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I. Overview of Business Associations

• Factors in choosing business structures: trying to maximize benefit while reducing
risk
o Who will own business
o Who will manage business
o Who will reap profit
o Who will bear risk of loss
o Who will pay income tax on business profit
• Two fundamental differences of various structures
o Tax treatment of profits
o Liability exposure of owners for debts

II. Sole Proprietorships

• Problems with sole proprietorships
o Employees and Agency principles
 2 requirements for agency
• Principal must consent—give authority—that agent will act for
him
o Actual Authority
 Actual express – principal specifically gives
agent power to undertake specific act on her
behalf
 Actual implied – agent has authority to get
assigned job done even if principal did not spell
it out in detail
o Apparent Authority –
 indication by principal to third party that
agent has authority
 no need for detrimental reliance by third party
• Agent must agree to that consent
 Tort liability: master liable for torts of a servant only if committed
within scope of employment
• Master/servant: master has right to control physical conduct of
servant
• Intentional tort is not usually within scope of employment
• Could be if, e.g., bouncer at a party
o Other agency relationships
 Attorney-Client: Hayes v. National Service Industries
• Client didn’t want to be bound by attorney’s settlement
• Attorney has authority unless it is limited by the client in the
representation agreement
• Court says apparent authority was created by the fact that agent
said he had authority
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o This is wrong use of apparent authority, more accurate

would have been if apparent authority was granted
because of the attorney’s position
• If settlement was prohibited by client, settlement would still be
enforced but client could then bring a breach of contract suit to
attorney
 Franchises/other Business relationships
• Franchise: successful business doesn’t own all of its outlets
• Miller v. McDonald’s Corporation
o 3K owns a McDonalds franchise, woman chokes on a
sapphire stone in sandwich
o woman sues McDonalds
 Does McDonalds have control over 3K?
• Franchise agreement has detailed
requirements
• Strict enforcement of requirements
 Apparent agency
• McD held out 3K as its agent to the
public
• General public doesn’t know enough
about franchising to know 3K owned
restaurants
 Another possible theory is that McD and 3K
were partners because of profit sharing, etc.
o How could McD make sure that franchisees pay
 McD could write an indemnity clause in
franchise agreement
 Make franchisee take out indemnity/ liability
insurance
• How does a sole proprietorship grow
o Funding by owner
o Overview of debt and equity
 Debt: loan that business is legally obligated to repay
• Riskier to business
• If business fails, must be paid in full before anything is given
to owners
• Return amount is known
• Fixed cost to business – interest rate
 Equity: investment that business is not legally obligated to repay
• Riskier to investor
• Higher potential return – based on stock price
• Variable cost to business
o Investors share in success of company
o Investors have right to some control of business
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o Cash flow view of debt and equity

 Debt is selling portion of future cash flow in exchange for money now
 Equity is ownership, and thus selling ownership turns sole
proprietorship into partnership
o Borrowing money
 Get funds in a way that is least risky to the providers
• Pledge personal or corporate assets against loan as collateral
• Can have other people guarantee -- cosigner
• Promise to pay in a short time
• Give creditor control over business
o Loan covenants
o Participation in business decisions (seat on board of
corporation)
• Profit sharing may change type of business structure, i.e. make
it a partnership
o Partner is behind lender in getting money back
o Partner is liable for torts
o Sharing Profits with a Lender
 In re Estate of Fenimore
• Watt (Serge) and Fenimore make an agreement where Watt
gives 12,500 to Fenimore to do business selling cars and share
profits
• Generally, sharing profits is prima facie evidence of
partnership, unless the profits are received in payment:
o As a debt by installments
o As wages of an employee/rent to landlord
o Annuity to widow or representative of deceased partner
o As interest on a loan (even tho amount payment varies
with business profits)
o Consideration for sale of a goodwill of business
• Not essential that all partners have right to make decisions
o Can use profit sharing, and other conduct to show
partnership exists
• If a partnership, what is the consequence, i.e. who gets paid
first?
o Order when insolvent as to claims against separate
property is:
 1 - Money owed to separate creditors
 2 - Owed to partnership creditors
 3 - Those owing to partners by way of
contribution
o Here, Villabona is a separate creditor, and Serge is a
partner, so Villabona takes priority over Serge
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III. Partnerships
• Definition: association of two or more persons to carry on as co-owners a business for
profit (RUPA 202)
• Creating partnership: no need to formally create, but courts look at 5 factors to
characterize as partnership:
o Right to control
o Agreement to share losses
o Contribution of property to business
o Payout via profit share
o Called a partner in agreement?
• Property ownership
o 201- Partnership is entity
o 203 – Property acquired by partnership is property of partnership, not of
individual partners
o 204 – 3 ways property is partnership property
 If acquired in name of partnership or one of partners with indication
that it is in capacity as partner
 If acquired in name of partnership by transfer to
• Partnership in its name
• Partners in their capacity as partners in partnership (name of
partnership indicated in instrument)
 Presumed if purchased with partnership assets (even if not in name of
partnership)
o 501 – partner not co-owner in partnership property, and has no interest in it
o 502 – only transferable interest of partner is share of profits and losses and
right to receive distributions
• Decision making
o Meinhard v. Salmon (1928)
 Salmon (real estate developer) was offered a lease for a building on 5th
avenue, couldn’t really afford it himself, so he found Meinhard to join
with him on the lease
• Lease was 20 years long
• Meinhard gave money for renovations
• Shared proits from building
• Salmon was sole manager of building
 Near end of lease the owner wanted someone to lease all of his 5th ave
buildings and improve them with a new large building instead
 Owner approached Salmon, and they entered an agreement with each
other, unknown to Meinhard
 Meinhard found out after lease was executed and sued after not being
allowed to be part of the lease
 Court found that Salmon, as manager of this coventure should have
given Meinhard the opportunity to join or compete
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• Since the Salmon was manager it was even more important that
he tell Meinhard, considering Meinhard wouldn’t have known
about the opportunity otherwise
• To renew the same lease in his own interest without conferring
with Meinhard is wrong, it might have been different if it was
for an entirely different place
o 103 - Partnership agreement effect; nonwaivable provisions
 cant unreasonably restrict right of access to books/records
 cant eliminate duty of loyalty
• can identify activities that don’t violate duty (as long as not
manifestly unreasonable)
• all partners (or percentage specified in agreement) can ratify
act that would have otherwise violated, after the fact
 cant unreasonably restrict duty of care
 cant eliminate good faith/fair dealing, but can prescribe standards by
which to be measured (as long as not manifestly unreasonable)
 cant vary power to at will dissociation (but can require notice in
writing)
 cant vary requirement to wind up partnership in 801(4-6)
 vary applicable law under 106(b)
 cant restrict rights of third parties
o 401 – Partner’s rights and duties
 each partner has account
• credited with anything contributed: money, value of property,
amount of liabilities, and share of partnership profits
• charged with distribution by partnership: money, value of
property, net amount of liabilities, share of partnership losses
 entitled to equal share of partnership profits, chargeable with share of
losses
 partnership reimburses for advance to partnership beyond capital
contributions
• counts as a loan with interest
 each partner has equal rights in management
 deciding differences
• if ordinary course of business: just majority
• if outside ordinary course or amendment to agreement:
unanimous consent
o 404 – Standards of Partner’s conduct
 Fiduciary duties
• 404b - Duty of Loyalty – codification of meinhart
o Hold partnership as trustee
o If you get personal benefit, you owe it to partnership
• 404c – Duty of Care
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o Just don’t be grossly negligent or reckless or conduct

