Business Associations Flashcards
(78 cards)
1
Q
Agency - Exam Approach
A
- Identify the existence of agency relationships, and what authority the agent had (or didn’t have),
- Discuss whether the principal is subject to liability for the agent’s actions,
- Articulate an agent’s fiduciary duty to the principal and whether the agent has breached that duty, and
- Determine if or when an agency relationship has terminated.
2
Q
Agency - Defined
A
Agency is defined as the relationship that arises when one person, the principal, manifests an intention that another person, the agent, act on the principal’s behalf. In order to be valid, agency requires:
- Intention to enter the relationship;
- Capacity (only minimal capacity is required; can be a minor or incompetent)
- Consent
- Control
- Agent not otherwise disqualified to act as an agent.
3
Q
Negligence of the Agent - Liability of the Principal
A
A principal is vicariously liable for the negligence of their independent contractor if:
- The independent contractor is engaged in inherently dangerous activities; or
- The duty is nondelegable—such as the duty of a business to keep its premises safe, the duty of an owner of property to keep it from being dangerous to those offsite, or the duty of an owner of a vehicle to keep the parts of the vehicle operating safely.
Employers are generally not vicariously liable for an agent’s intentional tort, because intentional tortious conduct is not within the scope of agency, unless force is authorized in the agency, friction is generated by the agency, or the agent is furthering the business of the employer.
4
Q
Types of Authority - Generally
A
There are several main types of authority, including:
- Express Authority (type of actual authority)
- Implied Authority (type of actual authority)
- Apparent Authority
5
Q
Express Authority - Defined
A
Express authority means that the agent expressly has the authority from the principal to act.
6
Q
Implied Authority - Defined
A
Implied authority results when the principal’s words or actions cause an agent to reasonably believe in the agent’s authority to act. Such belief can be the result of:
- The agent’s reasonable understanding of the manifestations and objectives of the principal,
- Custom and usage,
- Acquiescence, or
- Emergency or necessity.
7
Q
Apparent Authority - Defined
A
Apparent authority results when the principal causes a third party to reasonably believe that the agent has authority to act.
8
Q
Ratification - Defined
A
Ratification occurs when a principal affirms a prior act that was done or purported to be done on the principal’s behalf. The principal’s affirmation may be either express or implied (such as through conduct), and consideration is not required.
Only discuss ratification if the principal knowingly approves the act afterwards.
9
Q
Agent’s Duties to Principal - Generally
A
An agent holds certain duties to the principal, including:
- Undivided loyalty;
- Strict obedience to the principal’s instructions; and
- Reasonable care (in light of local community standards and taking into account any special skill of the agent).
10
Q
Principal’s Duty to Agent - Generally
A
A principal owes certain duties to their agent, including:
- The duty to reasonably compensate the agent and to reimburse him for all expenses or losses reasonably incurred in discharging any authorized duties;
- Duties imposed by the contract; and
- A duty to cooperate in carrying out the purpose of the agency.
11
Q
Agent’s Remedies Against Principal - Generally
A
If the principal breaches any of their duties to the agent, the agent may seek a remedy in the form of:
- Damages for breach of contract (subject to a duty to mitigate); and
- An agent’s lien in any property the agent holds (such as a broker’s commission in proceeds from a real property sale).
12
Q
Principal’s Remedies Against Agent - Generally
A
If the agent breaches any of their duties to the principal, the principal may seek a remedy in the form of:
- Damages;
- Accounting for the agent’s secret profits; and
- Withholding of compensation.
13
Q
Termination of the Agency - Generally
A
The Principal-Agent relationship can be terminated by:
- Lapse of time;
- The happening of an event;
- A change of circumstances;
- Breach of fiduciary duty;
- Unilateral act; or
- Operation of law
14
Q
Termination of the Agency - Actual Authority
A
An agent’s actual authority terminates when they knew or should have known of the termination.
15
Q
Termination of the Agency - Death of the Principal
A
Death or incompetency of the principal terminates all authority of the agent without notice to either the agent or third parties.
16
Q
Termination of the Agency - Written Authority
A
If the principal has given the agent a writing, manifesting their authority, that is meant to be shown to third parties, the apparent authority will not be terminated with respect to third parties who see and rely on such writing.
