Business organizations
Prof. Han, Santa Clara University School of Law, Fall 2006; by Joseph J. Wang,
I.Agency; Sole Proprietors
A.Principal's Liability for Agent's Act
1.Actual Authority is communicated by Principal to Agent. RS2d §7.
a)May be inferred by words or conduct that the Principal has reason to know will indicate to the Agent he is to do the act. Teamsters.
2.Apparent Authority is communicated by Principal to 3rd Party. RS2d §8.
a)Includes conduct, if reasonably interpretable. RS2d §27. Fennell.
3.Inherent Agency Power is incidental to a common role. RS2d §8A.
4.Agent is liable when Principal is undisclosed or partially disclosed. Agent is not liable if Principal is fully disclosed. Sally Leiner.
a)Disclosure, RS2d §4
Fully disclosed = 3rd party has notice: Agent is an agent, and Principal's identity.Partially disclosed = 3rd party has notice: Agent is an agent.
Undisclosed = 3rd party has no notice.
5.A creditor who assumes control of a debtor's business may be liable as principal for acts of the debtor in connection with the business. Cargill.
II.Partnerships Joint Ventures
A.Law
1.UPA (1914). P-ship is an aggregate of principals, not own entity.
2.RUPA (1997). P-ship is own entity.
B.Formation
1.Implied In Fact
a)Intent to do business for profit. UPA §6. Holmes v. Lerner.
b)Agreement to share profits is evidence of P-ship. UPA §7.
(1)Equal shares, by default. UPA §25.
(2)Royalties are not profit sharing. Schlumberger.
c)Mutual right of control = partner. Defensive measures = not. Martin.
2.Implied In Law
a)By Estoppel - representing oneself as a partner makes one liable. UPA §16.
b)Defectively formed business organization
C.Management
1.One vote per partner, regardless of capital contribution.
2.Unanimous vote required to add partner, by default.
D.Fiduciary Duty Among Partners - owed at time of opportunity; lasts until P-ship dissolved. Meinhard.
III.LPs, LLPs, LLLPs, & LLCs
A.Limited Partnerships (LPs)
1.Law
a)RULPA (1985)
b)ULPA (2001)
2.Two Types of Partner
a)General (tractator) - active, unlimited personal liability, paid first
b)Limited (commendator) - passive, liability ltd to contribution, paid later
3.Ltd Partner may become Gen Partner by over-participation, only to 3rd parties reasonably believing he is a Gen Partner. RULPA §303. Gateway.
B.Limited Liability Partnerships (LLPs)
1.Treated like P-ship, except must file certificate of LLP with state.
2.California: LLP is only for licensed professionals.
3.Limited liability for own torts and contracts, but not for malpractice.
C.Limited Liability Limited Partnerships (LLLPs) - available in some states, not CA
D.Limited Liability Companies (LLCs)
1.Law - ULLCA
2.Management
a)Member-managed LLC treated like P-ship - members can bind LLC
b)Manager-managed LLC treated like C - only managers can bind LLC
3.Taxation - choice of Flow-Thru or Double
4.Operating Agreement - written or oral. ULLCA §103(a). Elf Atochem.
5.Management
a)Election of managers is separate from removal. Broyhill.
b)Fiduciary Duties - majority members have duty to minority. Anderson.
IV.Corporations
A.Promoter's Contracts
1.Can be adopted, but not ratified since C did not exist at time. Times.
2.Promoterliable until obligation fulfilled or novated by obligee.
B.State of Incorporation - Delaware
1.Nevada - upcoming rival. "Race to the bottom."
C.Articles of Incorporation. MA §2.0.
1.Required
a)Corporate Name - must say Corp., Inc., Co., or Ltd. MA §4.01.
b)Number of Shares
c)Registered Agent and Office
d)Incorporators Names and Addresses
2.Optional
a)BoD - number, names, addresses
b)Corporate Purposes - e.g. default: "any lawful business." MA §3.02.
c)Corporate Powers - e.g.default: "same powers as an individual" MA §3.02.
d)Par Value of Shares - e.g. $0.0001
e)Classes of Shares
D.Pre-Incorporation Shareholder Agreements - allok, if not against public policy. MA §7.32.
