Business Associations

LLC Fiduciary Duties

A member of a member-managed LLC owes to the company and the other members the fiduciary duties of loyalty and care. When a majority member oppresses a minority member, courts may sustain minority owners in their claims. Under Delaware law the operating agreement may eliminate all fiduciary duties except good faith and fair dealing.

First American Title Ins. Co. v. Lawson (N.J. 2003) [Partnership Management - Facts]

A partner in a law firm organized as a limited liability partnership made material misrepresentations when applying for malpractice coverage for the firm. Court held the firm's policy is void in respect of the firm as an entity and any defalcating partner, but not in respect of any innocent partner.

American Federal of State, County & Municipal Employees v. American International Group, Inc. (2nd Cir. 2006) [Shareholder Proposal - Elections]

AFSCME, one of the country's largest public service employee unions, submitted to AIG for inclusion in the proxy statement a shareholder proposal that would amend the AIG bylaws to require the Company to publish the names of shareholder-nominated candidates for director positions along with the AIG nominated candidate. AIG requested and received a no-action letter from the SEC on the basis that it related to elections. The rule states if the proposal relates to an election for membership on the company's board of directors or analogous governing body it may be excluded. Court held not election related because the exclusion is for a particular election and not for procedural rules governing elections generally.

Grant v. Mitchell (Del Ct. Chancery 2001) [Incorporation]

Action brought to determine proper directors and officers of a software company. The certificate of incorporation was filed with the Secretary of State naming Grant as incorporator. Attorney prepared two documents (1) Unanimous Written Consent of the Directors in Lieu of an Organizational Meeting and (2) Bylaws. The first purported to adopt the second and named Grant as President, Mitchell as Treasurer and Secretary. The directors' consent had signature lines for Grant and Mitchell, thus signifying that the creator of the document believed the were the two initial directors. However, it was never executed. However both signed the Foreign Corporation Certificate with their respective roles. As sole incorporator, Grant had the limited but important authority to name the board. A single incorporator may meet with himself to do such. Grant signed the Foreign Corporation Certificate under penalty of perjury. It's a simple easy-to-read form, its harder to miss the part naming the directors than not.

Effect of a Staggered Board

Acts as a powerful anti-takeover device. One way to take control of a public corporation where the target corporation's board is unwilling to approve the business combination is to change the composition of the board through a proxy contest - an insurgent nominates its own slate of nominees for the board. The insurgent typically purchases 10 to 15 percent of the firm's outstanding shares prior to the shareholder vote, and attempts to recruit other shareholders to support its position. If a board is staggered, an insurgent would be required to win two annual elections to gain a majority of seats on the board. Given the amount of time during which the insurgent would not have control of the company but would have a large financial stake, companies with staggered boards are not often successful targets of attempted hostile takeovers.

Alderstein v. Wertheimer (Ct. Chancery Del. 2002) [Contested Election of Directors]

Adlerstein, former Chairman and CEO of SpectruMedix, a mfg co., brought suit against the Company and the current directors. At issue is the creation and issuance of a new class of stock to the Reich Partnership, the removal of Adlerstein for cause and the appointment of Reich, and the written consent in lieu of stockholders meeting. Under Adlerstein the company became insolvent. The question is whether the meeting at which this occurred was a meeting of the board of directors. The court looked at the record, the bylaws of SpectruMedix which require 2 days notice and the urgency of the problems facing the company. Next the court addressed how keeping Adlerstein uninformed about the content of the meeting invalidates the board's actions. The court considered SpectruMedix's bylaws which did not require such notice and no legal rules requiring such notice, also he probably would have killed the deal had he been informed, and the insolvency crises but found no legal justification. Adlerstein was entitled to know ahead of time of the plan to issue new stock with the purposeful effect of destroying his voting control over the Company. This right to advance notice derives from minimum standards of fairness. Adlerstein possessed the contractual power to prevent the issuance and should have afforded the opportunity to do so. The board had the option to issue a dilutive option instead.

Model Act § 7.32 Shareholder Agreements

Agreements must be unanimous, must be included in the charter or bylaws or in a separate agreement, limited to ten years unless otherwise provided, must be included on a legend on the share certificate, limited to close corporations, shareholders will not have personal liability even if the effect of the agreement is to create a partnership.

Vote Pooling

Agreements which obligate shareholders to vote together as a single block

Cumulative Voting

Allows shareholders to concentrate their voting power by cumulating all of the votes associated with their shares and voting them in a block for a limited number of nominees.

Supermajority Voting - Amendment under MBCA

Amendment or repeal of supermajority provisions requires a supermajority vote

Soerries v. Dancause (Ct. App. Geo. 2001) [Piercing the Corporate Veil]

Soerries was the sole shareholder of Chickasaw club which operated a nightclub. An 18-year-old entered the bar intoxicated, no employee checked her id, and drank additional alcohol, and was visibly intoxicated when she left. She later died after crashing into a tree. Soerries held jointly liable with the corporation. The concept of piercing the corporate veil is to remedy injustices which arise where a party has overextended his privilege in the use of a corporate entity in order to defeat justice, perpetrate fraud or to evade contractual or tort responsibility. Sole ownership of a corporation by one person is not a factor, and neither is the fact that the sole owner uses and controls it to promote his ends. There must be evidence of abuse of the corporate form. Plaintiff must show that the defendant disregarded the separateness of legal entities by commingling on an interchangeable or joint basis or confusing the otherwise separate properties, records or control. Soerries paid his employees, suppliers, and entertainers in cash, while a busy nightclub, he continually reported tax losses and had discrepancies in what he showed as rental payments. A jury could construe this evidence to demonstrate that Soerries commingled individual and corporate assets by personally assuming the corporation's financial liablites, waiving corporate rental payments, or using corporate funds to directly pay his personal mortgage notes and other expenses.

Purcell v. Southern Hills Investments LLC (Ct. App. Ind. 2006) [LLC Fiduciary Duties]

Southern Hills LLC having common owners with Smithville purchased fiber-optic cable from Metro LLC, owned by Purcell. Southern Hills purchased from Metro the right to use the cables in Southern Loop. Southern Hills and Metro formed VillageNet LLC. The record discloses that Purcell not only kept money that should have been forwarded to VillageNet and instead chose to repay a personal loan, but he also failed to inform VillageNet and its members of the money that was owed to them. Purcell held in breach of his fiduciary duties.