intentional misconduct
o Merely being a partner does not absolve someone of
normal liability to third parties
 401c, partnership reimburse a partner/indemnify
for liabilities incurred in ordinary course of
business
• encourages partnerships to act normally
• partner will still contribute his
proportion of partnership
 404d - Duty of good faith and fair dealings – arises out of contract law
 404e – just because u benefit from it doesn’t mean u violated the duty
 404f – specifically says you can lend and transact business with
partnership
o 405 – Actions by Partnership and Partners
• Liability
o 306 – partners are jointly and severally liable for all partnership obligations
o 401(c) – partnership reimburse/indemnify partner for payments
o made/liabilities incurred by partner in ordinary course of business
• Growth
o Existing owners: no requirement, but agreement may require capital
contribution
o Lenders
o Additional owners
 401(i) - Need unanimous consent of existing partners unless agreement
says otherwise—(not in ordinary course of business)
 306(b) – new partner not personally liable for any obligations incurred
before they became partner
o Earnings from business operations
• How Owners make money
o Salary – 401(h) not entitled to payment for services, but agreement can
obviously provide otherwise
o Profits – 401(b) each entitled to equal share of profits and charged with share
of losses in proportion
o Sale of Ownership Interest
 502 – can sell share of profits/losses and right to receive distributions
 503 – transfer of interest
• does not automatically cause dissociation or dissolution or
winding up
• transferor still has rights and duties other than distribution, and
profit/loss sharing
• Dissociation – partner withdrawing from partnership
o 601 - events causing dissociation
 partner gives notice of express will to withdraw
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 event agreed to in partnership agreement

 partner’s expulsion pursuant to agreement
 expulsion by unanimous vote of other partners if
• unlawful to carry on partnership business
• transfer of all or substantially all of partner’s transferable
interest in partnership (other than transfer for security or court
order charging partner’s interest)
• within 90 days after partnership notifies partner it will be
expelled because it has filed certificate of dissolution, …
• a partnership that is a partner has been dissolved and business
wound up???601(4)(iv)
 on application by partnership or another partner, partner’s expulsion
by judicial determination
• wrongful conduct
• material breach of agreement
• not reasonably practicable to carry on business with partner
 bankruptcy
 death
o 602b: wrongful dissociation
 breach of partnership agreement, OR
 before term or undertaking, if
• withdraw by express will unless within 90 days of another
partner’s dissociation by death or otherwise under 601(6-10),
OR
• expelled by judicial determination under 601(5), OR
• dissociated by becoming debtor in bankruptcy, OR
• if not individual, trust, business trust….
o 602(c) - Person wrongfully dissociating is liable to partnership and to other
partners for damages caused by dissociation
o 603 – Effects of dissociation
 Lose management
 No more duty of loyalty (404b3) as far as competing
 Duty of loyalty 404b1/404b2 are not eliminated if they arise out of
stuff from before dissociation
• Dissociation without winding up (RUPA 7) buyout price if no dissolution/winding
up:
o 701(b) - Price determined by the higher of the following (proportional share)
 Liquidation of assets at the time of dissociation
 Sale of entire business as a going concern at date of dissociation
o 701(c) - Subtract damages for wrongful dissociation
o 701(h) – wrongfully dissociated partner wont get money until expiration of
term/undertaking unless partner shows earlier payment wont cause undue
hardship
o 702(a) – for two years partnership bound if
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 third party believed dissociated party was partner

 didn’t have notice of partner’s dissociation
 not deemed to have had knowledge under 303e/704c
o 704 – statement of dissociation
 name and that partner is dissociated
 have notice 90 days after this is filed
o 705 – continued use of partnership name does not by itself make a partner
liable for obligations of partnership
 703 reasonable belief
• Dissolution
o 801 - events causing dissolution and forcing winding up of business
 in partnership at will notice from a partner who dissociates by express
will
 for partnerships of term or undertaking
• within 90 days after partners dissociation by death or going
away (i.e. bankruptcy, etc.), or wrongful dissociation, half of
remaining partners expressly willing to wind up….
• Express will of all partners to wind up business
• Expiration of term or completion of undertaking
 Event agreed to in partnership agreement
 Event making it unlawful –not a default rule
 Judicial determination (on application by partner) – not a default rule
(103(b)(8))
• Unreasonable frustration of economic purpose
• Partner’s conduct making it not reasonably practicable to carry
on business
• Not otherwise reasonably practicable to carry on business
under agreement
 Judicial determination that it is equitable to wind up business – not a
default rule(103(b)(8))
o 802 – how/why partnership continues after dissolution
 (a) generally only for purpose of winding up, except under exceptions
of b
 (b) after dissolution and before winding up, all partners, including non-
wrongfully dissociating partner can waive the right to wind up and
terminate
• partnership carries on as if it never happened
• cant adversely affect third party rights
o 803 – right to wind up partnership business
 (a) if not wrongfully dissociated, you can participate in winding up
• any partner can ask for judicial supervision with good cause
 (b) legal rep of last partner can wind up
o 804-806: partner/partnership ability to bind each other after dissolution
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 804 – partnership bound by partner’s act after dissolution that is

appropriate for winding up or that would have bound partnership
(under agency laws), if other party did not have notice of dissolution
 805 – c – you have notice 90 days after this statement is filed
 806 – partners liability to other partners
o 807 – settlement of accounts etc.
 (a) first pay the creditors, partners can be creditors, they are treated
same (inside or outside debt)
 (b) entitled to settlement of all partnership accounts upon winding up
o Partnership Accounts
 Amount invested
 + share of profits
 + other gains
 - share of liabilities
 - share of losses
 – distributions
o Issues come up with labor partners
 Kovacik v. Reed (1957)
• Capital partner invests 10000
• Only $1320 left, 8680 in losses
• Split loss with labor partner?
• Under RUPA, they would share losses
• Court though says most of the time this rule of sharing losses is
when both contribute capital including money or land or
tangible property
o So capital partner bears risk
o Not majority rule
 RUPA rules are only fair in the “average situation”
• For capital contribution, look at what interest is of the
contribution
o E.g. 10k, 10% = 1k
• Labor contribution, look at what he could have made salary
wise in a year (more than 1k/year)
• In this case, labor partner should ask for more partner
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IV. Corporations Defined

• Requirements for a corporation
o Articles of incorporation
 MBCA 2.02
• a: Must include:
o Name for corporation satisfying 4.01
 Corporation, incorporated, company, limited, or
abbreviations….or similar words
o Number of authorized shares
o Address of registered office and agent at this office
o Name and address of each incorporator
• b: May include:
o Names/addresses of initial directors
o Provisions not inconsistent with law regarding
 Purpose for corporation
 Managing business
 Defining powers of corp/directors/shareholders
 Par value
 Imposition of personal liability on shareholders
for debts of the corporation
o Provision under this act required or permitted to be set
forth in bylaws
o Provision limiting/eliminating liability of a director to
corp or shareholders for money damages with 4
exceptions
o Bylaws
 2.06 managing business/regulating affairs as long as not inconsistent
with law or articles of incorp.
o Promoters
 2.04 any people acting as or on behalf of corporation, KNOWING
there was no incorporation is jointly and severally liable for all
liabilities created while so acting
 Promoter/agent should do three things to limit liability:
• Indicate nonexistence of corporation
• Indicate representative capacity
• Provide for novation – not automatic must be agreed to by both
parties
• Ways to raise money
o Loan from banks, investors (bonds)
o Retain earnings
o Issue Stock – sell ownership in company
 Shareholder “control” – management decisions
 Shareholder financial benefits
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• Own assets (entitled to value of assets if sold – not property

