Exam

 3 Hour Exam: It is a Point Grab System* – (1) Use IRAC Headings, (2) Set forth issues and sub-
issues, (3) Cite the rules and the authority, (4) Analyze and argue both sides, (5) Must reach a
Conclusion;
 Discuss all theories, use buzzwords!
Agency

Wagner’s Questions
 1. How does the agency relationship arise?
 2. Under what circumstances can an agent bind a principal in contract and in tort?
 3. What duties does the agent owe the principal?
Who is an agent?
 Agency RS2d §1, RS3d §1.01
o Agency is the fiduciary relationship that results from
 1. Manifestation of consent (assent) by the principal
 2. That the agent shall
 Act on his behalf and
 Subject to his control,
 3. Consent by the agent so to act for the principal
 RS2d §15
o It is not essential to the existence of authority that there be a contract between
principal and agent that the agent promise to act as such
 RS2d §16
o No need for the agent to receive compensation
 Gordon v. Doty
o Principal manifested consent by telling agent that he could use the car if he
personally drove it. This also satisfied the elements of (a) acting on principal’s
behalf, and (b) subject to the principal’s control, by telling him that kids could not
drive it. Finally, the agent consented by actually driving the car.
 Issue: whether there was an agency relationship between the owner of the
car and the driver of the car? If so, then the owner of the car could be
liable for the lawsuit by the people who were injured in this case.
 Rule: Where one undertakes to transact some business or manage some
affair for another by authority and on account of the latter, the relationship
of principal and agent arises.
 There does not need to be a contract for creation of an agency
relationship
o No need for offer, consideration and acceptance
 There does not need to be an exchange of compensation for
creation of an agency relationship
 Ownership of a vehicle establishes a prima facie case against the
owner that the driver is the agent, regardless of whether or not the
owner is present.
o Dissent- Agency means more than mere passive permission. It involves request,
instruction, and or command. It was a gratuitous bailment. Just lent the car.
 o Key in this case is control. By telling Coach Garst he must drive the car, Doty
acted as a principal (by placing a condition upon receipt of her car).
Formal Relationships that may give rise to Agency
 Security Holder Becoming a Principal RS2 § 14O (Agency v. Creditor-Debtor)
o A Creditor who assumes control of his debtor’s business…may become a
principal…with liability for acts and transactions of the debtor in connection with
his business.
o Comment a
 Merely exercising a veto power does not create an agency relationship.
 However, taking over the management of the business either in person or
through an agent, and directing what contracts may or may not be made,
creates an agency relationship
 When the alleged principal “assumes de facto control over the
conduct” of the alleged agent.
 Agent or Supplier – RS2 §14K
o One who contracts to acquire property from a third person and convey it to
another is the agent of the other only if he agreed that he is to act primarily for
the benefit of the other and not for himself.
o Comment a
 Factors indicating that one is a supplier, rather than an agent are:
 (1) That he is to receive a fixed price for property irrespective of
price paid by him
 (2) That he acts in his own name and receives the title to the
property, which he thereafter is to transfer
 (3) That he has an independent business in buying and selling
similar property.
 A. Gay Jensen Farms Co. v. Cargill, Inc.
o Facts: Cargill (D) was creditor of Warren. Because it was going under, Cargill
took over the Warren Co.’s day-to-day operations. Warren became bankrupt,
defaulted on money owed under K’s with local farmers (P) for grain. Farmers (P)
sued to recover for breach of K.
o Held: Cargill became the principal of Warren because of its extensive control and
influence
 The parties do not have to call it an agency relationship
 Existence of agency can be proved by circumstantial evidence showing
that dealings between two parties that amounted to de facto control by
Cargill:
 Cargill’s constant recommendations to Warren
 Cargill’s right of first refusal on grain
 Warren’s limitations on its independent dealings
 Cargill’s right of entry to carry on audits
 Cargill’s correspondence and criticism of Warren’s finances,
salaries, inventory
 Cargill’s determination that Warren needed “strong paternal
guidance”
  Provision of drafts and forms to Warren with Cargill’s name
imprinted
 Financing all of Warren’s purchases of grain and operating
expenses
 Cargill’s power to discontinue the financing of Warren’s
operations
o Warren is an agent, not merely a supplier, because all portions of its operations
were financed by Cargill and almost all its grain sold to Cargill. Thus, there was
no independent business.
o Control exercised by Cargill was consistent with a principal/agency relationship.
Not normal for a simple creditor/debtor relationship.
Liability of Principal to Third Parties in Contract - Attribution Rules
 Overarching Issue
o Does the agent have the authority to bind the principal to a third-party and a third-
party to a principal?
 Actual Authority
o Authority - RS2 §7
 The power of the agent to affect the legal relations of the principal by acts done
in accordance with the principal's manifestations of consent to him.
- Two types of Actual Authority – Implied Actual Authority and Express Actual
Authority
 Express Actual Authority
o Creation of Authority; General Rule - RS2 §26
 (1) Objective manifestation of the principal
 Created by written or spoken words or other conduct of the principal
 (2) The agent’s reasonable interpretation of that manifestation
 (3) The agent’s belief the he or she is authorized to act for the principal
 Implied Actual Authority
o When Incidental Authority Is Inferred - RS2 §35
 Acts which are incidental, usually accompany, or are reasonably necessary to
accomplish a transaction
 Serves to fill the gaps in express authority
 “within the bounds of what agent is approved to do, but not discussed between
principal/agent”
o Mill Street Church of Christ v. Hogan (Implied Authority Case)
 Facts: Church Elders (D) hired Bill to paint the church and Bill hired his
brother, Sam Hogan (P) to help him finish. Hogan (P) was injured on the job
and filed a claim for workers comp. Workers comp board granted his claim and
D appealed
 Issue: Did Bill have implied authority to hire his brother?
 Rule: Implied authority is actual authority circumstantially proven, which the
principal actually intended the agent to possess and includes such powers as are
practically necessary to carry out the duties actually delegated.
 Factors used to determine if implied authority exists:
 o In examining whether implied authority exists, it must be
determined whether the agent reasonably believes because of
present or past conduct of the principal that the principal wishes
him to act in a certain way or to have certain authority
o The nature of the task may be another factor, because implied
authority may be necessary to implement the express authority
 Held: Implied authority existed because church allowed painter to hire his
brother in the past and the job required more than one person.
Apparent Authority
 Apparent Authority - RS2 §8
o Apparent authority is the power to affect the legal relations of another person by
transactions with third persons, professedly as agent for the other, arising from
and in accordance with the [apparent principal’s] manifestations to such third
persons.
 Apparent Authority - RS3 §2.03
o Power held by an agent or other actor to affect a principal's legal relations with
third-parties when a third-party reasonably believes the actor has authority to act
on behalf of the principal and that belief is traceable to the principal's
manifestations.
 Creation of Apparent Authority; General Rule - RS2 §27
o (1) Objective manifestation of the apparent principal . . .
 Created by written or spoken words or other conduct of the apparent
principal
 Direct communications from principal by letter or word of mouth
 Authorized statements of the agent
 Documents or other indicia of authority given by the principal to
the agent
 Communications from third persons who have heard of the agent’s
authority from authorized or permitted channels of communication
 Appointing a person to a position like manager or treasurer which
carries with it generally recognized duties
 Communication to the public through signs or advertising
 Continuously employing the agent
o (2) Which reaches a third-party . . .
o (3) Causing the third-party to reasonably believe that the apparent agent is
authorized to act for the apparent principal
 Three-Seventy Leasing Corporation v. Ampex Corporation
(Apparent Authority Case)
 Facts: In a transaction for the lease of computers, the plaintiff entered into
a contract with a 3rd party after he presumed the agent of defendant had
authority to enter into a leasing contract.
 Issue: can a principal be bound by actions of its agent? Whether Kays was
an agent who bound Ampex to perform under the sales contract?
  Rule: An agent has apparent authority sufficient to bind the principal when
the principal acts in such a manner as would lead a reasonably prudent
person to suppose that the agent had the authority he purports to exercise.
 Further, absent knowledge on the part of third 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, which
he is employed to conduct.
 Held: The agent had the apparent authority to bind the principal to the
contract because:
 It was reasonable for the third-party to assume that as a salesman,
the agent had the authority to bind the principal
 Principal did nothing to dispel this belief; in fact, its actions
provided a further basis for this belief
 The fact that only certain officers could bind the principal was
never conveyed to the third-party
 He had no knowledge that there was a limitation on Kay’s
authority.
 There was a financing agreement in the document which makes it seem
like more than a sales contract – therefore, cannot use actual authority here
(agent [who was a salesman] is exceeding normal authority of his
position)
o Book Problems
 1. What should Ampex have done to protect itself?
 Communicated to other side that Kays didn’t have any authority to
do a sales contract with financing
 What if Ampex didn’t know Kays was going out doing his thing?
o Require another signature by a higher-positioned person in
the business’s form contract
 Make it more clear to Kays what his authority was
 2. What should Joyce have done to protect itself?
 He could’ve checked with Kays’ boss that this was okay. Do more
due diligence.
 He should’ve asked for evidence of Kays’ authority.
Inherent Authority
 Inherent Agency Power - RS2 §8A
o The power of an agent which is derived not from authority, apparent authority or
estoppel, but solely from the agency relation and exists for the protection of persons
harmed by or dealing with a servant or other agent
 Unauthorized Acts of General Agent - RS2 §161
o A general agent for a disclosed or partially disclosed principal subjects his principal
to liability for acts done on his account which usually accompany or are incidental to
transactions which the agent is authorized to conduct if, although they are forbidden
by the principal, the other party reasonably believes that the agent is authorized to do
them and has no notice that he is not so authorized.
 Acts of General Agents - RS2 §194
 o A general agent for an undisclosed principal authorized to conduct transactions
subjects his principal to liability for acts done on his account, if usual or necessary in
such transactions, although forbidden by the principal to do them.
 Acts of Manager Appearing to Be Owner - RS2 §195
o An undisclosed principal who entrusts an agent with the management of his business
is subject to liability to third persons with whom the agent enters into transactions
usual in such businesses and on the principal's account, although contrary to the
directions of the principal.
 General Agent; Special Agent - RS2 §3
o (1) A general agent is an agent authorized to conduct a series of transactions
involving a continuity of service [think: CEO or GM]
o (2) A special agent is an agent authorized to conduct a single transaction or a series of
transactions not involving continuity of service.
o Courts are reluctant to use inherent authority for special agents
 Disclosed Principal; Partially Disclosed Principal; Undisclosed Principal - RS2 §4
o (1) [Disclosed Principal] If, at the time of a transaction conducted by an agent, the
other party has notice that the agent is acting for a principal and of the principal's
identity the principal is a disclosed principal
o (2) [Partially Disclosed Principal] If the other party has notice that the agent is or may
be acting for a principal but has no notice of the principal's identity the principal for
whom the agent is acting is a partially disclosed principal.
o (3) [Undisclosed Principal] If the other party has no notice that the agent is acting for
a principal the one for whom he acts is an undisclosed principal
Inherent Authority Traditional Case
 Watteau v. Fenwick (Inherent Authority Case)
o Facts: Humble was the owner of a bar in England. The bar was sold to defendants
but Humble remained the bar’s manager and his name remained on the pub’s
façade. The outside world still thinks that Humble is the owner. Humble had no
authority to buy anything for the business except for bottled ales and mineral
water, anything else that Humble needed to run the pub could be purchased from
his bosses, the owners. Humble purchased cigars, Bovril, and other articles. The
trade creditors (suppliers of cigars, Bovril, and other articles) sued the bar. The
suppliers weren’t aware of who the true owners of the establishment were.
o Issue: Whether owner of a pub can be liable for products supplied in
contravention of the owner’s express wishes.
o Held: Principal is liable (§195) b/c it’s usual in such businesses
Inherent Authority Modern Rule
 Nogales v. ARCO
o Facts: lawsuit by a big oil company (ARCO) against a small truck stop (Nogales).
The operator defaulted on the loan and Nogales counterclaimed that Arco had
promised a discount and never received it.
o Held: because of the scope of the agent’s authority, the court found that he was a
general manager and held that inherent authority bound the principal.
Ratification
  Ratification - RS2 §82
o The affirmance by a person of a prior act which did not bind him but which was
done or professedly done on his account, whereby the act, as to some or all
persons, is given effect as if originally authorized by him
 Affirmance - RS2 §83
o Affirmance is either:
 (a) A manifestation of an election by one on whose account an
unauthorized act has been done to treat the act as authorized, or (words)
 (b) Conduct by him justifiable only if there were such an election (i.e.
conduct, silence)
 Knowledge of Principal at Time of Affirmance RS2 §91
o (1) If, at the time of affirmance, the purported principal is ignorant of material
facts involved in the original transaction, and is unaware of his ignorance, he can
thereafter avoid the effect of the affirmance.
o (2) Material facts are those, which substantially affect the existence or extent of
the obligations involved in the transaction, as distinguished from those which
affect the values or inducements involved in the transaction.
 RS3d Ratification (Generally)
o Timing: Ratification cannot follow events that would cause ratification to have
adverse and/or inequitable effects on a third-party.
 Botticello v. Stefanovicz
o Facts: Mary and Walter each owned half of the family farm and they entered into
a lease with option to purchase with the plaintiff. Walter agreed upon a price with
the plaintiff. Mary refuses to sell at the agreed upon price.
o 1st claim is that Mary is bound since Walter was acting as her agent as a result of
their marriage. Was there an agency relationship?
 There is no agency because Walter handled many of the business aspects
and Mary had consistently signed any deed, mortgage, or mortgage note in
connection with their jointly held property.
o Even if there was no agency, did Mary ratify the new contract? 2nd claim is that
even if no agency relationship existed at the time the agreement was signed, Mary
was bound by the contract executed by her husband because she ratified its terms
by her subsequent conduct.
 Even if Walter didn’t act as Mary’s agent, did she ratify terms by her
subsequent conduct?
Estoppel
 Estoppel; Change of Position - RS2 §8B
o (1) Principal allows another (who has no authority) to create the appearance of
authority and does not correct the misimpression
o (2) Reasonable belief by the third-party
o (3) A change in position by the third-party (reliance)
 Ex: Payment of money, Expenditure of labor, Suffering a loss, Subjection
to legal liability
 Estoppel to Deny Existence of Agency Relationship - RS3d §2.05
 o A person who has not made a manifestation that an actor has authority as an agent
and who is not otherwise liable as a party to a transaction purportedly done by the
actor on that person's account is subject to liability to a third party who justifiably
is induced to make a detrimental change in position because the transaction is
believed to be on the person's account, if
 (1) The person intentionally or carelessly caused such belief, or
 (2) Having notice of such belief and that it might induce others to change
their positions, the person did not take reasonable steps to notify them of
the facts.
 Hoddeson v. Koos Bros
o Facts: Old lady goes to furniture store and deals with a guy who ends up being an
imposter. Never gets a receipt or sales contract. She sues the furniture company to
get her money back.
o Initially, the Ct. found that there was no apparent agency because there had to
have been a manifestation by the principal that the agent had some authority.
However, the Ct. used an estoppel theory: there was detrimental reliance and a
loss was suffered, but only the scam artist put forward the impression of agency,
not the principal
o Rule: Where a proprietor of a place of business by his dereliction of duty
enables one who is not his agent to act as such…and the appearances being of
such a character as to lead a person of ordinary prudence and
circumspection to believe that the imposter was the proprietor’s agent, the
law will not permit the proprietor defensively to avail himself of the
imposter’s lack of authority and thus escape liability for the consequential
loss sustained by the customer.
o Held: Ct. remanded and held that agency by estoppel required a manifestation
and/or allowance by the principal that the agent had some authority. The acts of
the supposed agent alone are not enough.
 The duty of the proprietor includes the exercise of reasonable care
and vigilance to protect the customer from loss occasioned by the
deceptions of an apparent salesman.
Agent’s Liability on the Contract
 Liability of Agent for Disclosed Principal RS2d §320
o Unless otherwise agreed, a person making or purporting to make a contract with
another for a disclosed principal does not become a party to the contract
 Liability of Agent for Partially Disclosed Principal RS2d §321
o Unless otherwise agreed, a person purporting to make a contract with a 3d party
for a partially disclosed principal is liable on the K
 Liability of Agent for Undisclosed Principal §322
o An agent acting on behalf of an undisclosed principal is liable on the contract
 Atlantic Salmon v. Curran
o Facts: Curran was acting on behalf of a corporate entity but the people he was
dealing with didn’t know that. He was using names but didn’t formally organize
those names as formal corporations. He was using names like Boston Seafood
Exchange and Boston International Seafood Exchange. He did have a formal
 thing called Marketing Designs, Inc., which was involved in a completely
different industry.
o Issue: Can an agent for a certain principal given this set of facts?
o Holding: There’s a duty on the part of the agent to disclose that he was acting
for a principal and the name of the principal. Burden is on the agent to
establish, not on the 3rd party.
Liability of Principal to Third Parties in Tort: Master/Servant vs. Independent Contractor
 Master; Servant; Independent Contractor – RS2d §2
o Master – principal who employs an agent to perform service in his affairs and
who controls or has the right to control the physical conduct of the other
o Servant - agent employed by a master to perform service in his affairs whose
physical conduct in the performance of the service is controlled or is subject to the
right to control by the master
o Independent contractor = person who contracts with another to do something for
him but who is not controlled by the other nor subject to the others right to control
with respect to his physical conduct … may or may not be an agent
o Right to control physical conduct = control over day to day operations
 When Master Is Liable for Torts of his Servants - RS2 §219 (Doctrine of respondeat
superior)
o (1) A master is subject to liability for the torts of his servants committed while
acting in the scope of their employment.
o (2) A master is not subject to liability for the torts of his servants acting outside
the scope of their employment, unless:
 (a) The master intended the conduct or the consequences, or
 (b) The master was negligent or reckless, or
 (c) The conduct violated a non-delegable duty of the master, or
 (d) The servant purported to act or to speak on behalf of the principal and
there was reliance upon apparent authority, or he was aided in
accomplishing the tort by the existence of the agency relation.
 Definition of Servant - RS2 §220
o (2) In determining whether one acting for another is a servant or an independent
contractor, the following matters of fact, among others, are considered:
 (a) Extent of control over the details of the work;
 Right to terminate relationship.
 (b) Engaged in a distinct occupation or business;
 (c) Whether occupation is usually directed by the employer or
independently carried out;
 (d) Level of skill required;
 (e) Who supplies the tools and the place of work for the person doing the
work;
 (f) Length of time of employment;
 (g) Method of payment (hourly or per job);
 (h) Whether or not the work is a part of the regular business of the
employer;
 (i) Whether or not the parties believe they are creating a master/servant
relationship; and
  (j) Whether the principal is or is not in business.
 Hoover Test: Who has control of the day-to-day operations of the front-end business
(business dealing with customers)?
o Humble Oil v. Martin  master/servant
 Principal maintained considerable control and dictated several important
aspects of the business
 The contract gave Humble significant financial control and supervision
 Humble didn’t sell the products to the station owner until he sold it to the
customer. Risk of loss rested with big oil company.
o Sun Oil  Independent contractor
 Gas station Owner controlled all day-to-day operations of the station
 Did not have to follow Sun Oil’s advice
 Could sell competing products
 Hoover didn’t bear the risk of loss (because title to the oil was transferred
to the station owner). As a result, the station owner has more risk of loss.
 Not nearly as much day-to-day control by principal here
Scope of Employment
 Scope of Employment - RS2§ 228(1)
o (1) Conduct of a servant is within the scope of employment if, but only if:
 (a) It is of the kind he is employed to perform;
 (b) It occurs within the authorized time and space limits;
 (c) It is actuated, at least in part, by a purpose to serve the master; and
 (d) If force is intentionally used by the servant against another, the use of
force is not unexpectable by the master
 Kind of Conduct Done Within Scope of Employment RS2 §229
o (1) To be within the scope of the employment, conduct must be of the same
general nature as that authorized, or incidental to the conduct authorized.
o [Factors To Determine] (2) In determining whether or not the conduct, although
not authorized, is nevertheless so similar to or incidental to the conduct authorized
as to be within the scope of employment, the following matters of fact are to be
considered:
 (a) Act commonly done by servants;
 (b) The time, place and purpose of the act;
 (c) Previous dealings between the master and the servant;
 (d) How business is apportioned between different servants;
 (e) Act is outside the enterprise of the master or not entrusted to servant;
 (f) The master’s expectation that the act will be done;
 (g) The similarity to the act authorized;
 (h) Whether or not the instrumentality is furnished by the master;
 (i) The extent of departure from normal methods; and
 (j) Whether or not the act is seriously criminal.
 Employee Acting within Scope of Employment - RS3d §7.07
o (1) An employer vicariously liable for torts of an employee acting within scope of
employment
o (2) The scope of employment = performing work assigned by employer or
engaging in the course of conduct subject to employer’s control
 o (3) The scope of employment ≠ events occurring w/n independent course of
conduct not intended by employee to serve any purpose of the employer
 Bushey v. United States “Seaman Lane case”
o Facts: Seaman Lane returned from drinking to open some water intake valves
which resulted in the ship listing and falling off the dry dock wall. Government
was held liable for damage to the dock under master/servant rule.
o Issue: Were Seaman Lane’s acts within his scope of employment? Should
government be liable for the damage done to the dry dock?
o Holding: Lane’s conduct was not so unforeseeable as to make it unfair to charge
the government with responsibility.
o Court says that expressions of human nature are inherent to bringing employees
along and must be considered.
o This was within scope of employment.
 Said that it was foreseeable that he would come back drunk from leave b/c
that’s what seamen do
 The ship was in a part of the drydock that the government insisted he have
access
 Risk that damage to drydock is enough to make it fair to coast guard bear
the loss. Court reasons this because the gov’t could have been more
proactive in IDing what the risks are of damage to the drydock. Control
requirement fulfilled because the gov’t could’ve controlled the risk
reduction methods
 Clover v. Snowbird Ski Resort
o Restaurant employee was skiing between restaurants on the mountain and crashed
into a guest and injured him.
o Court declined to use the scope of employment test here because of the way that
the employee was traveling down the mountain.
Liability for Torts of Independent Contractor
 Definition of Servant – RS2d §220
o General rule – One who hires an independent contractor is not liable for such
contractor’s negligent actions
o Exceptions: 1) retain control of manner and means of doing work; 2) engages an
incompetent contractor; 3) inherently dangerous activity
 RS2d §416
o Imposes liability upon the landowner who engages IC to do work which he should
recognize as necessarily requiring the creation during its progress of a condition
involving a peculiar risk of harm to others unless special precautions are taken, if
the contractor is negligent in failing to take those precautions.
o Furthermore, liability is automatic in ultra-hazardous cases
 Majestic Realty v. Toti
o Facts: Toti was hired to demolish a building owned by a landowner. This building
was immediately adjacent to a building owned by Majestic Properties. Toti
carelessly demolished the original building and damaged the roof of Majestic’s
building in the process.
 o Holding: Razing of buildings in a busy part of the city is an inherently dangerous
activity
Franchises
 Overview
o Franchise is licensing system
o Franchisor obligations are the licensed use of valuable name and “system”
 System= distinctive features of that particular franchise (food preparation,
menu, appearance, use of logo)
o Franchisee obligations are payment of royalties and advertising fees and operating
within the system (as embodied in the operating manual and contract)
o Franchisor-franchisee relationship can give rise to liability claims against the
franchisor for franchisee negligence
 Murphy v. Holiday Inns
o Facts: guest slips on a puddle of water at a Holiday Inn. Operator of the hotel is
Betsy-Len and is a franchisee of the Holiday Inn’s hotels.
o Issue: Whether an agency or master-servant relationship exists? Is Holiday Inn
liable to the plaintiff who slipped and fell at the hotel.
o Holding: Betsy-Len retained all the powers that an owner typically had, including
bearing of the risk of loss. Holiday Inn had no right to control details of doing the
work. There was no master-servant relationship. Holiday Inn had no control over
hotel’s daily operation.
o Rule: If a franchise contract so regulates the activities of the franchisee as to
vest the franchisor with control within the definition of agency, the agency
relationship arises even though the parties expressly deny it.
 McDonald’s test
o Right to control; go beyond stage of setting standards and allocate franchisor the
right to exercise control over daily operations:
 1. Did putative principal hold franchisee out as agent?
 2. Did 3d party rely on holding out of agent?
Fiduciary Obligations of Agents
o Duty of Loyalty
o Restatement 2d Agency §1
 “Agency is … [a] fiduciary relationship”
 A fiduciary relationship is one involving trust and confidence
 Agent must place principal’s interests over her own
o General Principle RS2d §387
 A is subject to a duty to act solely for the benefit of the P in all matters
relating to the agency
 Compare to RS3d §8.01
o Duty to Account for Profits Arising Out of Employment RS2d §388
 If A makes profit in connection with transactions conducted by him on
behalf of P, A must turn in profits to P
 Compare RS3d §8.02
o Liability for Use of Principal’s Assets RS2d §404
 A must pay over profit if uses assets of P in violation of a duty
  A not liable for profits made by use of time to be devoted to principal
unless he violates duty not to act adversely or in competition with P
o R 3rd of Agency, §8.02 – Material Benefit Arising out of Position
 Agent has a duty not to acquire a material benefit from a third party in
connection with transactions conducted or other actions taken on behalf of
the principal or otherwise through the agent’s use of his position
o R 3rd of Agency, §8.05 (1) – Use of Principal’s Property
 An agent has a duty not to use the property of the principal for the agent’s
own purposes or those of a third party
o Reading v. Regem
o Fact: British soldier got paid lots of money to escort some cargo, on multiple
occasions, from one part of Cairo to another. This was done illegally. He was
smuggling some shizzit for some people.
o Issue: is the Crown entitled to his profits?
o Held: A servant is accountable to the master if he takes advantage of the master’s
service and violates his duty of honesty and good faith to make a profit for
himself.
 He got this money solely by reason of the position as a soldier—as
demonstrated by his army uniform—in the army and that is why the
government is entitled to the money. The wearing of the uniform and his
position is the sole cause of him getting the opportunity to make this
money.
o Rule: If a servant takes advantage of his service and violates his duty of honesty
and good faith to make a profit for himself, in the sense that the assets of which he
has control, the facilities which he enjoys, or the position which he occupies, are
the real cause of his obtaining the money as distinct from merely affording the
opportunity for getting it, that is to say, if they play the predominant part in his
obtaining the money, then he is accountable to his master. For example, taking
advantage of the assets of the employer, the facilities, or his position.
o Hypo A8—Moonlighting Hypo
o Would the result under Reading be the same if U.S. law were applied?
 1. Sergeant in Reading had been discharged by army before riding on the
cargo and he was allowed to wear the uniform for 30 days afterwards?
 It’s his use of the uniform that gave rise to the profit.
 2. American war hero is given cash by restaurant owner for making public
appearance?
 This probably applies within the moonlighting exception that’s
been accepted by courts.
 What’s different about this case is that he’s not violating any
duty.
 3. Norman Schwarzkopf gets royalty from writing memoir about his
heroic feats during his career in the army.
 This probably also applies during the moonlight exception.
No Competition (Part of Duty of Loyalty)
 Restatement 2nd of Agency, §393 – Competition as to Subject Matter of Agency
 o Agent under a duty not to compete with principal concerning the subject matter of
the agency
 After termination of agency, barrier to competition ends §396(a)
o Exceptions: cannot use confidential information, no deceit, non-compete contract
clauses
 Competition RS3d 8.04
o Throughout the duration of an agency relationship, an agent has a duty to refrain
from competing with the principal and from taking action on behalf of or
otherwise assisting the principal’s competitors. During that time, an agent may
take action, not otherwise wrongful, to prepare for competition following
termination of the agency relationship.
 General Automotive Mfrg Co.v. Singer
o Facts: Singer was hired to be a manager of P’s plant. Singer got a proposal for
some work that P couldn’t do but he told the proposer that the factory could. He
would quote a price, collect that price, but contract out the work to another factory
at a lower price and make a profit on the difference.
o Held: Singer’s actions were inconsistent with the obligations of a faithful agent.
Fiduciary duty requires utmost good faith and loyalty so that agent does not act
adversely to the interests of the principal by serving or acquiring private interests
of his own. Agent is bound to act for the furtherance and advancement of the
interest of his employer/principal.
o Rule: there was a conflict of interest here. Singer should have informed the other
side and let them make a business decision.
Confidential Information
 Using or disclosing confidential information RS2d §395
o During agency, A has duty not to use or disclose confidential info unless info is a
matter of general knowledge
 Using confidential information after termination of agency – RS2d §396(b)
o After termination of agency, A has duty not to use…in competition with the P or
to his injury…trade secrets, written lists of names, or other similar confidential
matters
 Use of Principal’s Property; Use of confidential information - RS3d §8.05(b)
o An agent has a duty not to use or communicate confidential information of the
principal for the agent’s own purposes or those of a third party
 Town and Country House & Home Service v. Newberry
o Facts: The plaintiff was a cleaning service that had established an expansive client
list through cold-calling, sales methods, and good will. Defendants were a group
of P’s employees but then broke up and tried to steal P’s customers. The Plaintiff
sued to prevent this, claiming that any competition using the private information
of the plaintiff was a breach of D’s fiduciary duty.
o Even where a former agent does not operate fraudulently under the banner
of his former principal, he still may not solicit the latter’s customers who are
not openly engaged in business in advertised locations or whose availability as
patrons cannot readily be ascertained but “whose trade and patronage have
been secured by years of business effort and advertising, and the expenditure
 of time and money, constituting a part of the good will of a business which
enterprise and foresight have built up.”

