Chps 1 & 2 Summaries -all partners are liable for what the business does

[CORPORATIONS]
Chapter 3. The Nature of the Corporation
General Principles Definition of corporation: an entity having authority under law to act as a single person distinct from the shareholder who own it and having rights to issue stock and exist indefinitely (Blacks Law) Incorporation o Internal affairs of a corporation (roles and duties of directors, officers, and shareholders) are governed by the law of the state of incorporation. Separate entity Corporations have a separate legal personality. It can sue and be sued, hold property, be a partner in a partnership, make donations, pay income taxes, etc. Double taxation The corporation must pay income taxes on its profits and if the shareholders get dividends on their shares, they are taxed again. Limited liability o Legal independence from the people who create it. o Generally, officers and directors are not personally liable for what the entity does. o Generally, shareholders are not liable for debts that remain owing to the corporation's creditors. Shareholders are generally only liable for the price of their stock. Power structure: o Shareholders control the company through a board of directors, which, in turn, typically delegates control of the corporation's day to day operations to a full-time executive. Formation Requirements o (1) People. You must have one or more incorporators. These are people/entities that sign and file the articles of incorporation. o (2) Paper. You must have an articles of incorporation. Two purposes: The articles are a contract b/w the corporation and

shareholders and also a contract between the corporation and the state. Information the articles must include: The corporate name (must have corporation, company, incorporated, or limited at the end) Names and addresses of incorporators, initial directors, and the corporations legal representative. Statement of duration o Corporation can live forever. Statement of purpose o It can be general or specific. o Ultra Vires Act an action beyond the scope of the stated purpose Capital structure -Must include: o Authorized stock maximum number of shares the corporation can sell o Number of shares per class o Voting rights o Preference of each class of stock o (3) Act. Must file articles with Secretary of State and pay required fee. Acceptance by State is conclusive proof of valid formation. At that point, it is a de jure (by law) corporation! o Next, the Board holds an organizational meeting, where they select officers and adopts by laws and conducts other appropriate business.

Section 1. Promoters and The Corporate Entity

[Promoter] Definition: a person who identifies a business opportunity and puts together a deal, forming a corporation as the vehicle for investment by other people. o A person acting on behalf of a corporation not yet formed. Liability: The promoter remains liable on pre-incorporation contracts until there is a novation. (agreement of the promoter, the corporation, and the other contracting party that the corporation will replace the promoter under the contract) o The corporation is not liable on pre-incorporation contracts

until it adopts the contract either expressly or implicitly. Express Board takes action adopting the contract Implied arises if the corporation accepts a benefit of the contract

Obligations: The obligation is like that of an agent to a principal. o Rmr: Restatements of Agency (Second) 388 says that unless otherwise agreed, an agent who makes a profit in connection with transaction conducted by him on behalf of the principal is under a duty to give such profit to the principal. o A promoter can have a fiduciary relationship to an entity that doesnt exist because of public policy.

[Corporation by Estoppel] Principles o Under this doctrine a business failing to achieve de jure corporate status nonetheless is treated as a corporation (so shareholders will not be personally liable for business debts). o Generally, a person asserting either of these doctrines must be unaware of a failure to form a de jure corporation. Corporation by Estoppel -Definition o One dealing with a business as a corporation, treating it as a corporation may be estopped from denying the businesss corporate status. May also be used to prevent company from avoiding an obligation by asserting its own lack of valid formation. Southern-Gulf Marine Co. No. 9, Inc. v. Camcraft, Inc. (One who contracts with what he acknowledges to be a corporation, incurring obligations in its favor, is estopped from denying its corporate existence unless he is actually harmed) o Facts: Southern-Gulf Marine Co. (P) signed an agreement as a corporation to purchase a 156-foot supply vessel from Camcraft (D), but it did not incorporate until later. After the agreement was already signed, Southern-Gulf decided to incorporate in a different area. Camcraft failed to deliver the vessel on time and said that Sothern-Gulf could not sue b/c it was not incorporated at the time the parties formed the contract. o Rule: A defendant may not interpose as a defense to a breach of contract that a plaintiff corporation lacked the capacity to contract b/c it was not incorporated at the time

it executed the contract, unless the failure to incorporate actually harmed the defendant. o Note: The court said there was no reason to expect that incorporating in a different place was done in any bad faith. Camcraft ratified the change in incorporation when they accepted the notification and agreed to it. o Ratification =confirmation and acceptance of a previous act, thereby making the act valid from the moment it was done. May be satisfied by acquiescence. Executory Contract = a contract that remains wholly unperformed or for which there remains something to be done on both sides Peremtory Exception= a defensive pleading asserting that no legal remedy exists for the plaintiffs alleged injury

