Corporations Chapter One: I.

Introduction to Business Forms Classification of business two categories: 1) corporations and 2) unincorporated associations Other dividing lines: closely held versus publicly held Source of law: Statutes Uniform Partnership Act (UPA 1914) Uniform Partnership Acts (UPA 1997) Uniform Limited Liability Company Act of 1996 (ULLCA) Model Business Corporation Act (MBCA) financial provisions of the Model Business Corporation Act of 1969 (MBCA 1969) Agency Law 1.01 Agency defined: Fiduciary duty that arises when one person the principal manifests consent to another person the agent that the agent shall act on the principals behalf and subject to the principals control. And the agent consents so to act. Principal one for whom act is to be taken Agent one to act Agency is consensual, not contractual (no consideration). 1.02 Agency relationship must meet elements announced in 1.01; parties labeling not controlling 1.03 Consent can be manifested through written words, spoken words or other conduct (i.e., acquiescence is sufficient in some cases) 1.04 Co-agents in relationship with the same principal; superior and subordinate agents can exercise authority, be delegated, respectively. Actual authority and Apparent authority: Authority concept that defines scope of the agency relationship Power to bind principal is broader than agents authority to bind principal. How can you have power without authority?
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(a) Estoppel (b) Inherent agency power Actual authority Manifestation of consent from principal to agent May be express or implied Implied authority relies on industry custom One form of implied authority is incidental authority (which includes things needed to effectuate actual authority) Apparent authority Power to affect a principals legal relations with third parties held by an agent or other actor when a third party reasonably believes actor has authority to act on behalf of principal Third partys belief MUST be reasonable Belief must also be traceable to principals manifestations

Respondeat Superior Employer is subject to liability for torts committed by employees while acting in the scope of their employment. Estoppel Very similar to apparent authority Compensates for loss caused by reliance While apparent authority requires affirmative manifestation, estoppel may follow mere inaction. Actual and apparent authority may co-exist, but are terminated differently. II. Choice of Business Entity What are the seven basic choices? (a) Sole proprietorship one owner (can have a business name) (b) Corporations C type (designation for tax purposes) (c) Corporations S type (federal tax election, special elections creates tax benefits) (d) Partnership General (two or more people who are co-owners of a business for profit) (e) Partnership Limited (you have limited liability) (f) Limited Liability Companies (hybrid between corporations and partnership; all owners have limited liability; liability is limited to amount you invest) (g) Limited Liability Partnership

III. Theories of corporation: Incorporation results in the creation of a new legal entity, a fictitious person with its own obligations. A corporation is an entity independent of its shareholders. Though corporation is recognized as a separate entity, it is not shielded with certain privileges extended to individuals. For example, a corporation has: no right to privacy no 5th Amendment privilege against self-incrimination But Corporation: enjoys First Amendment protection Cannot have property taken without just compensation Is protected from unreasonable search and seizures Can plead double jeopardy Is entitled to due process 1. Nexus of contracts model argue the firm is not a single entity, but an aggregate of various inputs acting together with the common goal of producing goods or services 2. Contractual theory of corporation is in stark contrast to the legal concept of the corporation as an entity created by the state.

Chapter 2 THE PARTNERSHIP A .THE NEED FOR A WRITTEN AGREEMENT A written agreement is not necessary to form a partnership. Advantages to a written agreement: 1) Avoids future disagreements about the arrangement. 2) Provable in court. 3) May focus on potential trouble spots in the relationship that may go unnoticed in an oral agreement. 4) Provides proof to the IRS that a partnership exists, ensuring that the partners to allocate the tax burdens among themselves. 5) Upon death or retirement of a partner, UPA provides that the business is
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either disposed of or the interest of the deceased partner is to be purchased by the other parties. Having such provisions in writing should protect spouses and others that may be affected by the agreement. 6) Where a partner lends property to the partnership, 7) Where real estate is to be contributed as partnership property or the agreement includes a term of more than one year, a written agreement may be necessary to comply with the statute of frauds. 8) Helpful to the attorney setting up the partnership, providing less reasons for a missunderstanding. D. LIMITED LIABILITY PARTNERSHIP (LLPS) -- UPA 306 (c): An obligation of a partnership incurred while the partnership is a LLP is solely the obligation of the partnership. -- A partners is not personally liable, directly or indirectly, by way of contribution or otherwise, for such an obligation solely by reason of being or so acting as a partner. E. MANAGEMENT National Biscuit Co. v. Stroud 1959 -All partners are jointly and severally liable for the acts and obligations of the partnership. UPA -- All partners have equal rights in management even if sharing profits are unequal. UPA 18 Smith v. Dixon 1965 -In this case, the managing/general partner contracted to sell land to Defendant for $200,000. The partnership refused to close the sale because these other partners said they only gave the general partner the authority to sell the land at $250,000. The court held that one partner has the authority to sign for the partnership in transferring land as long as that partner is operation with apparent authority, which he did. -- A partnership is bound by the acts of a partner when he acts within the scope or apparent scope of his authority. UPA 11 Rouse v. Pollard 1941 -- In this case the partner (an attorney) did not act within the scope of (law) partnership when he embezzled money from a client and invested it, as the partnership was a law firm, not an investment firm -- Each partner is authorized to act as the general agent for his co-partners in all
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matters coming within the scope of the business of the firm, -- All partners are responsible for the acts of each of their agents -- If the transaction is outside the partnership business, the other partners are not liable and they are not bound by a statement of the partner who conducts such transaction that he is acting on behalf of the firm. -- To hold partners for the fraudulent acts of a co-partner, the acts with which the fraud is committed must have been within the general scope of the partnership business.

Roach v. Mead 1986 -- In this case, the partner (an attorney) failed to advise client on the legal consequences of a loan. The court held this was in the ordinary course of the business of the partnership and his law partner was vicariously liable for these negligent acts. -- Partners are jointly and severally liable for the acts of co-partners based on the principal-agent relationship between the partners and the partnership. -- Partners are jointly and severally liable for the tortious acts of other partners if they have authorized those acts or if the wrongful acts are committed in the ordinary course of the business of the partnership.

Notes (read in class) Model Rules of Professional Conduct, Rule 1.8 A lawyer shall not enter into a business transaction with a client or knowingly acquire an ownership, possessory, security or other pecuniary interest adverse to a client unless: (1) The transaction and terms on which the lawyer acquires the interest are fair and reasonable to the client and are fully disclosed and transmitted in writing to the client in a manner which can be reasonably understood by the client. (2) The client is given a reasonable opportunity to seek the advice of independent counsel in the transaction; and (3) The client consents in writing thereto. UPA 17, 306 (b)
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F. DUTIES OF PARTNERS TO EACH OTHER Meinhard v. Salmon 1928 -- The duty owed by a partner to fellow partners is based on a fiduciary relationship. -- Joint adventurers, are like partners and owe to each other, the duty of the finest loyalty. The duty is even higher for the managing co-adventurer G.PARTNERSHIP PROPERTY Official Comment to Subdivisions (1) and (2-B) of Section 25 of the Uniform Partnership Act -- UPA 25 (1) -- Partners are co-owners of partnership property. UPA 25 (2-b) -- The right of a partner as co-owner in specific partnership property is not separately assignable. -- Example: A and B are partners. A wants to assign all his rights in partnership property to C. He cannot do so without the consent of B because the rights of A in the property is to possess the property for a partnership purpose; and because a partnership is voluntary and A cannot force a partner on B without Bs consent. H.PARTNERSHIP ACCOUNTING The interest of partners are reflected in capital accounts.

-- Capital account: sets forth the partners ownership interest in the partnership. -- UPA (1997) 401: describes how each partners capital account is maintained. -- Equation: that account equals the capital contributed by the partner less the amount of any distributions to the partner plus the partners share of the profits less the partners share of the losses. -- When a partnership is terminated, a partner with a negative capital account must pay the partnership that amount. UPA (1997) 807b -- Most partnerships also have a second set of books to record transactions for tax purposes.
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-- Equity = Assets Liabilities (net worth of a business = assets liabilities) -- Equity: ownership or net worth. -- Balance sheet: most fundamental financial statement. Equity = Assets liabilities. -- Asset side is the left-hand side. -- Liability/equity side is the right hand side. -- Records a situation at one instant at a time, therefore every transaction potentially creates a new balance sheet when the transaction is recorded. -- The bottom line of a balance sheet is not itself a meaningful figure because transactions such as a bank loan that do not affect the real worth of the business to the owners may increase or decrease it. -- Profit and loss statement/income statement can be created for a business for one day of operation. -- It is a right-hand entry on the balance sheet. -- Income = Revenues Expenses -- Balance sheet v. Income statement: -- Balance sheet: shows the status of a business at a particular instant in time. -- The basic document which all financial statements are constructed -- Income statement: describes the results of operations over some period of time-daily, monthly, quarterly, or annually. -- Provides the bridge between the balance sheet at the beginning of the period and the balance sheet at the end of the period