17
Q
Agent’s Liability Under Contract - Generally
A
When an agent enters into a contract on the principal’s behalf and binds the principal to the contract, the agent might also become a party to (and liable on) the contract.
Whether the agent becomes a party depends on:
- The terms of the contract, and
- The degree to which the agent discloses to the third party the existence and identity of the principal.
18
Q
Agent’s Liability - Disclosed Principal
A
A principal is a disclosed principal if the third party has notice of both the existence and identity of the principal.
Unless the agent and third party agree otherwise, an agent who enters into a contract on behalf of a disclosed principal does not become a party to the contract.
19
Q
Agent’s Liability - Partially Disclosed Principal
A
A principal is a partially disclosed principal if the third party has notice of the principal’s existence but not the principal’s identity.
Unless the agent and the third party agree otherwise, an agent who enters into a contract on behalf of a partially disclosed principal becomes a party to the contract.
20
Q
Agent’s Liability - Undisclosed Principal
A
A principal is an undisclosed principal if the third party has no notice of the principal’s existence.
An agent who enters into a contract on behalf of an undisclosed principal becomes a party to the contract. Thus, when the agent does not inform a third party of the identity or the existence of the principal, the agent becomes liable to the third party on the contract.
21
Q
Agency & Partnership Liability - Generally
A
A partnership is liable for the acts and omissions of any partner acting in the ordinary course of the partnership business or with the authority of the other partners, to the same extent that the acting partner is liable.
To the extent a third party reasonably believes a partner is acting for the partnership, that partner will have the apparent authority to bind to partnership.
22
Q
Agency & Corporation Liability - Generally
A
When a corporate officer exceeds their authority, that officer may be liable both to the corporation and to the third party on the contract based on a breach of their implied warranty of authority.
23
Q
Agency & Partnership Liability - General vs. Limited Partnership
A
In a general partnership, all partners are jointly and severally liable for all the obligations of the partnership.
In a limited partnership or a limited liability partnership, partners’ liability is limited to their capital accounts in the partnership. Unless they act in a manner inconsistent with any limitations on their duties, they cannot be held individually liable.
24
Q
Partnership - Defined
A
A partnership is an agreement among two or more persons to carry on as co-owners a business for profit.
25
Partnerships - Formation, Generally
No intent to form a partnership needs to be expressed for a partnership to be created—only the two elements of carrying on as co-owners and the sharing profits.
Where the basic elements are not met, discuss those factors indicating a partnership may have been formed:
1. Common ownership of property;
2. Designation of the entity as a partnership; and
3. Higher degree of activity—such as both purchase and management of property.
26
Partnerships - Formation, General vs. Limited
Unlike a general partnership, limited partnerships and limited liability partnerships require certain formalities, such as an agreement and the filing of documents with the State.
If improperly or defectively formed, the result is a general partnership—if the entity is in fact a partnership at all.
27
Partnerships - Management and Operation, Generally
Subject to any agreement between the partners, all partners have equal rights in the management and conduct of the partnership.
Ordinary matters connected with the partnership business may be decided by a majority of the partners.
No act in contravention of the partnership agreement may be done without the consent of all the partners.
28
Partnerships - General Partnerships, Generally
In a general partnership, all the partners contribute something to the partnership, and, absent agreement to the contrary, profits and losses are divided equally, and losses are shared in the same ratio as profits are divided.
Any partner can bind the partnership. All partners are jointly and severally liable for all obligations of the partnership—contract or tort.
Each general partner is personally liable for all partnership obligations, and if one partner is compelled to pay the entire obligation, they may seek indemnity from the partnership.
An incoming partner is not liable for any obligation incurred before their admission as a partner, except to the extent of the contributed property.
29
Partnerships - Fiduciary Duties, GPs
Partners are in a fiduciary relationship to each other, and to the partnership as a whole. A partner's duty of loyalty requires them to act in good faith and fairly toward one another, including:
1. To refrain from dealing with the partnership as or on behalf of a party adverse to the partnership;
2. To refrain from competing with the partnership; and
3. To account for profits, property, opportunities, or other benefits derived by the partner in conjunction with the partnership business.
A partner who usurps a partnership opportunity or otherwise breaches a duty of loyalty must account to the partnership for any profits he earns as a result of the breach.
