savings and loan associations in Texas led to suits being brought against shareholders, directors, and officers of the failed institutions. The total claims greatly exceeded the liability insurance available. The LLP statute enacted by Tex. in 1991 was designed to meet this precise liability crisis.

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Even under broad LLP statutes, individual partners who themselves commit acts of malpractice or negligence remain personally liable because of their conduct.

The narrow statutes do not affect basic partnership rules except in the case of firms that actually face substantial malpractice claims in excess of their malpractice insurance. In all other situations, the partnership rules continue to apply.

D. Management

National Biscuit Co. v. Stroud (N.C. 1959)Facts: Straud and Freeman entered a general partnership to sell groceries. Nothing in the agreement suggested that Freeman’s power as a general partner was restricted with respect to the ordinary business. Stroud advised P that he personally would not be responsible for any additional bread sales. After this, at Freeman’s request, P sold them bread.Issue: Was the partnership bound to pay for the bread, even though one P said he would not be personally responsible?Holding: Yes. What any partner does toward a third person is binding on the partnership. All partners are jointly and severally liable for acts and obligations of the partnership. Freeman had equal rights in the management of the business and Stroud could not restrict his power to conduct activities within the scope of ordinary business. The partnership was bound to pay the P.

Smith v. Dixon (Ark. 1965)Facts: Smith Family constitutes a partnership. A contract for sale of realty with lease was signed by W.R. Smith on behalf of the partnership. Partnership agreed to sell plantation and convey title to Appellee. Partnership refused to convey the title.Issue: Was the contract of sale binding on the partnership?Holding: Yes. Partnership is bound by acts of a partner when he acts within the apparent scope of his authority. To determine apparent scope of authority, look to past transactions indicating a course of dealing. W.R. Smith was acting within the apparent authority as a partner when he signed the contract, and it was enforceable on the partnership.

Burns v. Gonzalez (Tex. Civ. Ct. 1969) – To determine apparent authority under the UPA, look to the ways that other firms in the locality conduct business, or in the way in which the particular partnership in question transacts its business.

Third parties are not bound by provisions in the partnership agreement regarding the authority to transact business, and may enforce liabilities and rights created by UPA or RUPA without any regard to the agreement.

Rouse v. Pollard (Chancery Court of N.J. 1941)

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Facts: Seven partners were in general practice of law. Fitzsimmons took care of P’s business. He took her valuable securities and suggested she turn them over to the firm for them to invest for her. The law firm dissolved and he was arrested for embezzlement. P sued the firm to get her securities back.Holding: The other lawyers in the firm are not liable for the embezzlement of the former partner.Rationale: The other partners are only responsible if he was acting as their agent in taking her money. He had no express authority. He was only an agent for acts within the scope of the firm’s business. This was not within the scope of the firm’s business. Not part of the practice of law according to the usual and ordinary course pursued in N.J.

Roach v. Mead (Or. 1986)Facts: Mead represented P before he formed partnership with D. Advised P on traffic charges and business dealings. P asked Mead how he should invest his $20,000. Mead said he would take it at 15% and represented to P that he would get his money back. Mead later borrowed $1,500 more from the P.Issue: Were Mead’s former law partners liable for Mead’s negligence?Holding: Yes. Turns on whether this was within the ordinary course of business. Partners are jointly and severally liable for the tortuous acts of partners if they authorize the acts or if the acts are committed in the ordinary course of business. If a third person reasonably believes that the services are undertaken as a part of the partnership business, the partnership is liable, even if a person in the business would find it unusual. P here reasonably believed that the investment advice was part of the usual practice of law.

E. Duties of Partners to Each Other

Meinhard v. Salmon (N.Y. 1928)Facts:

F. Partnership Property

1. It is rather difficult to determine the legal incidents attached to the right of each partner as co-owner of specific partnership property.

2. UPA provides that: “the right of a partner as co-owner is not separately assignable.” Thus, a partner has a beneficial interest in partnership property considered as a whole.

3. Therefore, each partner has a beneficial interest in each part, and such interest might be assignable if it were not impossible, except by purely arbitrary and artificial rules, to measure a partner’s interest in a specific chattel belonging to the partnership.

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G. Partnership Accounting

1. From an accounting standpoint, he business of the partnership is universally recognized as being distinct from the financial affairs of the individual partners.

2. The capital account represents the partner’s ownership interest in the partnership and equals =

a.) The capital contributed by the partner.- MINUS -

b.) The amount of any distributions to the partner.+ PLUS +

c.) The partner’s share of the profits.- MINUS -

d.) The partner’s share of the losses.

3. Gross Profit = Sales ($) – COGS (cost of goods

4. EQUITY = ASSETS – LIABILITIES.Equity = Net worth of a business.

5. Assets on the left, liability/equity accounts on the right.

6. The Three Major Financial Statements:a.) Balance Sheet = photograph.

NOTEE: It is not a valuation statement; it only tells you the cost of the assetsb.) Income Statement = motion picture.c.) Statement of Cash Flows

6. The Four Fundamental Assumptions of Financial Acct.:

a.) Assume that the business that is the subject of the financial statements is an entity.b.) All entries have to be in terms of dollars valued according to either historical cost or fair market value.c.)The Balance Sheet must balance; or there is a mistake.d.) Every transaction must be recorded in at least two ways: double entry bookkeeping.

NOTE: Rousseau also stresses conservatism rule: write down value (for depreciation), but never write-up (for appreciation); and the “business as a going concern” assumption.

7. All assets are really just pre-paid expenses- Depreciation: The cost of an asset allocated over time. This is a non-cash expense in that it does not reduce the amount of available cash of the business.

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H. Partnership Dissolution

1.§ 29 of UPA: Dissolution is a change in legal relationship "caused by any partner ceasing to be associated in the carrying on of the business." The termd deals with changes in personal relationships, it does not deal with the disposition of assets or selling the business. §30 describes two other periods that follow dissolution: "winding up," and then "termination of the partnership."

2. Today, to avoid the confusion stemming from the definitions of "dissolution," "winding up," and "termination," RUPA simplified & consolidated the confusing terms into the word "dissociation" which refers to "an event that causes a partner to cease being a participant in the partnership" RUPA uses the word "dissolution" only when referring to an event that leads to the termination of the partnership.

1. Collins v. Lewis (1955):Facts: C & L enter into partnership agreement to construct & operate a cafeteria, under which C furnishes the cash & L manages the construction & eventual operations of the cafeteria.Holding: The Ct. held that C should not be forced to continue the partnership because he has the power, as does any partner, to terminate the partnership relationship. However, C does not have the "legal right" to breach his partnership contract, therefore, C will be accountable to L for breach of contract if he cancels the partnership arrangement.Rule: There are no Indissoluble Partnerships!

- Rousseau says that an astute lawyer would have put a monetary amount "ceiling" on Collins monetary investment in the contract, along with a provision that all other costs are to be paid by Lewis.

- Also, Lewis probably should not have started a partnership in the first place, he should have just taken out a straight mortgage.

2. Cauble v. Handler (1973): Not reviewed in class?Holding: If the partnership is not "wound up" after the death of the only "other Partner", but instead continues under the direction of the surviving partner, with or without an agreement as to dissolution, the non-continuing partner or his estate has a right of first election between two alternatives:

Force a liquidation at market value; or As was done in this case, under the authority of §42 of UPA: Claim as

a creditor, an amount equal to the value of the non-continuing partner's interest in the dissolved partnership as of the date of dissolution, plus

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the profits attributable to his right in the property of the dissolved partnership—shields them from losses incurred by the enterprise after the dissolution date.

3. Adams v. Jarvis (1964):Facts: Adams withdrew from a Medical Partnership (7 years after it was formed) & seeks a declaratory judgment concerning the extent of his right to share in the partnership assets—accounts receivable($ owed for services already rendered). Adams was a 1/3 interest partner & was therefore, entitled to 1/3 of the value of the partnership. Paragraph 15 of the agreement provided that upon withdrawal of a partner, the books of the partnership would stay open until the end of the fiscal year—so the partnership was not "wound up" at the moment of withdrawal.Holding: Paragraph 16 of the Partnership Agreement is controlling & provides:

"A withdrawing partner shall receive (1) any balance to his credit on the partnership books, (2) his proportionate share of profits calculated on a fiscal year basis, & (3) his capital account as of the date of his withdrawal." And further, that in the event of a withdrawal, "any & all accounts receivable for any current year & any & all years past shall remain the sole possession & property of the remaining member or members of the partnership."

Rule: When a withdrawing partner is entitled to a share of the partnership assets for the remainder of the fiscal year, the continuing partners have a fiduciary duty to conduct the business in a good faith manner—including making a good faith effort to collect accounts receivable in a manner consistent with good business practices.

Why did the partnership retain all rights to the Accounts Receivable? The remaining doctor partners want to keep an on-going relationship with the patient, & they want to retain their referrals from the rest of the group practice. They also want to keep the medical records.

4. Things to consider when drafting a continuation agreement:

(a) What types of dissolutions will trigger the continuation clause?- "Triggering Clause" = Death; retirement; disability; expulsion; withdrawal; increasing the # of partners; bankruptcy; etc…

(b) What will happen to the outgoing interest?- Other partners purchase the interest; sell to a third party, etc…

(c) May the remaining partners elect to terminate, or is the continuation clause mandatory?

(d) How will the withdrawn interest be valued—what is a fair valuation for the type of interest concerned?

Techniques of valuation:

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A fixed sum with a provision for periodic adjustment; Book value with supplemental appraisals; Professional appraisal; Capitalization of earnings in the past; A fractional portion of future earnings over a period of time; Negotiation/Arbitration after the dissolution; Right of First Refusal to meet the best offer obtainable by the

withdrawing interest; A lump sum based on past income or an average thereof; A valuation of a similar interest in a trade journal.

NOTE: As investors, we want to buy a company for its future value flow—look to the capitalization of earnings in the past.

(e) Is the payment to be made in a lump sum, or in periodic payments?

(f) How will the cash be raised to pay for the withdrawn interest?- Insurance policy; Special reserve fund; Debt financing; the regular

operations of the business.

(g) May the retiring interest compete with the surviving partners, or is there a mandatory non-compete?

(h) Will the retiring interest have the power to inspect the books & records or demand an audit of the surviving partnership?

Meehan v. Shaughnessy (1989):Facts: Plaintiff broke away from their law partnership—Parker Coulter, and in so doing they took some of the old partnership's clients from them and started their own firm. There was a partnership agreement that provided that upon payment of a fair charge ANY case could be removed by a withdrawing partner, regardless of whether the case came to the firm through the personal efforts of the departing partner.Holding: First, the plaintiffs did not breach their fiduciary duty to their copartners because they handled their on-going cases no different as a result of their decision to leave the firm. Second, they did not breach fiduciary duty to copartners by planning to compete with the entity to which they owed allegiance, provided that "in the course of such arrangements they did not otherwise breach their F.D. See Chelsea Industries v. Gaffney. Finally, the plaintiffs did breach their F.D. by unfairly acquiring consent: through their preparation for obtaining clients' consent, their secrecy concerning the clients they intended to take, & the substance & method of their communications with clients, the plaintiffs obtained an unfair advantage over their former partners in breach of their fiduciary duties. In recompense therefor, the law partnership is entitled to recover only the damages which are causally connected to the plaintiff's unfairly acquired consent from the clients.

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Baronni v. Marine Quality Company properly states the rule for competition in Louisiana, & which is different from the Chelsea rule. Baronni holds that after termination, a partner can't compete without breaching his fiduciary duties to the former partnership.

Cohen v. Lord, Day & Lord: Partnership agreement provided that if a withdrawing partner continued to practice as a lawyer in any jurisdiction within which the Law Partnership maintained an office, he would not be allowed to collect any payments from services rendered. The Ct held that the penalty clause of the partnership agreement unreasonably restricted the withdrawing partner's right to practice law & therefore deprived the public of free choice of legal advisers.

In both Starr v. Lane & Stuart v. Lane, the Ct. held that the Law Partnership breached its fiduciary obligations and the covenants of good faith & fair dealing implicit in all partnership agreements when they deviated from the firm's long standing practice of distributing its profits in a fair & reasonable manner so as to deprive the withdrawing partner of the compensation to which he was entitled.

What is a "prohibited solicitation" by a withdrawing partner—Secretly attempting to lure firm clients (even those that the withdrawing partner has brought into the firm & personally represented) to the new association, lying to clients about their rights as to choice of counsel, lying to partners about plans to leave, and abandoning the firm on short notice (taking the clients & their files) would be a breach of fiduciary duty.

5. Gelder Medical Group v. Webber (1977):Facts: Expelled partner (Dr. was expelled without cause-but this was allowed under the partnership agreement) violated the non-compete covenant of his former medical partnership.Holding: Having joined a partnership governed by an agreement that provides for expulsion of partners without cause, on terms that are not oppressive & including a reasonable (WRT both time & place) non-compete covenant—the expelled partner will not be heard to complain of the agreement's enforcement. Rule: Absent a showing of bad faith a reasonable non-compete will be enforced.

See La. R.S. 23:901 on Non-competes.

Beasley v. Cadwalader: A N.Y. law firm had no agreement as to expulsion of members & when one branch of the firm started to operate at a loss, the firm started identifying & eliminating "less productive partners". When one of the expelled partners filed suit for breach of fiduciary duties, the court awarded

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substantial compensatory & exemplary damages for what it called "highly questionable conduct."

Dawson v. White & Case: A partner refused to "retire," and since firm did not have an expulsion provision, the firm chose to "dissolve" and immediately reform without the partner who refused retirement. The Ct. held that this procedure was a proper way to effectively expel the undesirable partner, noting that "partners may choose with whom they wish to be associated.

"Dissolution" under RUPA: Under RUPA it is clear that a partner may be "dissociated" and yet have the partnership continue if the value of the withdrawing partner's interest is paid to him.

Triggering events = death, withdrawal, cessation of existence, or expulsion of a partner is a "dissociation."

Once an event requiring dissolution and winding-up occurs, the partnership is to be wound up unless all of the partners agree.

If a partner "dissociates," but the business is not dissolved & wound up, the partner is entitled to receive the "buyout price."

RUPA does not provide for the §42 "election" contained in the Cauble case, but rather, provides that a "dissociated" partner is entitled only to interest on the amount to be paid the dissociated partner from the date of dissociation to the date of payment.

I. Inadvertent Partnerships

1. trying to allege that you are not a partnership when you really are one. a. Ex: Cajun Electric case

2. At common law, a person is a partner if he participates in the profit sharing.a. But, could also be a lessee, creditor, etc.

3. Martin v. Peyton (NY 1927)The person P alleged was a partner here had veto power of business decisions. But, this court held that this was not enough to hold him personally liable for the debts of the partnership.a. Cargill case, though held differently. Cargill was a creditor

of a company. The debtor did not repay. Cargill could have taken over his business, but instead it simply decided to exercise veto power and voting rights. Court found Cargill liable to the other creditors when the company went into bankruptcy because it had control.

4. Smith v. Kelley (Ky. App. 1971)Facts: In 1964, D and Gallow were partners in an accounting firm. Smith left another firm and came to work for them. For 3.5 years, Smith made $1,000 per month plus a $100 travel stipend. At end of

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the year he was paid a productivity bonus based on profits. Once he left the firm, he made a claim that he was entitled to a fixed percentage of the profit as a partner. Issue: Whether the parties intended to, and did, create a contractual relationship that would entitle Smith to share in the profit. Can partnership by estoppel apply to the parties themselves, rather than just to third parties?Holding: Based on the fact that there was no writing evidencing a partnership, and although Smith was held out to the public as a partner, as between the parties, a partnership relation was not intended to be, and was not in fact created. Did not matter that the tax returns listed him as a partner, or that in a third party contract he was listed as a partner.Rule: As long as the parties did not intend it, a partnership is not created between themselves and an employee cannot raise partnership by estoppel.a. Of course, under these facts, partnership by estoppel could

have been asserted by a third party.b. Appellate court here was bound by the factual finding of the

district court that the original partners had at no time agreed that he would share in a percentage of the profits.

5. Young v. Jones. (Dist. Ct. of SC 1992)Facts: Price Waterhouse, chartered accountants, is a Bahamian general partnership. Price Waterhouse, United States, is a NY general partnership and one of the big six firms. Ps but money into a bank based on the Bahamian Price Waterhouse’s unqualified opinion. Ps lost their money.Issue: Is the United States Price Waterhouse liable for the opinion of the Bahamian Price Waterhouse?Holding: Because there is no evidence that Ps relied on any statement or act of any partner of the United States Price Waterhouse which indicated the existence of a partnership between the two organizations, the US company is not liable under the rule of partnership by estoppel.Rationale: The brochure that describes Price Waterhouse as one of the “world’s largest and most respected processional organizations with professionals in 400 offices throughout the world” was not found by the court to be relied on by the Ps in making the decision to invest.Rule: A person who represents himself, or permits another to represent him, to anyone as a partner in an existing partnership is liable to any person to whom such representation is made. If that person loans money to that partnership in reliance upon that representation.a. Simpson v. Ernst & Young (6th Cir. 1996)

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Facts: Employee is claiming age discrimination against D. If he is a partner, he cannot recover, so he’s saying he is not one.Holding: He was an employee, not a partner, because he had no right to examine the books, no authority to manage, or participate in the profits.

J. Other Unincorporated Forms of BusinessA. Today, there are a number of business forms available to a newly created

enterprise, including:1. The proprietorship.2. The general partnership3. The Limited Liability Partnership (Registered L.L.P.)6. The limited partnership (Partnership in Commendam)7. The “member managed” Limited liability company (L.L.C.)8. The “manager managed” Limited liability company (L.L.C.)9. An S Corporation10. A C Corporation11. A Professional Corporation

The most modern business forms are the L.L.C. & the L.L.P., covered below:

1. REGISTERED LIMITED LIABILITY PARTNERSHIP2. Normally for attorneys & doctors3. Flow through tax4. Insulation from tort liability arising out of the acts of other partners or

partnership representatives. 1. Specifically, a partner in an RLLP is not individually liable for the

damages of the P arising from1. errors2. omissions3. negligence4. incompetence5. malfeasance

5. Partnership and the partner who is the tortfeasor are 100% liable for the tort1. If A commits malpractice B&C are not liable for A’s tort.

1. HOWEVER there are cases that say practice of law is under the jurisdiction of the SC so all should be liable for everyone’s tort in Law practice - no matter what kind of organization you form.

2. More likely than not more than 1 partner will work on a case together.

3. Also courts say b/c B&C get they benefits of A’s practice they should also reap the costs.

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6. All partners are liable for contracts of each partner though7. No common law background. The ULPA is similar to the Louisiana

partnership in commendam laws.8. The modern limited partnership seems closer to a corporation than an

general partnership. A federal income tax driven business with scores of limited partners and one or two general partners.

9. Continental Waste System v. Zoso (N.D. Ill. 1989)Facts: I. Jones Partners, LLP was composed of the limited partner, Zoso partners (a general partnership composed of Ivo and Cook) and the general partner, McKiel. The LLP began to experience money problems due in part to environmental clean up costs. McKiel was replaced as general partner by Cook. Ps seek to hold Ivo liable as a general partner for debts that the LLP owed.Holding: Ivo had personal liability because the statutory requirements were not followed. No limited partnership if the articles are not filed. There was a way out under Ill. Stat: if Ivo had promptly renounced his interest. There was a genuine issue of material fact whether he did this.a. Some of the facts that might lead a jury to find that Ivo controlled

the LLP: 1) control over the LLP2) acted as agent of the LLP3) had weekly meeting with the general partner to discuss the

status of the organization.4) he was the one who decided to remove McKiel.

10. There are safe harbors under the RUPLA and La. law. See art.2844(b) above for a detailed list of the safe harbors.

11. Creditor must always prove that he relied on the limited partner’s actions as a general partner. Art.2844.

12. To deal with the fact that there must be one general partner, lawyers often make a corporation the general partner.a. This is a totally different entity than the traditional limited

partnership.b. If a director of the corporation is also a limited partner, he needs to

be careful about borrowing money! Don’t want to confuse the status as a corporate officer and a limited partner.

c. Fiduciary duties seem to conflict: cases state that a corp who is the sole general partner owes a fiduciary duty to the limited partnership. The jurisprudence seems to require that officers and directors of the corp. general partner favor the duties to the limited partnership above their duties to their corp. shareholders. 1) Entails the duty not to use control over the partnership’s

property to advantage the corporate director or his corporation at the expense of the partnership. In re USACAFES, L.P Litigation. (a DE case)

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2. THE L.L.C. a. Four characteristics:

1. limited liabilitya) All LLC statutes provide that members are not liable for the

debts of the LLC. However, LLC statutes do not protect members from liability for agreed contributions and excessive distributions, for memebers’ own wrongs, or for debts that members contractually assume or guarantee. i. ex: Nancy and Joe form an LLC. Nancy, while

driving the co. truck, runs over someone. LLC and Nancy are liable, but not Joe.