Partnerships
Overview
 UPA §6(1) of 1914
o An association of two or more persons to carry on as co-owners of a business for
profit
 UPA, Section 7(4)
o Share of profits is prima facie evidence of partnership but not if received…as
wages of an employee…or as interest on a loan… (see other exceptions)
 UPA, Section 18(e)
o All partners have equal rights in the management and conduct of the partnership
business
 UPA, Section 18(a)
o Partners share equally in profits and losses
 UPA, Section 15
o All partners are jointly and severally liable for debts and obligations of the
partnership that exceed the resources of the partnership
Partners Compared with Employees
 Fenwick v. Unemployment Compensation Commission
o Facts: Girl and her boss drew up a new employment agreement that purported to
make them partners. She used to get paid a fixed salary but now is getting a cut of
the profits. Her boss makes a lot more money. Also, she didn’t put any money
into the business but her boss did. This is one of the main issues of the case.
o Issue: whether girl was a partner or just an employee?
o Holding: partnership has not been established. Agreement was nothing more than
getting the girl higher wages. She had no authority or control in operating the
business. She was not subject to losses. She was not held out as a partner.
o What’s missing is evidence of true co-ownership.
Judicial Factors for Existence of Partnerships
o Intention
o Sharing of Profits
o Sharing of Losses
o Contribution of Capital and Share in Capital Upon Dissolution
o Control of Business
o [day to day management of business]
o Language in Agreement
o Conduct towards Third Parties
o Courts don’t require a written partnership, they can happen informally

Partnership By Estoppel
 UPA, Section 16
 o If a person represents himself as a partner in an enterprise (or allows another to so
represent him) and
o 3P relies on that representation and enters into a transaction with the supposed
partnership (“has given credit”)
o That person is liable to 3P on that transaction
 Young v. Jones
o Facts: P gave $500,000 to a South Carolina bank and it disappeared.
PriceWaterhouse-Bahamas issued an audit letter that caused P’s to deposit that
money in the SC bank. P alleges that PWC-US are partners in fact with PWC-
Bahamas
o Rule: Partners in a partnership by estoppel are jointly and severally liable
for everything chargeable to the partnership. Moreover, the individual
partners of PWC-US would be jointly and severally liable for negligent acts
of PWC-Bahamas.
o To establish partnership by estoppel: you need evidence that you’re holding out
each other as partners, that third party relied on this representation.