Whole Enterprise Theory of Liability

Special problems arise in trying to justify limited liability within corporate groups, such as a parent company and its wholly owned subsidiaries. A wholly owned subsidiary is a legal entity separately incorporated from the parent corporation, but where the parent owns 100 percent of the stock. In this context it is not so clear that he various entities should be treated as separate, rather than looking at the enterprise as one related entity. But this has been soundly rejected.

First American Title Ins. Co. v. Lawson (N.J. 2003) [Partnership Management - Rule]

Any partner can execute any instrument, such as an application for insurance requiring the payment of premiums, and in so doing can bind the partnership as a whole in the ordinary course of its business. Thus, any one partner can incur general business indebtedness on the partnership's behalf. When a firm is a limited liability partnership, a special rule exists to shield partners from incurring liability arising solely from the wrongful acts of fellow partners. Although they remain liable for their own personal misconduct, partners of a limited liability partnership are not responsible for the professional negligence or wrongful acts of other partners.

Apache Corporation v. Nycers (S.D. Tex. 2008) [Shareholder Proposal Exclusion - ordinary business]

Apache, a independent energy company, sought declaratory judgment that it properly excluded the New York pension fund shareholder proposal. Apache requested and received a no-action letter from the SEC stating the proposal requests that management implement equal employment opportunity policies which relate to ordinary business operations. The Court held the proposal was properly excluded because it went too far, into Apache's employee benefits allocation, corporate advertising and marketing activities, thereby seeking to micromanage the company.

D.R. Horton Inc.-New Jersey v. Dynastar Development LLC (N.J. 2005) [LLCs - Piercing the LLC Veil - Analysis]

As to the alter ego prong here is no doubt that Borne failed to correct misimpressions of the entities' respective roles. He maintained control over all his entities, and used a central office, common employees, and common telephone lines. Borne did not intend to mislead. The other parties were generally disinterested in the identity of the assignee. Borne's failure to correct their confusion did not cause the part to act to its detriment. The party would have made the same investments even if the identity was made clear. Borne was a small-business owner. His lack of attention to detail - his misuse of stationery was not uncharacteristic of entrepreneurs and other LLC owners. His operational efficiencies - in maintaining a central office was understandable. It would make little business sense to rent separate space, hire separate workers, and acquire separate phone lines. To penalize him for rational economic behavior would be inconsistent with the business-promotion goals of the Limited Liability Act.

Grimes v. Alteon Inc. (S. Ct. Del. 2002) [Closely Held Corporation - Issuance of Stock]

The CEO of a pharmaceutical corporation made an oral promise to sell stock to another without the board's approval. Commitments regarding the issuance of stock must be approved in writing by the board of directors. This policy preserves the board's broad authority over the corporation and protects the certainty of investors' expectations regarding stock. Shares of stock are a species of property right that is of foundational importance to our economic system. Thus, it is critical that the validity of those securities, especially those that are widely traded, not be easily or capriciously called into question. Explicit board approval of a stock issuance or a commitment to issue stock makes it more likely that the board will have considered thoroughly the reasons for and against the issuance. Thus, director approval of stock issuance or agreement affecting the respective rights of the corporation and a putative purchaser of stock reduces later disputes about their propriety and enhances corporate stability and certainty. Because the purchaser was a 10% stockholder already, such a commitment could have tangible negative effects for Alteon's raising of capital from other sources. In essence, the promise to the purchaser cost Alteon a certain freedom in raising capital.

Blasius Industries, Inc. v. Atlas Corp. (Ct. Chancery Del. 1988) [Board of Director Rights]

Blasius, the largest shareholder at 9%, brought suit against Atlas' board of directors for violating its fiduciary duty when it expanded the board and elected new directors without shareholder vote. Blasius issued a consent for a restructuring. The board in reaction increased the size of Atlas' board by two and filled the positions thereby precluding the shareholders from voting on Blasius' consent solicitation. The action was motivated by the boards' desire to stop Blasius. If it had been otherwise, there'd be no judicial oversight. The question is one of authority as between the fiduciary and the beneficiary, involves a conflict between the board and a shareholder majority. Requires determining the legal and equitable obligations of an agent towards his principal, it's for the court to decide and not left to the agent's business judgment. Here it had time to inform the shareholders of its view on the merits of the proposal. The board could have spent money informing its shareholders of the risks. Even though the action was in good faith, it violated the duty of loyalty that the board owed the shareholders.

Remedies for Minority Oppression

Buyout, even if not provided for in statute; appointment of a custodian or provisional director; canceling or altering the charter, the bylaws, or a corporate resolution; directing or prohibiting any act of the corporation, shareholders, directors, officers or other persons; selling all the property and franchises of the corporation to a single purchaser; and paying dividends or damages.

Capital Group Companies, Inc. v. Armour (Ct. Chancery Del. 2005) [Transfer Restrictions - close corp]

CGC, a Delaware corporation brought suit against two trustees of a trust, husband and wife, seeking declaration that transfer restrictions are applicable to them. CGC requires all persons purchasing shares of its common stock to sign off on the Stock Restriction Agreement which precludes the transfer of stock to any non-employee and allows CGC the right to repurchase if they are transferred to a non-employee. With CGC's consent the shares purchased by the husband were placed into a trust, in both the husband's and wife's name, but to get CGC's consent they agreed that CGC would have to consent before any of the shares could be transferred, and if the trust is revoked CGC has the right of repurchase. The proper inquiry is whether the actual restrictions are reasonably to achieve a legitimate corporate purpose. The policy of restricting the number of record shareholders to avoid public company reporting and filing requirements is clearly a valid purpose. It is reasonable to conclude that CGC's purposes would not be achieved if the stock was transferable, first transfer to a large number of owners would destroy CGC's exemption from SEC regulations, second, restricting ownership interest to employees clearly aligns the interests of the employees with CGC. Having an ownership interest in the company gives the employees more of the benefits of the company's success and more of the risks in failure.