30
Partnerships - Limited Partnerships, Generally
In a limited partnership, only the general partner has the authority to bind the partnership and make management decisions, and thus is liable for all partnership obligations.
The limited partners merely contribute capital, and are liable only to the extent they risk their invested capital.
Profits and losses are shared according to their limited partnership capital accounts.
Limited partners can vote on major issues, such as dissolution of the partnership or sale of all or the majority of assets of the partnership.
31
Partnerships - Dissolution
If a partnership does not have a definite term, it is an “at will” partnership. An at-will partnership may be dissolved by any partner by their express will.
Other acts that can also cause the dissolution of a partnership, include:
1. Bankruptcy, wrongful dissociation, or the express will of at least half of the remaining partners to wind up the business within 90 days of a partner's death;
2. The express consent of all partners to wind up the business; or
3. The expiration of the term.
32
Partnerships - Dissociation, Generally
Dissociation is the change in the relationship among the partners caused by any partner ceasing to be associated in the carrying on of the business.
Dissociation can occur:
1. Voluntarily, or
2. Involuntarily - such as when a partner dies, becomes adjudged incompetent, or is expelled from the partnership.
33
Partnerships - Effect of Dissociation
On dissociation, a dissociating partner is paid their capital account and share of profits.
If the dissociation is in breach of an express term of the partnership agreement, it will be a wrongful dissociation. A partner who wrongfully dissociates is liable to the partnership for any damages caused by the dissociation.
Dissociation often may, but does not necessarily, cause the dissolution of the partnership. Dissolution can sometimes be avoided if the partnership continues and buys out the dissociated partner’s interest.
34
LLCs - Organization, Generally
LLC’s are primarily governed by operating agreements that control most aspects of business and management. An LLC is an entity distinct from its members.
An LLC is taxed like a partnership, but the members enjoy limited liability like shareholders and directors of a corporation.
Profits and losses are allocated on the basis of each member's contribution. An assignment of a member’s interest transfers only the right to profits and losses. Membership transfer requires unanimous consent of the members.
35
LLCs - Formation
An LLC is formed by filing Articles of Organization with the Secretary of State. They must include:
1. A statement that the entity is an LLC;
2. The name, which must include “LLC” or “Limited Liability Company;”
3. The street address of the office and the registered agent for service of process; and
4. The names of all the members.
If an LLC is defectively formed, the result is most likely a general partnership, assuming the entity would otherwise qualify as a partnership.
36
LLCs - Dissociation
Disassociation (death, retirement, resignation, bankruptcy, termination of a member) causes dissolution. However, the remaining members can file a notice of continuation to avoid cessation of business.
37
Corporations - Formation, Generally
A corporation is formed by filing Articles of Incorporation with the Secretary of State.
An incorporator is the person who signs the Articles of Incorporation.
38
Ultra Vires - Generally
A corporation is presumed to be formed for a lawful business purpose, and any business outside of the corporation’s purposes as stated in the Articles of Incorporation is ultra vires.
39
Ultra Vires - Remedies
In the case of an ultra vires act, there are three possible remedies:
1. A shareholder can sue to enjoin the ultra vires act;
2. The corporation can sue officers and directors for damages arising from the ultra vires act; and
3. The state may seek dissolution of the corporation.
Directors cannot generally be removed for causing the corporation to perform an ultra vires act, although causing the performance of such an act may violate the director’s duty of care, subjecting them to a suit for damages.
40
Corporations - Formation Types
A corporation can be formed:
1. de jure, in accord with the formation statutes; or
2. de facto, which requires:
a. an available statute for valid incorporation,
b. a colorable compliance, and
c. good faith; or
3. Corporation by Estoppel, where persons who treat an entity like a corporation are estopped from later claiming it was not
41
Piercing the Corporate Veil - Generally
There are three main theories to justify piercing the corporate veil:
1. Alter Ego;
2. Inadequate capitalization at the time of incorporation; and
3. Avoidance of existing obligations or fraud
42
Piercing the Corporate Veil - Alter Ego
A court may pierce the corporate veil if it is found that the corporation was the alter ego of individuals. This requires:
1. a failure to observe corporate formalities, such as keeping adequate minutes and books and records, etc., and
2. a basic injustice so that equity would require that shareholders be liable for the damage caused.
