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Business Organizations Outline
AGENCY è Person who acts on behalf of and subject to the control of another.
Duty of AGENT to PRINCIPAL à FIDUCIARY OBLIGATIONS
Duty of Care – Agent must exercise the diligence, care & skill of a reasonable person in carrying out his duties. Business Judgement Rule – agent must use good faith in exercising his business judgment given the agent’s experience, expertise and familiarity with the principal’s affairs. Special Skills or Knowledge – Agent who possesses greater skill or knowledge than a reasonable person must utilize that higher level of ability or expertise in performing his duties as agent.
Self-deal – take advantage of a business opportunity within the scope of his agency w/o giving the principal the opportunity to act first.
R-Agency § 387 à Unless otherwise agreed, an agent is subject to a duty to his principal solely for the benefit of the principal in all matters connected with his agency. R-Agency § 388 à Unless otherwise agreed, an agent who makes a profit in connection with transactionns by him on behalf of the principal is under a duty to give such profit to the principal. Test is NOT how the principal has been damaged – agent must be disgorged of profit to discourage such conduct.
Commingle funds with those of the principal Withhold material facts which the agent learns relating to the substance of the agency OR use confidential information acquired during the course of his agency relationship for his own benefit. Act simultaneously for more than 1 principal w/o consent of all principals involved.
Duty of PRINCIPAL to AGENT à
Compensation – for services rendered Indemnification – for L incurred as a result of: Action taken pursuant to principal’s instructions Action which conferred a benefit on the principal OR A breach of duty by the principal Reimbursement – for reasonable expenses necessary to carry out his duties
Authority of Agent è 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. (§7 R-Agency)
Actual Authority – expressed in writing, or orally… also done by acts.
Apparent Authority – (R-Agency §8) Power of the agent to affect the relations of another person by transactions with 3rd persons, professedly as agent for the other, arising from and in accordance with the other’s manifestations to such 3rd persons.
3rd party point of view can have apparent authority w/o actual authority must be a manifestation of consent by principal Inaction by principal may be manifestation of consent (failure to deny…) e.g. being “clothed” with authority (appearance)
Inherent Authority – (R-Agency §8a) 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.
MUST be actual agent to bind the principal 4 Was it reasonably foreseeable by the principal that agent would do as he did?
Trade Secrets è 6 Factor Test
The extent to which the information is known outside of his business The extent to which it is known by employess and others involved in the business The extent of measures taken by him to guard the secrecy of the information The value of the information to him and his competitors The amount of effort or money expended by him in developing the information The ease or difficulty with which the information could be properly acquired or duplicated by others
Partnerships
Uniform Partnership Act è Rights & Duties
UPA § 6 Partnership Defined è An association of 2 or more persons to carry on as co-owners of a business for profit.
what is a co-owner? à UPA does NOT define co-owner 4 Factors to determine ownerà Risk – Bears much of the risk Return – Gets the return Control – Exerts a lot of control Duration – In it for the long haul… don’t expect them to leave of get kicked out
Partner OR Employee? è Factors to consider (Fenwick)
Intent of the parties Right to share in profits Obligation to share in the losses Ownership & Control over partnership property & business Community of power & administration Language in the agreement Conduct of the parties
Are they holding themselves out as partners? Rights of the parties on dissolution
Partner OR Creditor? è Factors to consider (Peyton)
Is the creditor exerting control over the business? Is creditor receiving payment out of profits only? Careful à Is creditor guaranteed a minimum amount regardless of profit? See UPA §7(4) 4 Risk/ Return is the biggest factor 44
Partnership by Estoppel è No in-fact partnership exists (Jones) – Price Waterhouse
Attempt to hold partner L based on à Detrimental Reliance Must show the reliance 4 General Rule à Persons who are not partners to each other are NOT partners as to 3rd persons. Exception à Person who represents himself to others OR permits another to represent him… is L to others on the faith of the representation, given credit to the actual or apparent partnership. (UPA §16)
Fiduciary Obligations of Partners è (Meinhard) “Duty of the finest loyalty”
When in doubt disclose 4 Duty of care (under RUPA § 404(c)) – UPA § 21 Duty of loyalty under RUPA § 404(b)) – UPA § 21 Reasoning for Fiduciary Duties à limits the cost of overseeing by the principal… otherwise, principal must police their agents (too costly & wasteful) Keeps agent from lining own pockets Creates disincentives for the agent to do as he pleases Agent must do what is in the best interest of the principal Duty continues through dissolution (Meehan) NOTE è RUPA § 103 allows you to limit the fiduciary obligations of §404, as long as they are NOT manifestly unreasonable 44