Section 2. The Corporate Entity and Limited Liability

o A court may disregard corporate form (pierce the corporate veil) to prevent fraud or achieve equity. o Walkovszky v. Carlton (An individual can be held liable for the acts of a corporation through the doctrine of respondeat superior if it can be shown that the individual used his control of the corporation for personal gain.) Facts: Plaintiff, Walkovszky, was injured by a taxi owned by a corporation which was owned by Defendant, William Carlton. Plaintiff sought to hold Defendant personally liable for his injuries. Defendant was a shareholder in ten separate corporations wherein each corporation has two cabs registered in its name. Plaintiff contends that Defendant was fraudulently holding out the corporations as separate entities when they actually work as one large corporation. Rule: No. If an individual controls a corporation for personal gain rather than the corporations gain, the individual is responsible under respondeat superior for the corporations acts in commercial dealings and in tort claims. Note: Plaintiff failed to allege that the individual defendants were acting in their individual capacities.

o Inability to satisfy a judgment is insufficient to pierce the corporate veil o Sea-Land Services, Inc. v. Pepper Source (Van Dorn test -The veil of limited corporate liability will be pierced when the plaintiff proves that 1) there is a unity of interest between the individual and the corporation, and 2) to allow the limited liability would promote an injustice or sanction a fraud.) Facts: Plaintiff corporation, Sea-Land Services, Inc., delivered a shipment of peppers for Pepper Source, but they were not paid. Marchese was the sole shareholder of Pepper Source. Evidence was presented that showed Marchese treated the corporate accounts as his own personal account, and he frequently shifted money around. Rule: The veil of limited corporate liability will be pierced when the plaintiff proves that 1) there is a unity of interest between the individual and the corporation, and 2) to allow the limited liability would promote an injustice or sanction a fraud. To determine whether theres a unity of interest, the court looks at 4 factors: o The failure to maintain adequate corporate records or to comply with corporate formalities o The commingling of funds or assets o Undercapitalization o One corporation treating the assets of another corporation as its own To determine whether there has been an injustice: o It must be more than an unsatisfied judgment o It must be found that if limited liability was allowed some wrong beyond a creditors inability to collect would result. Example: unjust enrichment (but plaintiffs didnt argue that) o [Parents vs. Subsidiaries] o Generally, the parent, like any other shareholder, is not liable for the debts of the subsidiary. o If the parent isnt cautious, the creditors of the subsidiary may be able to pierce the corporate veil of the subsidiary or the parent may become liable by virtue of its

participation in the activities of the subsidiary. o Subsidiaries controlled by the same parent are not alter egos o Roman Catholic Archbishop of San Francisco v. Sheffield (When a parent corporation controls several subsidiaries, a subsidiary is not liable for the actions of the other subsidiaries.) Facts: goes to Switzerland and contracts to buy a dog for $175 from a Catholic monastery, to be paid in $20 installments. makes 2 payments. Monastery refuses to ship the dog until all payments made, plus additional fees, and refuses to refund the money. sues the Roman Catholic Church (parent), the Roman Catholic Archbishop of San Francisco (subsidiary) & others. Rule: To impose personal liability under the alter ego theory, a corporation must not only be influenced and governed by the individual, but there must be such a unity of interest and ownership that the separateness of the person and the corporation has ceased, and the facts must be such that adherence to corporate protections would sanction a fraud or promote injustice. Note: As long as both parent and subsidiary observe proper corporate formalities and act as distinct, though related entities, the alter ego theory will not apply. However, if the parent uses the subsidiary on the parents own behalf, the parent may be liable for the subsidiarys misconduct. The alter ego theory may impose liability on a parent corporation for the liability of its subsidiary, but does not make one subsidiary liable for another subsidiarys actions merely because the same parent controls both. Parent corporation a corporation that has a controlling interest in another corporation (subsidiary), usually through ownership of more than one-half the voting stock. o A parent corporation is liable for its subsidiarys torts if the parent controlled the subsidiary as its alter ego. o In Re Silicone Gel Breast Implants Products Liability Litigation Facts: Breast implant recipients brought a products liability action against Bristol Myers (D), which was

