BE 2014

Question 1

3 Formations/Types of Businesses

Answer 1

1. Partnership
2. Corporation
3. Limited Liability

Question 2

Formation of an Agency Relationship

Answer 2

An agency is created when a principal and agent mutually agree that the agent will act on behalf of the principal and subject to the principal’s control. A fiduciary relationship results from manifestation of consent by one person to another that the other shall act on his behalf and subject to his control, and consent by the other so to act. The existence of an agency = A question of fact.

a. Agent owes the principal a fiduciary duty
b. Principal is liable in tort and K
c. Principal ←→ Agent ←→3rd Party

Question 3

Requirements to Create an Agency Relationship

Answer 3

a. There must be a mutual agreement
i. There may be a K but it is not necessary
ii. No consideration is needed

b. The agent must be acting on behalf of the principal and
c. The agent must act subject to the principal’s control
* KEY: As long as all of these requirements are present an agency exists regardless of what the parties intentions or understanding is.

Question 4

Courts Look At These 3 Things within a Relationship when Determining if an Agency Relationship Exists:

Answer 4

(1) The relationship of the principal and agent
(2) The relationship of master & servant
(3) The relationship of employer or proprietor and independent contractor

Gorton v. Doty (Football coach and librarian case)

Question 5

Creditor/Debtor Relationship & Agency

Answer 5

An agreement may result in the creation of an agency although the parties did not call it an agency and did not intend the legal consequences to follow.
o Can be proved by circumstantial evidence
o Principal must have consented

A creditor (Cargill) who assumes control of his debtor’s business may become liable as principal for the acts of the debtor (Warran) in connection with the business.
    o	Just because a creditor has veto power does not = a principal
   o	The point at which the creditor becomes a principal is that at which he assumes de facto control over conduct of his debtor.
     •	Not just some control

Look at the type of control:
• Positive Control (Not just limiting)
• Day-to-Day Control: What should you do & what should not be done (Here: Cargill was constantly sending employees to check out what was going on and give guidance to what Warren should be doing).

• Note on Creditors – Banks who loan money give limits – it is in the bank’s interest to make money on lending money. (In the previous case, Cargill’s interest was to gain customers & grain, not to make money off the loan/money lent).

Question 6

A principal will be liable to third parties if …. (List six different forms)

Answer 6

His agent has authority to effectuate the K.

Authority comes as:

(1) Express Actual,
(2) Implied Actual,
(3) Inherent
(4) Apparent,
(5) Ratification
(6) Estoppel

Question 7

Express Actual Authority

Answer 7

A principal has expressed authority to the agent in spoken or written words the power to perform certain acts on the principal’s behalf.
- The scope express authority can be limited

TEST: Whether a reasonable person in the agent’s position would interpret the principal’s communication to encompass a particular act.
- Example: “I hereby authorize you to borrow money to pay my taxes on my property”

NOTE: The power to borrow money or execute and deliver PN must be granted in express terms of flow as a necessary and inevitable consequence from the nature of the agency actually created (Williams v. Dugan)

Question 8

Implied Actual Authority

Answer 8

Not expressly granted but the principal’s words or conduct “reasonably interpreted” cause the agent to believe that he has authority.

• Focus on whether the agent believes he has power
• Example: If you hire someone to do a job for you but you can’t describe every task, the agent might assume he has been authorized to do more than you have expressly authorized him to do.

Question 9

Apparent Authority

Answer 9

Usually some type of secret agreement. Corp. rules state something that is in contradiction w/what occurred. Secret instructions can easily destroy actual authority.

• Focus on whether the third party reasonably believes the agent had authority to act on behalf o the principal.
  
  1. Apparent authority cuts out secret agreements between the principal and the agent.
  2. Obviously if someone has actual authority they also have apparent authority
• Allows third party to back out but does not allow the principal to back out.

NOTE: If the principal wants to hold the third party to the K, they must have that party ratify the K. When the K is ratified, it relates back to the K that was originally signed. (You don’t have to notify the K, just have them sign and move on as if that was always the agreement or K).

Question 10

Implied Authority Test:

Answer 10

Look at what is going on between the principal and the agent. Ask whether the agent reasonably believes she/he had actual authority based upon the relationship between the agent and the principal.

ESCO v. Harvard (Examples)
o Gary’s actions were in line w/the mission and the company’s desire for him to take a more active role in his dept.
o Received a written evaluation stating he was doing a good job & should be more proactive
o Gary thought had authority
o Counter: Understood this was an iffy proposition so he did not get the PO signed off by the president (as memo specified). (Gary thought this was only a formality because President always signed)

Question 11

Apparent Authority TEST

Answer 11

Would a third party reasonably believe that the agent had authority?

Manifestation + Reasonable Belief by 3rd Party = Apparent Authority

(1) There must be a manifestation from the principal to the third party that the agent is an agent (Example: Simply give the “agent” an office, business cards, etc.)
• If the principal allows an agent to occupy a position which, according to the ordinary habits of people in the local, trade, or profession carries a particular kind of authority then anyone dealing with the agent is justified in inferring that the agent has authority.
• May also be created by the appearance of authority by “prior acts”

(2) Third party must reasonably believe that the agent had authority to act on behalf of the principal. (Example: Secretary buys copy paper, probably okay).

ESCO v. Harvard (Example):
*KEY: The third party doesn’t know about the memo like Gary did so it cannot stand to prove that Gary was not in fact an agent.

Question 12

Undisclosed Principal

Answer 12

Subjects the principal to liability for acts done on his account if they are in the usual or necessary in that line of business. (Even if the principal forbode the agent to incur such debts so long as the transactions are in the usual course of business engaged in by the agent).

Question 13

Ratification:

Answer 13

A principal may ratify the conduct of an agent who acted w/o authority – unless allowing ratification would be unfair to the third party as a consequence of changed circumstances.

 i. Where the principal retains the benefits or proceeds of its business relations with an agent w/knowledge of material facts, the principal is deemed to have ratified the methods employed by the agent in generating proceeds. 
ii. Even if the agent is w/o authority, the principal may be bound pursuant to the doctrine of ratification and estoppel.    iii. Can be express or implied as long is there an “affirmance” of the K by the principal    iv. The most common is when a principal has knowledge of a transaction, accepts its benefits, and fails to repudiate it.
v. Principal’s ratification must be complete (not as part of the K)    vi. Regardless of when ratification occurs, it is considered from original formation

• Ratification requires acceptance of results of the act w/ an intent to ratify & w/full knowledge of all material circumstances.

Question 14

Estoppel:

Answer 14

A principal who misleads a third party into believing that an agent has authority to effect a particular transaction is liable w/respect to that transaction. If a principal allows a situation to happen in which people reasonably believe someone is an agent – then the principal may be estopped to deny the agency relationship.
– Example: Someone hears that an agency is representing them (you’re in Dallas and you hear someone in Lubbock is representing you) If you don’t take reasonable steps to correct, then agency by estoppel can occur. (However, if you never heard or were unaware, estoppel could not occur because you never knew about it to fix it).

Hoddison v. Koos Bros.:
When a party wants to impose liability upon a principal, on a K made by an alleged agent, the party must prove the agency relationship & the principal does not have to disprove it.

Question 15

The Agent’s Liability to Third Parties:

Answer 15

1. If the agent Ks with a 3rd party on behalf of a disclosed principal, the agent is not liable on the K absent a contrary agreement.
2. Courts typically require clear proof of intent to bind the agent.
3. When an agent Ks on partially disclosed or undisclosed principal the agent is normally liable on the K.
4. If the agent lacks power to bind the principal, the 3rd party may sue the agent for breach of warranty of authority or misrepresentation of authority.
5. To ensure a principal is liable when an agent signs, the agent must: Name the principal & use By followed by a signature line.
   a. If there is no “By” but a signature line = Still leaves agent liable
   b. “By” overrides personal liability even if a person lists “By” and “Personal”

Question 16

The Third Party’s Liability to the Principal:

Answer 16

1. Unless the K provides otherwise, if an agent is acting for a disclosed or partially disclosed principal & has authority, the 3rd party is bound as well as the principal.
2. When the principal is undisclosed, and where the agent has authority, the 3rd party is bound to the K, unless:
   a. The principal’s existence is fraudulently concealed or
   b. The third party is induced to enter into the K by representation that the agent was acting for himself and the agent or principal has notice that the third party would not have dealt with the principal.
3. An undisclosed principal cannot require a third party to accept the principal’s performance instead of the agent’s if this substitution substantially changes the performance contemplated by the K.

Question 17

Principal’s Liability in Tort:

Answer 17

A principal who is the master is responsible for the torts of servants acting w/in the scope of their employment.

a. Master/Employer: Principal who controls or has the right to control the physical conduct of the other in the performance of the service
b. Servant/Employee: Agent whom the principal controls (vs. independent contractor)

RULE: Principals are always responsible for their own misconduct and are liable for the torts of his agent if the agent acts under his direction and the principal intents the conduct or its consequences (THINK: It is unlikely any principal will give an agent authority to commit a tort so, likely no actual authority. Apparent, the third party is unlikely to get up off the street and note that the tort feasor was acting as an agent. Inherent, ratification, etc. works in K not in tort).

a. Principals are liable for agent’s tort if the agent is an employee of the principal
b. Employee/Employer are separate until
- Make the connection that there is an employee/employer relationship
- When the employee committed the tort, he was acting w/in the scope of his employment

Question 18

3 Ways to make principal liable for the Agent’s tort (even when the agent is not an employee):

Answer 18

1. Abnormally Dangerous Activities
2. Peculiar Risk of Harm
3. Apparent Authority in Tort Actions

Question 19

Abnormally Dangerous Activities:

Answer 19

If the activity might very well result in injury even if conducted with all due skill and caution. When an activity is abnormally dangerous, it is important not only that people engaged in it use the highest practicable degree of skill and caution, but also – since even if they do so, accidents may result.

i. The people who authorize the activity consider the possibility of preventing some accidents by curtailing the activity or even eliminating it all together. (Example: Transporting nuclear waste).    ii. Anderson was not an abnormally dangerous activity because there was an easy way to make not dangerous

Question 20

Peculiar Risk of Harm:

Answer 20

The peculiar risk = Death from breathing the sandblasting unless special precautions are taken.

i. Casto thinks that this fits the Anderson case
ii. If the company is aware of the harm, or learns of the harm, they might become liable (again, fits the Anderson case)    iii. In Anderson, the court rationalizes that there is no liability because worker’s comp claims are meant to address workplace injury, and if you allowed lawyers to sue everyone would be connected to the tort whether they should be liable or not.

Question 21

Apparent Authority in Tort Actions:

Answer 21

When someone acts and has no authority to act – it is outside the scope of the employee’s employment making the principal not liable. (There are some situations where it appears someone has authority).

Question 22

Servants v. Independent Contractors

Answer 22

Multi factor test to look at the nature of the relationship between franchisee and franchisor court looked at the amount of control exercised by the latter over the former – if the employer’s right to control the activities of an ee extends to the manner in which a task is to be performed than the employee is not an ind. contractor

(1) What was the extent of control of the er over how the ee does business?
(2) Is the ee involved in a distinct operation (unskilled might suggest employee)
(3) Whether the er or the workman supplies the tools or instruments of the trade (pizza guy has his own car might suggest he is not an employee)
(4) Method of payment (Hourly suggests employee – getting money for each specific task suggests not an employee)
(5) Whether the action is part of the regular task of the er (Cannot provide delivery pizza if there is no delivery man)

Question 23

If the action of an employee benefits both the employee and the 3rd party, is the act outside the scope of the employment?

