Shared Flashcard Set


Business Associations-
Scharff's Cases

Additional Law Flashcards





Gorton v. Doty,

Who is an Agent?

Facts: Lady loans her car to coach. Issue: Was the coach an agent of Doty when he was driving her car?


Coach was an agent and Doty is liable.
§ Court misconstrues the relationship. □ They may have been Principal-Agent, but not Master-Servant.
1) Agency: Relationship 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 the other consenting so to act. The fact of ownership of a vehicle alone establishes a prima facie case against the owner for the presumption that the driver is the agent of the owner.

A Gay Jensen Farms v. Cargill

Who is an Agent?


Facts: Warren is a grain elevator company and has a relationship with Cargill. 

Issue: Is Cargill acting as Warren's principal?
Generally, Creditors aren't liable for actions of their debtors.
A creditor who assumes de facto control of his debtor's business may become liable as principal for the acts of the debtor in connection with the business.
Holding: Cargill, by its control and influence over Warren, became a principal with liability for the transactions entered into by its agent Warren.
Mill Street Church of Christ v. Hogan, (Implied Authority)
 Facts: Church hires Bill to paint. He hires his brother Sam to help.
Issue: Did Bill have implied authority as an agent to hire Sam? Was there apparent authority?
a) Implied Authority: Actual Authority Principal intended agent to possess, includes all practically necessary powers.
i) Consider: 1- Whether Agent reasonably believes because of past or present conduct that the Principal has given authority, 2- Nature of task, 3- Existence of prior similar practices,
ii) Person alleging agency and authority has burden of proof.
    Consider actions and conduct, words aren't enough.
Holding: Bill had implied authority to hire Sam. There would be apparent authority also.

Lind v. Schenley Industries, Inc.,

(Apparent Authority)


Facts: Lind was promoted to District manager under Kaufman. VP told Lind that Kaufman would give details. 

PH: Jury finds for Lind, judge overturns verdict- on grounds that Lind couldn't have reasonably believed that Kaufman had authority.
Issue: Did Kaufman have Apparent Authority to offer Lind commission?
a) Apparent Authority: Principal acts in a manner as to convey the impression to a 3d party that an Agent has certain powers which he may or may not actually possess.
Holding: Kaufman did have apparent authority, he was Lind's direct supervisor, company directed Lind to Kaufman for details of employment. a) Court could also have found Ratification or Actual Authority.
Three-Seventy Leasing Corp., v. Ampex Corp., Apparent Authority
 Facts: 370 negotiated the sale with Ampex reps, there was evidence that Ampex reps orally accepted the agreement.

Issue: Did Ampex reps have apparent authority to contract with 370?



Apparent Authority:

i) Principal acts in such a way as to lead a reasonably prudent person to believe the Agent has the authority he purports to exercise,

ii) Absent knowledge of 3d parties to the contrary, an Agent has the Apparent authority to do those things which are usual and proper to the conduct of the business in which he is employed.


Manifestation- Came through the agents (Mueller/Kays), Ampex called Kays a 'Sales Rep.'


Watteau v. Fenwick,

 Inherent Agency


 Facts: Humble sold a beerhouse to Fenwick, but H stayed on as manager.  H's name was on the door, but he only had authority to buy bottled ales and mineral waters.

Principals are liable for all the acts of the agent which are within the authority usually confided to an agent of that character, not-withstanding limitations put on agent's authority.


Holding: Humble had inherent authority. Bar managers usually have authority to by supplies.

Kidd v. Thomas Edision Inc., 1917
Inherent Agency
Facts: Kidd is a singer hired by Edison's agent to do tone test recitals for Edison's record player.
Issue: Did Fuller have authority to contract with Kidd and bind Edison?
An agent binds his principal so long as he acts within the general scope of the business entrusted to his care, even if he disregards his principal's directions.
Customary practices within an industry can create reasonable belief.
Holding: Fuller had apparent authority.
  • What could Kidd have done to avoid the problem?
  • Inquire as to Fuller's actual authority, or get a confirmation of authority from someone higher up in the company.
  • What could Edison have done to avoid liability?
    • Used a written form contract, threaten employees for disobedience, properly train employees, restrict titles.
Nogales Service Center v. ARCO, AZ 1980
Inherent Agency
Facts:ARCO rep-Tucker, told NSC that they needed to build a motel and restaurant, that if they did so ARCO would loan $100K and give NSC a 1 cent/gallon fuel discount, and promised to make NSC "competitive".  The loan was made, but the discount was not. 