2. partnership tax features3. chameleon management:

a) Member managed v. manager managed1. Member managed (direct management)– similar to a

partnership . 2. Manager managed (centralized management)–

similar to a corporation.4. creditor protection provisions – in many ways weaker than a

partnership.a) piercing the veil is available to creditors even though it is an

LLC. Hard to pierce because LLCs do not usually keep records. i. Based on equitable and common sense principles

b. Buy/Sell Agreement1. Without this, the value of your interest in the LLC falls drastically2. A response to a “no market” situation where you cannot readily sell

your interest because no one wants to be involved if they are just an assignor with no vote. a. Someone who gets a member’s interest in an LLC is called

an assignor. This person has no vote, but is entitled to distributions.

3. The law deals with partnerships by providing for forced buyouts. LLCs have nothing in law to deal with these problems. Ex: where one member dies and his wife becomes the assignor. She will have no vote and will get angry. A bad situation

4. May take the shape of:a. redemption agreement – sale of the interest back to the

entity.1) A capital gain to the member/shareholder

b. cross purchase agreement – sale of the interest among/between the members/shareholders

5. The buy-sell agreement is a contract, it is not optional.c. Most LLC statutes require at least two members. However, LA does not

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have this requirement.d. Filing

1. Although not as formal as a corporation, must file articles of organization.

2. Operating agreement – without this the default provisions of the statute prevail.a. In Louisiana, this can be oral also.

3. Louisiana Statutes- (§1301 - §1369)1. Definitions §1301

a. LLC – an entity that is an unincorporated association having one or more members which is organized and exists under the LLC statutes.

b. Membership interest – a member’s rights in an LLC, collectively, including the members’ share of the profits and losses of the LLC, the right to receive distributions of the assets, and any right to vote or participate in management.

c. Operating agreement – can be any agreement, written or oral, ofthe members as to the affairs of the LLC and the conduct of its business.

2. Purpose §1302 - Don’t have to state a specific purpose in AOI = just state a general purpose. “for any lawful purpose.”a. cannot have one for banking or insurance or any heavily regulated

industry.3. Powers §1303 -

Powers are not limited – perpetual existence

4. Formation §13041. 1 or more persons2. File Articles of organization w/Secretary of State (corp files papers

w/secretary of state and recorder of mtgs)3. File Initial report with Secretary of State also4. File affidavit of agent of service of process with Secretary of State5. Must pay fee to Secretary Of State

1. If everything cogent and paid secretary of state shall file2. If you get a certificate back that is conclusive that you are an

LLC. Attny should advice his client to wait to operate until receive certificate otherwise there may be a lot of malpractice suits.

3. HYPO: 2 people want to form Business. You recommend LLC. Secretary Of State puts it in the wrong file and the members are out conducting business. What happens? Don’t know b/c no case law but look at Corporation law for analogy:(1) De facto Corporation = the members are in good

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faith they thought there were a corporation and operated as such.

(2) ESTOPPEL ARGUMENT == people contracted w/you b/c they thought you were a corporation but really you weren’t. They are estopped from being sued b/c there would be no complaint otherwise.

5. Name §13061. Name must be distinguishable from other names

1. In Corporation name must not be deceptively similar to other names. Can still be sued if your name is accepted by the Secretary of State but is close to someone else’s.

2. Reserve the name before you organize b/c someone else might have the name and when you apply to Secretary Of State everything comes back to you.

3. Problem w/names that comes up w/Corporation law. 1. ACME repair Company Inc. is the name registered

w/Secretary Of State but use trade name ACME fast repair in everyday business. Creditor sues b/c thought he was doing business w/partner b/c Inc. was not in name. Prof says court might say you had a name and didn’t use it so we are going to treat you as a P.

6. Transferability of Membership interest1. Membership interest =

1. member’s rights in an LLC, collectively, including (1) the members share of the profits and losses of the

LLC, (2) the right to receive distributions of the LLC assets and (3) any right to vote or participate in management

(1) default rule: if don’t say anything each member has 1 membership interest and 1 vote. 1) So in ARTICLES OF ORGANIZATION

disclose that each unit shall have share in profits and loses = to contributions and # of votes = to units

2. Most 3. Analogous to stock certificate and ownership interest in a

corporation. If you lose certificate you don’t lose your ownership interest.

2. Most people want a certificate of membership interest. So you can create a certificate of membership = name, date, signed, w/# of units.

3. Transferability of membership interest in LLC is not as flexible as in corporation. 1. What might happen if member tried to sell that certificate to

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another. Put on face of certificate that these units are restricted by ARTICLES OF ORGANIZATION right to encumber, alienate etc and whatever limitations are set out in ARTICLES OF ORGANIZATION ie. They must be offered to members first. (Corp law: to limit sale of certificate, must be put on the face of the certificate)

7. Who?1. Non-resident aliens can’t be partner in LLC.

8. Documentation- Articles of Organization- Initial Report- Affidavit of acceptance of agent for service of process- operating agreement1. Articles of Organization - §1305

1. Must be in English2. Shall be executed by at least person (who need not be a

member or manager)3. Articles Of Organization shall be acknowledged (authentic

act) by the person or one of the persons who signed the Articles Of Organization

4. Shall be filed w/ Secretary Of State5. The Articles Of Organization shall set forth:

(1) Name of LLC(2) Purpose formed.

2. Initial Report §1305e1. Shall be signed by each person who signed Articles Of

Organization or by his agent2. Shall set forth the following:

(1) location and address the registered office of LLC(1) must distinguish registered officer from PPB.

(2) name and address of each Registered agent(1) must have at least 1 registered agent.

(3) a notarized affidavit of acknowledgment and acceptance signed by each of its registered agents

(4) names and addresses of the first managers. (If not yet decided must file a supplementary report)

3. Affidavit of acceptance of agent for service of process1. Purpose: person go to to sue2. Sign affidavit b/c you could just put anyone’s name down as

agent (1) w/signature you have an affidavit (statement sworn

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before a notary) of a persons agency acceptance4. Operating Agreement

1. Private agreement that need not be filed (analogous to P agreement)(1) any agreement written or oral (does not have to be in

writing but it is advised that you put it in writing)(1) REMEMBER: can’t have oral PIC. Must be in

writing and file w/ Secretary Of State. I want to be limited partner and only want to put up $100K. Although he wants to be limited partner its not b/c its not in writing.

2. What should be in the drafting of OA?(1) Don’t put anything about power unless you want to

limit power. (2) Voting

(1) expelling a member(2) transferability of assets.(3) Issue units of beneficial interest or membership

units for every $ you put up. Then voting of each member is based on each unit of membership interest. 1) good for planning b/c if successful in

future you could give away some of those units

(3) Fiduciary duty (1) make clear what members are giving up to

form LLC1) ie. What are the duties of a member

who specialized in R/E. Can he buy another building for himself

(4) Transferability of ownership(1) do you want to limit transferability(2) put it in AOI and OA.

1) puts people on notice(5) Moral turpitude

(1) sexual harassment, alcohol(6) Triggering events

(1) bankruptcy, death, interdiction, criminal conviction, disability, losing license

(7) General Cause. (8) Buy/Sell agreement

(1) valuation formula1) how do you come up w/a formula that

fairly values the LLC1) adjusted BV

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2) tri-parte appraiser9. Amendment of ARTICLES OF ORGANIZATION - §1309

1. Articles Of Organization must be amended when any of the following occur:1. Change in the name of LLC2. False erroneous statement in Articles Of Organization3. Members desire to make a change in any other statement in

the Articles Of Organization in order to accurately represent their agreement.

10. Liability of members vs. Liability of SH1. §1320 LLC

1. No member, manager, employee or agent of LLC is liable in such capacity for debt, obligation or liability of the LLC

2. A member, manager, employee or agent of LLC is not a proper party to a proceeding by or against a LLC, except when the object is to enforce such a person’s rights against or liability to the LLC

3. Member can be liable when breach of professional duty = (1) commit personal tort(2) personal contracts and guarantees(3) veil piercing(4) acts as agent under agency law and exceeds scope(5) fraud

2. RS 12:93 Corp1. A SH of corp organized after 1/1/29 shall not be liable

personally for any debt or liability of the corporation. 2. When can a SH be liable for Corporation liability

(1) Piercing corporate veil (1) co-mingling of assets and can’t distinguish

between corporate assets and owner assets. Owner starts taking $ out of register and using it for his personal use.

(2) Siphoning - bled the corporate dry and end up bankrupt

(3) Under capitalized - not enough $ to start corp but you do anyway and go belly up

3. Corporation/LLC = 1. We need to look to corporation law to see when we can

pierce the corporate veil and hold members liable2. Entity is ALWAYS liable. 3. Members are at least liable to what they contributed to the

LLC (same as SH).

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- Question will corporate law apply to LLC? Some say that here language of LLC is stronger

11. Management and Voting1. Management by members and by non-members §1311 and

§13121. If you don’t say anything about management in ARTICLES

OF ORGANIZATION the members will manage.2. If you want members to appoint management, put it in the

ARTICLES OF ORGANIZATION. 3. In ARTICLES OF ORGANIZATION or OA may prescribe

qualifications for managers. 4. The number of managers shall be specified in or fixed in

accordance w/ARTICLES OF ORGANIZATION or OA

2. Elections & removal of managers §13131. elections of managers shall be by plurality vote2. any or all managers may be removed by a majority vote of

members with or without cause, at a special meeting expressly for that purpose(1) notice tells you what the special meeting if for(2) notice time, place and purpose.

3. Duties of members and managers §13141. A member as management or nonmember as management:

(1) shall be deemed to stand in fiduciary duty(1) discharge duties in gf, diligence, care,

judgment and skill which an ordinary prudent person in a like position would exercise under similar circumstances and in a manner reasonably believed to be in best interest of LLC. (This statute if literally read says members owe fiduciary duty in all aspects of the business)1) CAN WAIVE FIDUCIARY DUTY, if there

is a provision in ARTICLES OF ORGANIZATION

2) if waive fiduciary duty the members are not liable.

(2) Also there is exculpatory clause of fiduciary duty 1) when member/manager makes a

decision in gf and no conflict of interest; rationally believing its in best interest of company.

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2) Someone doesn’t come to meeting to vote.

(3) Notwithstanding part A, a member/manager is not liable to LLC for $ damages unless he acted in grossly N manner (A talks about ordinary care)1) grossly N manner - acts with reckless

disregard or carelessness amounting to indifference.

2) ONLY get these protections if he doesn’t have conflict of interest

(4) in claiming breach of duty of care has burden of proving that member or manager is liable

(2) Corporation = fiduciary duty(1) SH don’t ow fiduciary duty to corporation(2) Prof. says if members are passive investors

shouldn’t they be analogized to corporation SH who have no fiduciary duty

2. Record Reliance Defense: A member/manger shall be fully protected in relying in fg upon the records of the LLC when reasonably believes such reports are w/in such other person’s professional or expert competence and which person is selected w/reasonable care by members, managers, any committee thereof, or any agent

3. Member/manager shall account to the LLC and hold as trustee for it any profit or benefit derived by him, w/o the informed consent of a majority of the uninterested members, in accordance w/12:1318(C), from any transaction connected w/the conduct or winding up of the LLC or from any personal use by him of its property

4. Limitation of Liability and indemnification of members and managers §13151. If member/manager does wrong , is sued, and is liable,

company or insurance may indemnify you (in ARTICLES OF ORGANIZATION or OA) when (1) breach of fiduciary duty(2) penalties, fines, expenses incurred b/c he is member.

(1) DOES NOT INCLUDE intentional violation of a criminal law. 1) infers that if you violate criminal law

unintentionally you could be indemnified (2) Danger of indemnification; those who are

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responsible will do wrong things knowing the company will indemnify

5. Voting by managers §13161. (Unless agreed otherwise) If LLC has ore than one manager,

each manager shall be entitled to a single vote on all matters properly brought before the managers , and all decisions of the managers shall be made by majority vote of the managers

6. Agency power of managers or members §13171. Each manager (member or nonmember) is a mandatary of

the LLC for all matters in the ordinary course of its business NOT INCLUDING alienation, lease sale of immovables, unless agreed otherwise. UNLESS such person lacks authority to act for the LLC and the person w/whom he is dealing has knowledge of the fact that he lacks authority (unless agree otherwise)(1) NO Apparent Authority: persons dealing

w/managers shall be deemed to have knowledge of restrictions on authority of such manager contained in written OA if the ARTICLES OF ORGANIZATION contains a statement that such restrictions exist. (Constructive knowledge)(1) This is an attempt to do away w/Apparent

authority. 1) So can’t claim that he Principle

member emanated apparent authority and thus he relied. If it is in ARTICLES OF ORGANIZATION that member/manager has no authority, is put on notice

(2) Prof says might circumvent this rule w/equitable estoppel

(2) Certifying official: persons dealing w/LLC may rely upon a certificate of any person name in the statement to establish the membership of any member, the authenticity of any records of LLC or the authority of any person to act on behalf of the LLC. (1) what happens when there is conflict in

ARTICLES OF ORGANIZATION and OA both saying manager has no authority but certifying official gives him authority to borrow $ = conflict1) Prof. thinks the certifying official should

trump.2) it could be fraud or it could be error.

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3) you may be able to hold manager liable for certifying authority when he shouldn’t

(2) what happens if bank knows that there is a limitation to borrowing on public record but still allows certifying official to borrow? By law banks can rely on certifying official.

(3) How to cover your ass if you are contracting w/LLC:1) Look at public record of ARTICLES OF

ORGANIZATION2) Ask for OA (b/c its private), and 3) get a Certificate which provides:

1) who is managers,2) authenticity of managing

agreement and 3) who can sign agreement.

4) to cover your ass get all of managers to sign (or power of attny someone acting for them), then have them personally warrant that they have authority complete the transaction and have them certify that they will indemnify.

2. Who are the agents of Corp and LLC(1) Corp:

(1) Agents: officers (Pres./VP); Employees(2) management: directors; SH

(2) LLC(1) Agents: members/managers.

1) no distinction btwn passive investors (like SH in Corp) and active managers

7. Voting rights of members §1318 (default rule)1. Each member can case 1 vote

(1) All decisions of MEMBERS shall be by majority vote of the MEMBERS:

(2) Majority vote of MEMBERS required to approve the following matters(1) dissolution and winding up of the LLC(2) sale, exchange, lease, mtg, pledge or transfer

of all or substantially all of the assets of LLC(3) the merger or consolidation of the LLC(4) the incurrence of indebtedness by the LLC

other than in the ordinary course of business(5) The alienation, lease, or encumbrance of any

immovables of the LLC(6) An amendment to ARTICLES OF

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ORGANIZATION or OA.

- Remember managers are elected by plurality- Managers are removed by majority

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2. No contract between LLC and one of its members shall be void or voidable solely b/c the interested member/manager was present at or participated in the meeting which authorized the contract or b/c his vote was counted if:(1) the material facts as to his interest and to the contract was

disclosed or known to the members, was approved by majority w/o counting the interested member or

(2) the contract or transaction was fair to the LLC as of the time it was authorized, approved or ratified.

(3) Interested members may be counted in determining the presence of quorum which authorized the transaction.

3. Prof: dangers of how LLC voting is set up(1) the LLC does not have to have the formality requirements

associated w/meeting and minutes the corporation has (BOD meeting and minutes)

(2) no notice, quorum or record requirements (put in OA)(3) statute doesn’t talk a/b vacancies. (4) your voting is not tied to your financial stake unless you change it(5) agency law is still in effect.

12. Finance (§1321 - §1323)1. The statute does not mandate the contribution of capital.

1. Prof: its hard to find a mandatory contribution but b/c the statute talks a/b the form of capital, this might imply that contribution of capital is mandatory. (1) The contribution of a member to LLC may take the form of §1321

(1) cash, (2) property, (3) service rendered or (4) promissory note or(5) other binding obligation to contribute cash or property

2. Prof.: I’d put up capital b/c what would happen if you later claim to be a member but never put up anything. They could argue that you did not comply w/the statute. (1) Morris & Holmes - it is implied that member should put up capital

- P don’t have to make a contribution to capital- Corporation: you must make a contribution to capital. In corporate law you can’t give a promissory note as a contribution to capital

2. Liability for contribution §13221. Must be in writing (oral promises to contribute to LLC are not allowed)

(1) Suppose a person orally promises to put up $ but never does and company has accrued $100K in capital. It is possible that b/c he has not contributed, he may have to give back everything he has

earned b/c §1321 implies that you must contribute capital. 2. OA does not have to be in writing but must be in writing if 1322(B) is going

to apply. (1) If a member does not make the required contribution of property or

services, he or his personal representative is obligated, to contribute cash equal to that portion of value of the state contribution which has not been made or forfeit his entire membership interest.

(2) Unless otherwise agreed in OA, the obligation of member to make a contribution may be discharged by unanimous consent of members. (1) Death, disability or other reason does not discharge the debt

unless agree otherwise(3) a Creditor of LLC who extends credit may enforce the note if

company discharges the debt, by showing he relied on the note for payment. (1) However if creditor lent money after forfeiture of note he

cannot enforce the note. After the forfeiture the creditor has no rights

(2) If extended credit before forfeiture, creditor must prove reliance. 1) what will happen is that the LLC will look at the

situation of partner and compromise it w/o telling creditor thus forcing creditor to prove reliance

(3) To prove reliance, prove note due was on F/S1) to protect creditor in this situation make all members

guarantee the debt. Thus executor can’t claim it has 1st right or members can’t reliquish members debt to LLC.

(4) a succession representative can beat creditor out of right, so if succession rep gets to the right first then succession rep has to pay all creditors out of that

- ULLCA - creditor who extends credit can bring an action to enforce no matter when. More favorable to creditors- LA written in favor of debtors,

3. Sharing of profits and losses §13231. Unless you say something in ARTICLES OF ORGANIZATION & OA about

profit/loss distribution, it will be divided equally.(1) The statute does not say that members have to contribute capital

but absent an agreement members share in losses equally (the statute talks about paying debts to 3rd parties but don’t have to make capital contribution = discrepancy) (1) Prof: put in OA that each person bears his/her share of

capital losses.

13. Rules against Distribution (§1324- §1328)1. If the company makes money, but there is no distribution the members still have

to pay taxes on the distribution. All members have to agree to distribution and they all may not agree.

2. Need authorization for interim distribution §13243. A withdrawing or resigning member is entitled to receive distribution.

1. LLC for a term - member may w/draw w/o the consent of other members prior to the expiration of the term, needs just cause arising out of another member’s failure to perform an obligation

2. LLC w/no term - member may w/draw upon not less than 30 days prior written notice filed w/SECRETARY OF STATE and delivered to each member

3. W/drawing members are paid FMV of member’s interest. (1) very important in OA to outline FMV formula

4. Restrictions against distribution in LLC(§1327)1. No distribution may be made if LLC could not pay debts in usual course of

business; can’t pay your debts as they accrue (bankruptcy in the equity sense)(1) Corporation definition of insolvency = inability of a

corporation to pay its debts as they become due in the usual course of business.

(2) Total assets are less then total liabilities (bankruptcy in the federal bankruptcy sense) (biting provision of preferred - must pay preferred members first)

(3) Distribution would be contrary to any restrictions contained in the articles.

2. Restrictions against distributions in Corporation (dividends)(1) The BOD may pay dividends out of surplus except when

(1) Insolvent (equity insolvency)(2) Corporate assets exceed liability (3) biting provision of preferred

3. Protection on those who declare a dividend. (1) Reasonable use of financial statements prepared on basis of

accounting practices. (2) don’t need to make allowance for depletion or amortization of cost

of assets Oil and gas when asset intended for sale in the ordinary or usual course of business with limited life, (such as a lease for a term of years or patents or Oil ad gas properties)

(3) Proper allowances must be made for depreciation and depletion sustained and ascertained.

(4) deferred assets and prepaid expenses shall be considered as assets only to the extent of amount thereof not amortized (1) deferred asset = prepaid expense.

