1) principal must consent to agency

2) agent must act on behalf of the principal

3) principal must exercise control over the agent

Facts: D loaned car to G, G has traffic accident, injures Gorton.  Gorton's father sues D under agency principles

Holding: where one undertakes to transact some business or manage some affair for another by authority and on account of hte latter, the relationship of principal/agent arises

Facts: Cargill loaned funds to Warren and eventually took control of the day-to-day operations.  Jury rendered verdict against both Warren and Cargill claiming Cargill acted as principal

Rule:  A creditor who assumes control of his debtor's business may be held liable as principal for the acts of hte debtor in connection with the business

Authority

(General)

1) Principal has manifested to the agent (or 3rd party) his consent for the agent to act on his behalf

2) Agent while acting within the scope of his agency may a) bind the principal in contracts, b) subject him to tort liability (respondeat superior), c) subject principal to criminal liability

3) Principal not liable for acts of agnet outside scope of his agency

1) Principal bears all risk for the actions of the agent a) agent is not liable to the principal or to others

2) if agent breaches fiduciary duty in acting, he will be liable to the principle for any detriment (subrogation)

Types of Actual Authority

(Two)

1) Express Authority

2) Implied Authority

Implied Authority

(Definition)

1) Actual authority circumstantially proven which the principal actually intended the agent to possess and includes such powers as are practically necessary to carry out the duties actually delegated

2) authority which is reasonably necessary to carry out the objectives of the agenty, even if it is not expressly granted in the manifestation of agency

Facts: Church hired B to paint building, B hired S to help complete job.  S broke leg while working, filed claim for worker's comp under theory that he was working as agent of the church

Holding: a person possesses implied authority as an agent to hire another worker where such implied authority is necessary to implement hte agent's express authority

Apparent Authority 

(General)

1) results from manifestation by the prinicpal to third parties that the agent has authority to perform the act in question

2) based on the course of conduct between the principle and agent (c.f. inherent authority)

1) A principal is liable to the third party for actions by the agent that hte third party was reasonable in believing were within apparent authority of the agent

2) principal is estopped from denying the agent's authority 

1) established by principle via direct communication to third party

2) principle's direct communication to public at large

3) implication from the conduct of the principle toward the third party

4) implication form the principle's conduct toward agent in the third party's presence 

Apparent Authority

(Exceptions)

Inherent Agency Power

(c.f. Apparent Authority)

Facts: salesperson at Ampex agrees to sell a number of computers to 370 leasing.  Salesperson, however, was not given the authority to enter such an agreement

Holding:  a salesperson binds his employer to a sale if he agrees to that sale in a manner that would lead the buyer to believe a sale had been consummated 

Apparent Authority

(Defined)

Inherent Authority

(General)

1) relates more to status, less to conduct

2) undisclosed principal grants powers to agent that are reasonably constured as duties principal would perform

3) agent's status nder principal leads one to reasonably believe that agent is to conduct the ordinary course of principle's business

Manifestations of Representation

(Inherent Authority)

1) principal does not grant power to agent

2) principal (undisclosed) does not make representation to third party

Some courts hold:

1) agent may have inherent authority to bind corporation only by acts arisingi n the usual and ordinary course of business

2) may not bind principle to contracts of an extraordinary nature (one that is so important to the welfare of the corporation that third parties would naturally supposed that only the BoD or shareholders could properly handle the matter)

Policy Considerations

(Inherent Authority)

1) undisclosed principals should not be able to place risk on employees while incurring the benefit of employees risk

2) company may be held accountable for actions of employees

3) an innocent third party should not be detrimented while principal is unjustly enriched (Watteau v. Fenwick) 

Facts: H worked at beerhouse but later transferred business to F.  H remained manager but had no authority to buy goods for business.  Action brought against F to recover cost of goods purchased by H

Holding: when one holds out another as agent, that agent can bind the principal on matters normally incident to such agency, even if he was not authorized for a particular type of transaction 

Estoppel 

(Inherent Authority)

Ratification

(Defined)

Restatement §82

The affirmance by a person or a prior act which did not bind him but which was done or professedly done on his account 

Ratification

(Three Elements)

Boticello v. Stefanovicz 

1) acceptance of the results of the act

2) an intent to ratify the act

3) full knowledge of all the material circumstances 

1) express words

2) course of conduct by principal

facts: husband and wife owned farm, husband accepted offer while wife refused, Boticello paid 85k and made improvements to farm, wife later rejected his option to purchase, Botticello sued for specific performance, alleging ratification

holding: marital status cannot in and of itself prove an agency relationship, agent must have full knowledge of material circumstances

Agency

(Burden of Proof)

Hoddeson v. Koos Brothers

(Authority by Estoppel)

Facts: Hoddeson gave cash to man whom she thought was furniture salesman.  She later discovered he was not an employee, but a conartist who took her money.  She sued the store alleging privity of contract based on agency

Holding:  to establish agency by estoppel the appearance of authority must be shown to have been created by the manifestations of hte alleged principal and not solely by the supposed agent 

Authority by Estoppel

(Policy Considerations)

Atlantic Salmon v. Curran 

(Agent's Liability on K)

Facts: salmon wholesalers sued Curran for outstanding debts.  Wholesalers believed Curran netered contracts as agent of Boston Seafood, when in actuality, he entered contracts as another company, Marketing Designs, as a partially disclosed principal

Holding:  it is the duty of an agent in order to avoid personal liability on a contract entered into on behalf of the principal, to disclose not only that he or she is acting in a representative capacity, but also the identity of the principal

Partially Disclosed Principal

(Defined)

Partially Disclosed Principal

(Avoiding Personal Liability)

Principal Liability in Tort

Restatement (Second) §219(1)

Servant

(Defined)

an agent performing services in the master's affairs whose conduct is controlled or is subject to the right of control by the master

(Master does not have to actually exercise control over what hte agent does; merely needs to have the right to control)

Independent Contractor 

(Defined)

1) agent type independent contract

2) non-agent independent contractor

1) subject to limited control by principal with respect to the chosen result (no physical control)

2) agent has power to act on principal's behalf

3) example: carpenter hired to build garage for homewoner and agrees to buy lumber for the project on credit account of homeowner-- he is now acting on behalf of hte homeowner

1) perhaps less control on principal's part, BUT

2) agent has no power to act on principal's behalf

3) example: carpenter hired to build garage for homeowner, carpenter simply responsible for getting the job done and is not to take directions from homeowner

Facts: vehicle rolled out of service station and injured Martin, Service station owned by Humble Oil, but operated by Schneider.  Humble appealed judgment contending it was not responsible for the torts of its independent contractors

Holding:  a party may be liable for a contractor's torts if he exercises substantial control over the contractor's operations

(General rule is that liability will not be imputed to the principal for the torts of an independent contractor)

Facts: Barone operated franchise of Sun Oil, Barone controlled day-to-day operations and was allowed to carry products by other companies.  Hoover suffered burns from a fire at the station and sued Sun.

