Corporations
Professor Bradford
Fall 2001
Exam 2001
The following answer outlines are not intended to be model answers, nor are they intended to include every issue that students discussed. They merely attempt to identify the major issues in each question and some of the problems or questions arising under each issue. They should provide a pretty good idea of the kinds of things I was looking for. If you have any questions about the exam or your performance on the exam, feel free to contact me to talk about it.
I graded each question separately. Those grades appear on the front cover of your blue books. To determine your overall average, each question was then weighted in accordance with the time allocated to that question. The following distribution will give you some idea how you did in comparison to the rest of the class:
Question 1: Range 0-9; Average 5.71
Question 2: Range 0-9; Average 6.21
Question 3: Range 0-9; Average 5.40
Question 4: Range 0-9; Average 4.89
Question 5: Range 0-9; Average 5.80
Question 6: Range 0-9; Average 6.15
Total (of exam, not final grades): Range 0-8.65; Average 5.62
Question One
Schilling is incorrect. Johnson may unilaterally dissolve the partnership. A majority vote is not required. Section 601(1) of the UPA says that a partner may dissociate from a general partnership by giving notice of his express will to withdraw. Johnson has done that.
The partnership agreement does not specify a term for the partnership, so this is a partnership at will. Section 801(1) says that Johnson’s notice under section 601(1) dissolves the partnership at will, and the partnership business must be wound up.
Section 807(a) governs the winding up process. The partnership’s assets, including any necessary contributions from the partners must be applied to pay its creditors, including creditors such as Schilling who are also partners. Thus, the machine must be sold, and the $100,000 used to pay the creditors, including Schilling. However, this still leaves a deficit of $60,000 for the partners to make up.
To understand how much each of the partners must pay, we must first go to section 401(a), which deals with partners’ accounts. Section 401(a)(1) says that each partner’s account is credited with, among other things, the money or property contributed to the partnership and charged with, among other things, the partner’s share of the losses of the partnership.
Johnson contributed $30,000 cash to the partnership, so his account is credited with this amount. Schilling contributed property with a value of $60,000 to the partnership, so his account is credited with this amount.
The partnership agreement does not specify how the partners are to share losses, so we must turn to the default rule, section 401(b), which says that losses are to be shared “in proportion to the partner’s share of profits.” The agreement provides that Johnson will receive 25% of the profits and Schilling 75%, so, under section 401(b), they will shares losses in the same proportions. The total loss here is $150,000. Diamondback lost the entire $90,000 the partners invested, plus it owes an additional $60,000 to the creditors. Johnson is responsible for $150,000 x .25 = $37,500 of this. Schilling is responsible for $150,000 x .75 = $112,500 of this. Each partner’s account must be charged with these respective amounts.
Thus, the partners’ respective accounts look like this:
Johnson
+ 30,000
-37,500
- 7,500
Schilling
+ 60,000
- 112,500
- 52,500
Section 807(b) says that each partner will receive any positive balance in his account and pay any negative balance. Thus, Johnson must pay $7,500 and Schilling must pay $52,500 to make up the additional $60,000 needed to pay Diamondback’s debts. Of course, as a creditor, Schilling will get back $15,000 in repayment of his loan.
Once these contributions are made and the creditors paid, the process of winding up is completed and the Diamondback partnership is terminated. Section 802(a).
Question Two
Both Target and Arrow are incorporated in MBCA states, so, under the internal affairs rule, the MBCA applies.
A. Voting Rights
1. William
Voting rights in mergers are covered by section 11.04 and 11.05. Arrow owns 90% of the voting power of Target, so section 11.05 applies. Section 11.05(a) says that, unless the articles of either corporation provide otherwise, the merger may occur with Arrow board action “without the approval of the board of directors or shareholders of the subsidiary”, Target. All Arrow has to do is to notify the Target shareholders of the merger. Section 11.05(b). As far as we know, the articles of neither Target nor Arrow provide otherwise. Therefore, William has no voting rights.
2. Gio
Section 11.05(a) only eliminates voting by the subsidiary’s shareholders and section 11.05(c) says the other provisions of Chapter 11 otherwise apply. Therefore, to determine Gio’s voting rights, we must look at the general merger section, section 11.04. Shareholders such as Gio generally are required to approve a merger. Section 11.04(b). There is an exception to those voting rights in section 11.04(g), but that exception doesn’t apply here. The conditions in (g)(1), (g)(3), and (g)(4) are met. Gio’s corporation, Arrow, will survive the merger, Arrow’s shareholders will own the same identical shares after the merger, and section 6.21(f) would not require a vote because the Arrow shares to be issued will not comprise more than 20% of the preexisting voting power. Only 80,000 shares will be issued and Arrow had 1 million shares outstanding prior to the merger. However, all four conditions must be met for the section 11.04(g) exception to apply and (g)(2) is not met. Arrow’s articles of incorporation will be changed as part of the merger, to increase the size of Arrow’s board, and that amendment is not within section 10.05. Since the 11.04(g) exception does not apply, Gio has voting rights under the general rule in 11.04(b).