E.Capitalization
1.Equity
a)Par Value not used today; set to infinitesimally low value.
b)BoD may issue stock for consideration consisting of any property or benefit. MA §6.21.
(1)Promissory notes and future services disallowed in many states.
(2)BoD must set adequate consideration before stock issues.
c)"Duly Authorized" = enough "headroom" in charter to issue shares"Validly Issued" = no statutes broken in issuance"Fully Paid" = appropriate consideration received"Nonassessable" = no more money due from stockholder
2.Debt
a)Notes are secured/unsecured, short/long term, protected by loan contract
b)Bonds aresecured by mortgage, protected by indenture contract
(1)Debentures are unsecured
3.Watered Stock means full value not yet received, dilutes other shares.
a)Stock not fully paid and nonassessable until full consideration received. Hanewald.
4.Thin Incorporation; Subordination
a)If debt owed to shareholders is too high, C is "thin."
(1)IRS may treat debt as equity for tax purposes.
(2)Court may subordinate shareholders' debt behind other debts.
b)Debt-Equity Ratio should be under 2:1 to avoid "thin." Obre. Fett Roofing.
5.Preemptive Rights
a)Three Approaches
(1)Mandatory grant of preemptive rights.
(2)Articles must opt-out to deny preemptive rights.
(3)Articles must opt-in to grant preemptive rights. MA §6.30. CA.
b)Issuing close corporation stock at far below book value requires valid business reasons. Katzowitz.
6.Share Transfer Restrictions; Buyout Agreements
a)Articles may authorize restriction for reasonable purpose. MA §6.27(c).
b)Restriction may obligate offering, purchasing, approving. MA §6.27(d).
F.Organizing a Corporation
1.Organization Meeting required. MA §2.05(a)(1).
2.Consent in Lieu of Meeting allowed for "written consents." MA §2.05(b).
a)Shareholders may use proxies. Directors cannot. MA §7.22.
3.Hierarchy: law charter bylaws BoD resolutions
4.An invalid bylaw may be enforceable as a contract. Jones v. Wallace.
G.Defective Incorporation
1.De Jure means only missing certificate. Incorporator not liable.
2.De Facto required 3 elements:
a)Statute, under which you could have incorporated;
b)Good faith attempt to incorporate; and
c)Corporate power used in honest belief a C existed.
d)OBSOLETE per Timberline.
3.By Estoppel - only protects incorporators, does not create C; one who has recognized a C cannot deny it later.
a)Plaintiff must believe he was dealing with C. Timberland.
b)Both parties must have believed C existed. American Vending.
(1)C exists when articles are filed. MA §2.03. Robertson.
(2)But ppl who act as a C, knowing there wasn't one, are liable for all liabilities created while so acting. MA §2.04.
V.Corporate Authority
A.Board of Directorsholds bulk of power, usually defers to officers.
B.Shareholders
1.Elect directors. MA §8.03.
2.Remove directors. MA §8.08.
a)Remove directors affirmatively, else they continue to serve. MA §8.05(e).
3.Dissolve BoD, after proposal by BoD. MA §14.04.
4.Amend articles, after adoption by BoD. MA §10.03.
5.Amend or repeal bylaws. MA §10.20. (BoD usually does this.)
6.Approve mergers and acquisitions, after adoption by BoD. MA §11.04.
7.Cannot directly manage C.
a)BoD shall exercise corporate powers. Gashwiler.
8.Annual meetings required. Special meetings optional. Hoschett.
9.Inspect ledger, records, and shareholder lists.
a)Proper purpose required, germane to investment. Honeywell. Mite.
C.Officers
1.Bylaws or BoD must pick a Secretary. BoD may elect officers. MA §8.40.