Rule: A franchisee is considered an independent contractor of the franchisor if the franchise retains control of inventory and operations

Control test: control over day-to-day operations is dispositive in establishing liability

1) duration of relationship

2) control

3)risk of loss

4) return

Facts: Murphy sought to hold Holiday Inns liabile when she slipped and fell at a motel operated by the franchisee

Holding:  the degree of control vested to the franchisee in a franchise contract is dispositive of tort liability

Facts:  Miller argued that McDonalds Corp. was liable for injuries hse sustained while eating at a McDonald's franchise restaurant owned by 3K restaurants

Holding: agency relationship may exist where franchisor retains significant control and insists on uniformity of appearance and standards designed to cause the public to think that the franchise is part of the franchisor's business

Apparent Agency

Restatement §267

Substantial Control

Restatement §220

1) extent of control master may exercise over details of the work

2) whether or not employee is engaged in a distinct occupation or business

3) nature of occupation, with reference to whether the type of work is usually done under the direction of hte meployer or by specialist w/o supervision

4) skill required to perform work

5) who supplies the instrumentalities, tools, and location

6) length of time

7) method of payment (Time-based or job-based)

8) is work part of the regular business of the employer

9) intent of parties

10) whether the principal is or is not in business

Fiduciary Obligations of Agents

Restatement §1.01

Agency is the fiduciary relationship that arises when one person (a "principal") manifests assent to another 

person (an "agent") that the agent shall act on the principal's behalf and subject to the principal's control, and 

the agent manifests assent or otherwise consents so to act.

Fiduciary Obligations of Agents

§8.01

Fiduciary Obligations of Agents

(Two categories)

1) duty of care

2) duty of loyalty

Restatement §8.08

insufficient effort or precautions

Restatement §8.01-8.05

Conflict of interest

Fiduciary Obligation of Agents

(General Principal)

Restatement §387

Unless otherwise agreed, an agent is subject to a duty to his principal to act solely for the benefit of the principal in all matters connected with his agency

Restatement §388

1) agent must account for all profits that the agent will make in the course of agency, including secret profits

2) agent must not use the authority, information, or resources of the agency in order to make an undisclosed profit 

Facts: Sergeant in military accepted bribe money while acting within scope of his position.  Military authorities seized bribe money, and Reading demanded it back

Holding:  An agent who takes advantage of the agency to make a profit dishonestly is accountable to the principal for the wrongfully obtained proceeds

Facts: Singer worked for GAM, when GAM was not fit to do required work, Singer solicited customers for his own side business. GAM sued to recover his profits

Holding:  an agent who draws business away from his principal for his own enrichment is liable to the principal for his profits

Facts: Town operated home cleaning service catering to affluent households.  Newberry resigned and opened her own business, soliciting accounts of her own

Holding:  Former employees may not use confidential customer lists belonging to their former employer to solicit new cutomers for their own business 

Partnership

(Statutory Authority)

1) UPA: adopted in all 50 states, controls in absence of K

2) RUPA: adopted in 12 states, also controls in absence of K

Partnership

(Defined)

1) UPA §6(1): A partnership is an association of two or more persons to carry own as co-owners in a business for profit

2) RUPA §202: Association of 2 or more persons to carry on as co0owners a business for profit forms a partnership, whether or not the persons intend to form a partnership

1) each partner is deemed to be an agent of the other

2) there may be imputation of liability

3) each partner is a fiduciary of the other

Partnership 

(Formation)

UPA §7: Rules to determine exsitence of partnership:

1) except as provided in §16 (partnershpi by estoppel), persons who are not partners as to each other are not partners as to third persons

2) joint tenancy, tenancy in common, tenancy by the entireties, joint property, common property, or part ownershp does not itself establish a partnership where such co-owners do or do not share any profits

3) the sharing of gross returns does not itself establish a partnership, whether or not the persons sharing them have a joint or common right or interest in any property from which the returns are derived

4) the receipt by a person of a share of hte profits of a business is prima facie evidence that he is a partner in the business 

Facts: Fenwick and Chesire entered into "partnership" agreement for beauty shop where Chesire would make no capital investment, no control over the management, and would not be liable for any losses

Holding: courts will look beyond the mere language of an agreement to determine the true nature of business association (see 6 factors, next card)

1) intent of the parties

2) right to share in profits

3) obligation to share in losses

4) ownership and control of the partnership property

5) control over management

6) rights of the parties on dissolution

Facts: Perkins and Freeman entered agreement where they would loan Martin $2.5M worth of securities to cover Martin's debts.  Perkins and Freeman were to be designated as "trustees" and kept advised on important matters.  Martin later claimed Perkins and Freeman's investments made them partners in the firm and liable for debts

Holding: absence of an explicit partnership agreement does not preclude the creation of a partnership

Fiduciary Obligations of Partnerships

Partnership Duties

1) non waivable (may not be waived even by express agreement, partnership agreement can narrow the scope of duties)

2) partners owe each other and the partnership a fiduciary duty of the utmost good faith and loyalty

3) partner must consider his partner's welfare and must refrain from acting purely in self-interest (duty of loyalty)

4) partner has obligation to render on demand true and full information of all things affecting the partnership or any partner

5) partner owes a duty of care-- to exercise diligence and care in using partnership property

Facts: Salmon entered joint venture with Meinhard to lease hotel in NYC.  Meinhard provided most funding, but Salmon managed and operated property.  Salmon entered new lease w/o disclosing to Meinhard and Meinhard subsequently demanded lease be held in trust as shared asset

Holding:  joint adventurers owe one another the highest fiduciary duty of loyalty while the enterprise is ongoing 

General Standards of Partners's Conduct

RUPA §404(b)

1) to account to the partnership and hold as trustee for it any property, profit, or benefit derived by the partner in the conduct and winding up of hte partnership business or derived from a sue by the partner of partnership property, including the appropriation of a partnership opportunity;

2) to refrain from dealing wit hteh aprtnership in the conduct of winding up of the partnership business as or on behalf of a party having an interest adverse to the parntership;

3) to refrain from competing with the partnership in the conduct of the partnership business before the dissolution of the partnership

Fiduciary Obligations of Partners

(After Dissolution)

Facts: Meehan and Boyle decided to terminate relationship with lawfirm and start their own firm.  Meehan denied he was leaving when rumors began to circulate.  Meehan did not immediately disclose to partners the clients and associaties of whom he already contacted and brought on to his new firm.