Issue: Did Tucker have authority to make those promises to Terpenning?  Did the court Err in failing to use inherent agency instructions?

 Rule: Three types of Inherent Agency situations: RSMT 8A Comment b.

-General agent does something similar to what he is authorized to do, but in violation of orders.

-An agent acts purely for his own purposes in entering into a transaction which would be authorized if he were actuated by proper motive.

-Agent is authorized to dispose of goods and departs from the authorized method of disposal.

Holding: Issue wasn't properly preserved for appeal.
Humble Oil v. Martin, TX 1949
Liability in Tort, Servant v. Independent Contractor
Facts:car belonging to Love (co-defendant), was left for service at Humble's gas station.  Before anyone touched it, it rolled into the street and hit Martin and his 2 kids.

Humble owns the property, and Schneider was the operator of the station, Manis was an employee, Martin was the injured party.

Issue:Was Schneider an independent contractor or a servant of Humble?
Factual question based on individual circumstances.
Control over actions indicates servant status.
Holding:Since Schneider was required to do anything Humble told him to do, Humble had control over his actions and the gas station- this is an employer-employee relationship.

Indicia of Control, suggesting master-servant:

Schneider had Responsibility to report and perform duties requested by Humble,

Humble paid 3/4 operating expenses and bore risk of loss,

Humble determined operating hours, controlled what products were sold, and provided equipment, local, and advertising.

Humble could unilaterally terminate the contract,

Indicia of no control, of IC relationship:

Schneider hired, fired, supervised, and paid employees,

Schneider considered himself the boss of his own business.

Hoover v. Sunoco, DE 1965
Employee v. Independent Contractor
Facts: Hoover was injured in a fire at a gas station operated by Barone and owned by Sun, the car was being filled by Smilyk who negligently caused the fire. 
Sun supplied Barone, and monitored his business.  
Issue: was the station manager an employee or ind contractor of Sunoco?
The test to be applied is that of whether the oil company has retained the right to control the details of the day-to-day operation of the service station.
       Control or influence over results alone being viewed as insufficient.
       The best proxy for control may be the indirect indicia of control which is financial risk. 
Holding: Barone was indp contractor, no control over daily operations.

Indicia of Control:

Most of the same facts as Humble Oil.

Sun had power to terminate and inspect.

Indicia of no control:

No duty to report, he controlled more elements of the business, including hours of operation.

 Barone bore the risk of financial loss,

Mutual power of contract termination.

Murphy v. Holiday Inns, VA 1975
Employee v. Indp Contractor
Facts:  Slip and fall case, Murphy slipped at Betsy-Len Motel because of a leak.  Holiday Inn is the Franchisor(alleged master), Betsy is the Franchisee(alleged servant), and Murphy is the guest/3d party. 
Issue: Was Betsy an indp contractor or employee of Holiday?
Masters are liable for employees torts where they have "control or right to control the methods or details of the employee's work."
Holding: Holiday had no control over motel, no M/S relationship.

Indicia of control:

Holiday had right to terminate,

Indicia of No-control:

Holiday had no power to:  control daily maintenance, expenses, customer rates, demand profit shares, control employee terms and conduct.


Ira S. Bushey  & Sons, Inc. v. US,

Scope of Employment


Facts: Government argues that a drunken sailor returning to dock and turning valves is outside the scope of his employment.





Traditional test: is employee acting on behalf of employer


  • Friendly says sometimes courts stretch this argument to find liability
  • would be too much of a stretch here to say turning valve was acting in behalf of employer.

New rule: Foreseeability

  • Was conduct so unforeseeable as to make it unfair for employer to be liable.


Wasn't unforseeable for a drunken sailor to do some damage while walking to boat along the dock.


Clover v. Snowbird Ski Resort,

Scope of Employment


Facts: Resort cook hits skier while doing a few runs between shifts at restaurants on the resort. Was clearly negligent.




