Sole Proprietorship

GP LLP LP LLLP LLC (hybrid of P and Corp.)

Corporation Close Corp.

PC (like LLP)

Formation Owner and entity are identical

Express agreement or as a matter of

law

Filing per RUPA; limited

to licensed professionals

Filing per RULPA Filing; can’t be used by licensed professionals(operating agreement

recommended)

Incorporate per state statute

Incorporate per state statute; elect this in charter

Financing Contributions from owner;

loans

Every partner must contribute capital (loosely defined) and profit; can also borrow Equity and debt, subject to formalities and possibility of thin incorporation

Transfers N/A Can freely assign financial interest (but limited market),but need unanimous vote to assign management

Easy to sell shares on open market

Like a corporation except share transfer restrictions

are commonTax 1 level 1 level

(taxed in each state partnership does business)1 level

(can elect 2)2 levels (unless elect S-Corp, which places

restrictions on owners)Management Owner has sole

authority1 vote per capita; majority

wins, except unanimity required for extraordinary

matters

General partners have management rights, but

limited partners are passive investors

Can choose member or manager managed; voting per interest

Shareholders elect board as brain with

plurality, and they hire officers as brawn

Can run via shareholder’s agreement instead of a

board

Profits and Assets

Owner has exclusive claim

Equal sharing in profits; partnership owns the assets Dividends

Liability Unlimited Limited, except for individual

malpractice

Limited, except for GP (status-based under

RULPA)

Limited Limited to investment, but subject to veil piercing if formalities aren’t met

Limited, except for individual

malpractice

Duties Agency duties if employees

Meinhard “utmost good faith and loyalty” to partners and partnership

(duty of care is limited)

Good faith, care and loyalty to LLC (not

members); modifiable

Directors have duties to corporation and shareholdersOfficers to corporation

And majority to minority shareholdersFormalities No No Yes

(needed to continue limited liability)Minimal / thin statutes

(all about freedom to K)Yes Yes, but can opt-out

Dissociation N/A Right to be bought out at dissociation (b/c absence of market to sell)

DE = payout if rightfulCA = no payout

Can sell shares for FMV on free market

Like a corporation except less of a market

Life Span At will Under RUPA, can choose to continue after a dissociation; dissolution caused by express will of any partner

Dissociation ≠ dissolution

Perpetual life May dissolve at will

Pros/Cons No formalities

Max flexibility

1 level tax Only for

small businesses

No default rule

∞ liability

1 level tax Default rules Mandatory payout (b/c no market to sell) Fragile (because of mandatory payout) Hard to add partners/raise capital Taxed in many states

Unrestricted limited liability

Can pick taxes Flexible management Can modify duties Stable No mandatory payout Legal uncertainty (b/c

statute is thin, so analogize to P or Corp)

Centralized mgmt. Flexible capital structure Perpetual life (not affected by dissociations) Expense/formalities Agency costs Taxed twice (or S-Corp)

No formalities

Unlimited liability

Limited liability (restricted for some) Formalities

Limited liability Common Ready market (easy

to come and go)

Limited liability (with some restrictions)

Flexible mgmt. Fewer formalities Less of a market

Formationo Incorporation

Promoters’ contracts Defective incorporation

o After incorporation Meeting, bylaws, board…

o Capitalization Equity and debt (risk of thin

incorporation and subordination) Distributing Control

o Voting mechanisms o Shareholder contracts (trusts, proxies,

agreements, pooling)o Failures = deadlock, oppression (b/c

majority minority duties)o Remedies = buyout, dissolution

Bankruptcy Problemso Piercing the corporate veil (if didn’t follow

formalities and fraud)o Dividends and accounts payable

Mergers/Acquisitionso Through board (asset purchase or merger)o Tender offer

Powers and Organizationo Hierarchy: securities law > corporate statute

> charter > bylaws > board o Shareholders (exercised at meetings with

quorum [proxies] or written consent) Elect/remove directors with

plurality Approve fundamental corporate

changes by majority vote Inspection rights

o Directors = brain (collective powers exercised at meeting with quorum or unanimous written consent)

Appoint/remove officers Propose policies

o Officers = brawn Power via actual/express authority,

agency (implied, incidental, apparent), or ratification

President, Chair, VP, Secretary, Treasurer

Securities Regulation (fed = disclosure, state = merit)

Shareholder Litigation (direct/derivative & indemnity)

Duty of care = RPD gross negligence test

(Caremark)

BJR protection presumed unless P rebuts by showing:

Grossly uninformed

(Van Gorkum)Illegal

transactionNo rational

business purpose / waste

Bad faith / duty of loyalty implicated = · intentional disregard of duties or · purpose other than best interest of corp. (Disney)

Entire fairness standard

Safe harbor if disinterested vote:CA = shifts burden

DE = BJR

Takeover context = only get BJR if meet

threshold tests:

Unocal proportionality test

for unilateral defensive measures

Omnicare draconian test for deal

protective devices

Revlon maximizing value test once sale is

inevitable

DE 102(b)(7) charter provision = defenseunless bad faith / duty of loyalty implicated

------------------------------------------------------INTRODUCTION------------------------------------------------------

1. Business organizations (as opposed to non-profits) are:a. = a set of contracts among a group of constituents (owners, creditors [including tort victims],

officers and employees), aka “the firm”b. Formed for a business purposec. Intended to be profitabled. Financed by investors who expect to make money by sharing in the company’s profits

2. Theories a. Role of government

i. Entity theory = state created the corporation, so ok to regulate itii. Contractual theory = corporation is founded in private contract, so state should merely

enforce contractsb. Whose interests corporations should serve

i. Finance model = the interests of the shareholders b/c they own itii. Long term model = shareholders don’t know what is in their long term interest, so

mangers need to be insulated from them or their interests realigned iii. Society model = about what’s best for society

c. Problems the law should fix besides agency costsi. Behavioralist school = how to control for the fact personal behavior is different from

organizational behaviorii. Information school = control how information is shared and valued in organizations

iii. Power school = control how power affect behavior3. Role of a business lawyer

a. Planner/risk-avoider/conservativeb. Drafter (collegial, not adversarial)c. Counselor/main client contactd. Special ethical problems when interests of agents conflict with those of the entitye. Make it clear who you are representing via engagement letter (the entity? the individuals?)

4. Legal frameworka. Many different legal structures with different default rulesb. All about efficiency and promoting commerce by reducing transaction costsc. Authority

i. State = formation and organizationii. Federal = securities

5. CA vs. DE in generala. DE favors certainty, the board, and process over substance, plus:

i. Nice tax structure, competent judiciary, fast Sec. of State, and electronic meetings okii. Doctrine of independent significance = if two ways to do it in statute, then pick either

b. CA favors minorities and shareholders 6. 21st Century Entities

a. Digital Organizations / Virtual Corporations = relax in-person meeting/signing requirementsb. Social Enterprises/Low-Profit LLC = relax fiduciary duties directors have to owners

------------------------------------------------SOLE PROPRIETORSHIP------------------------------------------------

= business owned directly by one person who has sole decision-making authority, exclusive claim to business profits, and direct ownership of all business assets (most popular in US b/c it’s so easy)

1. Abouta. Legally, the owner and company are identical (not really a separate business entity)b. No statutes (CL), so no default rules

i. Just start doing business under a new nameii. May need a fictitious business name statement (county-level) so people know who to

hold accountable for your business’ dealings2. Pros/Cons

No formalities to form or operate Maximum flexibility in structuring and

operating the business The state doesn’t give you any power, so they

can’t revoke your right to do business Taxed once

Suitable only for small biz w/ few employees Owner has to devise structure, making it hard to

admit new investors successively Unlimited liability through vicarious liability

o Can limit through insurance (often inadequate) and contracts (awkward)

------------------------------------------------------------AGENCY------------------------------------------------------------

= when one person acts on another’s (or company’s) behalf—the foundation to partnerships

1. Pros/Consa. Pro: enables principal to accomplish more than could acting aloneb. Con: have to supervise agent b/c may not always act in principal’s best interest (= agency costs)

i. E.g. compensation, procrastination, monitoring, losing opportunities, etc.2. Formation

a. Elements (employees, but not true ICs):i. Manifestation by principal that agent will act on his behalf

ii. Agent is subject to principal’s control iii. Agent manifests consent to act for the principal (by agreement or conduct)

b. Expressly (oral or written agreement)c. As a matter of law (when parties enter into an association that has the legal attributes of an

agency relationship, even if they aren’t aware of this relationship) (Cargill = D controlled the grain elevator and became his principal by interfering with his internal affairs since that was easier than starting a new company, so liable for his contracts. Not the traditional lender/borrower relationship b/c too much control)

i. Doesn’t include: supplier/reseller, franchisor/franchisee (if doesn’t go beyond setting standards or says each is independent), lender/borrower, or parent corporation/subsidiary

d. Examples:

i. Principal-agentii. Client-lawyer

iii. Patient-doctor

iv. Layperson-clergypersonv. Heirs-executor

vi. Ward-guardian

vii. Student-teacher

3. Agent’s Fiduciary Duties (policy = reduce agency costs)a. Duty of loyalty (higher than in contracts where it’s a duty of “fair dealing”)

i. = must act loyally for the principal’s benefit in all matters connected to their relationshipii. Implied (Huong Que = employee automatically has duty of loyalty absent a contract to the contrary)

iii. Principal’s interests > agent’s1. But no breach if principal consents to the act with full knowledge of material facts

iv. Agent cannot:1. Acquire an improper personal material benefit2. Act on behalf of an adverse party3. Compete with the principal4. Improperly use the principal’s property5. Disclose principal’s confidential information

v. Damages1. Principal gets expectancy + punitive damages and attorney’s fees, regardless of

recovery against third parties (Tarnowski = principal gets benefits received by agent as a result of violating duty of loyalty by simply adopting representations of juke box sellers in exchange for payment instead of looking for best deals, thereby conveying false info to principal)