UPA §20: a partner has an obligation to provide true and full information of all things affecting the partnership to any partner 

UPA §18(e): All partners have equal rights in the management and conduct of the partnership business

UPA §18(h): Any difference arising as to ordinary matters connected with the partnership business may be decided by a majority of hte partners...but no act in contravention of any agreement between the partners may be done rightfully without the consent of all partners

Facts: Stroud and Freeman entered general partnership to sell groceries.  Periodically ordered bread from National Biscuit.  Stroud told National Biscuit that he would not be responsible for additional bread orders, but Freeman continued to order

Holding:  the acts of a partner, if performed on behalf of the partnership and within the scop of its business are binding upon all co-partners

Facts: Summers and Dooley entered partnership for trash collection business.  When Dooley was unable to work, Summers hired employee at his own expense to take Dooley's place.  Dooley refused to pay for employee out of partnership funds.

Holding:  business differences in a partnership must be decided by a majority of the partners provided no other agreement between the partners speaks to the issues 

Facts:  Day was senior partner at SA.  SA merged with other firm, and Day later resigned because of intolerable changes.  Claimed firm made active misrepresentations about merger proposal 

Holding: partners have a fiduciary duty to make a full and fair disclosure to other partners of all information that may be of value to the partnership

Dissolution of Partnerships

(Defined)

Winding-Up

(Defined)

Dissolution of Partnerships

(General Rules)

1) may dissolve partnership as long as express notice is given and other partner is adequately compensated

2) must satisfy "fairness factor-- goodwill and good faith requirement 

Dissolution of Partnerships

(3 Means of Dissolution)

1) UPA §31(1)(b): dissolution by act of one or more partners

2) UPA §31(4): dissolution by operation of law

3) UPA §32(1)(a): dissolution by court order

Facts: Owen and Cohen became partners in bowling alley.  Owen advanced 7K as loan to partnership.  Cohen constantly attempted to become dominating figure and appropriated partnership funds for his own use

Holding:  a court may order the dissolution of a partnership where there are disagreements of such a nature and extent that all confidence and cooperation between the parties has been destroyed or where one of the parties by his misbehavior materially hinders a proper conduct of the business

Dissolution by Decree of Court

UPA §32

1) partner is declared a lunatic

2) partner become incapable of performing K

3) partner guilty of conduct prejudicially affecting business

4) partner willfully/persistently breaches agreement

5) business can only be carried on at a loss

Collins v. Lewis

Facts: Lewis persuaded Collins to enter into partnership for operation of cafeteria.  Collins advanced money, but an investment turned out ot be larger than he anticipated.  Collins threatened to discontinue funding unless venture turend a profit and soon sued Lewis

Holding:  A partner who has not fully performed the obligations required by the partnership agreement may not obtain an order dissolving the partnership

Facts: Two brothers in partnership to run linen supply business. business unprofitable for first 8 years, but establishment of airforce base seemed promising.  P sought to dissolve partnership so as to capitalize on opportunity himself.  

Holding:  a partnership may be dissolved by the express will of any partner when no definite term or particular undertaking is specified 

Dissolution of Partners

(Duty of Good Faith)

Facts:  PSC owned patents in concrete pavin machines.  Formed partnership with Vasso to manufacture and sell machines.  Partnership was to be permanent unless mutual dissolution.  When Vasso discovered PSC was dissolving, Vasso immediately assumed all day to day management

Holding:  When a wrongful dissolution occurs, partners who have not wrongfully caused the dissolution shallh ave the right to continue the business in the same name and to receive damages for a breach of the agreement

Wrongful Dissolution under the UPA §38

UPA §38

When a dissolution is caused, the partner(s) that did not cause the dissolution is entited to:

1) continuing the business

2) damages for breach of partnership agreement

RUPA

A partners has option to continue the business or to dissolve it.  If continued, partner must compensate withdrawer for her share of property minus any damages caused by wrongful withdrawal

Facts:  G&S were partners with Nordale, but wanted to dissolve partnership because Nordale began making poor decisions due to persistent cocaine habit.  Filed complaint, but Nordale died.  Partners sought to acquire Nordale's interest, while Nordale's executor sought to assume liquidated assets

Holding:  a partnership buy-out agreement is valid and binding even if the purchase price is less than the value of the partner interest, since partners may agree among themselves by contract as to their rights

Limited Partnerships

Holzmann v. DeEscamilla

Facts: DeEscamilla was general partner of Hacienda  Farms.  Russell and Andrews were limited partners, however, exerted control over business operations and decisions.  Business went bankrupt and trustee sought to hold Russell and Andrews liable

Holding:  If a limited partner exercises control over the partnership business, he becomes a general partner 

Limited Partnerships

RULPA §303(a)

A) a limited partner is not liable for the obligations of a limited partnership unless:

 1) the limited partner is also a general partner; or

2) in addition to the exercise of his rights and powers as a limited partner, he takes part in the control of the business

B) if limited partner takes control, but is not a general partner, he is liable only to persons who transact business with the limited partnership and who reasonably believe, based upon partners conduct, that limited partner is a general partner

Limited Partnerships 

RULPA §303(b)

Formation of LLC's

Generally

Articles of Organization:

1) Names of LLC

2) Address of its registered office

c) length of term

d0 which members liable for debts

Facts: WWL employed by PII to perform work, but was not paid.  Business card had name of Lanham.  Though Lanham was a manager of the company, the card did not indicate that the company was an LLC.  WWL sued both PPII and Lanham in his individual capacity

