Business Associations Outline

I. The Law of Business Associations—Efficiency vs. Accountability

a. Revenue – (Operating Costs + Transaction Costs + Agency Costs) = Profit
b. Facilitate Efficient Business Transactions
i. Reduce costs associated with joint production
ii. Reduce costs associated with misbehavior
c. Promote Accountability
i. Protect those within the firm from bad actors who abuse the firm’s resources for their
own benefit
ii. Protect those outside the firm from negative consequences of bad business actions

II. Sole Proprietorship

a. Single business owner (but can have multiple employees)
b. Hires other factors of production (staff, supplies, etc)
c. Personally liable for business obligations
d. No separation b/w the business and the owner (not a legally separate entity from the person)
e. This is the most common business form for small businesses

III. Agency Relationships

a. What is it? A fiduciary relationship that arises when one person (P) manifests assent to another
person (A) that the agent shall act on P’s behalf and subject to P’s control and the agent
manifest assent or otherwise consents to so act (Restmt. (3rd) Agency § 1.01)

b. How is it formed?
i. Key Elements
1. Consent: mutual consent; P manifest consent to A’s action, and A consents to
engage in such action
2. Benefit: A’s action is on behalf of (or benefits) P
3. Control: A is subject to P’s control
ii. Three Step Inquiry
1. Identify P, A, and T in each case
2. Identify who is suing whom? (usually T suing P, but could be A)
3. Ask whether agency relationship is formed b/w P and A which might enable T to
go after P
iii. Based upon objective expressions of P&A, subjective intentions irrelevant, outward
conduct is what is important, no contract necessary

c. Policy Arguments
i. Least Cost Avoider: easier to impose liability on the owner as the person in the best
position to protect against these types of losses.

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d. Liability in Contract---Does A have the power?
i. Three Step Analysis
1. Has the A entered into a contract or committed a tort?
2. Did the A have “authority” to enter contract
3. Was authority actual, implied, inherent, other?
ii. Actual Authority (Restmt (Third) § 3.01)
1. Requires a manifestation b/w P and A that makes it reasonable for A to assume
he could act on P’s behalf
2. Two Step Inquiry
a. What did P do or say to A? (objective manifestations)
b. Was it reasonable for A to believe that P’s words or conduct authorized A
to act for P?
3. Two forms of Actual Authority
a. Express Actual: actually saying “I give you authority”; can be verbal or
written
b. Implied Actual (Restmt 2nd § 26):
i. conduct by P which can be reasonably interpreted by A that P
desires him to act on P’s account
ii. can be done through past practice, incidental acts (Restmt § 35),
and customary practice
iii. Act of putting agent in such a position leads AGENT to reasonably
believe he has the authority
iii. Apparent Authority (Restmt 2nd § 8 and § 27, Restmt. 3rd § 2.03 and § 3.03)
1. Determined by third party’s perspective for apparent authority…it’s what the
third party reasonably believed
2. Created as to a third person by written or spoken words or any other conduct of
P which, reasonably interpreted, causes the third person to believe P consents to
have the act done on his behalf by A
3. Can be express or implied apparent authority
a. Implied apparent authority is the act of putting agent in such a position
leads to a THIRD PARTY to reasonably believe agent has authority
4. Expands liability for P, b/c P doesn’t have a relationship with the third party. P
could even tell A NOT to do something, but if A never told the third party that,
and it’s reasonable for third party to believe A has the authority, then P is liable.
5. Two Step Inquiry
a. What did P do or say to T? (objective manifestations)
b. Was it reasonable for T to believe that P’s words or conduct authorized A
to act for P?
iv. Inherent Agency Power
1. Restmt 2nd § 8A---indicates the power of an agent which is derived not from
authority or apparent authority, but solely from the agency relation and exists
for the protection of persons harmed by or dealing with a servant or other agent
2. Elements of Inherent Agency Power w/ Undisclosed P