Shareholder Proposals Rule 14a-8

Can be used to require shareholder proposal and supporting statement in the company's proxy statement. REquires a proponent to own at least $2,000 work of stock, or 1% of outstanding stock, whichever is less, have owned it for at least one year prior to submitting the proposal, and must reach the company 120 days before the date of the company's proxy statement release.

Liability for Misleading Proxy Disclosure

Congress adopted mandatory disclosure as its preferred regulatory approach to protect shareholders' voting rights. In general, it is a violation of Rule 14a-9 for a company to make a false statement of material fact or to omit to state material facts in its proxy statements.

Conklin v. Perdue (S. Ct. Mass. 2002) [Deadlock - Close Corp]

Conklin and Perdue created CPInternational, Inc., a S-Corporation. Each were directors, officers and shareholders. Financed by Conklin. The company never made any money and the two fell out. Each accused the other of harming the company and breaching fiduciary duties to one another. The Court determined that under Del. law it could initiate dissolution. To determine the date of dissolution the court had to determine the first date of deadlock. Decided the date was after the last communication occurred between the two involving Conklin's decision that things were not working out. Decided no fiduciary duty to the other was owed after that date and nothing was left to distribute.

D.R. Horton Inc.-New Jersey v. Dynastar Development LLC (N.J. 2005) [LLCs - Piercing the LLC Veil - Facts]

Contract was entered into to develop housing. The agreement stated it was binding on the parties as well as their successors and assigns, did not require prior approval of its assignment or notice. One of the parties conveyed its interests to Esplanade LLC. Esplanade selected Dynastar to be the developer of the project. Dynastar was a member of Esplanade. Due to the Esplande/Dynastry manager's ignorance the agreement was breached. One of the parties sued and the court held it may not pierce Esplanade's veil. The court is not persuaded that an injustice would be done by maintaining limited liability, given the court's conclusion that Borne's alleged misuse of the limited liability company form did not proximately cause plaintiff's harm. Even if not an essential element of a veil piercing claim, causation necessarily must be a factor in the court's analysis.

Piercing the Corporate Veil

Courts requiring shareholders to pay the entire amount of a contract or a judgment on a tort law claim, beyond the amount of the shareholders' investments. May be understood simply as rough attempts to balance the benefits of limited liability against its costs.

Dow v. Jones (D. Md. 2004) [LLP Liability to Third Parties]

Criminal defendant hires attorney who unbeknownst to him belonged to a firm that was dissolved. The firm denied being a party to the agreement. In general partnerships, all partners are jointly and severally liable for all debts and obligations of the partnership, including any wrongful acts or omissions by another partner. By registering with the state, paying a fee, and carrying a specified amount of liability insurance, registered LLPs are granted a special statutory shield which limits the liability of individual partners for the misconduct of other partners. This does not relieve partners who are personally culpable of their individual liability to third parties, and partnership assets also remain available to satisfy third-party claims. Every partner of an LLP has the power to bind the partnership as an agent. Jones was listed as a partner in the firm's LLP application and the firm's operating name included Jones's last name and the designation of partnership. The client met with Jones and another named partner at the firm office, signed a retainer agreement on firm letterhead, and received at least one letter on firm letterhead. After dissolution a partner still can bind the partnership by any act appropriate for winding up partnership affairs or completing transactions unfinished at dissolution or by any transaction which would bind the partnership if dissolution had not taken place provided the other party had not known of the dissolution.

Massachusetts Approach to the Minority Shareholder

The Massachusetts courts have taken it upon themselves to craft a common law of minority oppression. In Donahue v. Rodd Electrotype Company of New England (1975), the Supreme Judicial Court of Massachusetts held that majority shareholders in a closely held corporation owe each another a heightened fiduciary duty comparable to the duty that partners owe to one another; the duty of utmost good faith and loyalty. Later tempered in Wilkes v. Springside Nursing Home (1976) the court determined its role to weigh the legitimate business purpose, if any, against the practicability of a less harmful alternative.

In re Caremark International Inc. Derivative Litigation (Ct. Chancery Del. 1996) [Breach of Duty of Care]

Derivative suit brought against Caremark's board of directors for breach of duty of care failed to show violation. In 1991 the United States Department of Health and Human Services initiated an investigation of Caremark's predecessor. Throughout the investigations Caremark had an internal audit plan designed to assure compliance with business and ethics policies. A settlement was reached whereby Caremark agreed to pay a fine and agreed to certain terms in exchange for the continued ability to contract with Medicare and Medicaid programs. The claim is that the directors allowed a situation to develop and continue which exposed the corporation to enormous legal liability. The Court held absent grounds to suspect deception, neither corporate boards nor senior officers can be charged with wrongdoing simply for assuming the integrity of employees and the honesty of their dealings on the company's behalf. It is important that the board exercise a good faith judgment that the corporation's information and reporting system is in concept and design adequate to assure the board that appropriate information will come to its attention in a timely manner as a matter of ordinary operations.

Shareholder Voting

Each share of common stock carries one vote. Shareholders vote on the election of directors and on certain fundamental transactions: amending the corporation's charter; amending the bylaws; approving a merger; approve the sale of assets not in the ordinary course of business; approving the dissolution of the company; and to ratify conflict-of-interest transactions. Majority vote wins except in director elections, when only a plurality is required.

Deadlock

Evenly divided shareholder vote. Usually leads to dissolution of a corporation. If the shareholders cannot agree to dissolve then the corporation may be judicially dissolved upon a showing of deadlock.

LLC Limited Liability

Every member of the LLC has equal management rights (member managed) unless the members provide for centralized management (manager managed) in the organizing documents. Members and managers of an LLC are responsible for their own acts or omissions and for obligations undertaken by agreement, but they are not personally responsible for the acts, omissions, or obligations of other members.

Prices of Buy-Sell Agreement

Fixed Price, which must be updated constantly to reflect the current value of the shares; Book Value, based on historical costs and may not reflect true underlying values; Appraisal, parties should decide beforehand on what basis to appraise; and Formula, which is complicated.