Alternative Dispute Resolution è In general
Private Can be included in agreement as way of settling disputes Cannot “drag” party into ADR Advantages à Less costly Expert hears facts Find out the other side’s case Faster Preserves reputation & relationship
Disadvantages à Morally correct usually wins (not legally correct) Must be consensual by BOTH parties Tip your hand May not be the end of the dispute (may still go to court) No jury to punish D with $$$ award If binding, NO APPEAL – must live with the decision
Mediation à
Arbitration à
Rights of Partners in Management è Nabisco - UPA §18(e) – RUPA §401
Preventing Partner from Exercising Agency Authority è Nabisco
E.g 3 partners… 2 may notify 3rd party that partner has no authority for certain functions UPA §9(1) requires actual knowledge (difficult to prove) Send registered mail & get signature Refuse to accept orders Notice to newspaper RUPA §301 – 3rd party knew OR received notification 4 Lower standard the UPA Allows for filing of statement of partnership authority 4
Dissolution Under UPA è UPA §29 à
Aggregate view – Partnership is a business, NOT a person Definition à Change in the relation of the partners caused by any partner ceasing to be associated in the carrying on as distinguished from the winding up of the business. Winding up is required… HOWEVER à Partnership continues until the winding up of partnership affairs is completed.
Causes of Dissolution (UPA § 31) à Without violation of the agreement b/w partners, By the termination of the definite term or particular undertaking specified in the agreement, By express will of any partner when no definite term or particular undertaking is specified, **** By the expulsion of any partner from the business bona fide in accordance with such a power conferred by the agreement b/w the partners:
In contravention of the agreement…
See wrongful termination (UPA §38 – L for breach) By any event which makes it unlawful for the business of the partnership to be carried on … By the death of any partner; By the bankruptcy of any partner of the partnership By decree of court under UPA § 32
Winding Up Under UPA è UPA § 37 à Default Term – Can otherwise agree
Definition à Process by which the affairs of the dissolved partnership are settled, including distribution of the remaining partnership property. Once the partnership is dissolved and the winding up is complete… the partnership is terminated. Generally, those who do not terminate wrongfully, have the right to force a winding up of the partnership business. (Can obtain from court)
Dissociation Under RUPA è RUPA § 601à Events Causing
notice of partner’s express will to withdraw event agreed to in partnership agreement expulsion pursuant to agreement expulsion by unanimous vote IF;
unlawful to carry on the partnership business with that partner; there has been a transfer of all or substantially all of that partner’s transferable interest in the partnership… *** ***
on application by the partnership or another partner, the partner’s expulsion by judicial determination b/c:
wrongful conduct adversely affecting the partnership business willful material breach of agreement OR duty owed…(under § 404) not reasonably practical to carry on the business in the partnership with the partner;
Wrongful Dissociation RUPA § 602 è Wrongful where à
In breach of agreement Before the expiration of a definite term specified in agreement
Dissociation When Business NOT Wound Up Under RUPA è RUPA § 701 à
Dissociated partner’s interest MUST be purchased for a buyout price determined pursuant to subsection (b) Includes interest from the date of the dissociation to the date of payment MINUS damages from wrongful dissociation under § 602(b) Partnership continues on (entity view), unlike under UPA 4
Events Causing Dissolution & Winding Up è RUPA § 801 à
MUST be wound up where à In a partnership at will… express notice of will to withdraw… Where definite term of undertaking: 90 days after dissociation caused by death OR wrongful dissociation UNLESS remaining partners agree express will of all of the partners to wind up… expiration of term OR completion of undertaking
Event agreed to resulting in the winding up Even makes it unlawful to continue… Application by partner, judicial determination…
Corporations
Advantages à
Distinct, legal entity Can sue Can own & convey property in its own name Owners & shareholder NOT personally L for debts (w/exceptions) Can exist for an indefinite period Centralized management through a BOD Increased freedom of transfer of ownership (sale or trade of stock)
Shareholders è
Participate in fundamental acts E.g. selling a major part of corporate assets Generally, buying another corporation is NOT a fundamental change They are the Residual Takers Vote for directors Do NOT have to participate in management Little risk of L Want Accountability 4 Power of Derivative Suits à Allows shareholders to pick up the claim on behalf of the corporation and bring it as if they were the corporation b/c directors are “conflicted out” (cannot sue themselves).