Four concepts of financial accounting: 1.Assumes the business is an entity. 2.All entries are in terms of dollars. - Both tangible and intangible property are shown on the balance sheet either at historical cost or fair market value. (Ex. Land and rights to a patent) -- Some assets such as a salesperson good with clients is not reflected on the balance sheet.
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-- A liability in the balance sheet sense is a recognized debt or obligation to someone else. 3.A balance sheet must balance. (The sum of the left must be the same as the sum of the right.) 4.Double entry book keeping: Every transaction entered into by a business must be recorded in at least two ways if the balance sheet is to continue to balance. (It is the cornerstone of modern accounting) -- Cash flow accounting: -- Considers only transactions that involve dollars in and dollars out, whereas traditional accounting includes some expenses that do not reduce the amount of available cash of the business. -- Most businesses prepare cash flow financial statements for internal purposes and to make sure that there will be cash available when foreseeable payments come due. I. PARTNERSHIP DISSOLUTION -- Steps to ending a partnership: 1 1.Dissolution 2 2.Winding up 3.Termination of partnership -- Dissolution: DOES NOT IMMEDIATELY TERMINATE THE PARTNERSHIP. -- a change in the legal relationship caused by any partner ceasing to be associated in the carrying on of the business. UPA (1914) 29 -- **Refers to a change in personal relationships among partners within the partnership and has nothing to do with the disposition of assets or closing down or selling the business. Chapter Three The Limited Partnership and Federal Income Taxation The Internal Revenue Code recognizes two distinct methods of taxing business income: (a) Corporate Income taxation described in Subchapters C and S of the Internal Revenue Code (b) Partnership Income taxation described in Subchapter K of the Internal Revenue Code Corporate Tax Rates:
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Marginal tax rate is applicable to a corporation with exactly $75,000 of income is 34% because that is the rate applicable to each additional dollar of taxable income the corporation earns over $75,000 and up to $100,000. Effective tax rate is 18% since a corporations tax bill on exactly $75,000 of taxable income is $13,750 (15% of $50,000 plus 25% of $25,000).

Federal Taxation The fundamental difference in the tax treatment of partnerships and corporations is that a corporation is taxed as a separate entity with its own tax rate, whereas the partnership is taxed as an extension of the individual. There is an element of double taxation in the corporate form if the corporation pays dividends. The corporate earnings are taxed to the corporation, and when the diminished earnings are distributed in dividends, they are treated as income in the hands of the shareholders, and taxed again.

S Corporation: A.k.a. taxed as a partnership or electing partnership taxation Only a single tax on corporate income is imposed on individual income tax rates at the shareholder level. The income is taxable to the shareholder whether or not the income is actually distributed. To be eligible, a corporation must meet the following conditions on the date of election, in order to be for a S corporation: (a) it must be a domestic corporation (b) it must NOT be part of an affiliated group of corporations (c) It must have no more than 75 shareholders (d) Each shareholder must be an individual cityizen no a nonresident alien (e) It may have only one class of stock outstanding, except that classes of common stock differing only in voting rights is OK Has corporate characteristics of limited liability and centralization of management. C Corporation A C corporation can minimize the disadvantages by reducing the substantial tax at the corporate level through the payment of salaries, rent, or interest to the shareholders. If reasonable, such payments are deductible as ordinary and necessary business expenses.
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A factor favoring corporate tax treatment is the availability of tax-free employee fringe benefits for shareholders that are employees of the corporations. Such benefits include medical insurance, life insurance and so forth. Proprietorships Proprietorships, businesses wholly owned by a single individual, are not a separate taxable entity. Its income is reported on the proprietors personal income tax return. The taxation of unincorporated business forms, such as general and limited partnerships and limited liability companies, is set forth in Chapter K of the Internal Revenue Code. The partnership itself does not pay tax; rather it allocates the income or loss of the partnership among the individual partners in accordance with the partnership agreement. Each partner then includes in his or her personal income tax return, the amount allocated.

Limited Partnerships with Corporate General Partners: A limited partnership with a corporation as the sole general partner creates a totally different kind of entity than the traditional limited partnership. No individual is personally liable for the firms debt. Most of the capital is provided by passive investors who have no right to participate in management. Control of the limited partnership is vested solely in the hands of the corporate general partner.

Chapter Four Limited Liability Companies An LLC is an entity designed to be taxed as a partnership while offering the owners the limited liability that shareholders of a corporation enjoy. Compared with a S corporation, an LLC may be better because it is not subject to the limitations of Subchapter S (75 or fewer shareholders, one class of stock, etc.) Compared with a limited partnerships, an LLC may be better because it does not require that there be at least one general partner that is personally liable for the partnerships obligation; no member need be personally liable for the obligations under an LLC.
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Although LLCs are governed by statute, the statute provides that members can adopt operating agreements that will control. Best understood in terms of four general characteristics: (a) limited liability (b) partnership tax features (c) ability to chose between centralized and direct member management (d) creditor protection provisions Management of an LLC is presumed to be by all members (unless specified in the articles) Management by members must follow these rules: (a) majority vote is required to approve most decisions and (b) each member is an agent of the LLC (meaning: LLC may be bound by the acts of any member)

Management rights are transferred ONLY with the consent of ALL members Disassociation of an LLC member by resignation, death, retirement, generally causes the dissolution of the LLC. Poore v. Fox Hollow Enterprises stands for the proposition that a formation of a limited liability company creates a separate legal entity that must be represented by legal counsel in court.

Chapter 6 The Formation of a Closely Held Corporation A. Where To Incorporate -selection of a state to incorporate in involves two factors: 1) cost of incorporation 2) advantages and disadvantages available under the state's laws of incorporation - most practical is to incorporate in the jurisdiction where most business activities will take place - DE is the most popular outside jurisdiction - if the corp is closely held and its business is to be conducted largely or entirely within a single state, local incorporation is preferred
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B. How To Incorporate - issues to be addressed: 1. whether substantive provisions should be placed in the articles of incorporation, the bylaws, or a shareholders agreement 2. modern trend is to limit the articles of incorporation to provisions that are required by law to appear in that public document while all other substantive provisions are placed in documents that are not filed of public record 3. but placing things in the public records gives legal notice to the world 4. formal requirements for filing documents found in MBCA Section 1.20-1.26 I. Corp Names - corp name must be distingusihable upon the records of the Sec. of State from other corp names - purpose of corp name regulation is to prevent unfair competition - a corp may conduct business under an assumed or fictitious name to the same extent that an individual may...test for the lawfullness of doing business under an assumed or fictitious name is that it is proper to do if the purpose is not to defraud - 3.20 automatically grants every corp perpetual duration and succession in its corp name, unless the Articles of Incorp provide otherwise II. Purposes corp may list multiple purposes without any limitation on the number of purposes specified and without any obligation that the corp actually pursue all the purposes contained in the articles several reasons why want a narrow purpose: a. some types of corp may be engaged in businesses subject to state regulation that permits incorp under general business statutes but requires limitations on corp activities b. some persons may be uncomfortable with the complete lack of useful info about the purpose of the corp permitted by the MBCA, preferring that some description of the principal business of the corp appear in the articles of incorp c. in closely held corp, a limited purposes clause may be used where one or more persons interested in the corp wish to restrict the lines of business the corp may enter III. Powers
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must distinguish between powers and purposes within the articles of

incorporation easiest way to do this is to precede each statement with the phrase to engage in the business of when stating purposes it is not necessary to make any reference to corporate powers in the Art. Of Incorp. IV. Registered office and registered agent having both a registered office and agent ensures that every corp has publicly stated a current place where it may be found for purposes of service of process, tax notices,etc often the office is its principal place of business and the agent is a corp officer or employee problem with mixing of the mails and confusing important documents with junk solve the problem by making an attorney the registered agent so that he can recieve all important documents and deal with them accordingly bylaws of a corporation constitute the internal set of operating rules for the corporation prepared by an attorney overseeing the formation of the corp C. Decline of the Doctrine of Ultra Vires - ultra vires literally means beyond the powers - an act undertaken by a corporation that is beyond the scope of its authority pursuant to law or its articles of incorporation - when a corporation does act or enters into a contract beyond the scope of its charter, t is not necessarily illegal and it is not necessarily void - instead it is voidable - The doctrine is declining in importance and should not be applied to purposes of articles of incorporation - 711 Kings Highway Corp v. FIM's Marine Repair Serv., INC - rule of law: no act of a corporation and no transfer of property to or by a corporation shall be held invalid by reason that the corporation was without capacity or power to do such act except in an action brought by a shareholder