Gagliardi v. Trifoods International, Inc. (Ct. Chancery Del. 1996) [Business Judgment Rule]

Gagliardi, founder of TriFoods brought suit against the directors of TriFoods for mismanagement and waste. Gagliardi disagreed with the president on the direction to manufacture the products itself, the buying of another plant and relocation to another state, the duplicative and therefore wasteful procurement of a research facility, and the purchase of exclusive rights to Steak-umms. In the absence of facts showing self-dealing or improper motive, a corporate officer or director is not legally responsible to the corporation for losses that may be suffered as a result of a decision that an officer made or that directors authorized in good faith. The business judgment rule provides that where a director is independent and disinterested, there can be no liability for corporate loss, unless the facts are such that no person could possibly authorize such a transaction in good faith. Because there is no allegation of conflict of interest nor any alleged improper motivation the complaint is dismissed.

Supermajority Voting - Adoption

Give minority shareholders veto power over corporate decisions through high quorum and voting requirements. Under Delaware law supermajority requirements can be adopted through a simple majority vote. Model Act requires the same vote as being proposed.

Delaware Approach to the Minority Shareholder

Holds there should not be any special, judicially-created rules to protect minority stockholders of closely-held corporations. Nixon v. Blackwell (1993) held a stockholder who bargains for stock in a closely-held corporation can make a business judgment whether to buy into such a minority position, and if so on what terms. One could bargain for definitive provisions of self-ordering through the certificate of incorporation or by-laws; may enter into definitive stockholder agreements and provide for earnings tests, buy-out provisions, voting trusts or other voting agreements. The tools of good corporate practice are designed to give a purchasing minority stockholder the opportunity to bargain for protection before parting with consideration. It would do violence to normal corporate practice and corporation law to fashion an ad hoc ruling which would result in a court-imposed stockholder buy-out for which the parties had not contracted.

Long Island Lightin Co. v. Barbash (2nd Cir. 1985) [Definition of Proxy Solicitation]

In a hotly debated contest over whether a utility company should be sold to the city, one shareholder, paid for ads on the radio and in the newspaper criticizing the company's management and encouraging citizens to replace the company with the state-run company. The proxy rules apply only to direct requests to furnish, revoke or withhold proxies, but also to communications with may indirectly accomplish such a result or constitute a step in a chain of communications designed ultimately to accomplish such a result. The question is whether the challenged communication, seen in the totality of the circumstances, is reasonably calculated to influence the shareholders' votes.

Unisuper Ltd. et al. v. News Corporation (Ct. Chancery Del. 2005) [Shareholder Voting Rights]

Institutional shareholders brought against News Corp when News Corp extended its poison pill without shareholder vote, which it had contracted that it would not do. The problem was that it was never written down, however, in a press release the board agreed to adopt a board policy that would not permit the pill to be rolled over. Defendants argue that Delaware law provides any limitation on directors must be in the certificate of incorporation. The court held this to be incorrect; rather the contract ceded power to the shareholders, not an outside group and as such the requirement does not apply. Delaware's corporation law vests managerial power in the board of directors because it is not feasible for shareholders, the owners of the corporation, to exercise day-to-day power over the company's business and affairs. When shareholders exercise their right to vote in order to assert control over the the business the board must give way because the board's power - which is that of an agent's with regard to its principal - derives from the shareholders, who are the ultimate holders of power under Delaware law.

Kiriakides v. Atlas Food Systems & Services, Inc. (S. Ct. S. C. 2001) [Definition of Oppression]

John and his sister Louise, minority shareholders in Atlas, brought suit against older brother Alex and Atlas for fraud and oppression and sought a forced buy-out of their shares. Atlas was a family owned business with Alex in charge. Alex named his son as president and kicked John out. Court held case-by-case determination of totality of the circumstances should be applied. The court looks for factors or typical patterns of majority conduct which tend to be indicative of oppression, such as exclusion from management, withholding of dividends, and paying excessive salaries to majority shareholders.

Stone v. Jetmar Properties, LLC (Ct. App. Minn. 2007) [LLC - Equitable Theories]

Keith Hammond drafted and signed articles of organization for Jetmar Properties but did not file them with the secretary of state. Stone, a retiree, quitclaimed a duplex to Jetmar. The next day Hammond mortgaged the duplex to Ortega in exchange for a loan. After failure to pay Ortega foreclosed the duplex. Stone filed suit for declaratory judgment that he was the owner of the duplex. The district court concluded that because Jetmar did not exist at the time of delivery, it was incapable of taking title and the quitclaim deed was void. The rationale for the abolition of de facto corporations is that the process for incorporating is so simple that no one could ever make a colorable attempt to incorporate and fail. While Stone treated Jetmar as a corporation when he executed the deed, the estoppel doctrine does not apply when the acts forming the basis for an estoppel claim are induced by fraud. A court may refuse to apply the doctrine of corporation-by-estoppel when the corporation is used to accomplish fraud.

Leslie v. Boston Software Collaborative, Inc. (Superior Ct. Mass. 2002) [Massachusetts Approach to Minority Shareholder]

Khayter, Goulart and Leslie entered into a partnership, Boston Software Collaborative, later incorporated as an S-Corp. Leslie brought suit against Khayter and Goulart for freezing him out, failing to pay him dividends and wrongful termination. Customers and employees complained about Leslie, he used office hours for personal work, cursed vocally and in email, and used the secretary's desk to hide his gun. Khayter and Goulart tried to get Leslie to leave by presenting him with Termination Agreements which Leslie refused. Leslie received notice of a shareholders meeting where a vote was taken for his removal. He sent in a proxy against removal. That same same day there was a directors meeting for which Leslie never received notice. Khayter and Goulart voted on Leslie's removal as Treasurer. Here, the majority terminated Leslie's employment, removed him as company treasurer, voted him off the board of directors and since have paid him no dividends or distributions. Leslie was hardly a model employee. At the same time, as a founder and a nearly one-third minority shareholder, he was entitled to the utmost good faith and fair dealing. Less harmful alternatives would be insulating Leslie from other employees, encouraged to go off-site more, directed to take courses and other creative compensation approaches. Court remedy was compensation for loss of employment, compensation for any amounts received by Khayter and Goulart in the nature of a dividend and provision for Leslie to be able to monitor the management of BSC and participate in the returns to shareholders.