ownership)
• Dividends
• Capital gains
 Authorized share – corporation has permitted sale, not necessarily in
existence
• In articles of incorporation
• Corporation can only sell up to the number of authorized shares
• Corp might not sell all authorized shares
o to keep some control
o for economic interest
 Outstanding share – a share that is actually issued by the company
 Common stock – normal stock with normal voting and economic
rights (e.g. no guarantee of dividends)
 Preferred stock – any stock with different rights than common stock
• Can agree that dividends go to preferred before common
shareholders
• Can guarantee amount of dividends
• Can get favorable liquidation rights
• Can get redemption rights
 Stock can be issued for tangible or intangible property – board of
directors determines what value is of property
• 6.21(b)
• Delaware 152
 Par value – minimum price for which corporation can issue shares
• Shareholder not governed by this, only limits corporation
• NYSE for example is not issuance since it is the resale of
“used” stock
• Benefits of par value
o Protects shareholders (makes negative dilution less
likely)
o Must keep par value of stock - protects creditors
• Only certain states require this, and in these few states, par
value is usually set nominally low
• Optional to have par value in some states
• Reasoning behind change from required par value
o Might be reason for shareholders to want sales lower
than par value
 Stated capital = (number of shares) x (par value)
 Capital surplus = (price sold) x (number of shares) – (stated capital)
• Only allowed to distribute capital surplus
 Par = 1/share; sold for 10/share, 100 shares sold
• Stated capital = 100
• Capital surplus = 900
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o State of incorporation
 Any state you want
 Laws of that state become default rules governing “internal affairs” of
corp
• Internal affairs = procedures for corporate actions and rights
and duties of directors, shareholders and officers
• Cant avoid application of certain states’ tort law by
incorporating in a different state—would restrict third party
rights
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V. Operation of a Corporation
• Liability to Creditors
o Generally, corporation as an entity can be held liable to third parties
o Shareholder is generally protected from personal responsibility (MBCA 6.22b
and Delaware 162)
o Exceptions to rule that shareholders are not personally liable
 Contractual – third parties can refuse to extend credit without
agreement by shareholders to guarantee payment
 Judicially created exceptions – piercing corporate veil
• Dewitt Truck Brokers (1975): factors to pierce corporate veil:
o Undercapitalization – owners have only put limited
amount into corporation—this is usually the key one
o Fraud
o All stock owned by 1 person
o Corporate formalities – meetings, voting, etc.
o No dividends
o Excess salary to main Shareholder
o No functioning board or officers
o No corporate records
o Commingling of funds
o SH treats assets as his own
o Holding out SH as personally liable
 Make sure to refer to corp. as “inc.”
o Directors and officers are same people
 Get multiple directors
• Enterprise liability: all corporations in an industry are
enterprise and treated as single entity for liability purposes
o Walkovsky – enterprise liability
 corp owned by same person who also owned 9
other corporations with 2 cabs as assets –
 basically operated as if one single business.
 Argument that profits were drained out of
companies (i.e. undercapitalization).
 Enterprise liability would allow him to recover
from combined assets of all companies.
• Decision Making in a corporation
o Board of Directors and Officers
 Generally (where corporation has more than a few shareholders) board
of directors makes decisions regarding business operations
 MBCA 8.01
• (a) requires BOD unless specified in shareholder agreement
(under 7.32)
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• (b) Powers exercised by or under authority, business/affairs

managed by or under direction of BOD other than limitations
set in agreement
 BOD is not usually agent of corporation or shareholders
 ALI Corp. Governance 3.02 – publicly held corporations – p. 1307
 MBCA 8.40/41: officers
• corp can designate its own offices and BOD can elect officers
• duties are set forth in bylaws, by BOD, or by direction of
authorized officer authorized by BOD.
 McQuade v. Stoneham
• BOD make agreement to keep M treasurer,
• Then voted against him, later dropped as a director
• Dropped because of a falling out
• Contract is illegal and void if it precludes BOD from
changing officers, salaries, or policies or retaining
individuals in office, except by consent of the parties
o Don’t want to allow agreements to abrogate judgment
o Want them to be able to act in best interest of business
o Company here isn’t worse off in any way by allowing
them to kick out M
• Pretty much overturned by new statutes
o Shareholder decisions instead of director decisions
 Villar v. Kernan
• Two founders agreed orally that they wouldn’t get salaries
• Had a falling out and then one made an agreement with
shareholders that he would get a salary
• Couldn’t enforce the first because it was not in writing and it
dealt with corporation (since it limited ability to hire the
founder as an employee)
o Shareholders’ Decisions about Directors and Cumulative Voting
 In small, closely held corporations several shareholders can have
power to elect/remove directors
• May depend on state corporate code or articles of incorporation
 Cumulative voting v. straight voting
• Straight voting
o separate election for each seat
o each shareholder gets to cast his number of shares in
any way for each election
• Cumulative voting
o One selection, shareholders cast votes and top vote-
getters (depending on how many directors are elected)
are elected to board
o Multiply number of shares by number of directors to
get number of votes
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o Number of shares required to elect

 [S/(D+1)]+1
 S = total number of shares voting
 D = number of directors to be elected
• Some states require cumulative voting, others give choice
 Removal of directors
• Delaware – 141k – majority can remove with or without cause
with some exceptions:
o If cert. of incorporation OR
o If cumulative voting, certain requirement regarding
number votes
• NY Bus. Corp – 706 –
o any or all directors can be removed for cause by vote of
shareholders
o without cause if certificate of incorporation allows
o some exceptions to both above
• MBCA 8.08 – with or without cause unless articles of incorp
say otherwise
o If elected by voting group, only shareholders in that
group can remove
o If Cumulative voting, cant be removed if number
enough to elect under cumulative vote are voted against
his removal
o Shareholders’ Voting on Directors’ decisions on Fundamental Corporate
Changes
 Generally, things that are not routine business decisions, such as
• Amendment of articles of incorporation
• Dissolution
• Merger with another corporation
• Sale of all or substantially all of the assets of corporation
 Approval or disapproval of BOD decision is a shareholder reaction, as
opposed to action (i.e. decision of election/removal)
 No cumulative voting, may be supermajority approval requirement
o Where Shareholders Vote, and Who Votes
 Annual meeting
 Special meeting – any other meeting other than annual meeting
 Record owner – person with legal right to vote at meeting of
shareholders
 Record date – owners as of that date can get notice of and vote at the
meeting – 7.07a limits on record date
 Street name
 Proxy – person entitled to vote authorizes another person, i.e. the
proxy
o Who Votes and Proxies?
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 person entitled to vote can authorize another person, i.e. the proxy
 proxy can be revoked (even if no provision)
• proxy holder is agent of stock owner
• irrevocable if
o the proxy says it is irrevocable AND
o coupled with some interest in the stock
• example of irrevocable is bank that has interest in stock and
gets shareholder to execute irrevocable proxy
o Shareholders’ Inspection Rights
 Kortum v. WSI (2000) Delaware provision
• For shareholders: Must prove (1)compliance with requirements
for demand in statute and (2) that inspection is for a proper
purpose
• Must also then show that scope of inspection is proper (i.e. that
it matches purpose above
• Valuing ones shares is proper reason for inspection, even if
they plan on selling the shares
• Pending litigation does not prevent inspection
 MBCA 16.02 – burden of proof is on shareholder to show they are
entitled to access—certain docs are automatically (i.e. corp bears
burden)
 Corporation has burden to show purpose
o Shareholders’ Voting Agreements
 Ringling Bros. Barnum & Bailey v. Ringling (1947)
• Voting agreement by shareholders was not against public
policy
• Court didn’t grant specific performance, but the mere
acknowledgment that it was valid was groundbreaking
 MBCA 7.31 and Delaware 218(c) would now command specific
performance
• Responsibilities of Decision-makers
o Legal Responsibilities - Duty of care
 Breach by board action
• Shlensky (Wrigley Field case - 1968): court didn’t think Cubs’
management’s decision not to install lights for night games was
a dumb or negligent decision
o court also didn’t care whether it was a dumb or
negligent decision:
o Shlensky could’ve sold his shares or pushed for new
directors.
o Is there any different rule for privately held
corporations where no sale or assignment or shares
allowed? No.
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o Big problem if he is a minority shareholder in a closed

