Corporations
Professor Bradford
Fall 2003
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 2-9; Average = 5.68
Question 2: Range 0-9; Average = 4.89
Question 3: Range 0-9; Average = 4.69
Question 4: Range 0-8; Average = 5.07
Question 5: Range 2-9; Average = 5.88
Total (of unadjusted exam scores, not grades): Range ***; Average = ***
Question 1
[As some of you pointed out, there was a stupid error in the first sentence of the question. The question should have said that Imperial was organized under the Revised Uniform Limited Partnership Act. I apologize for the mistake. I took this into consideration inn the couple of cases where it affected people’s answers.]
Arthur’s Liability as a Limited Partner of Imperial Galactic
Arthur Dent is a limited partner of Imperial Galactic. Limited partners are not usually liable for the obligations of a limited partnership. RUPA § 303(a). Under that general rule, Arthur would not be liable on the contract with Ford. However, limited partners like Arthur can be liable if they participate in the control of the business and the third party reasonably believes, based on the limited partner’s conduct, that the limited partner is a general partner. RUPA § 303(a).
Ford will argue that Arthur participated in the control of the business by signing the contract. Since Arthur told Ford he was in charge and ran the company, and did not indicate, even on the contract, that he was only a limited partner or that he was acting for Vogon, the general partner, Ford’s belief that Arthur was a general partner would probably be reasonable.
The real question is whether Arthur participated in control within the meaning of § 303. Section 303(b) lists activities that do not constitute impermissible control. Under RULPA § 303(b)(1), a limited partner is not liable for acting as an employee of the limited partnership or of a general partner. Arthur is the managing member of Vogon, the general partner. If his actions were on behalf of Vogon, his appears to protect him. In addition, § 303(b)(6) allows limited partners to propose, approve, or disapprove, by voting or otherwise, a number of matters. The only possible item applicable here would be subsection (6)(ix): matters related to the business “which the partnership agreement states in writing may be subject to the approval or disapproval of limited partners.” The limited partnership agreement specifically allows limited partners to enter into contracts. Writing checks and entering into contracts is not voting, but § 303(b)(6) says “or otherwise” and arguably Arthur is approving the contract and the expenditure by signing the contract and the check. If so, he is not liable under § 303.
There is an additional problem that might create liability for Arthur. Section 101(5) of the RULPA says that a general partner is a “person” and § 101(11) defines “person” to include a number of entities, but not an LLC. The drafters probably meant for any legally recognized entity to be included, but didn’t mention LLCs because they didn’t exist at the time. A court might include LLCs as being within the intent of the statute. But, if the court is true to the literal language of the statute, Vogon is not a proper general partner. Absent a general partner, this is not a valid limited partnership. And, if it’s not a valid limited partnership, the only alternative seems to be that it is a general partnership, so all the “limited partners” would be personally liable. Section 304(b) makes people who believe they are limited partners, but aren’t, liable to third parties who believe in good faith they are general partners. If the court accepts that argument, Arthur would be liable on the contract regardless of the outcome under RULPA § 303.
Arthur’s Liability as a Member of Vogon
Vogon, as the general partner of Imperial Galactic, is liable on the contract. RULPA § 403(b); RUPA § 306(a). The question does not indicate in which jurisdiction Vogon is organized. However, wherever organized, Arthur is not liable merely because he is a member or manager of Vogon. See ULLCA § 303(a); Del. § 18-303(a). This is true even though Arthur failed to follow the formalities for action on behalf of Vogon (assuming he was acting for Vogon and not as a limited partner of Imperial Galactic) by putting Vogon’s name on the contract. ULLCA § 303(b).
There is, however, a possible argument for Arthur’s liability, although it’s not clear how you would prove it factually. Assume that Arthur intended to sign the contract on behalf of Vogon as general partner of Imperial Galactic, not directly as a limited partner of Imperial Galactic. Since he did not tell Ford he was acting for Vogon and there is nothing in the contract to indicate Arthur is acting for Vogon, Vogon is an undisclosed principal. Restatement (Second) of Agency § 4(3). Then, Arthur is liable on the contract. RSA § 322.
However, this argument breaks down when examined more closely. Vogon, even if fully disclosed, is not liable on the contract. It is liable because of its capacity as general partner. Arthur does disclose the person he is making the contract for, Imperial Galactic. Since Vogon has no liability on the contract, whether or not disclosed, it is hard to see how Arthur could be derivatively liable by not disclosing Vogon’s status.
Question 2
Section 16(b)
Yossarian has no liability under § 16(b) of the Exchange Act. Yossarian is a director of Milo Enterprises, but section 16(b) only applies to companies that have a class of equity securities registered pursuant to section 12 of the Exchange Act. Section 12 requires registration if a company’s security is traded on a national stock exchange or if the security has more than 500 record holders and the company has $10 million in assets. Milo meets neither requirement: its stock is not publicly traded and it only has 300 shareholders.
Rule 10b-5
Rule 10b-5 has no such jurisdictional threshold. It applies to the purchase or sale of any security, whether or not it is publicly traded. Yossarian has made no fraudulent statements, but Rule 10b-5 also applies to insider trading even if no fraudulent statements are made, as long as Yossarian has a duty to disclose. This information clearly is material to the value of the Milo stock.
Yossarian is not liable under O’Hagan for misappropriating the information from Heller. It is clear the other partners expect him to keep the laser guidance development secret, but he told Nately and Clevinger, the only other two partners, that he intended to use the information to sell the Milo stock. O’Hagan makes it clear that misappropriation requires fraud, and there is no fraud if Yossarian tells the source of the information that he intends to use it to trade. Yossarian is also not liable for “classical” insider trading, as in Texas Gulf Sulphur. The information comes from the partnership, but he is not buying its securities.