Limited Partnerships
 Overview
o Default rules for general partners is equal profit sharing and losses and controls
o GP assumes unlimited liability
o LP’s have limited liability—up to amount of their investment in the business
 Restatements
o California Civil Code §2483
 “A limited partner shall not become liable as a general partner, unless in
addition to the exercise of his rights and powers as a limited partner, he
takes control of the business.”
o RULPA Section 303(a): Limited partner is NOT LIABLE FOR
OBLIGATIONS of limited partnership unless
 Limited partner is also a general partner OR
 Limited partner takes part in the control of the business
 In this case, limited partner is liable to 3P who transact business
with limited partnership and who reasonably believe based on
limited partner’s conduct, that she is a general partner
o RULPA Section 303(b): Limited partner does not participate in control solely by
consulting/advising with general partner on partnership business
 DIFFERENCES FROM GENERAL PARTNERSHIP
o Formalities: Need to file certificate of limited partnership
o Two categories of partners: GP & LP
o Limited liability for LPs; Unlimited for GP
o Management in GP; LPs are passive investors
o Profit and Loss Sharing: LPs share in profits and losses based on their
contributions
o Dissolution: Dissociation of LP does not dissolve
Fiduciary Obligations of Partners
 UPA, Section 21
o Partner must account/hold as trustee (disgorgement)
o Profits/benefits derived from any transaction connected with partnership or use of
its property
 RUPA, Section 404b – Duty of Loyalty
o Duty of loyalty to account/hold as trustee profits/benefits derived from a use of
partnership property including partnership opportunity
o Refrain from conflict of interest transactions
o Refrain from competing before dissolution of the partnership
 RUPA, Section 404c – Duty of Care
o Partner must not act in a manner that is grossly negligent or reckless or engage in
intentional misconduct or knowing violation of the law
 UPA, Section 20
o Partners shall provide on demand true and full information of all things affecting
the partnership to any partner
 UPA, Section 19
o Partners may inspect and copy partnership’s books
 Revised UPA, Section 403 (stricter)
o Partners may inspect and copy books and records
o Partner entitled to information from other partners and partnership that is needed
for exercise of partner’s rights and duties without making demand
 Example: Rachel and Sam are partners and Rachel is considering selling
her transferable interest to Sam. Sam learns of some information
suggesting the partnership is entering a boom period. Rachel is unaware
of that information. He must disclose that information to Rachel even
though she has not made demand.
o Partner entitled to other information upon demand
 Meinhard v. Salmon
o Facts: Involved lease of a hotel in New York. Salmon entered into a joint venture
with Meinhard. Meinhard sues Salmon because he thinks Salmon violated
Salmon’s fiduciary duties to Meinhard. Meinhard was disgruntled because there
was initial lease term for 20 years.
o Rule: Partners owe each other the utmost duty of loyalty. Cardozo said,
“they are held to something stricter than the morals of the market place. Not
honesty alone, but the punctilio of an honor the most sensitive, is then the
standard of behavior.”
 Meehan v. Shaughnessy
o Facts: three partners decided that they wanted to go off on their own. There was a
provision in the partnership agreement for former law firm that allowed partner to
leave firm and take clients with him. Once they left the partnership, they want the
court to specify how much they owe their former firm and the old firm
counterclaimed. One issue was that they planned in secret and made plans to set
up a new office while they were working at the old firm. Other partners asked to
their face whether they planned to leave and so departing partners also lied.
 o Issues: what duties are owed to the law firm when partners decide to leave the
business?
o Rule: Fiduciaries may plan to compete with the entity to which they owe
allegiance “provided that in the course of such arrangements they do not
otherwise act in violation of their fiduciary duties.”
 Logistical arrangements to establish a new physical plant for the new
entity are permissible.
 Executing lease for office, preparing lists of clients expected to leave,
and obtaining financing is permissible.
o However, the firm also argued that partners breached their fiduciary duties by
unfairly acquiring consent from clients to remove cases from firm.
 Also, the contents of the letter was unfairly prejudicial since didn’t explain
choice of remaining with Parker Coulter.
 The ABA Committee on Ethics and Professional Responsibility set
forth ethical standards for attorneys announcing a change in professional
association: (a) The notice is mailed; (b) The notice is sent only to persons
with whom the lawyer had an active lawyer-client relationship
immediately before the change in the lawyer’s professional association;
(c) The notice is clearly related to open and pending matters for which the
lawyer had direct professional responsibility to the client immediately
before the change; (d) The notice is sent promptly after the change; (e)
The notice does not urge the client to sever a relationship with the
lawyer’s former firm and does not recommend the lawyer’s
employment (although it indicates the lawyer’s willingness to continue
his responsibility for the matters); (f) The notice makes it clear that
the client has the right to decide who will complete or continue the
matters; (g) The notice is brief, dignified, and not disparaging of the
lawyer’s former firm
Expulsion
 UPA, §31(d)
o Dissolution is caused without violation of the partnership agreement by expulsion
of any partner from the business bona fide in accordance with such a power
conferred by the agreement between the partners.
 Lawliss v. Kightlinger & Gray
o Lawlis struggled with alcoholism, enters rehab and stops drinking. Firm tells him
he can stay but he has to go to rehab. Lawlis keeps drinking and the Firm pushes
him out.
o Court says that Firm gave him enough chances and has every right to expel him.
o Rule: When a partner is involuntarily expelled from a business, his expulsion
must have been “bona fide” or in “good faith” for a dissolution to occur
without violation of the partnership agreement. If the power to expel is
exercised in bad faith or for a “predatory purpose,” the partnership
agreement is violated, giving rise to an action for damages.
Partnership—Financial Investment and Return
 Partners contribute capital and/or labor
 Financial return (UPA §18(a))
  Right to repayment of contribution
 Right to share equally in profits and surplus after payment of liabilities
 Obligation to contribute to losses sustained by partnership according to share in profits
 Right to indemnity against expenses and liabilities incurred in partnership business (UPA
§18(b))
Partnership Property
 Rules Determining Rights and Duties of Partners UPA §18(a)(b)
o Rights and duties of the partners in relation to the partnership shall be determined,
subject to any agreement between them, by the following rules:
 (a) Financial return:
 Right to repayment of contribution
 Right to share equally in profits and surplus after payment of
liabilities (regardless of contribution)
 Share of losses is by default same as share of profits
 (b) Indemnity
 If a partner pays expenses or liabilities on behalf of the partnership,
then they shall be entitled to reimbursement from the partnership.
 Extent of Property Rights of a Partner UPA §24
o Rights in specific partnership property
 Partner is co-owner with partners of specific partnership and has right to
use specific partnership property for partnership purposes (but not for
other purposes)(UPA §25 (1))
 Interest in the partnership
 Partner’s interest in partnership is share of profits and surplus and is
personal property (UPA §26)
 Right to participate in management
 Assignment of Partner’s Interest UPA §27
o The assignee may only receive profits of assignor but may not participate in
management, require information, or account of partnership transactions, or look
at the books, unless there’s an agreement with the other partners.
o Partners may only assign their economic interests in the partnership (“the profits
to which the assigning partner would otherwise be entitled”)
 Putnam v. Shoaf
o Facts: A former partner conveyed all of her interest in the gin company to the
other partners. It was learned that a former bookkeeper had embezzled money
from the gin company.
o Holding: former partner isn’t entitled to the money collected by the business
 A partner does not personally own any specific property of the partnership
and therefore cannot retain any rights to the partnership after she conveyed
it away.
Rights of Partners in Management
 Default Voting Rules
o Disagreements among partners are decided by a partnership vote
o One partner = one vote, even if contributions are not equal (UPA §18e)
 o If you want to have different votes, you have to put it in the partnership
agreement
 Default Voting Rules
o Some matters are decided by majority vote = ordinary business decisions
(UPA §18h)
o Other matters require unanimous consent (UPA §9(3), §18g, §18h)
 Assign partnership property in trust to creditors/secure payment of
debt
 Dispose of good will of partnership
 Do an act making it impossible to carry on partnership’s ordinary
business
 Confess a judgment against partnership
 Submit a claim involving the partnership to arbitration
 Admit new partners
 Contravene any agreement of the partners
 This may include extraordinary matters that substantially change past
practice e.g. entering new lines of business
 Partners as Agents
o Each partner is an agent for partnership and binds the partnership when
apparently carrying on in the usual way the business of the partnership
“ordinary business transaction” (UPA §9(1))
o Exception: Partner has no authority to act for partnership in the matter and 3P
knows that
o Partners are jointly and severally liable for debts and obligations of
partnership (UPA §15)
 Changing Management Rights by Contract
o Default rules are often changed in the following areas:
 Delegating decision making to a managing partner or executive
committee
 Weighting partnership voting to reflect pro rata contributions to capital
 Changing requirement of unanimous consent
 Requiring supermajority voting for important decisions
 Right to expel partners
 Nabisco v. Stroud
o Facts: Stroud and Freeman decided to dissolve their business. Stroud informed
Plaintiff that he was not going to be held liable for any deliveries made by
Plaintiff. Plaintiff still made deliveries to the business through Freeman’s
consent. After the business dissolved, Stroud agreed to liquidate the business’
assets and discharge the debts, and Stroud ended up losing his own personal
money in the process. Stroud disputed the money owed to Plaintiff because he
specifically requested that Plaintiff not make any deliveries or else he would
not be liable.
o Holding: Stroud can be held liable for the deliveries. Partners are jointly and
severally liable for the actions of the partnership carried out in “ordinary
business transactions”. Freeman’s conduct in allowing the deliveries was
within the scope of the business and he has a right to make these decisions
 unless a majority of the partners vote to deny him of these rights. Since Stroud
is only one half of the partnership, and not a majority, he is unable to prevent
Freeman from exercising his rights.
 If Stroud wanted to be absolved for liability, he could’ve put
something to the contrary in the original partnership agreement.
However, that wouldn’t do anything here, he could’ve
 The §9(1) exception didn’t apply here since Freeman had the authority
to act
 Day v. Sidley & Austin
o Facts: Day was senior partner with Sidley Austin. He was one of the leaders
of the Washington office for the firm. Firm wanted to merge with another firm
and P voice approval for it. Firm then wanted to move offices and P objected
and resigned.
o Changing internal structure of firm is not breach of fiduciary duty.
o Class hypo:
 Suppose that you were advising Mr. Day at the time of the merger.
How should he have secured his position as sole head of the
Washington office?
 When agreement was made, he should’ve put a clause in the
agreement to guarantee his rights. This is doing it by contract, which is
allowed in partnership law.
Partnership Dissolution
 Dissolution
o Dissolution versus Winding Up: Partnership is not terminated upon dissolution
but continues until winding up of business is completed. (UPA, Section 30)
 Causes of Dissolution (UPA §31)
o Without violation of partnership agreement:
 At the end of a fixed term or with consent of all partners if partnership for
a term
 By express will of any partner if partnership at will
 Upon expulsion of a partner under a clause in the partnership agreement
o With violation of the partnership agreement, if dissolution not permitted by any
other section, by express will of any partner at any time
 Business becomes unlawful
 Death or bankruptcy of partner or bankruptcy of partnership
 Court decree under Section 32
 Dissolution by Court Decree (UPA §32)
o Upon application to the court:
 If partner is insane or unable to meet requirements of partnership
agreement
 If partner guilty of such conduct as prejudices carrying on the business
 Partner willfully or persistently breaches the agreement or makes it not
reasonably practicably to carry on business with him
 Business can only be carried on at a loss
 Owen v. Cohen
 o Facts: Owen gets sick of his partner and goes to court to ask for judicial decree of
dissolution. He also seeks return of this loan that he made for the partnership. He
wants to dissolve partnership on grounds of differences of important business
decisions. Cohen is also a douchebag.
o Holding: Court found dissolution was proper and dissolved the partnership
according to default rule of UPA §32
o Rule: As a general rule, trifling, minor differences and grievances, which involve no
permanent mischief, will not authorize a court to decree dissolution of a partnership.
 However, dissolution of a partnership may be ordered where there are quarrels
and disagreements of such a nature and to such extent that all confidence and
cooperation between the parties has been destroyed or where one of the parties
by his misbehavior materially hinders a proper conduct of the partnership
business.
 *The grounds have to be related to business, can’t be just a personality
dispute
Duration of Partnership
 Three Categories
o At will - no limitation on duration; default rule
o Express term – “Together for [5, 10, 15…]years”
o Implied term
 Until certain sum of money earned
 One or more partners recoup investment
 Certain debts are paid
 Certain property disposed of on favorable terms
 Page v. Page
o Facts: two brothers run a laundry business. Weaker partner says that this is a
partnership for a term. They were in this business until the debt extended by the
wealthy brother was paid off. The richer partner sought to dissolve the partnership
when things were going well and the risk of liability decreased. The poor partner
claimed this proposed dissolution would be in bad faith
o Holding: Rich partner did not act in bad faith by attempting to use his superior
financial position to appropriate the now profitable business of the partnership.
 court found that there was not a distinct durational term for the partnership
nor was there an implied term, meaning the partnership was a partnership
at will.
 A common hope that the partnership earnings would pay for all the
necessary expenses does not establish even by implication a “definite term
or particular undertaking”
o Rule: the UPA provides that a partnership may be dissolve by the express
will of any partner when no definite term or particular undertaking is
specified. However, this power, like any other power held by the fiduciary,
must be exercised in good faith.
 A partner may not freeze out another partner to pirate the business
for his own use. A partner may not dissolve a partnership to gain the
benefits of the business for himself, unless he fully compensates his co-
partner for his share of the prospective business opportunity.
 o Not all courts read a good faith requirement into the UPA regarding the
dissolution of an at-will partnership
Liquidation
 Right to Require Liquidation, UPA §38(1)
o If dissolution caused in any way except in breach of agreement, partner may
request liquidation
 Liquidation or Continuation
o Default rule is that upon dissolution caused in any way (except in breach of
partnership agreement) any partner may request liquidation
o In practice, partners often agree to continue the business because liquidation
will not produce maximum value to partners
o Partners may agree to continue the partnership rather than liquidate and pay
out the partners in cash.
o Example: Andrew, Barry and Chris have formed a partnership (ABC) to sell
used casebooks to law students. They have no written partnership agreement
and no agreed term. Andrew decides to accept full time employment as a
casebook editor and talks to the others about resigning. David expresses an
interest in joining the business. After discussions among the four of them, A,
B, C & D agree that David will buy out Andrew’s interest. Andrew starts his
new job and David joins the business. B, C & D continue to sell used
casebooks through a successor partnership (BCD). Andrew’s withdrawal has
dissolved the old ABC partnership, but A, B & C have each agreed not to
compel liquidation.
 Right to Damages and to Continue the Business UPA § 38(2)
o If dissolution in violation of partnership agreement occurs: non-breaching
partner may claim for damages against breaching partners and may continue
the business and possess the partnership property for that purpose
o If business continued, breaching partner entitled to receive value of her
interest less damages but not including good will
 Pav-Saver Corporation v. Vasso Corporation
o Facts: Termination in breach of agreement. The parties agreed to a permanent
partnership, unless the dissolution was mutually agreed upon.  The breaching
party provided patents and trademarks (good-will) to the partnership.  Upon
the breach, the breaching party sought recovery of the intellectual property or,
alternatively, the value of the intellectual property.  The non-breaching parties
sought to continue the business.
o P is not entitled to the patents and trademarks because they are necessary to
continue the business
 The partnership agreement stated that the partnership was for a
permanent length of time; since the machines could not be produced or
marketed w/o P’s patents and trademark, it is essential that the return
of the patents not be honored for the business to continue
o Further, Ps are not entitled to collect for the value of the property.
 The value of the intellectual property is primarily good will, and under
the UPA § 38(2) a party cannot collect for good will.  
 o Dissent argued that the agreement dealt with the rights of use of the patents
and trademarks and the agreement was terminated so the right to use the IP
was also terminated (CW agrees)
Rules for Distribution after Dissolution
 Rules for Distribution – Payment of Liabilities, UPA Section 40(b), RUPA 807
o 1. Payment to creditors other than partners
o 2. Payment to partners other than for capital or profits
o 3. Payment to partners for capital
o 4. Payment to partners for profits
 Rules for Distribution – UPA, Section 40(d)
o Partners must contribute the amount necessary to satisfy the liabilities in
Section 40(b)
 As provided in Section 18(a)
 Rule against extra compensation – Partner not entitled to remuneration for acting in
the partnership business except for surviving partner receiving reasonable
compensation for his services in winding up the partnership, UPA Section 18(f)
 Partnerships establish capital accounts for each partner where the following are
recorded:
o Additions: initial capital contributions and additional capital contributions,
fair market value of contributed assets at time of contribution, profits allocated
to partners from ongoing activities
o Subtractions: interim withdrawals of capital, losses allocated to partners from
ongoing activities
o Post-contribution appreciation or depreciation of contributed asset does not
affect capital accounts.
 In a rightful dissolution, where the partnership is liquidated, the assets are sold.
 Out of the proceeds, partners receive value of their capital accounts after creditors
and partner loans are paid off.
 Profits are what remains and that is divided according to the default rule of equal
sharing or as agreed by the partners.
 In a wrongful dissolution, settling among partners is the same except breaching
partner share is decreased by damages under UPA §38 (2)(a)(II)
 Example
o A&B form partnership
o Agree to share profits equally
o A contributes $10,000
o B contributes value of his legal services in his partnership agreement
o Capital accounts upon formation
 A=$10,000
 B=0
 Kovacik v. Reed
o Facts: two partners in partnership. One contributed money while the other
contributed labor. There was a profit sharing agreement but no agreement on
sharing the losses.
 o Issue: Whether partners who agreed to split profits equally are also equally
responsible for financial losses.
o Holding: P isn’t entitled to any of the losses since the PA didn’t have any
allocation of losses and it’s assumed that the person who contributed money
is responsible for any financial losses. Person providing labor would be
responsible for losses stemming from the labor.
o Default rule is the equal sharing of losses when there’s no explicit agreement
but that rule only applies when the partners contribute any amount of
money.
Buyout Agreements
 Overview
o Allows partner to end his relationship with other partners and receive a cash
payment, or series of payments, or some assets of the firm, in return for his
interest in the firm.
o Common terms in such agreements
 Trigger events—for ex: one partner’s cocaine use in G&S Investments
 Obligation versus option to buy
 Price
 Method of Payment
 Protection against partnership debts
 Procedure for offering to buy or sell
 G&S Investments v. Belman
o Issue: (1) Whether G&S could continue partnership after the death of another
partner. (2) How to compute the value of dead partner’s partnership interest.
o Facts: G&S was majority partner in a LP that was formed to own a big apartment
complex. Nordale was dead partner. He started doing cocaine and stopped
functioning. He lived in the apt complex and his lifestyle raised objections with
other partners. He was also making bad business decisions like wanting to raise
rent. G&S filed judicial dissolution of partnership and buy out Nordale’s interest.
Nordale died after filing of the complaint. G&S then wanted to continue the
partnership and buy out Nordale’s interest. Appellant (on Nordale’s side) argued
that filing of complaint dissolved the partnership.
o Holding: wrongful conduct of Nordale in contravention of PA gave court the
power to dissolve the partnership and allow remaining partners to carry on w/o
Nordale.
Law Firm Dissolution
 Jewel v. Boxer—goes with default rule UPA as to sharing of fees
o Issue: Proper allocation of attorney’s fees from cases that were ongoing at the
time of the law firm’s dissolution.
o Facts: law firm dissolved partnership and formed two new firms from the existing
four partners. Three associates from the old firm went to the new firm of Boxer
and Elkind. Trial court used a math formula to determine the partnership interests
of all of the partners.
o Rule:
  In the absence of a partnership agreement, UPA requires that attorneys
fees received on cases in progress upon dissolution of a law partnership
are to be shared by the former partners according to their right to fees in
the former partnership, regardless of which former partner provides legal
services in the case after dissolution.
 Even though clients have absolute right in choice of their attorney, the fees
should still be split according to preexisting arrangement when the
partnership was active.
 Follow the UPA when there’s no written agreement
o Under the UPA, a dissolved partnership continues until the winding up of existing
business. No partner is entitled to extra compensation for services rendered in
completing unfinished business.
o Policy reasons: don’t want lawyers fighting for the biggest clients and don’t want
partners fighting over files or hiding files, etc.
 Meehan v. Shaughnessy
o Facts: Partnership agreement provided for rights that are different than what the
UPA has as default rules. Any partner could dissolve the firm at any time.
 (1) Agreement provided for an allocation of the firm’s current net income,
and a return of his capital contributions.
 (2) The partner could also take clients that he got in return for a fee given
to the firm.
 (3)Also could get the right to a portion of the firm’s unfinished business,
but gives up right in remaining assets of the firm.
 This was a very fast way of winding up departing partner’s business
o Holding: provision in UPA that governs dissolved firm’s unfinished cases also
applies to cases that didn’t come to the firm through efforts of departing partner.
This is because restrictive covenants between attorneys is not ethical and partners
strongly intended not to allow UPA to govern the firm’s dissolution.
o If any of the partners unfairly remove clients, partner must account for any profits
which flow from such client from a breach of fiduciary duty.
o Meehan and his friend breach fiduciary duty to Parker Coulter. If any clients left,
then they owe the old firm profits in addition to the fair charge in place in the PA.