Kimberlin v. Ciena Corporaiton (S.D.N.Y. 1998) [Preemptive Rights - Close Corp]

Kimberlin, an investment banker, seeded Ciena, a technology mfg, in return for placing future investments. In the second round of financing Kimberlin received preemptive rights. Included in the contract was a waiver which required a vote of 67% of shareholders to vote to enact. Kimberlin argued only disinterested shareholders should be counted but the court disagreed because the claimed interested parties would not benefit through increased proportion. Next Kimberlin argued the waiver was not in good faith. The court disagreed holding the contract was unambiguous and routine.

Formation of a LLC

LLCs are formed through a formal filing of a certification of organization (aka articles of organization) with the state. If the certificate of organization and the operating agreement conflict, under RULLCA the operating agreement controls with respect to members, while the certificate of organization controls with respect to third parties who reasonably rely on it.

Minno v. Pro-Fab (Ct. App. Oh. 2007) [Piercing the Corporate Veil]

Minno, while performing his duties as ironworker, fell 19ft and became paraplegic. Pro-Fab was the subcontractor for the project. Pro-Fab in turn subcontracted the work to See-Ann, who shares corporate ownership and offices with Pro-Fab. Minno contends that Pro-Fab is the alter-ego of See-Ann and is vicariously liable for his injuries. Minno was paid by See-Ann and considered by See-Ann to be its employee. Look to whether control over the corporation by those to be held liable was so complete that the corporation has no separate mind, will, or existence of its own; control over the corporation by those to be held liable was exercised in such a manner as to commit fraud or an illegal act against the person seeking to disregard the corporate entity; and injury or unjust loss resulted to the plaintiff from such control and wrong. Here, they shared the same business address and had the same corporate business and purpose. At one point, one man owned both. Some of the companies' employees, commonly work for both entities. Safety training is combined and both companies share a similar written safety and loss control program. Tools and supplies are also shared, and Pro-Fab provides the welding equipment that is used by both. Also, See-Ann carries no liability insurance.

Klang v. Smith's Food & Drug Centers, Inc. (S. Ct. Del. 1997) [Distributions - Contested Calculation of Limit]

No corporation may repurchase or redeem its own shares except out of surplus as statutorily (based on a solvency test) defined. Balance sheets are not, however, conclusive indicators of surplus or a lack thereof. Corporations may revalue assets to show surplus, but perfection in that process is not required. Directors have reasonable latitude to depart from the balance sheet to calculate surplus, so long as they evaluate assets and liabilities in good faith, on the basis of acceptable data, by methods that they reasonably believe reflect present values, and arrive at a determination of the surplus that is not so far off the mark as to constitute actual or constructive fraud. Stockholder brought suit claiming Smith's (a chain of supermarkets) had incorrectly calculated their surplus in a deal with Yucaipa (another chain of supermarkets). Smith's had hired an investment firm to make sure the deal would not cause any insolvency issues and in on reliance on that the board board enacted a resolution. The stockholders then approved the transactions. The General Assembly enacted the statute to prevent boards from draining corporations of assets to the detriment of creditors and the long-term health of the corporation. Allowing corporations to revalue assets and liabilities to reflect current realities complies with the statute and serves well the polices. Even a mistake in documentation does not negate the substance of the action.

Phelps v. Frampton (Mon. 2007) [Partnership Accounting]

One attorney in a law firm sued another for alleged breach of contract because the profits from a case were not equally distributed. It is clear that the $1.8 million is a fee earned, the allocation of which is governed by the Partnership Agreement. The Partnership Agreement reveals that the relationship among these lawyers allows a large fee-generating partner such as one doing contingency work, to retain a disparate proportion of fees compared to a partner billing only hourly.

Meinhard v. Salmon (Ct. App. N.Y. 1928) [Partnership Fiduciary Duties]

One of two business partners, without informing the other, entered into a contract with a third party to lease property at the conclusion of the partnership's lease. Here the subject-matter of the new lease was an extension and enlargement of the subject-matter of the old one. A managing coadventurer appropriating the benefit of such a lease without warning to his partner might fairly expect to be reproached with conduct that was underhand. Salmon had put himself in a position in which thought of self was to be renounced, however hard the abnegation. He was much more than a coadventurer. He was a managing coadventurer. Form him and for those like him the rule of undivided loyalty is relentless and supreme.

Tzolis v. Wolff (Ct. App. N.Y. 2008) [LLC Derivative Suits]

Pennington Property Co. LLC was the owner of an apartment building. Plaintiffs, owning 25% of the membership interests, brought suit claiming that those in control leased and sold the LLC's principal asset for an amount below market value; that the lease was unlawfully assigned; and that company fiduciaries personally benefited from the sale. The Court held that there was no clear legislative history eliminating derivative suits, hence LLCs can bring them. To hold that there is no remedy when corporate fiduciaries use corporate assets to enrich themselves is unacceptable. Derivative suits are not the only possible remedy but they are the one that has been recognized for most of two centuries, and to abolish them in the LLC context would be a radical step.

Benchmark Capital Partners IV, LP v. Vague (Ct. Chancery Del. 2002) [Conflict of Rights between Classes of Stock]

Plaintiff Benchmark invested in the first two series of Defendant Juniper's preferred stock. When additional capital was needed Defendant CIBC invested and became a controlling interest. Benchmark, holder of junior preferred stock, had a certificate stating its right to vote on corporation actions that would materially adversely change the rights, preferences and privileges of its stock. And entitled to vote before Juniper may authorize or issue any senior stock. The certificate also provided those rights may be waived by the senior stock holder as long as it doesn't impair the economic interests of the junior preferred holders. Realizing this restriction Juniper restructured itself to avoid the restriction. Juniper argues that the harm comes from the merger and not the amendment of the certificate, none of the certificate provisions apply to mergers. Court looked at the statutory language, which did not mention mergers, the certificate's language, which only pertained to issuance of stock and held the merger is not implicated in the restrictions. However, the issuance of Series D stock to CIBC is but that issuance will only burden Benchmark and not diminish or alter it because of precedent which held issuance of shares of a security that has priority will not adversely affect the preferences or special rights of a junior security. The terms and powers of that particular class have not themselves been changed.