Court rejects foreseeability test from Bushey and goes w/ conduct being motivated by serving employer's interest.


Held a jury could find he was going from one restaurant to another and deviation wasn't severe enough to not serve employer's interest.


Manning v. Grimsley,

Scope of Employement


Facts: Orioles Pitcher Case


Fans heckle Oriole pitcher in bullpen at Redsox game.

Pitcher turns and throws ball at 90 degrees from plate to the netting in front of the fans.

The ball goes through and an injured fan sues Pitcher Grimsley and Orioles for negligence and battery.





If an employee's assault is in response to P's conduct which presently interfered w/ employee's ability to perform his duties successfully then employer can be liable.




Constant heckling could have affected Grimsley's ability to pitch. Should have gone to a jury.

Rejects RSMT 231, which indicates that serious crimes may be outside the scope of employment.



Arguello v. Conoco,

Tort Liability, Statutory Claims



Hispanics and African Americans sued Conoco alleging racial discrimination while purchasing gas.  All but one station was a Conoco-branded stores, which were indp. owned and entered into an agreement w/ Conoco to carry their brand and sell their products.  The station in the Arguello case was Conoco owned.





Factors used when considering scope:

Time, place, purpose of act,

Its similarity to acts which servant is authorized to perform,

Whether the act is commonly performed by servants,

Extent of departure from normal methods, and

Whether master would reasonable expect such act would be performed.

Just because her conduct was unacceptable it doesn't mean she was obviously outside the scope of employment.




Majestic Realty Assoc. v. Toti Contracting Co.,

Liability for Torts of Indep. Contractors




The Parking Authority of Paterson NJ hired Toti to demolish buildings near and adjacent to Majestic's building.  Toti is negligent in the demolition and damages Majestic's building. 




Generally no liability for actions of indp contractor:


  • Control retained over manner/means of work,


  • Incompetent Contractor,

Is financial irresponsibility sufficient?  Cts are split.

License, bonded, insured all bear on competency.

  • Inherently dangerous activities/ Nuisance per se.



Reading v. Regem,

Duties During Agency



Reading was a soldier in Cairo, he made money on the side by escorting a lorry across town while he was in uniform.




If a servant violates his duty of honesty and good faith to make a profit for himself, and his employment plays a predominant part in his obtaining money, then he is accountable for it to his master.

Predominant part:

The assets, facilities, or position he has as a result of his employment is the real cause for his getting the money, as distinct from his opportunity to get it.



Reading is liable to the army for his profits.

Uniform is important factor; The uniform was the sole cause of his getting the money.




General Auto Manuf. Co. v. Singer,

Duties During Agency



 Auto sued Singer to account for secret profits received by him while working for Auto. 

Singer took some orders from customers, but didn't place the orders with Auto instead sent the orders to other cheaper Co.'s, and he kept the profits in his own account.



Court found a Duty to Disclose potential conflicts of interest.

-Activities closely related to the master's business must be disclosed.

-Sunlight is the best way to preserve the duty of good faith and loyalty.

Disgorgement remedy for breach of fiduciary duty, remedy for breach of contract may be actual damages.




By failing to disclose all the facts to his principal, and by receiving secret profits from those orders, Singer violated his fiduciary duty to act solely for the benefit of Auto.



Town and Country v. Newberry,

Duties During and After Termination "Grabbing and Leaving"



Defs worked for P, for several years in the house cleaning business.  Then they quit and formed a rival company, they solicited P's customers.




A former employee may not solicit a former employer's customers who are not openly engaged in business in advertised locations or whose availability as patrons cannot be readily ascertained but whose patronage has been secured by years of effort and expenditures.



Defs violated a Duty to their former employer.


What could Newberry have done to avoid problems?

Performed a broader search for customers, don't just solicit former customers.

Don't conspire to steal customers while still working for the former employer.


Broz v. Cell Info Systems, Inc.,  DE 1996

Corporate Opportunity


Facts: Broz was on CIS board, he was also CEO and sole shareholder of RFBC.  He helped RFBC buy a cell phone service contract, CIS was in the same business.  CIS claims this was an usurpation of a CIS corporate opportunity.



Issue: Did Broz violate Corporate Opportunity Doctrine by taking the opportunity for himself instead of giving it to CIS?