Holding: when a third party sues a manager or member of an LLC under an agency theory, an LLC statute providing that articles of orgainzation serve as constructive notice does not supersede common law agency principles

LLC's

Legislative Intent

1) LLC Act provisions often require companies to use initials LLC as part of their names

2) Legislature intended to compel any entity seeking to claim the benefits of the LLC act to identify itself clearly as an LLC

Operating Agreements of LLC's

Elf Atochem North America v. Jaffari

Facts:  Elf and Jaffari entered joint venture via LLC.  the LLC however, was not a signatory to the agreement detailing governance of new company.  Agreement also contained arbitration and forum selection clauses

Holding:  Parties may contract to avoid the applicability of certain provisions of the ULLCA

Piercing the LLC Veil

Kaycee Land and Livestock v. Flahive

Facts:  Kaycee entered contract with Flahive, allowing Flahive to use the surface of its real property.  Flahive, however, caused environmental contamination to Kaycee's property.  Kaycee sought to pierce the LLC and brought direct suit.  No fraud was alleged

Holding:  In the absence of fraud, a claim ot pierce the veil of an LLC is treated in the same manner as a court would pierce the corporate veil

Fiduciary Obligation in LLCs

McConnell v. Hunt Sports Enterprises

Facts:  members of LLC formed to explore possibility of applying for a new NHL franchise.  McConnell and others formed a hockey LLC, but hwen difficulties in arena construction came about, mcConnell signed required documents in his individual capacity

Holding:  A member of an LLC does not breach a fiduciary duty to the company by directly competing against it where the operating agreement expressly permits competition

1) corporations have generated case law and forms that unincorporated firms would have to leave behind

2) clear rules concerning profit allocations and other matters

3) corporate form is cheaper than customized agreement generally needed for LLCs

4) costlier to convert from a partnership or LLC to a corporation when the firm goes public

5) moving to new corporate forms involves new learning and risks for lawyers

1) limited liability

2) partnership tax features

3) chameleon management (ability to choose between centralize and direct member-management)

4) creditor-protection provisions

1) continuity of life

2) centralized management

3) limited liability

4) free transferability of interests

1) a member may agree to be held liable for all or some of hte LLC's debts if liability stated in articles or organization

2) statutes do not protect members from liability for agreed contribution and excessive distributions

1) 2/3 of statutes explicitly requires that LLC have two members (or at least two members from inception)

2) liability to third parties

a) some statutes preclude application of liability shield by requiring:

i) two members

ii) providing that members are personally liable for purporting to act as or on behalf of a LLC, knowing there is no organization under this chapter

Veil-Piercing

Basic Veil-Piercing Principles

1) misrepresentation of capitalization or owners' responsibility

2) continued deliberate undercapitalization in the form of excessive dividends or failure to separate adequately the firms and owners' assets

3) disregarding decision-making and other formalities

Management

(LLC)

1) absent agreement, LLC is managed directly by its members (Chameleon management)

2) authority to bind

a) members have partner-like authority to bind a member-managed LLC

b) magers have similar authority to bind manager-managed LLCs

c) members have no authority as such to bind manager-managed LLCs

Duty of Care

(LLCs)

Defined

1) duty to refrain from willful or reckless conduct; or

2) duty to act as a purdent person in similar circumstance with a right to rely reasonably on reports of others

"the manner in which the director performs his duties, not hte correctness of his decisions"

*a gross negligence standard*

Duty of Loyalty

(LLC)

UPA §21

Manages can benefit from transactions with the firm only with the consent of other managers or members

Duty of Loyalty

Affirmative DUties

1) to refrain from self-dealing

2) to not use firm's assets selfishly

3) to not usurp any firm's business opportunities

Corporate Entity and Limited Liability

Corporate form

1) separate legal entity

2) limited liability

3) continuity of existence

4) management and control

5) corporate powers

Corporate Entity and Limited Liability

Limited Liability

1) liabilities belong to the corporation itself

2) corporation is not responsible for hte debts and obligations of its owners

Exceptions to Limited Liability

1) fraud or injustice

2) disregard of corporate requirements

a) fraud or injustice

b) disregard of corporate requirements

i) use for personal purposes

ii) not maintaining records

iii) financial commingling

Facts: Walkovsky run down by a taxicab owned by company.  Was one of ten cab companies owned by Seon.  Each corporation carried only minimum liability insurance.  Walkovsky sought to pierce corporate veil, alleging corporations were operated as a single entity

Holding: courts may pierce the corporate veil when necessary to (i) prevent fruad or to (ii) achieve equity.  THere is no issue with one corporation being part of a larger corporate enterprise, as long as business not being carried on for personal purposes

Facts:  Sea shipped ppepers for the PS but could not collect because PS was dissolved.  Sea sought to pierce corporate veil and hold Marchese liable.  PS then took measure to be reinstated as corporation

Holding:  Corporate veil will be pierced where there is 1) unity of interest and ownership between the corporation and an individual and; 2) adherance to the fiction of a separate corporate existence would sanction a fraud or promote injustice

1) corporate records and formalities not maintained

2) funds and assets commingled with abandon

3) undercapitalization

4) movement and borrowing of corporate assets

1) unsatisfied judgment, by itself, is not sufficient

2) required to show the kind of injustice necessary to evoke the courts power

1) situations where there has been an abuse of corporate priviege, because ofw hich the equitable owner of a corporation will be held liable for hte actions of the corporation

2) must demonstrate "control and dominion" so as to be liable for actions under later ego doctrine

3) makes a parent liable for the actions of a subsidiary which it controls

4) requirement for alter ego is that failure to pierce corporate veil would lead to inequitable result

5) purpose of doctrine is not to protect every unsatisfied creditor, but ot afford him protection where some bad fiath conduct makes it inequitable

Facts:  Plaintiffsi njured by breast implants produced by MEC, a subsidiary of Bristol-Myers Squibb.  Plaintiffs sought to pierce corporate veil and hold BMS liable.  MEC owned by a single sharholder of BMS

Holding:  in corporate control claim seeking to pierce the corporate veil to abrogate limited liability and reach the parent corporation, summary judgment could be proper if the evidence presented could lead to but one result

1) the parent and subsidiary have common director,s officers, or common business departments

2) the parent and subsidiary file consolidated financial statements and tax returns

3) the parent finances the subsidiary

4) the parent caused the incorporation of the subsidiary

5) the subsidiary operates with grossly inadequate capital

6) the parent pays the salaries and other expenses of the subsidiary

7) the subsidiary receives no business except that given to it by the parent

8) the parent uses the subsidiary's property as its own

9) the daily operations of the two corporations are not kept separate

10) the subsidiary does not observe the basic corporate formalities, such as keeping separate books and records and holding shareholder and board meetings

Closely Held Corporations

6 Attributes of Close Corporations

1) owned by a small number of persons (arising out of family, entrepreneur, etc.)