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- Theodora Holding Corp. v. Henderson - rule of law: a majority stockholder may cause a charitable contribution to be made out of corporate funds if such charitable gift is within reasonable limits as to amount and purpose - the test applied in passing on the validity of any corp gift is that of reasonableness - this test is based on provisions of IRC permitting charitable gifts by corp within 5% of annual income to be deductible - when a corp makes a gift of corporate property or funds, such transactions can raise an ultra vires issue - some courts do allow these gifts, but do not allow gifts to a directors or majority shareholder's pet charity - question is whether the gift is reasonably necessary to furthering a valid corp objective D. Premature Commencement of Business 1. Promoters a. includes a person who acting alone or in conjunction with one or more other persons, directly or indirectly takes initiative in founding and organizing the business or enterprise of an issuer b. usually are individuals engaging in a useful and desirable economic function c. owe significant fiduciary duties to other participants in the venture d. exact good faith in their intra-company activities, and must adhere to a high standard of honesty and frankness e. if a subsequent investor has dealt directly with the promoter in connection with the investment, there is little doubt that the promoter is liable for common law fraud in the event of misrepresentation f. but additional remedies are available such as fraud , or nondisclosure of a material fact g. people that can attack transactions between a promoter and a corporation on grounds that the transaction violates promoter's fiduciary duty include: 1) general creditors of the corp or their representative, usually the trustees in bankruptcy or receivers based on theory that promoters converted corp assets to their own use in fraud of creditors 2) Co-promoters
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 fiduciary relationship exists between co-promoters 3) Corporation itself must be done after corp has come under the control of subsequent investors or other persons h. tasks of promoter: 1) locate a plant and rent or buy it 2) negotiate employment contracts with key personnel 3) make necessary arrangements as to the business's distributive network or a source of raw materials 4) raise capital if necessary either through the sale of equity interest in the business, loans or combo of both - Stanley J. How & Assoc., Inc. v. Boss - rule of law: a promoter will be liable on a contract he entered into on behalf of a corporation yet to be formed unless the other party agreed to look to some other person or fund for payment - three exceptions to this rule 1) the contract is treated as an option which can be accepted by the corporation when it is formed, and the promoter agrees to form the corporation and give it the opportunity to pay 2) a novation with the corporation assuming the promoter's liability and replacing him in the contract 3) the promoter remains liable even after formation but only as a surety - general rule: when work is to be performed prior to incorporation, the promoter will be personally liable unless another person or fund is made so under the contract - when a principal is not yet in existence, the agent's reputation and assets must be assumed to have induced the other party to enter the contract - Quaker Hill, INC v. Parr - rule of law: while promoters are personally liable on contracts made on behalf of a corp "to be formed," if (1) a contract is made on behalf of such a corporation and (2) the other party agrees to look to the corporation and not the promoters for payment, the promoters incur no personal liability - McArthur v. Times Printing Co. - rule of law: formal adoption or acceptance of a contract by a corporation is not a requirement, but acceptance may be inferred from acts or acquiescence on the part of the corporation or its
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authorized agents - a corp may not be bound by engagements made on its behalf by its promoters before its organization, but it may, after its organization, make such engagements its own contracts - adoption or acceptance may be inferred from acts or acquiescence on part of the corporation or its authorized agents - the agreement must be one which the corp itself could make and one which the usual agents of the company have express or implied authority to make 2. Defective Incorporation - Robertson v. Levy - rule of law: officers and directors who attempt to act for a defectively formed corporation or prior to its formation are jointly and severally liable for those acts - a corporation's existence does not begin until the certificate of incorporation has been issued - a creditor, even with knowledge of the defective formation, is not estopped from looking to those who incurred liability for payment - Cantor v. Sunshine Greenery, Inc. corporation by estopple: by perception of the third party. Equitable doctrine: must convince courtv - rule of law: one who deals with a de facto corporation as a corporation is estopped from denying its existence in an attempt to hold those with whom he dealt personally liable on its contracts

Cranson v. International Business Machines Corp. - rule of law: two doctrines have been used by the courts to clothe an officer of a defectively incorporated association with the corporate attribute of limited liability: 1) doctrine of defacto corporations, where there is evidence showing a) the existence of law authorizing incorporation b) an effort in good faith to incorporate under that existing law, and c) actual exercise of corporate powers, and 2) doctrine of estoppel where the person seeking to hold the officer personally liable has contracted or otherwise dealt with the association as a corporation - where a de facto corporation is found from the three above elements, the association becomes a corporation de jure against all persons but the
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state - a corp where sufficient steps have been taken toward incorporation for a court to be justified in finding that the association involved was in fact operating as a corporation - estoppel is an equitable theroy invoked by the courts to avoid injury due to detrimental reliance upon someone's representations - estoppel depends upon and is limited to the facts of each particular case - a de jure corporation is one which has been created and recognized in compliance with the general incorporation law of the particular state - means literal compliance with all mandatory requirements and substantial compliance with all directory requirements Chapter 7 DISREGARD OF THE CORPORATE ENTITY A. Common Law Doctrine of Piercing the Corporate Veil 1. One of the key attributes of the corporate form is limited liability. Piercing the Corporate Veil refers to extreme situations where some or all shareholders will be personally liable for corporations obligations. 1. Bartle v. Home Owners Corp. (NY, 1955) Court finds no piercing unless there was intent to commit fraud by the parent company. Fraud, illegality, misrepresentation 2. Cane - Piercing is the exception, not the rule. The rule is that corporations limit liability and the burden of proof is on the party trying to pierce. 3. Dewitt Truck Brokers v. W. Ray Flemming Fruit Co. (4th Cir. 1976) Court looks at equity and fairness to see if subsidiary is mere instrumentality or alter ego - theres no real separation between the person and the corporation. No fraud required. B. Factors of which courts may consider any number: 1. Undercapitalization for purposes of corporate undertaking. 2. Failure to observe corporate formalities. 3. Non-payment of dividends. 4. Insolvency of debtor corporation at the time. 5. Siphoning of funds of corporation by dominant stockholder. 6. Non-functioning of other officers and directors. 7. Absence of corporate records. 8. Element of injustice or fundamental unfairness required.
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4. The decision to pierce does NOT mean the corporation no longer exists. 5. Piercing is entirely a phenomenon of closely held corporations, and predominantly one-person corporations. 6. Baatz v. Arrow Bar (SD, 1990) Piercing is allowed to avoid injustices and inequitable consequences. C. Factors the court considered include any number of the following: 1. Fraudulent representation by corporation directors. 2. Undercapitalization. 3. Failure to observe corporate formalities. 4. Absence of corporate records. 5. Payment by the corporation of individual obligations. 6. Use of corporation to promote fraud, injustice, or illegalities. 7. Courts are more likely to pierce in tort cases than in contract cases. D. Voluntary Creditor Doctrine - in a contract case, there is the opportunity to look into the credit of a corporation or bargain for personal guarantee. In tort, such opportunity for the plaintiff/creditor/victim to protect themselves. 8. Radaszewski v. Telecom Corp. (8th Cir. 1992) A. In tort case, courts will consider whether corporation has insurance against the type of risk that came to pass. Adequate insurance makes a finding of undercapitalization less likely. This case would not be the best precedent to use in a contracts case. B. Choice of Law is determinative because different states have different tests for piercing. Federal courts, through Erie, will apply state law. C. Three more factors courts consider, translated from factors on page 317: 1. Parent has such control that subsidiary couldnt even act without it. Parent representation on subsidiarys board doesnt necessarily qualify. 2. Such control was used in committing the wrong. 3. Such control and activity was the proximate cause of the injury. 9. Sibling Corporations - Page 320, Note 4: Walkovsky v. Carlton (NY 1966) A. Fragmented Corporate Entity Theory - When you plead that there really arent several sibling companies, just one. The assets of one company are really the assets of all of them. Pleading this may be easier than pleading piercing. Were ten cab companies really one
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big company owned by Carlton? Here, they should have gone after the assets of all ten companies, whereas piercing would have meant the assets of Carlton. 10. Fletcher v. Atex, Inc. (2nd Cir. 1995) A. Court chooses the law of the state of incorporation of the subsidiary to decide piercing. B. The Alter Ego Theory. Since many corporations are incorporated in DE, this test from this case is probably important. In DE, P must show: 1. Parent & subsidiary operated as single economic entity, which can be shown by many of the factors in the preceding cases: A. Undercapitalization. B. Solvency of subsidiary. C. Payment of dividends. D. Corporate formalities. E. Functioning directors. F. Siphoning of funds by dominant shareholder. G. Subsidiary functioning as facade of dominant shareholder. 2. An overall element of injustice or unfairness is present. 11. An important difference between operating as a subsidiary and as a division or department of the company is that the subsidiary has legal separation from the company, while a division or department does not. E. The Piercing Doctrine in Federal/State Relations 1. United States v. Bestfoods (S.Ct. 1998) A. Who pays under CERCLA? 1. The Supreme Court uses traditional veil piercing: A. The responsible directors/actors had to be actively engaged in operating the site itself, not just managing the subsidiary. B. If you cant show direct operation, then show direct influence over daily operations of the site. 2. The issue of whether CERCLA cases are governed by federal or state law have yet to be resolved. 2. Stark v. Flemming (9th Cir. 1960) - nothing useful. 3. Roccograndi v. Unemployment Comp. Bd. of Review (PA, 1962) A. If youre self-employed, you cant lay yourself off. Court will ignore the existence of your corporation.
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F. Reverse Piercing 1. Cargill, Inc. v. Hedge (MN, 1985) A. Defendant, not plaintiff, wanted to pierce, and be treated as an individual instead of a corporation. 1. Factors the court considered: A. Degree of identity between individual and his/her corporation. B. Extent to which corporation is an alter ego. C. Whether others, such as creditor or other shareholders, would be harmed by the pierce. D. Policy reasons. Ex: furtherance of homestead exemption. 2. Pepper v. Litton (S.Ct. 1939) A. Deep Rock Doctrine - a dominant-control shareholder will have his claim against the corporation subordinated if he abused his position to make his claim come ahead of other creditors. Its a matter of equity. B. The test is a violation of fair play and good conscience; a breach of fiduciary standards of conduct owed to your corporation, its stockholders, and creditors. G. Florida Veil Piercing 1. Dania Jai-Alai Palace, Inc. v. Sykes (FL, 1984) A. Piercing may be granted if you prove Improper Conduct. Its conduct worse than in the alter ego test, but better than fraud. B. District courts conflict as to what Improper Conduct means. You can find cases to support any position, depending on whom you represent. H. Summary of Veil Piercing 1. Some or all shareholders will be liable for corporations obligations. 2. Done in extreme cases. 3. Different states have different standards, but the bottom line is usually what is fair.