Corporations
Corporations v. Partnerships
 Corporations
o Required formalities – government requires certain particular findings
o Limited liability – default rule, although the veil may pierced
o Free transferability of interests – shares can be freely bought/sold
o Continuity across management – centralized management; clearly set out board of
directors
o Double taxation – corporate income and capital gains
 Partnerships
o Informal
o Unlimited liability
 o Have interests that are not freely transferrable
o Exist at will (partners deemed to remain together as long as they choose to, but
they can freely leave the partnership when they so choose)
o Equal management rights
o Single taxation
Setting up a Corporation
 (1) Choice of Corporate Form
o Publicly or Privately held
 Choice is often driven by tax considerations
 (2) Choice of State of Incorporation
o Can choose any jurisdiction, even though not the state where business has principal
office
 If incorporated in another state, the business will be subject to an additional tax
burden and will have to qualify to do business in each state where of operation
However, if the business is larger and not localized, and will definitely cross
state lines, then the business will probably have to pay multiple state taxes
anyway, so forum shopping is more important
 Internal affairs of a corporation will be governed by the corporate statutes and
case law of the state in which the corporation is incorporated
 Delaware is the leading state for corporate law
 DE regarded as ‘permissive haven’
 Many important corporate law cases come out of DE. They decide lots
of corporate law cases
 (3) Reserve a Corporate Name (Inc., Corp., etc.)
o Name must be distinctive and indicate corporate status
 (4) Draft and file certificate of incorporation (with secretary of state) - §102
o The certificate of incorporation must be filed with the Division of Corporations of the
Secretary of State’s office - DGCL §101
 The Secretary of State: can reject the certificate based on the name being too
close to another existing corporation or not having appropriate designation in
the name. But as long as the name meets the minimal requirements and states a
lawful purpose the certificate will be accepted.
 Steps in setting up a corporation
o Hold first meeting of directors
 If directors named in certificate of incorporation
 If directors not named, hold meeting of incorporators
 At first meeting of directors, adopt by-laws and take other action
o Issue shares and accept paid in capital
o Take steps to qualify as a foreign corporation in all states where corporation will be
doing business.

o Certificate of Incorporation - DGCL §102

 Mandatory:
 Name (include the words Inc. or Corp)
 Address
 o A registered office is required, but need not be the place of
business - DGCL § 131
 Receives service of process within the state
 The registered agent must be a resident person or
corporation
o New York designates the secretary of state as the corporation’s
agent to receive process
 Business/Purpose (any lawful business)
o Generally, there is no need to limit the purposes of the business
actually contemplated, and an “all purposes” clause assures
flexibility, certainty, and efficiency, as well as conferring wide
discretionary authority on the directors and management as to the
kinds of business operations in which they may engage.
o Dealings that are entirely irrelevant to the purposes are
unauthorized.
o Statutes do not require repeating in the articles of incorporation
the powers that may be enumerated or embodied in the
incorporating statute.
 Capitalization structure (shareholders have identical rights unless
specified)
 Incorporators’ names and addresses
o “Any person may incorporate a corporation” - DGCL §101
 An incorporate can be an insignificant person, but must
meet some minimal requirements.
 This is a purely ministerial position, not involved in
management
 Sometimes a business will be required to have more than
one.
o Signed & dated, pay fees - §103
 Directors names and addresses
o If no directors are named in the certificate, the incorporators shall
manage the business until directors are elected - DGCL §107
 Optional
 Management provisions/provisions limiting powers of corporation,
directors, shareholders, Preemptive shareholder rights, Provisions
changing the voting rules of DGCL, Limit on duration of business,
Exceptions to limited liability of shareholders, Limits on monetary
damages for director breach of fiduciary duty (some fiduciary duties
cannot be eliminated)
o Commencement of Corporate Existence - DGCL § 106
 The corporation shall exist from the date of filing of the certificate of
incorporation until dissolution.
 (5) Hold first meeting of directors to adopt by-laws, issue shares for consideration & take
other action- §107
 (6) Issue shares and accept paid in capital
 o Ownership interests in the company; no minimum capital requirement but must pay
something in
 (7) Qualification as a foreign corporation in all states where doing business
 (8) Capitalization
o The corporation is expected to have some assets
o There should be sufficient capital to pay liabilities
o There is no minimal capital requirement for general corporations under state
incorporation laws.
 However, courts do not look favorably on corporations that have no capital, but
are merely shells set up to protect directors from liability.
 (9) Corporate charter
o Basically, the articles and the laws of the state of incorporation
o The document is for the benefit of the corporation and those who will become
shareholders.
 (10) By-Laws
o By-laws adopted at organization meeting of directors or incorporators - §108
o By-laws may contain provisions on business, conduct of affairs, rights or powers of
shareholders, directors, officers, employees - §109
 The by-laws may be amended by directors until payment of initial capital; after
this, the shareholders must vote to amend (subject to contract)
 Not filed with the Secretary of State
 Cannot be inconsistent with Articles of Incorporation