Answer 23

No, as long as it’s furthering company policy it is still within the scope of employment.

Question 24

Factors to be considered w/regard to the scope of employment:

Answer 24

(1) Time, place, and purpose of the act
(2) Its similarity to act which the servant is authorized to perform
(3) Whether the act is commonly performed by servants

(4) Whether the master would reasonably expect such act would be performed
a. Smith’s acts occurred while she was on duty in the store – interaction was to complete the sale of items from the store. All actions were customary of store clerks.
b. Did not use normal methods of conducting the sale (The fact that an ee commits an intentional tort does not require finding that the behavior was outside of the scope of their employment). No evidence to show that Conoco could have expected this behavior from Smith.

(5) The extent of departure of normal methods

Question 25

Agent's Duties to the Principal - The Restatement:

Answer 25

An agent is a fiduciary of the principal in the classic sense of the word. As such, he has an obligation to act in the principal’s best interest rather than his own. The law places three major duties on the agent (1) loyalty (2) care (3) obedience.

Question 26

Agent's Duty of Loyalty:

Answer 26

Flows from fiduciary nature of the relationship i. Agent must account to the principal for all profits from the transaction that have not be promised to the agent by K ii. Refrain from acting as or on behalf of the adverse party iii. Refrain from competing w/the principal iv. Refrain from using the principal’s property or confidential information for personal purposes or for a third party v. Disclose relevant information to the principal vi. Segregate the principal’s property and keep render accounts vii. Act in accordance w/a general duty of good conduct Tarnowski v. Resop: *All profits (or benefits) made by agent in the course of an agency belong to the principal, whether they are fruits of performance or the violation of an agent's duty. (Doesn't matter if the principal suffered no damage or even if the transaction was profitable). Principal is entitled to recover its value, or proceeds, and also amount of damages caused.

Question 27

Agent's Duty of Care:

Answer 27

Flows from the parties’ implicit assumption that the agent will carry out his duties w/ reasonable care

Question 28

Agent's Duty of Obedience:

Answer 28

Flows from the nature of the agency definition which specifies that the agent must be subject to the principal’s control i. The agent must act only as authorized by the principal and must obey the principal’s instructions ii. Must also perform any contractual duties owed to the principal

Question 29

151.001: Definitions: Partnership Agreement:

Answer 29

Means any agreement written or oral, of the partners concerning a partnership

Question 30

152.002: Effect of Partnership Agreement; Non- waivable and Variable Provisions:

Answer 30

(a) A partnership agreement governs the relations of the partners and between he partners and the partnerships. To the extent that the partnership agreement does not otherwise provide, this chapter govern the partnership and partnerships (b) Includes what is not covered under (a) in other words – what cannot be changed

Question 31

General Formation of Parnterships

Answer 31

1. A partnership is an “association of two or more persons to carry on as co-owners a business for profit.” a. No special filing required, no need to be in writing (but it is typical to have one that addresses all the important issues – instead of leaving them to be addressed by statute. You could use the provisions of the statutes as a guide but … you might not like them) b. Partnership law is like contract law, it boils down to what the agreement is – The actual express agreement between or among the parties might be silent i. Statutes fill the gap/are default provisions if the partnership leaves things silent

Question 32

Tex. 152.203: Rights and Duties of Partner:

Answer 32

(c): A partner is not entitled to receive compensation for services performed for a partnership other than reasonable compensation for services rendered in winding up the business of the partnership -- Common Sense: You take compensation out of profits, which are not directly tied to how hard you work. If the agreement does not address the compensation of the partners, the code does.

Question 33

Tex. 152.051(b): Partnership Defined:

Answer 33

(a) .. (b) An association of two or more persons to carry on a business for profit as owners creates a partnership, regardless of whether: (1) the persons intend to create a partnership; or (2) the association is called a “partnership,” “joint venture,” or other name (c) An association or organization is not a partnership if it was created under a statute other than …

Question 34

4 Factors that Courts Look at to See if Partnership Exists:

Answer 34

1. An agreement to share profits and losses 2. A mutual right of control or management of the enterprise and 3. A community of interest in the venture 4. These are important but a partnership can exist w/o them and are not exclusive ** What really matters is whether the parties have created the kind of association defined by statute to equate to a partnership. (An agreement to share profits is by far the most important). This is determined on a case by case basis.

Question 35

Texas Act 152.052: Rules for Determining if Partnership is Created (Factors)

Answer 35

(a) Factors indicating that persons have created a partnership include (1) Receipt or right to receive a share of profits in the business (2) Expression of intent to be partners (even though you can become a partner even if you do not intend to do so) (3) Right to participate in control of the business (seems like the friends do have control – more than just veto power set negative controls) (b) Following factors do not indicate .. (1) The receipt or right to receive profits as payment of a debt. (c) An agreement to share losses is not necessary to create a partnership (Intended to deal with the situation that no one enters into a partnership to lose money) (e) Of interest or other charge on a loan, regardless of whether the amount varies w/the profits of the business – including a direct or indirect present or future ownership interest in collateral or rights to income, proceeds, or increase in value derived from collateral * You can structure an agreement w/o becoming a partner by receiving profits

Question 36

152.307: Extension of Credit in Reliance on False Representation:

Answer 36

(a) just because someone claims they are a partner, does not make them one – the person extending credit or relying on the representation is determined by applicable law other than this chapter & other partnership provisions, including the law of estoppel, agency, negligence, fraud, and unjust enrichment. (b) The rights and duties of a person held liable under Sub.(a) also determined by law other than the law described in (a).

Question 37

TX 152.501: Evidence of Withdrawal:

Answer 37

a) .. (b) An event of withdrawal of a partner occurs on (1) receipt by the partnership of notice of the partner’s express will to withdraw as a partner on (A) the date on which the notice is received; or (B) on a later date specified by notice;

Question 38

152.301: Partner as an Agent:

Answer 38

Each partner is an agent of the partnership for the purpose of its business.

Question 39

152.203: Rights and Duties of Partners

Answer 39

(a): Each partner has equal rights in the management and conduct of the business of a partnership.

Question 40

152.209: Decision-Making Requirement

Answer 40

(a) A difference arising in a matter in the ordinary course of the partnership business may be decided by a maj. in interest of the partners (51%) (b) An act outside of the ord. course of business of a partnership may be undertaken only w/ the consent of all parties.

Question 41

151.001: Definitions (4) Majority in Interest:

Answer 41

With respect to all or a specified group of partners, means partners who own more than 50% of the current percentage or other interest in the profits of the partnership that is owned by all of the partners or the partners in the specified group as appropriate (If 50%, or no specified way of splitting, like here, you’ll need a gap filler).

Question 42

Partnership Accounting (In General):

Answer 42

1. Everyone contributes their specified amount, unless there is a unique agreement, when the business is sold each partner would be entitled to receive an amount equal to their capital investment, if available. Any excess of deficit would be shared in accordance w/ each partner’s share of gain and loss. 2. The default partnership rule is that losses are apportioned among the partners in the same manner as profits. Thus if there is no agreement as to profits but not losses, losses follow profits. If there is no agreement at all – both profits and losses are split equally.

Question 43

Draw:

Answer 43

Even if a firm has had profits and does have spare cash the partners are not automatically entitled to receive a cash payment. A draw is used to describe cash distributions to partners. -- The amount of the draw of each partner is determined by the majority vote of the partners and may be more or less than the profit.

Question 44

152.202: Credits and Charges to Partner:

Answer 44

Each partner is credited with an amount equal to: (1) the cash and value of property the partner contributes to the partnership (2) the partner’s share of the partnership’s profits (b) Each partner is charged with an amount equal to (a) (1) & (2) the share of the partner’s losses (c) Each partner is credited w/an equal share of the partnership’s profits and is chargeable with a share of the partnership’s capital or operating losses in proportion to the partner’s share of the profits (Example: If profits are split 60/40, the losses are split the same way)

Question 45

Joint-Ventures:

Answer 45

1. Voluntary relationship (not created by law) a. Agreement is essential i. Can be express or implied b. Usually in relation to a specific venture i. Even if it’s not something that can be completed immediately ii. In other words, not general in operation or duration c. Must share profits i. Not several (i.e. joint and severally liable) d. Must have equitable interest in profits themselves e. Usually a management of property & authority to act for each other 2. Partnership rules typically govern

Question 46

Partnership Liability to Third Parties (Generally)

Answer 46

1. Partners are joint and severally liable for partnership obligations 2. Partners are liable to: a. Third parties in tort for wrongful acts or omissions of partners acting w/authority in the ordinary course of the partnership b. Certain breaches of trust committed by partner

Question 47

RULE: Texas Uniform Partnership Act:

Answer 47

Every partner is an agent of the partnership for the purpose of its business, and the act of every partner, including the execution of the partnership name of any instrument for apparently carrying on in the usual way the business of the partnership of which he is a member binds the partnership, unless the partners acting has in fact no authority to act for the partnership in the particular matter, and the person w/ whom he is dealing has knowledge of the fact that he has no such authority.” ASK: Is it carrying on in the usual way of business? ASK: Is there an agreement tha says otherwise?

Question 48

152.302: Binding Effect of Partners: (apparent authority)

Answer 48

(a) Unless a partner does not have authority to act for the partnership in a particular matter and the person with whom the partner is dealing knows that the partner lacks authority, an act of a partner, including the execution of the instrument in the partnership name, binds the partnership if the act is apparently for carrying on in the ordinary course: (1) partnership business; or (2) business of he kind carried on by the partnership (b) an act of a partner that is not apparently for carrying on in the ordinary course a business described by Sub (a) binds the partnership only if authorized by other partners (c) a conveyance of real property by a partner on behalf of the partnership binds the partnership if the property has been conveyed by the grantee or a person claiming through..

Question 49

(Tort Liability) 152.303: Liability of Partnership for Conduct of Partner:

Answer 49

(a) A partnership is liable for loss or injury to a person, including a partner or for a penalty caused by or incurred as a result of a wrongful act or omission or other actionable conduct of a partner acting (1) in ord. course of business of the partnership, (2) w/authority of the partnership (b) A partnership is liable for the loss of money or property of a person who is not a partner that is: (1) received in the course of the partnership’s business; and (2) misapplied by a partner while in the custody of the partnership o Typically a question of fact unless the partner is not acting w/in the scope of employment, then it becomes a matter of law

Question 50

Enforcing Partnership Liabilities Against Partners - Personal Liability?

Answer 50

Generally, the individual personal assets of all partners are subject to the claims of the partnership’s creditors (and obviously to their own personal creditors)

Question 51

152.056: Partnership as Entity

Answer 51

A partnership is an entity distinct from its partners. THINK: Partnership debt is owed by the partnership (Not the case)

Question 52

152.304:Nature of Partner’s Liability:

Answer 52

(a) Except as provided in (b) or .801, all partners are JSL for all obligations of the partnership unless otherwise: (1) Agreed by the claimant; or (2) provided by law (b) A person who is admitted as a partner into an existing partnership does not have personal liability under (a) for the obligation of a partnership that … • The theory of the act is that it is a debt or obligation of the partnership so you should go to the partnership and request payment. Typically, partnership pays.