Elmaleh v. Barlow (Superior Ct. Mass. 2005) [Massachusetts Approach to Minority Shareholder]

Plaintiffs Elmaleh and other shareholders in Molecular brought suit against Barlow and Babich, controlling shareholders, for breach of fiduciary duty for reducing the price of their stock through a repricing plan. Barlow accused of lowering the price in order to sell to his friends. Barlow defended by saying Molecular was not a close corporation. Close corporation defined as (1) a small number of stockholders; (2) no ready market for the corporate stock; and (3) substantial majority stockholder participation in the management, direction and operations of the corporation. Court held because Molecular was actively seeking additional investment and had hired an outside placement agent to attract new and diverse investors the first prong failed. All agreed no ready market. Court held no majority participation since the active board only held 16% of the outstanding common stock. Court held Molecular was not a close corporation and as such Barlow and Babich, as shareholders, did not owe a fiduciary duty of utmost good faith and loyalty to the other shareholders.

Duty of Care

Primarily a procedural duty - a duty to make lawful decisions in a well-informed, careful manner. Part of the duty is is to be informed about what is happening within the corporation - to provide oversight. SOX requires ensuring there are systems in place to get financial information to the board on a timely basis so that directors can determine if the company is on target financially; ensuring that there is reason to believe the company's financial reporting is accurate (procedures in place that make sense and adequate financial controls); and ensuring that company has a functioning law compliance structure.

In re Phillips (S. Ct. Col. 2006) [Reverse Piercing the Corporate Veil]

Reverse piecing occurs when a claimant seeks to disregard the separate existence of a corporation and obtain the assets of the entity due to the actions of a dominant shareholder or other corporate insider. Connolly, the Chapter 7 Bankruptcy trustee of Debtor Phillip, brought suit to keep the assets within Philsax, of which Debtor was the dominant and controlling shareholder. In outside reverse piercing the corporate form protects the corporation which, through the acts of a dominant shareholder or other corporate insider, uses the legal fiction to perpetuate a fraud or defeat a rightful claim of an outsider. It is particularly appropriate to apply the alter ego doctrine in reverse when the controlling party uses the controlled entity to hide assets or secretly to conduct business to avoid the preexisting liability of the controlling party. Must show (1) the controlling insider and the corporation are alter egos of each other, (2) justice requires recognizing the substance of the relationship over the form because the corporate fiction is utilized to perpetuate a fraud or defeat a rightful claim, and (3) an equitable result is achieved by piercing. Here, Debtor removed and added directors without board approval and used the sale of corporate assets to pay for his personal expenses. The other shareholder, his wife, could not explain her role. Lacked a bank account, no bylaws, no notice of board meetings, no financial statements. The only creditors were personal creditors. If innocent shareholders would be prejudiced piercing would bot be warranted.

Mason Capital, Ltd. v. Kaman Corp. (D. Conn. 2005) [Supermajority Requirements]

Shareholder Mason brought suit to enjoin Kaman from completing a business combination until approved by 2/3 vote of disinterested shareholders. Connecticut law provided any business combination had to be approved by supermajority. Kaman has two class of stocks, one is publicly traded, the other is not and has voting rights. The Kaman family own 82% of the voting stock. The company wanted to restructure to free up assets and imbue the publicly traded stock with voting rights. Under the proposed plan the certificate of incorporation would be amended to replace the two-tier stock with one tier. Holders of the voting stock would be entitled to convert their shares. The plan would prevent the Kaman family from increasing ownership by more than 5%, the trigger under Conn. law for a business combination. Because of this, supermajority voting was not required, since change in ownership was less than 5%.

Niato v. Niato (Ct. App. Ore. 2001) [Minority Oppression Remedy]

Shareholder plaintiffs brought suit against the company and controlling shareholder for minority oppression. Two brothers ran the company, a Japanese gift shop wholesaler and retailer. When one brother died the other effectively took control, did not adhere to the buy-sell agreement and effectively forced the dead brother's family out. Court held remedy was to force dividends for five years, at rates determined by the board at a prior board meeting, and the court to continue monitoring.

First American Title Ins. Co. v. Lawson (N.J. 2003) [Partnership Management - Analysis]

Snyder in no way participated in the fraudulent conduct of his fellow partners. Lawson testified that Snyder did not engage in any misappropriation and had no knowledge of any improprieties or that the firm was foundering. Further, Lawson did not inform Snyder of the grievances filed with the OAE or that the OAE had demanded an audit. Snyder also was a distant partner in the sense that he did not share offices with Lawson and Wheeler, but instead conducted his practice in a separate office that he alone maintained. Because he did not issue checks from the firm's accounts, Snyder presumably was unfamiliar with the firm's trust-account ledger or with similar records. Those facts require us to consider Snyder an innocent partner for purposes of balancing the equities. Further, by organizing the firm as a limited liability partnership, Snyder had every reason to expect that his exposure to liability would be circumscribed in accordance with the Uniform Partnership Law. Also, it would leave members of the public, whom Snyder had represented unprotected even though the insured himself committed no fraud.

Holmes v. Lerner (Cal. App. 1999) [Partnership Formation]

The agreement here, as presented to the jury, was that Holmes and Lerner would start a cosmetics company based on the unusual colors developed by Holmes, identified by the Urban theme and the exotic names. The agreement is evidenced by Lerner's statements" We will do . . . everything," "[i]t's going to be our baby, and we're going to work on it together." The additional terms were filled in as the two women immediately began work on the multitude of details necessary to bring their idea to fruition. The fact that Holmes worked for almost a year, without expectation of pay, is further confirmation of the agreement. Lerner and Soward never objected to her work, her participation in board meetings and decisionmaking, or her exercise of authority over the retail warehouse operation. Holmes was not seeking specific enforcement of a single vague term of the agreement. She was frozen out of the business altogether, and her agreement with Lerner was completely renounced. The agreement that was made and the subsequent acts of the parties supply sufficient certainty to determine the existence of a breach and a remedy.