corporation
o We think this is a just result anyway because we
assume he got a discount when he purchased them
because market should have recognized corporation
was being run by a director who didn’t like lights in the
ballpark.
• Presumption that board of directors’ judgment was in good
faith and designed to promote best interests of corporation
• Q: would courts be more lenient in looking at negligence of
directors if shares not
assignable and there is no public market?
o MBCA 8.30 – duty of directors is to run the company in
the best interests of the corporation
• Joy v. North (1982) – BJ rule and its limits
o BJ rule: wont hold directors/officers liable for bad
judgment
 Shareholders can select which corps to invest in
 Hindsight is 20-20, cant analyze effectively the
circumstances around a decision
 Want to encourage businesses to make some
risky decisions (otherwise too cautious and less
potential for profit)
 Insurance expensive
o Limits exist in cases where this rationale is not
supported, i.e. if:
 No business purpose
 Conflict of interest exists
 No-win situation (not recognized by DE)
 Failure of oversight
 Other examples
o Here, there is likely a finding that potential gain was no
more than interest on a loan, i.e. no-win situation
• MBCA – 8.31(a)(2)(ii)(A): reasonable believe to be in best
interests of corp.
• Smith v. Van Gorkom (1985)
o Informed decision: turns on whether directors have
informed themselves of all material information
reasonably available to them, prior to making decision
o Based decision solely on one director’s representations
in an oral presentation
 No documents or summaries, etc
o Board did not do research
o Must do research for big decisions
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• MBCA – 8.31(a)(2)(ii)(B) – not informed to extent reasonably

believed appropriate in the circumstances
• Delaware 102(b)(7) –can limit personal liability of director but
can’t limit liability for (1)breach of duty of loyalty, or (2) acts
not in good faith, or (3) improper personal benefit
 Breach by board inaction
• Barnes v. Andrews (1924)
o Director allegedly failed to give enough attention to
company affairs.
o Directors have “individual duty to keep themselves
informed in some detail”
o P’s burden that performance of duties would have
avoided loss
o Must show causation between breach and damages
• Codified in MBCA - 8.31(a)(2)(iv)
• Francis v. United Jersey Bank (1981)
o Must exercise diligence, care, skill that ordinary
prudent person would use under circumstances
o Plaintiff must prove that the lack of care caused some
harm to corporation
• In Re Caremark Int’l (1996) – monitoring systems for
employees
o Narrows original precedent from Graham which said
you need cause for suspicion to impose duty to monitor
employees on directors
o Without grounds to suspect deception, directors/officers
cant be charged with wrongdoing for simply not
monitoring employees
 Legal Responsibilities - Duty of Loyalty
• Competing with the corporation
o Regenstein (1957)
 Directors of company were involved in
ownership/operation of another store which competed
with one store of the company
 Corporate officers and directors can engage in a
business similar to that carried on by their corporation
(as owners or officers or directors), as long as they act
in good faith toward their company
• Cant wrongfully use corps. resources
• Cant enter the other business to cripple
or injure corporation
o Majority rule – cant compete with corp
 Exceptions
• No negative affect
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• Ratified by corp.
• Usurping corporate opportunity
o Delaware rule – no distinction between officers and
directors - factors
 Line of business?
• Difficult to determine
• Key is whether opportunity closely
associated with existing business activities
 Financial ability
• Gives edge to director who has access to
finances
• Disincentive to execs to solve financing
problems
 Corporation has interest or expectancy
 Opportunity puts O or D in confliction/awkward
position
• Source of information (used in Broz v.
CIS)
o ALI corporate opportunity test
o Corporate opportunity under ALI model rules, if
 For both O’s and D’s, learned of through
director or officers position, OR
 For both O’s and D’s, learned of from
corporation, OR
 For officers only, if “closely related” to line of
business
o If shown that it is corp opportunity
 Corp must show that there was no offer to corp.
OR that corp didn’t reject properly (vote of
disinterested directors after full disclosure)
 D can still can show taking was fair if offered
o NE Harbor Golf Club (1995)
 President of corp (owner/operator of golf club)
personally purchased land nearby and informed board
 Learned of availability of one parcel through
position
 Applies ALI test
o Broz v. CIS (1996) – application of Delaware test
 Broz acquired a license from a company doing
similar cellular business, CIS was almost bankrupt,
being acquired by another company
 CIS did not have financial ability
 Was in line of business
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 Not clear that CIS had interest or expectancy in

license – CIS was trying to divest cellular licenses, and
had no plans to acquire licenses
 Don’t need to present opportunity to a company
in the process of acquiring your corp, if your corp
doesn’t have the interest/expectancy or financial ability
• Interested director transactions – being on both sides of a deal
with a corporation
o HMG v. Gray (1999)
 No disclosure, and didn’t show fair dealing or
price
 Liquid market – can make sale for going rate
• Cant be liquid if its unique land
 Burden on the interested parties to show fairness
• Dealing – timing, initiation, structure,
negotiation, disclosure and general procedure
• Price – economic and financial
considerations, assets, market value, earnings,
future prospects, etc.
o General rule – Delaware 144(a)
 disclose and then have a vote by disinterested
directors OR
 disclose and then have a vote by majority of
disinterested shareholders OR (ALI)
 show transaction was fair procedure and
pricewise
• Shareholder Derivative Suits
o Overview
 Shareholder sues to vindicate corporation’s claim
 Not derivative suit if some shareholders benefit from defendant’s
conduct
 Might not be a derivative suit even if all shareholders are harmed
• e.g. Company didn’t give dividends
 Eisenberg v. Flying Tiger Line
• Eisenberg challenged reorganization of corporation because it
didn’t allow him any control
• This is direct suit because he is not asserting a claim on behalf
of the corporation, but rather on his restricted right.
• So, no security was needed since it was a direct suit
 Hypo: 5.8, CEO is bouncer at restaurant, and hits a shareholder
o Compared to class action
 Class action vindicates a lot of individual claims
 Both are controversial because there is room for abuse
• So they put in procedural requirements as discussed below
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o Procedural Requirements of Derivative Suit

 Joinder
• Corporation is necessary party and must be joined
o Recovery goes to corp, so they must be in court to be
affected by judgment
o Ensures judgment will bind interest of corp (i.e. res
judicata effect)
• Corporation is nominal defendant, even though sh are suing on
behalf of corporation
 Stock ownership/standing reqs.
• MBCA 7.41
o Must be a shareholder of corporation at time of
act/omission complained of (or became sh through
transfer by a person who was at that time) AND
 Interpreted that need to be at time of
act/omission AND time of suit
o Must fairly and adequately represent the interests of the
corporation in enforcing the right of the corporation
• NY 626(b)
o Plaintiff is holder at time of bringing suit and was
during transaction he complains of, or his shares
devolved on him by operation of law
 Security for expenses
• Some states require, some do not
 Right to Jury Trial
• Arises in cases of law, not equity.
• Derivative suit can be product of equity or law
o Seventh amendment doesn’t apply to states
 Court approval of settlement – cant just be agreement between lawyers
 Demand on directors
[graphic on derivative suit process]
• MBCA
o 7.42 – (1) must make demand
 (2) once made, must wait 90 days unless
• company rejects demand, OR
• waiting 90 days would cause irreparable
injury to corporation
o 7.44 – dismissal
 (a) determined in good faith after reasonable
inquiry, that not in best interests of corp. by one
of three groups:
• majority vote of independent directors
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• majority vote of committee made up of

independent directors (with or without
quorum)
• (f) court appointed panel of independent
persons upon motion by corp: P must
show that it is not in interest of corp.
 (c) certain things wont by themselves cause a
director to be considered not independent
 slc – 7.44(f)
 (e) burden shifting based on number of
independent directors – structural bias
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• Who actually pays, 3 ways directors escape liability