2. Unlike in contracts, there are no efficient breaches b. Duty of care, competence and diligencec. Duty of reasonable candord. Duty to keep account of money (don’t commingle)

4. Principal’s Fiduciary Dutiesa. Limited in US, but must:

i. Follow express and implied contractual terms with agentii. Deal fairly with agent

iii. Furnish info to agentiv. Refrain from harming agent’s business reputationv. Indemnify agency

5. Principal’s Liability a. Authorized acts: principal is liable if agent had the following to engage in the conduct:

i. Actual authority1. = created by principal’s manifestation to the agent such that he reasonably

believes the principal wishes him so to act2. Scope:

a. Express authority = oral or written communicationsb. Implied authority = conduct/acquiescence (so be clear if you mean “no”)c. Incidental authority = agent has authority to do whatever is

required/appropriate in the usual course to accomplish his responsibilities (ex. can buy paint and use ladders if you’re hired to “paint a house”)

3. Note: lawyers do not have authority to settle without client’s approval, but can act on behalf of client with power of attorney (Koval)

Agents liable only if principal is unidentified

ii. Apparent authority (largest umbrella)1. = created by the principal’s manifestations to a third party (Fennell = no apparent

authority when “agent” makes manifestations to a third party, so even though attorney said he could settle that’s not binding since client made no such manifestations that he was his agent)

b. Unauthorized acts of the agent (a scoundrel’s last refuge)i. Ratification

1. = affirmation of agent’s prior act so it is as if it was done with actual authority (Daynard = law firm knowingly accepting the benefits of P’s work means P is its agent and P’s contacts that were ratified are sufficient to give the court PJx over the firm)

2. Shown by assent/conduct that justifies a reasonable assumption principal consents3. Must:

a. Be timely and b. Principal must have all material facts (Papa Johns = no b/c employer did not have

knowledge employee’s statement was false and other employees encouraged him to file a report, not the employer)

ii. Estoppel (equitable doctrine)1. = principal induced 3rd party’s detrimental reliance (or knew of reliance and did

not stop it) based on the 3rd party’s incorrect understanding that the act was done on behalf of the principal, so he is estopped from denying an agency relationship

c. Tortious acts of the agenti. Principal is liable if:

1. Actual/apparent authority or ratification2. Negligent in choosing or supervising the agent3. Agent fails to perform duty to act carefully delegated by principal4. Employee acting “within the scope of employment” = MAIN (Papa Johns = not

responsible for deliveryman who filed a false police report against a customer to justify being late b/c does not server employer to be late)

a. All negligent actsb. Intentional acts if they are:

i. Foreseeable (e.g. bouncer at a bar) and ii. Intended to serve employer (so not the drunk Navy guy opening

valves and hurting the dock)ii. Agents are also personally liable for their own tortious acts

-------------------------------------------------------PARTNERSHIPS------------------------------------------------------

= two or more co-owners (people or other bus orgs) carrying on a business together (both made capital contributions of some sort) for profit (not a separate entity from owners)

1. Introductiona. Authority: Uniform Partnership Act in all states but LA, RUPA/UPA 1997 in most

i. Based on agency theory b. Theory: Assumes close personal relationships between few partners, since each is an agent of

the partnership and can create personal liabilities for the othersc. Pros/Cons

Easy to organize an inexpensive to operate (no formalities; can default into it)

Taxed once (“pass through” partners ) Fragile (minorities have a lot of power b/c mandatory buyout) Personal liability if not LLP, LLLP, or limited partner in LP Partners are taxpayers in each state partnership does business (paperwork) Hard to add new partners

2. Formation a. General Partnerships

i. Express agreement orii. As a matter of law when relationship has certain attributes (e.g. contributions and share $)

1. Don’t need intent (Holmes = express agreement to divide profits is prima facie evidence, but what matters is intent of parties to carry on a business together, not to “form a partnership.” Here intent was present b/c talked about doing everything together to make the makeup company and P worked for a year w/out expectation of pay, so it’s a partnership and default rule says split profits)

2. No formalities required (except possibly a trade name registration)a. BUT SHOULD ALWAYS MAKE A PARTNERSHIP AGREEMENT

(i.e. a contract)!b. Limited Liability Partnerships (created by RUPA in 1997; in most states including CA)

i. Must strictly follow procedures in RUPA (cannot arise as a matter of law!):1. Partners must approve the decision to organize as an LLP by the same vote

required to amend the partnership agreement (if silent, then default = unanimous)2. File an LLP partnership statement with the Secretary of State

a. Then file annual report and pay a franchise fee3. Company name must indicate it’s an LLP

ii. Purpose: no personal liability for partnership debts (see below)iii. Grant of LLP status continues so long as it’s in good standing (Apcar = only get protection if

you renew it since we want incentive to file so state gets its fees, so no shield for lease obligation entered into after LLP status had lapsed)

iv. Notes:1. Usually limited to licensed professionals (everyone else can be an LLC)2. Insurance for tort victims often required3. LLP is a citizen of every state in which each of its partners is for diversity

3. Duties and Liabilitiesa. Fiduciary obligation = must act in the best interest of their common venture, aka duty of

“utmost good faith and loyalty” to partnership AND partners b/c liable to each other (Meinhard = partners owe each other duty of finest loyalty so must tell partner about opportunity to extend lease b/c “partnership opportunity,” so by not telling P, D appropriated it and violated the duty even though didn’t intend to defraud)

i. Higher duty than if merely contracting together, and not waived by acquiescence (Enea = don’t need a partnership agreement to require a partner rent a shared property at FMV)

1. RUPA = duties are “limited to” loyalty (narrowly defined in §404) and care2. CA = duties “include” loyalty and care

b. General Partnershipsi. Jointly and severally liable for partnership obligations, but creditors must exhaust

partnership assets first1. Partner who created the liability must have been carrying on in the usual way of

the business of the partnership (like “course of employment” test)

See LPs and LLLPs below

ii. The act of every partner in usual course of business can bind (aka create liabilities for) the partnership unless you file a statement of authority to limit one’s authority

iii. Partners have duties to indemnify each other (so pick rich partners)c. Limited Liability Partnerships

i. Partners who had paid full amount of capital contributions will not be liable (RUPA 306)1. Although still liable for own malpractice/negligence (just not partners’)2. But may be personally liable for claims by former partners (Ederer = in NY personally

liable when former partner seeks an accounting on dissociation, but most states call former partners creditors, so put this in the agreement)

ii. Creditors are sophisticated and usually look for collateral like personal guarantees4. Financing

a. Raise capital through:i. Capital contribution of owners and/or

1. Every partner MUST contribute something2. Default = money or property, but can be services per agreement

ii. Borrowing money from (increases liabilities):1. 3rd party lenders2. Partners (can contribute AND lend)

b. Problem of additional capital contributionsi. Small businesses have a hard time attracting capital b/c information costs are higher

1. So new partners may insist on disproportionate share of profits or control ii. Default = need unanimity to admit new general partner (usually ok by majority of capital

accounts)iii. Can’t force current owners to contribute more without an agreement…

5. Ownership Interestsa. Management Interests and

i. Every general partner has one vote (i.e. per capita)1. So equal say in management decisions even if capital contributions aren’t equal

a. Makes sense if few close, engaged owners, not passive investors2. But partnership agreement can create classes of partners w/ different voting rights

a. Used for tax planning so parent has all management rights but kids still get capital accounts

ii. Usually need majority vote, but unanimity required for “extraordinary matters” (including transferring management rights, adding new partners, and becoming an LLC)

1. So important to have provisions for breaking deadlocks in the agreementb. Financial Interests

i. Accounts1. Balance sheet equity capital account = total value of partners’ equity2. Separate accounts for individual partners reflecting capital contributions and share

of profits/losses a. No right to receive current distribution of profits without majority vote

RUPA 401(b)i. But still taxed (so force tax distributions in partnership agreement)

b. Losses can be used to offset other business income

ii. Partners have a right to:1. Share in the profits and losses

a. Default = equal sharing RUPA 401(a) i. But in CA if partner contributes only services then not subject to

recovery by cash partner b/c services = cash absent K (Kovacik) b. Good to link profit share to share of contribution to avoid windfalls

2. Be paid at dissolution the value of their equity (aka residual interest in enterprise)3. Transfer their shares to third parties (since it’s personal property)

a. Default = can freely assign financial but not management interest (need unanimous vote for that b/c law assumes close working relationship) (Casey = can only put right to receive profits, not voting or management rights absent evidence of unanimous agreement, up for sale at foreclosure auction)

b. Can assign financial and keep management, but still liable for partnership debts as a manager (have to withdraw to escape!)