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 a. A was a general agent for an undisclosed P and had authority to conduct
some types of transactions
b. The transactions in question were usual or necessary in such a business,
AND
c. A was acting on P’s account (in P’s interest)
3. Restmt 3rd § 2.06—an undisclosed P is liable to a third party who is justifiably
induced to make a detrimental change in position by an agent acting on P’s
behalf and w/out actual authority, if P, having notice of A’s conduct and that it
might induce others to change their positions, did not take reasonable steps to
notify them of the facts
v. Estoppel
1. Relevant when you can’t prove the elements of classic agency but are still
entitled to relief
2. Elements (Rest. 2nd § 8B)
a. P creates through intentional or negligent words, acts or omissions, an
appearance of authority on behalf of the agent
b. T reasonably and in good faith acts in reliance on such appearance of
authority; and
c. T changes position in reliance upon the appearance of authority
3. Similar to apparent authority, but it is NOT an agency doctrine
a. Estoppel requires detrimental reliance
b. Restmt 3rd says estoppel is for situations where there is no
“manifestation”
c. Estoppel does NOT bind the third party, only the principal
vi. Ratification
1. Affirmance by a person of a prior act which did not bind him, but which was
done professedly on his account, whereby the act, as to some or all persons is
given effect as if originally authorized by him (Restmt 2nd § 82)
2. Transactions can be ratified in 4 ways
a. Express affirmance by P
b. Implied affirmance through acceptance of the benefits (at a time when
it’s possible to decline to accept such benefits)
c. Implied affirmance through silence or inaction
d. Implied ratification through bringing a lawsuit to enforce the contract
3. Must have INTENT to ratify AND must know all the material facts relating to the
transaction
4. Restmt 3rd § 4.01-4.08

e. Liability in Tort
i. Two Step Analysis
1. Was there a Master/Servant relationship?
a. If yes, was it within the scope of employment? If yes, P is liable. If no, P is
not liable

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 2. If there is not master/servant, relationship, P is not liable b/c person is
independent contractor
ii. Respondeat Superior “let the master answer”
1. Master is subject to liability for the torts of his servants committed while acting
in the scope of their employment (Rest. 2nd § 219)
2. An employer is subject to liability for torts committed by employees while acting
w/in scope of employment (Rest. 3rd § 2.04)
3. Liability is considered vicarious liability
4. Must prove the element of control for the agency relationship (threshold is way
higher for respondeat superior to apply)
5. This theory enhances efficiency b/c if employer is dictating the actions of the
employee, than the employer is in a better position to mitigate damages; theory
enhances accountability b/c employee is only following directions, so employer
is accountable if the directions given end up causing harm
6. Rest 2nd § 220(2)---factors for the control element in the test for vicarious
liability
7. Agents vs. Non-agents
a. All servants or employees are agents
b. Independent contract may be agents, but some are not
c. P is only vicariously liable for torts of servant agents within the agent’s
scope of employment
8. Franchisor/Franchisee relationships
a. These are the gas station/oil cases (Humble Oil v. Martin, Hoover v. Sun
Oil)
b. Issue is whether the franchisor had enough control over the day to day
operations and conduct of the agent to be vicariously liable (see factors
in Rest. §220(2))
c. If a franchise contract so regulates the activities of the franchisee as to
vest the franchiser with control within the definition of agency, the
agency relationship arises even though the parties expressly deny it
9. Rationales for Respondeat Superior
a. Cheapest/Least Cost Avoider—If P has day to day control over
employees, P can most easily avoid harm by standardizing processes etc
b. Risk Spreading—P can spread risk over operations by taking out insurance
policies, passing risk to consumers, etc in order to spread risk
c. Enterprise Liability—if P is benefitting from whatever activity employee is
undertaking, P should also be responsible for the liability/cost of the
activity
iii. Scope of Employment
1. Master is liable for torts of Servant so long as Servant is acting “in the scope” of
employment (Rstmt. §219(1)
2. Restmt. §§ 228-229---“of the type he is employed to perform, occurs w/in
authorized time and space limits, and it serves the Master’s interests