Proxy Voting

The authorization given by a shareholder to another person to vote the shareholder's shares. Based on securities law, management must indicate to shareholders how they will vote on every item coming up on the agenda as part of the process of soliciting proxy authority.

Proxy

The authorization given by a shareholder to another person to vote the shareholder's shares. The holder of a proxy is an agent subject to the control of the shareholder and having fiduciary duties to the shareholder.

Indenture

The bond contract that specifies the procedures for issuance, payment, redemption, and discharge. Also contains the covenants which are promises by the corporation to perform certain actions. Also specifies the events of default which are certain events that will allow the bondholders to accelerate payment.

Capital Structure of a Corporation

The combination of claims sold by the corporation. Divided into equity claims and debt claims.

Treasury Shares

The corporation repurchases the shares, the corporation may continue to hold them as shares issued but not outstanding. They are not voted by the corporation, and they may be resold for any price determined by the board, even below par value. The Model Act eliminates the concept of treasury shares, providing the shares acquired by the corporation are authorized by unissued.

Public Corporation Control Structure

The formal mechanisms of control are exercised primarily by the board of directors, which has the statutory power to manage the affairs of the corporation. Shareholders control the directors, if at all, through annual elections of directors an through voting on specific proposals, when allowed.

Closely Held Corporation Control Structure

The formal mechanisms of control are exercised primarily by the shareholders, who often govern by prior agreement embodied in contracts among themselves. So dominant are shareholders in the close corporation that many states permit them to eliminate the board of directors.

Moral Hazard

The major potential social cost of limited liability is that people who have limited liability have an incentive to engage in riskier than optimal activities because they are not forced to bear the total costs of such behavior. Limited liability does not impose social costs in very type of transaction, however. In transactions involving the corporation and voluntary creditors (particularly lenders, but possibly employees, consumers, and trade creditors), the firm will be forced to pay for the freedom to engage in risky activities; therefore society theoretically will bear no extra costs. If the firm cannot make credible promises to refrain from taking excessive risks, it must pay higher interest rates. It's the involuntary creditors (tort victims), that suffer social cost. Insurance may internalize some of these costs, but not all.

Buy-Sell Transfer Restrictions

The most common of transfer restrictions. Solve many problems in close-corporations: (1) they provide liquidity for shareholders who wish to withdraw; (2) they determine the price of the shares at a time when none of the parties to the agreement knows which of them will be the sellers and which will be the purchasers (thus providing an incentive for a fair price); and (3) they allow the principals of the corporation to plan with some certainty.

Ronnen v. Ajax Electric Motor Corp (Ct. App. N.Y. 1996) [Shareholder Agreements - Close Corp]

The opposing parties are brother and sister, who hold a majority of the issued and outstanding shares of Ajax, a closely held corp. In question is the election of the board of directors. A shareholders agreement granted the brother the right to vote the sister's stock. At a shareholders' meeting the brother got upset that it was being videotaped by the sister's attorney and used the agreement to vote her stocks to adjourn the meeting. After he left the sister along with the remaining shareholders elected new directors. The agreement provided the brother with the voting proxy on Ajax's day-to-day operations and corporate management while leaving the sister with other major corporate policy decisions. Interpreted as brother with the right to vote on board of directors and sister with corporate mergers. Court affirmed that a new election should be held.

In re Keck, Mahin & Cate (Bankruptcy Ct. N.D. Ill. 2002) [Partnership Liability to Third Parties]

The plan administrator for a law firm in bankruptcy sought determination of the liability of partners who declined to pay a specified settlement amount for the partnership liabilities. A partner cannot escape liability simply by leaving the partnership after the malpractice is committed but before the client wins or settles a malpractice claim. Withdrawing partners remain liable for matters pending at the time of dissolution. Dissolution of the partnership does not of itself discharge the existing liability of any partners. In addition, partners cannot release one another from liability to third parties. Law requires consent by the third party itself to release the liability of any partner. The consent may be express or inferred based on the third party's course of conduct after it learned of the dissolution.

Classified Shares

The primary purpose of classifying shares is to allocate control among the various classes of shareholders.

Shareholder Proposals Rule 14a-8 - Reasons to Exclude

The proposal is improper under state law (shareholders cannot command directors to do something, they must recommend or suggest); proposal is not relevant (relates to less than 5% of company's total assets or less than 5% of its net earnings or gross sales unless it raises significant social policy issues related to the company's business); relates to ordinary business/management functions (operational details unless it raises important public issues); and relates to elections.

Preemptive Rights

The rights of a shareholder to subscribe to the portion of any increase in a corporation's capital stock necessary to maintain the shareholder's relative voting power as against other shareholders. May be granted or denied by the articles of incorporation.

Types of Transfer Restrictions

The shareholder must offer the corporation or other shareholders the option to purchase the shares; the corporation or other shareholders are obligated to purchase the shares (buy-sell); the corporation or other shareholders must approve the transfer of the shares (consent); the shareholder is prohibited from transferring to certain persons or classes of persons (typically struck down by the courts as unreasonable).

Phelps v. Frampton (Mon. 2007) [Partnership Fiduciary Duties - Good Faith and Fair Dealing]

To maintain a claim for breach of the implied covenant of good faith and fair dealing, it is insufficient to present evidence that the other party acted in bad faith, e.g., by holding "secret meetings" or breaking promises. The claimant must also come forward with evidence sufficient to support the conclusion that as a result of the other party's action, the claimant was deprived of a benefit or a justified expectation under the contract. Whether the claimant's expectation was justified depends on the various circumstances that surround the parties' relationship. The aggrieved partner must come forward with evidence sufficient to support the conclusions (1) that the other partner discharged a duty or exercised a right under the partnership agreement inconsistently with the obligation of good faith and fair dealing and (2) that, as a result of this action, the aggrieved partner was deprived of a benefit or a justified expectation created by the partnership agreement.

Partnership Accounting - Capital Account

Tracks each partner's ownership claim against the partnership. Determined by the contributions made by each partner to the partnership; each partner's share of profits or losses from operations; any withdrawals of funds from the partnership; and each partner's gains or losses upon sale of the partnership or its assets. Does not reflect loans made by partners to the partnership. A negative balance means the partner owes the partnership.