1) matching proper period income w/proper period expenses

(2) ie. If pre-pay insurance for 3 years worth $30K, amount must be reduced by $10K per year. 1) you can’t write off $30K in the first year that is

improper matching. (5) May include in the calculation of depletion in oil and gas = drilling

costs of oil and gas wells even if not successful = intangible costs = something you pay for but can’t touch it. (1) ie. Oil co. pays geologist $50K to look over patch =

intangible cost. Intangible cost can be depreciated. (6) If don’t have to pay P&I unless make pay distribution. Then

payment of P&I is not included in liability section. (1) redemption or interest

1) give not to a member for his membership interest. When make a distribution must be solvent.

(7) Accrual(1) $30K insurance. Company says you don’t have to pay

insurance til the end of the 3rd year. 1st year you don’t pay cash but accrue $10K . So decrease income accordingly. By process of accrual you pay less taxes.

4. Measuring effect of distribution(1) effect of the distribution shall be measured as of the date upon

which the distribution is authorized (signing of payout) if the payment occurs w/in 120 days after the date of authorization or

(2) distribution shall be measured as of the date upon which payment is made if it occurs more than 120 days after the authorization. (1) if debt is payable w/in 120 days of authorization. Then just

look at the solvency as of the date of signing.

(2) If debt is payable after 120 days you have to be solvent when each payment is made in the future. Must gage solvency of LLC each time the note is due. Thus this debt is a subordinated position

5. Member has option in LA of letting himself out (unless says otherwise in OA)(1) Uniform Act - member can only get out where death or something

that keeps member from performing. Then the LLC has the option of letting him out. (1) So in LA creditor losses b/c debtor can let himself out.

6. HYPO: 3 people form LLC. Make a lot of money. What happens if a member dies? Heirs inherit but they can’t vote. So people who are operating the LLC are going to take big salaries and fringe benefits. So always put in OA.

7. HYPO: guy wants to retire and OA says pay FMV of investment. Pay 10 year note. 5 years later LLC has problems. What are the retired members rights - past 120 days measured if you solvent at time of distribution. The not subordinated to all outside investors to solvency of LLC. (1) How does retired member deal w/this? Make them get a bank loan

to pay you and then they can pay the loan back or get them to sign the back of the note (guarantee the note)

5. Liability upon wrongful distribution §13281. Only time member has to pay back the distribution is when the member

has been negligent or knowingly (intentionally) wrong. They are liable to LLC(1) Corporation: illegal dividend, officers and directors are personally

liable. They are liable to corporation, or SH or creditors or both

2. 2 statute of limitation for bringing suit for wrongful distribution.

14. Assignment of membership Interest1. There is no right of withdrawal

1. In Corp. can sell interest to another SH2. If sell interest in LLC to 3rd party, they are only assignee. They get no voting

interest. §13301. Assignee only receives distributions, share in profits and losses similar to

assignor. NO VOTING RIGHTS until he is admitted by unanimous consent of members. Until assignee becomes member assignor will continue to be member.

2. Until become a member, assign had no liability as a member solely as a result of such assignment

3. When assignee becomes member, also shall be liable for any obligations of his assignor to make contributions and to return distributions received in violation. However, the assignee shall not be obligated for liabilities unknown to the assignee at the time that he became a member.

4. Member who dies, or is incompetent his membership ceases and the member’s executor, administrator, guardian shall be treated as an assignee of such member’s interest in the LLC. (1) if a member is a corp and is dissolved, the member’s membership

ceases and the members legal rep shall be assignee. 3. To get around this:

1. in OA put rights of assignees of decedents heirs. 2. put a buy-out clause. Upon certain events the members will buy out.

4. Creditor can get individual members interest but shall only have the rights of an assigne of the membership interest. This is cheap piece of property

15. Dissolution1. Dissolved when:

1. Occurrence of events specified in ARTICLES OF ORGANIZATION or OA2. Consent of members3. Entry of decre of judicial dissolution.

(1) on application by r for member, any court may decree dissolution of LLC when it is not reasonably practicable to carry on the business in conformity with the ARTICLES OF ORGANIZATION or OA

2. Winding up §13361. pay all debts2. What’s left

(1) members and former members to pay liabilities for distributions(2) members and former members to pay return of their capital

contributions. 3. Must give notice of dissolution so creditors can make claims

Advanced Orthopedic - 1 member put up capital for another. When it came time for dissolution, the guy who had not paid said he put up his time and labor. That needs to be in writing. Court said you didn’t contribute anything either

16. Poore v. Fox Hollow Enterprises (Del. 1994)Facts: D (not a lawyer) drafted an answer to the P’s brief because he thought that he could represent an LLC without a lawyer, as was possible under the general partnership law. Holding: The underlying purpose of the rule prohibiting the appearance of a corporation by anyone other than a member of the Del. bar also applies to representation of LLCs.

17. Meyer v. OK Alcoholic Beverage Commission (ok ct app 1995)Facts: Meyer tries to have her retail liquor license transferred to her LLC. The D denied the petition and held that an LLC is not authorized to hold a retail liquor license. Meyer asserts that the prohibition is only for “corporations,” and the LLC is essentially a partnership which may hold such a license.Holding: the constitutional directives regarding retail liquor licenses, although they do not specifically prohibit an LLC from holding a retail liquor license, do, in spirit, prohibit the LLC because the limited liability makes it more like a corporation with respect to regulations.Rationale: the evident purpose of the law was the assignment of personal liability and responsibility for compliance with the liquor laws. The LLC’s limited liability thwarts the purpose of the statute.

FEDERAL INCOME TAXATION OF BUSINESS FORMS1. Basically, income for tax purposes is receipts minus expenses2. Partnership tax v. Corporate tax

a. Corporations are taxed as a separate economic entity. They have their own sets of rules and their own tax schedules.1) Tax structure is mildly progressive – additional income is taxed at

increasingly higher effective rate.

a) a tax structure is regressive if lower amounts of income are taxed at a higher rate that higher amounts of income. Ex: sales tax.

2) The effective rate of taxation on corporate income can never exceed 34% at any level of income up to 10 million, or 35% at any level at all.

3) Double taxation occurs when the corporation pays tax on its earnings, then the shareholders pay tax on the dividends distributed to them.

b. Individual Tax Rates – calculation of individual income taxes, once taxable income is determined, is similar to the method followed by corporations. However, in the case of individual taxation, there are a variety of profit related and personal deductions that may be claimed, or a standard deduction.1) Highest marginal rate today is 39.6%.

3. Capital Gains and Lossesa. Capital assets are assets held for profit-making or investment purposes and not

for personal use. b. today, the rate is 20% for capital assets held more than 18 months. Gives an

incentive to transmute ordinary income into long term capital gain in order to make the 25% rather than the higher rate on ordinary income.1) Short term capital gains are taxed at regular income rates.

4. Basis – the investment the seller of the property has in the property (the cost)a. in the case of property acquired by a gift, the basis in the hands of the donee is

usually the same as the basis in the hands of the donor – a substituted basis.b. in the case of property acquired by inheritance, it is generally the fair market

value of the assets on the death of the decedent – a stepped up basis.5. Adjusted Basis – basis of the property:

a. Plus capital improvements made by the sellerb. plus purchase commissions originally paid by the seller c. plus legal costs for defending or perfecting title, and so forthd. minus returns of capital, particularly depreciation claimed as tax deductionse. depletionf. deducted casualty lossesg. insurance reimbursements, and so forth

6. The amount realized – includes the cash received for the property on a sale (minus the selling expenses) or the fair market value received in exchange for the property.

7. Gain – amount realized minus the adjusted basis. If the adjusted basis is greater than the amount realized, the difference is the loss.

8. Sole proprietorship – reported on the proprietor's personal income tax return (1040 schedule C)a. The amounts allocated are based on the income calculations of the partnership

and not on the amounts actually distributed in cash or property to the proprietor or partner.

9. Partnership – pass through taxation which allocates the income or loss of the partnership among the individual partners in accordance with the partnership agreement.a. The amounts allocated are based on the income calculations of the partnership

and not on the amounts actually distributed in cash or property to the proprietor or partner.

10. S-Corporation – a tax election. a. Need fewer than 75 shareholdersb. no nonresident alien shareholdersc. no entity shareholdersd. only one class of stocke. the corporation files a return showing the earnings allocable to each shareholder,

who includes the amount in his personal income tax return.f. The amounts allocated are based on the income calculations of the partnership

and not on the amounts actually distributed in cash or property to the shareholders.

11. Tax Planning Strategiesa. accumulation bail out – accumulate as many assets as possible within the

corporation at the favorable corporate rates. Then the shareholders sell their stock at a high price. They end up paying the lower capital gains rate on the sale.1) Corporations can buy the stock with their massive amounts of retained

earnings2) BEWARE the constructive dividend

b. Tax deferral1) IRA – you only pay when you take the money out (then, presumably, you

are retired and your income is taxed at a much lower rate! )2) Tax free bonds – federal and state bonds3) Accelerated depreciation – double declining balance, sum of the years

digits. 4) turning ordinary income into capital gains.5) because companies generally have losses in the first few years, could be

a flow through entity for these yearsc. zeroing out – reducing taxable income to zero by paying out all earnings in the

form of tax deductible payments to the shareholders of the corporation.1) Dividends are not deductible, but salaries, rents, pensions, and interest

are.13. Publicly held limited partnerships (A master limited partnership)

a. has the general partnership interest traded on the public market.b. because these often have characteristics that are indistinguishable from a

corporation, the IRS will sometimes reclassify.14. Kitner regulations governing corporate character (as opposed to a limited partnership)

were ended by check the box provisions. Basic provisions of the check the box regs:a. Cannot be formed under state statute and be a pass through entityb. an entity that is not classified as a corporation and has at least two members can

elect to be classified for tax purposes as either a corporation or a partnership by making the election at the time it files its first tax return.

c. An entity that has only one member can be taxed as a corporation or as a sole proprietorship.

d. Cannot go back and forth without permission within five years.1) Conversion of a corporation to an LLC is a taxable event2) Not a taxable event to go from a partnership to a corporation

15. Now there is a per se rule that if a business has ownership interests that are publicly traded, that business will be taxed as a C-Corp, no matter what business is adopted.

16. Why adopt an S-Corp over an LLC?a. lawyers are comfortable with S-Corps and know the rulesb. Subchapter S is more easily understood by non-tax specialistsc. conversion to a partnership would result in a gaind. easier to go public with an S-Corp (LLCs would have to incorporate)

17. Final thoughts on LLCsa. limited liability is not much of a factor when you deal with creditors who make you

pledge your personal assets.b. the area where the most concern is in is tort liability. Usually hard to pierce the

veil in a corporation.

THE DEVELOPMENT OF CORPORATION LAW IN THE UNITED STATES1. corporations come from England

a. Can trace back to the universities of the middle ages that needed continuity of life.

b. But, the business corporation began as a joint stock company2. Old Common Law rules:

a. every shareholder had one vote, regardless of the amount of sharesb. no limited liability (main purpose was not limited liability, but to get a large

amount of capital under one management)c. One corporation could not own stock in another (Rockefeller broke this one by

buying off the New Jersey legislature – “best legislature that money could buy”) d. Liggett v. Lee – common law put restrictions on corporations for fear that they

would form monopolies, mistreat workers, etc. Limits existed on amounts of capital and the scope of business. 1) Judicially, this idea began to erode on the theory of implied powers. The

Jacksonville Ry. Case held that to build a hotel was a power implied in building a railroad.

3. In the United States, every corporation was granted by the legislaturea. Government feared corporations: accumulation of capital in the hands of a few

people.b. Of course, as all communists believed, corporations became corrupt.c. Now, we have a “race to the bottom.” States try to get more corporations by

regulating them less.1) DE has won the race. The weak-ass legislators (a.k.a. farmers) have no

clue what a corporation is, so they pass whatever the Delaware bar tells them to pass. Consequently, the state’s laws are very favorable to corporations. a) Additionally, the MBCA was written by a bunch of corporate

lawyers. No representation of other parts of the population.2) Internal rules doctrine states that a corporation that incorporates in a state

is governed by the rules of that state, regardless of where it does business.

3) Louisiana has followed Delaware’s lead and relaxed its corporations laws.

d. federal law has filled the vacuum of corporate law with things like anti-trust laws.1) since managers are the ones who write corporation laws, the government

needs to help things like the environment.2) Also need laws to protect shareholders who cannot help themselves.

e. Now we have separation of ownership and control in big corporations. A shift in capitalism.

FORMATION OF CORPORATIONS (Generally)

A. SELECTION OF STATE OF INCORPORATION

For small enterprises planning to transact business primarily in one state, the corporation should usually be incorporated in the state in which business is principally conducted. This is to avoid the fee and hassle of being sued in another state. For larger enterprises transacting business in many or all states, incorporation in any one of several states is usually feasible; incorporation in Delaware is attractive for these businesses.

B. VARIATIONS IN STATUTORY REQUIREMENTS AND NOMENCLATURE

1. To form a corporation, it is essential to comply with the specific statutory requirements of the state chosen for the state of incorporation. There is a surprising degree of uniformity and consistency in most modern statutes.

a. Most states only require a single filing with a state official. Some states also require a local filing in the county in which the registered office is located or a public advertisement in a newspaper of general circulation of the fact of incorporation.

b. Variations among the states exist with respect to filing fees, franchise taxes, stock issuance or transfer taxes, and similar items.

A. Filings Required for formation of La. Business Corporation:

The actual creation of a corporation is itself an easy and inexpensive task. All that is required for the creation of a Louisiana-chartered corporation is the filing of two or three simple documents with the office of the Secretary of State and the payment of a $60 filing fee. Whether two or three documents are filed depends on whether the registered agent's notarized affidavit of acceptance is made part of the initial report itself, or is attached as a separate document. If this affidavit is integrated into the initial report, two documents are required, the initial report and the articles of incorporation. If the affidavit is executed separately, then it must be filed along with the other two

documents. and a notarized affidavit of acceptance by the registered agent named for the corporation in its initial report. (See La. R.S. 12:25).

Under legislation enacted in 1999, the Secretary of State is authorized to accept facsimile and electronic filings. All references to multiple originals of documents have now been deleted from the corporate filing rules, to eliminate any suggestion that an "original," manually signed document is required for an effective filing.

B. Initial Report (La. R.S. 12:101)The initial report is simply a listing of the name (or for the registered office, the location) and the municipal addresses for (a) the corporation's registered office, (b) its registered agent(s) and (c) its initial director(s). This report essentially tells the public who initially has been given the power to manage the corporation and who in the state has the authority to receive service of process on its behalf. If the initial directors have not been selected by the time of incorporation, then that item may be left out of the initial report, and the corporate existence may be begun without it, but a supplemental report listing the initial directors is then supposed to be filed "as soon as they have been selected." The initial report must contain or be accompanied by a notarized affidavit by the registered agent indicating that he has accepted his appointment as agent.

C. INCORPORATORS

Articles of incorporation are executed by one or more persons called "incorporators." In modern practice, the principal function of incorporators is to execute the articles of incorporation and receive back the certificate of incorporation or receipt for the filing fee. They generally serve no other function.

The “Incorporators” under La. Business Corp. Act (See 12:24 B (7))

The articles of incorporation must state the full name and post office address of each incorporator. No practical reason exists to use more than one incorporator, but the statute does not restrict how many may be used. It provides that the incorporators may be any one or more natural or artificial persons capable of contracting. If an artificial person, e.g., another corporation, is an incorporator, it will need to have an authorized agent execute the articles in its name and on its behalf. In that case, a document authorizing the agent to execute the articles must be attached to the articles.

Although the client often acts as the incorporator of his new corporation, he need not do so. Indeed, the incorporator need not hold any particular relationship with the company to be formed, i.e., he need not be a prospective owner, director or officer. Indeed, secretaries and paralegals in law offices are commonly used as incorporators for the corporations being set up by the law firm for clients. This common practice creates no risk for the client, as the incorporator's only powers are to prepare, execute and file the articles and initial report, and to name the initial directors. The issuance of stock and the completion of the other steps required before the corporation is capable of engaging in business are handled by the company's initial directors. The client should not allow assets to be

transferred to the new corporation until he is satisfied that he is in control of the corporation as desired. But that can easily be accomplished without his acting as incorporator.

D. CONTENT OF THE ARTICLES OF INCORPORATION

1. Mandatory Requirements

a. State statutes traditionally require certain minimum information to appear in articles of incorporation: 1) the name of the corporation; 2) its duration; 3) its purpose or purposes; 4) the securities it is authorized to issue; 5) the name of its registered agent and the address of its registered office; 6) the names and addresses of its initial board of directors; and 7) the name and address of the incorporator or incorporators.

b. Virtually all corporations elect the duration to be "perpetual" and most elect their purpose to be "the conduct of any lawful business."

La. Articles of Incorporation (See La. R.S. 12:24)

The articles of incorporation are potentially much more important than the initial report. They do not list matters as easy to change as a registered office or a registered agent. Instead, they set forth the basic terms of the agreement among the shareholders of the new company concerning its nature, structure and governance. But like the initial report, the articles will be available for public inspection and must satisfy statutory requirements concerning their content and execution. This triple role for the articles, as a requirement of incorporation, as public disclosure and as private agreement, make the articles important. But the minimal statutory requirements for articles sufficient to form a new corporation are easy to satisfy.

The articles of incorporation of Louisiana corporation need state only five things: 1. Its name;2. Its purpose[s];3. The number of authorized shares;4. The par value of the shares, or a statement that the shares are no-par; and5. The name and post office address of each incorporator.

The statute also says that the articles "shall" set forth three other items: duration, classified-share terms, and the corporation's taxpayer identification number but those items really are not mandatory, as neither of the first two items needs to be included unless the normal rules are being modified, and the omission of the third item, the taxpayer number, does not invalidate the articles or give the Secretary of State grounds to reject them.

2. Discretionary Provisions

Elective provisions may be included in the articles of incorporation for a variety of reasons. State statutes provide that corporations may elect

to eliminate or modify specified rules of fundamental corporate governance by specific provision in the articles of incorporation.

Under the La. Business Corp. Act, the articles may include any number of optional provisions concerning the regulation of the business and the conduct of the affairs of the company, as long as they are not prohibited elsewhere in the corporate statute or in other laws. Provisions dealing with preemptive rights, powers of the corporation, it’s directors, or shareholders, liability limiting provisions are often provided at the discretion of the drafter.

E. THE CORPORATE NAME

A corporate name under most statutes must (i) contain a reference to the corporate nature of the entity, (ii) not be the same or deceptively similar to a name already in use or reserved for use, and (iii) not imply that a corporation is engaged in a business in which corporations may not lawfully engage. The Delaware General Corporation Law and the MBCA (1984) substitute the test of "distinguishable upon the records of the Secretary of State" for the "same or deceptively similar" test.

1. Name Uniqueness

The requirement that each corporation have a unique name is primarily to avoid confusion in such matters as sending tax notices and naming defendants in law suits. Statutes prohibiting the use of "deceptively similar" names may involve an unfair competition standard as well as name confusion. Ex: Bolivar, Inc. and Bolivar of Shreveport was enough to distinguish.

Corporate Name (See La. R.S. 12:23)

Choosing a corporate name will often prove to be the most difficult task facing the incorporator, for that is the one thing that must vary among the otherwise standardized articles of incorporation that may be used in establishing new corporations. The name of a new corporation must be "distinguishable" from the corporate names already registered or reserved with the Secretary of State, and from any trade name or limited liability company name already registered with the Secretary of State.

Under the distinguishability test, the required differentiation of corporate names has rather limited purposes. The differentiation is not designed to serve an unfair competition-related function; that is left to trade name and unfair competition laws. Rather, the corporate-statute name distinctions are designed merely "(1) to prevent confusion within the Secretary of State's office and the tax office and (2) to permit accuracy in naming and serving corporate defendants in litigation." The proper test for distinguishability, therefore, is confusion "in an absolute or linguistic sense," and not in relation to some assumed competitive relationship among the affected corporations or other name- users.

The required name differentiation means that the clerk who reviews the corporate articles when they are delivered for filing at the Secretary of State's office will not accept them if he or she believes that the name does not conform to the tests and rules established within the office for distinguishing names. If this happens, the prudent thing to do normally is to make up another name, and if the second name doesn't work, to keep trying new ones until one satisfactory to the clerk can be found. It may theoretically be possible to litigate the issue of distinguishability and to have a writ of mandamus issued requiring the Secretary of State to register the name. But it seems highly unlikely that a court would order the Secretary of State to register a name that the secretary's representatives testify would create confusion in the records of the secretary's office under the current distinguishability standard.