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 3. Ask three questions
a. Was the conduct of the same general nature as, or incident to, that which
the servant was employed to perform?
b. Was the conduct substantially removed from the authorized time/space
limits of the employment?
c. Was the conduct motivated at least in part by a purpose to serve the
master?
4. Bushey v. US Foreseeability Test—changed language from “purpose to serve the
master” to “out of and in the course of his employment of labor”; this greatly
expanded liability for P’s (foreseeability is subjective); increased accountability
but decreased efficiency b/c nobody knew what to protect against
5. Scope of Employment Restmt. 3rd § 7.07
a. Replaces “time and space” element with “when performing work
assigned by the employer”
b. This one returns us to the “purpose to serve the master” theory
iv. Servants vs. Independent Contractors
1. Servants: physical conduct subject to control or right to control
2. Ind. Contractors: physical conduct not subject to control
3. Ind. Contractors may impose liability for:
a. Ultra hazardous activities
b. Inherently dangerous activities (nuisance per se)
c. Nondelegable duties
d. When P retains actual control over the aspect of the work
e. Incompetent contractor

f. Fiduciary Duty
i. Inward consequences between the principal and the agent
ii. Restmt 2nd § 13—definition of fiduciary duty and lists the duties
iii. Easier to establish a breach of fiduciary duty than a breach of contractual duty (burdens
are often shifted against those who are classified as fiduciaries)
iv. May have great remedies for breach of fiduciary duty than breach of contractual duty
(tort remedies, and not just contract remedies, are available for breach of fiduciary
duty, including punitive damages)
v. Duty of Loyalty (Restmt 3rd § 8.02 and Restmt 2nd § 387)
1. Duty not to compete
2. Duty not to act for one with competing interests
3. Duty not to use or disclose confidential information
4. Usurp Corporate Opportunities from P
5. Secret Profits (kickback, bribes, gratuity—Restmt § 388)
6. Abuse of position
vi. Duty of Care (Restmt 2nd § 379 and Restmt 3rd § 8.08)
1. Act with care, competence and diligence normally exercised by agents in similar
circumstances

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 g. Termination of the Agency Relationship
i. Agreement of the parties—contract states when it will end
ii. Agency at will—at common law, agency is presumed to be “at will” and terminable by
either party at any time after notice
1. Revocation—P revoked authority of agent to act
2. Renunciation—Agent notifies P they quit
iii. Fulfillment of the purpose of the agency relationship (completion of task)
iv. By operation of law—term occurs automatically (upon death of either party)

IV. General Partnerships

a. Formation and Fiduciary Duties
i. Relationship is b/w 2 people who are equal; different from an agency relationship,
which is more hierarchal
ii. “An association of two or more persons to carry on as co-owners a business for profit”—
UPA (1914) § 6(1)---UPA is kinda like the UCC…it’s the default rule, if the contract is
silent, then the UPA governs; RUPA is the newer version (1997), but need to know both
iii. Advantages of Partnership
1. Simplicity
2. Single Layer of Taxation (partnership is not a taxable entity)
3. More resources than sole proprietorship
4. Cost sharing/Risk Sharing
5. Broader skill/experience base relative to sole proprietorship
6. Longevity
iv. Disadvantages of Partnership
1. Unlimited liability---can burn thru partnership funds and go to individual funds to
satisfy liability/debts (similar to sole proprietorship)
2. Potential for conflict
3. Expansion, succession, and termination issues
v. Seven Key Attributes of any Business Organization
1. Formation—Does the org require formal creation under state law?
2. Legal Personality—does the org have a legal personality separate from that of
the owners?
3. Ownership & Control—do the org default rules require separations of ownership
and control?
4. Free transferability—does the org form have freely alienable or transferable
ownership interests?
5. Duration—does the org have a potentially indefinite duration?
6. Limited Liability—does the org form provide limited or unlimited liability for its
owners?
7. Taxation—how is the corporate entity’s income taxed? Double taxation or pass
thru taxation?
vi. Key Attributes of Partnership