Promoter’s Liability
 What is a promoter?
o A promoter is a person who identifies a business opportunity and puts together a
deal at the pre-incorporation state, forming a corporation as the vehicle for
investment by other people
o Oftentimes has a financial interest in the business
 Unlike an incorporator who typically does not have a financial interest
 Fiduciary duties
o Problem of self-dealing
o Status akin to join adventurer or partner
o Duties owed among promoters and to corporation to be formed
o Sometimes there is the temptation to engage in “self-dealing”
 Conflict of interest
 My interest as an individual (for my individual well-being)
 Interest of business itself
 If you are in a fiduciary relationship, you must put interests of
business first.
 Self-dealing refers to when a fiduciary puts their individual
interests ahead of the business.
 Liability for Pre-Incorporation Contracts
o If promoter forms corporation at a later date:
 Can the corporation become a party to the K?
  Yes – the pre-incorporation activities of the promoter are meant to
get the corporation going
 Can the promoter avoid liability?
 The promoter will be liable to the contract because they are
holding out for the non-existent principal, unless the other party
lets them out of the contract
 In order for promoter to avoid liability, they must say specifically
in K that they are “signing as a promoter, but not bound by K”
 If the corporation is never formed, or if the promoter forms a different
corporation
 Who is liable? See Southern Gulf on defensive incorporation
Defective Incorporation
 Corporation by Estoppel Doctrine
o The individual/corporation acted as though he was dealing with a corporation
 The individual/corporation would have earned a windfall if allowed to
evade liability based on the absence of incorporation; and
 Unless, per Southern-Gulf Marine, a substantial right of the
person/corporation was affected
o Southern-Gulf Marine Co. No. 9 v. Camcraft, Inc.
 Facts: P entered into contract with D to buy a supply ship from D. P
changed its mind and didn’t incorporate in Texas; instead doing it in the
Cayman Islands. D refused to comply with the contract because P was not
incorporated in Texas like the contract said.
 Rule: One who contracts with what he acknowledges to be and treats
as a corporation, incurring obligations in its favor, is estopped from
denying its corporate existence, particularly when the obligations are
sought to be enforced, unless its substantial legal rights were to be
affected by non-incorporation
 Held: The court applied the above-mentioned doctrine of corporation of
estoppel and found that the D could not escape liability b/c its rights were
not affected by incorporation in the Cayman Isles
 De Facto Corporation Doctrine
o 1. Promoter tried in good faith to incorporate; and
o 2. Had a legal right to do so; and
o 3. Acted as a corporation
Enterprise Liability
 Idea is to treat all corporations as one entity
 All of the corporation’s various assets and subsidiaries would be available to the P
o Ex: Walkovsky
 The assets of all ten corporations owned by Carleton would be available to
satisfy a judgment in favor of Walkovsky
 Courts sometimes invoke this doctrine as a means to find funds for creditors
 The doctrine will be invoked where the owner:
o Does not treat the corporations as separate entities; and
o Does not hold separate meetings for each entity; and
 o Commingles the funds of each corporation
Piercing the Corporate Veil
 Compared to enterprise liability
o The shareholder’s personal assets would be available to the creditor
 Ex: Wakovsky
 Carleton’s personal assets would be available to Walkovsky if he
won
 Test for piercing the corporate veil
o Van Dorn test
 Corporate entity will be disregarded and the veil of limited liability
pierced when two requirements are met:
 1. There must be such unity of interest (alter ego) and ownership
that the separate personalities of the corporation and the individual
(or other corporation) no longer exist
 2. Circumstances must be such that adherence to the fiction of
separate corporate existence would sanction a fraud OR promote
injustice
o (1) Unity of Interest (alter ego)
 Sealand factors – courts consider 4 factors to determine whether a
corporation is controlled by another as to justify disregarding their
separate identities
 1. Failure to maintain corporate formalities
 2. Commingling of funds
 3. Undercapitalization, AND/OR
o As in Dewitt Trucking v. Fleming, shareholder siphoning of
available corporate assets without disclosure to creditors,
such that the corporation is deliberately made insolvent
defeats the creditor’s expectation that business will set
aside adequate reserves to pay corporate obligations when
due and thus, can justify piercing
 4. One corporation/individual treats assets of another as its own
o (2) Fraud or injustice
 Sea-land said that in addition to unity of interest, circumstances must be
such that adherence to the fiction of separate corporate existence would
sanction a fraud or promote injustice, including “some element of
unfairness, something akin to fraud or deception or to the existence of
a compelling public interest in order to disregard the corporate
fiction.”
o Walkovsky v. Carleton
 Facts: P was run over by a taxi that was owned by D and his company.
The company only owned two taxis and had state minimum liability
coverage. All of the cabs in this fleet were owned by corporations and
each corp only owned one or two cabs. Carlton set up and owned at least
ten corporations in an attempt to shield himself from liability.
 Rule
  If the corp was run for purely personal ends and not for the benefit
of the corporation then there would be a basis for piercing the
corporate veil.
 The corporate form can’t be disregarded merely because the assets
of the corp and the corp’s mandatory liability insurance weren’t
enough to cover the judgment against the corp.
 Court isn’t an appropriate place to deal with this; legislature should
o How should P draft his complaint:
 To recover from Carleton individually?
 Pierce the corporate veil
 To recover from assets of other corporations?
 Tell court to disregard the sister corporations and treat all 10 corps
as single entity, all of whose assets in aggregate are available to
tort victim under enterprise liability
o Sea-Land Services, Inc. v. Pepper Source
 Facts: Plaintiff delivered a shipment of peppers for Pepper Source, but
they were not paid. Marchese was the sole shareholder of Pepper Source.
Marchese was also the sole shareholder of several other corporations, and
he was a co-owner of an additional corporation. Plaintiff asserted that the
corporations were shells wherein Marchese shifted money around the
different entities to avoid creditors collecting from the corporations.
Evidence was presented that showed Marchese treated the corporate
accounts as his own personal account, and he frequently shifted money
around.
 Held: P hasn’t introduced evidence of promoting injustice and unsatisfied
judgment isn’t enough
 There was a unity of interest here and alter ego but promoting
injustice section isn’t satisfied
 Rule: common examples of promotion of fraud or injustice
 Allowance of limited liability must promote fraud or injustice.
Some examples the court gave are common sense rules of adverse
possession would be undermined, former partners would be
permitted to skirt the legal rules concerning monetary obligations,
a party would be unjustly enriched, a parent corporation that
caused a sub’s liabilities and its inability to pay for them would
escape those liabilities, or an international scheme to squirrel
assets into a liability-free corporation while heaping liabilities
upon an asset-free corporation would be successful.
 Hypothetical: how should plaintiffs draft their complaint to state a cause
of action against Bristol-Myers Squibb:
 On a piercing theory?
o Mention how much control Bristol Myers had over MEC
and state particular facts that show this.
o Bristol Myers put their branding on the packages, helped
them with the clinical trials
 On a direct liability theory?
  (3) Assumption of risk – permitted by some courts
o Brunswick v. Waxman
 Stands for the proposition that where the creditor knew of the risk of
nonpayment and did not take any steps to mitigate the risk (demanding a
personal guarantee, the creditor assumes the risk and court should not
pierce the corporate veil)
Parent-Subsidiary Piercing
 Generally
o If one corporation owns all the shares of common stock of another corporation,
the first corporation is generally referred to as a “parent” corporation and the
second as a “subsidiary.”
o The parent, like any other shareholder, is not liable for the debts of the subsidiary,
so the parent may be able to undertake an activity without putting at risk its own
assets, beyond those it decides to commit to the subsidiary
o Like an individual shareholder, however, a corporate shareholder must be aware
of the danger that if it is not careful, the creditors of the subsidiary may be able to
pierce the corporate veil of the subsidiary
o The parent must also be careful not to become directly liable by virtue of its
participation in the activities of the subsidiary
 In re Silicone Gel Breast Implants Products Liability Litigation (DE)
o Facts: injured female patients who had breast implants. MEC was a subsidiary of
Bristol-Myers Squibb and manufactured the fake boobs. P is going after parent
corporation but negligence was caused by manufacturer. Bristol Myers basically
maintained complete control over MEC’s business.
o Rule:
 Generally, a parent corporation is expected to exert some control over its
subsidiary. However, when a corporation is so controlled as to be the alter
ego or mere instrumentality of its stockholder, the corporate form may be
disregarded in the interests of justice.
o Substantial Domination Test: The totality of the circumstances must be
evaluated in determining whether a subsidiary may be found to be the alter ego or
mere instrumentality of the parent corporation. A showing “substantial
domination” is required after consideration of the following factors:
 Common directors or officers;
 Common business departments;
 Consolidated financial statements and tax returns;
 Parent finances the subsidiary;
 Parent causes the incorporation of the subsidiary;
 Subsidiary operates with grossly inadequate capital;
 Parent pays the salaries and other expenses of the subsidiary;
 Subsidiary receives no business except that given to it by the parent;
 Parent uses the subsidiary's property as its own;
 Daily operations of the two corporations are not kept separate;
 Subsidiary does not observe the basic corporate formalities, such as
keeping separate books and records and holding shareholder and board
meetings.
  *DE does not require showing of fraud, inequity or injustice
o Alternative Theory of recovery
 Direct liability under a theory of negligent undertaking (RS2Torts §324A)
 One who undertakes, gratuitously or for consideration, to render
services to another which he should recognize as necessary for the
protection of a third person or his things, is subject to liability to
the third person for physical harm resulting from his failure to
exercise reasonable care to [perform] his undertakings, if:
o (a) His failure to exercise reasonable care increases the risk
of harm, or
o (b) He has undertaken to perform a duty owed by the other
to the third person, or
o (c) The harm is suffered because of a reliance of the other
or the third person upon the undertaking.
 There, Bristol held itself out on packaging and marketing and had
potential liability under this theory.
o Hypothetical: how should plaintiffs draft their complaint to state a cause of action
against Bristol-Myers Squibb:
 On a piercing theory?
 Mention how much control Bristol Myers had over MEC and state
particular facts that show this.
 Bristol Myers put their branding on the packages, helped them
with the clinical trials
 On a direct liability theory?
Shareholder Derivative Litigation
 Generally
o A derivative action allows a stockholder to step into the corporation’s shoes and
to seek restitution for wrongs committed by the corporation’s managers and
directors.
 Derivative v. Direct lawsuits
o Direct lawsuits
 A stockholder suit in his or her personal capacity to enforce rights as a
shareholder
 Ex: denial or dilution of voting rights, compel payments of
dividends declared but not distributed; compel inspection of
corporate books and records, require holding of a shareholder
meeting
o Derivative lawsuits
 A Stockholder sues on behalf of the corporation to enforce the rights of
the corporation
 Recovery goes to corporation
 Involve allegations of mismanagement, waste, fraud by corporate officers
and directors
 Attorneys fees
o If derivative suit is successful, the corp will pay the P’s expenses and fees
 o Some state statutes mandate fee shifting to the P if the derivative suit was brought
without reasonable cause or for an improper purpose
 Class actions
o Shareholder sues in his own capacity as well as on behalf of other similarly
situated stockholders
o A group of stockholders assert their individual direct claims through a
representative
o Special procedural rules apply to class actions, such as the P being a
representative of other stockholders’ interests, and any settlement must be
approved by court
o Some derivative suit procedural hurdles (like demand) may not apply to class
actions but other procedural hurdles may apply (like giving notice to class
members)
 Strike suits
o Lawsuit brought by a single person or group of people with the purpose of gaining
a private settlement before going to court that would be less than the D’s legal
costs. Most common when D is a large corporation.
o Cohen v. Beneficial Industrial Loan Corp
 Facts: NJ statute stated that in derivative actions, persons holding less than
5% or $50,000 in value must give security for reasonable expenses,
including attorneys’ fees. P, small investors, challenged the
constitutionality of the statute
 Held: It cannot seriously be said that a state makes such unreasonable use
of its power as to violate the Constitution when it provides liability and
security for payment of reasonable expenses if a litigation is adjudged to
be unsustainable
 Representative v. Derivative Actions
o Eisenberg v. Flying Tiger Line, Inc.
 Flying Tiger Line went through several reorganizations and a merger.
Flying Tiger Line sets up Flying Tiger Corp and two levels down, FTL Air
Freight Corp. Merger is between Flying Tiger Line and FTL. Air Freight
Corp adopted the name Flying Tiger Line, Inc. Eisenberg used to be a
shareholder of Flying Tiger Line and is now a shareholder of the
company’s holding company. Eisenberg sued to stop the company’s
reorganization – claiming that the reorganization has deprived him of his
right to vote on the operating company’s affairs.
 Holding: claim was personal because he was harmed in his voting rights.
 Rule: If the gravamen of the complaint is injury to the corporation the
suit is derivative, but “if the injury is one to the P as a stockholder
and to him individually and not to the corporation,” the suit is
individual in nature and may take the form of a representative class
action.
Business Judgment Rule
 Delaware General Corporation Law §141(a) – The business and affairs of the
corporation shall be managed by or under the direction of the board of directors
  Rebuttable presumption that directors and officers carry out their functions in good
faith, after sufficient investigation and for valid business reasons
 Applies in wrongful refusal cases where demand is required which makes it very
difficult for anybody who pleads wrongful refusal to succeed.
Requirement of Demand on the Directors
 As a general rule, a stockholder cannot be permitted to invade the discretionary field
committed to the judgment of the directors and sue in the corporation’s behalf when the
managing body refuses.
o A demand, when required and refused (if not wrongful), terminates a
stockholder’s legal ability to initiate a derivative action (See Grimes)
o Where demand is properly excused, the stockholder does possess the ability to
initiate the action on his corporation’s behalf.
 Even when demand is excusable, circumstances may arise when
continuation of the litigation would not be in the corporation’s best
interest.
o Rationale of Demand Requirement:
 Allow dispute to be resolved by corporation outside of ct., allow the
corporation to proceed if it is beneficial, if wrongful refusal, then the
shareholder can control proceedings, protect boards from harassment and
prevent strike suits.
 Grimes v. Donald
o Facts: The CEO’s employment agreement included a large severance package. P
filed an action against the Board and against Donald (the CEO) to invalidate his
employment agreement with the Board. The agreement was very generous to the
CEO and P argued that the Board was giving up its management capacity to the
CEO. P demanded that the Board invalidate the agreement and that was denied.
o Issue: whether P’s pre-suit demand that the Board invalidate the agreement
waives his right to contest the Board’s independence
o Holding: P waived his right to contest because he made a pre-suit demand.
 A pre-suit demand is a tool to avoid further litigation, but it would not
serve that function effectively if P was allowed to bifurcate his claims and
claim the demand was excused for one set of claims.
 Since Grimes made a demand, there’s no way that the demand
requirement can be excused, and accordingly, the business judgment rule
protects the corporation’s decision to not proceed with litigation and this
claim is dismissed.
 P didn’t fulfill the wrongful refusal standard because he didn’t plead his
argument with particularity
 Abdication of Directorial Authority Claim (direct claim)
 Directors may not delegate duties which lie “at the heart of the
management of the corporation.” A court “cannot give legal sanction to
agreements which have the effect of removing from directors in a very
substantial way their duty to use their own best judgment on
management matters.”
 o If a contract could have the practical effect of preventing a board
from exercising its duties, it would amount to a de
facto abdication of directorial authority.
o However, business decisions are not an abdication of directorial
authority merely because they limit a board’s freedom of future
action.
 If an independent and informed board, acting in good
faith, determines that the services of a particular
individual warrant large amounts of money, the board has
made a business judgment.
 That judgment normally receives the protection of the
business judgment rule unless the facts show such
amounts, compared with the services to be received in
exchange, constitute waste or could not otherwise be the
product of a valid exercise of business judgment
 Demand Requirement: A stockholder filing a derivative suit must allege either
(1) the board rejected his pre-suit demand that the board assert the corporation’s
claim OR (2) allege with particularity why he was justified in not having made
the effort to obtain board action.
 *Demand is always required in derivative suits unless you can show that
demand would be futile
o *Particularity is a tough standard because there is no discovery
o *Better to argue demand futility first, and then make demand and
argue wrongful refusal
 No Excusal After Demand
o By making a demand, a stockholder waives his right to claim
excusal and contest the independence of the board (see below for
rationale)
 When a stockholder demands the board of directors take
action on a claim allegedly belonging to the corporation
and demand is refused, the stockholder may not thereafter
assert that demand is excused w/ respect to other legal
theories in support of the same claim but the stockholder
still has the right to claim wrongful refusal.
 Wrongful Refusal (DE)
o If demand is made and rejected, the board rejecting the demand
is entitled to the presumption of the business judgment rule. To
overcome the business judgment rule, the plaintiff must allege
facts with particularity that create a reasonable doubt that the
board acted independently or with due care in responding to the
demand
 If successful, the stockholder then has the right to bring
the underlying action with the same standing, which the
stockholder would have had, ex ante, if demand had been
excused as futile.
 *Very difficult burden to meet
  Demand Futility/Excusal (DE)
o One ground for alleging that a demand would be futile is that a
“reasonable doubt” exists that the board is capable of making an
independent decision to assert the claim if demand were made. A
basis for demand excusal is either:
 (1) Majority of the board has a material, financial, or
familial interest
 (2) A majority of the board is incapable of acting
independently for some other reason such as ‘domination
or control’ (structural bias)
 (3) The underlying transaction is not the product of a
valid exercise of business judgment
 Universal demand requirement (present in some states)
o Marx v. Akers
 In NY, a demand would be futile if a complaint alleges with particularity that:
 1. A majority of the directors are interested in the transaction, OR
o Self-interest in the transaction at issue or a loss of independence
because a director with no direct interest in a transaction is
“controlled” by a self-interested director or breaches their duty of
care (Barr)
 2. The directors failed to inform themselves to a degree reasonably
necessary about the transaction
 3. The directors failed to exercise their business judgment in approving
the transaction
o The challenged transaction is so egregious on its face that it
could not have been the product of sound business judgment of
the directors
 Excessiveness of Director Compensation Claims
 A complaint challenging the excessiveness of director compensation
must—to survive a dismissal motion—allege compensation reates
excessive on their face or other facts which call into question whether
the compensation was fair to the corporation when approved, the good
faith of the directors setting those rates, or that the decision to set the
compensation could not have been a product of a valid business
judgment.
Special Litigation Committees
 Board Committees—Permitted under DGCL §141(c)(2)
o Board may designate 1 or more committees, each consisting of 1 or more
directors
o Board committee may exercise all the powers and authority of the full board
 Business Judgment Rule – DGCL §141(a)
o The business and affairs of the corporation shall be managed by or under the
direction of the Board
 o Establishes a rebuttable presumption that directors and officers carry out their
frustrations in good faith, after sufficient investigation and for valid business
reasons
 Zapata Corp v. Maldonado (DE)
o Facts: Plaintiff-shareholder filed a derivative suit alleging breach of fiduciary duty
against the Board and the Board created an independent investigation committee
composed of the two new directors on the Board. The shareholder did not
demand, instead arguing that the demand would be futile. The committee
concluded that the suit should be dismissed.
o Held: a demand, when required and refused, terminates a shareholder’s legal
ability to initiate a derivative suit unless it’s wrongful. However, where demand is
properly excused (where bringing it would’ve been futile), the shareholder does
possess the ability to initiate the claim
 A shareholder, once demand is made and refused, does NOT possesses an
independent and individual right to continue a derivative suit for breaches
of fiduciary duty over objection by the corporation
o Two-prong test
 1. Court should inquire into the independence and good faith of the cmte
and the bases supporting its conclusions
 Corp should have the burden of proving independence, good faith,
and a reasonable investigation, rather than presuming them.
 Court shall deny the motion if it’s not satisfied with independence
of the cmte or reasonable bases for its conclusions.
 2. Court should determine, applying its own business judgment, whether
the motion should be granted
 In re Oracle Corp. Derivative Litigation
o Facts: Insider trading case involving four high-ranking officers at Oracle,
including the CEO. Plaintiffs filed derivative suit against Oracle. Corporation
formed a Special Litigation Committee (SLC) to investigate and determine
whether Oracle should press claims raised by plaintiffs, settle the case, or
terminate it.
 The SLC was comprised of two Stanford University professors who were
also Board members.
 SLC concluded that the defendants did not inside stoc information.
o Issue was whether the SLC was independent (1st prong of Zapata court’s test)
o Test: question of independence turns on wehtehr a directors is, for any substantial
reason, incapcable of making a decision with only the best interests of the
corporation in mind. Court should ultimately focus on impartiality and objectivity.
o Held: SLC didn’t meet its burden to demonstrate the absence of a material dispute
of fact about tis independence.
o In Beam ex rel. Martha Stewart Living Omnimedia v. Stewart
 A director is deemed independent of alleged wrongdoers when he’s unable
to consider demand due to a relationship of a bias-producing nature.
Allegations of mere personal friendship or a mere outside business
relationship, standing alone, are insufficient to raise a reasonable doubt
about a director’s independence.
Role and Purposes of the Corporation
 Corporate Powers and Ultra Vires Acts
o Purposes of the Business – DGCL §102(a)(3)
 Certificate of incorporation shall set forth the nature of the business or
purposes to be conducted or promoted
 May simply say “any lawful act or activity”
 May contain restrictions
o Effect of Lack of Corporate Capacity – DGCL §124
 No conveyance of real or personal property by a corporation shall be
invalid b/c it is ultra vires (outside legal authority). However, such lack of
capacity or power may be asserted in the following ways:
 A shareholder suit to enjoin corporation from entering into such act
or transfer of property
 A corporate suit against directors and officers
 A suit by state attorney general
 Charitable Donations
o Every corporation shall have the power to…sue and be sued…acquire real or
personal property and dispose of same, …conduct its business within or without
this state,…appoint officers,…wind up and dissolve,…make donations for the
public welfare or for charitable, scientific, or educational purposes,…make
contracts and borrow/lend money,…pay pensions,…buy insurance for its benefit
on life of directors, officers, employees, or any shareholder
 Take-away: §1222 authorizes charitable donations that serve the basic
purpose of business corporations, which is to maximize profit
 Smith v. Barlow (NJ)
o Facts: Plaintiff-company made values, fire hydrants, and other equipment for the
water and gas industries. Corporation decided to donate $1500 to Princeton
University
o Held: Public policy supports statute that allows corporations to donate
money to charity. This is within corporation’s implied and incidental powers.
 Donation to charity is within corporation’s powers.
 BJR leads courts to be extremely tolerant when deciding whether a
donation is within a corporation’s power.
 Must promote the corporate objective
 Factors
 higher learning education place, modest amount, and it being well
within the limitations imposed by the statutory requirements, and it
was voluntarily made in the reasonable belief that it would aid the
public welfare and advance the interests of the plaintiff as a private
corporation and as part of the community in which it operates.
 Limitations into corporate giving
o Gift must be reasonable amount
o Gift must be to a bona fide charity
o Gift must tie into corporate purpose (Smith v. Barlow)
  Need some kind of intangible benefit to the corporation; namely
maximizing shareholder value; good will; donating to eventually get
future supply of labor
 Contract – Other jurisdictions do not consider corporate benefit
o California Corp Code §207(3): power to make donations regardless of specific
corporate benefit for the public welfare, or for community fund, hospital,
charitable, educational, scientific, civic or similar purposes
o NY §202(a)(12): make donations irrespective of corporate benefit for the public
welfare or for community fund, hospital, charitable, educational, scientific, civic
or similar purposes, and in time of war or other national emergency in aid thereof.
o PA §102(d): [very permissive stattue to account for the local community]
directors may in considering the best interests of the corporation consider the
effects of their actions on any and all groups affected by such actions, including
shareholders, employees, suppliers, customers, creditors of the corporation, and
upon communities in which offices/establishments of the corporation are located
Corporate Philanthropic Decision-Making
 Dodge v. Ford Motor Co.
o Facts: Defendant had record profits and has been sending out special dividends in
addition to the regular ones. Henry Ford of Defendant decided to get rid of the
special dividends. Dodge brothers, minority investors in defendant, sued this
cause they wanted their money.
o Held: Ford’s actions that keep so much money in the corporation for expansion
and security were to benefit the public generally and spread the profits out by
creating more jobs, but this is too far from the purpose of the corporation which
is to benefit the shareholders. This also amounted to a change in the ends of the
corporation and wasn’t a purpose contemplated or allowed by the corporate
charter.
o Rule: It is not within the lawful powers of a board of directors to shape and
conduct the affairs of a corporation for the merely incidental benefit of
shareholders and primary purpose of benefiting others
 DGCL §170(a): Directors may declare and pay dividends out of surplus or net profits,
subject to restrictions in certificate of incorporation
Exceptions to Business Judgment Rule
 Schlensky v. Wrigley
o Facts: P is minority shareholder in the ownership of the Chicago Cubs. Although
many other teams had started to play night games in an effort to boost attendance,
the Cubs refused to. P sued, claiming that this hurt the corporation (and by
extension him)
o Held: court shouldn’t interfere since the corporation’s actions don’t border on any
of the three elements of derivative action – fraud, illegality or conflict of interest
in making a decision
 P also had a hard time showing there was actual damage to the corporation
o