Other Requirements for Corporate Name (See LA. R.S. 12:23)

In addition to the distinguishability requirement, the Louisiana statute imposes three other requirements with respect to the naming a Louisiana corporation. First, the name must be expressed in English letters or characters. Second, it must contain within it the word corporation, incorporated, limited, or company, or an abbreviation of one of these four words. (Under this second requirement, if the word "company" is used in the corporate name, it must not be preceded by the word "and" or the symbol " & "). Finally, under the third requirement, the corporate name must not contain any one of a series of listed words, words that would create an erroneous impression about the types of businesses in which the corporation is permitted to engage, or words that suggest falsely or deceptively that the corporation is of a charitable or nonprofit nature.

The specific words that cannot be used lawfully under the provisions of the general business corporation law are: bank, banker, banking, savings, safe deposit, trust, trustee, building and/or loan [sic], homestead, insurance, casualty, redevelopment corporation, electrical cooperative, credit union, insurance, engineer, engineering, surveyor, surveying, architect, architectural or architecture.

2. Reservation of Name

An available name may be "reserved" for a limited period of time for a small fee. The reservation of a name permits the preparation of corporate documents, ordering of stationery, etc., with the assurance that the proposed name will be available if the articles are filed within the period the name is reserved.

Reservation of Name (See La. R.S. 12:23(G))

Anyone who "intends" to incorporate, to qualify an existing or prospective foreign corporation to do business in Louisiana, or to change the name of an existing business, nonprofit or foreign corporation, may reserve a corporate name that is not already registered or reserved. To reserve a name, the prospective registrant need only write a simple letter requesting the reservation of the chosen name, and enclose the required fee. Of course, it is always a good idea to phone ahead (or to check the Secretary of State's website to make sure that the name to be reserved actually is available, before sending in the written reservation request. And in most cases, if the name is confirmed as available over the phone or internet, it is just as easy to file the actual incorporation

documents as it is to file a name reservation. However, in those cases in which further negotiation or drafting is required to complete the incorporation documents, it may make sense to reserve an available name through the reservation of name mechanism.

A name reservation is good for sixty days, unless a shorter period is requested, and can be extended for two additional thirty-day periods for good cause shown. While a reservation remains in effect, it is possible to transfer it to others by filing a notice of the transfer, executed by the person for whom the name is currently reserved, and specifying the name and address of the transferee.

3. Use of Assumed Name

Corporations generally may adopt and do business under assumed names. If the state has an assumed name statute, the corporation must comply with that statute.

F. PERIOD OF DURATION

Statutes authorize the corporation to have "perpetual" existence = "indefinite."

Duration of the Corporation (La R.S. 12:24(4))

Although a statement of the duration of a corporation is listed as one of the items that the articles of a Louisiana corporation "shall" contain, it really is not mandatory, as a statement of duration is required only if the corporation is to have less than a perpetual life. As with the purpose clause, it is rare to see articles that vary from the norm, i.e., all-purpose, perpetual life, because a less generous provision provides little in the way of protection while posing significant risks.

In the case of the duration clause, the main risk is that the limitation on the life of the corporation will be forgotten, and that business will continue to be conducted on behalf of the corporation long after the life of the corporation officially ends. This type of unincorporated continuation of a business raises the specter of unenforceable contracts, confusion in the ownership of property, and personal liability for participants in the unincorporated business. The corporation statute does contain a provision that is designed to protect against that type of risk, permitting a retroactive amendment of the articles to extend the life of the corporation. But it still makes no sense to test the operation of this provision by inserting a limited duration clause.

Majority investors have no interest in such a clause because they can liquidate the corporation at any time through the exercise of their majority voting power. Minority investors might like to see such a clause included in the articles because it would require the liquidation of their investment at some determinable future date (assuming they had enough votes to block a term-extending amendment of the articles). As with the purpose clause, though, it usually makes better sense to deal with the minority investors' interests more directly and simply. The minority investors can be given individual withdrawal rights that will protect their own financial interests without also posing risks of unincorporated business operations and without requiring the liquidation of the entire company.

G. PURPOSES

Modern statutes authorize very general purposes clauses, e.g. "The purpose of the corporation is to engage in any lawful business." The nature of purposes clauses has evolved over a long period of time, reflecting varying attitudes of mistrust toward the corporation. They were formerly of much greater importance than they are today.

a. In the earliest general incorporation statutes, corporations could only be formed for a single specific purpose.

b. State statutes were modernized beginning in the early Twentieth Century to permit corporations to include a number of specific purposes clauses. Many persons forming corporations adopted the practice of including tens or even hundreds of specific purposes clauses routinely in every articles of incorporation. This practice quickly eliminated any significance the purposes clauses might have. The modern practice of allowing corporations to have the general purpose of engaging in any lawful business is a logical simplification of the practice of using multiple purposes clauses.

c. Today, there is little or no reason to have a purposes clause at all, and doctrines based on limited purposes clauses, such as ultra vires or implied purposes, have little modern relevance.

d. A limited purposes clause may be used today as a planning device or as a protection for investors or to appease a good old boy who wants to see his life’s work listed on the certificate. The effectiveness of such a clause is problematic at best.

Purposes Clauses (See La. R.S. 12:22)

The articles of incorporation must contain a purpose clause, but in most cases, the clause will be an all-purpose clause similar to this:The purpose of this corporation is to engage in any lawful activity for which corporations may be formed under the Louisiana Business Corporation Law.

More narrow statements of purpose are permissible, but they are rarely used in business corporations because they pose risks that exceed their potential benefits. The controlling persons of the corporation obviously have no interest in restricting their own power to cause the corporation to engage in any lawful activity they consider appropriate. But even from the standpoint of the minority investors, a narrow purpose clause is more likely to interfere in the desired operations of the corporation than it is to protect against serious abuses of managerial power.

The drafter of a narrow purpose clause faces the difficult task of describing the corporate purposes broadly enough to provide all of the desired corporate powers, yet narrowly enough also to provide the intended protections. And he must do this with the understanding that third party interpretations of his language are likely to differ from his own, whether or not he is "correct" in any objective sense. Indeed, regardless of what a court might eventually say a particular clause meant,

third parties, particularly lenders and other consensual creditors, could very well prove reluctant to deal with a narrow- purpose corporation in any transaction in which the power of the corporation was subject to the slightest question.

Those types of costs might be tolerable if narrow purpose clauses really provided important protections for minority investors, but they do not. Of all the things that a minority investor has to fear from the controlling persons of a corporation, manipulative changes in purposes are among the least important. Ordinary self-dealing and mismanagement are far more likely to cause problems. A minority investor certainly has good reason to be concerned about the weakness of his legal position in a corporation controlled by someone else, but he should not try to strengthen his position by imposing limitations on the corporation's scope of activities. Withdrawal rights, coupled with rights to information and to managerial participation, will work far more effectively than a narrow purpose clause in protecting a minority investor's interests in the corporation.

H. MINIMUM CAPITAL REQUIREMENTS

Most states today do not require any amount of minimum capital. However, the failure to capitalize a business adequately in light of its plausible liabilities may lead to application of the piercing corporate veil doctrine and personal liability of shareholders.

A minority of states require a new corporation to have a minimum capital, $1,000 being the most common figure. These provisions have less relevance than they did fifty years ago since no adjustment has been made for inflation.

Paid – In Capital requirement in Louisiana (12:26)

Before 1969, Louisiana corporations were require to obtain at least $1,000 in paid-in capital before they began to engage in business. The 1968 revision of Louisiana's corporation statute eliminated the mandatory paid-in capital requirement, but it retained a provision that attaches enormous importance to paid-in capital if a paid-in capital provision is includes in the corporation's articles of incorporation. No such provision needs to be included, but if it is, and the corporation begins business before the provision is satisfied, all the directors of the corporation and all the officers who participated in the transaction of business become jointly and severally liable for the debts of the corporation.

Practically, a paid-in capital amount should never be stated in a Louisiana corporation's articles, unless the corporation was formed before 1969. If a lawyer's form files contain articles with such provisions, they are old documents that need to be changed. No rational creditor cares what paid-in capital amount is stated in a corporation's articles, so such a provision produces no benefits that justify the enormous liabilities that a violation of the purely optional provision can create.

Number of Shares to be issued in Louisiana

Louisiana law imposes no requirements concerning the minimum or maximum number of shares to be authorized in a company's articles of incorporation, except for the implicit requirement that every for-profit corporation have at least at least one share of stock available for issuance. It is

not impossible, of course, to have a corporation without shareholders--nonprofit corporations may clearly be organized on a nonstock basis --but this type of no-shareholder organization does not fit the statutory scheme for business corporations.

Corporate articles often authorize the issuance of far more shares than the prospective owners of the corporation have any intention of issuing in the initial capitalization of the firm. The idea, apparently, is to provide plenty of "spare" shares for later issuance by the corporation's board of directors when the corporation wishes to raise additional capital. This approach is sensible for majority shareholders who have the power to elect the board, for it gives them the power to cause the issuance of additional shares when they wish. But for minority shareholders, the authorization of spare shares can be dangerous. It permits those in control of the board to dilute the percentage of shares held by the minority investors through the issuance of some or all of the spare shares to the majority investors or to their allies.

Classes of shares (See 12:24 B (6))

The articles of a Louisiana corporation need not contain provisions concerning classified shares unless shares of different classes are to be authorized for issuance. But if different classes of stock are to be created, § 12:24 B (6) requires that they be identified in the articles and that the authorized number and par value (or statement of no-par) of each be set forth in the articles. Beyond that, the statements of the relative rights and preferences of the various classes may be stated in the articles, or they may be left to future establishment by the board of directors, or a combination of both approaches may be used.

I. REGISTERED OFFICE AND REGISTERED AGENT

The registered office and registered agent at that office must be specified in the articles of incorporation. They provide a location where the corporation may be found and a person on whom process may be served.

K. CORPORATE POWERS

Every state statute lists general powers that every corporation possesses. They include such matters as the power to sue and be sued, to purchase, own, and sell real estate, to make contracts, to borrow money and guarantee the indebtedness of others, and so forth. Many of these specific provisions are designed to overrule earlier judicial decisions that corporations did not have power to enter into specific transactions.

1. General Policies

It is usually unnecessary and undesirable to list powers in the articles of incorporation, since any listing may be viewed as limiting rather than broadening and may give rise to a negative inference that the inclusion of

some enumerated powers implies the exclusion of unenumerated ones. If a corporation does an act which it does not have power to do, it is acting ultra vires.

2. Broad Purposes Statutes

MBCA (1984) and the statutes of many states provide that every corporation "has the same powers as an individual to do all things necessary or convenient to carry out its business and affairs" as well as a list of "general powers."

L. ULTRA VIRES

"Ultra vires" means beyond the scope of the powers of a corporation. It is used to describe acts that exceed either the stated purposes or powers of the corporation, and thus, cannot bind the corporation or shareholders.

1. The Common Law Ultra Vires Doctrine

The early common law view was that an ultra vires transaction was void since the corporation lacked the power to enter into the transaction. Over time this view softened, since the common law doctrine led to unfair and unpredictable consequences. 711 Kings Hwy Case.

a. Theodora Holdings v. Henderson (1969)Facts: Husband and wife owned a corporation. They split up. Husband ran the corporation and wife objects to his giving away money to charity. Tried to invoke ultra vires.Holding: Under the IRC, the IRS does not question a donation of 5% to charity. If the donation is within reasonable limits, it is not ultra vires.Rule: Charitable gifts of an excessive amount are ultra vires. To determine whether a charitable gift is reasonable, the court can look to federal income tax law.1) Hypo: CEO’s brother wants to buy a car. CEO signs the

loan for him. This is ultra vires because it is not related to the corporation. (loans to insiders are ultra vires.)

2. Modern Practice and Rules

Modern practice and rules have greatly reduced the importance of the ultra vires doctrine: (i) the use of multiple purposes clauses and "any lawful business" purposes clauses; (ii) the broadening of the statutory powers of corporations; (iii) acceptance of a broad power to amend

articles of incorporation; and (iv) enactment of special statutes dealing with ultra vires transactions.

Three areas where the courts misapply ultra vires:1) when the corporation is involved in a prohibited act. 2) When an agent exceeds authority3) Failure to follow proper procedure, such as things stated in the

bylaws.

3. Louisiana’s Treatment of the Ultra Vires Doctrine LA R.S. 12:42

No act of a corporation, and no conveyance or transfer of movable or immovable property to or by a corporation, shall be invalid by reason of the fact that the corporation was without capacity or power to perform such act or to make or receive such conveyance or transfer; unless the claim is asserted:

(1) In an action by a shareholder against the corporation to enjoin the performance of any act or the transfer of movable or immovable property by or to the corporation;

(2) In an action in damages by the corporation or by its receiver, trustee or other legal representative, or by its shareholders in a derivative or representative suit, against the incumbent or former officers or directors of the corporation;

(3) In an action by the state to dissolve the corporation, to enjoin the corporation from the transaction of unauthorized business, or to revoke a certificate of authority of a foreign corporation.

4. Modern Areas of Ultra Vires Concern

Ultra vires issues may continue to arise in some states on certain limited issues, for example, whether the corporation may make political contributions, engage in lobbying to influence legislation, make large charitable donations that appear to provide no benefit to the corporation, guarantee indebtedness of others that provides only incidental benefit to the corporation, and make loans to its officers or directors. State statutes in many states grant every corporation the express power to enter into some or all of these acts.

5. Power to be a Partner in a General Partnership

All states permit a corporation to be a general or limited partner in a partnership and to be a member of a limited liability company.

M. COMPLETION OF THE FORMATION OF THE CORPORATION

Formal execution of Documents (See 12:24/25)

Both the initial report and the articles of incorporation must be signed by each incorporator either personally or by an agent duly authorized by a document (a power of attorney) attached to the

report and/or articles, as appropriate. In addition, the initial report must contain or have attached a notarized affidavit of the registered agent stating that he has accepted his appointment as agent, and the articles of incorporation must either be executed by authentic act or they must be acknowledged by at least one of the persons who actually signed them. A multiple original of the articles may be filed in satisfaction of the filing requirement for the articles.

Corporate Existence (12:25(C))

Louisiana law contains a rather unusual, but very useful and sensible, provision that causes the corporate existence of a new corporation to begin immediately upon the proper execution of the articles of incorporation, before they are filed with the Secretary of State, as long as the articles are then filed with the Secretary of State within five days, exclusive of legal holidays, of their execution. Otherwise, corporate existence begins as of the time that the articles were filed. Besides the five-day relation-back provision, Louisiana law also permits a delivery of the articles to the Secretary of State up to thirty days in advance of the date that the articles are to be filed and the corporate existence to begin.

Parish filing in Louisiana (12:25(D))

Louisiana is among the minority of American jurisdictions that require a filing of the incorporation documents in some local office in addition to the central filing that must be made in the Secretary of State's office. In Louisiana, this filing must be made in the office of the recorder of mortgages for the parish in which the registered office of the corporation is located. The filing must be made within thirty days after the filing of the articles with the Secretary of State and must consist of a copy of the certificate of incorporation and a multiple original or a copy certified by the Secretary of State of both the articles of incorporation and of the initial report.

The statute does not deal directly with how the corporate existence is to be affected by a noncompliance with the local filing requirement. But because the local filing need not occur until thirty days after the issuance of the certificate of incorporation, and indeed must include the certificate of incorporation, the conclusive effect of the certificate under § 12:25 B should be sufficient to override any local filing defects, at least outside actions by the state to set aside the corporate franchise.

The statute does provide a monetary penalty for failure to satisfy the local filing requirement. Under § 12:172 A, any corporation that fails to comply with the local filing requirement within fifteen days of a written request by the Secretary of State to do so is subject to a penalty of fifty dollars for every day the corporation fails to comply. The penalty is recoverable in a civil action brought by the Attorney General or by the district attorney of the parish in which the registered office of the corporation is located, and is recoverable for the use and benefit of the State.

Legal effect of certificate issuance in Louisiana (12:25(B))

If the Secretary of State finds that the articles, initial report and fee delivered to him satisfy the requirements imposed by the business corporation law, then he must record the two documents, stamp them with the date, and if requested, the hour of filing (in practice, both the date and time are routinely stamped on the documents), and issue a certificate of incorporation. This certificate is deemed to be conclusive evidence of the due incorporation of the new company, except in

proceedings brought by the state to set aside the corporate franchise. In light of how little the articles have to say to conform to the statutory requirements for incorporation, attacks of this kind by the state are likely to be rare, for a company whose charter was being challenged could simply fix the problem and refile even before the first filing could be invalidated.

1. Additional Steps for Corporate Lawyers

Lawyers are expected to complete the formation of the corporation. Steps include:

a. Prepare bylaws;

b. Prepare minutes of the various organizational meetings, including waivers of notice or consents to action without formal meetings where appropriate;

c. Obtain blank share certificates and make sure they are properly prepared and issued;

d. Prepare shareholders' agreement, if any;

e. Obtain taxpayer identification numbers;

f. Open a bank account for the corporation;

g. Determine whether the S corporation tax election should be made, and, if so, make that election;

h. Make sure the directors and officers understand the nature of their duties and responsibilities.

2. Consequences of Failure to Complete Formation

The consequences of a partial formation of a corporation usually arise in the context of a suit against officers, directors, or shareholders seeking to hold them liable for an obligation incurred in the name of the corporation. A number of cases hold that no personal liability is created so long as articles of incorporation have been properly filed. If personal liability is imposed despite the filing of articles of incorporation, the result is likely to be analyzed as a case involving:

a. Promoters' liability (Premature commencement) 1. A promoter who operates for a corporation to be formed is personally

liable for all the debts. O’Rourke v. Geary – cannot be an agent of a non-existing principal.

2. Promoters do four things:a. discover a business opportunityb. assembles capital and management necessary to start the

business.c. executes binding contractsd. arrange for the formation of the corporation.e. operations

3. Promoters are essential to a business operation—they assist in putting together a new business.

4. The promoter owes fiduciary duties to the other participants in the venture. See Post v. United States.

5. The promoter also owes fiduciary duties to foreseeable third party creditors; which may protect them against unfair or fraudulent transactions by the promoter. See Frick v. Howard. These suits are based on the theory that the promoter converted corporate assets to their own use in fraud of creditors.

6. According to the "Massachusetts rule" the corporation may attack an earlier transaction if a subsequent sale to investors was contemplated when the earlier transaction was entered into.

7. In Old Dominion Copper Mining Co. II, the court applied the Massachusetts rule, & found that both the corporation & subsequent investors could attack the excessive land-sale contracts previously entered into by A & B. At the time A & B sold the property to the corporation for twice its market value, they were the sole shareholders of the corporation, but the sale to investors was contemplated at the time of the land-sale. The public investors were unaware and uninformed of the fraudulent transaction.

8. In Old Dominion I, the court applied the less popular "federal rule" and found that, under the same facts, the corporation could not attack the earlier transaction since "there were no members of the corporation who were not informed of the facts at the time of the fraud, & corporate assent was therefore given with full knowledge of the transaction.

9. How & Associates Inc. v. Boss (1963):Facts: P seeks to collect remainder of architect fees from promoter of “to be named corporation” for “services rendered before abandonment of construction contract.” Corporation was never formed and does not have assets to pay him.Issue: Whether the promoter is personally liable for the non-existent corporation’s debts?Holding: Promoter acted for himself and as president of the “to be named corporation.” This makes the promoter liable unless the contract were construed to mean: (a) that the P agreed to look solely to the new corporation for payment or (b) that the promoter did not have any duty toward the P to form the corporation and give the corporation the opportunity to assume and pay the liability.

Rule: stating that the corporation “to be named” will be the obligor is not enough to offset the rule that the signatory for the non-existent corporation is normally personally liable. a. All ambiguities will be resolved against the promoter. O’Rourke.b. Rstmt of Agency §329 – A person who purports to make a

contract on behalf of another becomes subject to liability to the other party thereto upon an implied warranty of authority unless he has manifested that he does not make such warranty, or the other party know the agent is not so authorized.

c. Rstmt of Agency § 330 – a person who tortiously misrepresents to another that he has the authority to make a contract on behalf of a principle whom he has no power to bind is subject to liability in action of tort for loss caused by the reliance.

d. Rstmt of Agency § 331 – promoter is excused from liability if he sufficiently manifests that he does not warrant his authority and makes no tortious misrepresentation.