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 1. Partners are agents of partnership (EXTERNAL consequence) (UPA § 9)—have
both actual and apparent authority to bind partnership
2. Partners are liable as principals (EXTERNAL consequence) (UPA § 15)
a. All partners are liable jointly and severally for everything chargeable to
the partnership (creditor can collect entire amount from any of the
partners)
b. Jointly for all other debts and obligations of the partnership (you have to
name all the partners, not just an individual)---RUPA fixed this one
c. RUPA § 306(a)—all partners are jointly and severally liable for all
obligations of the partnership unless otherwise agreed by the claimant or
provided by law
3. Partners share in profits and losses of business (INTERNAL consequence) (UPA §
18)—partnership agreement can specify a different split
4. Partners share jointly in management/control of business (INTERNAL
consequence) (UPA § 18)
a. When the partners disagree in ordinary partnership issues, they resolve
their differences by majority vote, §18(h), with each partner having one
vote., §18(e).
vii. Common Clauses in Partnership Agreements
1. Ownership of partnership and partnership assets—presumed to be equal unless
otherwise stated
2. Accounting procedures—including maintenance of capital account belonging to
each partner, etc
3. Distribution of profit/loss—presumed to be equal unless otherwise stated
4. Liability of each partner to the other(s)
5. Compensation for services—presumed to be none unless stated otherwise
6. What happens if a partner resigns or dies—default rule is termination of
partnership
7. Dispute resolution—including arbitration clause, if desired
8. Termination
9. Others, including how notice is given, how agreement is modified, costs/attorney
fees, life insurance agreements
10. Agreements must be executed by both parties
viii. Drafting a Contract w/out Creating a partnership
1. Avoid terms like “partnership”, “partners”, “joint venture”, “venturers”
2. Include a disclaimer
3. If profits are shared, saying something like “Person A shall receive 55% of the
profits as payment for services as an independent contractor”—use express
language of UPA (1997) 202 (3)
ix. Duty of Loyalty and Duty of Care
1. Care: make reasonable decision, not make irrational decision that you are
sacrificing the business and not fulfilling your obligations; don’t act grossly
negligent; Good Faith and Fair Dealing; see Restmt 2nd § 379, or RUPA § 404C

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 2. Loyalty: if there is a benefit to the partnership, you should hold that opportunity
for the partnership and not use it for yourself only, unless the other partner
consents (can’t compete, can’t conflict, can’t take) (see Restmt. 2nd § 387, 393,
or RUPA § 404b or UPA § 21(1)—RUPA makes it pretty strict, but you can change
it (just cannot eliminate duty of loyalty), per RUPA § 103(b); duty of care cannot
be unreasonably reduced
3. Should reference Meinhard v. Salmon case on essay

b. Fiduciary Duties: Grabbing and Leaving

i. The Guillotine Clause—a 2/3 majority of the senior partners, at any time, may expel any
partner from the partnership upon such terms and conditions as set by said senior
partners
ii. Acts Triggering Dissolution (of a partner) UPA § 31 and 32
1. Natural Causes
2. Wrongful Causes
3. External Cause