43
Piercing the Corporate Veil - Avoidance of Existing Obligations or Fraud
A court may pierce the corporate veil if it is found that the incorporation occurred in order to avoid existing obligations at the time of incorporation, or in an effort to commit fraud on creditors or other third parties.
44
Piercing the Corporate Veil - Equitable Subordination
Where the corporation is insolvent, and one or more shareholders have claims as creditors of the corporation, a court has discretion to subordinate the shareholder’s claims to any class of creditors, including unsecured creditors.
45
Corporations - Issuance of Securities
Formation requires the issuance of securities to the owners of the corporation—the shareholders.
Equity securities means common stock, which can be issued in consideration of any tangible or intangible property or benefit to the corporation, but many states prohibit issuance of stock for promissory notes or future services.
Debt securities include a bond, which is secured, or a debenture, which is unsecured. A debt security is not a form of ownership.
46
Promoters - Generally
A promoter is one who acts on behalf of a corporation in the course of formation.
Upon incorporation, promoters owe fiduciary duties to the corporation and to the shareholders. The duty is one of fair disclosure and good faith.
47
Promoters - Subscriptions
Prior to incorporation, persons may subscribe to purchase stock from the corporation when it comes into existence. These contracts are called stock subscriptions.
48
Promoters - Profits from Incorporation
A promoter who profits on the sale of property to the corporation may be liable to the corporation for the profit, or may be forced to rescind the sale, unless the promoter has disclosed all of the material facts of the transaction.
If the transaction is disclosed to, and approved by, an independent board of directors, there is no breach of fiduciary duty. If the board is not completely independent, the transaction must be approved by the shareholders and subscribers to the stock of the corporation.
Disclosure must be to all shareholders, and must include those persons contemplated as part of the initial financing. Thus, if the promoters only disclose their acquisition, for profit, of shares to some of the prospective shareholders, this is a breach of their fiduciary duty.
49
Promoters - Liability
If the promoter acts on behalf of a corporation prior to incorporation, thus knowing it has not yet been legally formed, the promoter remains liable for any liabilities, even after formation, unless the third party enters a novation with the corporation that expressly relieves the promoter of liability.
The corporation is not bound by any pre-incorporation acts or contracts of the promoter.
50
Corporations - Shareholder Powers and Voting
The shareholders hold the power to:
1. Elect directors;
2. Amend the articles and bylaws, and
3. Must vote on fundamental corporate changes, such as the sale of all the assets, mergers, etc.
51
Corporations - Transfer of Shares
The corporation may restrict the transfer of shares for any reasonable purpose, and restrictions may include:
1. A first right of refusal,
2. A buy-back provision,
3. Transfer approval, and
4. Prohibition of transfer to particular persons or groups.
A transferee is bound by the restriction if he has knowledge of it or the restriction is conspicuously noted on the certificate.
52
Corporations - Shareholder Voting
Shareholders may vote in person or by a written proxy, but not absentee. A proxy may only last for eleven months.
A proxy is revocable unless it expressly provides that it is irrevocable and the appointment of the proxy is coupled with an interest, such as:
1. A property right in the shares; or
2. A security interest given to him to protect him regarding any obligations he incurred or money he advanced
53
Distributions to Shareholders - Generally
Distributions can be in the form of:
1. Dividends to shareholders,
2. Redemption,
3. Repurchase, or
4. Liquidating distributions after dissolution.
Distributions are within the Board’s discretion, but are limited by solvency requirements, and any restrictions in the articles.
Absent an abuse of discretion, corporations cannot be compelled to issue or pay dividends, or any other type of distribution, such as repurchases or redemptions.
54
Direct Suits - Generally
A direct suit may occur after a breach of duty directly owed to the shareholder by an officer or director, or by the majority shareholders.
This largely involves suits against a controlling or majority shareholder for breach of fiduciary duties involving sales to looters, oppression, or sale of corporate office.
55
Direct Suits - Majority Shareholder Duties
There are three duties owed by majority or controlling shareholders toward minority shareholders:
1. A fiduciary duty to not act oppressively, illegally, or with fraud. Oppression involves acting so as to “freeze out” the minority and devalue their shares.