10. Quaker Hill, Inc. v. Parr (1961):Facts: P sells nursery stock to a corporation to be formed by Parr and Presba. At the urging of P’s representative, the contract is entered into in the name of the to be formed corporation with Parr signed as president, even though P’s representative knows that no corporation has been formed. Holding: Parr and Presba are not personally liable.Rationale: Ps were well aware that the corporation was not formed at the time of the contract formation. P, by its conduct, clearly indicated its intent to look for payment from the “to be formed corporation.” Rule: there is an exception to the general rule of personal liability of promoters where the contracting party is shown to be looking solely to the to be formed corporation for payment, and not to the promoters.a. Most courts put burden of proof on promoter. This was a

sophisticated creditor. 11. McArthur v. Times Printing Co. (1892):

Facts: Promoter for D hired P as an advertising solicitor for the period of October 1 to October 1 of the next year, for a corporation that was not organized until October 16. none of the directors or shareholders of the corporation objected to P’s employment and retained him without a new contract between him and the organized corporation.Holding: It is not necessary for express adoption by the corporation – may be inferred from the acts of acquiescence by the corporation or its agents.Rule: whether or not the contract was formally adopted by the BOD, the corporation has adopted the contract and is bound by it. It is therefore, liable for breach of the employment contract. a. Normally a newly formed corporation may accept or reject all pre-

incorporation contracts; they are not automatically liable on promoters’ contracts. Exceptions: 1) novation – corporation enters a new contract

2) adoption – express or implied (the case here)3) acquiescence – directors knew about the contract and made

payments.4) estoppel – equity principle where contract has been heavily

performed.5) ratification - doctrinally flawed in this context since the

corporation was not in existence when the pre-incorporation contract was entered into. a) Ratification assumes that the principal was in

existence when the agent entered into the unauthorized contract; hence, when a principal ratifies a contract it is deemed bound on the contract from the time the contract was originally entered into.

b) Adoption, however, does not date back6) Are corporations bound to pay attorney's fees that the

promoter incurred? Attorneys should demand the fees up front or contract personally with the promoter.

b. Defective Incorporation

1. Robertson v. Levy (1964):Facts: P and D entered into an agreement whereby they were supposed to form a corporation that would by the P’s business. Articles of incorporation were rejected by the secretary of state, so the unincorporated association assumed a note. The articles were later cured and properly filed. The corporation went under within six months, but before that, they paid an installment on the note, which the creditor accepted. But, P sued D personally for the balance due on the note. Issue: Can the president of the unincorporated association can be personally liable where the corporation was later formed and paid on the note?Holding: D was personally liable because the issuance of the certificate is conclusive as to corporate existence. §139 of the MBCA provides that all persons who assume to act as a corporation without authority to do so shall be jointly and severally liable for all debts arising as a result thereof.Rule: subsequent partial payment by a corporation does not remove the individual liability for defective incorporation. No limited liability before a certificate of incorporation is properly filed.a. Some courts read this as a bright line rule, others examine on a

case by case basis. Judge here gives a simple answer rather than a just answer.

2. A de facto corporation is one that has been defectively incorporated. The supreme court has stated that the requisites for a de facto corporation are:a. a valid law under which a corporation can be lawfully organized.b. an attempt to organize thereunderc. actual user of the corporate franchise

d. good faith1) Rousseau thinks that this makes more sense than the mechanical

rule of Robertson. Apply this de facto test if there is no certificate of incorporation.

2) Louisiana recognizes de facto corporation; thus, our statute does not mimic the MBCA §§50, 139. a) La. Rev. Stat. §25(b) provides that the certificate of

incorporation shall be conclusive evidence of the fact that the corporation has been duly incorporated. Upon issuance by the secretary of state, corporate existence shall begin.

3) Timberline case held that the only people who should be held personally liable are those who have an investment in the organization and who actively participate in the policy and operational decisions. a) Liability should not necessarily be restricted to the person

who personally incurred the obligation.e. Cantor v. Sunshine Greenery (1979) – common law de facto corporation

exists where state statute allows it (does not address obligations before incurrence of certificate). A good faith de facto corporation suffices to absolve the directors from personal liability. Rule: The act of executing the certificate of incorporation, the bona fide effort to file it, and the dealings with Ps in the name of the corporation fully satisfy the proof of existence of a de facto corporation.

3. Some cases have applied a concept of corporation by estoppel which appears to be independent of modern statutes and the common law de facto corporation.a. Cranson v. IBM (1964):

Facts: X executes articles of incorporation and reasonably but erroneously believes that they were filed by his attorney. X negotiates the purchase of typewriters in the corporate name and executes notes in the corporate name to pay for them. The seller relies solely on the corporate credit but later discovers that the articles of incorporation were never filed and brings suit against X personally.Holding: X is not subject to personal liability, even though the corporation is not de facto. The application of the estoppel doctrine shields X from personal liability where, as here, the other party deals with the entity as if it were a corporation. The seller is estopped to deny the existence of the corporation under these circumstances.1) IBM – a sophisticated client.2) Even where you can prove every element of de facto, can still fall

back on estoppelb. estoppel is more liberal than de facto corporation, which is more liberal

than the strict rule of Robinsonc. If this case arose in a state that adopted the Robinson type statute (stating

that there can be no limited liability before the articles are filed. MBCA §§50, 139), the same result could not have occurred.

b. Piercing the corporate veil1. Piercing the corporate veil (PCV) is a metaphor to describe the cases in which a

court refuses to recognize the separate existence of a corporation despite compliance with all of the formalities for the creation of a de jure corporation.a. Only for closely-held corporations!

2. In Louisiana, a shareholder is not personally liable for a debt of a corporation except:a. if they knowingly or negligently defraud creditors by grossly overvaluing

services or property, they are liable to the corporation for the debt owed to the creditor

b. if they receive an unlawful dividend or distribution of corporate assets.1) Prescriptive period for PCV of two years from the unlawful action.

3. Traditionally, the typical tests have centered around preventing fraud or achieving equity. But, this is too broad for courts to follow, so the courts have developed concepts to provide guidance for when the veil should be pierced.

a. Co-mingling of assets and affairs: the failure to separate corporate finance from personal finance.

b. Inadequate or “trifling” capitalization.1) nominally capitalized corporations usually have to pay higher rates

for creditors to account for the riskc. Confusion of the books and actions (deception)d. Siphoning of assets or deals.

1) Making sure the corporation never has any money2) Sometimes called purposeful insolvency

e. Failure to observe corporate formalities4. Need to distinguish tort from contract actions

a. In contract, a sophisticated creditor takes his chances with an under capitalized corporation.

b. In tort, the victims know nothing. Courts often find piercing here.5. Sometimes you have to pierce a subsidiary to get to a parent

a. Bartle v. Home Owners Corp (1955)Facts: the subsidiary was formed to build low cost housing for veterans. P alleged purposeful insolvency and tried to PCV to get to the assets of the parent company.Holding: Cannot pierce the subsidiary to get to the parent – general rule. Rationale: Courts try to protect parent/subsidiary relationships. Court focused on the fact that the P was a sophisticated creditor and that PCV only allowed to prevent fraud or achieve equity—the creditors were in no way mislead.

b. To pierce show Alter ego. Two elements:1) parent and subsidiary operating as a single entity2) injustice

c. Areas where it is OK for parents to exercise control over subsidiary without dominating it:1) consolidated financial statements

2) routine legal services3) parent company borrowing money for the subsidiary4) employee transferring5) cash concentration systems

d. Injured worker can sue parent as a third party under the workers comp exclusive remedy rule

6. DeWitt Truck Brokers v. Ray Fleming Fruit Co (1976)Facts: Supplier to the corporation refuses to make further shipments unless paid in cash on delivery. The shareholder orally promised to pay for the goods personally if the corporation does not, as an inducement to encourage the supplier to ship the goods immediately. The supplier, in reliance of the promise, ships the goods immediately. Holding: The shareholder is personally liable, even in the absence of fraud, under the PCV. Rationale: there was an obvious inadequacy of capital when the business began (only $3,000). The court also found failure to observe corporate formalities. But, he is mainly liable because he caused the corporation to make distributions to him out of the funds that were earmarked for the payment of P’s transportation charges. Clearly an improper diversion of assets.

7. Baatz v. Arrow Bar (1990)Facts: Ps were seriously injured when a man struck them with his automobile who had been served alcohol at the D bar after he was visibly intoxicated. The Neuroths formed D ten years before. In the first two years, they contributed $50,000 to the corporation and personally guaranteed a loan to the corporation. The corporation had no dram shop liability insurance, so Ps sought to PCV and hold the Neuroths personally liable.Holding: The court refused to PCV.Rationale: A personal guarantee of a loan is a contractual agreement and cannot be enlarged to impose tort liability. The evidence showed that the Neuroths treated the corporation separately from their individual affairs. Also there was no indication that the corporation was under capitalized. The name, Arrow Bar, Inc, shows that it is in compliance with the statute. No injustices or inequities existed.a. Mere failure to comply with all of the forms prescribed by law for the

conduct of the corporate activities will not justify disregarding the corporate entity.

8. Radaszewski v. Telecom Corp. (1992)Facts: Subsidiary had little capital. In fact, they had watered stock, so they took out a large insurance policy. But, the insurance company was insolvent.Holding: Adequate insurance can be considered by the court in lieu of adequate capital.a. But, just buying insurance from a squirrelly insurance company at, no

doubt, a cheap rate can prevent PCV! Seems inequitable.9. Walkovsky v. Carlton (1966)

Facts: Pedestrian is injured. The individual D, Carlton, is claimed to be a stockholder of ten corporations, each of which has only two cabs registered in its

name and has minimum capital and insurance. P alleges that these seemingly independent corporations are actually operated as a single unit with regard to supplies, repairs, employees, and garaging.Issue: Does this justify PCV in the absence of a parent/subsidiary relationship?Holding: The complaint was dismissed because it did not contain statements that Carlton was doing business in his individual capacity or shifting corporate funds to himself without regard to the corporate existence.a. Many courts disregard these paper corporate entities and base liability on

the entire enterprise if the operations are so intermingled that it has lost its identity or that the business arrangements indicate a mere instrumentality.

b. Minton v. Cavaney (1961):Facts: A corporation is formed to lease & operate a swimming pool. The corporation is formed but no capital is paid in by the shareholders. A child drowns at the swimming pool due to the negligence of an employee. An attorney who is an officer of the corporation, & who may have been an investor, was responsible for forming the corporation & was personally involved in the operation of the corporation.Holding: The attorney was personally liable under an alter ego theory, due in part to certain aggravating circumstances—the failure to complete formation of the corporation, the failure to provide any capital at all, & the failure to observe corporate formalities in connection with the corporate business.Rule: Inadequate initial capitalization, alone, is sufficient to PCV.

10. Fletcher v. Apex Inc. (1995)Facts: Tort case where P was trying to PCV of a subsidiary. Holding: Court found good business practice for this type of company. Management did not involve operating dominance of the subsidiary. Cash management by a parent is not unusual.a. Law to apply in PCV cases:

1) This case applied the law of where the corporation was formed (DE)

b. A minority though, most cases apply the law of where the corporation is located.1) Courts are especially more likely to apply local law in tort cases.

11. Louisiana Cases:a. Fina v. Aamoco – gives La. version of the PCV factorsb. Huard v. Shreveport Pirates – stresses co-mingling, lack of capital, poor

record keeping.c. Riggins v. Dixie Shoring – stands for the general proposition against PCV.

12. U.S. v. Kayser – Roth (1989)Facts: CERCLA imposes responsibility for clean-up and response costs on all “owners and operators” of hazardous waste disposal site.Rule: A parent corporation that dominates and manages closely the affairs of a subsidiary that operates a hazardous waste disposal site may be found to have direct responsibility as an “operator” of the site. Alternatively, the same control

activity can lead a court to ignore the separate corporate existence of the subsidiary under a PCV theory and hold the parent liable as an “owner.”

13. Stark v. Fleming (1960)Facts: Elderly woman put the family farm into a corporation so she could giver herself a salary and social security benefits.Holding: the establishment of a corporation to improve a person’s social security entitlement is not of itself an improper use of a corporation in light of the purpose of the social security system to assure persons an adequate retirement income.a. However, a court may revise the salary downward to a reasonable amount

to prevent an artificially high entitlement.b. Roccograndi v. Unemployment Comp Bd. (1962)

Facts: Under the same situation as Stark, the farmer incorporates in order to obtain unemployment benefits during the winter months when little work is done, and lays himself off during the slow periods.Holding: They are not eligible for unemployment benefits because they had control over when they were laid off. The statute was not meant to cover employees.

14. Reverse piercinga. Cargill v. Hedge

Facts: Farmers lost their farm to creditors. They went into bankruptcy and wanted to claim the homestead exemption, so the house would not be seized. They claimed that the corporation was an alter ego and the veil should be pierced. Holding: The court bought it, looked to equity, and let them keep the house.

b. this is usually not allowed.15. Pepper v. Litton(1939)

Facts: Officer made a claim for his past salaries when he knew that the company was going under, so that he could be first in line to get paid. Trustee sought to have this judgment set aside.Holding: Officer was acting in bad faith and in breach of his fiduciary duty. a. Could not do this now because this case is codified into the bankruptcy

code.b. Deep Rock Doctrine – the power to subordinate inequitable claims, e.g, for

excessive salaries. 1) a sole shareholder transfers funds to her corporation in the form of

loans and backdated deeds of trusts, at a time when the corporation was insolvent. The original capital was about $5,000 while the loans aggregated $77,000. The loans were in fact capital contributions, the deeds of trust are frauds on the creditors, and the shareholders’ claims should be subordinated to all other creditors.

c. Subordination, theoretically, simply changes the order of payment so that the shareholder’s claim may be paid only after other creditors are satisfied in full; as a practical matter, however, the claims of other creditors usually exhaust the estate so that if a claim is subordinated under the “deep rock” doctrine, it ends up not being satisfied.

d. Where both the parent and the subsidiary are bankrupt, proceedings may be consolidated and priorities between the parent’s and subsidiary’s creditors determined on an equitable basis.

c. The failure to comply with a mandatory condition subsequent.

Personal liability is usually (but not invariably) imposed if business is commenced before articles of incorporation are filed.

3. Organizational Meetings

It is not necessary to actually hold organizational meetings in many situations. In most states, unanimous written consents may be used instead of minutes to avoid any meeting requirement. If the consent procedure is unavailable, minutes of meetings should be created. Typically minutes are created by a lawyer before the meeting is held and used as a script for the meeting. If the corporation is closely held and there is no disagreement about what is to be done, actual meetings in the physical sense are not usually held.

N. BYLAWS

The bylaws of a corporation are a set of rules for governing the internal affairs of the corporation. They are typically adopted as part of the formation of a new corporation and are binding on the corporation, its directors and shareholders.

Bylaws in Louisiana:

Although statutory restrictions are placed on the adoption, amendment and repeal of bylaws, neither the statute nor the jurisprudence says what bylaws are. In practice, bylaws are the rules of corporate governance that are set forth in a document that is contained in the official corporate records and has the word "bylaws" printed or typed on it in a way that suggests that the word is intended to be the title of the document. Anything that could be set forth in the bylaws could also be set forth in the articles, and perhaps in separate resolutions. But either of these approaches could create problems. Putting "bylaw" provisions in the articles would make them available in the Secretary of State's office for public inspection, and would also make changes in the rules difficult to make. The bylaws, in contrast, need not be filed and, unless the articles say otherwise, can be changed without a shareholder vote by the simple adoption by the board of directors of the desired amendments.

As with all other corporate rules that can be made either easy or difficult to change, majority shareholders are generally better served by easy-to-change provisions while minority shareholders are better off with rules that are difficult or impossible to change without their approval. Thus, minority shareholders may very well wish to see those rules that are important to them set forth either in the articles, a Section 29 shareholders agreement, or in bylaws rendered more difficult to change by the appropriate provisions in the articles or in a side agreement that would give them the right not to be bound by any change made without their consent.

Another approach to "bylaw" like provisions would be to place them in resolutions adopted from time to time by the board and documented simply in the minutes of the meetings in which the resolutions were adopted. This approach normally should not be used, however, for at least three reasons: the rules adopted in this way are likely to prove difficult to find and easy to overlook, they will not satisfy statutory provisions that would otherwise permit changes in the normal statutory rules by means of "bylaw" provisions, and they could very well be treated as "bylaws" anyway for purposes of determining the persons entitled to change them.

The corporate statute says that the normal rules on bylaw control can be changed by the articles and that directors' power over the bylaws is subject to the power of shareholders to change or repeal any bylaw the directors may make.

O. CORPORATE OFFICERS

The bylaws of a corporation usually state what officers the company will have, what powers the officers will have and any special rules desired concerning the selection of the officers. Under Louisiana law, every corporation must have a president, a treasurer and a secretary. The same individual may hold any two of these three offices, but whenever the law requires the signature of two separate officers, for example, on certificates of amendment of the articles, two different individuals holding the appropriate offices must sign.

The bylaws should normally confer considerable managerial power on the president, including the power to delegate his responsibilities to others. This is particularly true in a company whose president is going to be the controlling shareholder, for it avoids as much as possible the need for formal, case by case board authorizations that would otherwise be required. It probably is not a good idea to delegate all managerial power to the president, as the complete delegation of authority to one individual may be considered inconsistent with the statutory scheme of management by a board of directors. Still, a broad statement of day-to-day powers should reduce the number of occasions on which the controlling shareholder, as president, has to go to himself, as director, to get authorization for a transaction that he believes (in all three capacities) is a good idea.

Chapter Seven: Financial Matters & the Closely Held Corporation

A. Debt & Equity Capital- Generally.

1. There are four likely sources of capital for a corporation: (a.) equity capital (capital contributed by investors in exchange for shares of stock);(b.) loans from shareholders to the corporation;(c.) loans from third persons (debt financing); and(d.) funds generated from the corporation's business through the retention of earnings, creation of reserves, sales of appreciated assets and the like.

2. There is a basic distinction between debt (capital from outside sources) and equity (capital from the inside owners of the business).

3. Debt = promissory obligation to pay the designated creditor the principal + interest over time; if the debtor fails to pay, he is subject to suit by creditor; not dependent on the earnings of the business.

4. Equity = Capital contributed by the investors in exchange for ownership interests in the business; can’t sue for a dividend—dependent on the earnings of the business. "Shares" of "stock" are the basic units of ownership of a corporation.

5. Security of investment:(a.) Common Stock = maximum risk coupled with potential for great return on investment.(b.) Preferred Stock = slightly less risk coupled with potential for great return on investment.(c.) Debentures = considerably less risk coupled conservative fixed rate of return on investment.

B. Types of Equity Securities.

1. Common shares: reflect the ownership of the residual interest in the corporation.(a.) The 5 characteristics associated with common stock are:

(i.) the right to receive dividends contingent upon apportionment of profits;(ii.) negotiability;(iii.) the ability to be pledged or hypothecated;(iv.) the conferring of voting rights in proportion to the number of shares owned; and(v.) the capacity to increase in value.

-from United Housing v. Forman (U.S.S.C. 1975).

(b.) The two basic rights of common shares are:(i.) entitlement to vote for directors and on basic corporate matters (organic changes); and(ii.) entitlement to the net assets of the corporation when distributions are made or upon dissolution.

(c.) In Louisiana, the Articles of Incorporation must have statement of delineation: voting or non-voting.

LA R.S. 12:24 (B). The Articles of Incorporation shall set forth:4) The aggregate number of shares which the corporation shall have authority to issue.(5) If the shares are to consist of one class only, the par value of each share or a statement that all of the shares are without par value.(6)(a) If the shares are to be divided into classes:

- the number of shares of each class; - the par value of the shares of each class or a statement that such shares are without par

value; - the designation of each class and, insofar as fixed in the articles, each series of each

preferred or special class; - a statement of the preferences, limitations and relative rights of the shares of each class

(ie., voting or nonvoting) and the variations in relative rights and preferences as between series, insofar as the same are fixed in the articles; and

- a statement of any authority vested in the board of directors to amend the articles to fix the preferences, limitations and relative rights of the shares of any class, and to establish, and fix variations in relative rights as between, series of any preferred or special class.

(d.) Classes of Common Stock: In Louisiana, common stock may be issued in classes with variations in rights from class to class. Classes of common shares are often used as planning devices in closely held corporations, since variations in dividend rights, voting rights, and other participation rights may be established through this device.

- LA R.S. 12:81 (D). The articles may provide that a particular class or series of shares, or securities as authorized in R.S. 12:75(H), may elect all or a certain number or proportion of the directors, or the directors of a certain class.

- LA R.S. 12:82(F). The articles may provide that only the shareholders or only a particular class or classes of directors, or only directors elected by the vote of a particular class or series of shares, or obligations as provided in R.S. 12:75(H), may elect certain or all of the officers, in which event officers so elected may be removed without cause only by the shareholders or directors empowered to elect their successors.

2. Preferred Shares: Shares of stock that have preference over common shares either as to dividends or on liquidation or both.