CHAPTER 8, FINANCIAL MATTERS AND THE CLOSELY HELD CORPORATION (PAGES 356-412) I. DEBT AND EQUITY CAPITAL ~Capital may be obtained by: 1. Borrowing funds (from friends or banks) 2. Capital contributions (from owners or persons who wish to remain
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inactive) 3. Retaining earnings of the business (rather than distributing them to owners) ~Debt must at some point be paid back; interest is paid periodically and its repayment is not dependent on the earnings of the business. ~Equity Capital is composed of contributions by: 1. The original entrepreneur(s) 2. Other investors in exchange for ownership interests 3. Retained interests Blue Sky Laws: State statutes that regulate the sales of securities within the specific state. Applicable whenever a business seeks fundsno limit as to amount. II. TYPES OF EQUITY SECURITIES A. Shares: (defined in MBCA 1.40(21) as the units into which the ownership interests in a business are divided) ~There may be different classes of shares, they may have different preferences, limitations and relative rights. ~There may only be one class issued and they may be called: 1) common shares, 2) capital shares, 3) shares, or 4) stock. ~All shares w/in a single class must have identical rights. ~Various designations and rights of shares must be set forth in the ARTICLES OF INCORPORATION (MBCA 6.01). MBCA 6.01(b): FUNDAMENTAL RIGHTS OF SHAREHOLDERS: 1. Entitle to vote for the directors 2. Entitle to the net assets of the corp. (after debts) when distributions are made in the form of dividends/liquidating distributions A. Common and Preferred Shares (When a corp. has ,more than one class of shares they are designated common and preferred. This is not defined in the MBCA.) ~Common Shares have the fundamental rights described in MBCA 6.01(b). Their financial interest is open-ended, b/c they benefit as the business prospers. ~US Housing Foundation, Inc. v. Forman, 421 US 837, enumerates the rights of Common Share holders: 1) right to receive dividends, 2) negotiability, 3) ability to be pledges or hypothecated, 4) capacity to increase in value and 5) voting rights in proportion to the number of shares owned. ~Preferred Shares (MBCA 13.01(6)) have preferential, limited rights. These shareholders are entitled to a specified distribution b4 anything is paid on the common shares. A.
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Special rights of publicly traded preferred shares

i. May be cumulative, noncumulative or partially cumulative dividend rights: 1. Cumulative Dividend: if preferred dividend is not paid in any year, it accumulates and must be paid b/4 any dividend may be paid on the common shares. Unpaid cumulative dividends are not debt, but simply a right of priority in future distributions. 2. Noncumulative Dividend: not carries over from one year to the next. If a dividend is not declared that year, this preferred stock holder loses the dividend from that year. 3. Partially Cumulative Dividend: cumulative to the extent that there are earnings in a year and noncumulative to any excess dividend preferences. ii. Preferred shares are usually nonvoting shares, with many exceptions: ~Example: For the election of a specified number of directors if preferred dividends have been omitted for a specified period. iii. Liquidation Preferences is in addition to the dividend preferences. It is not a debt, but merely a claim to priority if and when funds become available. The liquidation preference is often fixed at a special price per share. iv. Redemption rights means that the corporation has the power to redeem or call back the preferred shares at any time at a fixed price. The fixed price is usually set by the AOII or typically more than the liquidation preference. Redemption can usually only be exercised after a specific amount of time.

~Example: If the corporation calls back the stock and the stockholder has a $100 liquidation preference, the fixed price of the redemption would probably be $105 + any unpaid cumulative dividends. If the stockholder refuses, the corp will simply put the $105 in a bank and refuse to recognize the stock certificate. v. Conversion Rights means that the preferred shares may be converted at the option of the holder into common shares called Convertible Preferred Shares. These are appealing when the common shares are publicly traded. ~Converting allows a preferred holder to gain long term profit in the appreciation of the business and in return they give up their right of preference. ~Convertible Shares are also usually redeemable, however, usually the privilege to convert continues for a limited period of time after the call for redemption. ~A conversion is forced when shares are called when the market value of the shares obtainable exceeds the redemption price. ~A corp. may issue different classes of preferred shares, with different rights. ~There is a series of preferred shares where the directors may establish the terms w/o amending the AOI, usually called blank shares.
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D. Classes of common shares (MBCA 6.01) ~Classes of common shares are usually referenced alphabetically, i.e., Class A common shares, or by description, i.e., nonvoting common shares. III. ISSUANCE OF SHARES: HEREIN OF SUBSCRIPTIONS, PAR VALUE AND WATERED STOCK A. Shared subscription s and agreements to purchase securities (MBCA 6.20) ~Historically, subscription agreements were utilized to raise capital for a new corporation. ~Subscription Agreements occur when persons agree to purchase a specified number of shares contingent upon a specified number of capital being raised. ~Now, we use (mostly) Contractual Agreements to purchase securities. A. Authorization and issuance of common shares under the MBCA ~Prices for shares must be the same for, say A and B shares if they are to be treated equally, but the # of shares and corresponding price may be set at any level. A. Par Value and stated capital ~Concept of par value has been made optional by the MBCA. ~MBCA (1969) 54(d), 15 (second sentence), 18, 21. Par value is whatever amount that is designated by the drafter, it could be one mill, one cent, etc. Par value originally ensured proportionality of treatment and increased confidence the the shares had real value. ~Watered Stock is stock issued for less than par value. HANEWALD v. BRYANS INC., A shareholder may be held personally liable to his corporate creditors where and to the extent that his stock has not been paid for. MBCA 25. Purpose is to protect the public and those dealing with the corporation.

1.

D. Eligible and Ineligible considerations for shares (MBCA 19) ~Shares issued for a promissory note are prohibited. ~Intangible property is difficult to value; see Brumfield v. Horn, 547 So.2d 415 and Public Inv. Ltd. v. Bandeirante Corp., 740 F.2d 1222. D. Par value in modern practice ~most often, nominal par value is followed. That is to use a par value of one cent, ten cents, etc. when the shares are issued for several dollars or more per share. ~Par value is in no way an indication of the price at which the shares are issued.
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~One significant purpose of par value is to avoid watered stock liabilitythe issuance price for shares of stock must be equal to or greater than par value. ~Arguments in favor of nominal par value, 1) property may not be worth the par value of the shares received and the recipient may be sued for the difference; and 2) nominal par shares increase corporate flexibility in making distributions in the future. 2. TORRES v. SPEISER, 1) The Corp. may price its stock at less than par when the stock is not the original issuance; and 2) their agreement was based on mutually acceptable terms, which is essentially an agreement to agree, which is unenforceable.

IV DEBT FINANCING ~Debenture is an unsecured corporate obligation. ~A Bond is secured by a lien or mortgage on corporate property. ~Traditionally, debentures and bonds were payable to bearer and the interest was kept track of by way of interest coupons, which were attached to the debt security. The owner would clip, or cut off the coupon and submit it to the corporation for payment. ~A registered bond is one that has been registered in the name of a specific individual. ~Today, Zero coupon bonds are issued, often called Zeroes. They pay no interest at all, they sell at a substantial discount from face value and upon maturity, the holder receives face value. A. Concept of Leverage ~debt owed to third persons is leverage. ~Leverage is favorable to the borrower when the borrower is able to earn more on the borrowed capital than the cost of the borrowing.

A. Tax Treatment of debt ~A loan by a shareholder to his corp. reduces the double tax problem of a C corp. ~Risk of business formulation=contributors of capital undertake the risk because of the potential return; in the form of profits and enhanced value on their underlying investment. A. Debt as a planning device ~subordinating equity concept is the same as the deep rock doctrine at a state level. V. PLANNING THE CAPITAL STRUCTURE FOR THE CLOSELY HELD
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CORPORATION , Questions to ask when approached by a client for purposes of the capital structure: 1. Will the structure stand up when later faced with disagreements? I.e., a legal attack? 2. Will the structure provide the desired result, i.e., the client should be aware that the directors may choose to forego dividends on the preferred stock if they so choose? 3. Is the desired tax treatment available; C or S corp.? 4. Unexpected liabilities? 5. Clients financial contributions reasonably protected? VI. PUBLIC OFFERINGS ~Full compliance with the Securities Act of 1933, 77a-77aa involves the filing of a registration statement with the SEC. A registration statement has two parts: 1) a prospectus [a document to be distributed to potential and existing contributors], and 2) additional information that must be submitted to the SEC and is publicly available but need not be included in the prospectus. ~an unseasoned company one whose shares are not widely traded in the public markets and which has never previously filed a registration statement. ~Public offerings must comply with the state blue sky laws. ~some companies have offered free stock over the internet to investors who will simply visit their web site, purpose is to create a public market. 3. SEC V. RALSTON PURINA CO., For registration not to be required, transactions involving any public offering are exempted when all the offerees have access to the same kind of information that would be available if registration were required and have sufficient financial savy with regard to that transaction( ie. offers to board members, execs.) In this case, would have had to register.)