4. Be bought out upon dissociation (b/c absence of market for shares makes it hard to leave)

a. Default = at will partnership , so no penalty for dissociating at any timei. But if you breached the partnership agreement, then damages

b. This makes partnerships very unstable, and valuation may be difficult or partnership may not have enough cash on hand to pay

c. Valuation problems…iii. Partnership owns the partnership property, not the individual partners

6. Ending a Partnershipa. Dissociation

i. = withdrawal or death of a partner, two types:1. Rightful, if:

a. No partnership agreement orb. “At will” per the agreement or dissociated per the terms in the agreement

2. Wrongful, if:a. “For a term” per the agreement and dissociated before that term in breach

of contract (then liable for damages, but still get value of partnership interest)

ii. That partner is still liable for partnership obligations incurred when he was a partner1. Should file a statement to put 3rd parties on notice you are not liable for further

obligations (RUPA 704)iii. Under RUPA Art. 7 remaining partners have the option of continuing the business if they

can buy him out (but under UPA had to make a new partnership)b. Dissolution

i. = when partner(s) decide to close down the business entirely1. Caused by express will of any partner that need not be supported by justification

(Girard Bank = wrote to partners telling them she was dissolving the partnership before she died, so it was dissolved during her life)

ii. Often triggered by:1. Dissociation2. Event specified in partnership agreement

3. Circumstances making it illegal to continue the business4. Court order (when “no longer reasonably practicable to carry on the business”)

a. Example = deadlockb. But if expelling a member for wrongful conduct fixes them, then no need

to automatically force a dissolution (about finding least disruptive way to solve the problem) (Dunbar = two member LLC deadlocked, where one is expelled as an active manager, so can now continue with business)

iii. Partnership then only continues to conclude the businessc. Winding up

i. = process of closing down the business by selling the company or liquidating its assets (McCormick = RUPA says must liquidate land via forced sale after court ordered dissolution absent agreement) BUT (Horne = RUPA requires partners get cash after dissolution, but doesn’t have to be a forced public sale if partners can stipulate to asset value)

ii. Then pay creditors and distribute any net balance to partners according to their interests d. Termination = when winding up is complete

7. Limited Partnerships (created by ULPA, now covered by RULPA in 2001)a. Formation = must file a certificate with the stateb. Purpose: general partnerships often recast themselves as limited partnerships to raise capital

from passive investors i. Not that common (LLC, created recently, is now preferred), but still used by VCs and for

family estate planning b/c LLC has a fee not imposed on LPsc. Exceptions to rules above:

i. Profits/losses not shared equally (instead split per capital contribution)ii. Liability

1. General partners = management and financial rights, so unlimited liability a. UNLESS organized as a limited liability limited partnership under

RULPA, where limited liability for all! 2. Limited partners = passive investors (no management rights), so liability limited

to amount of capital contributiona. Under ULPA, limited partners were liable to relying third parties if they

participated in “control of the business” (limited safe harbors)i. But now under RULPA liability is status-based, not fact-based, so

limited partners are always shielded b. Exceptions to general rules for partners above:

i. Can only transfer interest to third parties if partners agreeii. Can withdraw without interrupting the partnership

-----------------------------------------LIMITED LIABILITY COMPANIES----------------------------------------

= hybrid/incorporated partnership (newest entity)

1. Introductiona. Authority = LLC enabling acts (very thin with a lot of “may” provisions)

i. Different in every state, unlike for partnerships where states adopted a uniform actii. Although ULLC does exist, just made after states already had their acts so ignored

b. Theory = maximizing freedom of contract (taken pretty far…); ability to buy limited liability

c. Legal treatment = Since LLC statutes are thin often need to analogize elements to partnerships or corporations to see which laws should apply

d. Pros/Cons Unrestricted limited liability for all partners Can elect partnership or corporate tax treatment Flexible management rights (choose corporate or partnership structure) Can modify duties No mandatory payout on dissociation (except in DE, where it’s fragile) Thin statute, so legal uncertainty if treated like a partnership or corporation

2. Formation a. Required: file articles of organization with Secretary of State and pay a fee b. Optional: operating agreement (i.e. a contract)

i. Helpful, but not required for formation (Moon) and signing is not dispositive of membership

ii. Interpret reasonably! (VGS = agreement is silent on % of board vote required, but if unanimity were required then no reason to expressly state 1 manger’s approval is needed for mergers)

1. Only invalidated if inconsistent with mandatory statutory provisions (Elf = don’t need to follow formalities b/c LLC statute is about freedom of contract so substance over form. So long as there is intent, an LLC can be formed and the agreement can do whatever, including have an arbitration clause)

c. Can convert from corporation or partnership to LLCi. Still personally liable to creditors from a general partnership prior to conversion

3. Financing and Ownership Interestsa. Same as partnerships except: default = voting per profits interest, not per capita

4. Management, can elect:a. Participatory structure (like a partnership) or

i. Since member-managed, any member is an agent of and can bind the LLC/has dutiesb. Centralized structure (like a corporation)

i. Since manager-managed, only managers are agents of and can bind the LLC/have dutiesii. Manger removal: default = majority member vote (Broyhill = operating agreement that says

manager must be appointed by unanimous vote but is silent on removal does not require unanimity for removal, so ok to remove with 55% interests when member with remainder was terminated by bankruptcy)

5. Duties and Liabilitiesa. Unrestricted limited liability, not even liable for own negligence (better than LLPs) so long as:

i. Properly formedii. Members have paid their promised capital contributions in full and

iii. LLC is not a fraudb. Corporate veil piercing standards (see below, but easier to satisfy b/c fewer formalities)c. Fiduciary duties

i. Duties of:1. Care (gross negligence standard)2. Good faith/fair dealing inherent in every contract3. Loyalty (VGS = breached when two directors don’t give notice to a third of acting by written

consent b/c purpose of written consent statute is to enable quick action when minorities can’t object but here could have, so no BJR)

ii. Largely modifiable, but can’t be eliminated or unreasonably restricted or reduced (Hunt Sports = “members may compete” clause in operating agreement can limit the duty of loyalty so long as it’s not eliminated, which this doesn’t [only eliminates one aspect—competition], and is not unreasonable, which this isn’t [b/c freedom of contract for LLCs and on notice]. So ok for member of LLC competing for NHL stadium to make his own deal for it)

1. DE:a. Narrow (“limited to” duties of care and loyalty)b. Duties to the LLC (not to the other members)

i. May be imputed to a separate entity formed and controlled by fiduciaries of another for the purpose of engaging in transactions with that other (Barbieri = LLC made up entirely of D Corp.’s officers owes a duty to D Corp., but the Partnership made up of LLC and someone else does not b/c no showing the other partner knew or/benefited from his partner’s relationship with D Corp.)

ii. And majority owners can owe fiduciary duties to minority owners (Anderson = in Tennessee they do b/c like a partnership, so can’t kick member out and pay him under the agreement, then sell his shares to someone else for more money b/c co-opting his value)

c. Can be expanded, restricted, or eliminated by contract i. EXCEPT must keep duties of good faith/fair dealing and can’t

limit liability for bad faith violations2. CA:

a. Broad (“include” duties of care and loyalty)b. Only managers owe duties to LLC/members (same as a partner does to

partnership/partners)c. Can limit these, but can’t eliminate them

6. Ending an LLCa. Dissociation

i. ULLC: can freely dissociate (wrongful or rightful) and get a payoutii. DE: only allows for rightful dissociation, but then you get a payout (so more fragile)

iii. CA: can freely dissociate, but no payout right 1. So you still have an economic interest, but no longer management rights

iv. Silent statute and operating agreement? Then can choose (Lieberman = P retains equity but not management interest on dissociation b/c that’s what he indicated he wanted. Don’t need to mandate withdrawal of both, thus triggering liquidation of his equity interest)

b. Dissolution i. Same as partnership except dissociation never automatically leads to dissociation

---------------------------------------------INTRO TO CORPORATIONS----------------------------------------------

= entity that consists of an intangible structure for the conduct of its affairs/operations, the essence of which is created by the state, and that possesses the rights/obligations given or allowed it by the state (more or less

parallel those of natural persons)

1. Historya. Developments:

i. Special state acts for each charter broad federal (for securities) and state statutes