(a.) “Preference" simply means that the preferred shares are entitled to a payment of a specified amount (fixed returns) before the common shares are entitled to anything. Most preferred shares have both dividend and liquidation preferences.(b.) This stock is usually non-voting stock.(c.) They have limited participation rights in distributions and upon liquidation are generally governed by the same rules as common shares with respect to par value, terms of issuance and so forth.(d.) Preferential rights are defined in the articles of incorporation, and the attributes of preferred shares may include some rights normally associated with common shares.

(i.)Preferred shares are usually redeemable at the option of the corporation at a price fixed in the Articles of Incorporation. The corporation has the privilege, after the passage of a period of time to “call” the stock at a price in excess of the share’s liquidation preference rate.(ii.) These shares may be made convertible at the option of the holder into common shares at a fixed ratio specified in the Articles of Incorporation. This allows the holder of preferred shares to obtain a part of the long term appreciation of the corporations assets—provided that they are willing to give up their preferred rights by exercising their conversion rights.

Downstream conversion = Preferred > Common Upstream conversion rights = Equity (Preferred Stock) > Debt (Note).

(iii.) Classes of Preferred Stock: The Corporation may issue different classes of preferred shares: for example, a dividend preference may be non-cumulative, cumulative, or “cumulative to the extent earned.”(iv.) Series of Preferred Stock: LA.’s corporate statute authorizes the creation by the board of directors of one or more "series" of preferred shares, the financial or

other terms of which may vary from series to series.(often called “blank shares”) A "series" differs from a "class" only in the manner of creation, classes being created by the articles of incorporation and series being created by the board of directors pursuant to general authority to do so in the articles of incorporation.

- The use of series permits a corporation to take advantage of transient changes in market conditions when raising capital.-Louisiana allows one or more series within a class See §24(B)(6)(a).

C. Issuance of Shares1. Historically, the traditional method of raising capital for a new venture was by public subscriptions pursuant to which persons agreed to purchase a specified number of shares contingent upon a specified amount of capital being raised.

(a.) Louisiana has retained the subscription agreement option for capitalization of a closely-held corporation with few investors, but this is the exception not the norm.

(b.) LA R.S. 12:71 (A). Subscriptions for shares, whether made before or after the formation of a corporation, shall be in writing. Subscriptions for shares may be revoked at any time by either party upon such ground as exists for the rescission of any contract.

2. Under modern statutes such as Louisiana's Corp. Law, there are virtually no restrictions on the issuance of shares. The price at which shares are issued is set by the board of directors. There is no minimum issue price for shares and no watered stock liability. Shares should be issued at the same price per share (unless otherwise agreed) if all investors are to be treated fairly and "dilution" of interests avoided.

3. "Authorized Shares" –VS-- "Issued Shares": Under La. R.S. 12:24, the articles of incorporation must set forth the number of shares the corporation is authorized to issue. If the corporation is authorized to issue more than one class of shares, the number of shares of each class, and a distinguishing designation for each class, must also be set forth. These terms of the articles of incorporation define the "authorized shares" the corporation may issue. "Issued shares" are the number of shares actually issued by the corporation. It is customary to authorize more shares than the number planned to be issued at the outset in the event additional capital is needed at a later date.

4. In Louisiana, the articles of incorporation must also state the par value of the shares of each class (or state that the shares are issued "without par value"). "Par value" is an arbitrary value associated with shares of stock set forth in the articles of incorporation. The par value also appears on the face of each certificate for shares.

5. Purposes of Par Value:(a.) Equality and proportionality of treatment among widely dispersed

shareholders.(b.) Increases confidence in the resale market that the shares had real value (and

were not "mere pieces of paper").

(c.) Solidifies an equity base, assuring the population in general that the corporation has been minimally capitalized.

6. Watered Stock Liability: In states like Louisiana, where the board of directors may set the price at which shares are issued, that price should never be set at less than par value. Such a practice may create "watered stock" and the possibility of liability being imposed on shareholders.

(a.) "Watered stock" is a generic term used to describe the issuance of shares below par value. A shareholder who receives watered stock may be required to pay in the difference between the par value and the actual issuance price.

"Bonus Stock": nothing paid for the shares. "Watered Stock": shares issued for property worth less than their par

value. "Discount Stock": shares issued for cash, but less than par.

(b.) It is customary in modern practice to use "low par" or "nominal par" value shares rather than "high par" value shares, e.g. $1 per share for shares to be sold on the markets for $10 or $50 per share.

(c.) Par value shares may also be issued for property of uncertain value. State statutes provide in effect that "in the absence of fraud in the transaction, the judgment of the board of directors * * * as to the value of the consideration received for shares shall be conclusive." Provisions of this type are absolutely essential to assure that shares issued in exchange for property are not watered.

7. Hospes v. Northwest Mfg. Co.: Facts: A car company issued over $2M worth of stock without receiving any consideration whatsoever. The Plaintiff sued individual stockholders on a "trust fund" theory of liability. Holding: The Ct. found the shareholders liable under the tort based "holding-out" theory: "the capitalization of a corporation as established by the par values of its issued shares was a public representation on which subsequent creditors might rely" and "compel[s] the shareholders to make good on their representation, unless the corporation can prove that the creditor extended credit knowing that the capital was not there."

8. Theories of Watered Stock Liability:(a.) Holding-Out Theory: A tort-based theory for holding the shareholders liable

for misrepresenting the company's assets.(b.) Trust-Fund Theory: flawed theory that the corp. its assets in a trust fund for

the creditors and shareholders.(c.) Statutory Rights Theory: There is liability imposed, on a standard less than

fraud (no reliance required) in Louisiana for violations of: 12:92 (B) §52(A) 12:92 (C) for exchange of property or services. 12:93 (C) §52(C) no future services.

1. LA R.S. 12:92 B. Any officers or directors who knowingly, or without the exercise of reasonable care and inquiry, consent to the issuance of shares in violation of the provisions of this Chapter or of

prior statutes, shall be liable jointly and severally to the corporation and any person who suffers any loss or damage as a result thereof.

- LA R.S. 12:52 (A). Par value shares may be issued initially for such consideration expressed in dollars, not less than the par value thereof, as shall be fixed by the board of directors. Shares without par value may be issued from time to time for such consideration expressed in dollars as may be fixed by the board of directors or by the shareholders by a vote of a majority of the voting power present, if the articles reserve to the shareholders the right to fix the consideration; provided however, the consideration for such shares may be initially fixed by the incorporators. Treasury shares may be disposed of by the corporation for such consideration as may be fixed from time to time by the board of directors.

2. LA R.S. 12:92C. If property or services taken in payment for shares are grossly overvalued contrary to the provisions of this Chapter, the officers or directors who knowingly, or without the exercise of reasonable care and inquiry, consented thereto, or voted in favor thereof, shall be liable jointly and severally to the corporation for the benefit of creditors or shareholders, as their respective and relative interests may appear, for any loss or damage arising therefrom.

3. LA R.S. 12:93C. If property or services taken in payment for shares are grossly overvalued contrary to the provisions of this Chapter, the shareholders who knowingly, or without the exercise of reasonable care and inquiry, consented thereto or voted in favor thereof shall be liable jointly and severally to the corporation for the benefit of creditors or shareholders, as their respective and relative interests may appear, for any loss or damage arising therefrom.

- LA R.S. 12:52 (C). The consideration for shares issued otherwise than as stated in subsection B of this section, shall be paid in cash or in corporeal or incorporeal property, or services actually rendered to the corporation, the fair value of which is not less than the dollar amount of the consideration fixed for the shares, before the shares are issued. Upon payment of the consideration fixed therefor, such shares shall be considered as fully paid. Cash consideration for shares may not be paid by the purchaser's note, secured or unsecured, or uncertified check; and in case of delivery of such a note or check in payment for shares, the shares shall not be issued until the note or check has been paid in full.

9. Hanewald v. Bryan’s Inc. (N.D. 1988)Facts: Bryan’s Inc., an insolvent retail clothing company, issued all of its authorized shares as “bonus shares” for free to the President and Vice President. The President and Vice President then loaned the corporation $10,000 in cash and personally guaranteed a $55,000 loan from a bank. These funds were used by the corporation to buy a dry goods store called Hanewald. The corporation was subsequently dissolved by operation of law (failure to file reports). Hanewald sued to collect the rest of the note.Holding: President and Vice President should be personally liable as the corporations directors and sole shareholders for breach of their statutory duty to pay for shares that were issued to them by the corporation. Their failure to pay for the shares in the corporation makes them personally liable under the MBCA § 25 for the corporation’s debt to Hanewald.Rationale: (1) The shareholder’s initial capital investments protect the shareholder’s personal assets from further liability in the corporate enterprise. (2) Generally, shareholders are not liable for corporate debts beyond the capital they have contributed.

(3) Shareholder liability may be enforced in a direct action by the creditor. (4) Shareholder is liable to the extent of the difference between the par value and the amount actually paid.

10. Eligible and Ineligible Consideration for Shares: Louisiana, like many states, prohibits shares from being issued for promissory notes or promises of future services. This prohibition is technically not part of the par value structure but it appears most commonly in states that have retained the concept of par value.

(a.) Shares issued for prohibited consideration may be viewed either as watered shares or as not being validly issued and subject to cancellation.

(b.) Treasury shares may be used to avoid this restriction.

11. Treasury Shares: "Treasury shares" are shares that were once issued for an eligible and adequate consideration but have been reacquired by the corporation and held in its "treasury." Under traditional statutes, treasury shares have an intermediate status between being issued and unissued. They are not outstanding for purposes of voting, quorum determinations or dividend payments but they are viewed as "issued" for other purposes, and thus may be resold at less than par value or for promises of future services.

(a.) LA R.S. 12:1 (X). "Treasury shares" means issued shares which have been acquired by and belong to the corporation, if not required by the articles to be cancelled, or if not cancelled by order of the board of directors.

12. Stated Capital and Capital Surplus: The aggregate of the par values of all issued shares constitutes the "stated capital" of the corporation. Any excess received for the issuance of par value shares is "capital surplus."

(a.) Because of the use of nominal par value, in most corporations there is a lot of capital surplus and relatively little stated capital.

(b.) Under most state statutes stated capital is "locked in" the corporation for the benefit of creditors. Capital surplus and retained earnings may be distributed to shareholders without the consent of creditors. Stated capital cannot unless it is first reclassified.

(c.) LA R.S. 12:1(E). "Capital surplus" means the aggregate of:(1) The amount of the consideration received on issuance of issued

shares in excess of the aggregate allocated value thereof; and(2) Amounts transferred to capital surplus as permitted by this Chapter;

and(3) Surplus arising from revaluation to reflect unrealized appreciation in

value of assets made in good faith by the board of directors of a corporation, including but not limited to revaluations based on appraisals of assets and, in the case of corporations engaged in extraction and oil and gas activities, reserve reports and reserve valuation information; less

(4) Transfers from, or other reductions in, capital surplus required or permitted by this Chapter.

(d.) LA R.S. 12:61 (A)(1). Upon initial issuance of par-value shares, the par value thereof, plus any part of any consideration received therefor in excess of the par value as the board of directors or the shareholders may fix, shall be allocated to stated capital, and the remainder of any consideration shall be allocated to capital surplus.

(e.) LA R.S. 12:61 (A)(2).Upon initial issuance of shares without par value, the board of directors shall state an amount to be allocated to stated capital, and the remainder of any consideration therefor shall be allocated to capital surplus.

13. No Par Shares: In Louisiana, "no par" shares are a permitted alternative. These shares may also be designated as "without par value." The rules with respect to such shares are tied into the rules with respect to par value shares.

(a.) The consideration for no par shares issued in par value states is allocated to stated capital, but the board of directors may determine that some part of that consideration may be allocated to capital surplus rather than stated capital.

(b.) There is no minimum price at which no par shares must be issued. The price is simply set by the board of directors or shareholders. However, watered stock liability may be created if the no par shares are actually issued at a price below that set for their issuance by the board of directors or shareholders.

D. Debt Financing.

1.) Debt securities, like bonds (secured debt) or debentures (unsecured debt), are long-term negotiable unconditional written obligations to pay a specific amount at a future date.

2.) Bonds and debentures historically were payable to bearer and the interest obligation was reflected by coupons to be detached and submitted for payment to the issuer.

- The modern practice, however, is to issue bonds and debentures in registered form, in the name of a specific person, with interest payments made automatically to the registered owner.

- Debt securities may be made convertible into common shares on terms established at issuance.

- "Junk Bonds" refers to debt securities that are rated below investment-grade debt instruments.

3.) Debt securities, differ significantly from equity securities:- Bonds or debentures pay interest that is legally required (secured), whereas preferred

stock pays dividends that are usually discretionary with the board of directors.- Bonds or debentures usually have a fixed maturity date whereas preferred stock is

outstanding indefinitely or permanently.

- Bondholders theoretically have a right of foreclosure upon the property that is their security whereas preferred stockholders do not.

- Debt securities are created pursuant to indentures that usually appoint a trustee to handle the rights of security holders whereas stock is created by provision in the articles of incorporation of the corporation.

4.) Advantages of Debt Financing:- Leverage.- Tax Treatment.

5.) The Concept of Leverage (trading on the equity): Debt owed to third parties creates leverage when the borrower is able to earn more on the borrowed capital than the cost of borrowing the capital (interest).

- The risk associated with leverage: The income generated by the capital may not be enough to cover the interest payments—could bankrupt the borrower.

6.) Advantages of providing a portion of the initial capital in the form of debt in a closely-held C corporation

- There are tax advantages for shareholders in a C corporation to lend a portion of the initial capital to the corporation. Interest on a debt is deductible by the corporation while dividends are not. A repayment of debt may be a tax-free return of capital rather than a taxable dividend. These advantages do not exist with third party debt.

- Going Thin: The ratio between a corporation's equity capital and its long term debt is the corporation's debt/equity ratio. (Example: A corporation with $10 K in equity that borrows $100 K has a debt/equity ratio of 10:1).

- The debt/equity ratio may be calculated on an "aggregate basis" (taking into account debts an obligations owed to both shareholders & persons other than shareholders) or on an "inside basis" (taking into account only those debts owed to shareholders). Probably "too thin" if the corporation's outside ratio is greater than 10:1 & its inside ratio is greater than 3:1, but the courts use a flexible fact-intensive analysis.

- Slappey Drive case: The Ct. announced 13 factors applicable to the determination of whether a corporation is "too thin": (1.)Names given in certificates; (2.) Presence/Absence of fixed maturity date; (3.) Right to enforce payment of principal & interest; (4.) Proportionality; (5.) Failure of Debtor to repay on the date due.

- Disadvantages of debt: (1.) No timely payment = bankruptcy; (2) Opportunity Cost (If you have borrowed the max allowable, you can't borrow $ when you really need it for a "sweet deal").

7.) Reclassifying debt in a “S” Corporation: In 1982, Congress created a safe harbor for “straight debt,” the existence of which does not disqualify a corporation from the S Corporation election.

- “Straight debt” = Debt that involves a written unconditional promise to pay a sum certain in money if:a. interest rates & interest payment dates aren’t contingent on profits.f. there is no direct or indirect convertibility into stock.g. the creditor is an eligible shareholder under Chapter S.

8.) Debt as a planning device.- Obre v. Alban Tractor (1962):

Facts: Obre & Nelson formed corp. to move dirt & build roads. Obre contributed equipment & cash ($65.5K) in return for $10K par value voting common stock, $20K par value non-voting preferred stock, and $35.5 unsecured promissory note. Nelson contributed cash & equipment worth $10K for an equivalent amount of par value voting common stock. The Corp. went “belly-up.”Holding: Ct. concluded that the note should not be treated as equity, and allowed Obre to be paid with preference as a creditor of the corp. The court concluded that the Corp. had been initially capitalized with $40K of equity (value of common and preferred stock) and only $35.5K of debt, and therefore the Ratio (almost 1:1) was not “too thin” and the corporation was not undercapitalized.Rationale: The Ratio was not shown to be inadequate. Further, Obre’s loan to the corp. was either known to the creditors or could have been easily discovered through examining state tax filings, requesting a financial statement, or obtaining a credit report.

E. Basic Concerns of the Attorney When Planning the Capital Structure for the Closely-held Corporation:

1.) Will the structure stand up in the event of later disagreement & possible legal attack?2.) Will the structure actually provide the desired business result?3.) Will the desired tax treatment be available, or more likely, is the structure created one that makes

the desired tax treatment probable if not certain?4.) Might the structure give rise to unforeseen liabilities like “watered stock liability” or “piercing the

corporate veil?”5.) Are the clients’ financial contributions reasonably protected & reasonably fairly treated in the event

of unexpected or calamitous occurrences causing sudden and premature termination of the venture?

F. Public Offerings

Background Information on Securities Laws:

1.) In 1911, under rising pressure to regulate the marketing of fraudulently valued securities. Kansas passed the first state security statutory regulation. It was noted that the Kansas statute's purpose was to protect the Kansas farmers against the industrialists selling them a piece of the blue sky. Hence, securities legislation at the state level has come to be known as "blue sky laws." Today, all states have blue sky legislation. The blue sky laws proved to be relatively ineffective in stamping out securities frauds, especially on a national level. Although federal legislation was successfully resisted for a while, the fact that the stock market crash of 1929 was due in part to the number of fraudulently floated securities made federal regulation imperative

2.) Congress entered into the regulatory arena with the Securities Act of 1933, A.K.A., the "Truth in Securities" Act. It contained many of the features of state blue sky laws, except that it did not (and, as amended, still does not) establish a system of merit regulation as the was common with blue sky statutes.

3.) The 1933 Act was initially administered by the Federal Trade Commission and focused on disclosure. The FTC's securities law jurisdiction was replaced in 1934 with the creation of the Securities and Exchange Commission.

4.) The Securities Act of 1933 is directed primarily at the distribution of securities. Generally, the 1933 Act requires the registration of all securities being placed in the hands of the public for the first time regardless of whether this is accomplished through a primary or secondary offering.

a.) The theory behind the federal regulatory framework is that investors are adequately protected if all relevant aspects of the securities being marketed are fully and fairly disclosed. Full disclosure provides investors with sufficient opportunity to evaluate the merits of an investment and fend for themselves. This obviates any need for the more costly and time-consuming governmental merit analysis of the securities being offered.

b.) The Securities Act of 1933 contains a number of private remedies for investors who are injured due to violations of the Act. There are also general antifraud provisions which bar material omissions and misrepresentations in connection with the offer or sale of securities.

c.) The scope of the Securities Act of 1933 is limited: o The registration and disclosure provisions cover only distributions of securities in the

primary market; o The investor protection reach extends only to purchasers (and not sellers) of

securities.

5.) The Securities Exchange Act of 1934 is a more omnibus regulation, with much broader investor-protection provisions. The Exchange Act of 1934 is directed at regulating all aspects of public trading of securities: both sales and purchases of securities in the secondary market. The Act does not focus only on securities, their issuers, purchasers, and sellers; it also regulates the marketplace, including the exchanges, the over-the-counter markets, and broker dealers generally.

6.) Following the Securities Exchange Act of 1934, Congress enacted a number of additional securities laws that form part of the federal regulatory scheme. This legislation includes: the Public Utility Holding Company Act of 1935 which deals with the special problems raised by financing public issue utilities; the Trust Indenture Act of 1939 which addresses debt financing of public issue companies; as well as the Investment Company and Investment Advisers Acts of 1940, which regulate mutual funds and those professional investment analysts in the business of generating and providing financial advice to investors. In 1970, Congress added the Securities Investor Protection Act which was enacted to address the increasing concern over the then increasing number of insolvent brokerage firms and broker dealer firm failures.

Compliance with Securities Laws:

1.) Full compliance with the ‘33 Act involves filing a registration statement with the SEC pursuant to § 5. Registration statement has two parts: (1) a prospectus, (a printed document that contains the company’s CPA-certified financial statements and a description of the main features of a corporation’s business, & which is distributed to prospective buyers or investors) and (2) additional information required by SEC, but not provided in the prospectus. Corporate attorneys are responsible for verifying the accuracy & completeness of registration statements in a “due diligence” investigation.

2.) Section 5 of the ‘33 Act provides that:a.) No issuer or underwriter may sell securities to the public without an effective registration

statement; andb.) No issuer or underwriter may offer securities until a registration statement has been filed.