Directors è Management
Setting up a Corporaton è Articles of Incorporation
Name Capital Structure Name of Agent Address of Agent Name of at least 2 incorporator
Articles may choose to specify a duration May incorporate in another state – Internal Affairs Doctrine Governing law is the state of incorporation Cannot be denied incorporation if you meet the rules above
Powers of a Corporation è Ultra Vires Doctrine RMBCA § 3.04
when parties create restrictions in the articles OR the corporation engages in activities NOT directly related to profit seeking (such as charitable giving)
RMBCA 3 exclusive means of enforcement è Shareholder suit – shareholders can sue to enjoin the corporation from entering into or continuing in an unauthorized transaction. Court may issue injunction only if “equitable” and only if all parties, including the 3rd party are present in court.
Corporate suit against directors & officers – Corporation, on its own or by another on its behalf, can sue directors and officers for taking unauthorized action. The officers and directors can be enjoined or held L for damages. Suit by state attorney general – state can seek involuntary judicial dissolution if the corporation has engaged in unauthorized transactions. “State concession” theory
Preincorporation K’s signed by them before the business is incorporated (Pre-incorporation Obligations) – problem is that there must first be a principal before there is an agent. See pg. 26 R-Agency
Promoter as non-recourse agent à No K unless Bridge Company is incorporated & adopts the K Promoter as “best efforts” agent à Geary agrees to use best efforts… No K until Bridge Co. is incorporated AND adopts the K Promoter as interim contracting party à Geary accepts L until co. is incorporated and substituted in his place Promoter as additional contracting party à Geary accepts L and remains severally L with the corporation (Co. may be obligated to indemnify Geary)
K’s signed by them for a business not properly incorporated (Defective Corporation) = partnership***
DeJure – “of law” or “by the law” – status of corporation actually met by law Documents were filed and you were incorporated by commissioner DeFacto – court may choose to use this
Corporation could have been formed (there was a valid law) Attempt was made to form corporation – took actual steps to organize a corporation. (Did all they were supposed to, but something went wrong) There had to be actual use of the corporate franchise…They must hold themselves out as a corporation. Must act in “good faith”
Transactions they enter into with the corporation (self dealing) *
E.g. bringing in new shareholders or buying land for the corporation Promoter owns the land which he sells to the corporation (over pricing the land*) Traditional agency principals require no self-dealing Shareholders are harmed by the transaction Under traditional agency law, shareholders are NOT 3rd parties 4 Can be acceptable where promoter discloses & gets permission NOTE: Agency law still applies here 4 R – Agency § 326 è Unless otherwise agreed, a person who, in dealing with another, purports to act as agent for a principal whom both know to be nonexistent or wholly incompetent, becomes a party to such a K.
Finding Corporations L è 3 Theories
Piercing the Corporate Veil è Rare Event è Shareholders L for corporate debts under certain circumstances. 3 Reasons court may pierce the corporate veil à
Disregard for Corporate Formalities è “Unity of Interest & Ownership”
Corporate procedures NOT followed – No BOD, no stock issued, no meetings held… Corporate books/records NOT kept Commingling of assets Parent & subsidiary are represented to 3rd parties as one & the same
Corporation is Undercapitalized è Shareholders monetary investment is inadequate in view of the capital required and risks created by the type of business in which the corporation is engaged. Not Piercing Results in Injustice è Must be more than the fact that no recovery results.