1. Model Code (in 25 states), DE and CA show major variationsii. Restrictive (b/c fear of organizations) enabling statues permitting any lawful business

iii. Unlimited limited liability (aka <porous> corporate shield) (BEST INVENTION!)1. Pro = more capital invested, increased tolerance for risk taking2. Con = creditors (including involuntary, i.e. tort victims) may go unpaid

iv. Trend toward state congruence (result of competition)b. Corporations = people in federal law b/c separate legal entity, so they have the following :

i. 1st Am. free speech rightsii. DPC and EPC rights

iii. 4th Am. lesser right against unreasonable searchesiv. But NO 5th. Am. right against self-incrimination

2. Typesa. Public = functions as governments (ex. cities, airport authorities)b. Government = wholly/partly owned by a gov to perform a special purpose (ex. Amtrak, USPS)c. Nonprofit = no shareholders b/c profits are not paid in dividends (ex. hospitals)

i. Charitable/eleemosynary = purpose to benefit other groups, so no taxes on profits and contributions are deductible (ex. private universities)

ii. Mutual-benefit = purpose is to benefit its members, so no taxes on profits but contributions are not deductible (ex. social clubs)

d. Businessi. Publicly held/reporting = presence of a ready market for corporate stock so required to

follow SEC Acts 1. Shareholder sees himself as owner of shares, not the company 2. Professional management (by officers) and monitoring (by board)

ii. Closely held/private= stock cannot easily be traded 1. Shareholder sees himself as owner of the company2. Consequences:

a. Greater latitude in internal management (usually shareholder managed and monitored)

b. Shareholders stand in fiduciary relationship to each other 3. Can escape some formalities , BUT if too lax then courts disregard corporate form

and allow personal liability (see piercing below)iii. Statutory close(d) corporations

1. = a special kind of closely-held corporation created by statute2. Formation:

a. Elect this in your charter (since board is required otherwise)b. < 35 shareholders in CA

3. Organized like an LLP and run via a shareholders’ agreement instead of a board:a. Management structure is informal b. May dissolve at willc. Share transfer restrictions are common

4. But you get corporate tax treatment

iv. Professional corporation

Dark corner of corporate law

1. = must be a licensed professional to be a shareholder, and personally liable for malpractice

2. Formation = elect this in your charter3. Organized like a closed corporation (aka like an LLP)4. But you still get corporate tax treatment

3. Corporate Pros/Consa. Pros

i. Flexible capital structure (many “off the shelf” variations, so don’t need to get creative)1. Easy to enter and leave b/c:

a. Liquid market for shares and b. Management rights not tied to shares

ii. Centralized management structure (can manage capital raised by large number of ppl)1. Shareholders = passive investors who vote for extraordinary corp. acts per share

(often via proxies, but ok b/c institutional shareholders are informed)a. Can only initiate dissolution or a lawsuit to oust directors

2. Directors = elected by shareholders to form board and set policy (BRAIN)3. Officers = elected by directors to manage day-to-day operations (BRAWN)

iii. Perpetual life (b/c separate and distinct legal entity, so death/exit of owner has no effect)iv. Scope of limited liability for shareholders = corp. is solely responsible except:

1. Lending institutions may require guarantees2. Shareholders must satisfy unpaid amounts of capital contributions3. If corporation is a sham

v. Well-established form for all types of business (so standard forms & easy to do things)b. Cons

i. Expense and trouble of formation and maintenance 1. Formation = charter, bylaws, minutes, qualify in states you do business in2. Continuing costs = annual reports and fees, minutes

ii. Required initial and continuing formalities (meetings, minutes, separate funds)iii. Agency costs related to separation of ownership and controliv. Taxed twice (corporation taxed on earnings, and shareholders taxed on dividends)

1. Can avoid this by:a. Being a Type S Corporation (elect this within 90 days of formation) and

treated like a partnership for taxes if:i. < 75? shareholders

ii. Incorporated in US with no nonresident alien shareholdersiii. 1 class of stock, and all shareholders agree to elect Type Siv. Shareholders are individuals, estates, or trusts (not companies)v. Not a life insurance company or certain other types

b. Not paying dividends (reinvest that money and pay as salary, which is a deductible expense)

c. Not making any money

-----------------------------CORPORATE FORMATION & CAPITALIZATION------------------------------

Comes from tax law, not corporation statutes

1. Incorporationa. Promoters’ Contracts

i. = contracts by person organizing the business before it exists 1. Since corporation doesn’t exist yet there is no limited liability, but parties do not

expect promoter to be held personally liable since acting on behalf of the nonexistent principal

ii. Liabilities of corporations 1. Once formed, corporation is only bound if:

a. Ratification = board adopts a resolution ratifying the acts and relating back to when they occurred (logical impossibility)

b. Adoption = ratification without a retroactive effecti. Formally by the board or

ii. Informally through performance + knowledge of K terms (Mac Arthur = SOF then starts on date of adoption… can’t relate it back via ratification b/c that’s a legal fiction)

iii. Liabilities of promoters = joint and several1. Liability before adoption depends on:

a. Intent of parties andb. How K is drafted

i. Be careful to avoid lack of consideration (courts consider equities)ii. Good to include a written option granted to promoter for benefit of

to-be-formed corporation to enter into this K2. Liability after adoption continues (corp. is just secondarily liable) absent a

novation (= release) by other contracting parties. Can be:a. Automatic (if language was in K)b. Formalc. Inferred

b. Where to incorporate, consider:i. Substantive provisions of state corporate law because of Internal Affairs Doctrine:

1. = state of incorporation generally governs your internal affairs2. BUT in CA, §2115 says if you have > 50% of shareholders here then we’re

imposing some sections of our corporate law on you a. DE says this is unconstitutional under CC, but CA hasn’t (Vantagepoint)

ii. Cost of incorporating in a state other than the one where you do business 1. Must pay annually to qualify wherever you do business (or can’t enforce Ks)2. Tax savings for big public companies, but not worth it if smaller

iii. Pick DE if going to operate in multiple states (but CA is good for IP issues…)iv. Can always re-incorporate

c. How to incorporate (automatically perpetual duration after doing the following):i. Prepare articles of incorporation/charter/certificate which includes:

1. Name of corporation (must contain designation as corporation) (TM issues)a. File trade name registration and fees

2. Number and types of shares authorized to issue (per state and federal law)3. Name and address of company’s registered office and agent for service of process

4. Name and address of incorporators a. Responsibilities = signing this and holding organization meeting

5. Corporate purpose (now “any lawful purpose,” but used to be ultra vires problem)6. Number and names of initial board of directors

a. Need not be shareholders; can have as few as 1 (lonely board meeting)7. Optional provisions concerning management

ii. File articles with Secretary of State and pay required feesiii. Then state issues you a charter and you’re incorporated!

d. Defective incorporation (different from promoters’ contracts)i. = where corporate power is used in good faith, but incorporation was faulty/not complete

ii. Curative doctrines rejected by Model Act (Robertson = since these don’t exist, doesn’t matter if P believed he was dealing with a person or a corporation. Before the certificate is issued the individuals are liable for any acts taken, period):

1. De facto corporationa. Law allowing for incorporationb. Good faith attempt to incorporate under the lawc. Corporate power used in honest belief corporation existed

2. Corporation by estoppela. = persons who treat entity as a corporation will be estopped from later

claiming it was not2. Procedures After Incorporation

a. Hold organizational meetingi. = incorporator must hold a meeting under the statute

1. Or can have written consent in lieu of meeting if unanimous agreementii. Must take minutes of the formal proceedings

1. Shareholders have inspection rights2. Subject to discovery and generally admissible as evidence

b. Adopt bylaws i. = contain provisions relating to the business and affairs of the corporation

1. Usually focus on shareholders and officersc. Elect board of directors

i. RMBCA and DE = ≥ 1ii. CA = 1 if 1 shareholder, 2 if 2, and ≥ 3 if ≥ 3

d. Have board (through meeting or unanimous written consent):i. Appoint officers (1 person can be everything but secretary [to prevent fraud])

1. CA requires:a. CEO/President/Chairman to be the general manager b. CFO/Treasurerc. Secretary to be the custodian of corporate records

2. DE and RMBCA have no requirements3. Can make up as many titles as you want (VPs, Brewmaster…)

a. Just describe responsibilities in bylaws or board resolutions

ii. Authorize initial share issuance iii. Adopt & novate promoters’ Ks

CA and DE retain these, but won’t as

soon as there’s a case

iv. Pass a resolution approving compensation of CEOv. Adopt a corporate seal (for old time’s sake)

vi. List officers on banking resolutions, etc.3. Capitalization = cash or other assets put into the corporation on a long-term basis (WANT A MIX)

a. Equity i. = cash or other assets contributed in exchange for stock (results in shareholder status)

ii. Types:1. Common stock (required by corporate statute)

a. Right to vote on certain matters, profits (via dividend), assets if liquidated2. Preferred stock (optional; what VCs want)

a. Pro: right to receive dividends and assets before common stockholders, but limited amounts

b. Con: voting rights subordinating to common stockholders and redeemable at the option of the corporation (so closer to debt than common stock)

c. Can be converted to common stock3. Different classes/series

a. Can distribute rights infinitely between classes/series (if in charter)b. CA = each class has veto rights for big transaction votesc. DE = only need majority of shares