The Corporate Opportunity Doctrine: If there is presented to a corporate officer or director a business opportunity which

1-the corporation is financially able to undertake,

2-is from its nature, in the line of the corporation’s business and 3- is of practical advantage to it, is one in which the corporation has an interest or a reasonable expectancy, and

by embracing the opportunity, the self-interest of the officer or director will be brought into conflict with that of the corporation, the law will not permit him to seize the opportunity for himself.

Holding: No breach of fiduciary duty.


Broz was open with CIS about the asset,

He spoke about the opportunity with CIS's CEO and other directors.

CIS wasn't in a position to buy the asset.

Would have been better to formally disclose to the board, this would provide a safe harbor.

If CIS had the ability and interest to accept the opportunity, Broz would have a duty to refrain from taking the opportunity.

What if RFBC had minority shareholders?  Broz would also have a fiduciary duty to them as well as CIS.

Broz would have to recuse himself.

Bad idea to participate in management of 2 competing corporations.




In re Ebay,

Corporate Opportunity



Plaintiffs argue that Goldman Sachs gave benefits to Ebay directors that should have gone to Ebay the corp.  Namely it gave them first crack at IPOs that were worth millions in order to secure future favorable business terms with Ebay.


Issue: Is dismissal of a corp opp claim proper here?


Holding:  Remanded to determine if IPOs were a corporate opp.




The IPOs could be a corporate opportunity, defendants can be liable under different claims.



CEO claims that the opp wasn't to Ebay, it was to him personally.

Court held that it came to CEO because of his position at Ebay.

CEO claims that Ebay isn't in the business of investing in securities.

Court points to fact that Ebay does invest in securities.




Sinclair Oil Corp v. Levien, DE 1971

Dominant Shareholder



Sinclair Corp owned 97% of shares in Sinven.  They caused Sinven to issue more dividends than they had earned.  They also caused Sinven to make a contract with another Sinclair subsidiary, this contract was then breached by the subsidiary.  Minority Shareholders in Sinven bring suit against Sinclair.


Issue: Did Sinclair have a duty to Sinven?  Did they breach it?



Generally Shareholders have no fiduciary duties to the Corp, but in cases of a dominant shareholder director like fiduciary duties can arise:

-Controlling, majority or maybe less control of board,

-When majority shareholders uses voting power in unfair way,

Self Dealing:

The Intrinsic fairness standard only applies when the fiduciary duty is accompanied by self-dealing, the situation where the parent is on both sides of the transaction.

Self Dealing occurs when the parent, by way of domination, causes the subsidiary to act in a way that is detrimental to the minority stockholder



Paying dividends was not a breach of fiduciary duty.

The minority shareholders were not discriminated against.

No breach of duty for corporate opportunity doctrine.

The Sinclair allocation strategy was reasonable and nondiscriminatory, based on geography.

There was self-dealing in the breach of contract between Sinven and the other subsidiary.


How could Sinclair avoid the problem?

Recognize that fiduciary duties may arise.

Act with intrinsic fairness.

Have minority representation on the board.

Have a reasonable strategy and stick to it.



Robinson v. Glynn,

Definition of a Security



Robinson was an officer of an LLC.  The membership was referred to as a stock.


Issue:  Is membership in an LLC a security interest?


Ruling: Howey test is not satisfied, wasn't primarily seeking profit from efforts of 3d party.

Never call something a stock unless you want it to be one.

Howey Test For Securities:

- Invest money in,

- Common enterprise,

- For Profit,

- Solely from efforts of 3d party.

Solely means "Primarily"

Investment contracts are defined very broadly:

- Investing in orange groves, investing in phone booths, investing in condominiums.

- Look at the economic realities of the transaction.


Fenwick v. Unemployment Compensation Comm,

Partners compared with Employers




Fenwick entered into a "partnership agreement" with the cashier at his beauty shop.




PH: Unemployment Commission held that the agreement was only a compensation agreement, NJ SCt held it was a partnership.