The Plight of the Minority Shareholder

Traditional corporation laws contemplate centralized control in the board of directors and majority rule, but close corporations are characterized by shareholder participation in management and by the lack of a public market for the corporation's shares. When traditional corporation laws are applied to close corporations, minority shareholders are vulnerable to harm at the hands of the majority. In the classic oppression scenario, a majority shareholder terminates the minority shareholder's employment and refuses to declare dividends. Thus cut off from any financial benefiot from his equity investment, the minority shareholder might attempt to exit, but the absence of a public market for the corporation's shares may foreclose this option.

Smith v. Van Gorkom (S. Ct. Del. 1985) [Breach of Duty of Care]

Trans Union, a publicly traded railcar leasing company, had hundreds of millions in cash flows but due to investment tax credits could not show a profit. The CEO, Van Gorkom, decided the sale of the company to another company with large amounts of taxable income would solve the problem. The CFO looked at a media article which detailed leveraged buy-outs. The record is completely void of any reason why Van Gorkom chose the $55 per share purchase price. Van Gorkom proposed the sale to the senior management, which objected to the sale. The next day a board meeting was held, all ten directors were present, five inside and five out. It lasted about two hours. Based solely on Van Gorkom's representations, legal counsel's advice that if the sale did not occur they might be sued, and the president's representations the directors approved the sale. The court held the board did not make an informed business judgment because the directors (1) did not adequately inform themselves as to Van Gorkom's role in the sale and establishing the price; (2) were uninformed as to the intrinsic value of the company; and (3) were grossly negligent in approve the sale upon two hours consideration, without prior notice, and without the exigency of a crisis or emergency. Could not use the later approval by the stockholders as justification because the board did not disclose all material facts to them.

Fischer v. Fischer (Ken. 2006) [Partnership Dissolution]

Two parties entered into a partnership to purchase, lease and sell real estate. When one of the partners died the widow wanted the partnership dissolved and interests distributed. The existing partner wanted to continue business. Prior to the partner's death he wrote a letter stating his intent to disassociate and dissolve the partnership. First, the court determined the partnership was for a particular undertaking because the land named in the contract was to be bought, leased and sold, meaning it could be accomplished at some point in the future. The absence of an exact date for accomplishment does not change the agreement. Additionally, the specific address was included. Dissolution must be unequivocal and this one was not. If it was unequivocal the surviving partner could sue under a breach of contract theory for wrongful dissolution (because it was before the selling). Dissolution occurred only upon the partner's death.

Gibbs v. Breed, Abbott & Morgan (Ct. App. N.Y. 2000) [Partnership

Two partners left one partnership to join another, taking personnel and personnel information with them. The members of a partnership owe each other a duty of loyalty and good faith. Uphold liability determination which found that plaintiffs breached their fiduciary duty as partners of the firm they were about to leave by supplying confidential employee information to the other while still partners. However, there is no breach with respect to Gibbs' interactions with Sheehan, or with respect to either partner's removal of his desk files. By contrast to the lawyer-client relationship, a partner does not have a fiduciary duty to the employees of a firm which would limit its duty of loyalty to the partnership. Thus, recruitment of firm employees has been viewed as distinct and permissible than solicitation of clients. Pre-withdrawal recruitment is generally allowed only after the firm has been given notice of the lawyer's intention to withdraw.

D.R. Horton Inc.-New Jersey v. Dynastar Development LLC (N.J. 2005) [LLCs - Piercing the LLC Veil - Rule]

Two-part test to veil pierce - the plaintiff must prove that the subsidiary was a mere instrumentality or alter ego of its owner. The parent or owner so dominated the subsidiary that it had no separate existence but was merely a conduit for the parent. Second, the plaintiff must prove that the parent or owner has abused the business form to perpetrate a fraud or injustice. Dominance and control requires proof of the complete domination and control of both the entity's policy and business practices. The alter ego factor is generally employed where two corporations are realistically controlled as one entity. Abuse of the privilege has been evidenced by facts that demonstrate some form of misrepresentation, deceit, undercapitalization, or other form of injustice.

Shareholder Voting Rights

Under state law common shareholders have the right to determine who will be on the board of directors, fundamental transactions, amendments to the charter or bylaws, and shareholder proposals.

Transfer Restrictions 2 Part Test

Valid if (1) the restrictions comply with the formal requirements relating to the adoption of the restriction and conspicuously noted on the share certificates and (2) the restrictions are for a proper purpose. Proper purpose meaning reasonable.

Supermajority Voting - Amendment under DGCL

When supermajority voting requirements appear in the charter, they can be amended or repealed only by the greater vote specified in the charter provision. No restriction if in the bylaws, only need a majority vote. No restriction on quorum requirements.

Separation of share ownership from effective control

While shareholders are the owners of the corporation, their powers of control over the corporation are limited, the limited control is reactive - electing a board of directors remitted by the current managers. Managers of large public corporations have the power to make almost all of the decisions in the corporation, from what pencils to buy to what companies to buy. Centralized power is necessary on a day-to-day basis otherwise it would be impossible to put every decision to a shareholder vote. Centralized power also ensures that someone with management expertise and knowledge in the relevant field is making decisions. What's in question is how to ensure the decisions are made in the best interest of the corporation and shareholders.

Transfer Restrictions

Widely used to control selection of business associates, to provide certainty in estate planning, and to ensure that the corporation complies with close corporation statutes, S corporation regulations, or securities act exemptions. Imposed in the charter or bylaws or in a separate agreement among shareholders or between shareholders and the corporation.

Equity

connotes a power to control, usually by voting, and the right to receive the fruits of the business through dividends, distributions, and liquidation, if necessary

Debt

connotes some fixed obligation of repayment independent of the success or failure of the business

Material Fact

information a reasonable shareholder would consider important in deciding how to vote. There must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available.

Public corporations

whose shares are owned by a large number of investors and are traded in the public securities markets

Close held corporations

whose shares are owned by a small number of shareholders without access to the public securities markets