2) high degre of overlap between shareholders, managers, and employees

3) less desirable management structure; not centralized;  more deadlock

4) shareholders have little liquidity (not publicly traded in open market)

5) the value of ownershp in the closed corporation is not readily observable

6) likely to experience significant deadlock in decision making (due to number 3)

Facts:  Dodge brothers used Ford after Frod decided not to pay any more special dividends and to instead reinvest profits into the existing business.  At the time, Dodge brothers were rising competitiors to Ford, despite being shareholders of Ford

Holding:  A corporation's primary purpose is to provide profits for its stockholders

Facts:  Wrigley, the majority shareholder in the chicago Cubs, refused to install lights at Wrigley Field in order to hold night games.  Shlensky, a minority shareholder, filed a derivative suit to compel the installation

Holding:  A shareholder's derivative suit can only be based on conduct by the directors which borders on 1) fraud, 2) illegality, 3) conflict of interest

Business Judgment Rule

Defined

1) Absent fraud, illegality, or conflict of interest, the board's business judgment is not second guessed by the court

2) deference to the Board's decisions, unless

1) directors' decision is tainted by fraud or illegality

2) directors decision is tainted by conflict of interest (duty of loyalty)

3) directors do not conduct sufficient investigation or deliberation to make a business judgment (duty of care)

Facts:  Kamin, a minority stockholde,r sued AE because of decision to declare a special divident to all stockholders resulting in share distribution in kind.  Kamin sought declaration that dividend in kind constituted a waste of corporate assets

Holding:  whether or not a divident is to be declared or a distribution made is exclusively a matter of business judgment for the board of directors and the courts will not, therefore, interfere as long as the decision is made in good faith

Facts:  Trans Union entered mass sale of shares based upon VG's representations ot hte board.  board did not have sufficient time to review merger document,s and VG could not substantiate his $55/share price

Holding:  The BJR shields directors or officers of a corporation from liability only if, in reachign a busincess decision, the directors or officers acted on an informed basis, availing themselves of all material information reasonably available

Facts:  When Disney CEO Michael Eisner agreed for hte new Disney president, MIchael Ovitz, to tkae a non-fault termination which left Ovitz with a $140 million severance package, a group of Disney stockholders, including Brehm, brought suit against Eisner and Disney's directors for a) corporate waste and b0 breach of fiduciary duties

Holding:  an extraordinarily lucrative compensation agreement and termination payout awarded to a companyp resident who underperformed does not necessarily constitute a breach of fiduciary duty on part of corporate directors

Facts:  Mrs. Pritchard inhereted 48% interest in company upon husband's death.  Her two sons ran the company, withdrawing money for their own personal uses.  Mrs. Pritchard was ignorant as to the fundamentals of the reinsurance business and paid little attention to it

Holding:  Liability of a corporation's directors to its clients requires a demonstration of a) duty; b) breach and c) proximate causation

Duty of Care

Two Elements

1) duty to monitor corporation's affairs

2) duty to regularly review financial statements

Facts:  Caremark regularly entered into managed healthcare contracts that were not prohibited by the Anti-Referral Payments Law, but that raised the issue of unlawful kickbacks.  The board attempted to monitor these contracts internally.  Government sued Caremark

Holding:  A board of directors has an affirmative duty to attempt in good faith to assure that a corporate information and reporting system exists and is adequate

Duty to Monitor

(Subset of Duty of Care)

1) implies that a board will make a good faith effort to ensure that a corporate information and reporting system is adequate

2) requires the board to be aware of major activities and related issues that could pose a threat to the company

3) tremendously difficult ot prove a claim that a duty to monitor has been breached

BJR Standard

2 Elements

1) Director reasonably informed himself

2) director rationally believed that his decision was in the best interest of the corporation

Duties of Loyalty for Directors and Managers

Types of Interested Insider Transactions

Direct:  director has contact with corporation

indirect:  director is also officer of other corporation, director of company uses company to benefit spouses and endeavor

Facts:  Celanese Corp. udnerwent advertising campaign to develop branch awareness that cost over $1M per year.  Wife of company's president was selected to perform in campaign.  Sued for negligence and self interest

Holding:  Policies of business management are left solely to the discretion of the board of directors and may not be questioned absent a showing of fraud, improper motive, or self-interest

Intersection of Loyalty and Good Faith

Stone v. Ritter

Facts:  a derivative action by shareholders of AmSouth, in the wake of the disclosure that AmSouth had paid $50 million in fines and civil penalties arising from violations of the federal Bank Secrecy Act.  The lawsuit alleged that the directors of AmSouth had breached their duty to act in good faith because, while AmSouth maintained a program to monitor Bank Secrecy Act compliance, the program was not adequate to prevent the violations giving rise to the fines and civil penalties

Holding:  Directors may be found liable when there is a sustained or systematic failure of the board to exercise oversight-- such as an utter fialure to attempt to assure a reasonable information and reporting system exists

Demand Futiltity

3-Prong Test

1) majority of board has familial interest with regard to issue of contention

2) majority of the board is incapable of acting independently for some other reason

3) not the product of a valid exercise of business judgment

Corporate Opportunities

Broz v. Cellular Information Systems

Facts:  Broz utilized a business opportunity for his wholly owned corporation instead of CIS, for which he served as a member of the board.  Broz received consent from directors, however, when CIS was bought by another corp., this action ensued

Holding:  The corporate opportunity doctrine is ipmlicated only in cases where the fiduciary's seizure of an opportunity results in a conflict between the fiduciary's duties to the corporation and the self-interest of the director as actualized by the exploitation of hte standard

Derivative Litigation

Direct v. Derivative

Direct

Defined

1) brought by the shareholder in his or her own name

2) cause of action belonging to the shareholder in his or her individual capacity