Ruling:  No partnership

Calling yourself partners doesn't make it a partnership,
Mere profit sharing doesn't make a partnership,


Elements in determining the existence of a Partnership:

Intention of the parties,

The right to share in profits,

Obligation to share in losses,

Shared Ownership and control of partnership property and business,

Community of power in Administration,

The language in the agreement,

Conduct of the parties toward 3d persons,

The rights of the parties on dissolution,

UPA defines partnership as: an association of 2 or more persons to carry on as co-owners a business for profit.




Indicia of Partnership:

Profit sharing, she has access to inspect books, agreement says they are partners

Indicia of employee:

Fenwick had all control, Chesire's duties didn't change at formation of agreement or put anything into the partnership, Fenwick bore all risk of loss.





Martin v. Peyton,

Partners compared with Lenders




Respondents (Peyton) loaned money to KNK, a broker business, they loaned 2.5 million.  The loaners had the right to inspect the books, and veto any business they found too speculative.  KNK defaulted and a 3d party sued PPF for the losses, claiming they were partners with KNK.



Ruling: No partnership


Court found that the restrictions were safeguards meant to protect PPF's investments.


Did they associate themselves with a firm as co-owners for a profit?  The court says no.
The court's question may dictate the answer.
Maybe only because they were asking if it looked like a loan, asking whether it looked like a partnership could have changed to answer.
PPF might not have had enough control.



Advice to PPF:

If you are going to have this much control, control it all the way, or don't get into it.

If it was so risky that you need lots of controls, you might not want to do it.

Take-away:  not a good idea to let others gamble with your money.

You risk all the loss, and if you win they get all the winnings.



Southex Exhibitions v. RI Builder's Assoc.,





Southex sued RIBA claiming that SEM and RIBA were partners, and that RIBA owed them a division of the homes show's assets as SEM's successor in interest.  RIBA claimed it just had a contract with SEM as an independent contractor.






Partnership determined by examining the 'totality of the circumstances.'

Profit sharing is prima facie evidence of partnership unless the profits are payment for:

- Debt, wages, annuity, interest on a loan, consideration for sales.

Holding:  Not a partnership.



Southex was too trusting, the agreement had partnership language but not in the technical legal sense.



Young v. Jones,

Partnership by Estoppel




P are investors who deposited over 1/2 million dollars in a SC bank, and the funds have disappeared.   PW Bahamas issued an unqualified falsified letter regarding the financial statement of SAFIG.  SAFIG had a connection with the SC bank. P argued that PW-Bahamas and PW-US were partners.




Generally, Persons who are not partners as to each other are not partners as to 3d persons.


A person who represents himself as a partner or permits others to so represent, is liable to any persons to whom such representation was made as if he were a partner.


Court rejects argument because there was no reliance on existence of partnership.


Meinhard v. Salmon,

Fiduciary Obligation of Partners



M and S were coadventurers and had a long term lease over a building.  Both put up money, Salmon is the manager but both shared in profits.  The owner of the building wants to tear down buildings and build a new one.  Salmon agrees to the idea, but doesn't tell M about the new lease.




  • At very least there is a duty to disclose.
  • Potentially a duty to share, especially where there is unequal power between partners.
  • A managing partner may be held to a higher standard.
  • In a term partnership, there usually isn't a duty to share, but there is a duty to disclose.

  • Partners owe own another the punctilio of an honor most sensitive.



Salmon had at least a duty to disclose information to Meinhard, if not to share.



Bane v. Ferguson,

Partner duties After Dissolution




Bane sued the managing council of his former firm for negligent mismanagement.  He sought damages.  Because of the negligence, Bane's pension plan is terminated.



Ruling: Minority Rule


Posner says that partners owe no fiduciary duty to former partners.

- This seems harsh and may be stricter than the actual bright line rule.

Posner says that even if there was a duty, partners are protected by business judgment rule.

- Unclear if this is supposed to apply to partnerships, or just corporations.

- Applies to duty of care.

Bane could have argued that the partners violated their duty of loyalty, because they only looked out for their own interests and not his.



Meehan v. Shaughnessy,

Grabbing and Leaving




Plaintiffs were partners of a law firm.  Plaintiffs left the firm and sued for money owed to them, Defendants countered that P violated their fiduciary duties, breached the partnership agreement, tortiously interfered w/ business and contractual relationships by improperly withdrawing cases and clients from the firm.  Meehan lied to partners about their plans, and took an unfair advantage in wooing clients.





