9

Corporations

Professor Bradford

Fall 2008

Exam Answer Outline

The following answer outlines are not intended to be model answers, nor are they intended to include every issue 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 your printed exam. 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 4-9; Average = 7.22

Question 2: Range 2-8; Average = 5.80

Question 3: Range 2-8; Average = 4.52

Question 4: Range 2-9; Average = 5.85

Question 5: Range 2-9; Average = 5.22

Total (of unadjusted exam scores, not final grades): Range 3.18-8.00; Average = 5.67


Question 1

Chico’s withdrawal from the partnership is not yet effective. RULPA section 603 says that, unless the agreement specifies in writing the circumstances of withdrawal, a limited partner must give not less than six months written notice to withdraw. Chico gave notice on Aug. 1, less than six months prior to the Dec. 31 distribution date. For purposes of the distribution, he is still a partner. So, even though he plans to withdraw, Chico is still entitled to receive all pre-withdrawal distributions. RULPA section 601.

Sections 503 and 504 say that profits and distributions shall be allocated “as provided in writing in the partnership agreement.” If the allocations are not specified in writing in the partnership agreement, profits are allocated and distributions are to be made on the basis of the value “of the contributions made by each partners to the extent they . . . have not been returned. Given the “return” language, we need to subtract the $5,000 that Harpo subsequently withdrew from the business.

The agreement to allocate 50% to Groucho was an oral agreement, not “in writing in the partnership agreement,” so it does not override the default provisions in sections 503 and 504, but it doesn’t matter because Groucho would receive 50% in any event.

The total amount contributions by the partners was $100,000 + $10,000 + $35,000 ($40,000 - $5,000) + $55,000, for a total of $200,000. Chico contributed $10,000 of that. Thus, Chico is entitled to 10/200, or 1/20 of the total $100,000 distribution. Chico is entitled to receive $5,000.


Question 2

Sally’s duty of loyalty challenge will be dismissed unless the transaction constitutes a “director’s conflicting interest transaction.” MBCA sec. 8.61(a). A transaction is not subject to challenge “on the ground that a director has an interest respecting the transaction” unless it’s a director’s conflicting interest transaction (DCIT) as defined in section 8.60(1).

Section 8.61(a) does not bar Sally’s claim, because this is a DCIT. This is clearly a transaction effected by the corporation (Zappa), MBCA sec. 8.60(1), and it falls within subsection 8.60(1)(iii) because a related person, Gamma, is a party to the transaction. The term “related person” is defined in section 8.60(5)(iv) to include an entity controlled by the director or by “any person specified above in this subdivision (5).” One of the prior categories in subdivision (5)(ii) is “sibling . . . (or spouse of any thereof) of the director or of the director’s spouse.” Frank, Alan’s brother-in-law, is either the sibling of Alan’s spouse or the spouse of Alan’s sibling. Thus, Frank is a related person under 8.60(5)(ii). Frank, in turn, owns 60% of Gamma’s stock, and thus controls Gamma, making Gamma a related person of Alan under 8.60(5)(iv). Since Gamma, a related person of Alan, is a party to the transaction, section 8.60(1)(iii) makes the sale a DCIT.

However, there is no automatic liability just because the transaction is a DCIT. Section 8.61(b) protects the directors against liability, including injunctive relief, if one of the three subsections in 8.61(b) applies. Subsection 8.61(b)(2) clearly does not apply because there was no shareholder approval of the transaction.

Subsection 8.61(b)(1) might apply if the board vote approving the transaction meets the requirements of section 8.62. The vote was clearly authorized by the affirmative vote of a majority of the qualified directors who voted. Alan, the director with the conflict, clearly isn’t a qualified director. Section 1.43(a)(3)(i). Barb may or may not be a qualified director. The transaction is not a DCIT as to her, so 1.43(a)(3)(i) doesn’t apply, but 1.43(a)(3)(ii) might apply. The question is whether she has a “material relationship” with Alan. “Material relationship” is any “familial, financial, professional, employment, or other relationship” that would “reasonably be expected to impair” Barb’s judgment as to this transaction. Barb and Alan are long-time close friends, and that could fall within “other relationship. In addition, Barb does legal work for Zappa, and it’s possible that Alan, as chairman of the board, could influence whether that work continues. The question is whether those relationships are strong enough that we would expect them to impair Barb’s judgment as to this transaction. Knowing that Frank is Alan’s brother-in-law, is Barb likely to act in a manner inconsistent with what’s best for Zappa? The answer is unclear.

Even if Barb is not a qualified director, the vote is still sufficient, as none of the other three directors appears to have any relationship that would keep them from being a qualified director. However, section 8.62(a)(1) provides that the qualified directors must deliberate and vote outside the presence of any other director. Barb was present at the meeting and participated in deliberations. If she’s not a qualified director, the action does not meet the requirements of section 8.62.

Even if Barb is qualified, there is still a potential problem under section 8.62: the vote must come “after required disclosure by the conflicted director.” Section 8.62(a). “Required disclosure” means disclosure of (1) the nature of the conflict and (2) all material facts concerning the subject matter of the transaction. Section 8.60(7). Alan didn’t even disclose the conflict, but that’s not a problem, because section 8.62(a) only requires disclosure of facts “not already known by such qualified directors.” All of the Zappa directors already knew about Alan’s relationship to Frank and Frank’s control of Gamma. The only other fact Alan knew that he didn’t disclose is Frank’s statement that the contract was “a great deal for Gamma.” Is this material? Arguably, a party to a contract might almost always describe it as a good deal, or they wouldn’t enter into the contract. Would the “great deal” language be likely to affect what the board did? If Alan disclosed this, would they say, we shouldn’t approve this—we need to renegotiate? If not, it probably wouldn’t be considered material.