4. Options to purchase shares at a fixed price during a period of time a. Rights = short term, Warrants = > 1 year termb. Transferable with no voting or dividend rights

iii. To get limited liability must be (Hanewald):1. Duly authorized (can’t give out more shares than in charter, but can amend)2. Validly issued in accordance with corporate law and charter (need minutes!)3. Fully paid, so nonassessable (corporation can’t demand future payments)

a. Consideration can consist of:i. Model Code and DE = any tangible or intangible property/benefit

ii. CA = not future services, and promissory notes must be securedb. If issued for less (sometimes hard to value…), then watered stock

4. Certificated or notiv. Par Value (not recognized in most states, but just put this in charter as $.01 to be safe)

1. = dollar figure specified in the charter that means:a. Stock can’t be issued for lessb. Money from sale of par value stock goes into special account that can’t be

reduced below aggregate par value of outstanding shares (way to protect creditors)

c. Fees and taxes are based on this2. If you don’t pay par value for your shares, then no limited liability (Hanewald =

shares not nonassessable since par wasn’t paid, so personally liable for corporation’s debt to P)v. Pros/Cons:

1. Pro = ownership rights, possibility of big payout, information rights2. Con = subordinated to debt if corp. goes bankrupt (see below)

vi. Preemptive rights

1. = give shareholders opportunity to buy a proportionate share of new issues so their ownership interests won’t be diluted (Katzowitz = must be offered at book value unless valid business reason not to b/c protects those who don’t buy from unfair dilution)

2. Important for closely held corporations , but problem for public b/c causes delayvii. Share transfer restrictions (so not freely transferable)

1. Used to maintain status as S, close or professional corporation2. Examples:

a. Vesting of shares (retaining tool since appreciate over time until vested)

b. 1st refusalc. First option right

d. Consent restraintse. Mandatory redemption rights

viii. Buyout agreements 1. = require corporation to purchase departing shareholder’s interest 2. Valuation problems , so put formula in charter (book or liquidation value, $ flow)

(Denkins = mid-year balance sheets aren’t good evidence of book value, need year-end)b. Debt

i. = loans of cash or other assets represented by notes (results in creditor status…can be this and shareholder)

ii. Types:1. Bond = secured long-term debt instrument (usually by mortgage or deed on corp.

property)a. Junk bond = high-yield, but subordinated to other debtb. Investment grade bond = low credit riskc. Bowie bond = secured by future IP royalties

2. Debenture = unsecured long-term debt instrumentiii. Convertible to stockiv. Pros/Cons

1. Pros:a. Interest payments are tax deductible to corp. (unlike stock dividends) b. Preference over all stockholders if corporation goes bankrupt c. If not repaid then qualify for tax deduction

2. Cons:a. No ownership rightsb. Possibility of thin incorporation at formation of corporation (Obre = not if

equity is 50%, which is reasonable for tractor biz, and no one was duped b/c disclosed)i. = nominal stock investment and obviously excessive debt structure

1. So have a low ratio (between 1:1 and 2:1) with enough equity to cover core assets

ii. Results in subordination (equitable doctrine)1. = court subordinates shareholder debt to other creditors in

the event of bankruptcyc. Leverage

i. = possibility of making a return on borrowed money greater than the cost of borrowing itii. Increases risk, but also benefits shareholders by increasing their returns

iii. Maximize this by having ~55% debt (ala public utilities)

RMBCA, CA and

DE = opt-in statutes, so must be in charter

------------------------------------CORPORATE POWERS/ORGANIZATION-----------------------------------

1. Hierarchy of Authority(Roach = bylaws are void if in conflict with statute, so having 70% quorum requirement in bylaws is invalid b/c statute says must be in charter, so default to majority and no need for dissolution)

a. Federal securities lawb. State corporate statutec. Charter (aka articles/certificate of incorporation)

i. Can only be amended by shareholdersd. Bylaws (Datapoint = can’t take away [actually or effectively] right of shareholders to act via written consent b/c

intent of statute is to have this make things faster, not prevent takeovers) (Paulek = provision in bylaws attempting to give power to maintain bylaws to the shareholders violates the charter which says only the Board can maintain bylaws, so void)

i. Can be amended by shareholders AND the board (flexible)e. Board of directors

2. Shareholdersa. Powers:

i. Elect and remove directors (with or without cause + notice) with a plurality1. If uncontested, can use bylaws to allow votes against a director (then holdover

rule may apply where old director continues to serve until a new one is elected)2. Nominated by the board and presented to shareholders via a proxy statement

a. But now those who qualify can require corporation to reimburse them for soliciting a competing proxy

3. Protection in closely-held corporations = make supermajority required to remove director-shareholders without cause (but can remove outside directors easily)

ii. Amend bylawsiii. Approve fundamental corporate changes proposed by board w/ majority vote, like:

1. Mergers2. Amendments to the charter

iv. Inspection rights (since board owes duty of candor must make these “available”):1. Shareholder list

a. Can be used to send competing proxy, make tender offer, solicit votes, etc. b. RMBCA: all shareholders have accessc. DE: need a “proper purpose” to access (DeRosa = ok to enable union to

communicate) (Mite Corp = ok to purchase stock)d. CA: ≥ 5% shares or purpose “reasonably related” to shareholder interests

2. Books and records a. RMBCA: good faith and proper purposeb. DE: proper purpose (Seinfeld = need to present evidence that establishes a credible

basis so court can infer legitimate issues of possible waste/mismanagement…disagreement with business judgment is not enough)

c. CA: purpose reasonably related to shareholder interests v. NOT to propose action or restrict the board (Gashwiler = shareholders can’t vote to let 3

directors sign conveyance of corporate property b/c that’s a corporate power which must be exercised by “the board”) (Manson = board powers come from the state. Shareholders can’t act in relation to the ordinary business of the corporation. If you want to act, then have a close corporation and get rid of the board altogether)

Can change these sorts of provisions in charter

b. And can be a bitch! (Hall = only obligation = pay in full for shares, don’t need to participate even if deadlock)c. Exercised:

i. At meetings or 1. Need a quorum (or more if in charter)

a. Easier than for board meetings b/c can use proxiesi. = generally solicited by corporation and with your approval they

have power of attorney to vote for limited time2. Can be called by the board or in CA ≥ 10% of shares entitled to vote

a. Must have annual meetings 3. If majority is required, then majority of quorum will do4. Attendance isn’t required (and neither is rationality…) (Hall = can prevent a quorum

on purpose by refusing to attend)ii. Via written consent

1. RMBCA = unanimous2. DE = true majority3. CA = true majority except unanimity for director elections

3. Directors = braind. Collective powers (can only limit these in the charter):

i. Appoint/remove/oversee officersii. Make important policy decisions

iii. Send out proxiese. Exercised:

i. At meetings (after notice [or waiver] and with minutes by majority?) or1. Need a quorum (can’t use proxies)

a. If vacancies, quorum still based on number of authorized (not actual) positions

b. Can ratify past actions if there wasn’t a quorum2. EXCEPTION = committees of ≥ 2 board members w/ delegated powers (& mins)

ii. Via unanimous written consentf. Types of directors

i. Inside/active = substantial shareholders, so active role in decision-making ii. Outside/passive = informal advisors who offer discipline and act in crisis situations

4. Officers = brawna. Powers via:

iii. Actual/express authority1. Statutes (general requirements like “President is CEO”)2. Charter or bylaws3. Board resolution

iv. Agency1. Implied/inherent authority = generally recognized duties that come with office2. Incidental authority = acts incidental to actually/impliedly authorized duties3. Apparent authority = based on principal communicating with third party

directly; only defeated if person dealing with officer knew he lacked actual authority (Hilton = parent company told community to go to local hotels, so liable)

Directors can’t act in individual capacity unless

board delegated power to them

v. Board acquiescence vi. Ratification (last refuge of a scoundrel; need disclosure & can’t ratify illegality or waste)

b. Specific Powers (where officer can bind the corporation):a. President

i. Inherent power to bind the corporation in the “usual course of business” (Molasky = can’t bind the corporation to guarantee a personal obligation b/c not in the usual course of business so need authority or board ratification)

ii. Broad, so how can you be sure when you’re dealing with a corporation?1. Ask for evidence of board approval (like minutes or secretary’s certificate)2. Get a corporate authority opinion3. Ask to see the bylaws

b. Chair of the Boardi. Sometimes the CEO, other times largely ceremonial

ii. No implied powers b/c ambiguousc. Vice President

i. Inherent power to serve in the place of the president (if incapacitated or absent) (Anderson = VP can bind the company by signing something as the president when president is absent even if contract erroneously describes his signatures as that of the president) (Hufstedler = if VP signs something and secretary attests to it, can assume contingency arose which authorized him to act for president)