c. Property and Management

i. Two main rights of a partner: Control rights (RUPA § 401(h)) and economic rights (RUPA
§ 401(b)).
ii. Property Default Rules (UPA § 24)
1. Right in specific “partnership property” (economic right)
2. “Interest” in the partnership (economic right)—done thru capital account
3. Right to participate in management (control right)
iii. At the time of inception, each partner contributes to the partnership, called Capital
Contributions. Can be money, labor, equipment etc.
iv. Capital Account (partner’s interest) consists of
1. Capital Contributions: made by each Partner to the partnership
2. Shares of P&L: from partnership operations
3. Withdrawals: periodic withdrawals of funds from the partnership
4. Gains & Losses: Upon sale of the partnership or its assets
5. Loans are not reflected in capital accounts (loans made by a partner must be
paid back first, before any of the partners gets paid out a share of profits/losses)
6. Extra services are also not reflected in capital accounts (must be paid in
additional salary or some other way)
v. Specific Partnership Property
1. Partner has a right to possess for partnership purposes, but has no right to
possess for personal or other purpose w/out the consent of the partners (UPA §
25(2)e)
2. Partner cannot assign this right, nor is it subject to attachment by the partner’s
individual creditors (UPA §25(2)b)---if individual partner has personal debt, the
partnership property cannot be taken
3. RUPA §204 has 3 rules for what Partnership Property is:

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 a. Any asset acquired in the name of the partnership, including
i. A transfer directly to the partnership in its own name
ii. A transfer to one or more partners acting in their capacity as
partners and the name of the partnership appears on the transfer
document
iii. If purchased with partnership assets
vi. Partnership Interest
1. Partner’s interest in the partnership is his share of profits and surplus, and the
same as personal property (UPA §26)
2. This interest is assignable and may be attached to any personal debt (UPA § 27
and § 28)
3. Definition of Partnership Interest RUPA § 102: A transferrable interest means
the right, as initially owned by a person in the person’s capacity as a partner, to
receive distributions form a partnership.
4. Transferable interest is personal property, and you can transfer your partnership
interest to someone else. But, you are only transferring the economic benefits of
the partnership, you are not making them a full partner with voting rights etc.
5. A partner who transfers his partnership interests to someone else remains a
partner (RUPA § 503(a)2). However, § 601(4) allows the expulsion of a partner
who transfers substantially all of his interests to someone else
vii. Continuation Agreement—governs what happens when there is a technical dissolution
of the partnership (ie, if someone dies). It’s just language in the partnership agreement
1. Cash Out Dissociated P interest
2. Form Successor Partnership
3. Continuing P’s rights
4. Transfer Assets
5. Hold harmless
viii. Aggregate Theory: the partnership is an aggregation of the partners, so when one
person leaves, the partnership is automatically dissolved
ix. Entity Theory: the partnership is its own entity, and so any one person leaving is not as
big of a deal
x. Asset Partitioning (RUPA § 306, 501, 504)
1. Affirmative Asset Partitioning—shielding the firm’s assets from the claims of the
personal creditors of the firm’s owners
2. Defensive Asset Partitioning—shielding the personal assets of a firm’s owners
from the creditors of the firm (aka “limited liability”)
xi. Right to Participate in Management: UPA § 18(h)—when the partners disagree on
ordinary partnership issues, they resolve the differences by majority vote, with each
partner having one vote
1. Some matters require unanimous consent (UPA §9(3))
a. Assigning partnership property
b. Disposing of goodwill
c. Doing any act that would make it impossible to carry on business

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 d. Confessing a judgement
e. Submitting a claim to arbitration
2. Most large partnerships have agreements that modify management rights
a. Delegation of decisions to a particular partners or committees
b. Changing one partner/one vote default
c. Changing unanimous consent requirements
d. Requiring super majority for certain decisions
3. Compare UPA § 20 and RUPA § 408(c)—this is on disclosures to partners