Because he is a director of Milo, Yossarian also owes a fiduciary duty to Milo. However, he does not acquire the information from Milo, so he is not a classical insider trader. He is not misusing any confidential information that belongs to Milo. As discussed below, however, his sale does appear to be self-dealing, which would breach a fiduciary duty under state law. That breach of duty, for personal gain, could be sufficient under Chiarella. If so, Yossarian is liable under Rule 10b-5.
State Law Breach of the Duty of Loyalty
As a director, Yossarian owes a duty of loyalty to Milo. He is engaged in a self-dealing transaction with Milo. Under Delaware law, that self-dealing transaction is subject to challenge unless it is approved by disinterested directors or shareholders after full disclosure of all material facts or it is fair to the corporation. Del. Gen. Corp. L. § 144.
The transaction was approved by a majority of the disinterested directors, but Yossarian did not disclose what he knew about the new system being developed. Section 144 requires that the approval be after disclosure of “the material facts as to the director’s or officer’s relationship or interest and as to the contract or transaction.” Yossarian’s interest was apparent from the deal itself, so the first requirement was made. The question is whether the information about the new system is a material fact as to the contract or transaction. It doesn’t relate to the sales contract itself, but it does affect the value of the stock, so this is probably something § 144 requires to be disclosed. Since it was not, the requirements of § 144(a)(1) are not met.
Section 144(a)(2) does not apply; there was no shareholder vote. And the fairness test in Del. § 144(a)(3) does not appear to be met. Fairness has two elements: fair dealing and fair price. HMG/Courtland Properties, Inc. v. Gray. Given the nonpublic information available to Yossarian, the price paid to Yossarian probably was not fair. But note that a non-related party would have received the price Yossarian did, so his transaction is equivalent to what would have happened if there was no conflict of interest. Does the process become unfair merely because he knows something about the value of the stock he does not disclose to Milo? If so, he hasn’t met the fairness test and he is liable for breaching his duty of loyalty.
The repurchase by the corporation might also trigger the Donahue equal opportunity rule, except that Delaware does not recognize the special partnership-like fiduciary duties Donahue says applies to closely held corporations. Delaware applies the same fiduciary duties to all corporations, public and closely held.
Finally, Yossarian might be liable for the insider trading under state law as a breach of his fiduciary duty. This was not a market transaction, but a face-to-face negotiation with a party to whom Yossarian owes a fiduciary duty of disclosure. Under the special facts doctrine, he could be liable for his misuse of the confidential information. See Goodwin v. Agassiz. However, it’s not clear that a court would impose this liability in a case where the nonpublic information does not come from within the company.
Question 3
The transaction between Marlin, Santiago’s sole proprietorship, and Hemingway, the corporation of which Santiago is a director, may involve a breach of fiduciary duty by Santiago. The opportunity to sell fish to DiMaggio’s new chain of grocery stores could constitute a corporate opportunity belonging to Hemingway. Santiago’s diversion of that opportunity to Marlin could breach the fiduciary duty he owes as a director of Hemingway. However, § 8.61 of the MBCA does not cover that claim because the deal between Marlin and DiMaggio is not a corporate transaction of Hemingway.
Section 8.61(b) applies to a transaction that is a “director’s conflicting interest transaction.” It tells the judge when he may not grant relief when the claim is that a director or someone related to the director has an interest in a director’s conflicting interest transaction. Section 8.60(2) defines “director’s conflicting interest transaction” as “a transaction effected or proposed to be effected by the corporation” or by a subsidiary of the corporation or another entity in which the corporation has a controlling interest. The corporation of which Santiago is a director is Hemingway. Hemingway is not effecting a transaction with either Marlin or DiMaggio, nor is any subsidiary of Hemingway or an entity controlled by Hemingway. The Marlin-DiMaggio transaction is not a corporate transaction with respect to Hemingway, so section 8.61(b) does not apply with respect to any claim against Santiago as a director of Hemingway.
The same restriction appears in section 8.61(a). It applies to any transaction “that is not a director’s conflicting interest transaction,” but it includes the same corporate transaction language. For § 8.61(a) to apply, the transaction must be one “effected or proposed to be effected by” the corporation, its subsidiary, or a controlled company. The Marlin-DiMaggio transaction does not meet this requirement as to Hemingway, so section 8.61(a) also does not apply.
Question 4
Delaware law requires that a shareholder make a demand on the board of directors before instituting a derivative action unless demand is excused as futile. Roark did not make a demand, so the action must be dismissed unless demand is excused. Under Delaware law, demand is excused if the plaintiff alleges in the complaint particularized facts creating a reasonable doubt whether (1) a majority of the board is disinterested or independent or (2) the challenged transaction was otherwise the product of a valid exercise of business judgment. Aronson v. Lewis.
Was a majority of the board disinterested or independent?
Roark clearly has alleged that Keating had a conflict of interest. He owned 60% of Cameron, the other party to the contract, and Keating clearly stood to benefit if Cameron profited from the contract.
Roark has not alleged that either Francon or Heller had an interest in the transaction. The question is whether he has alleged sufficient facts to create a reasonable doubt that they are independent. Clearly, the allegations establish that Keating and Francon are very close friends, but it’s not clear that friendship alone shows that he exerts an undue influence over her judgment. All directors on the same board are friends to one extent or another, and the Delaware courts have made it clear that merely being on the same board does not disqualify one from judging the merits of litigation against another director. See Zapata. Similarly, the fact that Heller and Keating usually vote the same way does not establish that Keating controls how Heller votes. They might simply share a philosophy about how the corporation should run. Thus, it’s unclear that Roark has pled particularized facts showing that they are not independent. If not, demand is not excused under this prong of the Aronson test, because he must allege that a majority of the directors were interested or not independent.