1. “Absence” should be defined in bylawsii. If multiple departmental VPs, then implied powers based on title

d. Secretaryi. Custodian of internal affairs and non-financial records, and certifies records (In Re

Drive In Dev. Corp. = can enforce a guarantee under estoppel when secretary certifies that the board authorized something even if it didn’t)

ii. No business powers (Dahl = can’t sign an affidavit b/c too far from certification duties)e. Treasurer

i. Internal powers and custodian over corporate funds (Overseas Films = no authority to make the company guarantee the repayment of another company’s loans b/c extraordinary [should have alerted P to inquire])

ii. Can have a treasurer who reports to a CFO (treated like a VP)

------------------------------------DISTRIBUTING CORPORATE CONTROL-----------------------------------

1. Voting Mechanismsa. Mandatory:

i. Straight voting (x shares = x votes per each director seat) 1. Effect = majority shareholders can elect all directors 2. CA = mandatory that cumulative voting can be invoked by ANY shareholder

(Campbell = can still remove directors for cause this way, but must give them notice so they can defend)

a. # of open seats × # of your shares = # of votes (cast all for 1 or spread out)b. Effect = increases chance minorities can elect directors (= factious board?)

i. But influence ≠ controlc. If elected cumulatively, must be removed cumulatively

3. DE and RMBCA = opt-in to cumulative voting

b. Optional (put in charter):i. Staggering = different seats up each year (provides continuity; undermines cum. voting)

ii. Class voting (if in charter) = different classes of stock can vote for different seats (can help minorities)

iii. Weighted voting where one class/series shares are worth more votes (Providence = but can’t have variations w/in each class)

2. Shareholder Contracts (to control shares held by others)a. Voting trusts

i. = formed in the ordinary way under trust law with voting stock as its corpus where trustee votes shares according to terms of the trust

ii. Not popular b/c drastic measure to relinquish all control, expensive, and complicated1. But used in family businesses to give younger generation an interest

iii. Specifically enforceable (usually last 10 years)b. Proxies

i. Irrevocable: agencies for a particular purpose ii. Revocable: agencies for specific meetings (< 1 year)

c. Shareholder voting/pooling agreements (POPULAR)i. = two or more shareholders providing for the manner in which they will vote their shares

via contract (so no statutory duration) 1. Often just for closed corporations, but no longer in CA (Galler = but if closely-held

and no public injury since only the parties are shareholders, then ok to uphold it)ii. Remedy is usually damages, but sometimes specific enforcement (Ramos = specific

enforcement for closed and closely-held corporations)iii. Can cover anything they want (since shareholders have no fiduciary duties) so long as:

1. Not an illegally formed voting trust or 2. In violation of public policy

a. Courts traditionally don’t favor agreements limiting discretion/authority of directors (since they have a duty to all shareholders and limiting their discretion impairs that ability)

b. BUT trend is to allow encroachments in closely held corporations if everyone knows

3. Failuresa. Deadlock

i. = unable to act1. If board is deadlocked but president can still act, then ok2. But if shareholders are deadlocked and can’t replace a board, then screwed

ii. Prevent it by:1. Having an odd number of directors (but one can abstain…)2. Coin flip mechanisms

b. Oppression i. = when minority’s reasonable expectations are frustrated by a majority w/ so much power

they treat the minority unequally by (Beatley = reasonable to assume employees thought they’d get dividends when employment ends b/c long-standing policy…about what majority should have known minority thought):

1. Serving themselves to corporation’s assets (selective liquidity) (Rodd Electric = no right to get money back, but equality of opportunity for stock repurchases for closely-held corporations. Note: here group as majority shareholder)

2. Refusing to share information (freeze out) (Brodie = remedy is what the minority reasonably expected when they bought shares, which usually will not include liquidity)

3. NOT when a majority simply votes their shares to elect directors who run the company in a way the minority doesn’t like

ii. Especially affects:1. Closely-held corporations (lack of market for stock means minority can’t escape) 2. Former employees who cashed in options and are now minority stockholders

iii. Because majority owes Meinhard fiduciary duty of utmost good faith/loyalty to minority (in contrast with duties owed by directors) when dealing with corporate operations and assets

1. Unless:a. Waived as to specific events in charterb. Valid business purpose (Blackwell = “fair” doesn’t mean “equal,” and here there was

a good business reason to restrict buyback of shares so ok)2. Minority also has limited duty to majority (ex. preserve “S” status when

transferring shares)iv. Slightly different per state

1. DE = equality opportunity in liquidity with business reason defense2. CA = reasonable expectations

4. Remediesa. Prevention via voting mechanisms and shareholder contractsb. Buyout

i. = corp. can elect to purchase shares owned by shareholder petitioning for dissolution ii. Introduces instability…

c. Dissolution if:i. Recommended by board and approved by shareholders, then filed with Secretary of State

and liquidated (aka voluntary) ii. Initiated by shareholders with sufficient number of shares if:

1. Deadlock or 2. Directors acted illegally/oppressively/fraudulently

iii. By agreement under request or a certain eventiv. Secretary of State initiates b/c delinquent in formalities (taxes, reports, agents)v. AG initiates b/c fraud

vi. Creditors initiate b/c insolvent and want recoveryd. Appointment of a custodian/provisional director (but who wants to?)e. Contractual provisions (e.g. arbitration)

i. Pro: cheaper and fasterii. Con: narrow grounds for appeal and limited discovery

-----------------------------------CORPORATE BANKRUPTCY PROBLEMS-----------------------------------

1. Piercing the Corporate Veila. = When the shield of limited liability is judicially pierced and shareholders are personally liable

i. Applies to horizontal/reverse piercing if entities somehow connected as 1 enterprise (Sea-Land = unity of interest by showing corporations are D’s playthings with no formalities and money was personally borrowed and moved between them)

ii. But ok to have riskier parts of biz as subsidiaries to protect parent if formalities metb. After P has proved the corporation is liable and its assets don’t cover judgment, consider:

i. Undercapitalization at time of formation1. Creates an inference of inequitable conduct2. But no one knows how much is enough (although liability insurance counts and

some states have a statutory minimum which is enough) (Walkovszky = can’t pierce to own D, who owns main corporation and all subsidiaries of taxis, b/c even if all taxis owned by one company they weren’t undercapitalized)

ii. Corporate formalities (follow to demonstrate separateness and strengthen shield):1. Issue shares 2. Hold shareholders’ and directors’ meeting with minutes (even if “lonely”)3. Sign written consents4. Don’t let shareholders make decisions as if they were partners5. Sharply distinguish between corporate and personal property6. Don’t use corporate funds to pay personal expenses7. Don’t use personal funds for corporate expenses without proper accounting8. Keep complete corporate and financial records9. Issue stock certificates

iii. Equity1. Some courts requires fraud (Fusion Capital = need to show such unity of interest that they

are inseparable, that the corporation was influence and governed by D, AND that adherence to corporate fiction would sanction fraud, which here it wouldn’t since P knew the corporation had no money)

a. Actual = purpose to deceive (DE)b. Constructive = breach of a legal or equitable duty irrespective of moral

guilt that is fraudulent b/c of tendency to deceive others or injure public interest

iv. Type of claimant:1. Contract claimants

a. Assumption of the risk is often a defense (should price services accordingly)

i. But smaller contractors may not have leverage to raise pricesii. And risks aren’t rationally evaluated when there is fraud

2. Tort claimantsa. We feel bad, but limited liability is worth it overall

v. Inadequate recovery for P is NOT relevant (Arrow Bar = can’t pierce veil of bar who served drunk driver with insufficient assets and no insurance b/c followed most formalities)

c. Choice of Lawi. Internal affairs? Unclear since 3rd parties are involved

ii. Matters b/c P wins the most in CA1. Overall, veil is pierced about 40% of the time (more so in small companies) 2. But large public companies always win (if they’re even sued)

2. Dividends a. = return to equity holdersb. Types:

i. Distributions = giving out profits per shareii. Redemptions = paying equity holders for their stock (that stock can then be reissued)

1. Can only do this out of “surplus” b/c don’t want board to drain assets (Klang = balance sheet is not conclusive indicator of surplus since doesn’t take appreciation into account, so board was ok to rely on investment firm)

c. Subordinated to debt in the event of insolvency i. CA = corporation must meet two tests in order to pay a dividend (otherwise directors are

personally liable):1. Balance sheet test = after its made the assets are 1.25x the liabilities (about

solvency) and2. Income test = need to have positive retained earnings

ii. DE = loose solvency test (easier to make dividends)3. Accounts payable

a. Vendors are often stiffed when corporation goes under, but can control for this through contracts restricting distributions

-----------------------------------------CORPORATE FIDUCIARY DUTIES----------------------------------------

Derived from (BUT NOT) agency law, because shareholders (in position of vulnerability) entrusted management of their property to D/O and justifiably relies upon their good faith, confidence, and trust.