2. The duty to not sell to looters, for which there is liability if the shareholders did not undertake a reasonable investigation; and
3. The duty to not sell at a premium if it was paid to sell a corporate office (such as replacing the Board of Directors) for private gain.
Most votes, other than major corporate matters such as merger and sale of substantially all of the assets, require a majority in interest of the shareholders voting.
56
Derivative Suits - Generally
A derivative suit is usually brought against directors or officers for breach of their duties of loyalty and care.
A derivative suit requires:
1. Standing, based on ownership of the stock at the time of the wrong or by operation of law from someone who owned it at the time of the wrong;
2. A written demand and inaction for 90 days, unless the demand would be futile; and
3. The corporation is a named but nominal defendant, because the directors failed to have the corporation correct the wrongs.
57
Director Duties - Generally
The major issues involving directors are the right to vote and the fiduciary duties.
Directors vote on the general direction of the company, approve significant actions or the incurring of liabilities, and they elect the officers.
If a quorum is present, only a majority of those disinterested directors present is required. A quorum is a majority of eligible voters.
When a shareholder brings a derivative suit, it usually claims a breach by directors of their fiduciary duties: the duty of care, and the duty of loyalty.
58
Director Duties - Duty of Care
The duty of care requires that the directors act:
1. In good faith;
2. With the care that an ordinarily prudent person in a like position would exercise under similar circumstances;
3. in a manner the director reasonably believes to be in the best interests of the corporation.
59
Director Duties - Duty of Loyalty
The duty of loyalty involves three major areas:
1. Conflict of interest;
2. Usurpation of corporate opportunity; and
3. Insider trading
60
Duty of Care - Business Judgment Rule
Under the business judgment rule, directors who meet this standard are not liable for decisions that, in hindsight, turn out to be erroneous.
The person challenging the action has the burden of proving the breach of duty. Ordinary prudence can include relying on information and statements prepared by others, provided the director reasonably believes such persons are competent and merit confidence.
The business judgment rule ONLY applies to the duty of care.
61
Duty of Loyalty - Conflict of Interest
A director has a conflict of interest if they know that they, or a related person:
1. Are a party to the transaction;
2. Have a beneficial financial interest in the transaction, or
3. Are a director, partner, agent or employee of an entity with whom the corporation is transacting business, and
4. The transaction is of such importance it would normally need board approval.
62
Duty of Loyalty - Usurpation of Corporate Opportunity
Usurpation of corporate opportunity provides that, if the corporation has an interest or expectancy in the business opportunity, a director or officer cannot take that opportunity for himself.
The closer the opportunity to the corporation’s line of business, the more likely it is a corporate opportunity.
63
Duty of Loyalty - Insider Trading
In addition to federal securities law, a director has a common law duty of loyalty to shareholders not to engage in insider trading, which involves trading stock with undisclosed knowledge of a special circumstance significantly impacting the value of the stock.
If plaintiff did not purchase or sell, they cannot prevail for common law insider trading.
64
Derivative Suits - Director Indemnification
A director is entitled to indemnification from the corporation for expenses in defending a lawsuit if the director prevails.
If the director does not prevail, indemnification depends on the nature of the lawsuit in some states, but generally, there is no indemnification permitted.
65
Duty of Loyalty - Conflict of Interest, Defenses
A transaction with a potential conflict of interest will not be enjoined or result in damages if:
1. Approved by a majority of disinterested directors;
2. Approved by a majority of disinterested shareholders; or
3. At the time, it was fair to the corporation.
66
Corporate Dissolution - Generally
There are three major ways to dissolve a corporation:
1. Voluntary dissolution;
2. Administrative dissolution; and
3. Judicial dissolution.
67
Voluntary Dissolution - Corporate Act
The most common method of voluntary dissolution is by corporate act, where the shareholders and directors both vote to dissolve the corporation.
A corporation that is dissolved may not carry on its business, but may wind up and liquidate its affairs. This includes collection of assets, discharging liabilities, and distributing remaining property among shareholders.
A claim can be asserted against a dissolved corporation to the extent of its undistributed assets, and against the shareholders for the pro rata share of the claim, to the extent of assets distributed to him or her.