the sole shareholder of Medical Engineering Corp (D), a major supplier of breast implants. Rule: If a parent corporation uses a subsidiary as its alter ego, as demonstrated by shared common directors or business departments, consolidated financial statements and tax returns, and an inadequately capitalized subsidiary, a plaintiff may assert its claims against the parent. Note: A showing of fraud is not necessary for tort liability when piercing the corporate veil. (even in jurisdictions where the courts require it, its only a requisite for contract liability)

o [Limited liability partnerships] o Definition: A form of general partnership that provides an individual partner protection against personal liability for certain partnership obligations. Comprised of a general partner and a limited partner. General partner a partner who ordinarily takes part in the daily operations of the business, shares n the profits and losses, and is personally liable for the partnerships debts and liabilities Limited partner a partner who receives profits from the business but does not take part in managing the business and is not liable for any amount greater than his or her original investment. o Lawyers of the promoters of tax shelter investments developed a variation on the basic limited partnership. A limited partnership with a corporation as the sole general partner. This way no individual was liable for the debts of the partnerships and partnerships arent taxed as an entity so there was a tax incentive. o General Partnership a partnership in which all partners participate fully in running the business and share equally in profits and losses (through the partners monetary contributions may vary. o Limited partners are not liable for a limited partnerships debts. o Frigidaire Sales Corporation v. Union Properties, Inc. Facts: Frigidaire Sales Corp. (P), a creditor of Commercial Investors, a limited partnership, brought an action against the corporate general partner and

its limited partners individually when the partnership failed to pay installments due on the contract. The controlling members were also the limited partners in the partnership. Rule: Limited partners are not liable for the debts of a limited partnership simply by their status as officers, directors, or stockholders of the corporate general partner as long as the conscientiously keep the corporate matters separate from their business and no fraud or manifest injustice results. Note: Just b/c the limited partners control the general partner, does not mean that the limited partners should incur general liability. Minimal capitalization the minimum amount of assets that an entity must have when operations begin Questions: Did swyggert say they shouldve been held liable? Can a corporation be formed solely to operate as a general partner in the partnership?

Section 3. Shareholder Derivative Actions

[Shareholder Derivative Actions] o Derivate action a suit by a beneficiary of a fiduciary to enforce a right belonging to the fiduciary; (usually a suit by a shareholder on behalf of the corporation against a corporate officer b/c of the corporations failure to take action against the third party) o They are intended to help stockholders in large corporations hold managers and directors responsible for wrongs the committed. If the shareholder has no success in demanding the company stop wrongful conduct, they may bring a derivative action. o In general, you can't institute a derivative suit until you either ask the directors to look into the problem, or you convince the court that it would be futile to ask because a majority of the directors were somehow involved in the thing you are suing about. A Court may require a plaintiff to post a bond in a derivative suit (bond= debt security) o Cohen v. Beneficial Industrial Loan Corp. Facts: David E. Cohen brought a shareholders

derivative suit against Beneficial Industrial Corp. (D) and others, and Beneficial brought a motion seeking to have Cohen (P), Davids executrix (female executor of a will), post security for the expenses associated with prosecuting the lawsuit. Rule: A New Jersey statute that requires a holder of less than five per cent of a corporations outstanding shares who brings a derivative suit to pay for all expenses of defending the suit and that requires security for the payment of these expenses should be enforced in cases prosecuted under federal diversity jurisdiction. Note: Plaintiffs with small ownership interests may abuse their right to bring a derivative action.