Enterprise Liability è Many corporations are really acting together as 1 enterprise. Recovery should be available from any one of them. Owner NOT L, but all entities are L for each other.
Agency è Respondeat Superior
Protecting Decisions By Directors è Business Judgment Rule
Shareholders voluntarily undertake the risk of bad business judgment After-the-fact litigation is a most imperfect device to evaluate corporate business decisions Because potential profit corresponds with potential risk, it is very much in the interest of the shareholders that the law NOT create incentives for overly cautious corporate decisions. (Shareholders Benefit) Shareholders can reduce the risk by diversifying their holdings
BJR deals with the decision making process Burden is on P to break through BJR 4 Then Burden to D… go to subroutine (see flow chart) 4 Fiduciary Duties à Care & Loyalty
Decision – Directors must actually act. Failing to act does not incur the protection of the business judgment rule for directors. Inaction gets no protection here. *** Careful… there can be a decision to do nothing.
Disinterestedness – Directors are protected where they have no personal stake in decision. (Duty of Loyalty) 44
Conflict of Interest – “Self-Dealing” – Must NOT put themselves in a position where personal interests would conflict w/interests of the corporation. Self-Dealing à Must be “duly authorized” by a disinterested quorum (sanitized in accordance w/statute) 4 Sanitization – Must be a transaction or K to be sanitized. 4 Relocation is NOT a transaction (BUT could be tainted by duty of loyalty) Corporate Opportunity – Director cannot take advantage of a corporate opportunity w/o first informing the corporation and obtaining permission. Competition – Director cannot engage in direct competition w/corporation.
Due Diligence – Investigated, informed, deliberated… made a decision.
Discretion – Directors NOT L unless abuse of discretion… (e.g. Ford changing the aim of the corporation).
E.g. no longer seeking to profit Good Faith – No protection where decision was made purposely in bad faith.
Role & Purpose of Corporations è “A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of the directors is to be exercised in the choice of means to attain that end, and does NOT extend to a change in the end itself, to the reduction of profits among stockholders in order to devote them to other purposes.” Ford
No protection for social policy considerations Does NOT have to damage the shareholder Dividends are at the discretion of the corporation
Duty of Care on Directors èRMBCA § 8.30 General Standards for Directors
General Rule è Director must act with such care as the ordinary prudent person in a like position would use under similar circumstances. Violated when in light of the director’s experience, expertise, and presumed familiarity with corporation’s affairs, the director’s actions were unreasonable. (Gross N standard) Clue – Facts usually indicate a result from a bad BOD decision, and the corporation sustains some type of loss.
Must ask – Whether the loss was occassioned be a breach of the duty of care in a manner which will permit the directors to be held personally L. No affirmative duty of care unless on notice (Allis-Chalmers)
Derivative Actions è Shareholders sue on behalf of the corporation.
Corporation may be harmed by à (May sue derivatively) Waste of corporations assets Self-Dealing Breach of Fiduciary Duty Missed Corporate Opportunity Declaring a dividend may harm corporation 4 Derivative suit (disfavored b/c of many requirements to meet) Not receiving a dividend may harm shareholder 4 Direct suit (favorable b/c not so many requirements to meet)
Procedure of Derivative Actions è
Pleading requirements Some states require “particularity” Efforts to make demand on the BOD or why no demand was made May require exhaustion of internal remedies first Standing Requirements Demand Requirements Court approval of settlements Must be fair & reasonable to the corporation May consider terms of the settlement & outcome that may have resulted Statute can allow Director to minimize L
Problems of Derivative Suits à Person holding 1 share may sue No “real” economic stake Directors have an interest in settling the case Covered by insurance Don’t want L to fall on them
Revisions of Law in Response à P must post a bond to cover expenses of D in case of frivolous suit “Standing” P must be a shareholder at the time c/a accrued P may also be required to hold shares while litigation proceeds
DE approach – Demand Required Unless Excused èProcess
Time – 0 à Board (BOD #1) does something (stupid/illegal/self-serving) Time – 1 à Shareholders find out Time – 2 à Shareholders decide to sue What happens where the persons on the board change?? (die/voted off/ retire) = BOD #2 Should the shareholder be required to demand that BOD #2 sue? C/a belongs to the corporation Law imposes on the shareholder the duty to make a demand BOD must consider this and respond It concedes that BOD #2 is in a position to decide whether or not to proceed with litigation 4 Shareholders can challenge a decision NOT to sue BUT Board is protected by business judgment rule 4 DE law does NOT require shareholders to make demand if demand would be futile ****************** How do you know when demand is futile ?? P must be able to allege particularized facts (pleading requirement) must raise a reasonable doubt as to 2 things
BOD lacks disinterestedness & independence whether to make the decision (in the BOD that is sitting at T-2) Did the board have a rational basis for their decision. Reasonable doubt that not otherwise protected by BJR
T-3 – SLC formed à What happens NOW? How much deference should the special litigation committee be given? They never agree that litigation should proceed TEST Aronson decision 4
Court will look at decision on a 2 prong test Inquire into the independence & good faith of the committee If finds not independent/bad faith… that is it Even if the court’s review of the SLC find independence, good faith… etc… court still won’t automatically respect their decision