To bar claims sooner, the corporation may notify its known creditors in writing of the dissolution, and set a deadline of not less than 120 days by which the claim must be received. If a claim is received and rejected, the creditor has 90 days to file suit.
To bar unknown claims, the corporation must publish a notice of dissolution in a newspaper in the county of the corporation’s principal place of business. A claim not brought within 5 years after publication is barred.
68
Administrative Dissolution - Generally
Administrative dissolution is brought by the state for failure to:
1. Pay corporate fees or penalties for 60 days after the due date;
2. Failure to deliver the annual statement by domestic stock corporation listing officers, directors, place of business and agent for service of process;
3. Failure to maintain an agent for service of process;
4. Failure to notify the state of a change in the agent for service of process for 60 days.
If the corporation fails to correct the grounds for 60 days after notice from the state, the corporation is dissolved, but it can apply for reinstatement for two years. Reinstatement relates back to the date of dissolution.
69
Judicial Dissolution - Generally
Judicial dissolution can be brought four ways:
1. The attorney general can seek dissolution on grounds of fraud or ultra vires acts.
2. Shareholders may seek dissolution for wrongful acts of the directors or majority shareholders;
3. Creditors can seek dissolution if the claim is reduced to judgment, remains unpaid, and the corporation is insolvent.
4. The corporation can ask the court to supervise what began as a voluntary dissolution.
70
Judicial Dissolution - Shareholder Initiated Dissolution
Shareholders may seek dissolution on the grounds that:
1. The directors are deadlocked and irreparable injury to the corporation is threatened;
2. The directors or shareholders have acted or will act fraudulently, illegally, or with oppression;
3. The shareholders are deadlocked and failed to elect one or more directors for two consecutive annual meetings; or
4. Corporate assets are being wasted or misapplied to noncorporate purposes.
The corporation or other shareholders may elect to purchase the petitioning shareholders’ shares.
71
Rule 10b-5 - Generally
There are two major, different types of violations under Rule 10b-5:
1. Basic fraud in the purchase or sale of securities,
2. Insider trading.
72
Rule 10b-5 - Fraud
It is unlawful, in connection with the purchase or sale of a security, to employ interstate commerce or the mails, or a national securities exchange, to:
1. Employ any device or scheme to defraud;
2. Make any untrue statement of material fact or omit to state a material fact; or
3. Engage in any act or business practice that would operate as a fraud or deceit on any person.
The fraud must be material, and there must be scienter: the intent to deceive, manipulate, or defraud.
If there is a 10b-5 fraud claim, discuss common law misrepresentation from Torts if an insider makes false statements in connection with the purchase or sale of stock.
73
Rule 10b-5 - Insider Trading, Generally
A person commits insider trading if he purchases or sells stock with knowledge of nonpublic information and without disclosing that information, and breaches a duty of trust and confidence owed to the issuer, the shareholders of the issuer, or another person who is the source of the nonpublic information.
Individual plaintiffs can sue under federal law for rescission or damages, but not punitive damages.
74
Insider Trading - Insiders
Insiders are those connected to the issuer, such as shareholders, directors, employees and officers, CPA’s, attorneys, and bankers.
An insider is liable if they use or disclose information for their personal benefit.
75
Insider Trading - Tipper
When an insider gives a tip of inside information to someone else who trades on the information, they are considered a tipper.
A tipper is liable if the tip was made for any improper purpose.
76
Insider Trading - Tippees
Tippees are those who trade based on information from an insider.
Tippees are liable if the tipper breached a duty of nondisclosure, and the tippee knows the tipper was breaching their duty of nondisclosure.
77
Insider Trading - Misappropriators
Misappropriators are those who trade in breach of a duty of confidentiality owed to the source of the non-public information.
The Securities Regulations include attorneys, bankers, brokers, and similar persons, of course, as those who owe such a duty, but they also include those persons who are within the parent-child relationship.
The government can criminally prosecute misappropriators.
78
Rule 16b - Generally
Any profit realized by a shareholder of more than 10% of the stock, or any director or officer, from any purchase or sale within a period of less than six months, must be disgorged to the corporation.
Purchases or sales made before becoming an officer or director are excluded, but those made within six months after ceasing to be an officer or director are included.