An action to reverse corporate actions that deprived shareholders of a voice in operations is not derivative o Two pronged standard to be used in determining whether a stockholders claim is derivative or direct: (1) who suffered the alleged harm, the corporation or the suing stockholders, individually; and (2) who would receive the benefit of any recovery or other remedy, the corporation or the stockholders, individually. direct/representative action -a lawsuit to enforce a shareholders rights against a corporation o Eisenberg v. Flying Tiger Line, Inc. Facts: A stockholder in a corporation that ceased to exist post-merger, brought an action on behalf of himself and all other stockholders of the dissolved corporation, to enjoin the plan of reorganization and merger. As a result of the merger, these shareholders only had a voice in the holding company. Rule: An action seeking to overturn a reorganization and merger that deprived an acquired corporations shareholders from having a voice in the surviving corporations business operations is a personal action rather than derivative action under the NY statute requiring the posting of security for the corporations costs. Note: Plaintiff didnt have to post a security because this did not count as a derivative action.

A holding company is a company or firm that owns other companies' outstanding stock (stock that hasnt yet been sold).

B. The Requirement of Demand on the Directors

A stockholder generally must demand the board bring an action before he or she brings a derivative suit o Grimes v. Donald Facts: Grimes (P), a shareholder who learned of the extremely generous compensation package DSC Communications (D) had extended to Donald (D), demanded DSC cancel Donalds (D) contract. Rule: A shareholder need not make a demand that a companys board institute a lawsuit before bringing a derivative suit on behalf of the corporation if he shows the demand would be futile, and if a demand is made and rejected, a shareholder may still proceed by establishing that the boards refusal was wrongful. High burden even with all inferences drawn in favor of the plaintiff. The demand is excused only if the shareholder can prove that a reasonable doubt exists that the board could exercise appropriate judgment. Proving wrongful refusal requires a reasonable doubt that the boards acted appropriately. Note: Directors may not delegate their duty to manage the corporation. Salary and benefit determinations are subject to the business judgment rule. o The presumption that in making businesss decision not involving direct self-interest or self-dealing, corporate directors act on an informed basis, in good faith, and in the honest belief that their actions are in the corporations best interest. o Function: shields directors and officers from liability for unprofitable or harmful corporate transactions if the transaction were made in good faith, with due care, and within the directors or officers authority. The plaintiff must provide more than conclusory

statements to establish that a demand would be futile. o Marx v. Akers Facts: A shareholder brought a derivative action charging breach of fiduciary duty and corporate waste by IBMs board of directors for excessive compensation of IBMs executives and outside directors. Rule: A plaintiff establishing that a demand on a companys board would have been futile must show either that: the measure furthered the boards self-interest o directors are deemed self interested if their benefits form a transaction are different from a shareholders benefits. o directors voting on director compensation =self interest the directors did not fully inform themselves about the challenged transaction or that the challenged transaction was so egregious on its face that it could not have been the product of the directors sound business judgment. Note: A court determines whether the board made its decision validly by examining the steps the board took to evaluate the issue. After having the demand excused, the plaintiff must still state a valid cause of action. To present a valid cause of action, the plaintiff must prove that the action was unfair/harmful to the corporation.

C. The Role of Special Committees

A board of directors may grant authority to a special committee to make recommendations on a derivative claim o Auerbach v. Bennett Facts: A corporation appointed a special committee to investigate the basis of a shareholders derivative suit charging mismanagement of corporate funds, and the committee determined the suit should be terminated. Rule: A special litigation committees determination forecloses further inquiry into a matter, provided the

committees investigation is bonafide. Note: The BJ rule will shield a committees decisions only if the members are found to have disinterested independence. The committee must exercise good faith. Interested board members may appoint a disinterested committee to investigate litigation o Zapata Corp. v. Maldonado Facts: Maldonado (P), a Zapata Corp. (D) shareholder, sued Zapatas officers and directors for breach of fiduciary duty, but Maldonado (P) did not ask Zapatas board to bring the action, considering the request to be futile. Rule: While a majority of a board may lack the independence to evaluate a derivative claim, the taint of self-interest is not necessarily sufficient to prevent the board from delegating the evaluation to an independent committee comprised of disinterested board members who may recommend dismissal of a shareholders action. Directors with ties to wrongdoers are not independent o In re Oracle Corporation Derivative Litigation Facts: Oracle shareholders filed a derivative suit against Oracle directors, which an Oracle special litigation committee sought to dismiss. Rule: A directors lack of independence turns on whether the director is, for any substantial reason, incapable of making a decision with only the best interests of the corporation in mind. Note: Under Delaware law, having a special committee look into the issue and find that everything is on the up-and-up almost always results in a derivative suit being dismissed.