Limited Liability Companies

Overview
 LLC’s are a hybrid form of business organization which combine limited liability
(corporation) and flow-through tax treatment (like partnerships)
o ULLCA provides rules for structure, governance, and operation
o ULLCA §201: LLC is a legal entity distinct from its members
 Corporate Characteristics
o 1. Limited Liability
o 2. Free transferability
o 3. Continuity of life
o 4. Centralized management (vs. member management)
o 5. LLC is a legal entity distinct from its members. ULLCA §201
o 6. Formation is through filing documents with the SoS office; partnerships are
formed informally
 Tax treatment
o Whereas corporations pay tax on its profits as earned and then again when profits
are distributed to shareholders, LLC members are taxed on the profits only once
as they’re earned—like partners.
o Flow-through taxation: investors can take account, on their individual tax returns,
of any losses of the LLC as those losses are incurred.
 LLP Distinguished
o Same type of formation where you file with the SoS
o Most LLP statutes provide limited liability only for partnership debts arising from
negligence and similar misconduct (but not for misconduct for which the taxpayer
is directly responsible), not for contractual obligations, although a few provide for
both contract and tort liabilities
LLC Formation
 (1) Filing of Articles of Organization with state
o One or more persons (“organizers”) may form LLC, consisting of one or more
members, by filing articles with secretary of state - ULLCA §202
o An LLC comes into existence when articles filed with secretary of state
 Contents of Articles of Organization - ULLCA §203
 Name of company, Address, Name and address of agent for service of
process, Name and address of organizer, Term, if there is one, Whether
manager managed and name and address of managers, Liability of
members for debts and obligations, if applicable
 Amendments of Articles - ULLCA §204
 Must be filed with the state
o Note: Analogous to filing a certificate of incorporation
 (2) Execution by members of Operating Agreement
o Not filed with state and not publicly available
o Often cover topics such as membership, governance, finance, dissolution
o Flexible structure can be used to revise default rules subject to limits spelled out in
ULLCA §103 (Elf)
o Note: Analogous to corporate by-laws
The Impact of Filing Articles of Organization
  Water, Waste & Land, Inc. d/b/a Westec v. Lanham
o Facts: P performed some construction work for D. D never notified P that it was
acting on behalf of an agent, P.I.I., an LLC. The only reference PII made available
was the initials on a business card. D couldn’t pay for the work. D asserted that they
weren’t liable because they’re acting on behalf of an LLC.
o Held: The LLC statutes notice provision was not intended to alter the partially
disclosed principal doctrine in agency law. When a third party sues a manager or
member of an LLC under an agency theory, the principles of agency apply
notwithstanding the LLC’s acts statutory provisions.
o Rule: Creditors have no affirmative duty to find out what type of a business entity
you are. In order to gain the protection that comes with being an LLC member, you
have to disclose the nature of your business clearly as a limited liability company.
This is true even though the LLC Act states that the filing of LLC paperwork is
sufficient notice that an LLC existed.
o Correct Interpretation of the LLC Act
 Once the LLC’s name is known to the third party, constructive notice of the
company’s limited liability status has been given, as well as the fact that
members will not be liable simply due to their status as managers or members
The Operating Agreement
 Effect of Operating Agreement; Nonwaivable Provisions - ULLCA §103
o (a): Members of an LLC may enter into an operating agreement to regulate the
conduct of the business and relations among members, managers, and the
company [freedom of contract]
o (b): The operating agreement may not:
 (1) Unreasonably restrict a right to information or access to records
 (2) Eliminate the duty of loyalty, but may:
 Identify specific types of activities that do not violate the duty
of loyalty (so long as not “manifestly unreasonable”)
 Specify the number of members that may authorize a specific
act that would otherwise violate the duty of loyalty
 (3) Unreasonably reduce the duty of care
 (4) Eliminate the obligation of good faith and fair dealing, but the
agreement may determine the standards by which the performance of
the obligation is to be measured (so long as not “manifestly
unreasonable”)
 (5) Vary the rights to expel a member in an event specified in § 601(6)
(relating to wrongful conduct of a member)
 (6) Vary the requirement to wind up the LLC’s business in a case specified
in § 801(a)(3) or (4) (relating to illegal and unreasonably activities)
 (7) Restrict the rights of any unaffiliated person.
 Elf v. Jaffari
 Facts: Operating Agreement contained forum selection clause and arbitration clause,
which isn’t prohibited by LLC Act.
 Issue: can you contract around and waive provisions of the statute?
 Rule: The operating agreement will only be invalidated where the operating
agreement is inconsistent with mandatory statutory provisions. Policy of DE law
 is to give maximum effect to the principle of freedom of contract and
enforceability of LLC agreements.
Piercing the LLC Veil
 Liability of Members and Managers - ULLCA §303
o Debts, obligations, liabilities of LLC belong solely to the company
o Members or managers are not personally liable for debts, obligations and liabilities of
LLC, whether arising in contract, tort or otherwise
 *Failure to observe formalities or requirements for exercise of powers or
management are not a ground for imposing personal liability
 *Members can become liable for debts etc. if they so consent in writing and
include a provision in articles
 Kaycee Land and Livestock v. Flahive
o Held: Court found no reason to treat corporations and LLCs any differently.
However, factors which justify piercing the LLC veil would not be identical to the
corporate situation since the structure of the two organizations are different.
 Says that piercing the LLC veil is among one of the equitable powers of
the court
 D argues for legislative intent
 Piercing is an equitable doctrine. Some states have codified it (allowed
piercing in the statute). The fact that it is not in the LLC statute does not
mean court cannot find equitable/fairness ruling.
 Court says piercing is possible
o The two-prong test above, from Sea Land – would have to be modified in order to
work for LLCs—some of the factors would no longer be relevant, such as the
formalities requirement.
 Differences between Corporation and LLC tests-
 Alter ego- absence of formalities factor does not apply.
o Some formalities won’t apply since LLC’s have flexible
management.
o Still Apply - Commingling of assets, separate bank
accounts, and undercapitalization
o Fraud prong of test- still probably applicable under
alter ego- absence of formalities
 * MN applies same corporate piercing test to LLC’s laid out in
Victoria Elevator
 *Third prong about assumption of risk in contract cases may apply
in some jurisdictions
Fiduciary Obligations
 Management of LLC - ULLCA §404
o Member managed: Members have equal rights in the management: majority voting
for business decisions.
o Manager managed: Managers have equal rights in management; majority voting by
managers for business decisions.
 Managers must be designated, removed, replaced by a majority of members.
o Consent of all members is required for certain important events: see 404(c) for list
 General Standards of Member’s Conduct - ULLCA §409(a)-(g)
o (a) The only fiduciary duties a member owes to a member-managed company and its
other members are the duty of loyalty and the duty of care imposed by (b) and (c).
o (b) A member’s duty of loyalty to a member-managed company and its other
members is limited to:
 (1) Accounting for profit from use of the LLC’s property and appropriation of
corporate opportunity
 (2) Refrain from acting adversely to the LLC’s interests;
 (3) Refrain from competing with the company in the conduct of its business
before dissolution
o (c) A member’s duty of care to a member-managed company and its other members
is limited to:
 (1) Refraining from engaging in grossly negligent or reckless conduct,
 (2) Refraining from intentional misconduct;
 (3) Refraining from a knowing violation of law.
o (d) A member shall discharge his duties consistently with the obligation of good
faith and fair dealing.
o (e) A member does not violate a duty or obligation under this Act merely because the
member’s conduct furthers his or her own interest.
o (f) A member may lend money to and transact business with the company.
o (g) This section applies to a person winding up the LLC’s business as the personal or
legal representative as if he or she were a member.
 General Standards of Conduct in a Manager-Managed LLC - ULLCA §409(h)
o (1) A member who is not also a manager owes no duties to the LLC or to the other
members
o (2) A manager is held to the same standards of conduct prescribed for members
in (b)-(f) above
o (3) A member who, per the operating agreement, exercises some or all of the manager
rights will be held to the same standards of conduct prescribed in (b)-(f) above.
o (4) A manager is relieved of liability imposed by law for violation of the above
standards to the extent of the managerial authority delegated to the members by the
operating agreement.
 McConnell v. Hunt Sports
o Facts: The parties created a member-managed LLC to purchase an NHL team. The
operating agreement specifically allowed competition with the company by its
members. After a dispute concerning the arena lease, McConnell created a new group
that accepted the lease agreement, and he was subsequently awarded the team.
o Fiduciary Relationship: An LLC involves a fiduciary relationship. Normally, the
presence of such a relationship would preclude direct competition between members
of the company.
 However, the operating agreement of a LLC may, in essence, limit or define
the scope of the fiduciary duties imposed upon its members by changing the
default rules.
 o Tortious Interference: The tort of interference with a business relationship occurs
when a person, without a privilege to do so, induces or otherwise purposely causes a
third person not to enter into or continue a business relationship with another.
o Held: McConnell did not breach his fiduciary relationship, nor did he tortuously
interfere.
 Authority to Bind the Business
o Agency of Members and Managers - ULLCA §301
 In a Member-managed LLC:
 Each Member is an AGENT of LLC for purpose of its business and
acts of Members for apparently carrying on ordinary business of LLC
binds the company, unless there was no authority and 3P knew
 Acts not for apparently carrying on ordinary business binds only if
authorized by the other members
 In a Manager Managed LLC:
 A Member is not an agent solely by reason of being a Member
 Each manager is an agent and binds the company if apparently
carrying on ordinary business of LLC, unless the manager had no
authority to act on that matter and 3P had notice of that fact
 Act of a manager not for apparently carrying on ordinary business binds
company only if authorized as required by ULLCA §404
Dissolution
 Events of Dissolution - ULLCA §801
o (a) An LLC is dissolved, and must be wound up, upon the occurrence of any of the
following:
 (1) An event specified in the operating agreement;
 (2) Consent by the number and percentage of members specified in the
operating agreement;
 (3) An event that makes it unlawful for all or substantially all of the business to
be continued, but any cure of illegality within 90 days after notice will not cause
dissolution;
 (4) On application by a member or a dissociated member, upon entry of a
judicial decree:
 (i) The economic purpose of the LLC is likely to be unreasonably
frustrated;
 (ii) Another member has engaged in conduct making it not reasonably
practicable to carry on with that member;
 (iii) It is not otherwise reasonably practicable to carry on in conformity
with the articles of organization and operating agreement;
 (iv) The company failed to purchase the petitioner’s distributional
interest as required by § 701;
 (v) The managers or members in control have acted or will act in a
manner that is illegal/oppressive/fraudulent/unfairly prejudicial, etc.
 (5) On application by a transferee of a member’s interest, upon entry of a
judicial decree that it is equitable to wind up the company’s business:
  (i) After the expiration of a specified term, if the company was for a
specified term at the time the applicant became a transferee by member
dissociation, transfer, or entry of a charging order that gave rise to the
transfer; or
 (ii) At any time, if the company was at will at the time the applicant
became a transferee by member dissociation, transfer, or entry of a
charging order that gave rise to the transfer.
 Winding up After Dissolution - ULLCA §802
o (a) Subject to (b), an LLC continues after dissolution only for the purposes of
winding up its business.
o (b) At any time after dissolution and before the winding up is completed, a member
(including a dissociated member who caused the dissolution) may unanimously waive
the right to have the LLC wound up and the company terminated.  In that case:
 (1) The LLC resumes carrying on its business as if dissolution had never
occurred and any liability incurred by the LLC or a member after dissolution
and before the waiver is determined as if the dissolution had never occurred;
and
 (2) The rights of third parties accruing under § 804(a) or arising out of conduct
in reliance on the dissolution before the third party knew or received a
notification of the waiver are not adversely affected.
 Filing of Articles of Termination - ULLCA §805
o (a) At any time after dissolution and winding up, an LLC may terminate its existence
by filing articles of termination stating:
 (1) Name,
 (2) Date of dissolution,
 (3) That the company’s business has been wound up and the legal existence
terminated
o (b) The existence of an LLC is terminated upon filing, or upon a later effective date,
if specified in the filing
 Creditors MUST be Paid!! (including members) - ULLCA §806
o (a) In winding up an LLC, the assets of the company must be applied to discharge its
obligations to creditors (including members who are creditors).  Any surplus after
creditors are paid must be paid to the members in accordance with their distribution
rights, pursuant to (b) below.
o (b) Each member is entitled to a distribution consisting of a return of all
contributions, which have not previously been returned and a distribution of any
remainder in equal shares.
 Known Claims Against Dissolved LLC - ULLCA §807
o (a) Dissolved LLC may dispose of known claims in the following way:
o (b) Notify its known claimants in writing of dissolution.  Notice must:
 (1) Specify the information required to be included in claim;
 (2) Provide mailing address where claims should be sent;
 (3) State the deadline for receipt of claim (Not less than 120 days after receipt of
notice); and
 (4) State that claim will be barred if not received by deadline
 o (c) A claim against a dissolved LLC is barred if the requirements of (b) are met, and;
 (1) The claim is not received by the specified deadline; or
 (2) The dissolved LLC rejects the timely received claim and the claimant does
not initiate proceeding to enforce the claim within 90 days after the receipt of
the notice of rejection.
 Other Claims Against Dissolved LLC - ULLCA §808
o (a) A dissolved LLC may publish notice of its dissolution and request that creditors
present claims in accordance with the notice.
o (b) Notice Must:
 (1) Be published in a paper in the county of PPB,
 (2) Describe the information required from creditors in their claims,
 (3) State that a claim is barred unless a proceeding to enforce the claim is
initiated within 5 years of publication of notice.
o (c) The following claimants are barred unless they commence their claim within 5
years of publication of notice:
 (1) A claimant who did not receive written notice under 807,
 (2) A claimant whose claim was timely sent to the dissolved company but not
acted on; and,
 (3) Claimant whose claim is contingent or based on an event occurring after the
date of dissolution.
o (d) A claim not barred under this section may be enforced:
 (1) Against the dissolved LLC to the extent of its undistributed assets; or
 (2) If the assets have been distributed in liquidation, against a member of the
dissolved company to the extent of the member’s proportionate share of the
claim or the company’s assets distributed to the member in liquidation,
whichever is less.  A member’s total liability for all claims under this section
may not exceed the total amount of assets distributed to the member.
 Creditors Must be Paid First
o New Horizons v. Haack
 Facts: Haack defaulted on a debt owed to plaintiff. Haack did not file articles of
dissolution, nor did she notify creditors of the termination of business when it
ceased. She distributed the company assets.
 Held: Regarding the piercing theory, electing partnership tax treatment does not
preclude the creation of an LLC. Thus, the TC improperly pierced the LLC veil.
 However, the Ct. held that Haack was personally liable because Haack
did not properly dissolve.
 Rule: Although filing articles of dissolution is optional, the order of distribution
of the company’s assets following dissolution is fixed by statute, and the
company’s creditors enjoy first priority.
 A dissolved LLC may dispose of known claims against it by filing
articles of dissolution, and then providing written notice to its known
creditors containing information regarding the filing of claims.
 The rule says that if assets are distributed in liquidation, members are
liable up to the lesser of the member’s proportional share of the claim
OR the company’s assets distributed to the member in liquidation.
 Duty of Officers, Directors, and Other Insiders

