1
Business Associations
Professor Bradford
Fall 2010
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. In some cases, the result is unclear; the position taken by the answer outline is not necessarily the only justifiable conclusion.
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 3-9; Average = 5.42
Question 2: Range 0-9; Average = 6.63
Question 3: Range 4-9; Average = 7.08
Question 4: Range 0-9; Average = 6.05
Question 5: Range 4-9; Average = 6.68
Question 6: Range 2-9; Average = 4.50
Total (of unadjusted exam scores, not final grades): Range 3.72-8.46; Average = 5.52
If you have any questions about the exam or your performance on the exam, feel free to contact me to talk about it.
Question 1
Shemp could be liable for breach of his duty of loyalty to Stooge if the copper mine investment is a corporate opportunity that belongs to Stooge, and if Shemp has not fulfilled the requirements of MBCA § 8.70 to avoid liability.
Corporate Opportunity?
If this is not a corporate opportunity, Shemp is not liable. Stooge is an MBCA corporation, but the MBCA does not define what constitutes a corporate opportunity, so the issue is left to case law.
There is no single accepted test for whether something is a corporate opportunity. Courts consider several factors in determining whether something is a corporate opportunity. See Northeast Harbor Golf Club. v. Harris; Broz v. Cellular Information Systems, Inc.
1. Financial ability: One factor is whether Stooge is able financially to exploit the opportunity. Stooge does not appear to have any financial problems here, so that would not keep this from being a corporate opportunity.
2. Presented in the director’s corporate or individual capacity: Another factor is whether the opportunity was presented to the director in his corporate or his individual capacity. That’s a difficult question here. Shemp was on a corporate trip, but learned of the opportunity at a cocktail party and, moreover, learned of it from a personal friend. On the whole, this seems to point against it being a corporate opportunity.
3. Interest or expectancy: Another factor is whether the company has an interest or expectancy in the opportunity. Stooge had no prior dealings with Shemp’s friend, so the only thing that might create a weak interest or expectancy is that Shemp was on a corporate trip. Again, this points against it being a corporate opportunity.
4. Essential to the corporation: Another factor is whether the opportunity is essential to Stooge; that does not appear to be the case here.
5. Use of corporate resources: Another factor is whether the director used corporate resources to pursue or exploit the opportunity. Shemp used his own funds to purchase both the option and to make the eventual investment. But, on the other hand, Shemp arguably did become aware of the opportunity because of a use of corporate resources—his use of company funds to take the trip in the first place.
6. Line of business: Another factor is whether the opportunity is within the company’s line of business. This investment arguably is; Stooge is a mining company and this is an investment in a mine. However, it does not appear that Stooge usually invests in other people’s mines; the question says it buys land and extracts the minerals itself. So this is at least a little different from its usual line of business.
7. Inimical to position as director: Another factor is whether taking the opportunity will put the director in a position inimical to his duties to the corporation. There is no evidence that taking this particular opportunity will put Shemp in a position adverse to the interests of Stooge.
8. Involvement of an officer: Finally, some courts are more willing to find a corporate opportunity when an officer is involved. See ALI Principles of Corporate Governance § 5.05(b)(2). Shemp is only a director, not also an officer.
Protection by MBCA § 8.70
Even if the copper mine investment is a corporate opportunity of Stooge’s, Shemp would not be liable if the action by the board meets the requirements of MBCA § 8.70. Shemp must use the § 8.70 procedure “before becoming legally obligated respecting the transaction.” MBCA § 8.70(a). Shemp meets this requirement. Although he acquired the option before he brought the opportunity to the board, he was not yet obligated on the investment itself.
Section 8.70(a)(2), dealing with action by the shareholders, is not applicable here. Although the opportunity was discussed at the shareholder meeting and shareholders were given an opportunity to object, no shareholder vote was conducted, and § 8.63(a) clearly requires a vote.
Section 8.70(a)(1) says that a director is not liable for taking a corporate opportunity if action is taken by qualified directors in compliance with § 8.62. Section 8.62(a) requires the affirmative vote of a majority of the qualified directors who voted on the transaction, but no fewer than two. Moreover, those qualified directors must deliberate and vote outside the presence of any non-qualified directors. § 8.62(a)(1). And that vote must come after “required disclosure,” § 8.62(a), which is defined to include disclosure of the nature of the conflict of interest and “all [material] facts known to the director respecting the subject matter of the transaction.” § 8.60(7).
Neither Shemp nor his brother Curly participated in the board’s deliberations or vote; both recused themselves. And the question indicates that Shemp told the board everything he knew about the offer and the option he had purchased, so the “required disclosure” requirement also appears to be satisfied. Thus, if the other two directors are qualified directors, the requirement of § 8.62(a)(1) is satisfied.
A “qualified director” is a director for whom the transaction would not be a director’s conflicting interest transaction if this were a self-dealing transaction and who does not have a material relationship with anyone for whom it is. MBCA § 1.43(a)(3),(4). Neither Moe nor Larry appear to have a sufficient relationship to the transaction or to Shemp to make this a director’s conflicting interest transaction. Neither is a party, § 8.60(1)(i); neither has a financial interest in the deal, § 8.60(1)(ii); and neither is a “related person” to Shemp, as defined in § 8.60(5). Thus, they are qualified directors unless they have a material relationship with Shemp.