Question 53

152.305: Remedy

Answer 53

An action may be brought against a partnership and any and all of the partners in the same action or in separate actions. • If you can’t get PJ over all of them, just sue those you can • (i.e. = JSL)

Question 54

152.306: Enforcement of Remedy

Answer 54

A judgment against a partnership is not by itself a judgment against a partner. A judgment may be entered against a partner who has been served w/process in a suit against he partnership. (b) Except as provided in (c) a creditor may proceed against one or more partners or the property of the partners to satisfy a judgment based on a claim against the partnership only if a judgment: (1) is also obtained against the partner; and (2) based on the same claim (A) is obtained against the partnership (B) has not be reversed or vacated; and (C) remains unsatisfied for 90 days after (i) the date on which the judgment is entered or (ii) the date on which the stay expires … (c) Sub (b) does not prohibit a creditor from proceeding directly against one or more partners or the property of the partners w w/o first seeking satisfaction from partnership property if (1) the partnership is a debtor in bankruptcy (2) the creditor and the partnership agreed the creditor is not required to pay under (b)

Question 55

152.101: Nature of Partnership Property

Answer 55

Partnership property is not property of the partners. A partner or a partner’s spouse does not have an interest in partnership property.

Question 56

152.102: Classification as Partnership Property:

Answer 56

Guidelines to decide whether property = partnership property. (a) Property is partnership property if acquired in the name of: (1) the partnership; or (2) one or more of the partners, regardless of whether the name of the partnership is indicated, if the instrument transferring title to the property indicates: (A) the person’s capacity as a partner; or (B) the existence of a partnership (b) Property is presumed to be partnership property if acquired w/partnership property, regardless of whether the property is acquired as provided by (a) (c) Property is presumed to be the partner’s property if it is acquired in the name of one or more partner and the instrument transferring title does not indicate the person’s capacity as a partner or the existence of a partnership, and if the property is not acquired w/partnership property (d) Property is acquired in the name of this partnership by a transfer to: (1) The partnership in its name; or (2) One or more partners in the partner’s capacity as partners in the partnership, if the name of the property is indicated in the instrument transferring title to the property

Question 57

154.001: Nature of Partners and Partnership Interest:

Answer 57

(c) a partner is not a co-owner of partnership property

Question 58

154.002: Transfer of Interest in Partnership Property Prohibited

Answer 58

A partner does not have an interest that can be transferred, voluntarily or involuntarily in partnership property.

Question 59

152.202(c): Credits of and Charges to Partner: (In relation to creditors)

Answer 59

(c) Each partner is entitled to be credited w/an equal share of the partnership’s profits and is chargeable w/ a share of the partnerships capital..

Question 60

152.201: Admission as a Partner: (In relation to creditors)

Answer 60

A person may become a partner only with the consent of all partners. • (In other words, the argument is the creditor can not take control of the partnership w/o agreement of all partners)

Question 61

1.002(68): “Partnership Interest”: (In relation to creditors):

Answer 61

Partners interest in a partnership. The term includes the partner’s share of profits and losses or similar items and the right to receive distributions. The term does not include a partners right to participate in management. * Creditor only gets the interest which the debtor partner owes - which is to receive profits, not manage the parntership

Question 62

152.308: Partner’s Partnership Interest Subject to Charging Order:

Answer 62

(a) On application by a judgment creditor of a partner or of any other owner of a partnership interest, a court having jurisdiction may charge the partnership interest of the judgment debtor to satisfy the judgment (b) To the extent that the partnership interest is charged in the manner under (a), the judgment creditor has only the right to receive any distribution to which the judgment debtor would otherwise be entitled in respect of the partnership interest (c) A charging order constitutes a lien on the judgment debtor’s partnership interest. The charging order lien may not be foreclosed upon (d) The entry of a charging order is the exclusive remedy by which a judgment creditor of a partner or of any other owner of a partnership interest may satisfy a judgment out of the judgment debtor’s partnership interest

Question 63

152.402: General Effect of Transfer: A

Answer 63

A transfer of all or part of a partner’s partnership interest: (1) is not an event of withdrawal (2) Does not by itself cause a winding up of the partnership business (3) Against the other partners or the partnership, does not entitle the transferee, during the continuance of the partnership, to participate in the management or conduct of the partnership business THINK: (3) Creditor

Question 64

152.202: Credits and Charges to a Partner:

Answer 64

Split the profits 50/50 (Here, their partnership agreement did not split it that way – First 5 years, 60/40 – thereafter 50/50) – the act shares losses the same that you do profits (In this case, the losses would have been 60/40 then 50/50; however their partnership agreement set it up that losses were split 50/50).

Question 65

Texas 152.002(b)(2): Effect of partnership agreement; non waivable variable provisions:

Answer 65

A partnership agreement or the partners may not: eliminate the duty of loyalty under 152.205, except that the partners by agreement my identify specific types of activities or categories of activities that do not violate the duty of loyalty if the types or categories are not manifestly unreasonable; • This also gets secret information of the partnership (i.e. if he wasn’t a partner, he wouldn’t have access to this information) KEY: Okay to cut back on the duty of loyalty but it should not be totally eliminated

Question 66

152.204: General Standards of Partners Conduct:

Answer 66

Partners owe partners and transferees … (1) A duty of loyalty (defined in 152.205) (2) A duty of care (defined in 152.206) (b) .. (c) A partner does not violate a duty or obligation just because the partner’s conduct furthers his own interest (d) A partner, in the partner’s capacity as a partner is not a trustee and not held to the standards of a trustee • Do not cite trustee cases in partnership cases

Question 67

152.501: Events of Withdrawal

Answer 67

(a) A person cease to be a partner on the occurrence of an event of withdrawal (b) An event of withdrawal occurs on: (1) receipt by the partnership notice of the partner’s express will to withdraw a partner on: (A) The date on which the notice is received (B) a later date specified by notice (2) an event specified in the partnership agreement as causing the withdrawal; o Okay under 152.002(b)(5) (3) the partnership expulsion as provided by the partnership agreement (4) the partner’s expulsion by vote of a majority in interest (A)… (5) the partner’s expulsion by judicial decree, on application by the partnership or another partner, if the judicial decree determines that partner … (Bad stuff) (6) .. (7) If a partner dies, he leaves the partnership o 152.002(b)(5): Cannot be eliminated

Question 68

152.502: Effect of Event of Withdrawal on Partnership and Other Partners:

Answer 68

A partnership continues after withdrawal. The event of withdrawal affects the relationships among the withdrawn partner, the partner, the partnership and the continuing partners as provided by .503-.506.

Question 69

152.503: Wrongful Withdrawal; Liability:

Answer 69

(a) can withdraw .. (b) A partner’s withdraw is wrongful only if: (1) breaches an express provision of the p’ship agreement (2)… (c) In addition to other liability of the partner to the partnership or the other partners, a wrongfully withdrawing partner is liable to the partnership and to the other partners for damages caused by the withdrawal. • The partnership may sue for the partner’s wrongful withdraw. • 152.604: Redemption if partnership has not wound up: If the partner wrongfully causes damages, he may set off against the redemption price payable to the withdrawn partner and all other amounts owed by the withdrawn partner to the partnership, whether currently due, including interest Example: Suppose wrongful w/draw has caused $60k in damages and the withdrawing partner is owed $100 – the partnership can just pay $40k

Question 70

152.504: Withdrawn Partner’s Power to Bind Partnership:

Answer 70

(a) The action of a withdrawn partner occurring not later than the first anniversary date of the person’s withdrawal binds the partnership if the transaction would bind the partnership before the person’s withdrawal and the other party to the transaction: (1) does not have notice of the person’s withdrawal as partner; (2) had done business with the partnership within one year preceding the date of withdrawal; and (3) reasonably believed the withdrawn partner was a partner at the time of the transaction (b) …

Question 71

152.506: Liability of a withdrawn partner to a third party:

Answer 71

If a partner withdraws under a circumstance that is not winding up, they remain liable to another party as a partner in a transaction entered into by the partnership or a surviving partnership for 2 years after withdrawing if the other party to the transaction: (1) Does not have notice of the partner’s withdrawal (2) Reasonably believed the withdrawn partner was a partner at the time of the transaction

Question 72

11.051: Event Requiring Winding up of Domestic Entity:

Answer 72

Winding up of a domestic entity is required on: (2) A voluntary decision to wind up the domestic entity • 11.057: Supplemental Provisions for Domestic General Partnership (How to voluntarily wind up) (5) A decree by a court requiring the winding up, dissolution, or termination of domestic entity, rendered under the code or law • 11.314: Involuntary Winding Up and Termination of Partnership of LLC: Basis for judicial winding up (Requires lawsuit – which you want to avoid because it requires

Question 73

Comparing the Partnership and the Corporation

Answer 73

1. Unlike a partnership, a corporation has to be formally created, the parties must make a conscious decision whether to become a corporation. 2. To form a corporation a certificate of incorporation must be filed w/the state in accordance w/specific criteria – must get the legislature’s permission - Entity Status: A corp. is an entity distinct from its owners in all juris. - Continuity of Existence: Corp. have perpetual existence until and unless it is dissolved (unless it explicitly chooses to have a limited duration). i. For owners who are dissatisfied w/the corp. they may sell their shares and get out *return invested capital w/o consent of the board or other share holders) - Centralized Management: Unlike partnerships, the decision-making power in a corp. traditionally resides w/the board (who may or may not be shareholders). Shareholders elect directors but otherwise they vote only on fundamental transactions - Limited Liability: Shareholders enjoy limited liability – losses are limited to the value of his investment (i.e. rarely do creditors have recourse against shareholders individually – usually just seize property of the corporation). - Free Transferability of Ownership Interests: Shares are freely transferable (unlike a partnership where new partners may be admitted by unanimous consent only) - Tax Status: Taxed as a separate legal person and pays its own taxes based on its own income for the year.

Question 74

Specific Corporate Model (Every Lawyer Needs to Understand):

Answer 74

a. Shareholders own the corporation but they do not run it (they cannot), the receive profits from the corp in the form of dividends, & also elect people to the BOD b. Board of Directors (typically a group of people – 3 to 10/15) i. Elected by the shareholders ii. The BOD has all the powers of the corp and supervise the corp’s activities iii. Provides general guidelines and selects managers iv. Typically a BOD will only meet once/four times a year v. Director is not an employee c. Management i. Run the business on a day to day basis

Question 75

3.001: Formation and Existence of Filing Entities:

Answer 75

(a) To form a filing entity, a cert. of formation needs to comply w/ 3.003, 3.004, and 3.005 & Ch. 4 (b) … (c) The existence of a filing entity commences when the filing of the certificate of formation takes effect as provided in Ch. 4 (d) Unless the state terminates the filing entity, an acknowledgment of the filing of a certificate of formation issued by the filing officer is conclusive of (1) the formation/existence of the filing entity; (2)the satisfaction of all CP to the formation of the filing entity; and (3) the authority if the filing entity to conduct business in the state.

Question 76

3.005:Certificate of Formation:

Answer 76

What must go in the certificate: • Name of filing entity before formation • Type of filing entity before formation • Purpose of formation (which can be stated or include any lawful purpose) • Period of duration, if the entity is not formed to exist perpetually and is intended to have a specific period of duration • Street address of the initial registered office of the filing entity and the name of the initial registered agent • The name and address of each: o Organizer (unless formed under a merger/conversion) o General Partner (if limited partnership) o Trust Manager o *Directors

Question 77

5.054: Name of Corp., Foreign Corp, Professional Corp., or Foreign Professional Corp.: (

Answer 77

(a) The name must contain “company,” “corporation,” “incorporated,” or “limited,” or an abbreviation of those words (b) Nonprofit corps. do not have to comply with (c) Instead of (a) can be the phrase “professional corporation” or an abbreviation of the phrase.