Management by Board of Directors

 DGCL §141(a) - BOARD AUTHORITY
o Business and affairs of corporation shall be managed by or under the direction of
a board of directors
 DGCL §141(b) – BOARD COMPOSITION & ACTION
o Composed of one or more members (fixed in bylaws or certificate)
o Majority of total # = QUORUM (can reduce to 1/3 in bylaws unless certificate
provides otherwise)
o VALID BOARD ACTION = vote of a majority of directors present at a meeting
with a quorum present (can require supermajority in certificate or bylaws)
Duty of Care
 Generally
o Two kinds of duty of care
 1. Directorial decisions  must be fully informed
 See Kamin v. Amex and Smith v. Van Gorkom
 2. Oversight of business and duty to monitor
 See Francis v. United Jersey Bank and In re Caremark
o To hold directors liable for violations of the duty of care, the plaintiff must prove
more than just a mistake; there needs to be malfeasance or a similarly qualifying
violation of duty
o Ordinarily, the business judgment rule will protect the decisions of board
members. However, sometimes actions are so egregious that they no longer fall
under the business judgment rule umbrella
Duty of Care: Obligation to Control
 Kamin v. Amex
o Facts: there was a derivative action by two minority shareholders asking the
Board to take back a dividend that it had given to the shareholders. Amex had
acquired some stock of DLJ and lost about $25 million. If Amex were to sell its
shares of DLJ, then it would sustain a capital loss that it could offset taxable
capital gains on other investments. That would save the company about $8
million.
o Rule: courts will not interfere with Board powers unless the acts were
fraudulent or collusive. Mere errors in judgment are not grounds for judicial
interference.
 The directors are entitled to exercise their honest business judgment
on the information before them and to act within their corporate
powers. That they might be mistaken, the other courses of action
might have differing consequences, or their action might benefit some
shareholders more than others presents no basis for judicial
interference, so long as it appears that the Board was acting in good
faith.
  A complaint that alleges merely that some course of action other than that
pursued by the Board would have been more advantageous does not give
rise to a cognizable cause of action
 Courts won’t interfere unless a clear case is made out of fraud,
oppression, arbitrary action, or breach of trust. Simple negligence is not
enough to warrant court intervention.
 Cash out merger
o One type of corporate combination
o Acquiring company pays shareholders of target company the value of their shares
o Target company is merged out of existence and shareholders have no interest in
any company that results from the merger
o Shareholders’ interests are protected by fiduciary duties of directors
 Merger Approval Procedures
o DGCL §251(b) – BOARD APPROVAL
 Board of each merging corporation shall adopt a resolution approving an
agreement of merger and declaring its advisability
o DGCL §251(c) – STOCKHOLDER APPROVAL
 Merger agreement shall be submitted to stockholders for approval
 Majority of shares entitled to vote must approve
 If approved by stockholders, merger agreement (or certificate of merger)
is then filed and becomes effective
 Shareholder Voting
o DGCL §216
 Majority of shares entitled to vote shall constitute a quorum at a
stockholder meeting (can reduce to 1/3 in certificate or bylaws)
 Vote of majority of those present or represented by proxy shall be the act
of the stockholders (except for election of directors)
 Directors elected by plurality
Directors Must be Fully Informed
o Smith v. Van Gorkom
 The Trans Union board of directors approved a merger agreement after 2 hours
of deliberation and based on rough LBO valuations (rather than merger) subject
to a market test period that did not matriculate.
 Rule: There is a presumption that in making a business decision, the directors
acted on an informed basis, in good faith and in the honest belief that the action
taken was in the best interests of the company. Thus, the party attacking a board
decision as uninformed must rebut the presumption that its business judgment
was an informed one. The determination of whether a business judgment is an
informed one turns on whether the directors have informed themselves “prior to
making a business decision, of all material information reasonably available to
them.” The proper standard for determining whether a business judgment
reached by a board of directors was an informed one is one of gross negligence.
 Held: The Ct. held the board breached its duty of care through failure to inform
themselves of all relevant information reasonably available and failure to
disclose all material info that a reasonable stockholder would consider
important in deciding whether to approve the offer.
  Under Van Gorkom, the directors have a duty to be fully informed (i.e.
full deliberation, get a fairness opinion, expert opinion, or a market test
etc.)
 Shareholder Ratification Argument
 While ratification can relieve liability, it did not save that transaction
because the shareholders were not adequately informed about the
transaction.
 DGCL §141(e) Argument: [“in performing their duties, directors may rely in
good faith on the records of the corporation and on information, opinions,
reports, statements presented to the corporation by corporation’s officers or
employees.’]
 However, at a minimum for a report to enjoy the status conferred by
§141(e), it must be pertinent to the subject matter upon which a board is
called to act, and otherwise be entitled to good faith, not blind, reliance.
o IN CONTRAST to Van Gorkam,
 Cinerama Inc. v. Technicolor held that despite the board not meeting its
obligations, the price was fair and dismissed the case. There, the Ct.
distinguished Van Gorkom and then proceeded to discuss various factors that
must be considered in the analysis of the entire fairness of a transaction
including: the timing, initiation, negotiation, and structure of the transaction, the
disclosure to and approval by the directors, and the disclosure to and approval
by the shareholder.
 Take Away: If you can show fairness in the transaction, even if the
process was defective, then the business did not breach its duty of
care.
o Limits on Director Liability
 The Certificate of Incorporation may contain a provision eliminating or limiting
personal liability of director for monetary damages for breach of fiduciary duty
DGCL, §102(b)(7)
 EXCEPTIONS
o Duty of loyalty
o Lack of good faith, intentional misconduct, knowing violation of
law
o Violation of Section 174 on dividends
o Transactions in which director derived improper personal benefit
Lack of Oversight
 Francis v. United Jersey Bank (NJ)
o Facts: Ms. Pritchard was a director but and had no idea what was going on with the
business.
o New Jersey law requires good faith and due care:
o Rule: Directors must discharge their duties in good faith and with that degree of
diligence, care and skill, which ordinarily prudent men would exercise under similar
circumstances in like positions. As a general rule, a director should acquire at least a
rudimentary understanding of the business and cannot set up as a defense lack of
the knowledge needed to exercise the requisite degree of care.
 o Also, directors must stay current with corporate activities:
 Keep informed about the activities of the corporation
 Not shut their eyes to corporate misconduct
 Generally, monitor corporate affairs and policies
 Maintain familiarity w/ the corporation’s financial status by regular review of
financial statements
o Generally, directors may rely upon the opinion of lawyers and accountants, BUT
 Must inquire further if financial statements disclosed problems on their face
 Upon discovery of an illegal course of action, a director has a duty to object
and, if the corporation does not correct the conduct, to resign.
o In many, if not most, instances an objecting director whose dissent is noted would be
absolved after attempting to persuade fellow directors to follow a different course of
action.
 But, if the director’s duty extends beyond the shareholders to third parties due to
holding funds of others in trust, the duties extend beyond mere objection and
resignation to reasonable attempts to prevent the misappropriation of the trust
funds
o Duties to Certain Third Parties
 In general, a director only has a fiduciary duty of care to the corporation and its
stockholders. With certain corporations, however, directors are deemed to owe a
duty to creditors and other third parties even when the corporation is solvent.
 Ex: banking corporations and non-banking corps holding funds of others
in trust
Showing Director Liability
o 1. When a Board decision results in a loss because the decision was negligent
o 2. May arise from unconsidered failure of the Board to act in circumstances which
due attention would have prevented the loss
o 2. “Failure to monitor”
 Graham v. Allis-Chatmers
 “Absent cause for suspicion there is no duty upon the directors to install
and operate a corporate system of espionage to ferret out wrongdoing
which they have no reason to suspect exists.”
 Modern interpretation  Absent grounds to suspect deception, neither
corporate board nor senior officers can be charged with wrongdoing
simply for assuming the integrity of employees and the honesty of their
dealings on the company’s behalf
 Rule 2: In order to show a failure to control the company’s employees, plaintiffs would
have to show
o 1. That directors knew or should have known that violations were occurring
o 2. That directors took no steps in good faith effort to prevent or remedy that situation
o 3. That such failure proximately resulted in these losses
Duty of Loyalty
 Conflict of Interests Transactions: Directors and Managers
o New York Standard -- NYBCL §713
 Covers contracts between:
  (1) Corporation; and (2) Director or corporation in which director has
substantial financial interest or is a director or officer
 No contract involving an interested director (definition) is void or voidable
because the interested director was present or voted in favor of it if:
 (1) There was disclosure and valid board approval without counting vote
of interested director
 (2) There was disclosure and the contract approved by shareholders OR
 (3) *In other cases, there was a showing that the transaction was fair and
reasonable (Bayer)
o DGCL §144(a)
 Interested director/officer transaction not void or voidable if:
 1. Material fact disclosure and disinterested director approval; or
 2. Material fact disclosure and shareholder approval; or
 3. Contract is fair
o Bayer v. Beran (NY) “singer wife case”
 Facts: The president, and director, of a company hired his professional singer
wife to do radio ads and the board justified it as a means of differentiation.
 Holding: there was a legitimate business reason to hire president’s wife and
thus, no conflict of interest.
 The Ct. recognized that the existence of a conflict if interest triggers a standard
of strict scrutiny.
 Rule: The business judgment rule yields to the rule of undivided loyalty.
Interested transactions tend to produce a conflict between self-interest
and fiduciary obligation and are, when challenged, examined with the
most scrupulous care. The burden is on the board of directors not only
to prove the good faith of the transaction but also to show its inherent
fairness from the viewpoint of the corporation and those interested
therein.
o If there is any evidence of improvidence or oppression, any
indication of unfairness or undue advantage, the transactions will
be voided.
 I.e. was the action intended “to subserve some outside
purpose, regardless of the consequences to the company,
and in a manner inconsistent with its interests
o However, if the contract is fair, it is valid even though other
disinterested directors have not formally ratified it.
 *Most cases can be decided under Bayer, but Cts have developed
corporate opportunities doctrine
Corporate Opportunities Doctrine
 Broz v. Cellular Information Systems
o Facts: Broz used a business opportunity for his own corporation instead of for a
company on which he was a director.
o Guth v. Loft Test: Corporate officer or director can’t take business opportunity for
himself if the following apply:
 1. The corporation is financially able to take
  2. Is, from its nature, in the line of the corporation’s business and
 refined in eBay, corp. has fundamental knowledge and practical
experience…
 2a. Is of practical advantage to it,
 3. Is one in which the corporation has an interest or a reasonable
expectancy, and
 4. By taking the opportunity, the self-interest of the officer or director will
be brought into conflict with that of the corporation.
o Guth safe harbor: formal presentation to the board (not your corp’s) and having
that rejected
o Alternatively, if the director or officer believes, based on one of above factors,
that the corporation is not entitled to the opportunity, he may take it for himself.
 In re eBay Shareholders Litigation (DE)
o Facts: The complaint alleged that Goldman bribed the officers and directors, using
the currency of highly profitable investment opportunities (IPOs) that should have
been offered to, or provided for the benefit of, eBay rather than favored insiders.
EBay argued that the IPO allocations were collateral investment opportunities and
not a corporate opportunity in which the corporation had an interest or
expectancy.
o Held: Applying the Guth v. Loft test, the court found that the corporate
opportunity doctrine was violated.
o Rationale: This is different from everyday financial advice from a broker. This is
a commercial rebate that belongs to the company.
 First, eBay was financially able to exploit the opportunities in question.
 Second, eBay was in the business of buying securities (toughest prong: D
argues this is merely incidental)
 Essentially, the evidence was sufficient to state: “investing was a
line of business of eBay.”
 Third, investing was integral to eBay’s cash management strategies and a
significant part of its business.
 Finally, defendant’s argument that IPOs are risky investments is
unavailing, as eBay did not even have the opportunity to turn down the
IPOs.
o *Duty of Loyalty argument is probably available in these cases if there is a
conflict under duty of agents.
Duty of Loyalty: Dominant Shareholders
 Sinclair v. Levien
o Facts: Sinclair was sued under derivative litigation for alleged wrongdoings in
connection with Sinven, of which Sinclair is a majority owner. Sinclair is the
majority shareholder of Sinven. Sinclair owned 97% of Sinven and paid out itself
with dividends and had agreements with Sinven. Sinclair was sued by Sinven
minority shareholders.
o Issue: did Sinclair breach its fiduciary duty to Sinven?
o Holding: When the parent is involved in a deal with its subsidiary, with the parent
controlling the transaction and fixing the terms, and when there is self-dealing, the
test of intrinsic fairness is applied.
 o Intrinsic fairness test: burden is on parent company to prove, subject to careful
judicial scrutiny, that its transactions with Sinven were objectively/intrinsically
fair.
 If there is no self-dealing, then the business judgment rule applies
 Regarding dividends, there was no self-dealing since the minority
shareholders received a proportionate share of the dividends
 Regarding denial of business opportunities, court says that P couldn’t
point out any opportunities which came to Sinven that Sinclair prevented
 Regarding breach of K, Sinclair did breach its agreement with Sinven
when it didn’t buy enough of products and didn’t pay in time
 Note that typically shareholders do not owe fiduciary duties to other shareholders
Shareholder Ratification
 Fliegler v. Lawrence
o Facts: Shareholder derivative action. President of P company acquired potential
mining properties and offered to transfer this land to Agau. Board of Directors of
Agau didn’t think it was a good opportunity and denied the offer. Agau kept an
option to buy the land at a later time. President created USAC to buy the property
and sell stock in USAC and develop the property. Agau later brought the
property. Deal was Agau would transfer 800k of its stock to USAC in exchange
for all of USAC’s stock. Shareholders of Agau brought this derivative action
against Agau for this deal.
 DGCL, §144(a): Interested director/officer transaction not void or voidable if (1)
material fact disclosure and disinterested director approval; or (2) material fact disclosure
and shareholder approval; or (3) contract is fair