o Corp. eliminates liability
 Van Gorkom case allowed corp to eliminate for violations of duty of
care at least
 2.02(b)4, with exceptions: can’t eliminate liability for duty of loyalty:
• amount of unentitled benefit received by director
• intentionally infliction of harm on corp/shareholders
• violation of 8.33 – unlawful distributions
• intentional violation of criminal law
o Indemnity
 2.02(b)5, can put indemnification clause in articles of incorp. for
director for anything but violations of duty of loyalty
 8.51(a) permissive indemnification of directors: 2 categories
• 8.51(a)(1)
o has good faith AND
o reasonable belief
 if official capacity: conduct in best interests of
corp.
 if other capacity: conduct at least not opposed to
best interests of corp
o AND no reasonable cause to believe conduct was
unlawful
• 8.51(a)(2): anything that was permissible under 2.02(b)5
 8.51(d) where indemnification is impermissive:
• proceeding by/in right of corporation resulting in settlement or
judgment against director
o but you can get reasonable expenses (NOT
JUDGMENT) if you meet the conduct of 8.51(a) (duty
of loyalty)
• proceeding resulting in judgment that director received
improper financial benefit as a result of his conduct
 8.52 – mandatory indemnification
• must indemnify a director who was
o wholly successful on merits/or otherwise
o when director was party because he was director
• for reasonable expenses incurred by him in connection with
proceeding
 8.51(c) judgment/settlement/etc. against director doesn’t automatically
mean he didn’t meet conduct of 8.51(a)
o D&O Insurance
 MBCA 8.57 authorizes corp to buy liability insurance
 Director can choose lawyer if suit is for more than insurance amount
 Relevant timing is when claim is made (to determine who is insurer)
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 Questions are
• Whether to buy it and what kind (business decision)
• Scope of policy and decision-making for settling claims
(contract law)
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VI. Growth of Corporation: 3 ways for corporation to earn money

• Debt – borrow money
o Who will make the loan?
o Covenants required by lender?
o How will corp repay loan?
o What happens upon default?
• Equity – issuing stock
o Existing shareholders: Preemptive rights
 Right to purchase the number of shares required to maintain current
percentage of ownership
 Byelick v. Vivadelli - Fiduciary duty not to issue stock in order to
determine control of company as opposed to issuing it to raise capital
 Delaware doesn’t have this duty
• So contract around this, or pay a good price for stock in the
first place
 MBCA 6.30 – not automatic, must be in articles (and if so, 6.30 will
guide)
o Venture capitalists
 Substantial equity investment in a non-public enterprise not
necessarily involving active control in firm
 Usually unstable companies seek venture capital – only 1/3 that use it
succeed
 VC demand high returns because
• no reduction of risk through diversification
• illiquidity of equity
 VC protect investments by contracting for “special rights”
• Liquidation preference
• Right to acquire stock at predetermined price
• Voting/veto rights
• Exit opportunities
 They do wait sometimes until IPO, no restriction
o Public offerings
 IPO – 3rd round of investing
• causes a 20% increase in value
• price often artificially high, so not a good long term investment
• pricing – need to know current investment return climate
• underwriting activities
o firm commitment – underwriter bears risk
o best efforts – corp bears risk
 most underwriting is done under this now
o Potential scams by underwriters – both types
 Best efforts –
 Firm commitment – low price, excess demand
give to friends
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• Retained Earnings
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VII. How Corporation Owners make money

• Salaries from Corp.
o Decisions on which shareholders get salaries
 Hollis v. Hill
• For closely held corporations, fiduciary duty between
shareholders is greater than normal
• In closely held corp, when majority shareholders try to take
away salaries from a minority shareholder/employee, there has
to be injury as a shareholder
• to determine if there is injury as a shareholder you can consider
factors:
o Whether corp distributes profits in salary form
o Whether shareholder/employee owns a significant
percentage of shares
o Whether sh/emp is a founder of business
o Whether shares received as compensation for services
o Whether sh/emp expects value of shares to increase
o Whether sh/emp has made sig. capital contribution
o Whether sh/emp has demonstrated reasonable
expectation that returns from investment will be
obtained through continued employment
o Whether stock ownership is requirement of
employment
 Mass you cant get forced out for nonlegitimate business, so shares
there will be worth less than Delaware
 MBCA 14.30(2) – dissolution by court liquidation, sometimes just
used as a bargaining to get settlement –
 Coase Theorem – you will get an efficient outcome if you bargain, no
matter what rule is.
o Legal limitations on salaries
 Exacto Spring Corp (1999)
• CEO/cofounder/principal owner got salaries of 1.3 million and
1.0 million
• IRS said reasonable would have been 381k and 400k
• Tax Court said about halfway between these two based on 7
factors
o Type/extent of services
o Scarcity of qualified employees
o Qualifications/earning capacity of employee
o Contrib. of employee to venture
o Net earnings of employer
o Prevailing compensation paid to employees with
comparable jobs
o Peculiar characteristics of business
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• Second Circuit said these factors are retarded

o Vague and nondirective
o Unrelated to purpose of limitations
 Keep dividends (which are not deductible
from corporate income) from being disguised
as salary (which is deductible)
o Court shouldn’t be a personnel department
o Factors lead to arbitrary decisions
• Indirect Market test
o Higher the rate of return that manager can generate,
more salary he should get
o If investors get higher rate of return than expected,
salary of CEO is presumptively reasonable
 Presumptive because there are cases in which
return is not due to CEO’s work
 Examples of things rebutting presumption
• Company run by someone else
• Rate of return was gotten by mere
chance not work of CEO
o Even if reasonable by this test, can still limit salary if it
is shown that company was concealing dividend in
salary, i.e. bad faith showing
 Natural control – built-in safeguard that shareholders will complain if
something is wrong
 Giannotti v. Hamway (1990)
• Here minority shareholders sued officers to dissolve and
liquidate the corporation because they claimed that they were
being “oppressive” and that the “corporate assets were being
misapplied/wasted”
• Normally, where there is disinterested approval of salaries,
Business Judgement Rule would apply, but here, the
defendants were the ones that authorized their own salaries
• When P shows director had interest in transaction, burden
is on director to show that it was a fair and reasonable
transaction
• Essentially 5 directors were doing the work of one person, and
they were closer to part-time employees with other interests
• Business would have been more profitable except for excessive
compensation extracted by D’s
• Dividends from Corp.
o Definition – payment out of current or retained earnings made to shareholder
in proportion to the number of shares they own
o Reasoning for dividends
o Rules on dividends
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 MBCA uses term distribution (1.40) – includes dividend

 6.40(c) spells out when dividends cant be declared
• if after giving it, corp would not be able to pay its debts as they
become due in usual course of business
• if after giving it, corp’s total assets would be less than sum of
its total liabilities plus the amount needed (if corp were to be
dissolved at time of distrib), to satisfy preferential rights of
shareholders whose preferential rights are superior to those
receiving distribution
o this is unless articles of incorporation permit otherwise.
• Land assets wont help insolvency
 Violations of (c) result in liability imposed by 8.33
• A) director who votes/approves to excess distribution (as
defined above) is personally liable to corp for amount of
distribution that exceeds what could have been distributed
without violating 6.40, but only if the other party shows he was
not in good faith or didn’t act reasonably in interest of
corporation.
• B) Director liable under A is entitled to
o contrib. from other directors who could have been held
liable
o AND recoupment from each shareholder of pro-rata
portion of amount of unlawful distribution sh accepted
knowing distrib was made in violation of section 6.40
 Traditional approach refers to specific accounts according to corporate
code (followed by many states, including NY and Delaware)
• Traditional approach uses solvency test AND restricts based on
what account it is—more restrictive than modern/MBCA
approach
• Earned surplus – value generated by business, i.e. profits minus
losses minus distributions already paid
• Capital raised by issuing stock
o Stated capital – par value times number of issued stocks
 No states allow dividends to be paid from
stated capital
 Original purpose of stated capital was to make
sure corps had enough assets to keep going
o Capital surplus – amount past par value times number
of issued stocks
 Some states allow dividends to be paid out of
capital surplus
o For no par issuance: directors can allocate funds
received between stated capital and capital surplus
 Zidell v. Zidell (1977)
• Plaintiff owned 3/8 of outstanding shares of closely held corp
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• Brother and Nephew owned remaining 5/8