2.Bylaws or BoD set functions of each officer. MA §8.41.
a)President has power to bind C in "ordinary" course of business. Else BoD must approve or ratify afterward. Greenspon's Sons. Elblum. Lighthouse.
b)Secretarycertifies BoD minutes and resolutions. Drive In Dev. Corp.
c)VP has no power, but to act as President in his absence or incapacity. Anderson v. Campbell.
d)Treasurer has no power, unless specifically granted by bylaws or BoD. Jamestown Mantel Co.
VI.Distributing Corporate Control
A.Cumulative Voting; Classification of Directors; Class Voting; Weighted Voting
1.Cumulative Voting: How many evenly distributed shares do I need to elect N directors?
X = [ S x N / (D + 1) ] + 1 = number of shares needed to elect N directorsS = number of shares to be voted for all shareholders [use number of votes being cast]
N = number of directors a shareholder (or block) wishes to elect
D = number of directors to be elected at meeting
Set N = 1. Multiply to elect more directors.
2.Classification of Directors - staggered terms: 2 or 3 equal groups, one year apart. MA §8.06.
3.Class Voting - each class of stock gets to elect defined number of directors. MA §8.04.
4.Weighted Voting
a)Some shares get many votes. Anti-takeover. Province Worchester Co.
b)Single class of stock cannot have different voting rights. Asarco.
B.Charter Provisions; Removal of Directors; Deadlocks; Oppression, Dissension, Dissolution
1.Charter Provisions - anything goes, if lawful. Amendable.
2.Removal of Directors
a)Stockholders inherently can remove directors. Auer v. Dressel.
b)Charter can require cause. MA §8.08.
3.Deadlocks - courts cannot compel shareholders to meet or enjoin officers. Hall.
4.Oppression and Dissension
a)Stockholders in a close C owe each other fiduciary duty. Donohue.
(1)Closely-Held C Factors (triggering treatment like P-ship) from Donahue:
(a)small number of owners
(b)no ready market for stock
(c)majority of owners participate in management
(2)Minority stockholders also owe fiduciary duty to majority. Chesterton.
5.Involuntary Dissolution - remedy for oppression or deadlock. MA §14.30.
a)Available for illegal, fraudulent, or oppressive conduct that substantially defeat reasonable expectations of minority stockholders. Kemp & Beatley.
(1)Appropriate if no alternative remedy. Kemp & Beatley.
(2)Remedy only for deadlocks and oppression. Hina Pharmacy.
C.Contracts
1.Voting Trusts - drastic step
a)Limited to 10 yrs. Extendable. MA §7.30. Lehrman v. Cohen.
2.Voting Agreements (Pooling Agreements)
a)Specifically enforceable. No time limit. MA §7.31. Ramos v. Estrada.
3.Shareholder Agreements
a)Anything goes, if not against public policy. MA §7.32.
b)Anything goes, even if against public policy. Galler.
4.Employment Agreements
a)Officer removable anytime with or w/o cause by BoD. MA §8.43.
b)Employment or removal does not change contract rights. MA §8.44.
c)Use salary escalator, liquidated damages, functional name of office, and "golden parachute."
VII.Piercing
A.Theories
1.Alter Ego - C is alter ego of a person.
2.Instrumentality - person openly using C as a tool to accomplish task
B.Tort Claims - victims had no choice, more likely to pierce
1.Factors compiled from Arrow Bar case and Laya v. Erin Homes:
a)Fraud
(1)fraudulent representation by directors
(a)e.g. using C as instrument to conduct personal business.