Question 78

5.053: Identical and Deceptively Similar Names Prohibited:

Answer 78

(a) A filing entity may not have a name, and a foreign filing entity may not register to transact business in the state under a name, that is the same as, or that is the secretary of state determines to be deceptively similar or similar to: (1) the name of another existing filing entity (2) the name of a foreign filing entity that is registered … • If SOS says it is similar – don’t fight it. • SOS is who makes this determination

Question 79

5.201: Designation and Maintenance of Registered Agent and Registered Office:

Answer 79

(b) The registered agent must be an individual (b)(2)(B)(3): Must maintain a business office at the same address as the entity’s registered office (c)(1) Must be located at a street address where process may be personally served on the entity’s registered agent .. • Fairly common for you (the attorney) to be the registered agent • You understand the important documents that will be coming to the office • Also good way to drum up business and if there’s action required, you’ll probably be chosen to help

Question 80

(The Corp. Theory in Law) 21.401: Management by Board of Directors:

Answer 80

The BOD shall: (1) Exercise or authorize the exercise of powers of the corp; and (2) Direct the management of the business and affairs of the corp.

Question 81

21.403: Number of Directors:

Answer 81

(a): May consist of one or more • Most corp’s have a minimum of 3 directors, mainly to avoid tied votes (b) If crop. In managed by BOD, the number shall be set by, or in the manner provided by, the cert. of formation, or bylaws of the corp., except that the number on the initial BOD must be set by crt. Of formation. (c) Increase or decrease is provided by the cert. of formation or bylaws. A decrease cannot shorten the term of the incumbent director (d) If the bylaws are silent as to the number, the number is the same as the number constituting the initial BOD as per the cert. of formation

Question 82

1.002(16): Director

Answer 82

Means an individual who serves on the BOD of a foreign or domestic corp.

Question 83

1.002(38) Individual:

Answer 83

Means a natural person | *Corp cannot be director of corp. but the corp. can be a partner

Question 84

3.003: Duration:

Answer 84

A domestic entity exists perpetually unless otherwise provided in the governing documents of the entity. A domestic entity may be terminated in accordance w/this code or the Tax code. • If one group owns 50% and the other owns less, it’s possible for majority owners to discriminate against minority o KEY: If you say it expires after a certain amount of time, the minority knows they can get out. o In a small corp. it’s almost impossible to sell stock • As soon as there is an expiration provision, it’s like murphy’s law, if something can screw up, it will – clients will forget about this and continue operating the corp. after the charter has expired o Opens up the possibility that it’s not a corp. but it is an association of two or more people conducting business (i.e. partnership) and the rules of personal liability substantially change Limited: When you see the word in a biz org. context – you’re talking that the shareholders are limited (their liability), the shareholders put money into the corp., once they do so – it’s the corp. money not the shareholders. If the corp. owns debt that money is at risk to pay corp. debts but aside from the money they’ve paid for their shares of stock they are not liable (only the amt. put in).

Question 85

3.001: Formation and Existence of Filing Entities:

Answer 85

(c) Existence commences when filing of cert. takes effect • i.e. it does not exist until SOS files and sends acknowledgement (d) The acknowledgement is conclusive evidence of the formation and existence of the corp. and the satisfaction of all CP • Even if your form/cert doesn’t comply with the law, once you receive this acknowledgement it’s conclusive evidence that you’re in compliance (d)(3): The authority of the filing entity to transact business in this state • If clients are conducting before the cert. is filed it looks like they’re acting as a partnership once they’re in existence, it’s the corp. doing biz.

Question 86

4.001: Signature and Delivery:

Answer 86

(a)(2): You deliver to SOS (or it may be mailed, e-mailed, or any other comparable form of delivery)

Question 87

4.002: Action by SOS:

Answer 87

The SOS checks it out – if it meets the requirements under (a)(2) the SOS will file your cert. of formation & send you an acknowledgement of the filing

Question 88

21.059: Organizational Meeting:

Answer 88

After the filing of a certificate of formation takes place, an organizational meeting shall be held at the call of the majority of the initial BOD or the persons named in the Cert. of Formation for the purpose of: • Creates by-laws • Approved by BOD • Shareholders receive dividends • Elect officers • Attorney should “draft” minutes and change them as needed before they are approved • May adopt the corp. and Ks associated w/ the corp. o If the board makes promoters not liable (if original K allows) o Essentially new K = novation (rights under the K and promoters are freed up) – adoption promoters may or may not be freed up

Question 89

Promoter’s Contracts:

Answer 89

1. A promoter is someone who helps to fund and organize a corp. 2. A promoter will often make Ks for the copr.’s benefit w/the intention of causing the corp. to adopt Ks once it is formed. 3. Legal questions: a. Whether the promoter has in fact made a K w/a 3rd party or merely solicited an offer that the corp. can accept once in existence b. If a K exists whether the corp. comes to be liable on the K; and c. If the corp. adopts the K, whether the promoter remains liable

Question 90

21.401: Management by BOD:

Answer 90

(a) The board exercises and authorizes the exercise of the powers of the corporation and directs the management of the business and affirms of the corporation • For the K to be valid the BOD has to authorized it or a person w/the delegation to exercise these Ks must sign off *If the corp. does no exist, it is obviously impossible to enter into an enforceable K w/the corp.

Question 91

De Jure Corp.:

Answer 91

Results when there has been conformity with he mandatory CP est. by statute (Not subject to collateral or direct attack by the state or a person) (i.e. filed by the SOS)

Question 92

De Facto Corp:

Answer 92

A valid law under which the corp. can be lawfully organized, an attempt to organize thereunder, actual use of the corp. franchise – recognized except for where there is a direct attack by the state In fact – Three Elements: a. Must have statue allowing the creation of the corp (tech. but not really necessary now) b. Must attempt to create the corporation (Should be easy – mailed, send) c. Have you used the corp. existence (when you sign the corp name)

Question 93

Corp. by Estoppel

Answer 93

Can arise whether there is a defacto corp. or not Fallback provision, if those purporting to act for the corp. have represented to a third party that the corp. has been lawfully formed (when it has not) (alleviates the consequences of defective incorporation) a. Must explain to clients that the corporation is not official until notice from the SOS is received b. One of the most important benefits of corp. status is to limit liability for stakeholders i. Shareholders are allowed to retain their limited liability when a third party understands his K to be with the purported copr. 1. When a third party looks to a corp. entity as the sole obligor on a K, he receives that for which he bargained when only the corp. is liable 2. Applies only to the corp.’s ability to K 3. Requires only that a third party consciously decide to deal with a purported corp.

Question 94

3 Types of Corp:

Answer 94

De Jure De Facto By Estoppel

Question 95

Typical Financing Scheme for Corp.

Answer 95

Common Shares: The residual or ultimate ownership of a corp. After all others (creditors and preferred shareholders) receive their contract rights, the value remaining belongs to common shares. i. Undistributed profits increase value ii. Common shareholders can typically vote and elect a board Preferred Shares: Typically have preference over commons shares with respect to dividends, can be participating or nonparticipating. i. Participating: After preferred shares receive their quarterly dividend, they are allowed to join any further dividend w/the common shares on the same basis. 1. Typically have preference on liquidation 2. Often convertible into common shares at some predetermined ratio 3. Usually carry no voting rights unless some number of dividend payments is missed ii. Non-Participating: All dividends accrue to the common shares once the preferred dividend is satisfied.

Question 96

Can improper inc. cause shareholders to lose limited liability?

Answer 96

The mere fact that there were no formal meetings or resolutions or issuance of stocks is not determinative of the legal or defacto existence of a corp. entity. The act of executing the certificate of incorporation, the bona fide effort to file it, and the dealings w/P’s in the name of that corp. fully satisfy the requisite proof of the existence of a de factor corp.

Question 97

The Ultra Vires Doctrine:

Answer 97

Generally: If the corp. charter says the corp. will never ______ (sign a K for indemnification), if the corp. then enters into a K of indemnification, there’s an argument that the corp. can’t do that because it’s beyond it’s powers. You have to put in the document what the corp. is going to do/be (it’s purpose) and if the corp. varies that equates to ultra vires. - This really shouldn’t happen any more because the charter can say “To run any and all businesses that it is lawful to run in this state" *NOW: Really only a problem when the conduct of the corp does not benefit the corp in any way. Purpose: To protect minority shareholders

Question 98

2.101: Powers of a Domestic Entity:

Answer 98

(Domestic Entity = Corp.) A DE has the same powers of the individual to take actions necessary to carry out business and affairs, this statute carries out a laundry list of things it can do. (13): May lend money, or otherwise assist its managerial officials, owners, members, or employees as necessary or appropriate if the loan or assistance reasonably may be expected to benefit, directly or indirectly the entity. (Would have worked for Goodman)

Question 99

2.104: Power to Make Guaranties:

Answer 99

Can make a guarantee if it may reasonably be expected directly or indirectly to benefit the entity…

Question 100

Management and Operation

Answer 100

1. Directors are true fiduciaries in that they have a duty to act solely in the best interests of the corporation. a. Although they manage corp. property on behalf of the shareholders they are not agents of the shareholders b. Also have more informational rights than shareholders (i.e. can inspect the books and records so long as they do not have a purpose detrimental to the corporation) c. This is why even if a shareholder is outvoted, at least he has access to information available to “his” chosen director 2. The traditional remedy for shareholders who are displeased w/the performance of the board is to elect new directors.

Question 101

21.401: Management by BOD: (2)

Answer 101

Directs the management of the business and affairs of the corp. • Whether the BOD wants to work with someone is up to the board. While shareholders own the corp. the BOD runs the corp.

Question 102

21.409: Removal of Directors:

Answer 102

Generally, the shareholders of the corp. may remove a director, or the entire board of the corp. with or without cause, at a meeting called for that purpose by a vote of the holders of a majority of the shares entitled to vote at an election of directors. (d): In the case of a corp. the directors of which serve at staggered terms, a director may not be removed except for cause unless the certificate of formation provides otherwise • This is a gap filler, the rules may be altered by bylaws or cert. of formation

Question 103

21.352: Special Meetings:

Answer 103

A special meeting of the shareholder corp. may be called by the President, BOD, or anyone authorized by the charter, or by-laws. A group of shareholders may also call the meeting provided they meet the percentage requirement.

Question 104

21.410: Vacancy (on BOD):

Answer 104

A vacancy occurs on the BOD, there can be a special meeting or as usual an affirmative vote of the remaining directors vote for someone to fill the vacancy, at the next shareholders meeting, there will be a SH election for the BOD (but until that time the BOD fills that vacant position). The vote can occur even if the remaining directors constitute less than a quorum of the BOD.

Question 105

21.413: Quorum (of BOD):

Answer 105

(a) A Q of the BOD is the majority of the number of directors set or established in the manner provided by the cert. of formation or bylaws of a corp. unless the laws of the state, cert.of formation, or bylaws require a different number or portion. (b) Neither the cert. of formation nor the by-laws may provide may provide that less than 1/3 of the number of directors constitutes a quorum. * Gap filler!

Question 106

21.359: Voting in Election of Directors:

Answer 106

Directors shall be elected by plurality of votes cast by holders of shares entitled to vote in the election of directors at a meeting of shareholders at which a quorum is present.

Question 107

21.407: Term of Office:

Answer 107

Extends from the date the director is elected and qualified or named in the crop. Certificate of formation until the next annual meeting of the shareholders and until the director’s successor is elected and qualified.

Question 108

21.415: Action by Directors:

Answer 108

The act of majority of the directors present at a meeting at which a quorum is present at the time of the act is the act of the BOD of a corp. unless the act of a greater number is required by the cert. of formation or by-laws of the corp. or by this code. (b) Unless otherwise provided by cert. of formation or bylaws, a written consent stating the action taken and signed by all members of the BOD is also an act of the BOD. • If you spend any time advising a close corp. you will use (b) because sometimes you need to act quickly and you can’t get the directors together quickly for a board meeting. Here, it allows you to act w/o a board meeting provided that all he board members agree and it has to be in writing.