2. Reasonable basis for the SLC’s decision.
Court will exercise its own business judgment in whether the litigation continues 44 court is 2nd guessing the business judgment of the board 4 what is the reasoning for this?? If the court does not step in, no one will This is only pleading, directors still protected by BJR This is only a decision to proceed with litigation, not about the merits of the case
Universal Demand– RMBCA (§ 7.41, 7.44)
Demand as a Pleading Requirement – NC Approach
Alford v. Shaw Pleading must describe what you did to bring this to the attention of the corporation Don’t necessarily have to make a demand… only need to describe in the pleading what you did to attempt to make known. No fatal effect to the litigation… merely a pleading requirement 4 For EXAM purposes Question may state NOT to discuss demand procedures 4
Duty of Loyalty è E.g. Self-Dealing transactions
Interest/Expectancy Test – (old) – Corporation deemed to have a right or interest in it linking them to the business idea Line of Business Test – (Broad) – 3 Elements fundamental knowledge practical experience ability to pursue
Inaction – Reason no action taken b/c company interested in giving opportunity someone else Religious Problems (Look to Disinterestedness) Duty of loyalty problems must be sanitized (by statute) Standard – Whether or not the decision served a legitimate and useful corporate purpose and the company received full benefit thereof. P must break through the standard here Burden then on Directors to show “inherent fairness” from the viewpoint of the corporation
Inherent Fairness Test è D must prove that the process & substance was fair (Difficult Standard to meet) 4 D must in effect show that the result was fair More difficult standard to meet than under BJR Loyalty (does NOT question the result) 4 Conclude on EXAM à Bottom line was that the decision was beneficial & fair to the company.
Duties of Dominant Shareholders è
Equal Opportunity Doctrine è Controlling shareholders may NOT exert their control over the corporation to extract a personal benefit unless the minority shareholders are also entitled to participate. Scrutinize BOD or Shareholder decision for à Self-dealing by controlling shareholders E.g. liquidations, repurchases, changes in the size of the BOD Controlling shareholder NOT allowed to exclude unless à Full disclosure Good faith motivation Overall fairness Look to find self-dealing … then… Follow flow chart May get to the intrinsic fairness test
Abuse of Control è B/w Shareholders
Wilkes Test à Treats minority shareholders in a closely held corporation like partners 4 Harm to the minority shareholder amounting to a breach of fiduciary duty Harmed in a way that did not harm others Burden on D to show a legitimate business purpose Burden then on P to show alternative course of action less harmful to his interest
Remedies è Court may order any 4
Agreement in articles of incorporation or by-laws of a buy back Petition for involuntary dissolution (by statute)
RMBCA § 14.02(2)(ii) Assets are liquidated & creditors are paid… remainder to shareholders Extreme remedy… it is the end of the corporation “The greater includes the lesser” Court may impose accounting of assets & Repurchase of shares 4 Must 1st meet the requirements of statute
Statutory right of appraisal
Breach of Fiduciary duty by director
Dissolution of Corporation è RMBCA § 14.02
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