3) arises from an injury directly to the shareholder

Derivative Litigation

Direct v. Derivative

Derivative

Defined

1) Brought by shareholder on the corporation's behalf

2) cause of action belongs to the corporation as an entity

3) arises out of an injury done to the corporation as an entity

1) who suffered the most direct injury (if corporation, suit is derivative)

2) to whom did the defendant's duty run?  (if corporation, suit is derivative)

Facts:  Cohen, a shareholder filing a derivative action, challenged the constitutionality of a NJ statute requiring an unsuccessful plaintiff to indemnify the corporation for its reasonable expenses in defending the action

Holding:  a statute holding an unsuccessful plaintiff liable for the reasonable expenses of a corporation in defending a derivative action and entitling the corporation to require security for such payment is constitutional

Facts:  Following merger, shareholder Eisenberg filed suit against Flying Tiger alleging that merger was a complex plan to deprive minority shareholders of influence; vote dilution

Holding:  A cause of action that is determined to be personal rather than derivative, cannot be dismissed because the plaintiff fails to post security for the corporation's costs

Direct v. Derivative

Damages

Direct: paid to the shareholder

Derivative: paid to the corporation

Facts:  Grimes, a shareholder, unsuccessfully sought a declaration of the invalidity of certain agreements made between donald (CEO) and the board, alleging excessive compensation and abdication of directorial duty by the board

Holding:  if a shareholder demands that the board of directors take action and that demand is rejected, the board rejecting the demand is entitled to the presumption that hte rejection was mde in good faith unless the stockholder can allege sufficient facts to overcome the presumption

1) direct, specific harm to the shareholder (i.e. contractual right to vote) that is not derivative of a prior injury to the corporate entity

2) breach of a contractual duty to a shareholder independent of any other duty

Demand Futility (Delaware)

"Reasonable Doubt"

1) a majority of the board has a material financial or familial interest

2) a majority of the board is incapable of acting independently for some other reason such as domination or control

3) underlying transaction is not the product of a valid exercise of business judgment

Demand futility (New York)

comes from Marx v. Akers

1) a majority of the directors are interested in the transaction

2) the directors failed to inform themselves to a degree reasonably necessary about hte transaction

3) the directors failed to exercise their business judgment in approving the transaction

Facts:  Maldonado instituted derivative action against officers/ directors of Zapata.  He did not first demand that the board bring the action, believing demand would be futile.  Board formed investigation committee consisting of two new board members, who sought to dismiss action

Holding:  when assessing a special litigation committee's motion to dismiss a derivative action, a court must: a) determine whether the committee acted independently, in good faith, and made a reasonable investigation, b) apply the court's own independent business judgment

Facts:  Shareholders brought derivative action asserting insider trading.  Oracle formed special litigation committee consisting of two Oracle board members (joined after alleged breaches) who were professors at Stanford.  Issued lengthy report, but failed to account for significant ties between Oracle and committee members

Holding:  A special litigation committee does not meet its burden of demonstrating the absence of a material dispute of fact about its independence where its members are professors at a university that has ties to the corporation and to the defendants that are subject of a derivative action that the committee is investigation

Facts:  Sinclair, majority shareholder, nominated all board members of subsidiary company, Sinven.  Derivative action brought by Levien claimed Sinclair used Sinven for the personal gain of his parent company

Holding:  The intrinsic fiarness test should not be applied to business transaction where a fiduciary duty exists but is unaccompanied by self-dealing

1) parent's fidicuary duty to subsidiary

2) evidence of self-dealing

Facts:  AF's stock divided into three classes: preferred, A, and B.  Transamerica acquired 80% and controleld board.  Redeemed class A stocks and liquidated assets of the corporation to Transamerica's benefit

Holding:  Majority shareholders owe a duty to minority shareholders that is similar to the duty owed by a director and when a controlling stockholder is voting, he violates his duty if he votes for his own personal benefit at the expens of the stockholders

1) dominant shareholder is held to the same duty as is a director, and when he benefits from dealing wht the corporation, he has the burden of proving good faith of the transaction and also fairness to minority interests

2) when a director votes for hte benefit of an outside interest, rather than for the benefit of the shareholders as a whole, there is a breach of duty

Introduction and Definition of Security

Two types of Markets

Primary

Secondary

Two Goals:

10 mandating disclosure of material information to investors

2) prevention of fraud

1) Principally concerned with secondary market transactions

2) issues covered

a) insider trading and securities fraud

b) short-swing profits by corporate insiders

c) regulation of shareholder voting via proxy solicitations

3) created securities and exchange commission

§2(1) of the Securities Act

1) intentionally ambiguous

2) "stock", "notes", and "bonds"

3) evidence of indebtedness, investment contracts, and any instrument commonly known as a security

Facts:  Glynn, founder of GeoPhone, solicited Robinson to invest $1M, and additionally $25M contingent upon successful test of new technology.  Gylnn falsely claimed testing was a succes, and Robinson invested follow-up sums of money.  Upon learning of misrepresentation, Robinson sued claiming federal securities laws violations

Holding:  a membership in a limited liability company is neither an "investment contract," no "stock," under the federal Securities Acts where the purchaser is a sophisticated businessman who is a knowledgeable and active executive at the company

LIteral Interpretation

Investment Contract

Practical Interpretation

Economic reality

1) right to receive dividends contingent upon an apportionment of profits

2) negotiability

3) ability to be pledged or hypothecated

4) conferring of voting rights in proportion to the number of shares owned

5) capacity to appreciate in value

The Registration Process

§5 Securities Act:  Three Basic Rules

1) a security may not be offered for sale through the mails or by use of other means of interstate commerce unless a registration statement has been filed iwth the SEC

2) securities may not be sold until the registration statement has become effective

3) prosepctus (disclosure document) must be delivered to the purchaser before a sale

Facts: a limited partnership in an oil drilling venture was offered, in an informal manner, to a handful of sophisticated investors, including Doran.  Oil wells were deliberately overproduced in violation of hte production allowances, and a government commission had them sealed.  As a result, Doran defaulted in his payments and sued seeking damages under securities laws

Holding:  even where an offering of securities is relatively small and is made informally to just a few sophisticated investor,s it will not be deemed a "private offering," exempt from the registration requirements of the 1933 Act absent proof that each offeree had been furnished, or had access to, such information about the issuer that a registration would have disclosed