Federal Securities Regulation

Securities Laws
 Securities Act of 1933
o Principally concerned with the primary market.
o Two goals: mandating disclosure of material information to investors and prevention
of fraud
 Securities Exchange Act of 1934
o Principally concerned w/ secondary market transactions.
o Requires periodic disclosures by publicly held corporations
o Created the Securities and Exchange Commission as the primary federal agency
charged w/ administering the various securities laws.
 Policy: protection of investors and integrity of markets
 Scope
o Disclosure provisions
o Anti-fraud provisions
o Regulation of markets and market professionals
 SEC
o Executive agency charged with administration & enforcement
 o Delegated authority to make rules and adjudicate matters arising under the statute
o Headquartered in Washington DC with regional offices
 State “Blue Sky” Laws
o Predate federal securities laws
o Must comply with both federal and state law; some overlap between the two
regulatory schemes
What is a Security?
 Statutes
o §2(a)(1) of Securities Act of 1933
 “Security” means, unless the context otherwise requires, any note,
stock, treasury stock, bond, debenture, evidence of indebtedness, …
investment contract…or in general any interest or instrument commonly
known as a security
 The “context” clause serves as an escape hatch: the terms shall be
defined in accordance with the act “unless the context otherwise
requires.”
o Can be used to say: “yes, this looks like a security, but,
given the nature of the transaction, we are going to hold
that it does not come within the Act, and vice-versa.
 Implications of calling an investment opportunity a “security”
 Disclosure and antifraud provisions apply, including 1934 Act
§10(b) and SEC Rule 10b-5
o Section 10(b) of the Securities Exchange Act of 1934:
 “It shall be unlawful for any person..to use or employ, in connection with
the purchase or sale of any security…any manipulative or deceptive
device or contrivance in contravention of [rules and regulations of the
Securities and Exchange Commission”
o Rule 10b-5:
 “It shall be unlawful for any person…(a) to employ any device, scheme or
artifice to defraud, (b) to make any untrue statement of a material fact or
[material omission], or (c) to engage in any act, practice, or course of
business…which operates as a fraud or deceit upon any person”
 Robinson v. Glynn
o Facts: Robinson was investor in GeoPhone and got shafted by Glynn, the owner
in GeoPhone. Robinson agreed to invest on the condition that Glynn succeed in
his field test with the new CAMA technology. Robinson sued for SEC violations
when he learned that Glynn never used the CAMA technology. Robinson must
establish he had stock or investment contract in the company in order to be able to
sue under Rule 10b-5.
o Issue: Was there fraud in connection with purchase of securities?
o Rule:
 “Investment Contract” (Howey test)
 1. Investment of money
 2. In a common enterprise
 3. With the expectation of profits
  4. To come solely from the efforts of others
o investors not required to rely “solely” from others’ efforts
anymore
 Economic Realities Test
 “Question is whether an investor, as a result of the investment
agreement itself or the factual circumstances that surround it, is left
unable to exercise meaningful control over his investment”
o passive  cuts towards there being security
 “Stock” (Landreth test)
 1. Right to receive dividends contingent upon an apportionment of
profits
 2. Negotiability
 3. Ability to be pledged or hypothecated
 4. Conferring of voting rights in proportion to the number of shares
owned
 5. Capacity to appreciate in value
o Holding: Robinson’s membership was neither an investment contract (too active)
nor a stock (no profit sharing and not negotiable)
 Interests in Various Others Business Entities
o LLCs: Particularly difficult to categorize under the Acts because they are hybrid
business entities that combine features of corporations, general partnerships, and
limited partnerships.
 LLCs limit the liability of their members, which may mean that LLC
members are more likely to be passive investors who need the protection
of the Acts.
 On the other hand, LLC members are also able to actively participate in
management without piercing the veil of their liability, which would
suggest that LLC members are more likely than limited partners or
corporate shareholders to be active investors not in need of the Acts.
o Corporation: an ownership interest in a corporation is typically stock
o Closed Corporation: contains a limited number of owners.  Ownership interest
would then be as a stockholder owning shares of stock.
o General Partnership: issue has been actively litigated and none of the specific list
of the definition really fits.  Generally, not investment contracts
 They would need to try to have it qualify as a security under the
investment contract language.  
 However, under that analysis, he would still have problems
because he would control the profit making abilities of the
partnership.
o Limited Partnership: Generally, are investment contracts.
Registration Process
 §5 of Securities Act of 1933
o Unlawful to sell or offer for sale securities in interstate commerce unless
securities are registered with the SEC
 o Issuer must provide disclosure in a prospectus – principal disclosure document
issuers are required by the Securities Act to give to buyers
o Remedy for selling unregistered securities is rescission
 Remedy
o For selling unregistered securities is rescission
 Two exemptions to the registration statement
o 1. Exempt security – never needs to be registered, either when initially sold by the
issuer or in any subsequent transaction
 ex: US government securities
o 2. Exempt transactions – one-time exceptions
 If A sells a non-exempt security to B in an exempt transaction, B is not
automatically free to resell that security. B must either register it or get
another exempt transaction.
 Ex: private placement transactions
 Doran v. Petroleum Management Corp
o Facts: Doran was an investor who was offered, along with five others, a limited
partnership in an oil company. Oil company wells got shut down for a year and
didn’t produce well after they reopened so Doran wanted to leave.
o Ralston Purina test
 Did the offerees need the protection of the registration provisions of
the 1933 Act or were they able to fend for themselves?
 Turns on access to information
o Four factors:
 1. Number of offerees and their relationship to each other and the issuer
 Number of offerees
o Number of offerees and not purchasers
o More offerees means more likely to be public
 Relationship to Issuer
o Focus is on information available to offeree by virtue of
relationship to issuer
o Role of Sophistication: Evidence of a high degree of
business or legal sophistication on the part of all offerees,
though certainly favorable to the defendants, does not
suffice to bring the offering within the private placement
exemption. However, sophistication is not a substitute for
access to the information that registration would disclose.
There must be a sufficient basis of accurate information
upon which the sophisticated investor may exercise his
skills.
o Availability: All offerees, whatever their expertise, must
have ‘available’ the information a registration
statement would have afforded a prospective investor in
a public offering (not independently sufficient [must still
weigh other factors] but it is a necessary condition for the
exemption)
  “Availability” means either disclosure of or
effective access to relevant information.
 2. Number of units offered
 3. Size of the offering
 4. Manner of the offering
o §4(2) and Reg. D Generally Exempt Only the Initial Sale
 If the buyer is not “an issuer, underwriter, or dealer,” he or she will rely on
§ 4(1) (see below).
 But an underwriter is defined to include someone who purchases
“with a view to” reselling.
o If this resale occurs quickly it may trigger the Acts as to the
reseller
o If it occurs quickly and to a large number of people, it may
trigger the Acts as to the reseller and the initial issuer.
 To avoid these resale problems, Reg. D provides that issuers can
protect themselves by using reasonable care, i.e. conducting a
reasonable inquiry into the buyer’s plans, disclose to the buyers
that the stock is unregistered and subject to various resale
restrictions, and print said restrictions on the certificates.
 Rule 144 is another option: subject to qualifications, it permits a
buyer to resell stock they acquire in a Reg. D offering if they hold
it for a year and resell in limited quantities
Fraud in the Registration Statement - §11 of 1933 Act
 §11 of 1933 Act: Fraud in Registration Statement
o Material misstatement or omission in a registration statement is actionable fraud
 1. Person acquiring such security has express private right of action
a.k.a. standing
 2. These people can be sued  Against any person who signed
registration statement, any director, any expert (accountant, engineer,
appraiser, but not lawyer) who prepared or certified part of
registration statement, underwriters
 3. Subject to defenses of loss causation (due to something else going on
like crappy stock market) and due diligence (if people who were charged
with verifying registration statement did due diligence and didn’t discover
fraud)
 Most common defense is statute of limitations
 Remedy = damages
 No reliance necessary by purchaser
 Due Diligence Defense Under §11 of 1933 Act
o Expertised Portion
 Expert: reasonably believes, after reasonable investigation that info is true
 Non-expert: no reason to believe info is false, may rely upon info given to
them by experts
o Non-expertised Portion
 Expert: no liability
  Non-expert: reasonably believes, after reasonable investigation that info is
true. Must do reasonable investigation into the truth of the matter.
o Expertised = audited portion
o Issuer never has due diligence defense. Issuer would be strictly liable if there’s
problem with the registration statement.
 Escott v. BarChris Construction Corp.
o Facts: Prospectus had false information. Overstated income and understated
liabilities to make the security seem more attractive.
o Holding: there were enough material misstatements alleged in complaint that
some of the allegations rise to the level of materiality/gone over the threshold and
we can get into the issue of liability.
o Rule:
 Materiality – limits information required to those matters as to which an
average prudent investor ought reasonably to be informed before
purchasing the security registered  matters such an investor needs to
know before he can make an intelligent, informed decision or not to buy
the security…
 Average prudent investor is not concerned with minor inaccuracies
or with errors as to matters which are of no interest to him.
o Note: lawyers are not experts just b/c they prepared the RS.
o Damages: difference between price buyer paid and price he would have paid if
misstatement had been disclosed.
Insider Trading
 Generally
o §10(b) of 1934 Act & Rule 10b-5 (Texas Gulf Sulfur and O’Hagan)
 Section 10(b): In connection with purchase or sale of securities, using
jurisdictional means, it is unlawful to use or employ manipulative or
deceptive devices in violation of SEC rules
 Rule 10b-5: In connection with purchase or sale of securities, using
jurisdictional means, it is unlawful to employ any device to defraud, to
make material misstatements and omissions, or to engage in any act
operating as a fraud or deceit
 Types of Cases: defective corporate disclosure, insider trading, fraud in
dealings between broker-dealer & their customers
 Implied private right of action that is well-established
 Elements of Private Right of Action:
 material misrepresentation or omission; and
 scienter; and
o knowing state of mind
 reliance; and
 causation; and
 damages
o Rule 14e-3 (deals with tender offer)
o §16(b) Short swing profit rule
 Classical theory
 o SEC v. Texas Gulf Sulphur
 Facts: TGS found a big cache of minerals in Canada. Rumor had broken
out that TGS had found ore and company released a statement quelling
those rumors. TGS released this statement because they didn’t want the
land surrounding the drilling to increase in value (they had The
defendant-insiders bought a ton of stocks when the stock price was still
low).
 Rule: illegal to trade on material, nonpublic information if you’re an
insider
 Abstain or Disclose rule: Insiders (anybody inside company with
access to material info) must disclose nonpublic information to the
investing public or abstain from trading on that info or
recommending the security while the inside information remains
undisclosed.
o Materiality: whether a reasonable investor would attach
importance in determining his choice of action in the
transaction in question
o If speculative information, use probability-magnitude
test for materiality: probability that the event will occur
(TGS will strike ore) against the magnitude of the event of
the event in light of the totality of company information 
applies for both positive and negative impacts
 Defective corporate disclosure
o “in connection with purchase or sale” covers situations
where issuer of securities is not itself trading
o expanded application of 10b-5 and 10(b) to cover
situations where there’s no privity of K between issuer and
public marketplace
 expands applicability of 10(b) and 10b-5 to more
cases
o In re Cady Roberts
 SEC recognized common law duty of corporate insiders (incl. officers,
directors, control SH) to disclose inside information when dealing in
securities.
o Chiarella v. U.S. (SCT 1980)
 Corporate insider must abstain from trading in the shares of his
corporation unless he has first disclosed all material inside information
known to him
 Duty to abstain arises from this relationship of trust between a
corporation’s shareholders and its employees; duty does not arise from
mere possession of material inside information
 Holding: No liability because Chiarella did not have a relationship of
trust with shareholders of company in whose stock he traded
 Tippee Liability
o Dirks v. SEC
 o Facts: Dirks was working for a broker-dealer firm. Corporation (Equity
Funding) had grossly overestimated its earnings. Dirks investigates and tries
to whistle blow. SEC investigates and goes after Dirks. Dirks was not trading
any of the stock. However, he (tippee) told his clients and some of his clients
(sub-tippee) dumped their stock.
o Holding: No 10b-5 violation since there tipper received no financial or
personal benefit for revealing Equity Funding’s practices.
o Rule for TIPPEE Liability
 1. Tipper-insider breached a fiduciary duty by giving info to the tippee
 Mere possession of material, inside info doesn’t give rise to a
duty to disclose
 Existence of breach turns on receipt of direct personal benefit
by tipper-insider
 2. Tippee knew or should have known of the breach
 Tippees liable only when inside info is improperly made
available to them
 Exception: Temporary insider (ex: retained on consulting basis)
 Underwriter, accountant, lawyer, or accountant may become
fiduciaries of shareholders if they have entered into a special,
confidential relationship in the conduct of the business and are
given access to information solely for corporate purposes
 In this case, classic theory of insider trading would apply.
 Misappropriation Theory
o US. v. O’Hagan
 Facts: O’Hagan was partner at firm who represented Grant Met in its
tender offer for Pilsbury. O’Hagan gets information about the tender offer
and trades the Pilsbury stock. O’Hagan makes a bunch of money off these
deals.
 Misappropriation Theory
 A person commits fraud “in connection with” a securities
transaction, and thereby violates §10(b) and Rule 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 undisclosed, self-serving use of a
principal’s information to purchase or sell securities, in breach of
a duty of loyalty and confidentiality, defrauds the principal of
the exclusive use of that information
 Disclosure to source of information forgives breach
 Rationale: protect integrity of markets against abuses by outsiders
who have access to confidential info that will affect a company’s
stock price but who owe no fiduciary duty to corporation’s
shareholders
 Compared to Classical Theory
  Classical theory: targets a corporate insider’s breach of duty to
shareholders with whom the insider transacts
o When a corporate insider trades in the securities of his
corporation on the basis of material, nonpublic information
 Misappropriation theory: outlaws trading on the basis of
nonpublic information by a corporate “outsider” in breach of a
duty owed not a trading party, but to the source of the information.
o Person in connection with securities transaction when he
misappropriates confidential information for securities
trading purposes, in reach of a duty owed to the source of
the information
 Insider Trading Prohibitions on Tender Offers
o §14(e): In connection with a tender offer, it shall be unlawful to make material
misstatements or omission or to engage in fraud, deception or manipulation
o Rule 14e-3(a): If a tender offer has been commenced, it is unlawful to purchase
or sell securities on the basis of material inside information if trader knows info
obtained from offeror, issuer or any officer, director, partner, or employee to
either offeror or issuer
 §16(b) of Securities Exchange Act of 1934
o Short Swing Profits (traditional rule)
 States that beneficial owner, officers, directors, and shareholders that
hold at least 10% of the stock must pay the corporation any profits
they make, within a six-month period, from buying and selling the
firm’s stock.
 Provided that the shareholder holds more than 10% both at the
time of the time of the purchase and sale
 Intended to combat insider trading and used less often and §10 and §14
o Reliance v. Emerson
 Facts: Emerson purchased 13.2% of Dodge stock. Dodge merged into
Reliance Co. Emerson sold its shares in two parts. First, Emerson sold
3.24% to bring it under 10% of total shares held. Second, Emerson sold
its remaining shares (9.96%)
 Holding: Court held that Emerson is liable on the first sale but is not
liable for profits on the second sale even though Reliance argued that this
should be treated as one sale because there is no consideration of intent
here. Reading strictly letter of the law, Emerson is not liable on the
second sale.
 Rule: as long as two sales are not legally tied or conditioned upon each
other, then this should be treated as two sales.
o Hypo
 Bill is chief executive officer of SCLaw, Inc. (SCLI), a chain of
proprietary law schools in southern California. SCLI stock is registered
under the 1934 Act, and 1,000,000 shares are outstanding. On January 1,
Bill purchased 200,000 shares of SCLI common stock for $10 per share.
Determine his liability, if any, under § 16(b):
 If he sells all 200,000 shares on May 1 for $50 per share.
 o Yes. He has 20% of shares before 6-month period for
$40 profit.
 If he sells all 110,000 shares on May 1 for $50 per share, and the
remainder on May 2 at the same price.
o This is like Reliance. He’s liable on the whole thing?
 If he sells 110,000 shares on May 1 for $50 per share, resigns
from SCLI, and sells the remainder on May 2 at the same price.
o Liable for the whole thing since he was an officer at the
time of the sale.

Corp. Review #9

Kane is a rich man who likes to run newspapers. He is the editor-in-chief of the New
York Inquirer and CEO and 33 percent owner of the Inquirer Corp., the parent firm. Geddes
owns 10 percent of the Inquirer Corp. and thinks he himself would make a better CEO and
editor. He decides to launch a proxy fight.

Kane throws a lavish party at Xanadu, his country estate, for the lead shareholders
(assorted managers of pension funds and mutual funds). He gives a short lecture about why the
status quo should continue, and then invites everyone to party until dawn. Can Kane charge his
expenses to the company?

- Incumbent party can use treasury of Corp. to fund a proxy fight only if:
o Legitimate policy dispute
o Shareholders are aware of how the money is being spent
o Expenses are reasonable
o No illegal or unfair means
- Doesn’t seem like these expenses are reasonable (lavish party, party until dawn)

Geddes throws a lean-and-mean party aboard his yacht, the Geddes Princess, at which he
harangues the same lead shareholders about Kane’s mismanagement and about his own ability to
run a newspaper. Can Geddes obtain reimbursement from the Inquirer Corp. if he wins? If he
loses?

- Insurgent party can be reimbursed if

o He wins
o Shareholders ratify
o Expenses were incurred in a legitimate policy dispute
- Seems like if he wins, he could obtain reimbursement, but not if he loses.

After issuance of the press release but prior to filing of the lawsuit, a second PI shareholder asks
PI for its shareholder list and for all records pertaining to the outside consulting firms’ audit of
PI’s overseas operations.  He is concerned about American jobs going overseas and wants to
communicate with other PI shareholders to convince them that what is bad for America is also
bad for PI.  Assuming that Delaware law applies to this issue, is the shareholder entitled to
receive such information?

- Proper purpose contemplates concern with investment return. If he can prove that his
concern about jobs going overseas relates to the long or short term economic effects on
PI then he would be good.