Question 109

Balance Sheet -1:

Answer 109

1. Find your net worth: a. Write assets, total them & subtract your liabilities b. A – L = NW (accountants never use) 2. Double entry accounting/book keeping a. If you have an equation & you add something to one side and don’t add a comparable something to the other side, the equation is out of whack b. Think: Assets went down, but received money for the assets, it all balances out 3. Balance Sheet: a. Assets | Liabilities over Net worth/Equitable Shares (As a table) i. Liabilities + Net Worth = Total Assets 1. Graphic representation of the fundamental equation 2. Look at the left hand side = Assets b. The balance sheets (the assets and liabilities) reflect what is going on in the corporation. (Value our assets what we paid for it) i. You don’t decide what to put on the balance sheet, you put what actually happened.

Question 110

21.002: Definitions: (6)(a) Distribution

Answer 110

Transfer of property, including cash, or issuance of debt, but a corp. to its shareholders in the form of: … . (B) The term does not include …

Question 111

21.302: Authorities for Distribution:

Answer 111

BOD of a corp. may authorize a distribution and the corp. may make a distribution sub. to 21.303.

Question 112

21.303: Limitations on Distribution:

Answer 112

(a) A corp. may not make distributions that violate the cert. of formation (b) May not make distributions (1) If the corp. would be insolvent after distribution (2) That exceeds the distribution limit.

Question 113

Bankruptcy Insolvency:

Answer 113

If the liabilities exceed the assets (i.e. the corp. owes more than it has, it is bankrupt in the sense of the word) o Recall you might maintain on the book the cost of acquiring assets which might be worth much more o Bankruptcy looks at the fair value of the asset, not the purchase price *THINK: Limits on Distribution

Question 114

Equitable Insolvency:

Answer 114

A lot of assets but you are unable to pay you debts when they are due. o Example: A lot of non-cash assets o Texas follows this definition re: insolvency. *THINK: Limits on Distribution

Question 115

21.301: Definitions: (1)(B) “Distribution Limit”:

Answer 115

The surplus of the corp. not described in (A). • The distribution of dividends may not exceed the cash value of the surplus (21.050(12) “Surplus”: the amount at which the net assets of a corporation exceed the stated capital of the corporation). • Net Assets v. Stated Capital: o Net Assets/Net worth = Assets – Liabilities (On Balance Sheet) o Surplus= Net Assets – Stated Capital

Question 116

21.050(9): Definitions: Net Assets:

Answer 116

The amount by which the total assets of a corp. exceed the total debts of he corporation

Question 117

21. 050(11): Definitions: Stated Capital:

Answer 117

The par value of all shares of the corporation that have been issued (Shares * Par Value). • To determine Par Value: Look at the Cert. of Formation

Question 118

21.160: Determination of Consideration for Shares:

Answer 118

BOD decides what the consideration for shares should be.

Question 119

21.161:Amount of Consideration for Issuance of Certain Share:

Answer 119

Consideration to be received by a corp. for the issuance of shares w/ par value may not be less than the par value of shares • Example: If the par value is high (like $100) and the corp. cannot negotiate a better deal w/ a potential owner, the corp. cannot sell the stock for $80 because that is below par value o If the par value = $1, you can’t share stock under $1. (Not a significant restriction) o Everyone does this – you’re crazy not too. If you put high par figure in the cert. of formation, that’s going to arbitrarily limit the ability of the board to make decisions

Question 120

Process to Amend Certificate of Formation:

Answer 120

1. 3.051: Right to Amend Cert. of Formation 2. 3.052: Procedures to Amend 3. 3.053: Certificate of Amendment 4. 21.054: Adoption of Amendment by BOD 5. 21.055 Notice of Meeting to Consider Proposed amendments 6. 21.364: Vote Required to Approve Fundamental Action

Question 121

3.051: Right to Amend Certificate of Formation:

Answer 121

A filing entity may amend its cert. of formation. (b) An amended certificate of formation may contain only provisions that: (1) Would be permitted at the time of the amendment if the amended cert. of formation were a newly filed original certificate of formation; or (2) effect a change, exchange, reclassification …

Question 122

3.052: Procedures to Amend Certificate of Formation:

Answer 122

(b) A filing entity that amends its certificate of formation shall sign and file, in the manner required by Chapter 4, a certificate of amendment complying with 3.053 or a restated certificate of formation complying w/ 3.059

Question 123

3.053: Certificate of Amendment:

Answer 123

A certificate of amendment for a filing entity must state: (1) The name of the filing entity; (2) The type of filing entity (3) For each provision of the certificate of formation that is added, altered, or deleted and, if the provision is added or altered, a statement of the text of the amended or added provision; (4) That the amendment has been approved in a manner required by the code (5) Any other matter required by the provision so fthis code applicable to the filing entity to be in cert. of the amendment

Question 124

21.054: Adoption of Amendment By Board of Directors:

Answer 124

The board of directors has to amend the by-laws , has to have a meeting (in the manner provided by 21.055).

Question 125

21.055: Notice of and Meeting to Consider Proposed Amendment

Answer 125

(a) Ea. shareholder of record entitled to vote shall be given written notice containing the proposed amendment or a summary of changes to be effected w/in the time and manner provided by this code for giving notice of meetings. The proposed amendment or summary may be included in the notice required for an annual meeting (b) At the meeting, the proposed amendment shall be adopted only on receiving the affirmative vote of shareholders entitled to vote required by 21.364. (c) An unlimited number of amendments may be submitted for adoption by the shareholders at the meeting.

Question 126

21.364: Vote Required to Approve Fundamental Action:

Answer 126

: (a) Fundamental action means … (1) an amendment of a certificate of formation, including an amendment required for cancellation of an event requiring winding up .. (b) Vote required by the shareholders is a super majority vote (2/3 of the outstanding shares entitled to vote on the fundamental action)

Question 127

21.351: Annual Meeting: (a)

Answer 127

(a) An annual meeting shall be held at the time that is stated or set in accordance w/the corp’s by-laws (b) On the application of s shareholder who has previously submitted a written request to the corp. that an annual meeting be held, account in the county in which the principal executive office of the corp. is located may order a meeting to be held if the annual meeting is not held or written consent instead of the annual meeting is not executed w/in any 13-month period, unless a meeting is not required under 21.655

Question 128

21. 352: Special Meetings:

Answer 128

A special meeting may be called by: (1) The president, the BOD, or any other person authorized by the cert. of formation or by-laws of he corp. or (2) The holders of the percentage of shares specified in the cert. of formation, not to exceed 50% of the shares entitled to vote or, if no percentage is specified, at least 10% of all of the shares of the corp. entitled to vote at the proposed special meeting

Question 129

21.353: Notice of Meetings:

Answer 129

Written notice under 6.051 should be given to each shareholder entitled to vote at the meeting not later than the 10th day and not earlier than the 60th day before the date of the meeting. Notice shall be given at the direction of the president, secretary, or other person calling the meeting.

Question 130

31. 358: Quorum (Shareholders):

Answer 130

The holders of the majority of the shares entitled to vote at a meeting of the shareholders of a corp. that are present or represented by proxy at the meeting are a quorum for the consideration of a matter to be presented at the meeting (b) the cert. of formation may provide that a quorum is present only if: …

Question 131

21.363: Voting on Matters Other Than Election of Directors:

Answer 131

Basically a majority vote.

Question 132

3.151: Books and Records for All Filing Entities:

Answer 132

Each filing entity shall keep: (1) books and records of accounts (2) min. of proceedings of the owners or members or governing authority of the filing entity and committees of the owners or members or governing authority of the filing entity. o Governing person is not an officer but is a BOD (see definitions)

Question 133

21.218(b): Examination of Records

Answer 133

(b) Sub. to governing docs and on written demand stating a proper purpose, a holder of shares of a corp. for at least 6 months immediately preceding the shareholder’s demand, or a holder of at least 5% of all outstanding shares of a corp. is entitled to examine and copy, at a reasonable time, the corp.’s relevant books, records of account, minutes, and share transfer records. The examination may be conducted in person or through an agent, accountant, or attorney.

Question 134

21.222(b): Penalty for Refusal to Permit Examination of Certain Records:

Answer 134

A copr that refuses to allow a person to examine and make copies of account records, minutes, and share transfer records under 21.218 is liable to the shareholder for any cost or expense, including attorney’s fees, incurred in enforcing the shareholder’s rights under 21.218. The liability here is in addition to any other damages or remedy afforded to the shareholder by law. (b) It is a defense to an action under this section that ther person suing is .. (4) Was not acting in good faith or for a proper purpose in making the person’s request

Question 135

6.251: Voting Trusts:

Answer 135

Except as by this code/governing documents any number of owners of a domestic entity may enter into a written voting trust agreement to confer on a trustee the right to vote or otherwise represent ownership or membership interests in the domestic entity • Trust owns the stock, the trustee of the stock (here, was someone the bank liked). Keep in mind it’s a “technical owner” of the stock because when dividends and whatnot are paid, the benefits are paid to the beneficiaries. • (a): Any number of owners (not all have to put in), must be in writing, a copy must be deposited w/ the corp.

Question 136

Straight Voting:

Answer 136

Every shareholder votes the entire number of shares that he owns for as many directors as there are seats up for election. Example: Corp. has 1000 shares issued and outstanding. A owns 600 shares and B owns 400 shares. The board consists of three seats and all directors are up for election. A votes his shares for A, B, and C. B votes his hares for D, E, and F. The final tally is A= 600, B = 600, C=600; E=400, F=400, and D=400. Thus A, B, and C are elected

Question 137

Cumulative Voting:

Answer 137

Every shareholder has a number of votes equal to the number of shares he owns multiplied by the number of board seats up for election. He may distribute these votes among the candidates in any matter he chooses. Example: A would now have 1800 votes and B would have 1200 votes. If A casts 900 for A and 900 for B, these directors will be chosen because B cannot split 1200 votes in a way that beats 900 votes. On the other hand if he casts 1200 votes for D, his election is also certain because A cannot split 1800 votes three ways in a manner that beats 1200 votes. - Provides a modicum of protection to minority shareholders (not a whole lot) - The goal is to provide minority shareholders w/roughly proportional board representation

Question 138

21.360: No Cumulative Voting Right Unless Authorized

Answer 138

Except as provided in 21.361/362 a shareholder does not have the right to cumulate the shareholder’s vote in the election of directors.