A. Securities Act Release No. 33-5450 ~Section 3(a)(11) was intended to allow issuers with local operations to sell securities as part of a plan of local financing. ~The Transaction Concept, the exemption covers only specific transactions and not the securities themselves. ~The Part of an issue concept, case by case basis. ~The person resident within concept, after securities have come to a rest within the state/territory, then the determination of whether all parts of the issue have been sold only to residents can be made. ~The doing business within requirement, the business must be located within the state and the principal or predominant business must be carried on here; substantially all of the proceeds of the offering must be put to use within the local area.
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A. Securities Act Release No. 33-6389 ~designed to simplify and clarify existing exemptions, expand their availability, and to achieve uniformity b/w federal and state exemptions. A. Securities without registration under the Securities Act of 1933 ~Regulation D is intended to be a basic element in the uniformity b/w Federal and State limited offering exemptions under Securities Act of 1933 18, 19(c). 4. SMITH v. GROSS, Test for investment K type of security is: 1) whether the scheme involves an investment of money; 2) whether the scheme is in a common enterprise; and 3) the profits came solely from the efforts of others.

Chapter Eight - Second Half Pages 414 - 463 A. Issuance of Shares by a Going Concern: Preemptive Rights and Dilution 1. Stokes v. Continental Trust Co. of City of New York Preemptive Rights - right whereby existing shareholders are given a right to acquire additional shares in a pro rata basis in order to maintain your proportionate interest in the corporation. Issue - Whether a shareholder has a legal right to subscribe for and take the same number of shares of newly offered stock that he had of the old stock. Rule of Law - Stockholders have a preemptive right to buy or turn down offer to buy more stock and have their stock diluted, as a matter of property law (the ownership of the stock, you have the right to vote). Case was decided prior to the formation of the MBCA, which allow corporation to opt-in or opt-out of preemptive rights in the Articles of Incorporation. See MBCA 6.30. Most publically traded corporation do not offer preemptive rights to stockholders. 2. Katzowitz v. Sidler
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Issue - Must additional shares in a corporation be offered to existing shareholders before new shareholders at a set, fair price? Rule of Law - Closely-held corporations may not issue new stocks for the sole purposes of squeezing out or diluting the shares of the partners who do not wish to purchase more shares and have no reason to purchase more shares. The price of the shares must also be offered to the remaining shareholders at a set, fair and legally adequate price. Closely-held Corporations are sometimes treated as partnerships by the courts when there is a small number of stock owners and the share holders are also the directors. In this case, the directors owe a fiduciary duty to one another to act in good faith. B. Distributions by a Closely Held Corporation 1. Gottfried v. Gottfried Issue - May a closely-held corporation be compelled to declare dividends on its common stock? Rule of Law - If an adequate corporate surplus is available for the purpose of distribution, directors may not withhold the declaration of dividends in bad faith. But the mere existence of an adequate corporate surplus is not sufficient to invoke court action to compel such a dividend. There must also be bad faith on the part of the directors. Admissible evidence of bad faith - Intense hostility of the controlling faction against the minority; exclusion of the minority from employment by the corporation; high salaries, or bonuses or corporate loans made to the officers in control; the fact that the majority group may be subject to high personal income taxes if substantial dividends are paid; the existence of a desire by the controlling directors to acquire the minority stock interest as cheaply as possible. If these are not motivating factors for withholding dividends, they do not constitute bad faith as a matter of law. 2. Dodge v. Ford Motor Co.
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Issue - May a corporation that has increased profits dramatically reduce the distribution of dividends in order to put the money back into the business at the expense of the shareholders? Rule of Law - A business corporation is organized and carried on primarily for the profits 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, or to the non-distribution of profits among stockholders in order to devote them for other purposes. 3. Wilderman v. Wilderman Issue - May excessive bonuses and salaries granted to the sole director in a closely held corporation be regarded as corporate profits and placed back into the treasury and distributed as corporate dividends to the shareholders. Rule of Law - Directors have a fiduciary duty to the stockholders and may not deduct a salary that is unreasonable as according to the Internal Revenue Service. 4. Business Organizations: Unincorporated Business and CloselyHeld Corporations Distributions - made when dividends are given to stockholders or when the corporation repurchases its own stock proportionately from each shareholder. Disproportionate Distribution - repurchase of shares held by just one shareholder (as opposed to proportionately from all) by the corporation. The corporation has made a distribution to the shareholder equal to the purchase price of the stock. A corporation cannot treat stock in itself that it has purchased as an asset any more than it can treat its authorized but unissued stock as an asset. Treasury Shares - Outstanding shares reacquired by the corporation. Treasury shares are held by the corporation until they are retired permanently or resold to someone else. They are not an asset of the corporation even though they are salable and may be sold at some later time.
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Investment - Transactions in which a corporation purchases stock issued by another corporation. 5. Donahue v. Rodd Electrotype Co. 1 Rule of Law - If the stockholder whose shares were purchased was a member of the controlling (majority) group, the controlling stockholders must cause the corporation to offer each stockholder as equal opportunity to sell a ratable number of his shares to the corporation at an identical price. C. Legal Restrictions on Distributions 1. Model Business Corporation Act Section 6.40 of the MBCA - Outlines the test and restrictions used by the majority of states for legality of distributions of capital, of dividends, and of reacquisition of shares. Distributions are authorized by the board of directors. Absolutely no distribution of dividends can be made (even if authorized by the board of directors) if: - the corporation would not be able to pay its debts - the corporations total assets would be less than its liabilities plus the amount that would be needed at dissolution to satisfy all preferential rights of all shareholders. 2. Equity Insolvency Test Used prior to Section 6.40 of the MBCA. Is incorporated into the statute under 6.40(c)(1). Test that prohibited payments of dividends if the corporation was, or as a result of payment would be, insolvent in the equity sense.

3. Balance Sheet Test

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Incorporated under 6.40(c)(2). Test that prohibited payment of dividends if the corporations total assets would be less than its liabilities plus the amount that would be needed at dissolution to satisfy all preferential rights of all shareholders. Sec. 6.40 authorizes asset and liability determinations to be made for this purpose on the basis of either (1) financial statements prepared on the basis of accounting practices and principles that are reasonable in the circumstances or (2) a fair valuation or other method that is reasonable in the circumstances. 4. Preferential Dissolution Rights and the Balance Sheet Test The addition of a surplus for distribution to preferential stockholders on dissolution in the Balancing Sheet Test treats preferential dissolution rights as if they were liabilities for the sole purpose of determining the amount available for distributions. 5. Timing and Indebtedness All indebtedness, whether it would be from reacquiring shares or using creditors, the transactions are judged at the time the debt is incurred for legal purposes. A leveraged buyout of bonds does not constitute a distribution of assets.

D. Non-Model Act Statutes 1. Pure Insolvency Test Liability is imposed on directors if the distribution renders the corporation insolvent or left with insufficient property to pay its debts. 2. Earned Surplus Dividend Statutes General Test for the legality of a dividend as:
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(1) the availability of earned surplus out of which the dividend may be paid, and (2) a solvency test to be applied immediately after giving effect to the dividend. Earned Surplus - the aggregation of income from all profit-andloss statements going back to the time the corporation was organized. Nimble Dividends - Dividends paid out from current earnings; not permitted in some states. 3. Impairment of Capital Dividend Statutes Payment of dividends based on a balance sheet rather than income statement analysis. 4. Distribution of Capital Surplus Distributions made out of the capital surplus. Only used by seven states. Chapter 9: pp. 463- 485 & pp. 492-544 McQuade v. Stoneham Facts: the majority shareholder (Stoneham) and 2 minority shareholders (one being McQuade) agreed that all would use their best efforts to keep one another in office as directors and officers at specified salaries. Later on, Stoneham refused to try and keep McQuade in office as director and treasurer; McQuade was dropped from his positions and he sued for breach; Holding: The Court held that the shareholder agreement was invalid and held for the defendants; Rationale: stockholders may not, by agreeing by themselves, place limitations on the power of the directors to manage the business of the corporation by the selection of agents at specified salaries; Notes: The Board must be left free to exercise its own business judgment;
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The agreement here prevented the board from doing that by trying to say that the board could not fire McQuade. * an agreement that results in a board of directors not being able to use their best business judgment might result in unfair and unnecessary injury to a minority shareholder or even a creditor. *so, while stockholders can by all means get together and elect directors, they cannot enter into contracts that limit the directors powers to manage the business of the corp;

-there is a trend in some jurisdictions, though, to allow such arrangements that interfere to some extent with the discretion of the board of directors (see case below) Galler v. Galler Facts: the two principal owners of the corporation, Ben and Isadore, each owned 47.5% of the stock. They signed a shareholders agreement in which they agreed to pay certain dividends every year and to pay, in case either should die, a specified pension to his/her widow. Ben died and Isadore refused to carry out the agreement Holding: Court upheld the agreement even though it limited the discretion of the board of directors. Rationale: The Court required an agreement to satisfy a 3-part test b-4 it would enforce it: (1) there must be no minority interest who is injured by it; (2) there must be no injury to the public or creditors; (3) the agreement must not violate a clear statutory prohibition; Notes: The Courts main point here was that, in closely-held corporations, we should allow broad shareholder agreements b/c here they are more than mere investors and usually started the corp. and invested all of their money and they shouldnt lose control to some unknowledgeable or oppressive majority; *the 3 requirements established in this case represent the modern majority view

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Zion b. Kurtz Facts: all stockholders agreed that they would not allow the corporation to get into any business transactions over Kurtzs objection. This corp. was incorporated in Delaware. There was a statute that would have allowed this arrangement to be valid if the corp. had elected to be treated as a statutory close corporation and put in its articles of incorporation a special provision to have the corp. run by its shareholder rather than the directors. The corporation had done neither.