• All worked for corp until 93 and got salaries
• P resigned after his salary increase demand was refused
• Then sued to compel payment of higher dividends
• Showed evidence
o Corp had enough earnings to pay greater dividends
o That D’s got substantial salaries (not excessive)
o And that there was hostility between P and D’s
• Trial court said he wasn’t getting reasonable return on
investment (no bad faith found), and forced more dividends
• State supreme court said P has to show bad faith by D
o i.e. Business judgment rule applies to discretion as
to payment of dividends
o important that here he resigned and did not get fired (so
they weren’t necessarily trying to get him to sell at
unreasonably low price)
 Dodge v. Ford Motor Company (1919)
• Ford had a lot of surplus and was closely held at the time, and
paid large dividends
• Dodge had stock and used dividends to start its own company
• Ford got pissed and stopped dividends….ended up paying
higher wages and concentrating on making cheap cars
• Instead of saying the reason was to increase profits, Ford said
he wanted to make sure people could afford cars and company
wasn’t trying to make money as first priority
o courts found this reasoning to be so grossly imprudent
that they were not protected by Business Judgment rule
o thus, they concluded directors had duty to distribute
large sum of money because of huge surplus, and
history of dividends
 Sinclair Oil Corp. v. Levien
• Sinclair owns Sinven and its board dominates the Sinven board
• Minority shareholder of Sinven is complaining that Sinclair
board gave out too much dividend
o Even if the corp statute requirement (i.e. only used
capital surplus) is met, the dividend payment may not
be justified
o If dividend is self dealing by parent then tough test of
intrinsic fairness is used
o Self dealing
 parent dominates subsidiary and board of
directors
 subsidiary has x (owned by parent) and y
(owned by minority) classes of stock
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 subsidiary (under direction from parent) gives

dividend only to class x
o Here, no self dealing because minority shareholders got
a lot of money too, so business judgment rule protects
the transaction
o Who gets dividends
 Usually found in articles of incorporation
 Preferences
• Priority of receipt – just get paid first, not more
o Example: 4k total dividend, 2000: $2 priority, 10,000
common stock
 Only give $2 each to priority = $4k
o Example: 40k total dividend, 2000: $2 priority, 10,000
common stock
 First give $2 to priority = $4k
 Then you split remaining $36k between 10k
 Priority = $2 each; common = $3.60 each
• Preferred participating stock – gets paid first and then again
with the leftover
o Example: 40k total dividend, 2000: $2 preferred and
participating, 10,000 common stock
 First you pay $2 each to 2000 = $4000 total
 Then you take remaining $36k and divide by all
12k
 Preferred/participating: 2+3= $5 each; common
= $3 each
• Only cumulative dividends accrue (carry over year to year)
o Total dividend of $40k, 2k shares of $2 cumulative
preferred, 10k of common stock, no dividend declared
in last three years
 First pay 4X$2 = 8 (3 previous plus current =
4X) to each 2000 = $16k
 Then split remaining $24000 between 10k, =
2.40 per share
o Rationale is so that they don’t delay and screw over
preferred
• Buying and Selling Stock at Profit
o Valuating shares
 Reliability of information – 10b5—protection from fraud
• Basic inc. v. Levinson
o Basic president denied they were in negotiations for
mergers (they had some interest and talks about merger)
o People sold stock before merger and after the denial
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o Sued saying they relied on material misleading

statements
o Standard for materiality = must be substantial
likelihood that reasonable shareholder would consider it
important…
 Merger discussions speculative nature make this
analysis difficult
 Weigh indicated probability of occurrence and
anticipated magnitude of event
• probability – look at indications of
interest in transaction at high corp levels
o Board resolutions, instructions to
i-bankers, actual negotiations,
etc.
• Magnitude
o Size of corporate entities
o Size of potential premiums over
market value
o Presumption of reliance by fraud-on-the-market theory
 Fraud-on-the-market theory says
• market price of the stock takes into
consideration all information the public
has(including misreps)
• so a misrep makes the price lower, and
thus the shareholders, by relying on this
price relied on this
 rebuttable if you can “sever the link between the
alleged misrepresentation and either price
received by P or decision to trade at fair market
price
• show actual market determining people
knew of truth behind misreps
• or if credible reports showed truth
• or if person knew of truth and still sold
for some other reason
• EP MedSystems Inc v. Echocath
o Echocath allegedly enticed MS to invest 1.4 million,
saying that licensing was imminent
o Echocath said investment is risky and had MS sign
saying it did not rely on representations etc.
o No licensing after investment and then stock dropped…
so MS sued
o Bespeaks caution doctrine
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 Cautionary language if sufficient can make the

alleged omissions/misreps. immaterial as a
matter of law
 Cautionary language must be directly related to
alleged misreps/omissions
 Only applies to forward looking statements
o Loss Causation
 In addition to but for causation you need to
show causal link between the fraud and the
harm done
 Plaintiff has burden
 Usually a matter of fact
• Malone v. Brincat
o Company overstated earnings and when it announced
this, stock plummeted
o Shareholders who didn’t sell the stock and lost money
after this sued to say the corp breached its fiduciary
duty of disclosure
o Court dismissed, and remanded
o Directors who knowingly give false information
resulting in corporate injury to individual stockholders
violate their fiduciary duty
o Here, they didn’t violate duty to disclose because it was
not combined with a request for action, and it was not
in connection with purchase or sale
o They could potentially file derivative suit on behalf of
corp saying that fiduciary duty was violated.
o Legal Duties for buying/selling stock
 10b5 – buying/selling with inside information
• Dupuy v. Dupuy
o Jurisdictional requirement for 10b5: “use of any means
or instrumentality of interstate commerce”
o Intrastate phone calls are enough to satisfy this
• Goodwin v. Agassiz
o State law treatment of insider trading
o President/director of mining company knew of a
geologist’s theory that Michigan was rich in copper,
and company was getting land in Michigan
o Only special circumstances will require disclosure by
director to stockholder in a transaction of stock
 here there was no “fact” it was more of a theory
 generally no duty when transacting on a stock
exchange
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o where director personally seeks stockholder for purpose

of buying shares w/out disclosing material facts it will
be closely scrutinized
• SEC v. Texas Gulf Sulphur
o Directors and management of TGS got word of a core
sample that was high in minerals. They kept it secret
and in the meantime bought a lot of stock and told close
contacts to do the same
o SEC sued based on 10b5
o Court said that “anyone in possession of material non
public information has a duty to disclose that
information before trading in the stock”
o Policy behind decision
 10b5 is based on expectation that all investors
have relatively equal access to material
information
 directors/officers have other incentives besides
inside info such as dividends and stock options
• Chiarella v. US (1980)
o Chiarella worked for printing company, whose client
was about to acquire a company
o There were some gaps for security, but he found out
who the target was, and bought stock before
acquisition, then sold it right afterwards, making 30k
o Was criminally convicted of violating 10b5, and appeal
went up to S.C.
o S.C. reversed, saying that the disclose or abstain rule
is limited to persons in fiduciary relationship with
one another
 Here, jury instruction only said he was guilty if
he did not disclose, did not speak to whether he
had fiduciary duty, which is new requirement
• Dirks v. SEC (1983)
o Facts
 Dirks worked for broker-dealer firm and got
nonpublic info that corps assets were overstated
from a former officer of corp.
 Dirks investigated further and told clients about
it—some of whom sold stock based on this
 Tried to get wall street journalist to write article
 Stock dropped from 26 to 15; Cal investigated,
SEC filed complaint, wall street published story
o How does tippee acquire duty to disclose or abstain?
 SEC says they inherit whenever they get inside
info from insider –
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• Tippee then breaches duty when he

transmits info to someone who is likely
to trade on the info.
 But this is based on notion that all traders
should have equal info, and conflicts with
chiarella
• Would inhibit the trading market
 Tippee gets duty from insider, which means that
tippee assume duty only when the inside info is
made available to them improperly
o Rule: need to show two things for tippee liability
(personal benefit test)
 Tipper breached fiduciary duty
 Tipper tipped for the purpose of obtaining some
sort of personal benefit
• Selling information
• Giving info to enhance
reputation/standing or with expectation
of reciprocal benefit
• Giving info to someone with whom you
have a personal relationship
o Here, no tippee liability
 Tipper was not employed and had no fiduciary
duty
 Tipper did not try to get any personal benefit,
merely a whistle blower
• US v. O’Hagan (1997) – misappropriation theory
o Classical v. misappropriation
 Classical is fraud on the other party of
transaction
 Misappropriation is fraud on source of
information
o Misappropriation theory
 Person commits fraud violating 10b5 when he
misappropriates confidential information for
securities trading purposes, in breach of a duty
owed to the source of the information
 Defense: if person discloses intention to source,
duty is relieved and thus no fraud.
 Section 16b and Short-Swing Trading
• 16b: If there is a purchase and sale within 6 months, and done
by an insider, than any profit (excess of sale and purchase)
must be relinquished to corporation
• only insider (and thus liable) if you are officer, director or if
before purchase and before sale you own more than 10%
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•only applies to large companies registered under Sec.