Question 139

21.361(a)(2): Cumulative Voting in Election of Directors:

Answer 139

If the cert. of formation expressly allows, then OK. (b) Give written notice of the intention to the secretary of the corp. on or before the day preceding the date of the election at which the shareholder intends to cumulate votes • Each shareholder gets a number of votes based on the number of shares * number of directors up for positions (see below) o A: 18 *5 = 90 o B: 82 * 5 = 410

Question 140

21.362:Cumulative Coting Rights in Certain Corporations:

Answer 140

Except as provided in the corp.’s cert. of formation, a shareholder of a corp. incorp. before (or on) Sept. 1, 2003 has the right to cumulatively vote the number of shares the shareholder owns in the election of directors to the extent permitted and in the manner provided in S. 21.361. A corp. may limit or deny a SH’s right to cumulatively vote shares at any time after Sep. 1, 2003 by amending its formation

Question 141

Controlling Matters within the Board’s Discretion:

Answer 141

1. A contract/agreement between shareholders that divests the director of their powers, or powers that should be made by tbe BOD is void (McQuade). a. If you’re determined to do this, have the BOD approve the K. Because they hire, set salary and policy, if the K is approved then it is likely enforceable. 2. ASK: Does the contract damage anyone? a. If the enforcement of a particular contract damages no one, there’s no real reason to find it illegal 3. McQuade v. Clark: a. Clark – Only shareholder i. If every shareholder agrees, it’s hard to say there’s a significant problem ii. In McQuade, not all shareholders agreed (The K was only among 3) b. Clark cuts back on McQuade a little big saying that minor deviations are okay i. It is impossible to decide whether something will be a minor deviation or a major deviations ii. Clark – Trying to help a minority SH

Question 142

21.401: Management by BOD

Answer 142

RE: McQuade /Clark (a) Except as provided by 21.101 or Sub O the directors of a corp. shall (1) Exercise or authorize the exercise of the powers of the corp and (2) Direct the management of the business and affairs of the corp. (b) & (c) Director is entitled to consider long-term & short-term interests of the corp. & social purposes specified in the cert. of formation (d) Same as above but officers (e) If the social is not listed in the cert. of formation nothing stops the corp. from considering, approving, or taking action that promotes or has the effect of promoting social, charitable, or environmental purposes.

Question 143

3.104: Removal of Officers:

Answer 143

RE: McQuade/Clark An officer may be removed w/o cause by the governing authority or as provided by the governing documents of the entity – unless other wise provided by the governing documents. The removal of the officer does not prejudice any K rights of the person removed. (b) Election or appointment does not by itself create K rights. • NOTE: In McQuade it seems as even if the K was approved by the BOD they could still fire McQuade. In other words under the last sentence of (a) McQuade would still have a K right and could sue for damages (probably wouldn’t get SP).

Question 144

Where the directors are the two sole stockholders...

Answer 144

there seems to be no obligation to enforcing an agreement among them to vote for certain people Holding in Clark

Question 145

6.252: Voting Agreements:

Answer 145

Except as provided by this code/governing docs, any number of owners of a domestic entity, or any number of the owners, and the domestic entity itself may enter into a written voting agreement to provide the manner of voting of the ownership interests – under this sub. it is not part of the voting agreement is not part of the govering documents (b) “office keeping” • Generally do not have to be unanimous but must be in writing and a copy must be deposited w/the corporation • Transactions like those in McQuade must be read as being applicable under 6.252 • Something appealing about all the shareholders getting together to agree on something, the come back and say “I like it then but not now” • TX Legislature tried to address McQuade o Common factor in closed corp. law that relaxes McQuade o To have a closed copr. Under the 700s, the cert. of formation must have “This corp. is a close corp.”

Question 146

21.701(2): “Close Corp. Provision”:

Answer 146

Means a provision in the cert. of formation of a close corp. or in the SH’s agreement of a close corp.

Question 147

21.714: Shareholder’s Agreement: (b)(1):

Answer 147

You can have a shareholder’s agreement that says the shareholder’s manage the corp. w/or w/o the BOD • You can agree that the shareholders will manage it

Question 148

21.715: Execution of Shareholder Agreement:

Answer 148

Must be executed by each SH – they all must agree

Question 149

21.101: Shareholder’s Agreement: (If you’re going to draft, this is how you do it)

Answer 149

(a)(1) It’s okay to restrict the discretion or powers of the BOD (McQuade) (a)(2) Get rid of BOD by agreement (a)(3) Est. who shall serve as directors or officers of the corp. • Under 6.252 – Can be among some but not all, but under 21.101, if you look at (b)(1) The agreement must be in writing and signed by all of the shareholders (Picky enough on Clark vs. Dodge) Now, not just fairness – legislature has said: If you get all shareholders to agree, you can write in all sorts of restrictions if all are in agreement • PROBLEM: What if at a later date, the shareholder sells stock to another person (after signing a shareholder agreement and purchasing shares), there could be fairness problem if the purchaser thinks its an ordinary corp. and you’ll have rights as a shareholder. To protect third parties … (If you’re a third party, you are not bound and could challenge). In closed corp. the new owner would take the cert. to the corp. and then change the name of he owner from the original owner to the new owner and issue a new cert.

Question 150

21.103:Disclosure of Agreement; Recall of Certain Cert:

Answer 150

he existence of a shareholder agreement must be noted “conspicuously” on the stock cert.

Question 151

21.109: Agreement Not Effective (re: Voting Agreements):

Answer 151

If a corp. shares of stock are listed on a national securities exchange then shareholder agreements are void under the Texas Statute • If stock is listed on stock exchange, people aren’t looking at certificates & will be surprised if there are special rules • There are also informal markets created by stock brokers • If shares are regularly traded (a)(2) agreement is also void

Question 152

21.403: Number of Directors:

Answer 152

RE: Frankino The BOD can consist of 1 or more directors. Can set by cert. of formation or by the bylaws. (c) Can amend either the cert. of formation or the by-laws (if it’s in the cert. of formation you have to change that, not the by-laws) a decrease cannot shorten the term of an incumbent director.

Question 153

21.057:Bylaws:

Answer 153

RE: Frankino (c) Needless to say the BOD may amend or appeal or adopt bylaws • 21.058: Allows the SH’s to amend, repeal, or adopt the corp’s bylaws regardless of whether they may be also be done so by the BOD

Question 154

Most common type of transfer restrictions:

Answer 154

1. First Option Agreement 2. First Refusal Agreement 3. A buy-sell agreement 4. Provision prohibiting transfer to designed classes of persons

Question 155

First Option Agreement:

Answer 155

An obligation to offer shares to the corp. or the other shareholders at a specified price prior to selling to a third party

Question 156

First Refusal Agreement

Answer 156

An obligation to offer the shares to the corporation or the other shareholders at the same price, and on the same terms, offered by a third party

Question 157

A buy-sell agreement

Answer 157

An agreement that gives a shareholder the opportunity or obligation to sell, and the corp. or other shareholders the opportunity or obligation to purchase, shares at a specified price upon the happening of certain events, such as death or termination of employment

Question 158

Share transfer provisions are ...

Answer 158

Strictly construed a. Important to specify clearly and unambiguously the essential attributes of the restriction b. Must be reasonable in order to be enforced i. THINK: Unreasonable alienation on property = void

Question 159

Courts typically oppose what type of transferability?

Answer 159

A prohibition against transferability itself (if the bylaw renders the sale of stock impossible to anyone except the corp. at whatever price it wished to pay) = Illegal. - To be illegal, you must show that there is more than a mere disparity between option price and current value of stock - Courts almost always hold valid and enforceable the first option provision (in character or in law)

Question 160

21.213: Enforceability of Restriction on Transfer of Certain Securities:

Answer 160

RE: Allen (a)(1): Can only place restrictions if reasonably and if it is noted conspicuously on the certificate THINK: If not noted, could buy the stock and pay good money and not be aware of the restrictions – the conspicuousness is designed to protect the repurchase of the stock. o 1.005: Conspicuous Information: Required information is conspicuous if the information is placed in a manner or displayed using a font that provides or should provide notice to a reasonable person affected by the information. The font is conspicuous if it is capitalized, boldfaced, italicized, or underlined or is larger or of a different color than the remainder of the document

Question 161

Generally - When does the four allow the corp. veil to be pierced?

Answer 161

Broadly speaking, the court will allow the corporate veil to be pierced broadly speaking “whenever necessary” to “prevent fraud or to achieve equity” 1. Cannot hold corp. directors or officers liable for corp. actions unless they are tort feasors or have agreed to liability 2. Typically, you can’t hold shareholders liable because they have limited liability – limited to whatever money they paid into the corp. for what they paid for their shares of stock

Question 162

When will a be personally liable on behalf of / instead of the corp?

Answer 162

TEST: Whenever anyone uses control of the corp. to further his own rather than the corp’s business, he will be liable for the corp’s acts “upon the principle of respondeat superior applicable even where the agent is a natural person Factors Include: 1. Undercapitilization 2. Corp.'s formalities 3. Co-mingling funds

Question 163

Undercapitalization

Answer 163

i. As is the corp. was set up where it didn’t really have enough money to operate ii. Helps, but requires more iii. If it is clear that the corp. was undercapitalized, the court will likely find that the SH who caused that will be liable for the corp’s debt 1. THINK: If it is shockingly undercapitalized, it’s not usually a close call 2. Wiscozi: No assests other than the cabs – No way that it would properly conduct business but resolved the problem by purchasing liability insurance (Even though the amount of insurance would not have taken care of K obligation)

Question 164

Corporations’ Formalities

Answer 164

i. Controversial Step ii. Ask: What was the normal way the corp. acted?, Did they have to get approval before drawing money? Did they distribute dividends? Was there an annual meeting? iii. Courts like to cite this 1. It’s easy to prove

Question 165

Co-mingling of Funds

Answer 165

RE: Walkousky/Cavaney i. Grand misconduct ii. Must have separate bank account for corp. iii. If there’s co-mingling & the corp. is failing = a real problem. iv. Also not following corp. formalities 1. Happens often when there is only one SH 2. Creates a real argument that the shareholder has been drawing money out of the corp. – How are we to know who’s money it is, maybe it’s the corp.’s money but the shareholder hasn’t paid the corp. back a. You go after the shareholder’s bank account on the basis that the shareholder is holding the corp.’s money

Question 166

Piercing the corp. veil only applies to...

Answer 166

Access SHs (not BOD, officer's etc.) (Walkousky) a. KEY: Most SH’s do not manage the corp. but in a closely held corp., they do b. In order to pierce the viel they must be a SH and manage/actively participate in the corp. Never encountered in a publicly held corp. -- only in closed * Texas favors limited liability * Also, courts will not pierce the corp. veil to reach the parent if the parent respects the separate identity of the subsidiary and does not exercise undue dominion and control over the subsidiary’s activities (i.e. if the corp.’s SHs is another corp.)

Question 167

Courts are extremely reluctant to lift the corp. veil in contract cases, were the “creditor has willingly transacted business” with the corp. unless...

Answer 167

RE: Perpetual Real Estate Services a. Unless, the corp. misrepresented its financial condition to the creditor, the creditor should be bound by its decision to deal with the corp. it should not later be able to complain the corp. is unsound b. KEY: Address contracts under contract law (sue for damages)

Question 168

Policy Justifications for LL

Answer 168

1. Under legal theory the shareholders are not allowed to run the corp. a. When the shareholders first purchase stock in the corp, they put their money into the corp. (you no longer own the money invested, it now belongs to the corp.) b. If the corp. winds up having liabilities (HYPO: Corp, through it’s agents enters into a K w/a third party the corp. is liable, the shareholders are not. If a corp. through it’s employees commits a tort, through respondent superior the corp. not the shareholders is responsible) 2. LL decreases the need to monitor a. All investors risk losing wealth because of the actions of agents b. The cost of monitoring could not actually be worth the cost 3. Reduces cost of monitoring other shareholders a. The greater the wealth of other shareholders, the lower the probability that any one shareholder’s assets will be needed to pay a judgment b. Thus existing shareholders have incentives to engage in costly monitoring of other shareholders to ensure that they do not transfer assets to others or sell to others with less wealth c. LL makes the ID of other shareholders irrelevant and avoids theses costs 4. By promoting free transfer of shares, LL gives managers incentives to act efficiently a. Investors individually respond to excessive agency costs by disinvesting. 5. LL makes it possible for market prices to impound additional information about the value of firms. a. Unlimited liability would not be homogenous commodities so they would not longer have one market price, investors would be required to expender greater resources analyzing the prospects of the firm in order to know whether the “price is right” b. When all can trade at the same terms, investors trade until the price of shares reflects the available information about a firm’s prospects. 6. Allows more efficient diversification 7. Facilitates optimal investment decisions

Question 169

Reverse Piercing:

Answer 169

1. A creditor’s of a SH seeks to hold the corp. liable for the SH’s debts. a. Of course a creditor who has obtained a judgment against the SH can seize the SH’s stock in the corp. b. Some creditors may want to obtain directly from the debtor’s SH corp.