Holding: The Court viewed these omissions as technical ones that could be remedied by another court and thus upheld and enforced the arrangement; Notes: This case indicates that the courts (at least this one) are now somewhat more willing to enforce director-fettering arrangements, at least those approved by all shareholders and injuring no one. Shareholder Voting and Agreements (pp. 492-544) Salgo v. Matthews Facts: Salgo was the president of Electrodynamics, Inc. Salgo appointed an attorney, Julian Meer, as election inspector. At the election, Salgo presented Meer with documents showing that proxies had been given to him on behalf of Pioneer Co. to enable Salgo to vote for them. Meer, however, refused to accept any of the proxies. The validity of the proxies was the main issue here. Holding: Held for Meer & Matthews; Rationale: an election inspector has the discretionary authority to determine the validity of proxies; Also, the corporation had in its bylaws that stock ownership is determined by the looking at the books. Here, the defendants argue that the person who gave the proxy did not have beneficial title but, according to the by-laws, they did in the books and the election inspector did the right thing. Notes: the main point derived from this case is that shares are always registered in the name of a specific person on the records of the corp. called the record owner and may or may not be the actual owners of the shares (beneficial owner). **The corporation may
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treat the record owner as the owner for purposes such as voting, payment of dividends, etc. Cumulative vs. Straight Voting Cumulative: allows a shareholder to aggregate all of his in favor of fewer candidates *the consequence here is that a minority shareholder is far more likely to get at least 1 seat on the Board; EX: A had 72 shares, B has 28 and they are electing 3 directors. In cumulative voting, B can take his entire package of 84 votes (28 shares X 3 seats) and put it all on his single favorite candidate; So, then A cannot divide his 216 (72 X 3) votes in a way that he has 3 candidates that beats Bs candidate- so, Bs guy gets on. Straight: each share may be voted for as many candidates as there are open slots on the Board, but no share may be voted more than once for any candidate. EX: A and B are sole shareholders; A has 72 shares, B has 28. The board has 3 directors. A cannot cast more than 72 votes for a single candidate, and, more importantly, B cannot cast more than 28 for one single candidate. So, As 3 candidates will receive 72 votes each and Bs 3 candidates will receive 28 each- As candidates will get all the seats on the Board! *so, if you have a majority(even 51/49), you simply will not get a seat on the Board; Ringling Bros.-Barnum & Bailey vs. Ringling Facts: Mrs. Ringling, Mrs. Haley & Mr. North are the 3 shareholders of the Corporation. Mrs. Ringling and Mrs. Haley sign a voting agreement in which both agree to consult the other and to vote their shares together on any issue put to vote. They also agree that if they disagree, their lawyer will act as arbitrator. They end up disagreeing and the arbitrator is called in. Ringling agrees to vote the way the arbitrator ruled but Haley refuses. The chairman rules that the arbitrator may cast Haleys votes (per the agreement) For whatever reason, Ringling (not Haley) sues to overturn the election. Holding: the agreement is valid but the court refuses to say that Haley created an irrevocable proxy in the arbitrator. Instead, they deny specific performance and say that Ringlings remedy is that Haleys votes dont count;
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Notes: most courts today would give Ringling the specific performance as a lot of states now have statutes in place that make such voting agreements specifically enforceable (as does the RMBCA ( 7.31(b))) Proxies (1) Every shareholder is entitled to vote at a meeting of shareholders or to authorize another person to act for him by proxy (2) No proxy is valid after 11 months unless otherwise provided in the proxy and every proxy is revocable at the will of the shareholder (3) A proxy is not revoked by the death or incompetence of shareholder unless if, before the authority is exercised, written notice of an adjudication of such incompetence or death is received by the officer responsible for maintaining the list of shareholders (4) Except when otherwise provided, the record holder of the shares has to issue a proxy at the demand of the pledgor. (5) A shareholder cannot sell his vote or issue a proxy to any person for money/value (6) A proxy labeled irrevocable is just that with a lot of exceptions though if it held by a pledgee, a creditor who is still extending credit, a person who has purchased the shares, etc. (someone with an interest) (7) A proxy can be revoked, notwithstanding a provision making it irrevocable, by a purchaser of shares without knowledge of the provision unless the irrevocability is noted conspicuously on in the certificate How can a shareholder issue a proxy?: (1) execute a writing (2) by transmitting or authorizing the transmission of a telegram, cablegram or any other electronic transmission provided that the info in it can be reasonably determined to be an authorization (3) any copy, fax, or other reliable reproduction can be used in lieu of an original writing provided that the copy id a complete reproduction of original Brown v. McLanahan Facts: Brown, the holder of voting trust certificates representing 500 shares of the preferred stock brought this suit against the company itself and everyone affiliated with it to try and set aside as unlawful an
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amendment to the companys charter that tries to vest voting rights in the debenture holders (people who have a certificate acknowledging a debt); Plaintiff alleges that this will dilute the voting power; that it was beyond the power of the trustees to diminish the voting power which they held in trust for holders of preferred stock and that it was an abuse of trust (fiduciary) to use their temporary voting power to their advantage and to the disadvantage of the actual shareholders; Holding: this action was beyond the power of the trustees; Notes: *the voting trustees are subject to the fiduciary obligations of trustees in general; They may exercise only those powers specifically spelled out in the trust and, unless the trust says they can, they may not vote in a way that damages the beneficial owners they represent; Lehrman v. Cohen Facts: The Lehrman and Cohen families each owned half the stock of Giant Food Corp.. They were worried that dissention between and within the families may interfere with the business so agree to create 3 classes of common stock: classes AL, AC, and AD. All AL stocks belongs to the Lehrmans, all AC stock to the Cohens, and the single share of AD to the companys lawyer. The certificate of incorporation is amended to give the AL holders and AC holders each the right to elect 2 directors and the AD holder the right to elect t he 5th (tie-breaking) director. After a peaceful 15 years, the AC and AD stock votes in favor of giving the layer (the holder of the AD stock) a 15-year contract as president. The AL holders oppose and sue to have the whole classification scheme ruled invalid on the theory that it doesnt conform with statutory requirements for such trusts; Holding: The arrangement is valid; Rationale: The creation of the AD stock did not separate the voting rights of the AC or AL classes from the other ownership aspects of those classes. Instead, there was simply a new class created; the fact that this new class somewhat diminished the voting power of the old classes didnt amount to creation of a voting trust. Ling and Co. v. Trinity Savings and Loan Assn Facts: A single line of small type on the front of the stock certificate referred to a 14-line small-type paragraph on the back. This paragraph in turn refers in very general terms to transfer restrictions in the articles of
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incorporation; Holding: The transfer restrictions were not conspicuous as required by 8204(a) of the UCC b/c something must appear on the face of the certificate to attract the attention of a reasonable person when he looks at it.

Buy-Sell Agreements Similar to a buy-back right except that the corporation is obliged to go through with the purchase when some specified event happens; -most often used when corporation and shareholders agree that corp. will re-purchase shares if the shareholder dies- this guarantees the shareholders estate a market for the stock; -the buy-back price is usually determined in one of 4 ways: (1) book value of shares at death (2) fixed price set in agreement (3) price fixed after death by appraisal (4) some self-adjusting formula 2 types of Buy-Sell agreements: (1) cross-purchase: each shareholder agrees to personally purchase his proportionate share of the stock of the other shareholders in the event of their death (2) stock-redemption: the corporation agrees to redeem or purchase the shares of the 1st shareholder to die and each of the 2 shareholders would bind his estate to sell or tender for redemption the shares he owns. Upon the death of the 1st shareholder, the corporation buys his shares using corporate funds. Chapter 9 Part 2......pages 545-602 C. DEADLOCK Gearing v. Kelly, NY CoA, 1962 Opposing parties each own 50% of stock and had 2 representatives on the board h/e after resignation, Kelly had 2:1 advantage with the vacancy Gearing rep did not attend meeting to avoid a quorum vote
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Kelly contingent elected a family member to vacancy Appellants motion to set aside election of a Board Director, claiming failure of quorum bars valid vote Court denied motion to set aside and order election stating that to do so would support stockholders in efforts to frustrate corporate action for their own gain Dissent opinion looked to original articles of incorporation which provided for 4 board members and identified a majority as a quorum 2 is insufficient Dissent further reports that in a contest for control, courts should not assist either side but may either confirm election or order new vote as justice may require If a member avoids a meeting to frustrate purpose of having control stripped and a deadlock results, other remedies are available ***====> MBCA 8.10 Vacancy on Board (a)(3) if the directors remaining in office constitute fewer than a quorum of the board, they may fill the vacancy by affirmative vote of a majority of all directors remaining in office In Re Radom & Neidorff, Inc. - NY CoA, 1954 Equal shareholding brother and sister Radom managed and ran business after death of Sisters husband (Neidorff) Concurrent civil action pending sister claiming Radom was holding out and gaining for his exclusive benefit (unjust enrichment) Radoms new action petitions for dissolution as remedy for deadlock b/c sister refuses to sign Radoms salary check, also refuses to elect directors to boardCorporate assets ~ $90k Neidorff responds that Radon offered $75k to buy her out, when she refused he threatened to dissolve the corporation and buy back in at lower value Neidorff further responds that she has signed all checks except salary for Radon b/c of pending suit claiming his unjust enrichment at expense of company Court reviewed the success of the business during the 3 years since death of
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Mr. Neidorff (sisters husband) -profits ~ $71k/yr then, -2 stockholders with dislike for each other; despite bad blood, there is no corporate stalemate; corporation is flourishingdissolution is unnecessary b/c Radons exclusive complaint is nonpayment of his salary Petition for dissolution arises from (NY) General Corporation Law 103 which describes situations where dissolution may be petitioned, but is not a mandatory grant 103 Petition in case of Deadlock Unless otherwise provided in certificate of incorporation, if corporation has an even number of directors who are equally divided respecting the management of its affairs, or if the votes of its stockholders are so divided that they cannot elect a board of directors, the holders of of the stock entitled to vote at an election of directors may present a verified petition for dissolution of the corporation as prescribed in this article The court found that dissolution is granted only when the competing interests are so discordant as to prevent efficient management and the object of its corporate existence cannot be attained. As the only real issue was failure of petitioner Radon to receive his salary, and that it did not frustrate the corporate business, as well as available remedy by other means, petition is denied. Dissent opinion points out that 103 resolves deadlocked management without regard for whether business is conducted at a loss or profit MBCA 14.30 Grounds for Judicial Dissolution The court may dissolve a corporation : (2) in a proceeding by a shareholder IF: (i) directors are deadlocked re: management, shareholders cannot break deadlock AND irreparable injury to the corporation is threatened or suffered OR business and affairs of corporation can no longer be conducted to the advantage of shareholders b/c of the
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deadlock D. Modern Remedies for Oppression, Dissension or Deadlock MBCA 14.30(2) is typical of statutes for involuntary dissolution for deadlock, Also, applied in many states for oppression, significant misconduct by directors and misapplication or wasting of assets Davis v. Sheerin, CoA Texas 1988 Davis 55% shareholder, appeals court ordered buy-out of Sheerins 45% share Sheerin brought original claim as oppressed minority shareholder (Sheerin was not corporate employee, Davis denied him the right to inspect corporate books jury ordered FMV buy-out) Issue falls to:

1. How is oppression defined? Oppression is deemed to arise only when the majoritys conduct substantially defeats the expectations that objectively viewed were both reasonable under the circumstances and were central to the minority shareholders decision to join the venture; and, Oppression is defined as burdensome, harsh and wrongful conduct, a lack of probity and fair dealing in the affairs of a company to the prejudice of some of its members or a visible departure from standards of fair dealing, and a violation of fair play on which every shareholder who entrusts his money to a company is entitled to rely. ***===>Oppressive conduct is an independent ground for relief not requiring a showing of fraud, illegality, mismanagement, wasting of assets nor deadlock. 2. What is the appropriate remedy? When less harsh remedies are in adequate to protect the rights of the parties, courts may decree a buy-out. Caselaw supports buy-out as less drastic measure than liquidation even when statutes like MBCA 14.30 only refer to dissolution. **Oppression is most common violation ===> buy-out.
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Abreu v. Unica Indus. Sales, Appellate Court of Illinois, 1991 Appeal of adjudicated fiduciary breach for oppression and fraudulent selfdealing which threatened corporate solvency. Defendant appealed court appointment of Plaintiffs son-in-law as provisional director to break any deadlocks based on presumption that he would not be impartial. Court applied Illinois Business Corporation Act 12.55 Alternative Remedies to Judicial Dissolution -the court in lieu of dismissing the action or ordering dissolution may retain jurisdiction and: Appoint a provisional director; custodian/receiver; or in an action by a shareholder, order a purchase of complaining shareholders shares (buy-out) A provisional director -May be named w/o regard for whether a board vacancy exists Shall have rights and powers of a duly elected director, including right to notice and voting power Until removed by order of the court, removed by a vote of shareholder majority sufficient to meet election requirements (quorum or majority)

*** Court denied appeal declaring that no obligation to impartiality exists and that a when appointing a provisional director only the best interest of the corporation need be attended to. Factors for evaluating best candidate for provisional director: * degree and quality of past involvement * understanding of corporations history and current situation * experience and ability to provide a cooperative unifying element * need for immediate appointment * degree of impartiality AND ===> ***True interest in the viability and advancement of the corporation as an entity and not allegiance to one of the deadlocked factions
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Trial court has a duty to oversee a provisional directors actions they are officers of the court and must act accordingly within court directed limitations E. Action by the Directors and Officers In The Matter of Drive-In Dev. Corp., USCA, 7th Cir., 1966 Issue of whether a corporation can be bound to a guaranty made by board member who had NO authority to do so Chairman of Drive-In corporation made a guarantee of payment for a bank loan to their parent company. Secretary of the board provided authorized, certified copy of board resolution giving authority for guarantee. No such guarantee is evidenced in minutes of board directors meeting. Referee declared that the guarantee was made with no authority either actual, or implied or apparent. However, as the secretary offered certified copy of a resolution re: the loan guarantee to support the chairmans claim, the appeals court reversed the referee, estopping denial of authority. ***===>Statements made by an officer or agent in the course of a transaction in which the corporation is engaged and are which are within the scope of his authority are binding upon the corporation. [the realities of modern corporate business practices do not contemplate that those who deal with officers or agents acting for a corporation should be required to go behind the representatives who have authority andverify the authority] Black v. Harrison Home Co., Sup. Ct. Calif., 1909 Mrs. Harrison owned 502/1000 shares in Harrison Home Co. Daughter owned remaining 498 shares, died intestate. Black sought specific performance of contract to sell property made with Mrs. Harrison Though presumed that as only heir, Mrs. H would receive the 498 shares, the estate had not been resolved, therefore she was not (yet) in possession of the shares. As a result the corporation could not be bound to the contract entered into by Mrs. H
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***===> A corporation will be bound so far as 3rd persons are concerned by the acts of its agent which are within the apparent scope of their authority, and that the authority of an officer to make certain contracts on behalf of the corporation may arise as to 3rd persons from his having assumed and exercised that authority in the past with the acquiescence of the corporation, and that a corporation may ratify and render binding a contract entered into by one of its officers in excess of his authority. (*N.B. Silence = Authority) MBCA 8.21 Action Without Meeting Unless otherwise prohibited in either articles of incorporation or by laws, informal unanimous decisions are binding so long as all board members subsequently sign written consent requirement and is noted in either minutes or corporate records. Lee v. Jenkins Bros. , USCA, 2nd Cir., 1959 Lee was promised a guaranteed pension to induce employment 37 years prior by now deceased board members, no written proof exists. Jenkins Bros. asserts that late President had no express, implied or apparent authority to enter into such (oral) contract. Appeal issue is whether an apparent authority existed. ***===> President only has authority to bind his company by acts arising in the usual and regular course of business but NOT for contracts of an extraordinarynature. ***===> Apparent authority depends not on the nature of the contract involved, but the officer negotiating it, the corporations usual manner of conducting business, the size of the corporation and the number of its stockholders, the circumstances that give rise to the contract, the reasonableness of the contract, the amount involved, and who the contracting 3rd party is (this is a partial list of relevant factors)
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*When an agent is an executive of a corporation, the application of actual and apparent authority rests on the executives formal position. MBCA 8.30 General Standards for Directors -Codifies Business Judgment Rule (a) A director shall discharge his duties as director, including duties as a member of a committee (1) in good faith (2) with the care an ordinarily prudent person in a like position would exercise under similar conditions; and (3) in a manner he reasonably believes to be in the be in the best interests of the corporation *Directors may be subject to personal liability for failing to use due care in decision making, failing to make decisions, or failing to be attentive to corporate affairs. F. Transactions in Controlling Shares Zetlin v. Hanson Holdings, Inc., NY CoA, 1979 Hanson (44% majority stockholder) sold entire controlling interest to 3rd party for 2x current trading value Zetlin (2% shareholder) petitioned that minority shareholders are entitled to share in the premium price paid for controlling interest. Court denied stating that to do so would require new legislation and contradict existing law ***===> Absent looting of corporate assets, conversion of a corporate opportunity, fraud or other acts of bad faith, a controlling stockholder is free to sell, and a purchaser is free to buy, that controlling interest at a premium price. Minority shareholders are entitled to protection against abuse by controlling shareholders, but NOT to inhibit legitimate interests of other stockholders. (Privilege of controlling interest ability to influence corporate affairs is what commands the premium price)
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Debaun v. First W. Bank and Trust Co., CoA Calif., 1975 Defendant Bank was 70% majority shareholder Opted to sell out position of flourishing corp. without notifying minority shareholders. Bank had knowledge of purchasers history of looting corporations and destroying them as well as judgments against, pending litigation and poor reputation with rating and recording reporting services. Bank failed to investigate negative history and dealings by purchaser. Buyer raided accounts, and generally mismanaged corporation into the ground for his exclusive gain and profit. Plaintiffs filed claim for rights as shareholders to recover against bank for damages Courts recognize that corporate control by majority ownership of shares may be misused: ***===> In any transaction where the control of the corporation is material the controlling majority shareholder must exercise good faith and fairness from the viewpoint of the corporation and those interested therein ***===>The duty of good faith and fairness encompasses an obligation of the controlling shareholder in possession of facts such as to awaken the suspicion and put a (reasonably) prudent man on his guard [that a potential buyer may loot the corporation of its assets to pay for the shares purchased] to conduct a reasonable adequate investigation [of the buyer] *Award was for total damages = the sum to restore negative net worth + value of tangible assets + going business value determined with reasonable estimation of future profits Perlman v. Feldmann, USCA 2nd Cir., 1955 Defendant Feldmann was dominant stockholder, chairman of board and president of corporation which produced sheet steel. Feldmann sold his stock interest to a Syndicate group of sheet steel end-users during a time where sheet steel was a demand commodity. Feldmann Plan took advantage for personal gain of his position and knowledge to benefit from the sale of his controlling stock interest to a party that had need for the end-product. The buyer now had an ability to control the price from the
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inside, undermining future profit gains of the remaining minority shareholders. ***===> Directors of a business corporation act in a strictly fiduciary capacity. Their office is a trust. When a director deals with his corporation, his acts will be closely scrutinized. Directors of a corporation are its agents, and they are governed by the rules of law applicable to other agents, and, as between themselves and their principal, the rules relating to honesty and fair dealing in the management of the affairs of their principal are applicable. They must NOT in any degree allow their official conduct to be swayed by their private interest, which MUST yield to official duty. ***===> The first principal duty in a directors official relation is to act in all things wholly for the benefit of the corporation. ***===> Fiduciary obligations of a majority stockholder are the same as for a director because in that capacity he chooses and controls the directors and is held to assume their liability. (Fiduciaries always bear the burden of proof in establishing the fairness of their dealings with trust property) Petition of Caplan, Sup. Ct. NY, Appellate Div., 1st Dept., 1964 Roy Cohn was 3% shareholder in corporation, served as a director and appointed 6 additional directorships of the 10 board members. Cohn sold his interest in a deferred sale. His appointees successively resigned their seats and elected buyers representatives into their seats until Cohn resigned and his directorship went to a representative of the purchaser. Stockholder brought action to set aside and vacate the elections of the 7 directors ***===> Management of a corporation is NOT the subject of trade and CANNOT be
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bought apart from actual stock. Only when a majority of stock, or a percentage which gives working control is transferred, is change of directors by resignation and election to vacancies proper. P601 Notes.....Carter v. Muscat and #3 Chapter 11: DUTY OF CARE AND THE BUSINESS JUDGEMENT RULE PAGE 747 LITWIN v. ALLEN: Supreme Court of NY, 1940 The Plaintiff (shareholders of Guaranty) brought a derivative action against the defendants (directors of the Guaranty). The plaintiffs theory was that the directors action constituted a breach of their duty of care. The defendants as directors had boughten stock and under the purchase agreement the seller had the option to buy the bonds back at sale price within six months of the sale. The bonds declined in value and the seller never buys back the bonds. The court held all of the directors who were present when they voted to buy the stock liable. (As a director if you approve of a transaction or do not verbally disagree than you are deemed to have assented.) The court stated that the purchase-with-option gave the bank no possibility of profit except for the interest it would have derived while holding the stock. The court held that the transaction was so improvident, so dangerous, so unusual and so contrary to ordinary prudent banking practice as to subject the directors who approved it to liability in a derivative stockholders action. The directors had breached their basic duty of care. It was basically a no win transaction. The defendants were only liable for the loss attributable to the improper repurchase option itself.