Is it OK to recruit other partners to leave a firm?  Preparing to leave?

-Yes, as long as you don't breach a fiduciary duty in the process.

Is it OK to recruit associates to follow you to a new firm?

-Yes, as long as you don't breach a fiduciary duty in the process.

-Some courts see this as a violation of fiduciary duties, especially if there is a gross difference in power- really high up partner recruits underlings.

Can you contact clients before leaving?

-Some courts have concluded that this is a breach of fiduciary duty.

-This court didn't get too worked up about it, lawyers should be careful about this.

Manner of taking clients?

-The letter to clients was misleading about client rights, and partners lied to their firm.

Lying to partners is a breach of fiduciary duty.



Lawlis v. Kightlinger & Gray,

Expulsion from Partnership



Lawlis was a senior partner, he became and alcoholic and hid it for a while, when the partners found out, they gave him several chances to clean up his life.  After he cleaned up, they decided to expel him.  He sued the firm.



Generally to be valid, involuntary expulsion of a partner must be done in good faith.


However,you can contract away your rights as a partner in the partnership agreement.

  • Lawlis signed away his rights, he gave the partnership the right to fire him without cause.

Fiduciary Duties are waivable-default terms, that can be adjusted or eliminated through partnership agreements.

  • Duty of Good Faith is an obligation that survives.

Putnam v. Shoaf,

Partnership Property



Putnam and Charlton had a partnership for a gin business.  Because the business was in debt, Putnam wanted out.  She sold her 1/2 to Shoaf, by paying Shoaf 21K.  Later it was discovered that the bookkeeper had been embezzling money, that money was returned to the partnership, and Putnam wanted 1/2 of it.



The real interest of a partner is the partner's interest in the partnership which is defined as his share of the profits and surplus.


Partners don't own the partnership property, it belongs to the partnership.

- Partners only own an interest in the partnership, which entitles him to profits and losses of the partnership.


Putnam conveyed her partnership interest to Shoaf, she retained nothing.

The lawyer who drew up the contract did a bad job, it purported to sell something Putnam didn't own.



Nabisco v. Stroud,

Rights of Partners in Management



Stroud and Freeman entered into a partnership to sell groceries, there was no agreement about management. Stroud told Nabisco he would not pay for any bread from them, but Nabisco sold bread at the request of Freeman.  The grocery store didn't pay, and Nabisco sued Stroud.



Absent an agreement to the contrary, all partners have equal rights to management and conduct of the business.

Partners are bound by the acts of the other partners.

Each partner is an agent to the partnership.

What could Stroud have done differently?

Dissolve the partnership, create mechanisms within the agreement that specify conduct, bring in another partner, contract around liability (but this is cumbersome), create a corporation instead (no personal liability), create an LLC/LLP instead (LLP differ by state limit partner liability for contract or tort?, LLC members aren't liable)


Doran v. Petro Management Corp.,

Securities: The Registration Process



PMC approaches 4 investors to buy into plan for 4 oil wells in WY in Limited partnership. Doran is only one to buy in--agrees to take over 25k note to bank and pay for it out of profits. PMC overdrills and is shut down for a year. Doran claims that PMC sold him an investment contract.



Rule for whether transaction should be exempted as a Private Offering:

4 factors and strong policy

# of offerees (private placement is few)

# of units offerred ("  "    ")

Size of offering (small for priv. plac)

Manner of offering (no public advertising for priv. plac)


Does person need protection?


This is all pretty vague, so look to Reg. D (not discussed at all in case)

Gives specifics for safe harbor so you sell the security as a "private placement"

-there are number and amount limitations

-Can only be the first time stock is sold

-afterwards must file notice of sale to the SEC

Holding: is a security

remanded to determine if sufficient information was given to 4 offerees--could they protect themselves w/ knowledge they were given




Escott v. BarChris Const. Corp.,

Securities Registration Process



Bowling alley co needed $, sold debentures, then filed BK



Everyone involved in the issuance of the registration statement is potentially liable.


Where there material misstatements/omissions in the RS?

Material- matters as to which an average prudent investor ought to know before buying a security.

Issuers held strictly liable for material misstatements.