Question 170

Reverse Piercing TEST:

Answer 170

a. The controlling insider and the corp. are alter egos of each other b. Justice requires recognizing the substance of the relationship over the form because the corp. fiction is utilized to perpetuate a fraud or defeat a rightful claim, and c. An equitable result is achieved by piercing d. Only when a claimant makes a clear showing of each factor may corp. form be disregarded – it should not be used unless it is required by justice to achieve an equitable result. i. THINK: Hide assets

Question 171

21.223: Limitation of Liability for Obligations:

Answer 171

RE: Piercing the Corp. Veil: The shareholder is not liable w/respect to shares other than paying the full amount of consideration (2) any contractual obligation or any matter arising from the obligation on the basis of that the holder, beneficial owner, subscriber, or affiliate is or was the alter ego of the corp. or on the basis of actual or constructive fraud, a sham to perpetrate fraud, or other similar theory (3) Any obligation of the corp. on the basis of the failure of the corp. to observe ay corp. formality, including ..

Question 172

1.101: Domestic Filing Entities:

Answer 172

(i.e. If you are piercing the corp. veil, you apply the law of that state) • Tx law governs corporate affairs of Texas Corp. 1.102: Foreign Filing Entities: Internal affairs of corp. formation in foreign states – apply that state’s law

Question 173

1.103: Entities Not Formed by Filing Instrument

Answer 173

If the formation of an entity does not occur when a cert. of formation is filed with the secretary of state or w/ a foreign governing entity, the law governing the entity’s formation and internal affairs is the law of the entity’s jurisdiction of formation.

Question 174

Equitable Subordination/Deep Rock Doctrine:

Answer 174

1. If a SH of a corp. engages in inequitable conduct, a bankruptcy court has the power to subordinate his claim to those of other creditors a. Less likely to have his claim settled in BRC but is also not required to pay the corp’s debt b. As a consequence, less misconduct is required to justify equitable subordination than veil piercing c. Less severe than veil piercing d. More liberally applied 2. Deep Rock Doctrine: a. Walkoski Case: Assets of that corp. was two taxi cabs subject to a SI, if the lender had been a bank , the bank could step in and get the cabs and whatever money leftover = for unsecured creditors 3. When notes are subordinated, the pie is increased for the other creditors

Question 175

In allowing and disallowing claims, courts of bankruptcy apply the rules and principles of equity jurisprudence. Where the claim is found to be inequitable, it may be set aside, or subordinated to the claims of other creditors.

Answer 175

* ASK: Whether the plan or transaction which gives rise to a claim is challenged as inequitable is “whether, within the bounds of reason and fairness such a plan can be justified.” * When claims are filed by persons standing in a fiduciary relationship another test will be “Whether or not under all circumstances the transaction carries the earmarks of an arm’s length bargain” * The fact that withdrawal of capital occurred prior to incorp. is immaterial. This transaction occurred in contemplation of incrop.

Question 176

Corp: The Traditional Role of Fiduciary Duty:

Answer 176

1. Directors and officers owe fiduciary duties to the corporations they serve. These duties primarily take two forms: a. A duty to exercise care in the management and op of the corp and i. Potential liability for negligently managing the corp. ii. In reality, this is a suit for negligence b. A duty to exercise loyalty by putting the corp.’s interest before personal interests c. THINK: Under respondant superior, the director is an employee of the corp. Under agency law, the director has no personal liability to the 3rd party. d. The Doctrine of Corp. – You have a duty of care and loyalty to the corp.

Question 177

CORP: The Duty of Care:

Answer 177

a. Directors owe a fiduciary duty to their corporation to act carefully in carrying out their responsibilities b. Duty encompasses two distinct settings in which director responsibilities arise: i. Oversight 1. Obligated to use care in monitoring the activities of the officers and the general affairs of the corporation as a whole 2. Disputes involve allegations that the directors were inattentive to what the officers and other employees of the company were doing and that such inattentiveness resulted in harm to the corp ii. Decision making 1. Obligated to use care in making decisions that affect the corp.’s welfare 2. Disputes tend to involve allegations that the directors were not reasonably informed in making a decision and/or that the decision itself was substantially unwise RE: Francis v. United Jersey Bank

Question 178

21.414: Dissent to Action:

Answer 178

Presumed you agree if you are present at the bard meeting unless (1) The director’s dissent has been entered in the board minutes (2) The director has filed a written dissent to the action with the person acting as secretary of the meeting before the meeting is adjourned; or (3) The director has sent a written dissent by registered mail to the secretary of the corp. immediately after the meeting has adjourned (b) A director who voted in favor of an action may not dissent to the action NOTE: To be safe, could do all three

Question 179

CORP: The Decision Making Context:

Answer 179

1. In the decision making context directors and officers consider whether to authorize a particular transaction or activity. a. If the decision turns out poorly, the directors and officers who made the decision may be sued for breach of the duty of care based on: i. The substance of the decision or ii. The process that led to the decision b. Shareholders can bring actions for the benefit of the corp.

Question 180

2. The business judgment rule

Answer 180

If there is a rational basis for the decision then the directors have a defense. a. Big difference in rational basis for a decision and showing you were not negligent i. Just point to something ii. It is easy to come up with a rational basis for a decision iii. Does not have to be right or reasonable b. “The directors are chosen to pass upon such questions and their judgment unless shown to be tained with fraud is accepted as final. The judgment of the directors of corps. enjoys the benefit of a presumption that it was formed in good faith and was designed to promote the best interests of the corp. they serve.” c. The idea is that if we allow directors to be sued then courts would have to make business judgment (Like weather it makes sense to have night games). d. Exceptions (Where the business judgment rule does not apply): i. You can establish the director engaged in fraud (Very difficult) ii. Illegality (Very difficult) iii. Conflict of Interest (Easier to prove)

Question 181

Shareholder’s Derivative (In General)

Answer 181

1. If SH has an action against a 3rd party, (say breach of K claim), the claim is the claim of the corp. not the SH. a. The corp. will decide whether to file a lawsuit, if they file the lawsuit, then recover, the recovery goes to the corp. b. Suppose a corp. decides they don’t want to file, there is a SH Derivative action in which the SHs may step in and sue on the corp’s claim i. Technically – as a pleading the shareholder sues the corp. and the 3rd party ii. If the SH’s litigate the action against the 3rd party, it’s not entirely clear that the judgment would be binding upon the corp. iii. Whatever happens here, if the third party wins, that’s it 1. If there’s a judgment against the 3rd party, the 3rd party pays the corp. (because it’s the corp’s claim) iv. What if the third party (suppose multiple) and they are D & O (directors and officers of the Corp.) you’re suing say they breached duty of care/loyalty – in that context = 3rd parties. 1. If there is a judgment, the D&Os would pay to corp. a. “Green mail” lawsuits

Question 182

21.552 Standing to Bring Proceeding: (1)(a) - (SH Derivative)

Answer 182

Whoever the SH is, that person must have been a SH of the corp. at the time of the complained of action

Question 183

21.553: Demand: (SH Derivative)

Answer 183

If you don’t like what the corp. is doing, you must give written demand (and state w/particularity the act, omission, or other matter that is sub to the claim or challenge and request the corp. take action)– if the corp. doesn’t respond w/in 90 days you can file the lawsuit

Question 184

21.555: Stay of Proceeding: (SH Derivative)

Answer 184

If the corp. is looking into the problem, they will file something stating they’re conducting a review of the problem, in that situation – if you look at (a), the court shall stay the derivative action – this suspends discovery (attorneys cant harass) i. NOTE: Court “shall” stay

Question 185

21.558 Dismissal of Derivative Proceeding:

Answer 185

After the stay, if the corp. can file for dismissal NOTE: Court “shall” dismiss a derivative proceeding on a motion by the corp. if the person or group described in 21.554 determines good faith, after conducting a reasonable inquiry and based on factors the person or group considers appropriate under the circumstances, that continuation of the proceeding is not in the best interest of the corp. There is still a basis for denial of the motion - If the decision that the action should be dismissed was not made in good faith, then the court does not have to dismiss the action – Must dismiss 1. Good faith 2. Created reasonable inquiry 3. Based on factors deemed appropriate One = Doesn’t make good business sense

Question 186

21.556: Discovery: (SH Derivative)

Answer 186

If a domestic of foreign corp. proposes to dismiss a derivative proceeding under 21.558, discovery by a SH after filing of the derivative proceeding i. “Shall” be limited to (1) Facts relating to whether the person or group of persons under 21.558 is independent and disinterested; (2) Good faith of the inquiry and review by the person or group; and (3) The reasonableness of the procedures followed by the person or group in conducting review ii. Need to figure out who’s deciding if it gets dismissed

Question 187

21.554 Determination by Directors or Independent Persons: (SH Derivative)

Answer 187

A determination of how to proceed on allegations made in a demand or petition relating to a derivative proceeding must be made by an affirmative vote of the majority of: i. Three possibilities 1. Independent and disinterested directors make the decision 2. You can have two or more – if you can’t find a quorum 3. (Least desirable) – Have a person who is independent and disinterested – appointed by the court a. Corp. loses control b. Allows corp. to provide a list of names, the court then selects from that c. In addition, if you have indp. and disinterested, usually you appoint special counsel

Question 188

21.561(b)(1)-(2) Payment of Expenses: (SH Derivative)

Answer 188

*When the derivative is terminated If the court thinks.. the corp. may be required to pay attorney’s fees of the P. if the case is dismissed at the P didn’t’ have probable cause, the P can wind up paying attorney’s fees (b) significant – the court “MAY” order – left to court’s discretion in this context

Question 189

21.563 Closely Held Corp.: (SH Derivative)

Answer 189

Litigation committee – cannot be used in a closed corp. i. In a closed corp. and you’re a minority shareholder and you say the corp. is messing, the directors would pay money to corp. which they already control because they’re maj.SH ii. KEY: Does not apply to closed corp iii. ©(2): If justice requires, the court MAY have the judgment paid to the minority shareholders – get around the notion that the directors and auditors paying into corp and stealing it again iv. fewer than 35 SH or no shares actively traded – closed

Question 190

TX 21.418: Contracts or Transactions Involving Interested Directors and Officers (SH Derivative):

Answer 190

(b) (!)(A) – Purpose is to allow a transaction to be set up in advance where it cannot be challenged in court (i.e. to create a safe harbor) – (1) Disclose material facts as to the relationship or interest described in (a) and so as to the K or transaction are disclosed by: (A) The corp’s BOD or committee of the BOD, and the BOD in good faith authorizes the K or transaction by approval of the maj. of the disinterested directors or committee members constitute a quorum; or (B) the SHs entited to vote on authorize of the K or transaction and the K or transaction is specifically approved in good faith by a vote of the SHs or (2) The K or transaction is fair to the corp when the K or transaction is authorized, approved, or ratified by the BOD, a committee of the BOD or the SHs TO DO: • ID disinterested directors • Have a meeting, present all the disinterested directors w/material facts • Have them vote/authorize the transaction in good faith • Brief disinterested BOD on the facts (b)(1)(B) – If above doesn’t work – have a SH meeting – and interested SH can vote here!! • Requires good faith *Hard to use in Closed Corp. (2) The K or transaction is fair to the corp. when the K or transaction is authorized, approved, ratified by the BOD, a committee of he BOD or the SHs

Question 191

Two ways to deal w/self dealing

Answer 191

(1) Have disinterested directors approve (1.004 “Disinterested Directors: No requirement under 21.418 (b)(1)(8) – no need to be independent but if Casto is trying to get this done he’d still want to get the dad to recuse himself) (Wheel case) (2) The Ks are fair o (b)(1)(a)(b): Disclose material facts to directors or shareholders, then take a vote, majority prevails o (b)(2): Material facts don’t apply – the K must be fair (that’s it) (only use if can’t do the first) *Ask are they selling items at the same price? (Wheel case, they were getting a 20% discount)

Question 192

Usurping:

Answer 192

Hard to come up with a firm predictable rule when a business opportunity has be usurped. If it should have gone to the org, then a director or officer cannot step in and take it himself – if it’s fair, they make you give it back. a. Basic rule of fairness b. Ways to fix in advance where an officer or director can usurp. c. Defined: Basically, use of corp. property for personal purposes – and competition w/the corp. d. Directors/Sr. Execs are prohibited from using company property, information, or position for personal benefit in various circumstances.