B. Appraisal Rights
1. William
A shareholder is entitled to appraisal rights—the right to the fair value of his shares—as provided in MBCA section 13.02.
Section 13.02(a)(1)(ii) says that the shareholders of the subsidiary in a section 11.05 merger are entitled to appraisal rights. That general rule would grant William appraisal rights.
However, section 13.02(b) provides exceptions to that general rule. William would fall within the 13.02(b)(1) exception because the Target shares he held are listed on the NASDAQ system. There is, however, an exception to the exception, in section 13.02(b)93). In spite of (b)(1), William gets appraisal rights if he is required by the terms of the merger to accept for his Target shares anything other than cash or shares of a corporation that meet the requirements of section 13.02(b)(1). Here, William receives Arrow stock. Arrow stock is not traded on a stock exchange or the NASDAQ system, so (b)(1)(i) does not apply. Arrow has 2,500 shareholders, so the first part of (b)(1)(ii) is met, but the market value of those shares is only $15 million, so the $20 million requirement is not met. Therefore, subsection (b)(1)(ii) also does not apply. William is receiving consideration that does not meet the requirements of section 13.02(b)(3), so the exception to the exception applies, and William is entitled to appraisal rights.
2. Gio
Gio is not entitled to appraisal rights. Section 13.02(a)(1)(i) says a shareholder is not entitled to appraisal rights if his shares “remain outstanding after consummation of the merger.” Gio’s Arrow shares remain outstanding. And section 13.02(a)(1)(ii) doesn’t apply because it covers only the shareholders of the subsidiary, in this case Target.
Question Three
This is a Delaware corporation, so, under the internal affairs rule, Delaware law applies.
Section 170(a) of the Delaware Gen. Corp. L. says that the directors of a corporation may pay dividends either (1) out of the corporation’s “surplus” or (2) if there is no such surplus, out of the net profits for the current and/or preceding fiscal year. Meridian has lost money for the last three years, so the second test is unavailable. Meridian may pay dividends only to the extent it has surplus.
Surplus is defined in Del. section 154 as the excess of the net assets over the amount determined to be capital. “Net assets” is defined in section 154 as the amount by which total assets exceed total liabilities.
Klang says that, in applying the Delaware test, the corporation’s assets and liabilities may be adjusted to their fair market values. Here, the only possible adjustment is to increase the land from its book value of $12,100 to its fair market value of $14,100. [Note: Because of the typo in the exam, I gave you credit based on whatever you assumed this fair value was supposed to be.] This increases the total assets to $30,000.
With this increase, Meridian’s net assets are $30,000 (total assets) - $22,600 (total liabilities) = $7,400. Its “capital” is the $1,200 in the common stock account. Thus, its surplus is $7,400 (net assets) - $1,200 (capital) = $6,200. This is the maximum amount of dividends Meridian may lawfully pay.
Question Four
Ajax is required to register its stock pursuant to section 12(a) of the Exchange Act because the stock is traded on a national securities exchange, the N.Y. Stock Exchange. Therefore, Ajax is subject to the federal proxy rules. Section 14(a) of the Exchange Act makes it unlawful to solicit proxies in violation of the SEC rules in respect to a security registered pursuant to section 12 of the Act.
Ajax was not required to send Jane’s proposal to its shareholders. This proposal does not qualify for inclusion in Ajax’s proxy statement pursuant to Rule 14a-8 because Jane does not meet the eligibility requirements of Rule 14a-8(b) [Question 2]. She only owns 20 shares, clearly not 1% of Ajax’s 5 million outstanding shares and the market value of her shares is only $1,000, not meeting the alternative $2,000. She also has not met the notice requirement of Rule 14a-8(e). She must submit her proposal at least 120 days prior to the date Ajax’s proxy statement was mailed last year. Rule 14a-8(e)(2). Last year, Ajax mailed its proxy statement on March 25; January 1 is not 120 days prior to that. In any event, Jane’s proposal would be excludable under Rule 14a-8(i)(1), as improper under state law, for the reasons discussed later.
Jane also could not force Ajax to send her proposal pursuant to Rule 14a-7. Under Rule 14a-7, Ajax would have the option either to send her proposal or provide Jane with a shareholder list. In either case, Jane would have to bear the cost of the mailing, not Ajax. Rule 14a-7(e).
Ajax made a fraudulent statement in its proxy statement: it said it was unaware of any shareholder proposals, when it was aware of Jane’s. This false statement violates Rule 14a-9 and Jane can recover damages if she can show that the solicitation was an “essential link” in defeating her proposal. Mills. Jane does not have to show that, if Ajax had been truthful, the shareholders would not have given their proxies to Ajax. She only has to show that the proxy solicitation was necessary to defeat Jane’s proposal. Management will argue that the proposal would have been defeated 27%-20% even without the proxies. Jane will respond that, as 27% is not a majority of the shares present, the proxies were necessary to have a binding vote, and therefore, an essential link.