None of the parties proved a due diligence defense.



Remanded to extent damages came from expertised portions and non-expertised portions



Basic v. Levinson,

Rule 10b-5



Publicly denied that it was in merger talks on 3 occasions.  Then when it announced the merger, it sold for $46/share, it was trading at $25/share before the merger was announced.


Issue: What about reliance issues?

Ruling: Adopts Fraud on the Market Theory for at least Class Action.


Fraud on the Market Theory: Guy gives false statements that effect the market, which affects investors.

Misleading statements will therefore defraud purchasers of stock even if the purchasers do not directly rely on the misstatements.


Materiality= Magnitude x Probability

       Merger negotiations are usually material.



Fraud on market shouldn't be applied.

     hard to adequately apply, too much market analysis.

Advice to Companies:

Don't issue false statements, just have a policy of never commenting.


West v. Prudential Securities, Inc.,




Hoffman, a Prudential employee, told 11 investors that Jefferson Savings Bank was going to be bought at a premium. This was a lie, and the stockholders sued.



Non-public information cannot be the basis for Fraud on the Market.



There was no causation or reliance here.

Hoffman's leak to 11 people couldn't have effected a fraud on the market.



SEC v. Texas Gulf Sulphur Co.,

Inside Information




TGS drills and finds minerals but keeps it quiet to facilitate land acquisition.  Several employees buy stocks and options based on this information, the number of employee holdings increased by 20 times.  TGS later issues press release down playing the significance of the ore strike.  When full disclosure was made the stock price nearly tripled.



PH:Lower court holds that press release wasn't in connection with the sale of a security, therefore no 10b-5 violation.

Issue:were the employees who bought stock engage in a violation of 10b-5?



The disclose or abstain rule:

o If you are an insider in possession of material information, you have a "duty to either disclose that information or to abstain from trading based upon that information."

Insiders need to give the market time to respond to and digest the information before they begin trading.

- You can’t issue a press release and issue a purchase order in the same instant.

Material misstatement or omission:

o Would a reasonable man attach importance to the information?



Remanded issue of press release to see if reasonable investor would find the information material misleading.

Doesn't matter if co. wasn't buying or selling, it only matters that it will affect buyers or sellers.


What can be done to solve the problem:

Routinize employee stock purchases and sales,

Create black out dates for employee stock purchases.




Chiarella v. US,

Supreme Court Case on Insider trading;




To violate 10b-5 insider trading, you must be an insider to the company whose stock you are buying/selling.



Dirks v. SEC,

Inside Trading




Dirks was a broker, not associated with any company.  He gets a tip from Secrist.  Secrist worked for an insurance company who was engaged in fraud, Secrist told Dirks about this in an effort to expose the fraud. Dirks goes public with the info and is ignored, Dirks tells his clients and they sell their stock.  The price of the company falls and everything is eventually exposed.  Then SEC charges Dirks with violation of 10b-5 insider trading.



PH: Lower court finds a 10b-5 violation.

Issue: Did Dirks violate 10b-5 in disclosing the inside information to his clients?




Tippee Liability:

A tippee (Dirks) assumes a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic information only when:

The insider (the tipper Secrist) has breached his fiduciary duty to the shareholders by disclosing the information to the tippee, and

The tippee knows or should know that there has been a breach.

If the Tipper isn't breaching his duty, then the Tippee cannot be breach a duty.




Dirks isn't liable for violation of 10b-5.

In this case Secrist disclosed to reveal fraud, which isn't a breach of fiduciary duty.



US v. O'Hagan,

Inside Trading




Grand Met makes a tender offer on Pillsbury Co.  O'Hagan was a lawyer at Dorsey, Dorsey is hired to work on the Pillsbury deal.  O'Hagan becomes aware of the transaction and starts to buy up Pillsbury stock.  (If he bought Grand Met stock this would have  been classic 10b-5 violation)  He became the largest single owner of Pillsbury options.  O'Hagan isn't an insider at Pillsbury, just at Grand Met.  O'Hagan not liable under the classical theory of 10b-5 violation.



Ruling: Court adopts the "Misrepresentation Theory"


 The “Misappropriation Theory” (indirect theory)

A person violates 10b-5 when: he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information.