3.) Liability under the ‘33 Act:a.) Any person who violates §5 is responsible to any purchaser. §12b.) Any person who signed the registration statement is personally liable (there are many people

who sign). §11c.) General fraud or omission liability provision. §17d.) Criminal liability for de-frauding the public. §19

4.) Broad definition of “security” under the securities laws: A "security" is any contract, transaction, or scheme whereby a person invests money in a common enterprise and is led to expect profits solely or primarily from the efforts of others. Non-stock interests such as limited partnership interests or investment contracts may be securities under this definition. See Gross case.

5.) Time Sequence of § 5:

Pre-filing Period Post-effectiveness Period

Waiting Period Filing Date Effective Date

6.) Pre-filing period: No offers or sales to the public. “Tombstones” allowed.7.) During waiting period (after filing): The enterprise can offer to sell with a preliminary (“Red

Herring”) prospectus. There is no settled price, but the parties negotiate with a “coming to market” tentative price. There is no “free writing” during this period.

8.) After Effective Date the company may sell securities with the final prospectus.9.) An I.P.O. is very expensive; However the SEC has created exemptions for most small and

medium-sized public offerings that permit most small enterprises to avoid these costs.10.) Exemptions From Registration: The principal exemptions under the Securities Act of 1933 are

the following: Regulation D, Rules 504, 505 and 506; Section 4(2); Section 4(6); Section 3(b); and Section 3(a)(11). Exemption of a small offering from registration by the SEC does not also exempt that offering from registration under the blue sky laws, though there is a considerable degree of integration and cooperation at federal and state levels.a.) Non-Public Offering: ‘restricted securities.’ Insiders don’t need the protections offered by the

’33 Act, they have information privileges.b.) Intra-State Sale (Rule 147): if one person in another state buys, no exemption. Mississippi

Cement Co.c.) Small-Offerings Exemption: SEC can exempt up to $5 M sales. See handout on Reg D.d.) Exempt Securities: State (municipal) Bonds; Federally Regulated Stocks (like the F.C.C.).e.) Exempt Transactions: Sales by persons who are neither statutory “underwriters” or “issuers.”f.) Sales to “Control Persons” (Rule 144): This exemption applies if A controls B (issuer), And/Or

if A is controlled by B (issuer).g.) “Accredited Investors” as defined in §501 of Regulation D:

- Banks or S&L’s- 501 (c) (3) corporations with assets in excess of $5M.- “Insiders”: Directors, executive officers.- Natural person with net worth over $1M.- Natural person with individual income over $200K/year.- Trust with asset holdings in excess of $5M.

11.) The provisions of most state "blue sky" regulatory provisions roughly parallel the federal securities act but there are many differences. But the methods of state regulation vary in their onerosity on the company:

a.) Registration by notification (least onerous on company)b.) Registration by coordinationc.) Registration by qualificationd.) Registration by regulation (most onerous on company)

12.) The federal National Securities Markets Improvement Act of 1996 (NSMIA) preempts overlapping state regulations of full scale, nation-wide IPO’s. However, it does not preempt state law when the securities are sold publicly pursuant to an exemption.

13.) SEC v. Ralston Purina Co. (USSC 1953)Facts: Since 1911, Purina had a policy of encouraging stock ownership among its employees. Between 1947 and 1951, they sold nearly $2,000,000 of stock to employees without registration, and in doing so, it made use of the mail. Section 4(2) of the Securities Act of 1933 exempts transactions by an issuer not involving any “public offering” from the registration requirements of the act.Issue: Was D’s offering of treasury stock to its “key employees” within the exemption for non-public offering?Holding: No. because the offering was not only to “key” employees, but to all of its employees, the offering was public and should have been registered.Rationale: Among those employees who responded to the offer were clerical assistants, foremen, electricians, and veterinarians – a wide range took advantage. To be “public” under the act, the offer need not be open to the entire world. The term “public” distinguishes the populace at large from groups of individual members of the public separated by some common interest or characteristic. (1) For the offering to be non-public, the means used to select the particular individuals to whom the offering is made must bear a sensible relation to the purposes for which the selection is made. (2) Further, the applicability of § 4(2) of the act turns on whether the particular class of persons affected need the protection of the act. Some employee offerings may come within the exception if made to executive personnel who, because of their position, have access to the same kind of information that the act would make available in the form of a registration statement. Absent such circumstances, employees are just as much members of the investing “public” as anyone in the community.

14.) Secondary sales by corporate officers (who are exempted) to corporate employees (who are usually not) would also violate §5 because the officers will be deemed “underwriters” under the ’33 Act. An underwriter is “any person who has purchased from an issuer with a view to, or offers or sells for an issuer in connection with, the distribution of any security.”

15.) The SEC has adopted Rule 144 to establish guidelines for the resale of outstanding shares that have not been registered (restricted stock) by investors without concern that the seller may be deemed to be an “underwriter” under the ’33 Act. Rule 144 requires that the re-seller hold the securities for a year, and when they sell them, they can only sell a limited amount or else the transaction is unexempt.

16.) Regulation D: Designed to simplify & clarify existing exemptions under §5, to expand their availability, and to achieve uniformity between federal & state exemptions in order to facilitate capital formation consistent with the protection of investors. Reg. D protects small businesses from inadvertently violating the securities laws. (See Handout on Reg. D)

- Integration: Offers and sales made more than 6 months before/6 months after the Reg D offering do not count towards limitations of the Reg D offering, unless the following factors mandate integration:

o If the sales are part of a single plan of financing;o If the sales involve issuance of the same class of securities;o If the sales are made at or about the same time;o If the same type of consideration is received;o If the sales are made for the same general purpose

- Section 504: Small business can sell up to $1M with no integration applicable for the year before and the year after the offering.

- Section 505: Small business can sell up to $5M with no integration applicable for the year before and the year after the offering, if there are less than 35 purchasers

- Section 506: Small business can sell unlimited value of securities to 35 or less accredited investors.

- Section 508: The Substantial Compliance Rule states that “insignificant deviations from a term, condition, or requirement of Reg. D will not result in the loss of the exemption.

17.) Smith v. Gross (9th Cir. 1979)Facts: D solicited buyers-investors to raise earthworms to help D sell his quota to fishermen. Success was guaranteed by the D, who promised the P they would buy the worms back at a set price. D did not buy the worms back ,and P sued under the federal securities laws, alleging a statutory right to rescind the contract under § 12 of the Sec. Act of 1933. Issue: Could the P bring suit against the corporate D for violation of the federal securities laws, even if no security was involved between the parties.Holding: The transaction between the parties involved an investment contract and P could sue under the securities laws.Rationale: The Howie test for whether an investment contract exists:(1) an investment of money(2) a common enterprise - one in which the fortunes of the investor are interwoven with and dependent on the efforts and success of those seeking the investors.(3) with profits to come solely from the efforts of others. “Solely” has been defined to mean whether the efforts made by those other than the investor are undeniably significant ones.The court found an investment contract by focusing on these elements: (1) obviously an investment of money was present(2) if the Ps diligently complied, they still would not have gained the promised profits. Thus, the fortunes of the Smiths here were interwoven with and dependent on the success and efforts of the Grosses.(3) the D persuaded the P to invest by representing that the efforts required of them would be very minimal.

1. This court used a broad, expanded definition of “security.”2. Did not matter that the Ps were free to sell the worms to anyone they wanted3. Not a franchise agreement where the franchisee is responsible for his own success

because the only market for worms in the Phoenix area was through the Ds.18.) Ponzi Schemes – SEC v. Glen W. Turner: The Supreme Ct.’s “sole efforts” clause interpreted

to mean that the efforts of the “other” party are “undeniably significant ones.” In Turner, the Ct. found that the efforts promised by Turner (the ring leader) were “undeniably significant” ones in the scheme, and held Turner liable for securities fraud in an investment contract.

E. Issuance of shares by a going concern: Preemptive Rights and Dilution

1.) Preemptive Rights: The principal common law protection for existing minority shareholders is the doctrine of "preemptive rights," which gives existing shareholders the right to subscribe and pay for their proportionate part of any new issue of securities by the corporation at the price established by the board of directors. Preemptive rights may be eliminated in the articles of incorporation. Where preemptive rights are inapplicable or have been eliminated, the power of controlling shareholders to issue new shares may be limited by fiduciary duties they owe to minority shareholders

2.) Stokes v. Continental Trust Co. of NY (N.Y. Ct. App. 1906) Facts: P was an original stockholder of the D banking corporation, owning 221 shares of $100 par stock. D corporation voted to double the amount of capital stock, and sell the new amounts to Blair & Co, another influential bank, for $450 per share. P demanded the right to subscribe to 221 shares of the new stock at par and the company denied. The market value of the stock was $350 per share before the sale, $550 immediately after, and $700 at the time of trial.Issue: Did the P have the right to subscribe for and take the same number of shares of the new stock that he held of the old stock?Holding: The plaintiff should have been able to buy his proportionate interest so that his interest in the corporation would not be diluted. Rationale: This is a right of property belonging to the P and he could not be deprived of that right by the joint action of the other stockholders. The right of the shareholder to vote in proportion to his number of shares is vital. The other stockholders could give their property rights to a third party, but they could not give away the P’s. Because he was deprived of this property right, he is entitled to the difference between the $450 sale price and the $550 market price. Rule: A stockholder has an inherent right to a proportionate share of new stock issued for money and not to purchase property for the purposes of the corporation, and he can waive this right, but he must give his consent to be deprived of it.

1. The court believed that this rule would prevent tyranny of the majority.2. It is now generally accepted though that a preemptive right is not inherent aspect of

ownership, but the right may be granted or withheld by the articles of incorporation.a. Default rule today is no preemptive rights.

3.) Katzowitz v. Sidler (N.Y. Ct. of App. 1969)Facts: P, D, and Lasker were the only directors and stockholders of three closely held corporations. P agreed to withdraw from active management, but was to continue receiving the same salary as the other two. The corporation became indebted to each stockholder for $2,500. instead of paying for this debt, the two wanted it to loan money to another corporation which all three men controlled, so they called a meeting and proposed that additional securities be offered at $100 per share to substitute for the money owed to the directors. P refused to vote for this. The two called another board meeting where P did not attend, and approved the sale (the shares were sold for less than market value). Mailed notice that each stockholder had the right to purchase these new shares. P did not exercise his right, so his interest was diluted. When corporation liquidated, P was paid proportionately less, and sued.Issue: Did the P waive his preemptive rights?Holding: No, P is entitled to his share of the assets of the corporation.Rationale: The Ds had a fiduciary duty to determine the price of these new shares and the price must be exercised for the benefit of the corporation and in the interest of all the shareholders. But, issuing

stock for less than book value can inure the shareholders’ rights by diluting their interest and future liquidation rights. Directors must show a valid business reason to justify this type of thing. Here, the Ds do not even allege to have a good reason for this. Also, P possibly was not aware of the effect of the stock issuance on his interest until the corporation dissolved.Rule: The corollary of a stockholder’s right to maintain his proportionate equity in a corporation by purchasing additional shares is the right not to purchase additional shares without being confronted with dilution of his existing equity if no valid business reason exists. So he has the right to insist on compliance with the law, whether or not he cares to exercise his option. 4.) “Freeze-Out” tactics:

a.) Katzowitz-type transactions.b.) When inside shareholders pay for their additional shares by canceling debts owed to them by

the corporation, while outside shareholders are put to the painful choice of investing fresh capital (which they may not have) over which they lose effective control or see their proportionate interest decline drastically.

c.) Refusal to pay dividends.d.) Drain corporate earnings by paying high salaries and bonuses to majority shareholder-officerse.) Charging corporation high rent for property owned by majority shareholders.f.) Causing corporation to sell its assets to majority shareholders at inadequate prices

5.) LSA-R.S. 12:72 Shareholder’s preemptive rightsA. Shareholders shall have only such preemptive rights as may be provided in the articles. If

the articles provide simply that "shareholders shall have preemptive rights", then:(1) At issuance, each holder of shares having voting rights shall have a preemptive right, during a reasonable notification period to be fixed by the board of directors, which need not exceed fifteen days, to subscribe, at such price and upon such terms as may be by the board, for such proportion of the shares to be issued, as the number of shares having voting rights held by him bears to the total number of shares having voting rights then outstanding.(2) A shareholder shall have no preemptive right to subscribe for shares:

(a) Which are to be issued for consideration other than cash (i.e., property).(b) Which are to be issued to satisfy conversion or option rights.(c) Which are treasury shares.(d) Which are issued pursuant to a employee stock option plan.

F. Distributions by a Closely-held Corporation1.) A "dividend" is a payment out of current or past earnings; other distributions, to the extent

permitted, are distributions of capital, not distributions of earnings. Dividends or distributions are typically discretionary with the board of directors.

2.) Types of Distributions:- Dividends

o The source traditionally was net profits; the rationale behind dividends paid from net profit was that the company had a good year & the shareholders should reap benefits.

o Proportionate redemption of stock is an ordinary dividend

- Disproportionate Redemptions of Stock: Occurs in situations where there is a triggering event (when an employee turns 65) in the Articles of Incorporation, after which the corp. will buy back some or all of a shareholder’s stock. This transaction is treated as a sale or exchange of the shares, resulting in a capital gain or loss for the shareholder equal to the difference between the redemption price of the shares and the shareholder’s basis. Although this transaction results in an increase in the remaining shareholders’ ownership interests, the IRS has stated that this is not a constructive dividend.

o Hosley v. SEC: The Court held that the remaining shareholders could be taxed on the increase in wealth once the gain was realized by a sale of the shares.

- Compensation: Salaries; Benefits/Retirement; Auto; Vacation/Trips.o The distribution of corporate income in the form of salaries, rent, etc. may give rise

to internal disputes since some shareholders may receive larger payments than others, and the payments may bear no relationship to relative shareholdings.

o When there are no legitimate business purposes for these expenses, they are treated as regular dividends, which cannot be deducted for tax purposes. Hatt case.

3.) Dividend Policies:- Publicly held corporations generally adopt stable dividend policies that permit regular

periodic distributions even though corporate income fluctuates.- In closely held corporations, dividend policy generally is income tax driven:

o In a C corporation, the dividend policy generally adopted is "no dividends." The payment of a dividend carries a higher tax cost than the payment of the same amount in the form of salaries, rents or other payments to shareholders that are deductible by the corporation.

o In an S corporation, corporate income is taxed directly to the shareholders whether or not distributions are made. Distributions therefore have no tax effect. A common pattern is the distribution of amounts at least sufficient to pay the income tax due on the corporate income allocated to each individual shareholder under the S corporation election.

4.) Suits to compel the payment of dividends succeed only rarely and require a showing of bad faith. It is usually pretty difficult and expensive for a shareholder to prove misconduct by the Board of Directors.

5.) Gottfried v. Gottfried (Sup. Ct. N.Y. 1947)Facts: Gottfried Baking Corp. was a closely held corporation where all shareholders are family members. Ps were the minority stockholders, Ds were the majority. Ps brought action to compel declaration of dividends on common stock. Ps contended that the Ds’ excessive salaries, bonuses, and corporate loans eliminated the need for dividends to the Ps.Issue: Was there bad faith on the part of the majority shareholders in not paying dividends on an adequate corporate surplus sufficient for the Ps to compel a dividend?Holding: There was no evidence of bad faith or undue conservatism, so the Ps could not compel dividends.Rationale: Mere existence of a surplus is not enough to compel court action to compel a dividend. The following are relevant to the issue of bad faith: hostility, high salaries, bonuses, corporate loans. But, if these are not motivating causes, they do not constitute bad faith. The essential test of bad

faith is to determine whether the policy of the directors is dictated by their personal interests rather than the corporate welfare. Here, there was bitter dissension and personal hostility that existed for a long time. Additionally, the Ps have been discontinued from the payroll, and Ds have received substantial sums and given substantial loans. But, the evidence does not show that they were made with a view to the dividend policy of the corporation. These were incurred, to a large part, long before any controversy arose with respect to the dividends. Additionally, the aggregate amount of these transactions is not of sufficient magnitude to affect materially the corporation’s capacity to pay dividends. The financial condition of the corporation also did not change. Court also looks to the fact that a dividend was finally paid after the suit was filed.Rule: The burden of proving bad faith is on the plaintiff in a derivative suit.

6.) Dodge v. Ford Motor Co. (Ma. 1975)Facts: D had its most prosperous year of business in 1915. Ps filed suit in 1916 as minority shareholders for refusal of the directors to declare and pay further dividends. Total assets were 132 million, total liabilities were 20 million. The board of directors approved a general plan of expansion which reduced the selling price of its cars. The shareholders alleged that Ford intended to run the business like a charitable corporation – sharing its large profits with the public by reducing the price of the cars. With regard to dividends, the company paid 60% of its capitalization of the 2 million (1.2 million), leaving 58 million to reinvest for the growth of the company.Holding: the court approves the business plan, concluding that the motives of the directors were in the interest of the company and, therefore, benefiting the shareholder interests. However, the 1.2 million dollar dividend was too small for the amount of the surplus. The directors have a duty to pay out a much larger dividend because the accumulation of so large a surplus ($58 million) establishes the fact that there has been an arbitrary refusal to distribute funds that ought to have been distributed to the shareholders as dividends.Rationale: A business corporation is organized and carried on primarily for the benefit of the shareholders. The powers of the directors are to be employed to that end. At the directors’ discretion, to be exercised in good faith are infinite details of the business: wages, hours, conditions, and price.

a. this is an exceptional case and not often followed.

7.) Wilderman v. Wilderman (Chancery Ct. of Del. 1974)Facts: P is a 50% shareholder in a corporation engaged in the business of installing ceramic tile called Marble Craft Corp. P is also VP, Sec., Treas. of the corp. which she and her husband originally operated out of their home. D is the president and major force in the business of the corporation. P sues D and corporation for the return of excessive and unauthorized payments made to D out of the earnings of the Corp. made in the form of salary and bonus. She also wants the excessive money returned to be treated as corporate profits which the corp. should be required to distribute as dividends. D caused by his own act his compensation to raise from 30K to 90K in five years, while the earnings of the corp. only rose from 380K to 680K.Holding: D has not met his burden of proving that his quantum meruit compensation was reasonable. Factors include: what other similarly-situated executives received, the ability of the executive, whether salary bears a reasonable relation to the success of the corporation, the amount of previously received salary, other salaries paid. D is entitled to a reasonable increase that should be within the IRS limits for appropriate compensation. Therefore, the amount of $45K is reasonable, and all money paid in excess of that sum must be returned to the corporation’s treasury with interest.

However, the Board of Directors has the right and prerogative to set and pay what it deems to be appropriate dividends of its reconstituted net profits. Court refuses to order a dividend.Reasoning: (1) authority to compensate officers is vested in the BOD and is a matter of contract.(2) D’s formula basis for arriving at his compensation was clearly unauthorized. (3) any compensation above the amount in the contract must find its authorization in the theory of quantum meruit. (4) compensation paid to defendant by corp. on theory of quantum meruit must be reasonable and the burden of proof falls on the D as he was a director with a fiduciary duty.

8.) Difference between a Redemption and a contractual Cross-Purchase:- Redemption: Vertical agreement between corporation and individual shareholder, from

whom the corporation is redeeming its stock.- Cross-Purchase: Lateral agreement among the shareholders, by which one shareholder’s

interest is bought-up by the remaining shareholders.9.) Rationales behind Redemptions of Stock:

- Reasons for Repurchases in Publicly Held Corporation: Share repurchases may occur in publicly held corporations for several reasons: e.g., to provide treasury shares that are available for employee share purchase plans or for the acquisition of other businesses.

- Reasons for Repurchases In Closely Held Corporations: Repurchases in closely held corporations are usually designed to permit a shareholder to withdraw from the corporation and liquidate his or her investment on favorable tax terms.

- Status of Reacquired Shares: Reacquired shares under par value statutes are classed as "treasury shares." These are not assets (investments) even though they may be sold at a later date. The corporation should treat treasury shares as authorized but un-issued shares.

10.) Donahue v. Rodd Electric (Ma. 1975) – Facts: Shares owned by the father of the majority shareholder had been redeemed by the corporation but the corporation offered to redeem shares owned by a minority shareholder at a much lower price. This is a disproportionate redemption.Holding: This conduct violated the fiduciary duty that the majority shareholder owed to the minority. The minority shareholder is entitled to have his shares purchased on the same terms as the majority shareholder. Rule: a controlling shareholder in a closely held corporation has a strict fiduciary duty (similar to that in a partnership) and a duty of utmost good faith and loyalty to minority shareholders when redeeming shares. Extends to managerial as well as financial obligations- This is a widely cited and important case.

Other courts have used this case to state that freeze out tactics also constitute a breach of the duty.

Crowley case held that remuneration to paid to controlling shareholders in order to zero out, without making any payments to minority shareholders violated the Donahue rule.