Question 193

Defenses of Usupring:

Answer 193

a. Proof of advance authorization b. Later ratification (after full disclosure) c. By disinterested directors/SHs

Question 194

What is viewed as a business opportunity that should go to the corp?

Answer 194

If the corp. could have been making money on the sale of small wheels instead a director was making money on the sale of small wheels.

Question 195

Usurping Test:

Answer 195

a. Whether the corp. had the financial ability to take advantage of the opportunity? i. ASK: Do you think the corp. can get the money? Be careful! b. Whether the opportunity is in the corp’s line of business? (i.e. is it the type of business they do?) c. Is the opportunity of a practical advantage to the business? d. Make arguments on each of these factors – a judge will decide if it’s fair (A little unpredictable) Another argument could be made – Does the corp. have a reasonable expectation that the opportunity would come to the organization? THINK: If the other person knew this, took advantage of the opportunity through the corp., then that demonstrates there was a reasonable expectation. i. It’d be the same as using corp. assets to find out about it, or learning about it while being an officer (like constantly getting asked about it, etc.). Another question: If a director takes the opportunity, would it place them in direct competition with the corp.? PLAN IN ADVANCE: If something is corp. opportunity, go to the BOD, present the information, when they say they aren’t interested, then even if all the factors suggest otherwise and the corp. turned it down, you can’t be sued since you first got their approval.

Question 196

General Issue w/Executive Compensation:

Answer 196

1. Executive compensation is often the preferred mechanism for distributing the financial returns of the business but can give rise to troublesome issues – particularly when the SHs perceive that the amounts of compensation are excessive. a. Hard to shake in a closely held corp. b. Exec. Compensation is set by the BOD – and in closely held – they typically also = officers (i.e. they’re usually est. their own compensation as officers) c. As long as there isn’t fraud going on (like three SH’s playing salaries the others don’t know about)

Question 197

Compensation for executives are significantly influenced by...

Answer 197

Tax Concerns a. For example – Reasonable compensation paid to an ee is a deductible expense for a corp. but a dividend paid to a SH is not b. Compensation in a CHC may be: i. Sums representing the value of the labor provided by the SH-EE and ii. Sums representing “disguised” or “de facto” dividend (i.e. amts beyond the value of the SH-EE’s labor that represent a distribution of profits to the SH-EE

Question 198

Executive Compensation Challenges are raised:

Answer 198

1. Compensation amounts in CHC may be de facto dividends - termination can affect share of rightful distributions 2. Tax issues w/the IRS (If they succeed the "reasonable" amount the extra is considered a dividend and is now taxed - can decide 1/2 and 1/2) 3. Actions may be brought in an effort to recover the "excess" or "unreasonable" amount of compensation through: - Duty of loyalty claim (COI) - Duty of Care (Claiming gorse negligence in procedures setting salaries) - Substantive duty of care claim asserting the board committee "waste" in setting the executive compensation

Question 199

If SH Challenges Executive Compensation the Corp's Answer will be:

Answer 199

Business Judgment Rule | - As a practical basis, there is always a rational explanation

Question 200

The waste doctrine prohibits:

Answer 200

An “exchange that is so one sided that no business or person of ordinary, sound judgment could conclude that the corp. has received adequate consideration” A waste entails the exchange of a corp. asset for consideration so disproportionately small as to lie beyond the range at which any reasonable person might be willing to trade i. Often: Transfer of corp. asset that serves no corp. purpose or for which no consideration at all is received (A gift) ii. IF there is any substantial consideration and there is good faith judgment that in the circumstances the transaction is worthwhile, there should be no finding of waste (even if the fact finder would conclude ex post that the transaction was reasonably risky) iii. SH may not ratify corp. waste except w/ a unanimous vote iv. If under the facts pled, any reasonable person might conclude that the deal made sense – the judicial inquiry ends.

Question 201

Duties of Controlling SHs:

Answer 201

Absent a K obligation – a SH has no duty to the corp. or other SHs a. Controlling SHs generally have certain duties to the corp. and the minority investors b. They typically arise in two contexts: i. COI Transactions ii. Sales of controlling interest (look for looting & be sure that the buyer is legit *cannot sell to a looter if there is ANY suspicion at all)

Question 202

“Controlling SH”

Answer 202

Is an investor (or group) w/ the power to direct corp. affairs – the board is often only a conduit for the wishes of the controlling person/s

Question 203

Usually if you own a corp (i.e. you are a SH – you might have two types of shares of stock:

Answer 203

Common: If you own this, that means you have a right to vote for the BOD & a right to receive dividends in the stock (Sinvin) – gave a right to receive dividends & a right to vote for BOD Preferred: If you have this – typically, you can’t vote – no right to vote + your dividends are a set amount (like 4%), if the corp.does really well, (Can have preferred stock that doesn’t vote )( This corp. had a lot of these) *If assets are easy to dispose of, that probably gives the SH more of a duty to look out for looters

Question 204

21.4091: Resignation of Directors

Answer 204

Director may resign at any time

Question 205

21.410: Vacancy:

Answer 205

May be filled by a vote of the majority of the organizers or by an affirmative vote of the majority of the remaining directors, even if the remaining directors constitute less than a quorum.

Question 206

Issues re: the Sell of Controlling Interest:

Answer 206

i. Looting ii. Stock sale that requires the board to immediately turn over control is subject to attack if the sale does not involve a true controlling interest iii. Courts may also intervene if the court perceives that a sale of the controlling interest involves a conversion of a corp. opportunity. 1. (Buyer purchases controlling stock after contemplating the purchase of the entire company – by persuasion of the controlling SH) iv. Cases seem to indicate that a controlling SH is liable for selling control in a secret transaction, when the minority owners are induced to sell their shares w/o disclosure that the controlling SH received a premium (the idea being that the knowledge of the premium would help their minority owners get the best possible price)

Question 207

Indemnification (Generally)

Answer 207

The concept of indemnification recognizes that there will be situations where the director does not satisfy all of the elements of the standard of conduct set forth … but where the corp. should nevertheless be permitted (or required) to absorb the economic costs of any ensuing litigation

Question 208

An indemnification statute must:

Answer 208

a. Ensure that indemnification is permitted only where it will further sound corp. policies b. And to prohibit indemnification where it might protect or encourage wrongful or improper conduct c. KEY: “Seek middle ground between encouraging fid. To violate their trust and discouraging from serving it all” Every state in the union will have some type of indemnification statute – a. One mandatory (You must) – Does not provide for judgment against you i. If you win, you get reasonable expenses actually incurred b. One permissive (if you want to you may)

Question 209

8.051: Mandatory Indemnification:

Answer 209

1) BOD Member 2) Reasonable expenses actually incurred (8.001 lists inclusive) 3) In connection w/ a proceeding because they are or were a governing person (BOD) 4) MUST BE WHOLLY SUCCESSFUL An enterprise shall indemnify a governing person (1.001 = BOD), former governing person, or delegate against reasonable expenses actually incurred (8.001: Includes reasonable attorney’s fees. NOTE: Includes – Inclusive, not exclusive language) by that person in connection with a proceeding (8.001(8): Can be threatened, pending, or completed, civil/criminal/admin., an appeal, or an inquiry/investigation) in which a person is a respondent because the person is or was a governing person or delegate if the person is wholly successful on the merits or otherwise in defending the proceeding.

Question 210

8.101 Permissive Indemnification: :

Answer 210

8.105 - Extends to directors, employees, or agents: MAY get if you acted in good faith and had a reasonable believe that you were acting properly (even if you've been convicted of a crime) An enterprise may indemnify a governing person, former governing person, or delegate who was, is, or is threatened to be made a respondent in a proceeding to the extent permitted in 8.102 if it is determined in accordance w/8.103 that: (1) The person (A) Acted in good faith; (B) Reasonably believed: (i) In the case of conduct in the person’s official capacity, that the person’s conduct was in the enterprises best interest; and (ii) in any other case, that person’s conduct was not opposed to the enterprise’s best interest; and …

Question 211

8.102 General Scope of Permissive Indemnification:

Answer 211

An enterprise may indemnify a governing person, former governing person, or delegate against a judgment and expenses (other than a judgment) reasonably incurred in connection w/ a proceeding (b) Indemnification under this subchapter of a person who is found liable to the enterprise or is found liable because the person improperly received a personal benefit: (1) Limited to reasonably expenses actually incurred in connection w/ the proceeding (2) Doesn’t include the penalty, fine, … (3) Cannot be in connection w/ a guilty charge for: • Willful or intentional misconduct in the performance of the person’s duty to the corp. • Breach of the person’s duty owed to the enterprise • May not be made in relation to a proceeding in which the person has been found liable for – intentional misconduct, breach of loyalty, breach of duty or an act or omission not committed in good faith

Question 212

8.103 Manner for Determining Permissive Indemnificatio

Answer 212

1) Majority vote of disinterested and independent OR 2) Majority vote of a committee of directors/governing authority - Cant get either, get legal counsel - Or SH unanimous vote (1) Maj. vote of the governing persons who at the time of the vote are disinterested and independent (no need for quorum) (2) A maj. vote of the governing authority of the enterprise if the committee (A) Is designated by a majority vote of the governing persons who at the time of the vote are dis. And independent (no quorum needed) (B) is composed solely of one or more governing persons who are disinterested and independent (3) Special legal counsel selected by the governing authority of the enterprise, or selected by a committee .. (4) Owners or members of the enterprise in a vote that excludes the ownership or membership interests held by ea. governing person who is not disinterested and independent; or (5) Unanimous vote of owners or members of the enterprise

Question 213

Note of Advancement of Expenses:

Answer 213

1. Traditional indemnification statues reimburse the indemnitee only after a particular dispute is resolved a. Obvious “cash flow” timing issue 2. Modern statues allow advance expenses to a prospective indemnitee before a dispute is resolved a. If it is ultimately decided that the indemnitee is not entitled, he must repay b. Policy based on the idea that a person who serves an entity in a representative capacity should not be required to finance his or her own defense i. THINK: Many people will only serve as directors only if they have the assurance that the corp. has the power to advance these expenses

Question 214

8.104: Advancement of Expenses:

Answer 214

Provides that the corp. may advance expenses pending the outcome requirements: (a)(1): Person indemnified has to give a written affirmation that the person believes in good faith that the person will prevail or be entitled to permissive indemnification • Must agree to repay in writing – if the person isn’t entitled to indemnification (i.e. the final judgment is that the person has not met that standard or that indemnification is prohibited under 8.102) o Even if you are judgment proof