Under this theory, a fiduciary’s (O’Hara) undisclosed, self-serving use of a principal’s (law firm) information to purchase or sell securities, in breach of a duty of loyalty and confidentiality, defrauds the principal (law firm) of the exclusive use of that information.

Full disclosure forecloses liability under the misappropriation theory.

The disclosure must be to the source of the information that he plans to trade on the nonpublic information.

You must disclose to all those parties that you owe a duty to.



Summers v. Dooley,

Rights of Partners in Management



Summers and Dooley entered into a partnership agreement for the purpose of operating a trash collection business. Whenever one was unable to work he had to hire a replacement at his own expense.  Dooley became unable to work and at his own expense hired an employee to take his place.  Later, Summers hired another employee against the wishes of Dooley, and paid him out of his own pocket.  In 1967, Summers sued for reimbursement of the employee's salary from the partnership fund.



Changes to the status quo usually require a majority vote.

Hiring the 3d man wasn't beneficial to the partnership.


In this case only half the partner's voted to change, not a majority.


Moren v. JAX Restaurant,

Rights of partners in management



Wife was a partner in JAX, her sister was the another partner.  She was asked to come into work by her sister to cover for someone.  She took her son with her into the kitchen at JAX.  Son reached his hand into the pizza dough roller and it was crushed.  Father is suing JAX in behalf of his son.  JAX wants Wife to indemnify them and pay for the damages.


Issue: When does a partner have to indemnify the partnership?



Partners don't have to indemnify the partnership when acts took place during ordinary course of business.



Wife was acting in course of business.

The insurance company denied the claim, and countersued against wife.
Insurance companies are in the premium collecting business, not the claim paying business.

Corporation Duty of Care

Business Judgment covers decisions,

unless there is gross negligence.

  • Process oriented, not Substantive.
  • Directors have duty to Adequately inform themselves of All Material Information.

DE 102(b)(7) Corps can eliminate Director Liability for DoC.

  • Still, good faith is its own cause of action.
    • Bad Faith:
      • Subjective Bad Faith= actionable
      • Gross negligence- not actionable
      • Intentional disregard of duties = is actionable.
  • Duty to be aware of business type activities
    • If you learn of wrongdoing, may have duty to take action.
Corporation Duty of Loyalty

BJR doesn't apply if there is a conflict of interest.

  • BoP shifts to directors to show:
    • Good Faith and
    • Inherent Fairness.  (Reasonableness)

DE-144: Self Dealing Safe Harbor

  • Disclose info to disinterested Directors and
  • Majority agree in good faith.

Corp. Opp. Doctrine

  • Can't take opp. if:
    • Corp is financially able,
    • Opp is in Corp. line of business,
    • Opp is of practical advantage,
    • Corp has interest,
    • Taking Opp would put director in conflict with Corp.
  • Go to board and present Opp. to avoid liability.
  • Doesn't matter if approached personally.

Dominant Shareholders: Have Director-like fiduciary duties.

  • In cases of Self-Dealing, must show Intrinsic Fairness of transaction.
Agency Duty of Loyalty

Agent must:

  • Only act in Principal's interest in agency transactions,
  • Give all $ made in connection w/ transactions to principal,
  • Pay principal for use of assets and profits made.

Agent can't use insider knowledge to target principal's customers.

Partner Duty of Care

Partner can't act:

  • Grossly negligent,
  • reckless,
  • knowingly violate law,
  • intentional misconduct.

Most say that partners owe former partners come duties, not Posner.

Must act in good faith.

Partner Duty of Loyalty

Partner must:

  • Give partnership all benefits derived from the partnership,
  • avoid conflicts of interest,
  • avoid competing.


  • Duty to disclose partnership opportunities,
  • Perhaps a duty to share, consider:
    • term or at will,
    • ability to compete,
    • relation to partnership bus.,
    • managing partner.

Can plan to compete, can't violate duties.

Expulsion, must be in contract.

LLC Duty of Care

Member managed, everyone has duties.


Manager managed, only manager has duties.


May not overly reduce duty of Care.


Same default duties as Partnership:


LLC Duty of Loyalty

May not eliminate duty of loyalty


Same defaults as Partnership.

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