(2)same management in two entities [AE]
(3)use of corporation to promote fraud, injustice, or illegalities
b)Commingling
(1)commingling of funds or assets [AE]
(2)payment by corporation of individual obligations [AE]
c)Undercapitalization
d)Failure to observe corporate formalities
(1)failure to maintain arm's-length relationship
(2)absence of corporate records
C.Contract Claims - victims had a say, less likely to pierce
1.Piercing Requirements from Pepper Source (quoting Van Dorn):
a)Inseparable identities - unity of interest and ownership
b)Promoting injustice - some wrong beyond a creditor's inability to collect
2.Factors
a)undercapitalization
(1)e.g. Radazewski (in financial responsibility sense, not in accounting sense),
(2)but see, Harris (undercapitalization not determinative, common in startups).
b)failure to observe corporate formalities
VIII.Directors & Officers
A.Duty of Care - ordinary prudent person standard
1.Minimum Standard - go to meetings, stay informed, RPS. Francis.
2.Duty to Inquire and Monitor
a)Duty to set up process to stay informed. In re Caremark.
b)Duty to inquire suspicious activity - may arise preemptively due to history.
3.Business Judgment Rule - non-egregious mistake ok. Joy v. North.
a)Except if director or officer is self-interested. See Duty of Loyalty.
4.Informed Decisions - gross negligence standard. Van Gorkom.
a)Presumption that BoD judgment was informed.
B.Duty of Loyalty - fairness standard
1.Common Law: Director self-dealing is ok if fair. Else, void.
a)Directors have burden to show fairness. Lewis.
2.Safe Harbor Statutes - two more situations where directors may self-deal, from Marciano:
a)facts disclosed or known to BoD, and they approve
b)facts disclosed or known to shareholders, and they approve
3.Compensation Agreements
a)Officer has fiduciary duty to negotiate honestly and in good faith so as not to advantage self at expense of shareholders. Walt Disney.
C.Corporate Opportunity Doctrine
1.Line of Business Test, given inBroz (quoting Guth).
a)Director or Officer may take opportunity if:
(1)presented to him in individual capacity
(2)not essential to C
(3)C has no interest or expectancy
(4)C's resources not used to pursue or exploit opportunity
b)Director or Officer may not take opportunity if:
(1)C is financially able to undertake opportunity
(2)Opportunity is in C's line of business and advantageous to C
(3)C has an interest or reasonable expectancy
(4)Taking opportunity causes conflict of interest
2.Full Disclosure (First Offer)
a)Director or Officer must first offer opportunity to C and disclose conflict. Northeast Harbor Golf Club.
IX.Controlling Shareholders may assume fiduciary duties.
A.BJR if no self-dealing exists. Else, intrinsic fairness standard. Sinclair Oil.
1.Publicly-traded C - no duty to minority shareholders
2.Closely-held C - fiduciary duty to minority shareholders (like P-ship)
X.Shareholder Derivative Litigation
A.Derivative v. Direct Action
1.Direct Action - must allege separate and distinct injury.
a)Seeking only injunctive or prospective relief seems more direct. Grimes.
B.The Demand Requirement
1.Must first ask BoD to sue, or show good reason for failure. FRCP 23.1.
2.Futile demand need not be made.
a)Demand is futile where reasonable doubt exists that BJR applies. Aronson.
b)Exceptions from Rales, where demand must still be made.
(1)a majority of BoD has been replaced
(2)subject of suit was not a business decision made by BoD
(3)business decision was made by BoD of different C
C.Special Litigation Committees may nix suit
1.NY approach - BJR applies to SLC. Auerback.
2.Two-Step Delaware Approach. Zapata.
a)Establish independence and good faith of SLC, then
b)Court applies its own independent business judgment.
XI.Proxy Regulation
A.SEC Act §14 - unlawful to solicit proxy in violation of SEC Rules
1.SEC Rule 14a-9 - no false/misleading statements, or material omissions.
a)Applies to both sides of a Proxy Contest. Kennecott.
B.Causation
1.Causation is presumed if solicitation is misleading, material, and necessary. Mills.
2.No causation if minority cannot stop majority. Virginia Bankshares.
C.Material Fact - Northway Test
1.Omission material if substantial likelihood reasonable shareholder would consider it important in deciding how to vote. Northway.