Donahue rule has been invoked to Ps in several cases where employee-shareholders were fired for reasons that did not constitute good cause.

- Delaware corporation law provides protections for minority shareholders though the tests are narrower and more specific. It is the “entire fairness” test discussed in Wilderman.

- Massachusetts has recently stated that the Donahue rule is not intended to stop legitimate business activity. Cannot hamper management from making decisions in the best interest of the co.

11.) Legal Restrictions on Dividends: ?????????a.) Louisiana follows the “general surplus” test.

o This means that you can make distributions out of both the earned surplus account and the capital surplus account.

o Cannot distribute from the capital stock accountb.) The rights of shareholders

o Once the dividend is declared & announced The shareholders are creditors of the corporation.

o If the dividend is declared but remains unannounced The shareholders have no rights.

o If the dividend is declared & announced, but the corporation would be violating the corporate statute by paying the dividend, the shareholders have no rights above creditors: “Every shareholder who receives any unlawful dividend, shall be liable to the corporation, its creditors, or both, in an amount not exceeding the amount so received by him.” LA R.S. 12:93(D).

c.) LA R.S. 12:63. DividendsA. Subject to the rules on Surplus, the board of directors may from time to time declare, and the

corporation may pay, dividends in cash, property or its own T-shares out of surplus, except (1) when the corporation is insolvent ("Insolvency" means the inability of a corporation

to pay its debts as they become due in the usual course of business. LA R.S. 12:1 (L)equity insolvency); or

(2) when the corporation would be made insolvent by paying the dividend; or (3) when the declaration or payment thereof would be contrary to any restrictions

contained in the articles of incorporation. - When a dividend is paid in cash or property out of capital surplus, notice shall concurrently

be given to all shareholders that the dividend is being paid out of capital surplus. (They are returning your $).

- When a dividend is paid in shares without par value, notice shall concurrently be given to the shareholders receiving the dividend, of the allocated value of the dividend shares.

B. If the corporation has no surplus available for dividends,C. it may pay [ NIMBLE ] dividends out of its net profits for the then current or the preceding fiscal

year or both; except that no dividend shall be paid:(1) at a time when the corporation's assets are exceeded by its liabilities (balance sheet

insolvency), or when the net assets are less than the aggregate amount payable on liquidation upon the issued shares, if any, which have a preferential right to participate in the corporation's assets in event of liquidation, or

(2) which would reduce the assets below the liabilities, or which would reduce the net assets below the aggregate amount payable on liquidation upon the issued shares, if any, which have a preferential right to participate in the corporation's assets in event of liquidation.

LA R.S. 12:62. Surplus.

A. If there is no earned surplus, the board of directors may apply capital surplus to the reduction or elimination of any deficit resulting from losses.B. The board of directors may create and abolish reserves out of earned surplus for any proper purposes. Earned surplus so reserved shall not be available for payment of dividends, purchase or redemption of shares, or transfer to capital surplus or stated capital. Earned surplus not otherwise reserved shall be deemed reserved, to the extent of accrued unpaid preferential dividends, for the payment of such dividends pursuant to declaration thereof or as part of the redemption or purchase price of shares of the class or series on which such dividends are payable.

12. Two other tests exist:a. Equity insolvency – cannot make a distribution if you cannot pay your debts.

1) The Model Act approach2) Cash flow statement is important.

b. Balance sheet solvency – after you pay the dividend, your assets must exceed your liabilities.

13. Earned surplus dividend statutes exist in many states.a. This means that a company may only ay dividends out of the earned surplus account.b. Thus, if the company loses money in a year, it cannot pay a dividend.

1) In some states, it is allowable to do a quasi-reorganization.a) This “cleans up the books” and lets you start anew.

2) Steps:a) Get the shareholders to vote on an amendment to the articles of

incorporation to reduce the par value of the stock. i. This takes money out of the common stock account and puts it into

capital surplus.b) Restate all assets to value. Usually much lower.c) Take this amount out of capital surplus and put into earned surplus.

c. This crap illustrates why the smart states like Del. and La. have a two fund method of paying dividends.

14. Handout (Does this help???)a. Net worth jurisdiction – can pay dividends if assets exceed liabilities. No cushion.b. Surplus jurisdiction – can pay dividends if there is either capital surplus or earned

surplus.c. Earned surplus jurisdiction – can only pay dividends out of earned surplusd. surplus or current net profits jurisdiction – can pay if there is surplus or current net

profits. Can pay out of this years and last years net profits. Called nimble dividend statutes. This is what Louisiana is.

MANAGEMENT AND CONTROL OF THE CLOSELY-HELD CORPORATIONA. The general common law rule is that directors of the closely held corporation are fiduciaries of:

1. the corporation and

2. the shareholders3. McQuade v. Stoneham (N.Y. 1934)

Facts: P was elected permanent treasurer of a baseball team (publicly traded). Other two directors had a falling out with the P. Stoneham was the primary shareholder. There was a shareholder agreement that salary could not be changed and that the directors would have to stay in their offices.Holding: this agreement was against public policy. This is the strict common law approach that agreements between shareholders that attempt to resolve questions that are the responsibility of the board of directors were against public policy and may be ignored by parties to the agreement.a. Directors cannot be bound to vote in one way.b. By statute, the corporate powers are with the directors.

1) A director is (many theories)a) agent (universally recognized)b) concession theory – his powers come from the statec) platonic guardian – broad duties to shareholders, societyd) sui generis – courts define the unique position.

4. Clark v. Dodge – two sole shareholders elected each other as officers. Same court held that this was OK because no one was hurt. There was no attempt to sterilize the board; all shareholders were parties to the contract. a. The difference between this case and McQuade is that this was a closely held

corporation. 5. Long Park v. Trenton-New Brunswick Theaters

Facts: All shareholders entered agreement giving one shareholder the full authority and power to supervise and direct the operation and management. This person could only be removed by binding arbitration.Holding: This completely sterilized the power of the directors. Such restraints are clearly a violation and much more strict than the conduct in Clark.

B. Authorization of Shareholder agreements1. MBCA § 7.32 – gives closely held corporations greater freedom to tailor the rules of

their enterprise. a. Rejects the line of cases such as Long Park.

2. Galler v. Galler (Ill. 1964)Facts: Accountant came up with a plan to preserve the family business. The plan gave very complex restrictions which technically violated corporation statutes.Holding: the court will uphold the agreement because all of the shareholders agreed to it. It was a close corporation and no one was harmed (no public detriment either).a. This case changed the face of corporate law – first time the close corporations

were really treated differently. Now special statutes for closely held corporations are the norm.

3. La. Rev. Stat. 12:29 – any lawful provision may be made on a matter by all shareholders entitled to vote on that matter, if proposed as an amendment to the articles of incorporation.

4. About 17 states have enacted special close corporation statutes following the Galler decision. In Nixon v. Blackwell, the court held that special rules for close corporations in Delaware could only be obtained by including a provision that “This corporation is an

electing close corporation” in its articles of incorporation as required by the Delaware Close Corporation Statute. In an earlier case, Zion v. Kurtz, the court upheld an agreement (between the shareholders that all minority shareholders had to consent to all business activities) under the Delaware Close Corporation Statute even though the corporation’s certificate of incorporation did not contain the required language and the corporation did not qualify under the requirements of the Delaware Close Corporation Statute. Zion is SHIT!!! In order to get the advantages offered to close corporations, you must comply.

C. Testamentary Directions1. Such directions are generally unenforceable on the ground that they restrict the

discretion of the directors.a. Unavoidable conflicts between the duty of the trustee to follow the directions of

the testator and the duty of the director to make decisions based on the best interest of the corporation.

2. Estate of Hirshon (N.Y. App. 1972)Facts: Z, a 68% shareholder has the power to elect the entire board of directors of A corporation. Z’s will bequeaths his shares to a trust and directs the trustees to elect themselves directors and to pay certain salaries to his family. Holding: The court found a violation of public policy in telling the trustee who to name as chairman of the board and president and the set salaries. The dead cannot make trustees do something when the dead person does not know all of the facts.

D. Traditional Roles1. Matter of Auer v. Dressel (N.Y. 1954)

Facts: Class A shareholders sued the president for failure to call a special meeting as required. Issue: Can shareholders make a president call a special meeting when the bylaws provide for it?Holding: Yes, the people who can call a meeting may be different than those who can vote. Although they cannot order the meeting, they can bring a resolution urging the directors to have a special meeting.

2. La. Rev. Stat. 12:73 – meeting can be initiated by the president or the board of directors. But, upon written request of one fifth (or any lesser amount provided in the articles of incorporation) of the total voting power, the secretary must call a special meeting.a. They can be held anywhere, in or out of state.

b. They are to be held once per year, but, if there has been no meeting for 18 months, a shareholder can compel a meeting.

3. Special agents in a publicly held corporation:a. transfer agent – keeps names and addresses of the shareholders. Those names

become record holders. So, if the directors want to give a dividend on June 1, only those listed as record holders will get the dividend

b. registrar – makes sure that the corporation does not issue more stock than it is allowed to sell.

E. Shareholder Voting and Shareholder Agreements1. Eligibility to vote at a shareholders’ meeting is determined by record ownership on a

specified date, called the record date.a. The record owner is the person who buys shares from a current shareholder,

executes a power of attorney, presents the certificate to the corporation, which then cancels the old certificate, and issues a new one to the record owner.

b. A beneficial owner is one who simply buys the shares and has not gone through the formalities of arranging for a new certificate.1) When the record owner is different from the beneficial owner, the record

owner only has naked ownership; thus, the beneficial owners may compel the record owner to execute a proxy appointment in his favor.

2. Salgo v. Matthews (Tex. App. 1973)Holding: Disputes as to entitlement to vote are usually resolved by the inspector of elections who may be granted discretionary authority to resolve disputes on the basis of the statutory voting rules and records of the corporation.

4. La. Rev. Stat. 12:75(c) – A shareholder may vote in person or by proxy duly authorized in writing and filed with the secretary of state before the meeting.a. Any person may vote by proxy without the necessity of obtaining authorization from

the court transferring the name on the stock, unless they are a Receiver or a Trustee.

5. Rights of common shareholders:a. elect directorsb. remove directors. In Louisiana, we can remove with or without cause by majority

vote (§8l(c)(4)).c. make recommendations to the board about business and personnel matters.

Aur.d. Right to examine changes in the fundamental organization, such as amending

the articles of incorporation and the bylaws, sales substantially all of the assets. (directors also have this right), right to inspect the books.1) In Louisiana, the right to inspect the books is found in §103.2) Ex: shareholders write letter to the corporation asking to see the books

and records. The corporation will deny. So, shareholders have to file a motion to show cause. Court will allow if it is reasonable. Ex: it would not be reasonable for a competitor to buy shares and then demand to see the books.

e. Vote on things like mergers and consolidations.1) There is a difference in the right to vote and the right to initiate (ex:

shareholders cannot initiate a merger)f. Settle internal management conflictsg. Right to hope for dividendsh. right to liquidation after the creditors and preferred shareholders have been paid.

6. Shareholder meetings:a. Annual meeting – held to elect directors and vote on matters. Notice of the date

is usually set out in the bylaws.

b. Special meeting – Ex: removal of director, amendment of articles.1) Look to statutes and bylaws to see how much notice is required.

7. In order for a meeting to occur there must be a quorum. Need this to accomplish anything.a. Usually, to approve an action, a majority of a quorum is required.b. Shareholders can vote on general things, not things like: the president must do

business in Albania. These types of things are for directors.c. Historically, a corporation could not require a super majority vote. It was against

public policy. But, today, it is common.d. La. Rev. Stat. 12:74 – the presence, personal or proxy, of a majority of the total

voting power shall constitute a quorum. Except, no quorum can consist of less than one fourth of the total voting power. (this means that ¼ of the total voting power cannot pass something). Once you have a quorum, they cannot get mad and leave to not let anything pass. It is their presence, not the actual vote that makes a quorum.

e. Cumulative voting is not important anymore. You never know how many votes will be cast. 1) La. Rev. Stat. §75 – one share, one vote

a) But, articles of incorporation can provide for cumulative voting. Ex: In a close corp, A owns 200 shares and B owns 100 shares. If three directors are to be elected, multiply the number of shares times three. This means that A gets to elect two and B gets to elect one (otherwise A could elect all three)

b) But, it is troublesome.f. La. Rev. Stat. 12:76: When the law or the Articles of Inc. require an affirmative

vote of the shareholders to perform a corporate action, all of the shareholders may execute signed consent forms, in lieu of calling a shareholder's meeting. Unless there is an agreement in the Articles of Incorporation that a lesser percentage of the voting power may consent.

g. La. Rev Stat. 12:77: To determine who may vote at a meeting, the board may fix a record date on which a determination of record ownership shall be made for the purposes of the upcoming meeting. The date may not be more than 60 days before or less than ten days before the meeting. If no record date is fixed, the record date shall be the day before notice of the meeting is mailed.

8. Humphrys v. Winous : Represents an attempt to minimize the effect of cumulative voting. The court upheld a staggered election system that placed only a single director in each class. The plan effectively destroyed the cumulative voting system in the corporation. Such plans are now prohibited by state statutes, which effectively overrule the case.a. Louisiana deals with this by providing that if you want cumulative voting, you must

put it in the Articles of Incorporation. (12:75(B)).

9. Voting Pools: Shareholder voting agreements are valid as long as they relate to issues, such as the election of directors, on which shareholders may vote. See Barnum & Bailey.

10. Ringling Bros.-Barnum & Bailey v. Ringling (1947):Facts: Three members of a family own a circus. The two sisters didn't want the brother to run the company They decided to pool their votes & made an agreement that: (1)Neither party would sell their shares without giving the other a right of first refusal; (2)They will act jointly to elect the directors; & (3)If they can't agree of something they will submit the dispute to arbitration. They had a dispute & went to arbitration, but the arbitrator was not given a proxy to cast his vote in accord with his decision. (Big Mistake!!!) The shares are registered in the names of the sisters individually.Holding: The Delaware Supreme Court enforced the pooling agreement by disqualifying the shares which could not be voted for lack of a proxy. The effect of the disqualification defeated the purpose of the pooling agreement and the brother took control of the corporation.

11. McKinney's Bus. Corp. Law: States that a shareholder shall not sell his vote for anything of value. It also makes irrevocable a proxy granted in connection with a pooling agreement that states its irrevocability & is held by:a. A Pledgee;b. A person who has purchased or agreed to purchase the shares;c. A creditor who has extended credit in consideration of the proxy;Also §620 states that: "An agreement between two or more shareholders, if in writing & signed by the parties thereto, may provide that in exercising any voting rights, the shares held by them shall be voted as therein provided, or as they may agree, or as determined in accordance with a procedure agreed upon by them."This provision would certainly have protected the daughters in Ringling Brothers case.

12. Voting Trusts: (a.) For people with a successful business, who don't want their weak ass kids to have a

vote when they die. The father can make a reliable person the trustee for 25 years, so that the son is the owner of the stock & gets dividends, but can not vote the stock;

(b.) Also, if shareholders are deadlocked, the attorney may create a trust & let the trustee manage the company while the shareholders settle their differences;

(c.) In bankruptcy, when the old management has been kicked out, the court can create a voting trust to get the company back on its feet; or

(d.) Regulatory agencies can use voting trusts to run subsidiaries.13. La. R.S. 12:78: Shareholders may make a written agreement transferring shares to a

trustee for no longer than 25 years.(a.) The voting trust vests in the trustee, all voting rights and other rights pertaining to

such shares transferred in accordance with the terms of the voting trust agreement.(b.) The agreement is binding & may stipulate:

- Who are the trustee(s);- The method & amount of compensation;- The length of time of the trusteeship;- How they are to vote: person or proxy.

(c.) Procedure: Shareholder surrenders shares to the trustee(s) pursuant to the agreement. The trustee surrenders the old shares to the corporation. The

corporation cancels the old shares & issues new certificates. The trustee then shall execute & deliver certificates of beneficial interest to the transferring shareholders.

14. Brown v. McLanahan (4th Cir. 1945):Facts: Voting trust formed with all common and preferred stockholders. State law limited it to ten years. At the end of the ten year period, the trustees decided to amend the corporate charter to water down the voting rights of the common stock holders. Holding: This was a violation of fiduciary duty the trustees tried to extend their own interests.Rule: The trustee must act as a fiduciary. There are equitable limitations on the power of trustees to approve damaging fundamental changes despite clear and broad language in the governing document.

15. It is important to recognize that the procedural requirements for creating a voting trust are essential for the validity of a voting trust.a. There is a strong state interest in preventing secret voting trusts.b. The filing of a copy of the voting trust agreement with the corporation is particularly

essential.1) There is a Louisiana case that held that the trust failed when they forgot to file

the copy.

Classes of shares as a voting device.1. Modern statutes offer a high degree of flexibility and adaptability:2. Lehrman v. Cohen(Del. 1996).

Facts: Two shareholders each own 50% of the stock of the corporation. After a series of disagreements, they agree to restructure the corporation. Two classes of shares are created, each with the power to elect two directors. Each shareholders holds all of the shares of one class of shares. In addition, a third class of shares, consisting of one share, is issued to the corporation's attorney. This third class has a par value of $10 per share, is not entitled to receive dividends, may be redeemed at any time by the unanimous vote of the other shareholders for its par value, and may receive only its par value on dissolution of the corporation. There was a claim that this arrangement was impermissible as a voting trust because not limited to ten years as required by statute.Issue: Is this a valid class of shares?Holding: A Class with such limited financial rights and significant voting rights is a valid class of stock. Rationale: This did not divest and separate voting rights. In any recapitalization involving the creation of additional voting stock, the voting power of the previously existing stock is diminished, but a voting trust is not necessarily the result. Three elements of a voting trust:a. voting rights of the stock are separated from the other attributes of ownershipb. the voting rights granted are intended to be irrevocable for a definite period of

timec. the principal purpose of the grant of voting rights is to acquire voting control of

the corporation.Purpose here was not to gain control, but to solve deadlock.

3. Abercrombie v. Davies (Del 1957) – an arrangement that has most of the characteristics of a voting trust must fully meet the statutory requirements if it is to be upheld, even though it is formally a voting agreement or proxy arrangement rather than a voting trust.

4. La. Rev. Stat. §81(D) – the articles may provide that a particular class or series of shares may elect all or a certain number of the directors, or the directors of a certain class.

5. La. Rev. Stat. § 82(F) – The articles may provide that only the shareholders or only a particular class or classes of directors, or only directors elected by the vote of a particular class of shares, may elect certain or all of the officers, in which event officers so elected may be removed without cause only by the shareholders or directors empowered to elect their successors.

Share transfer restrictions1. Ling & Co. v. Trinity Savings & Loan –

Issue: Can you limit the resale of stock in a closely held corporation?Holding: There can be no limitation on the transferability of shares unless it appears on the certificate itself.Rule: To limit transferability: (1) have a clear agreement, (2) be sure to put on the certificates in a conspicuous place.a. La. Rev. Stat. §57(F) – No restriction on the transfer of shares, no provision for

the compulsory offer of shares of its own stock for sale to the corporation, no agreement among shareholders binding on non-signatories, shall be recognized unless it is set forth, referenced, or summarized on the stock certificates.1) The source of the restriction can be the articles, by-laws, shareholder

agreement such as buy-sell or right of first refusal.2) But, it cannot unreasonably restrain or prohibit transferability.

Summary of internal control devices in a close corporation:1. pool (Ringling case)2. shareholder agreement (§29 in La.)3. classes of shares (Lambert case)4. high quorum for voting requirements5. buy-sell agreements with triggering events

a. cross purchaseb. redemptionc. specify a price for buy-sell

1) Book value is a bad idea because courts will always enforce, no matter how inequitable.

2) A self adjusting formula is good3) can also make provisions for independent appraisals.

d. Specify how the company will pay for the interest.6. voting trusts7. cumulative voting8. provisional director9. mandated buyout

a. Rousseau thinks that the best two are buy-sell agreements and shareholder agreements.

b. Buy-sell agreements that are triggered by the death of a stockholder may raise serious problems for the decedent’s estate. According to the IRC, in order for the buy-sell price to establish the value of the shares for tax purposes:1) Price must be fixed or determinable and reasonable when made2) the estate must be obligated to offer to sell the shares at the agreed price3) the obligation must have been binding on the decedent during his lifetime.4) the agreement must be a bona fide business agreement.5) the agreement must not be a device to pass the decedent’s share for less than

full consideration6) must be comparable to those of similar arm’s length transactionsIf these are not met, the IRS may seek a valuation for tax purposes that is considerably higher than the agreed on price.