A “material relationship” is a “familial, financial, professional, employment or other relationship that would reasonably be expected to impair the objectivity of the director’s judgment.” MBCA § 1.43(b)(1). Moe does not have a familial relationship with Shemp, and he does not have a current professional or employment relationship with Shemp, but he has represented Moe in the past. That creates at least the possibility of future legal work and that could potentially affect Moe’s judgment, but is a $2,000 fee sufficiently material that it would impair Moe’s objectivity? If so, he’s not a qualified director. Moe also serves on another board with Shemp, but that alone doesn’t constitute a material relationship. MBCA § 1.43(c)(2).
Larry appears to be a qualified director without question. The fact that Shemp nominated Larry to Stooge’s board does not prevent Larry from being a qualified director, § 1.43(c)(1), and Larry has no other ties to Shemp.
Thus, if Moe is qualified, the requirements of § 8.62 are met and Shemp is not liable. MBCA § 8.70(a)(1). If Moe is not qualified, § 8.70 does not help Shemp.
In some jurisdictions, to avoid liability, a director must first present the opportunity to the corporation before taking it. See ALI Principles of Corporate Governance § 5.05(a); Northeast Harbor Golf Club v. Harris. However, other jurisdictions do not accept this as an absolute requirement. See Broz v. Cellular Information Systems, Inc. Failure to use the procedures in § 8.70 does not create any unfavorable inferences or alter the burden of proof, MBCA § 8.70(b), but merely relegates the Shemp to what the case law would otherwise say.
Question 2
Caremark requires the board of directors to implement a corporate information and reporting system designed to provide the board with information about both the corporation’s compliance with law and its business performance. However, Caremark indicated that directors are not liable merely because the company’s compliance and monitoring system fails to detect a problem.
The design of any corporate compliance system is a question of business judgment, protected by the business judgment rule. If the board adequately informs itself before establishing such a system and acts in a good faith belief that the system established is appropriate, they won’t be held liable. Caremark indicates that only “a sustained or systematic failure of the board to exercise oversight,” “such as an utter failure to attempt” to establish such a system, will result in liability. Thus, if the board in good faith establishes such a system, no liability is likely, even if the system fails to catch wrongdoing or other problems.
Question 3
The Effect of the Transfer
A partner in a general partnership may transfer only her financial interest—the share of profit and losses and the right to distributions. RUPA § 502. The transferee does not become a partner or receive the right to vote. RUPA § 503(a). Absent a provision in the partnership agreement, and there is no agreement, Buyer may become a full partner with governance rights only with the consent of all the partners. RUPA § 401(i). No one objected to the transfer, but there’s no evidence that Alpha and Omega consented to Buyer becoming a partner.
Therefore, when Seller sold her interest to Buyer, Buyer did not acquire any voting rights. Any votes he cast are irrelevant. Instead, Seller retains her rights as a partner other than the transferred financial rights. RUPA § 503(d). Seller still has the right to vote and, therefore, her votes are counted.
The Vote to Make a Distribution
Considering the votes of Alpha, Omega, and Seller, the vote to make the $50,000 distribution was 2-1 in favor of the distribution. Whether to make a distribution like this is a matter in the ordinary course of business of the partnership, and therefore subject to majority rule. RUPA § 401(j). The distribution was approved.
The Allocation Vote
The default rule is that partners are entitled to an equal share of profits and losses. RUPA § 401(b). Therefore, the distribution should be shared equally by Alpha, Omega, and Buyer (who has Seller’s financial rights as per § 502). Changing that default rule would require an amendment to the partnership agreement, or in this case, a partnership agreement in the first place. See RUPA § 103(a). That requires the consent of all the partners. RUPA § 401(j). The vote to give Alpha 50% was only 2-1, ignoring Buyer’s ineffective vote. Thus, this vote is ineffective.
As a result, the distribution is approved, but it will be distributed according to the default rule—with equal shares to Alpha, Omega, and Buyer.
Question 4
This is a Delaware corporation so, under the internal affairs rule, Delaware corporate law applies. Delaware § 170(a) says dividends may be paid out of surplus or, if there is no surplus, out of net profits from the current and previous years.
Omega has no surplus. Surplus is the excess of the net assets over capital (meaning stated capital), and net assets is defined simply as total assets less total liabilities. Del. § 154. Omega’s net assets are $15,000 ($95,000 – $80,000). Its capital is the amount in the common stock account, $20,000. Therefore, its surplus is a negative number, -$5,000. Even if the assets and liabilities are revalued to their fair market value, which Delaware common law allows, there still is no surplus. Net assets would then be $20,000 ($100,000 – $80,000), and surplus would be $0 ($20,000 – $20,000).
However, section 170(a) says that, if there is no surplus, dividends may be paid “out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year.” The profit so far in this fiscal year is $15,000. Omega had a net loss of $5,000 in the preceding fiscal year, but that loss does not need to be netted against this year’s profit because § 170 says out of this year’s “and/or” last year’s profits; we may combine the two years or look at each separately. Therefore, Omega may pay a dividend of $15,000.
Question 5
Under RULPA § 602, a general partner in a limited partnership may withdraw at any time by giving written notice. Geena has done that, so she is no longer a general partner. RULPA § 402(1). She is liable for damages if her withdrawal breaches the partnership agreement, § 602, but there is no partnership agreement here, so she will have no such liability.
Upon withdrawal, Geena is entitled to be paid (1) any distribution to which she is entitled under the partnership agreement and (2) unless otherwise provided in the partnership agreement, the fair value of her interest in the partnership as of the date of withdrawal. RULPA § 604. The first provision is inapplicable since there is no partnership agreement, so Geena is entitled to receive from the partnership the fair value of her interest as a general partner. The value of her interest is based on her right to share in distributions. RULPA § 604. Since there is no partnership agreement, her proportionate interest would be the same as her proportion of unreturned capital contributions. RULPA § 504.