Exchange Act
 Common law duty of selling shareholder
• Debaun v. First Western Bank & Trust Co. (1975)
o Founder of close corp owned 70% of stock, when he
died, bank sold company to someone who then looted
corp (turned net worth of 220k to negative 218k)
o Minority shareholders sued bank in derivative capacity
o RULE: where control of corp is material, controlling
majority shareholder must exercise good faith and
fairness from the viewpoint of the corp and those
interested therein
 If you have facts to awaken suspicion you must
conduct a reasonable and adequate investigation
o Here, there were enough facts to alert the prudent
person:
 bank knew from report that his financial record
was bad
 knew only source of funds was corp assets
 dividends wouldn’t have been enough to cover
cost of shares
 bank officer knew that he was guilty of fraud
 THUS, bank had duty to investigate
o Can recover from either the looter or the former
controlling shareholder
o Bank had to pay corporation net worth of copr when
bought
 To allow corp to pay creditors
 Sometimes it gives to minority shareholders
• Perlman v. Feldman (1954)
o Controlling sh and CEO sold stock and got 8/share
control premium, minority sued saying he had to share
it.
o Court, based on the specific, unique facts in this case
(steel market issues), found that he had used his
corporate opportunity for personal gain and owed duty
to minority shareholders…
o HELD only to its own facts….not many courts have
followed this.
o To whom can Shareholder sell her shares?
 Redemption and equal access rule
• Donahue v. Rodd Electrotype Co. of NE (1975)
o For Closely Held Corporations: Controlling
shareholders owe duty to minority shareholders to give
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them equal opp to sell shares to corporation on same

terms as controlling shareholder
o Remedy here was to either buy the minority shares at
same price as controlling, or rescind agreement to buy
controlling shares at that price
o Definition of close corp:
 Small number of stockholders
 No ready market for corp stock
 Substantial majority stockholder participation in
management/direction/operations of corp.
• Greenmail -
 Buy-sell agreements
• Contract requiring corporation/majority stock holder to
purchase shares in specified situations at a specified price
o Usually upon death, disability, or retirement of owner
• Purpose: Guarantee that there is a market for stock in close
corporations (since in large, public corps
• Funding: two primary ways to fund
o Sinking fund: ongoing contributions from owners
o Life insurance covering the owners
• Types of buy-sell agreements
o One-way: third party acquires the interest
 Usually a “key” employee
 CEO, .e.g. may not have money, so insurance or
set aside money
o Cross-purchase: surviving owners obligated to purchase
interest from heirs or directly from owner (if
disabled/retired)
 Usually buy enough to keep proportional
ownership
 If funded by life insurance, must have multiple
policies (if more than two owners)
• Each owner gets policy on other owners’
lives
• E.g. 4 owners = 12 policies
o Stock redemption – corporation buys back stock
 Look at ownership outcomes: control can shift
 Ex. A, B, C have 20% each, D has 40%
• A dies (and corp buys back stock)
• B, C, now have 25% each, D has 50%
 Business gets one policy on each owner
• E.g. 4 owners = 4 policies
o Wait-and-see – give options, corp gets first stab, then
other shareholders
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• Jordan v. Duff & Phelps

o Closely held corporation; buy-sell agreement; 10b5
o Jordan resigned and then sold shares back to D&F
pursuant to agreement (after end of year to use new
year’s valuation)
o D&F then announced merger which made stock rise
greatly, and Jordan sued saying corp had duty to
disclose merger negotiations
o Issue was whether the info was material (depended on
time of actual sale—since that would determine the
probability v. magnitude test)
o Would have trouble proving scienter, since they didn’t
intend to fraud necessarily…
o Go through 10b5 elements when closely held corps
buy back stock through buy-sell agreement
• Berreman v. West Publishing Company (2000)
o State case
o Berreman retired from West (closely held corp), sold
back shares at 2000/share pursuant to agreement; West
then merged with Thomson, and Thomson paid 10k per
share
o Berreman sued saying that West had duty to disclose
info about potential merger
o Issues:
 whether there was duty: yes, because close
corporation buying shares back
 if duty, were facts material: no, low probability
of occurrence at time of sale
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VIII. Corporation Endgame

• Dissolution
o Involuntary/judicial: 14.30
 By attorney general if fraudulently incorporated, or abuse of legal
authority
 By shareholder petition: often used as negotiation/blackmail
• Deadlock
• Oppression
• Corporate waste
• illegality
 By creditor if debts are unsatisfied, and corp. insolvent
 Administrative, don’t pay taxes, etc. 14.20
o Voluntary: majority vote default (14.02(e)), can be greater
• Merger
o MBCA - 11.06
o Liabilities of disappearing corporation transfer to surviving corporation.
o Triangular merger
 McDonalds creates a subsidiary MCSUB
• Puts cash or stock into subsidiary
• Cause subsidiary to merge with bubba’s burritos
• McDonalds controls MCSUB which now includes BB
 Result: McD limits liability to MCSUB
• i.e. McD cant be sued for BB (unless corporate veil is pierced)
o Effect of a merger on Creditors/SH of disappearing corp: MBCA – 11.07
o Stockholder protection
 Sue directors who approved merger for breach of duty of care
• Van Gorkom
 Vote against merger – 11.04e/g
•
• DE need a vote if 20% or more are issued
 Assert dissenting shareholders’ right of appraisal
• Hypo
o target corporation worth 1 million; acquirer buys 51%
for 600k
o acquirer proposes merger for very low price
o “cash out” merger
• HMO-W Inc. v. SSM Health Care System (2000)
o Minority discount – might pay more than price per
share for a majority of the shares
o Marketability discount – shares are worth less if there is
no public market for them
o No minority discount
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o In appraisal hearings court can entertain assertions of

misconduct that relate to value of dissenter’s share
• Short form merger – already hold 90% of target corp: easier to
cash out on minority
• Public corp, if you own 20% of target corp, you have a right of
appraisal
• MBCA – once you seek appraisal, you lose right to sue
• Delaware – appraisal doesn’t bar suit
 Sue directors who approved merger for breach of duty of loyalty
• Weinberger v. UOP, Inc.
o Signal was majority shareholder of UOP, and decided
to merge with it
o Decided anything up to $24 would be acceptable and
then offered $21 cash out merger price
o Proposal went to board of UOP and signal members did
not vote, but it was still approved
o No Business Judgment rule because same people were
on both sides of transaction
o Since no business judgment rule, look to fairness
 Procedurally – rushed through, didn’t reveal
information, etc.
 Price – should be further evaluated based on
newer techniques
o No business purpose necessary to squeeze out minority
in Delaware.
o Ways signal could have avoided this
 Better procedure
 Interested directors shouldn’t have participated
in meetings
• Valuation techniques
o
• Coggins v. New England Patriots Football Club (1981)
o Sullivan bought football team, nine others bought
10000 shares for 2.50 each
o Sold some non-voting shares in addition (120k @
5/share)
o Sullivan bought all voting shares back at 102/share
o Pledged assets of company to do that, so he needed to
get rid of nonvoting shares (otherwise hes usurping
corp assets, etc.)
o Organized subsidiary (wholly owned), and merges the
new company with the old company
 Buys nonvoting shares for 15/share
o One person sues to undo merger
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 No business judgment rule since owner is on