Section 4. The Role and Purposes of Corporations

A corporation need not have specific authority to make valid charitable contributions o A.P. Smith Mfg. Co. v. Barlow Facts: Barlow (P), an A.P Smith (D) shareholder, brought a action seeking to find that a charitable donation made by the corporation was invalid. Rule: A corporations may make reasonable charitable contributions, even in the absence of

express statutory provisions. Note: Public policy supports these types of actions.

A for-profit corporation must pay dividends absent a justifiable business reason o Dodge v. Ford Motor Co. Facts: Ford Motor Company (D) made extraordinary profits and its founder, Henry Ford (D), intended to use those profits to lower the price of its cars and expand its factories capabilities by adding a steel plant, but Ford Motors shareholders (P) objected to these policies claiming that the companys first obligation was to make profits for its shareholders. Rule: Although a corporations directors have discretion in the means they choose to make products and earn a profit, the directors may not reduce profits or withhold dividends from the corporations shareholders in order to benefit the public. Note: The plaintiffs must show that the action taken instead of giving dividends was contrary to the corporations interests and withholding the dividends from the shareholders is arbitrary. The court demanded the company pay out dividends rather than retain profits in order to finance future corporate expansion. A corporation is organized for the benefit of its shareholders. It is not lawful for the company to direct profits from the shareholders to others. Keep in mind these were special dividends (those given in addition to regular dividends) (they were being greedy) Officers and directors decisions are protected by the business judgment rule o Shlensky v. Wrigley Facts: Shlensky, a Chicago Cubs shareholder, brought a derivative suit against the Chicago Cubs and its directors for negligence and mismanagement and for an order that the defendant install lights for night baseball games. Rule: A shareholder fails to state a cause of action unless it alleges that a corporations directors conduct was causing financial loss to the shareholder

and was based upon fraud. Note: Ct upheld business judgment rule there must be some showing of fraud, illegality, or a conflict of interest for the court to interfere with the directors policy choice (to not have lights installed, in this case)

Chapter 4. The Limited Liability Company

If a third party is not aware that an agent is acting for a principal, the agent may be liable to the third party. o Water, Waste & Land, Inc. d/b/a Westec v. Lanham Facts: Westec (P) negotiated with Larry Clark (D), believing Clark (D) agent, but Lanham (D) and Clark (D) were both members of Preferred Income Interest

Class Notes 9/20: (handout) Formation: A partnership is a private relationship; any terms are game. However, a corporation is an entity created by statute. The state requirements must be met before a corporation can come into existence. Limited Liability: Generally there is no limitation to liability in partnerships. You can limit your liability however by creating a limited partnership. A limited partnership must have one general partner. As lawyers we frequently make a corporation a general partner and us the limited partners. A corporation can act as an individual. As a shareholder, your liability in a corporation is limited to the equity u put into the corporation. Transferability: In a corporation, stocks are transferable. Some corps can have limited transferability by restricting who can transfer what. Continuity: Partnerships are for the most part at will and/or expire upon the completion of the task. Corporations have perpetual life. They can go one forever. Centralized Management: In a partnership, absent language in the agreement each partner has an equal voice in the affairs of the partnership. Centralized management is the norm in a corporation. Governance & control of a corp is vested in the

Board of Directors. Cost: Partnerships dont cost anything to form. There are filing fees for a corporation. Default rules: The UPA is extensive and governs partnerships but corporate law is far more challenging. Client perception: Flexibility: There are lots of rules in terms of how you provide your shares and issues of control in corporations. Taxes: The profits and losses flow directly to the partners in a partnership. In corporation, there is double taxation. (If it earns a profit it pays corporate income taxes and if it distributes those profits you pay income taxes.) In a partnership you can be the direct beneficiary in a law suit.