1) numbero f offerees and their relationship to each other and the issuer

2) number of units offered

3) size of the offering

4) manner of the offering

1) principal express cause of action directed at fraud committed in connection with the sale of securities through the use of a registration statement

2) may not be used in connection with an exempt offering

3) defendant may reduce the amount of damages if it is able to prove that hte reduction in value was caused by some other factor

4) does not contain any privity requirement (generally, liste of potential defendants is quite expansive)

1) imposes strict liability on sellers of securities for offers or sales made in violtion of §5

2) liability arises where the seller improperly fails to register the securities

3) is available if the seller registers but fails to deliver a statutory prosepctus, violates the gun-jumping rules, or commits any other violation of §5

1) recission

a) the buyer can recover the consideration paid, plus interest, less income received on the security

b) if the buyer is no longer the owner of the securities, he or she can recover damages comparable to those which would be provided by recission

Imposes private civil liability on any person who:

1) offers or sells a security in interstate commerce

2) who makes a material misrepresentation or omission in connection with the offer or sale, and

3) cannot prove he did not know of the misrepresentation or omission and could not have known even with the exercise of reasonable care

prima facie case

under Securities Act §12(a)(2)

1) sale of a security

2) through instruments of interstate commerce or the mails

3) by means of a prospectus or oral communication

4) containing an untrue statement or omission of a material fact

5) by a defendant who offered or sold the security

6) which defendant knew or should have known of hte untrue statement

*liability arises under this section only with respect ot material misrepresentations or omissions made in written documents or oral communications used in connection with public offerings*

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

a) to employ any device, scheme, or artifice to defraud

b) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security

1) scienter

2) prodimate cause (fraud on the market, efficient capital market hypothesis)

3) materiality (reasonable investor would consider the mistake as important)

4) reliance (rebuttable presumption in favor of plaintiff, PSLRA (1995)-- a heightened pleading standard for plaintiffs (must plead with particuliarity, demonstrate motive and opportunity, have strong circumstantial evidence))

1) traditional insider rule 10b-5

a) Texas Gulf Sulfer, Chiarella, Dierks

2) misappropriation theory for app of 10b-5

a) O'hagan

3) Special rule for tender offer cases 14e-3

a) O'hagan

4) mail and wire fraud

Facts:  Despite participating in merger discussions and subsequent negotiations with Combustion, Basic three times publicly denied that it was engaged in any merger negotiations.  Shareholder Levinson alleged denials were material misrepresentations as to which Basic shareholders should be entitled to a presumption of reliance for purposes of class certification.  Alleged that each had sold stock in reliance on a market price artificially depressed

Holding:  whether a company statement is material will be determined on a case-by-case analysis of:

1) probability transaction will be consummated, 2) significance of the transaction, 3) investor's reliance on material, public misrepresentations may be presumed under a fraud-on-the-market theory for purposes of 10b-5

two elements:

1) material misrepresentation

2) causal connection

*party not disclosing must have duty to disclose (i.e. fiduciary or relationship of trust or confidence)

Facts:  Hofman, a Prudential Securities stockbroker, gave material non-public information (apparently false) to his clients about a forthcoming company merger.  A class action was certified on behalf of everyone who bought the touted stock during the period the misinformation was being given

holding: a class action may not be brought on behalf of everyone who purchased stock during a period when a broker was violating securities laws by providing material non-public information

Fraud-On-The-Market

Rationale

Facts:  Santa fe merged with Kirby for the sole purpose of eliminating minority shareholders.  Minority shareholders initiated suit under 10(b)and 10b-5 alleging a) absent business purpose and b0 lack of prior notice

Holding:  Before a claim of fraud or breach of fiduciary duty may be maintained udner §10(b) or Rule 10b-5, there must first be a showing of a) manipulation, b) deception

Facts:  Agassiz and another, president and directors of Cliff Mining, purchased Goodwin's stock in a corporation (through a stock exchange).  Through other companies had been unsuccessful at finding mineral deposits, Agassiz had new geological theory which expected to discover minerals on land.  GOodwin sued for recission

Holding:  A director of a corporation may not personally seek out a stockholder for the purpose of buying his share without disclosing material facts within his peculiar knowledge as a director and not within reach of the stockholders; but, the fiduciary obligations of directors are not so onerous as to preclude all dealing in the corporation's stock where there is no evidence of fraud

Facts:  TGS maintained that because its employees were ordered not to disclose material information to hte public, those employees were entitled to trade on that information prior to its dissemination ot the public.  TGS further maintained that, because its press release was not issued in order to affect the market price of TGS stock, it could not form the basis for a violation of federal securities laws

Holding: a) it is unlawful to trade on material inside information until such information has been disclosed to the public and has had time to become equally available to all investors b) a company press release is considered to have been issued in connection with the purchase or sale of a security for purposes of imposing liability under the federal securities laws, and liability will apply if a reasonable investor, in the exercise of due care, would have been misled by it

Facts:  Criminal proescution where defendant had been a "markup man" in the composing room of a financial printin company.  Chiarella, by virtue of his job and ingenuity, was able to identify prospective merger company, and bought shares of its stock

Holding:  Chiarella's conduct is not a violation because he was not an insider of the corporation whose shares he had traded

Insider

Defined

Facts:  Dirks, based on nonpublic information he received and a subsequent investigation, aided the SEC in convicting EFA for corporate fraud and was then sued by the ESC for violating §10(b) because he openly disclosed the nonpublic information to investors

Holding:  a tippee will be held liable for openly disclosing nonpublic information received from an insider, if the tippee knows or should know that the insider will benefit in some fashion from disclosing the information to hte tippee

Constructive Insider

Defined

Three Elements:

1) obtains material nonpublic information from the issuer

2) expectation on the part of hte corporation that the outsider will keep the disclosed information confidential

3) relationship at least implies such a duty

Can be held liable only when:

1) the tipper breached a fiduciary duty by disclosing the information to the tippee, and

2) the tippee knows or has reason to know of the breach of duty

Facts: O'Hagan, an attorney, was indicted for trading securities in Pillsbury based on confidential information he obtained by virtue of his position with the corporation's retained counsel.  O'Hagan, howerver, was not assigned to the case

Holding:  1) when a person misappropriates confidential information in violation of a fiduciary duty, and trades on that information for his own personal benefit, he is violation of §10(b) of the Securities Exchange Act of 1934 and Rule 10b-5