both sides
 3 part analysis for Massachussets
• fair procedure
• fair price
• business purpose
• advising clients when they want to have a merger to get rid of
minority shareholders: have some sort of business purpose
o deadlock, expensive with minority shareholders,
• Sale of Assets
o Definition – instead of becoming part of original company, you sell all of your
assets; i.e. two companies survive after sale of assets
o Effect of sale of assets on the creditors of the selling corporation
 Buyer of corporation’s assets is not liable for selling corps’ debts
 Sale of assets does not automatically terminate its legal existence
 But often it is followed by corps’ dissolution
 Franklin v. USX Corp (2001)
• WPS sells assets to ConCal. ConCal sells assets ConDel
• General rule is that there is no successor interest in sale of
assets, but there are exceptions.
• Look to see if the acquisition is a de facto merger
o Main factor is whether adequate consideration was paid
o As long as it was adequate consideration, no successor
liability
o Effect of sale of all/substantially all of assets on shareholders of selling corp
and buying corp.
• Hostile Takeover – who cares
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IX. Limited Partnerships

• Defined
o Limited partnerships practically obsolete, but states have some similar
entities, and many still exist.
 More likely LLC or similar entity now
o When founders want control, but need money from outside sources they can
form limited partnership
 E.g. two founders, and two investors who don’t want liability
 Two founders are the general partners, the investors are the limited
partners
o Rights and responsibilities of general partners are the same as normal
partnership – RULPA 403
 Personal liability, management, etc.
• Legal Problems with starting Limited Partnership
o Need to file certificate of limited partnership to come into existence
o Can form a limited partnership under a different state’s laws, and will be
governed by those laws
o 102: Name of partnership – must contain “limited partnership” – to give
others notice of the entity’s nature
o name and address of registered agent
o name and address of general partners
• Setting up LP to avoid ALL personal liability
o Make a corporation the general partner – thus the only way you get to specific
person is if you pierce the corporate veil (cant sue limited partners)
o Shareholders of corporate general partner might also want to be limited
partners
 Benefit from tax treatment
• If only shareholders, they would get taxed twice (corp, then
dividends)
• If both, they could have control through cheap shares as
shareholders, but have their economic ownership through role
as limited partners (and not be taxed twice)
• Operating Limited Partnership
o Decisions
 Unless agreement specifies, limited partners have no say in decisions
• RULPA 302
o Liability
 Third parties
• RULPA 403b – general partners are personally liable
• RULPA 303 – limited partners not personally liable
o Unless they are also general partners or
o “participate in control of business”
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o if you find they participate in control of business then

only liable to people who reasonably believe they are
general partners
o things that are not considered participating in control of
business:303(b)(1-8)
 1 - contractor, agent, employee of limited
partnership/general partner or officer, director,
shareholder of corporate general partner
• Zeiger v. Wilf (2000)
o Wilf is one of owners of corporate general partner, and
also a limited partner.
o Limited partnership agrees to pay plaintiff consulting
fees and then defaults on this payment after struggling
o Note – remember that corporate general partners should
avoid undercapitalization in order to avoid piercing the
corporate veil
o Plaintiff sues Wilf personally
 Wilf has safe harbor under 303(b)1, and retains
his limited liability status
 Even if no safe harbor, plaintiff knew that
general partner was the corporation, so 303(a)
would give same result
 Should have argued for piercing corporate veil
because Wilf didn’t observe corporate
formalities
o Plaintiff should have made Wilf sign guarantee of
payment to avoid litigation in the first place
 To partnership/partners
• 403b – general partners have liabilities of normal partnership to
the partnership – i.e. fiduciary duties
• Kahn v. Icahn (1998)
o Agreement essentially said gp was allowed to usurp
corp opportunities (compete directly with business of
partnership)
• How Owners of Limited Partnership make money
o Salaries for employees
o Distributions from business earnings
o Transfer of ownership interest to third party
 504
 702 – sale of partnership interest only gives right to get distributions,
no right to control
o Transfer of ownership interest to limited partnership
 602 – general partner can give written notice and leave whenever
 603 – default rule: limited partner must give at least 6 months notice to
leave
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• reason behind tougher standard for limited partner is that they

contribute the money which would stop business, whereas gp
can be replaced more easily.
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X. Limited Liability Companies

• Generally: unincorporated business association which provides its members with
limited liability (like corp), pass through taxation(like partnership), and management
flexibility (more than with corp or partnership)
• LLC statutes vary widely, but are mainly just default rules
• KEY document is Operating Agreement (part contract-part articles of incorp.)
• LLC’s almost always closely held BA’s
• Operating problems
o Decision making: two ways, up to owners
 Member managed company – owners run it themselves
• Operating agreement determines how to determine number of
votes by member, and which matters require more than
majority vote
 Manager managed company – hired like board of directors in
corporation
• Operating agreement determines how members elect/remove
managers, and what issues require member vote
o Liability
 Members’ To Third Parties
• No personal liability of members for company’s debts
• Open question of whether you can pierce the LLC veil
o Louisiana court says it can be pierced if the LLC is
acting as “alter ego” of its members or if members were
committing fraud or deceit on third parties through the
LLC. Hollowell v. ORH LLC (ED La. 1998)
 Members’ and managers’ liability to company
• Fiduciary duty members owe to member-managed company
and other members
o ULLCA 409(b): duty of loyalty
 Account to company and hold as trustee…
 Don’t deal with company on behalf of adverse
party
 Don’t compete with company in conduct of
business before dissolution
o ULLCA 409(c): duty of care: refrain from engaging in
grossly negligent/reckless conduct, intentional
misconduct, or knowing violation of law
o ULLCA 103(b): what operating agreement cant
waive/limit unreasonably:
 Cant eliminate duty of loyalty but can
essentially limit it to the point of practical
elimination
 Cant unreasonably reduce duty of care
• Lynch Multimedia v. Carson Communications
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o Member/manager of LLC acquired cable company on

his own behalf after telling company about the
opportunity, was sued by other members for violation
of fiduciary duty
o Operating agreement basically limited the duty of
loyalty to the point of nonexistence, so his mere
disclosure of opportunity was enough to relieve him
from any liability
• How do LLC owners make money
o Sharing in earnings of business
 Operating agreement provides how and when LLC earnings are to be
distributed to members
 ULLCA 405 creates default rule: distributions before
dissolution/winding up must be in equal shares
o Selling ownership interest
 Usually tough to sell because not a big market for ownership in closely
held entities
 Even if you can find buyer, there are statutory limits or operating
agreement limits on selling
• Delaware LLCA 18-702:
o assignee has no right to participate in management, but
can if agreement says so and:
 Members all approve
 Comply with procedure in agreement
o Unless otherwise provided in agreement
 Assignment of LLC interest doesn’t entitle
assignee to become member or get member
rights
 Assignment of LLC interest entitles assignee to
share in profits/losses, to get distributions,
receive allocation of income, gain, loss,
deduction, credit…etc.
• ULLCA 502, 503
o 502: transfer doesn’t give transferee rights of member,
just distributions which transferor would have gotten
o 503: transferee CAN become member if its in
accordance with operating agreement or if all other
members consent
• Lieberman v. Wyoming.com LLC (2000)
o Entity theory of LLC: if remaining members of LLC
want to continue, they can.
o Withdrawing member can get his initial capital
contribution.
o Question is what happens to his equity interest?
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 i.e. he is a 40% owner, does he get this back

somehow?
 Usually look to operating agreement