1. Introductiona. Who

i. Directors (collectively) are agents/fiduciaries of the corporation and shareholders ii. Officers are agents/fiduciaries of the corporation

iii. Shareholders have no fiduciary duties toward each other or the corporation1. Except regarding oppression (see above)

b. Pros/Cons

Default rules are efficient b/c minimize agency costs

Can’t contract for everything Encourages voluntary

transactions (wealth enhancing)

Encourage managerial risk aversion Inefficient to litigate these after the fact May interfere with contracts/private ordering (and

marketplace controls for a lot…)

2. Duty of Carea. = directors must act in good faith as reasonably prudent directors would, including duties to:

i. Monitor

1. Must put reasonable reporting systems in place (Caremark = absent some reason to suspect wrongdoing, no need to inquire beyond these. Ok to assume honesty in reporting. Need systemic failure of the board to establish breach of duty)

ii. Inquire1. When circumstances would alert a reasonable director in “like position”

b. Covers both malfeasance and nonfeasance (no dummy directors)i. May reasonably rely on others’ reports to meet this

c. Standard = gross negligence (objective)i. = must act in good faith as a reasonably prudent director would

1. So more than in contracts where standard is merely “fair dealing” ii. Exception: greater care in trust-like business (like insurance) (Francis = widow breached duty

by having no idea what is going on and letting sons steal from business. She could have threatened them with a suit to deter them, so “spawned in the backwater of her neglect”)

d. Should only be about process (WLR Foods = rationality of defensive measures shouldn’t matter, so can only get discovery about the process the board took)

3. Business Judgment Rulea. = presumption that board is not liable for poor business decisions (doesn’t apply to inattention) b. Policy = shouldn’t impose liability for bad business judgment b/c:

i. Shareholders voluntarily undertook that riskii. After-the-fact litigation is a bad way to evaluate these decisions

iii. Potential profits often corresponds to potential riskc. Rebuttable (burden on P, then shifts to duty of care analysis) if:

i. No rational business purpose (i.e. no-win decision/waste)ii. Interested transaction (i.e. conflict of interest) so duty of loyalty is implicated

1. Interested board member should disclose and abstainiii. Bad faith (as defined in Disney below)iv. Illegal transactionv. Grossly uninformed (Van Gorkom = board didn’t know about Van Gorkom’s role in forcing the sale

of the company and establishing the purchase price, which was essentially a guess. They should have informed themselves of the intrinsic value of the company and given it more than 2 hours consideration. Their reliance on others was unfounded!)

4. Exculpation Statute DE 102(b)(7) as Affirmative Defense to Breach of Duty of Carea. Enacted in response to Van Gorkom (other effect = big emphasis on records of process taken)b. = allows shareholders to eliminate personal financial liability of directors in charter unless

(Bancorp = partial disclosures in merger proxy statement that were materially misleading are immunized under 102(b)(7) because inadvertent breach of duty of care):

i. Breach of duty of loyalty / improper personal benefit orii. Act or omission in bad faith (subjective test as defined in Disney) (= directors get BJR

b/c compensation committee was adequately informed, so no bad faith)1. = intentional/conscious disregard of responsibilities (Tyson Foods = spring-loading,

aka a compensation of stock right before good news, is bad faith b/c board had material, non-public info and intended to circumvent a valid shareholder-approved restrictions plan, so implicates duty of loyalty) (Gifford = intentional violation of shareholder approved stock option by back-dating [issuing stock and changing date to get benefit of gain] + fraudulent disclosures about compliance is disloyal, so bad faith)

2. = acting with a purpose other than that of advancing best interests of the corporation (aka being DISLOYAL) (Malpiede = no bad faith where rejected $9 bid for

So Ps try to frame everything as “bad

faith”

initial $7.75 merger b/c need to look at the whole deal, not just the price) (Stone = no bad faith where bank employees fail to file money laundering reports and have to pay a fine b/c can’t prove officers failed to supervise in bad faith)

3. = acting with intent to violate the law5. Duty of Loyalty (easier for P to prove and get insurance settlement)

a. = implicated when there is a conflict of interest between director and corporation, where must exercise powers in the interest of the corporation

i. Not interested if merely stands to benefit by virtue of stockholdingsii. Ex. “washout” financing where VC owner contributes more, but significantly dilutes

other shareholders - duty of loyalty implicated, but ok b/c would have gone bankruptb. Overlaps with bad faith , discussed above (Tyson Foods) (Gifford)c. Standard = directors must prove entire fairness to the corporation given the business context

at time of the transaction (objective) (Lewis = directors of two corporations use one to lease space for cheap from another at the expense of its shareholders, so no BJR b/c D could not disprove breach of duty of loyalty)

i. Consider: 1. Process (undue pressure, arms length)2. Whether it was affirmatively in the corporation’s best interest3. If initiated on behalf of the corporation by disinterested persons

d. Safe harbor statutes (= satisfy procedural rules and you can shift the burden)i. If directors can show they used any of the following to approve the interested transaction:

1. Disinterested & fully informed director vote (often independent committee)a. Directors must prove they were truly independent, fully informed, and had

freedom to negotiate at arm’s lengthb. DE = can have committee of 1, so only need 1 disinterested directorc. CA = need 2 or more on a committee and need a quorum for a vote

2. Disinterested shareholder vote (take out interested shares) ora. Harder b/c need disclosures, a meeting or written consent

3. CL intrinsic fairness test (Marciana = don’t have to use statutes, and here ok b/c personal loans without board approval [since deadlocked] ok b/c bona fide attempt to help save the company and statutes were realistically unavailable)

ii. Then they get the following:1. DE = shift the burden of proof to shareholders and give directors BJR protection

(Benihana = when board knew about D’s dual role as negotiator and director they knew enough to be adequately disinterested and get BJR protection)

2. CA = Shift the burden of proof to shareholders or3. Minority = transaction isn’t automatically void, but no other effect (still argue)

e. Specific Casesi. Corporate opportunity doctrine (most common at small, closely held corporations)

1. = where D/O pursue economic opportunities on their own behalf the corporation also wants to pursue

a. About fairness (burden on director who took the opportunity)2. Guth line of business test (Broz = not obligated to refrain from competition with his

company’s acquiror since it was contingent/uncertain):a. Can the corporation take the opportunity (financially)? b. Is the opportunity in the corporation’s line of business?

c. Does the corporation have an interest or expectancy in the opportunity? i. About tie between property and nature of corporation’s business

d. Does the fiduciary have an interest against the corporation?3. ALI safe harbor (but not required per Broz) = bring the decision to the board and

have them reject it formally to defeat expectancy interest (NE Harbor Golf Club)a. Good to have a bright line, but disincentive for directors

4. DE 122(17) = can have charter or resolution renouncing corporation’s interest in specified business opportunities (everyone wants it now)

a. BJR applies to this decision ii. Compensation agreements

1. Distinguished from other self-interested transactions b/c necessary and sufficiently recurring/publicized for comparisons

a. So usually a duty of care rule with BJR (P has heavy burden of demonstrating no reasonable business person could consider it adequate)

b. But when personal interest in the transaction (i.e. own compensation), duty of loyalty is implicated and burden is on D

6. Corporate Social Responsibilitya. Objective is mainly enhancing shareholder profit (Dodge), but what about stakeholders?

i. Examples:

1. Employees2. Suppliers

3. Customers4. Creditors

b. Duty of care issue b/c can implicate bad faith since not directly advancing interest of shareholders (i.e. increasing profits)

i. Charity generally gets BJR protection b/c considered marketing/building goodwill so arguable indirect benefit to shareholders (Wrigley = ok for directors not to allow night games b/c considering effect on the neighborhood is in long term interest of the corporation. Since no fraud or conflict of interest, it gets BJR)

c. Other Constituencies Statutesi. = allow D/O to consider stakeholders and short/long term interests (but no bright line)

ii. Effect: diminishes duty of care to shareholdersd. Note: corporations are inherently good b/c advance prosperity and maintain political pluralism

----------------------------------------------MERGERS/ACQUISITIONS-----------------------------------------------

1. Typesa. Acquiring corporation negotiates directly with target

i. Types (some transactions may have elements of all 3):1. Asset purchase (cash/stock for assets)

a. = buy selected assets from target companyi. Liabilities only assumed if explicit OR equity demands it (e.g.

defective product injury and no one else left to sue)ii. Usually acquired by subsidiary to reduce liability to parent

b. Rights: shareholders get voting but dissenters do NOT get appraisal rights2. Purchase of stock (cash/stock for stock)

a. Often a hostile tender offerb. After acquisition, target is a subsidiary of the acquiring company