PAGE 754 SHLENSKY v. WRIGLEY: Appellate Court of Illinois, 1968 The action was a stockholders derivative suit against the directors for negligence and mismanagement. The corporation was also made a defendant. The plaintiff was a minority stockholder of the defendant corporation, Chicago Cubs. Wrigley was a majority shareholder and president of the Chicago Cubs. SHLENSKY brought this suit to compel the corporation to install lights in the stadium so that games could be played at night. He said that the corporation was losing money because they did not have night baseball. He presented no evidence that showed that the corporation was in fact losing money. Wrigley opposed night baseball and refused to install the lights. The court held that the a shareholders derivative suit can only be based on conduct by directors which borders on fraud, illegality or conflict of interest. In this case it was unsure whether the corporation was in fact losing money by not having night baseball. The court stated that absent a form of wrongdoing the courts did not want to get involved and second guess the corporation. They deferred it to the board of directors to decide.
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Difference between the SHLENSKY case and the LITWIN case: The bank directors have an even higher duty because of their position of trust to the public. Furthermore, in the LITWIN case anyone would have said the loan was a clearly bad idea.

Page 767 Smith v. Van Gorkom: Supreme Court of Delaware, 1985 Van Gorkom the defendant acting on his own arbitrarily came up with $55 per share. He then goes t the corporation and stated that he was offered 55 for the shares. He does not state how he came up with the number. They assume that the D used correct methodology to come up with the number rubber stamped it. They should not have assumed anything, they should have stated that they needed time to inform themselves. Even though they probably would have been sued for not selling the stock, they would of had a defense. It was not a real evaluation of the companys worth and the decision constituted gross negligence cause they did not make an informed decision. The ironic part was that the shares sold for more money then they ever were sold before. However, the problem was the process they used. Business Judgment Rule: need to demonstrate that the board was not reasonably informed and they were grossly negligent.

Page 801, Gall v. Exxon, United States District Court, Southern District of New York, 1976 - Gall the Plaintiff is a shareholder of the defendant Exxon corporation. Plaintiffs complaint arises out of the alleged payment by Exxon Corporation of some $59 million in cooperate funds as bribes or political payments to Italian political parties. The defendant moved for summary judgement stating that the Special Committee acting as Board of directors of the corporation has determined in good faith that it is contrary to the interest of Exxon to institute suit on basis of any matters raised in Plaintiffs complaint. The Special committees was formed for the purposes of determining whether Exxons actions in several pending actions relating g to the Italian expenditures. The plaintiff contended that the Special Committee was composed of Exxon directors who were personally involved in the transaction in question. They contended that this involvement would impair their exercise of business judgment on behalf of the corporation. The court held that it was premature to grant summary judgment. The plaintiff must now be given an opportunity to test the Special Committee. This case created the special litigation committees.

Page 816 Aaronson v. Lewis, Supreme Court of Delaware, 1984

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Aaronson Plaintiff and others brought a shareholders derivative action. They contended that the defendant Fink a 47%shareholder in the corporation had personally hand picked each of the directors. And, that was why they had given him such a nice retirement package. The court held that the Plaintiffs failed to allege facts with particularity indicating that the Myers directors were tainted by interest, lacked independence, or to action contrary to Meyers best interests in order to create a reasonable doubt as to the applicability of the business judgment rule. A prior demand can be excused only where facts are alleged with particularity which create a reasonable doubt that the directors actions was entitled to the protections of the business judgment rule. Page 829 Cuker v. Mikalauskas, Supreme Court of Pennsylvania, 1997 PECO was a publicly traded utility company that underwent an audit in accordance with state regulations. The report issued recommended changes regarding PECOS credit and collection function. After the report two groups of minority shareholders filed an action alleging wrongdoing by Pecos officers and directors. Peco responded to the first action by creating a special litigation committee to investigate the allegations. The investigation concluded that there was no evidence of bad faith, self dealing, concealment or any other breaches of the duty of care by the defendant officers. The issue was whether the business judgement rule permits the board of directors of a Pennsylvania corporation to terminate derivative lawsuits brought by minority shareholders? YES. However, on summary judgment the court may dismiss the action if it is satisfied that the board of directors decision was valid. The court must look to the surrounding circumstances to determine whether the business judgement rule applies. Chap 11 P2 (807-847) Duty of care Zapata Corp. v. Maldonado Delaware case Derivative action lawsuit Findings by committee said that the lawsuit should be dismissed Business judgment rule is a judicial creation that presumes propriety under certain circumstances in a boards decision The rule is not relevant in corporate decision making until after a decision is made A board decision to cause a derivative suit to be dismissed as detrimental to the company after demand has been made and refused will be respected unless it was wrongful Derivative Litigation in Delaware If there is a demand made by a shareholder in Delaware: (a) Special litigation committee will either accept a demand or the suit goes
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on. (b) SLC can also reject . If so, the Business Judgement Rule protects them unless their behavior was wrongful.

What happens if there is no demand and a case is filed? (Demand excused, futile) If there is no demand made by a shareholder but a case if filed: (1) SLC will either allow the suit to continue (0.0009 percent of the time!) (2) SLC will intervene to dismiss the suit (here, there must be a determination that is independent, in good faith and reasonable) BUT if the plaintiff that any one of the three factors, the lawsuit constitutes. IF board can prove all three things, the court applies its independent business judgement and the suit can either go on or be dismissed. Aronson v. Lewis

Delaware case Derivative action lawsuit demand can only be excused where facts are alleged with particularity which create a reasonable doubt that the directors action was entitled to the protections of the business judgment Court held that plaintiff trying to demonstrate futility (in Delaware) must show the directors were tainted by interest, lacked independence, or took action contrary to companys best interest. function of the business judgment rule is of paramount significance in the context of a derivative action Comes into play when: Addressing a demand Determination of demand futility Efforts by independent disinterested directors to dismiss the action as inimical to the corporations best interests A defense to the merits of the suit

Cuker v. Mikalauskas Pennsylvania case Derivative action lawsuit Committee found there was sound business judgments and that the lawsuit should be dismissed The business judgment rule permits the board of directors of a Pennsylvania corporation to terminate derivative lawsuits brought by minority shareholders The business judgment rule should insulate officers and directors from judicial
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intervention in the absence of fraud or self-dealing, if challenged decisions were within the scope of the directors authority if they exercised reasonable diligence and if they honestly and rationally believed their decisions were in the best interests of the company

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