If the requirements of section 8.62(b)(1) are not met, Alan and the board still have another argument. The transaction is not subject to challenge is it “judged according to the circumstances at the relevant time” was “fair” to the corporation. MBCA sec. 8.62(b)(3). As under the common law, fairness has both a procedural component and a substantive component. Section 8.60(6). The procedural component appears to have been met. The transaction was negotiated for several weeks by two disinterested board members. Neither Alan nor Barb was involved in the negotiations. The two board members consulted an appraiser, and the contract price fell within the range the appraiser indicated to be fair. Moreover, the negotiations resulted in a price drop from the original offer of $4.7 million down to $4.0 million. In sum, the process appears fair.

Substantive fairness is more difficult. The subsequent drop in value is irrelevant, because the relevant time for judging fairness is the time the board approved the contract. Section 8.60(3). But even Zappa’s expert concedes the value at the time was probably only $3.9 million, and the plaintiff’s expert places the value even lower (and both of these opinions are consistent with what the appraiser told Dan and Elaine at the time). The courts have made it clear that fairness is a range, not a point price, so perhaps this contract price was within the “range” of fairness. In any event, the procedural fairness may be enough to correct for the slight substantive unfairness, as the usual view is that both elements must be considered together.

If the approval was consistent with section 8.62, fairness doesn’t matter; the possibilities in section 8.61 are phrased in the alternative. If the requirements of section 8.62 were not met, then the transaction is protected only if the court decides it was fair at the time of the approval.


Question 3

Alicia’s Liability under MBCA 2.04

Section 2.04 of the MBCA says that anyone “purporting to act as or on behalf of a corporation” is personally liable if they acted “knowing there was no incorporation.” ABC Corporation’s articles had not been filed when Alicia purported to sign a contract on its behalf on Oct. 8. The corporate existence does not begin until the articles are filed. Thus, Alicia was clearly purporting to act on behalf of the corporation. The question is whether Alicia knew there was no incorporation. She told Bob Barrister on October 6 to file the articles immediately, so arguably she believed the incorporation occurred on that date. However, Bob told her we would notify her when the articles were filed, and he had not so notified her on Oct. 8. Until he notified her, she arguably still knew there was no incorporation. If so, she’s personally liable. The corporation’s adoption of the contract on Oct. 15 does not release her from this liability.

Betty and Carl’s Liability on the Lease

Neither Betty nor Carl acted directly on behalf of ABC Corporation. However, they still might be personally liable on the lease—either through the partnership or on an agency theory.

Alicia as an agent of the partnership

As a partner of ABC Partnership, Alicia is an agent of the partnership for purposes of its business. RUPA sec. 301(1). If she was acting on behalf of the partnership when she signed the pre-incorporation lease, then the partnership acted on behalf of a corporation knowing there was no incorporation, and the partnership would be liable under MBCA section 2.04. If the partnership is liable, then Betty and Carl are personally liable. RUPA section 306.

The decision to incorporate was made by the partnership and Betty and Carl as partners gave Alicia the authority to incorporate. Thus, Alicia was arguably acting on behalf of the partnership in her efforts to incorporate the business, but it’s not clear that includes the lease.

Betty and Carl only authorized Alicia to take steps to incorporate; the lease was not a necessary step towards incorporation. If the grant of authority to Alicia includes authority to sign the lease, then the partnership can be liable, even if the contract was not in the ordinary course of the partnership’s business. RUPA section 301(2). But signing the lease is probably not a step “necessary to put the partnership business into corporate form,” and therefore outside the scope of Alicia’s authority.

A partnership can be liable under section 301(1) even for unauthorized actions if the partner is “apparently carrying on in the ordinary course the partnership business” and the third party (in this case, Landlord) didn’t know and had not received a notification of the lack of authority. However, Alicia probably wasn’t acting “in the ordinary course” of the partnership business in creating and contracting on behalf of another entity.

Alicia as an agent of Betty and Carl

A second possibility is to argue that Alicia signed the lease not as an agent of the partnership, but as an agent of Betty and Carl individually. This argument runs into the same difficulty: Alicia’s actual authority does not appear to include signing a lease, only steps necessary to incorporate. And there is no apparent authority because neither Betty nor Carl communicated in any way with Landlord to create apparent authority.

Piercing the Corporate Veil

The only other potential liability is through piercing the corporate veil. ABC Corporation’s acceptance of liability on October 15 made it liable on the lease. However, Alicia, Betty, and Carl deliberately did not contribute enough capital to the corporation to enable it to make the required lease payments. Undercapitalization is one of the factors courts consider in deciding to pierce the corporate veil. Undercapitalization alone is usually not enough to pierce the veil, but the deliberate decision to cease corporate operations to avoid the lease seems almost fraudulent. Fraud or conduct touching on fraud is also a consideration in piercing the veil. There does not seem to be anything else supporting piercing, such as a failure to follow corporate formalities. The corporation simply wasn’t in existence long enough for anything else to occur. Therefore, it’s unclear if a court would be willing to pierce the veil and hold Alicia, Betty, and Carl personally liable for the corporation’s obligation on the lease.


Question 4

A person is liable for insider trading under Rule 10b-5 only if the trading involves a breach of fiduciary duty. Chiarella. Neither Fred nor Lotta is a classical insider; neither is an employee, officer, or director of Giant, so this is not the kind of liability involved in Texas Gulf Sulphur and subsequently approved by the Supreme Court.