3. Statutory merger (cash/stock for stock)a. = mush two companies together under state corporate lawb. Rights: shareholders get voting and dissenters usually get appraisal

i. Ways to avoid dissenters’ cash-out rights:1. Do an asset or stock purchase! 2. Market out exception = when public companies receive

cash/shares b/c valued in the market3. Triangular merger = use a subsidiary to enter into the

mergerc. De facto merger doctrine and successor liability

i. = if substance is the same as a merger, then effects should be same (Glen Alden = bought target as subsidiary, then it bought all of the acquiror’s assets and liabilities for shares, then acquiror dissolved)

ii. Abandoned except to protect creditors (Hariton = since there are two ways of achieving the same result there are two effects, so if you pick to not do a statutory merger then no dissenters’ rights) (Knapp = can’t allow a formality to defeat recovery of tort victim, and since D is better able to spread the loss and could have gotten its targets insurance, it pays)

b. Tender offer (other way to overcome a hostile board = proxy fight to through them out)i. = acquiring corporation purchases directly from shareholders of target corporation a

controlling interest in company’s stock (non-statutory)1. Can be with or without board approval, but if without then “hostile”

ii. How? 1. Bidder buys a “tow hold interest” to become a shareholder with inspection rights,

then solicit via the shareholder list2. Place newspaper ad to buy more shares at a “premium” contingent on having

enough shares tendered to give bidder controla. Must be open to all security holders in same class under 14d-10

i. So no discriminatory self-tender offers like Unocal under Securities Exchange Act

3. Shareholders either do nothing, sell in the open market, or tender to the bidder (can take back and get benefit of better deals until bidder has control 14d-10)

4. Once he has control, bidder uses it to merge companies and squeeze out the boarda. Shareholders are forced to exchange their shares for tender offer amount

iii. Federally mandated disclosure1. Purpose: to protect shareholders from having to respond without adequate info

a. Private sellers less likely to be pressured, but if public with time limit…2. So ID a tender offer by statutory purpose (Hanson = not a tender offer where D

terminated tender offer and then made private purchases of stock from a few sophisticated individuals b/c not publicized and they don’t need help)

a. Do the selling shareholders need protection or are they sophisticated?b. Is there a substantial risk they lack info needed to evaluate the proposal?c. Is it publicized?

2. Defensive measuresa. = director primacy, so can put defensive measures in place w/out shareholdersb. Poison pills

i. = shareholder rights plan that gives all shareholders other than unwelcome acquiror the right to buy additional stock at a discount

1. Triggered when someone announces purchase of x% of stock ii. Formation: can be adopted without shareholder vote b/c right to declare dividend

unilaterally1. But shareholders don’t want the pill to block a good deal for them just b/c the

board wants to keep its job… (tension)iii. Purpose: to dilute ownership interest and increase acquisition cost

1. Protects against unfair takeover by encouraging acquiror to negotiate with the board

2. Only triggered 3 times ever, so usually works! iv. Board duties

1. DE = Unocal (see below) 2. NY and Penn = BJR

c. Deal protection measuresi. Bidder doesn’t want to be stalking horse (= where his action starts a bidding war), so

target can get extra payment in exchange for certainty via these:1. No shop = board won’t actively solicit bidders2. No talk = board won’t talk with potential suitors who come knocking3. Lock-up = bidder can buy selected shares/assets at a discount 4. Stockholder voting agreements = major stockholders agree to vote for the

transaction to assure sufficient shareholder approval in advance5. Termination/break-up fees6. Force-the-vote provisions (Omnicare)

a. = where board agrees to submit merger to shareholder vote even if it withdraws its own support for a superior proposal

b. CA = doesn’t allow it?c. DE and Model Act = ok with fiduciary out?

ii. DE doesn’t approve locked deals without shareholder approval3. Enhanced Board Duties in Takeovers (b/c risk of entrenchment)

a. For unilateral defensive measures:i. Threshold = Unocal proportionality test before BJR protection where must (= met here

b/c reasonable grounds to believe danger to corporate policy b/c of P’s stock ownership since approved by independent board, and defensive measure of self-tender offer was reasonable to this threat):

1. Reasonably perceive a threat to current corporate strategy as shown by:a. Acting in good faithb. Informed through reasonable investigation (helps to have independent

committee)2. Have defensive measures that are balanced/proportional to the threat, not

draconiana. Must be reasonable chance you can get a better value for the shareholders

Only ok if untainted by

director interest

ii. Some states just call it a duty of loyalty issue b/c self-dealing (b/c want to stay in power)b. For deal protective devices

i. Can’t be preclusive or draconian (Omnicare = when it’s mathematically impossible under a contractual lock-up measure for other proposals to succeed and the vote is forced, these contractual expectations must yield to supervening director fiduciary duties)

c. When break-up/sale is inevitable (no longer defending it):i. = duty shifts from preservation of the corporate entity to maximizing value for

shareholders (Revlon = no BJR b/c focused on shoring up sagging market for note-holders [contract creditors, not shareholders] instead of getting best price for shareholders)

1. So when bidding is in progress can’t have concern for anyone/thing unless it is rationally related to benefiting shareholders

ii. This duty only comes up once the decision to sell has been made (Lyondell = ok for board to “wait and see” while in play since this is exercise of business judgment, not conscious disregard of duties)

--------------------------------------FEDERAL SECURITIES REGULATION-------------------------------------

1. State Securities Laws (based on merit review)a. Mostly preemptedb. Substantive review of whether securities are suitable for citizens (paternalistic)

2. Federal Securities Laws (based on full disclosure)a. Securities Act of 1933

i. Regulation of offers1. Must register a statement with the SEC unless:

a. There’s a federal and state exemption (e.g. 4(2) = transactions by an issuer not involving any public offering)

2. Must be made by a prospectusii. Regulation of sales

1. Registration statement must be declared effective by the SEC unless exemptionb. Securities Exchange Act of 1934

i. Formed SECii. Implemented quarterly and annual reporting for companies that have issued securities

iii. Regulates:1. Insider trading

a. Purpose: efficiency, fairness, administrability b. 10(b) = Board anti-fraud mandate, where can’t dupe shareholders into

selling shares cheaply to you based on insider info c. Theories:

i. Classical = insiders shouldn’t deal with their shareholders from a position of superior info (duty of candor) (Chiarella = when D learned info from working at printing press and then traded on it his silence is ok b/c no affirmative duty to disclose so no fraud)

ii. Misappropriation = insider trading if some duty to another party was breached in connection with the trade (O’Hagan = lawyer who gets info from around the firm and trades on it violates 10(b) b/c owed duty to his firm)

1. “Duty” can arise even if just history of sharing confidences

2. Communications (e.g. proxy solicitation) 3. Acquisitions and tender offers

iv. Requires ownership disclosure (so you can’t become a majority owner by secret)3. Sarbanes-Oxley

a. = imposes uniform requirements on all public companies, many not disclosure-basedb. Duty of care encroachment on state corporate law

i. CFOs and CEOS must certify to accuracy of financial statements and that they designed internal controls to promote reliable reporting

ii. Independent audit committee requirements1. Whistle-blower protections2. Pre-crime reporting procedures

c. Lawyer reportingd. Code of ethics requirement

------------------------------------------SHAREHOLDER LITIGATION----------------------------------------------

1. How to Alter D/O Personal Liability:a. Exculpation statutes (above)b. Indemnification statutes (although not permitted for intentional acts)

i. Goal = want to broaden universe of capable ppl who will serve and deter meritless claims1. Officers are employees , so have right to indemnification for expenses/losses in

carrying out their employment, but directors aren’tii. Mandatory

1. DE 145(c) = entitled to be indemnified for expenses if they are “successful on the merits” “wholly or otherwise” (Waltuch = success when suit is settled and dismissed with prejudiced where corporation pays but individual doesn’t)

a. Settlement with prejudice and dismissal without any assumption of liability = success in DE (needn’t demonstrate freedom from wrongdoing or go through with a whole trial)

2. CA 317(d) = not “or otherwise” iii. Permissive

1. = empowers but does not require corporations to indemnify anyone who is a part of a suit “by reason of” fact he is D/O (Heffernan = if you make this mandatory and a complaint accuses former director of knowing liabilities because of his position as a director, then nexus is made even though he’s no longer working for you)

c. Purchase insurance i. Can fill the gap, but limits for intentional acts (so P tries not to sue for fraud b/c wants

insurance money)2. Personal/direct suits (what Ps want)

a. = shareholder sues to enforce his own rightsi. Allowed in close corporations even if in a public one it would be derivative

b. Examples:

i. Dividendsii. Inspection rights

iii. Voting rightsiv. Entrenchment

v. Fraud vi. Oppression and dilution

3. Derivative suits (what Ds want)a. = shareholder sues on behalf of the corporation for alleged breach of fiduciary duty

i. Line can be blurry between direct and derivative action…b. Demand requirement: must ask directors to pursue lawsuit on corporation’s behalf unless they

can show demand futility b/c of collusion i. Most states makes this a matter of BJR, but DE makes a judge apply its own business

judgment to see if board can get it (Zapata = court must determine itself whether the motion to terminate the action by the independent committee should be granted given public policy and the corporation’s best interests)

ii. If board gets it, can seek dismissal c. Subject to many procedural rules like FRCP 23.1d. Effects:

i. P gets attorney’s feesii. More complex

iii. Distributes recovery to the corporationiv. Has a preclusive effect so others can’t sue