Ajax will also argue that the essential link is destroyed because the proposal was improper under state law and therefore would not be effective even if it passed. Therefore, the proxy solicitation was not necessary to avoid the proposal; even if it passed, it would be void. Section 141(a) of the Del. Gen. Corp. L. provides that “The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.” Whether to adopt a poison pill plan is a management decision. Thus, Jane’s resolution can take away that authority only through an amendment to the certificate of incorporation. However, shareholders do not have the power to initiate amendments to the certificate of incorporation; such amendments must first be adopted by the board. Del. section 242(b)(1). Thus, Jane’s proposal is improper.
Jane can also argue that the proxies should not have been voted in management’s favor. Rule 14a-4(b)(1) says that proxies must give shareholders an opportunity to vote separately on each matter to be acted on at the annual meeting. Rule 14a-4(c)(1) allows a proxy to confer discretionary authority if Jane doesn’t notify Ajax in time of the matter to be presented at the annual meeting. The usual notice deadline, applicable here because this year’s annual meeting is the exact same date as last year’s, is 45 days prior to when the proxy materials were first mailed for last year’s meeting. Last year’s materials were mailed on March 25 and Jane notified Ajax of her proposal on January 1, clearly more than 45 days. The (c)(1) exception allowing discretionary authority does not apply.
Rule 14a-4(c)(2) allows a proxy to confer discretionary authority even if this notice deadline is met if Ajax includes in the proxy statement “advice on the nature of the matter and how the registrant intends to exercise its discretion.” That also does not apply here because Ajax’s proxy statement did not even mention Jane’s proposal. Therefore, Ajax could not vote the proxies against Jane’s proposal. It is not clear how this violation of federal proxy law helps Jane, however, as her proposal failed even without the proxies. Perhaps she could argue that the shareholders should be resolicited and another vote taken.
Question Five
Konfusion, the state in which Carefree is incorporated, has adopted the MBCA, so it applies, but the MBCA contains little to cover this corporate opportunity situation. Subchapter F of Article 8 of the MBCA deals only with self-dealing situations, where the director, or a party related to the director, is involved in a transaction with the corporation or its subsidiary. For there to be a conflicting interest under section 8.60(1), there must be “a transaction effected or proposed to be effected by the corporation.” Section 8.61(b) applies only to director’s conflicting interest transactions, so limited, and section 8.61(a) applies only to transactions “effected or proposed to be effected by a corporation” that are not director’s conflicting interest transactions. Dimwit is not engaged in a transaction with his corporation, Carefree, or with any subsidiary of Carefree. Thus, Subchapter F does not apply.
Purchasing the Advice stock could still violate Dimwit’s duty of loyalty to Carefree, however, if the stock purchase was a corporate opportunity belonging to Carefree. The MBCA has nothing to say about corporate opportunities, so we must look to the common law. In this case, Konfusion applies the ALI Principles of Corporate Governance.
The ALI approach to corporate opportunities is in section 5.05 of the Principles. Under that test, if the transaction is a corporate opportunity, it cannot be taken by Dimwit unless it is first offered to Carefree and rejected by Carefree. Section 5.05(a). This never occurred because Dimwit did not inform Carefree of the opportunity until after he had taken it. Thus, if it is a corporate opportunity under section 5.05(b), Dimwit is liable. The possible legal inability claim arising from Konfusion insurance law is irrelevant under section 5.05.
Dimwit is not a senior executive, so section 5.05(b)(2) does not apply. There is no evidence that Molly expected Dimwit to offer the stock to Carefree. In fact, it looks like she made the offer for Dimwit’s benefit. Therefore, the second half of 5.05(b)(1)(A) does not apply. For the first half of 5.05(b)(1)(A) to apply, Dimwit must become aware of the opportunity in connection with his performance of functions as a director. When Molly offered the opportunity to Dimwit, he was in Miami on behalf of Carefree. However, he was not doing anything for Carefree when he met Molly and agreed to the deal. The question is whether the corporate nature of the trip itself makes everything Dimwit does in Miami “in connection with the performance of his functions as a director.”
A similar issue arises under section 5.06(b)(1)(B) which applies if the director uses corporate resources to become aware of the opportunity. Dimwit undoubtedly used corporate resources to pay for the trip. Is that direct enough to qualify under 5.05(b)(1)(B) or is that too indirect? Even if it falls within this, would Dimwit reasonably expect Carefree to be interested in the Advice stock? He knew the company had “millions in free cash” and was looking to expand, but he also knew Carefree could not own Advice stock directly.
Finally, if this is a corporate opportunity, Dimwit might try to use section 5.05(e). He could argue that he did not in good faith believe this was a corporate opportunity because of the issues raised above. If he now offers the Advice purchase to Carefree and they reject it, he could avoid liability.
Question Six
Bounded rationality is, quite simply, the limits on individual’s abilities to act rationally—in this context, their inability to understand and anticipate everything that might happen in the business relationship. Because of bounded rationality, people entering into a corporate relationship cannot anticipate all the activities officers and directors might potentially engage in. Therefore, they are unable to contractually specify all of the possible actions they want to prohibit.