2) the SEC did not exceed its authority by promulgating Rule 14e-3(a), which prohibits trading on undisclosed information in a tender offer situation, even where the person has no fiduciary duty to disclose the information

1) holds an insider liable for trading in securities of his corporation based on relevant, nonpublic information

2) such trading satisfies requirement of deception due to the relationship of trust and confidence reposed in the insider by virtue of his position

3) requires an insider to disclose or abstain from trading in the securities of the corporation in order to protect unsuspecting shareholders

4) duty applies to officers and directors, as well as to anyone else who acts in a fiduciary capacity towards the corporation, including attorneys, accountants, and consultants

1) holds a person liable for the misappropriation of material, nonpublic information for the purpose of trading thereon, in breach of a fiduciary duty due to the provide of the information

2) extends liability to include corporate outsiders who owe no duty to the shareholders of the corporation but who nonetheless have access to the confidential information by virtue of their fiduciary postion

3) deceptive device (misappropriator of confidential information necessarily effectuates a deception on the source of that information through his nondisclosure of his intent to trade on it, involves illusory loyalty to the company that has the exclusive right to use of the infomration, equivalent to an act of embezzlement)

1) prohibits trading on undisclosed information in a tender offer situation, even where the person has no fiduciary duty to disclose the information

2) protects uninformed shareholders involved in a potential tender offer situation

3) imposes a duty on the trader to disclose the confidential infomration, or abstain from trading on it

4) consistent with legislative goal of proscribing fradulent or deceptive acts in the purchase or sale of securities

Short Swing Trading

Rule 16(b)

Generally

Rule 16(b)

Issuers

Applies only to companies that register their stock under the 1934 Act

1) companies traded on a national exchange

2) companies with assets of at least $10million and 500 or more shareholders

Rule 16(b)

Officers

Rule 16(b)

Class Distinctions

1) a shareholder will be liable for the short-swing profits that he or she makes on any class of stock

2) classes of stock are considered separately

a) beneficial ownership of only a given class subjects one to 16(b) provisions

b) does not matter if he does not own 10% of another class or total shares outstanding

Rule 16(b)

Matching Stock

Rule 16(b)

Treatment of Options

Rule 16(b)

Unconventional-Transaction Doctrine

1) Certain transactions are not deemed sales under §16(b)

2) Three Factor Test for exculsion

a) whether the transaction is volitional

b) whether the transaction is one over which the beneficial owner has any influence

c) whether the beneficial owner had access to confidential information about the transaction or the issuer

Facts: Reliance argued that since Emerson intentionally disposed of its stock in two separate sales in an effort to avoid liability under §16(b) as to the bulk of it short-swing profits, the two sales should be treated as one

Holding:  When a holder of more than 10% of stock in a corporation sells enough shares to reduce its holdings to less than 10% and then sells the balance of its shares to another buyer within six months of its original purchase, it is not liable to the corporation for hte profit it made on the second sale

1) Imposes strict liability, regardless of the intent of the insider

2) beneficial (10%) owner must be such both at the time of the purchase and sale of the security involved

3) excluded if: person in question does not meet statute's definition of insider, person in question sells more than six months after purchase

4) manipulation, person may sell enough shares to bring his holdings below 10% and later (but still within 6 months), sell additional shares free from liability

Facts: Provident brought suit seeking a declaration that it was not liable to Foremost under §16(b) of the SEA of 1934 for any profits it realized on the sale of a $25M debenture to underwriters

Holding:  in a purchase-sale sequence, the transaction by which the shareholder crosse the 10% threshold is not a matchable purchase; only purchases affected after one becomes a 10% shareholder are matchable

1) should not be construed to cover any transaction where beneficial owner was not such both at the time of the purchase and sale, or the sale and purchase

2) does not require that a person purchasing securities placing his holdings above the 10% level is a beneficial owner at the time of hte purchase so that he must account for his profits realized on the same of those securities within six months

Shareholder Proposals

Lovenheim v. Iroquois Brands LTD.

Facts: Lovenheim sought an injunction barring Iroquois from excluding from its proxy statements a proposed resolution he intended to offer at hte upcoming shareholders meeting

Holding:  A shareholder proposal can be significantly rleated to the business of a securities issuer for non-economic reasons, including social and ethical issue, and therefore may not be omitted form the issuer's proxy statement even if it relates to operations which account for less than 5% of the isuser's total assets

1) demonstration of a liklihood one will prevail on the merits

2) determination as to whether

a) plaintiff will suffer irreparable injury without relief

b) issuance of the requested relief will substantially harm other parties

Abuse of Control

Wilkes v. Springside Nursing Home

Facts: Wilkes was terminated as director and officer of Springside in violation of a shareholder agreement that each investor would serve as a director and receive salsary from the corporation

Holding:  in a closely held corporation, the majority stockholders have a duty to deal with te minority in accordance with a good faith standard

Abuse of Control

Balancing Test

1) legitimacy of the intended purpose versus

2) practicability of the less harmful alternative

Abuse of Control

Burden-Shifting

1) initial burden of proof

a) rests upon the majority to show a legitimate purpose for its decision related to the operation of the business

Abuse of Control

Partnership Analogy

1) shareholders in a closely held corporation owe one another substantially the same fiduciary duty in the operation of the enterprise that partners owe to one another

2) shareholders in closely held corporation owe each other duty of strict good faith

3) if brought by minority shareholder, controlling group must show a legitimate business objective for action

4) minority shareholder can prevail if he shows that controlling group could have accomplished business objecting in a manner that harmed him less

Freeze Outs

Defined

Freezeouts

Methods

1) removal as director

2) termination of employment/participation

3) exclusion from benefits

4) bonuses

5) corporate opportunities

6) no dividend paid

Freezeouts

Purpose

Abuse of Control

Reasonable Expectation Test

Facts:  Jordan, an employee of D&P, purchased stock in the company at book value.  Jordan later resigned, but stayed on until the end of the year in order to receive book value for his stock as of the end of that year.  Only days after his resignation, D&P merged with another company, drastically inflating sotck prices.  Jordan sued asking for damages measured by the value of his stock would have under the terms of the acquisition

Holding:  Close corporations buying their own stock have a fiduciary duty to disclose material facts

Book Value

Defined

Fair Market Value

Defined