D.Necessity
1.Solicitation is essential if minority has ability to stop majority. Cole.
E.Misleading
1.Knowingly false statements of reasons for recommending actions can be materially misleading even if conclusory. Virginia Bankshares.
F.Shareholder Proposals
1.SEC Rule 14a-8 lets shareholder add proposals to proxy statement. Transamerica.
a)Proposals on "ordinary business matters" may be excluded. Roosevelt.
XII.Insider Trading & Other Securities Fraud
A.State law may apply - e.g. insider trading ok. Freeman.
B.SEC Act (1935), § 10
Unlawful for "any person" to use "in connection with the purchase or sale" of any security "any manipulative or deceptive device or contrivance" in contravention of SEC rules.1.SEC Rule 10b-5. Employment of manipulative and deceptive devices
Unlawful for any person… by use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchanges,(a) To employ any device, scheme, or artifice to defraud, [or]
(b) To make any untrue statement of a material fact or to omit… a material fact necessary [to] not [be] misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit…
in connection with the purchase or sale of any security.
a)Applies to all companies, even privately held ones.
b)Duty to Market: insiders, info from insiders, or misappropriated info.
2.Materiality - "substantial likelihood" test (Northway). Basic Inc.
3.Causation = obligation to disclose + failure. Tippees = Tippers. Shapiro.
4.Reliance - rebuttable presumption of investor reliance on public material misrepresentations. Basic Inc.
5."In Connection With" - req nexus btwn fraud and securities sale. Ivie.
6.Standing - only actual buyers & sellers of securities. Blue Chip.
7.Fault Required - scienter. Negligence insufficient. Hochfelder.
8.Persons Subject to Trading Constraints
a)Only with duty to disclose arising from relationship of trust. Mere possession of info insufficient. Chiarella.
b)Misappropriation of nonpublic info in breach of fiduciary duty. Materia.
(1)Misappropriation also creates criminal liability. O'Hagan.
9.Issuer has duty to correct historical statements, but not toupdate forward-looking statements. Stransky.
10.Damages and Penalties: Disgorgement Measure
a)Post-buyloss(up to reasonable time after discovering tip or after public disclosure), limited by amount gained by tippee. Liggett & Meyers.
b)If buyers claim more than tippee gained, recovery is shared pro rata.
11.Sarbanes-Oxley Act (2002) - increased penalties, including prison.
a)Also penalizes attempted acts not completed.
b)Only applies to Exchange Act reporting companies.
C.Short-Swing Trading, SEC Act §16
(a) Applies to director, officers, and "beneficial owner of more than 10%" of stock. Must file sell/buy reports with SEC.10+% shareholder must be "both at time of the purchase and sale."
(b) Any profit from any sell-buy or buy-sell within 6 months (forward or backward) goes to the issuer.
1.Profit - from any buy/sell or sell/buy. Lowest in, highest out. Smolowe.
2.Directors, Officers, and 10+% Shareholders
a)Beneficial ownership includes immediate family.
b)Directors and officers are functionally defined.
c)If officer or director buys, then resigns, still covered for 6 months.
d)If non-officer buys, then becomes officer, not covered. Watch Rule 10b-5.
e)Business partners of directors are exempt. Blau v. Lehman.
(1)Today, courts would scrutinize for deputizing.
3.Only sales with possibility of speculative abuse of inside info are subject to §16. Kern County Land (exempting options to undo a failed takeover).
4.Timing
a)A sale that drops ownership below 10% is within §16. Reliance. Subsequent sales are out.
(1)But two sales to same buyer were collapsible into one transaction. Reece.
b)A buy that ups ownership above 10% is outside §16. Foremost-McKesson. Subsequent buys are in.
5.Standing
a)Plaintiff must own a security of the issuer to file suit. §16.
b)Plaintiff must have a continuing financial stake in the suit. No requirement for continuous ownership, though. Gollust.
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