d. Dissolution
i. Three phase of demise of a partnership---dissolution, winding up, termination
ii. UPA § 29—change in the relation of the partners caused by any partner ceasing to be
associated in the carrying on as distinguished from the winding up of the business
iii. UPA § 30—on dissolution the partnership is not terminated, but continues until the
winding up of partnership affairs is completed
iv. Dissociation: The separation of a partner from the partnership (under RUPA, death of a
partner would be an example of dissociation); partnership agreement cannot eliminate
the option of a partner to dissociate; you always have the power to
withdraw/dissociate, but may not have the RIGHT to do so (which would be in the
partnership agreement); big question here is if the partner gets paid out or not and how
v. Dissolution: The point at which the partnership stops functioning as a forward
enterprise and begins to wind up its business (under UPA, everything is a dissolution)
vi. Effects of Dissolution on the Partnership
1. After dissolution, the partnership must be wound up, absent agreement among
the partners to carry on the business—assuming the business will not be
continued, the winding up process generally contemplates that the firm’s assets
will be distributed to the partners
2. Authority of partners to act on behalf of partnership terminated except in
connection with winding up of partnership business (UPA § 33 and RUPA § 804)
vii. Acts Triggering Dissolution under UPA (§ 31 and § 32)
1. Natural Causes
a. End of Express or Implied Partnership Term
b. Partner Expressly Withdraws from a Partnership at Will
c. Express Will of all Partners
d. Expulsion of a partner pursuant to agreement
2. Wrongful causes (RUPA § 602(b))
a. Partner expressly withdraws in violation of partnership agreement
(normally a withdrawal prior to the end of a “partnership for a term”)
3. External cause
a. Any event that renders partnership business unlawful
b. Death or bankruptcy of partner
c. Judicial Decree

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 4. Court Ordered Dissolution (UPA § 32)—upon application by a partner, court can
decree dissolution when
a. Partner has been declared “lunatic”
b. Partner becomes incapable of performing partnership duties
c. Partner has been guilty of conduct that tends to “affect prejudicially the
carrying on of the business”
d. Partner willfully or persistently breaches agreement or acts in a way such
that “it is not reasonably practicable to carry on the business
e. Partnership can only be carried on at a loss
f. Other circumstances render dissolution equitable
viii. Wrongful Dissolution
1. Critical question revolves around characterizing whether the dissolution that
occurred breach any express/implied terms in the P.A. (UPA § 31(2)
2. if answer is YES, then it’s wrongful. If answer is NO, then its rightful
ix. The Stakes of Rightful/Wrongful Dissolution under UPA § 38
1. Non Wrongful partners
a. Right to force liquidation and pro-rata distribution of partnership
property/assets
b. Option to continue partnership at termination with other partners who
remain
c. Right to bring legal action against “wrongful” party for breaching
partnership agreement
2. Wrongful partners
a. No liquidation right
b. No option to continue; can demand partnership interest minus any
damages
c. Subject to liability for breach
x. UPA § 40—partnership must pay off liabilities in the following order
1. Those owing to creditors other than partners
2. Those owing to partners other than for capital and profits (i.e, loans given to
partnership by a partner)
3. Those owing to partners in respect of capital (i.e., equipment partner purchased
for partnership) AND
4. Those owing to partners for profits
xi. Dissolution Five Part Inquiry
1. What type of partnership is it?
2. What is the cause of the dissociation?
3. Rightful or Wrongful?
a. Was it at will or for a specified term or undertaking?
b. It it’s at will, did the dissolving partner do something in violation of her
fiduciary duty that would nevertheless make it wrongful?
4. Court ordered?
5. UPA or RUPA?

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 xii. Term Partnerships
1. Explicit Terms
a. Duration specified in partnership agreement
b. Specific purpose/object specified in partnership agreement
2. Implicit Terms
a. Must be clear evidence allowing one to infer an agreement among the
partners that the partnership 1) has a minimum or maximum duration or
2) terminates at the conclusion of a particular venture whose time is
indefinite but certain to occur
xiii. Continuation per Agreement
1. Technically creates a new partnership
2. Creditors of former partnership automatically become creditors of new
partnership (UPA § 41)
3. Effect on Departing Partner
a. Departing partner entitled to accounting—the fair value of the
partnership and the interest from date of dissolution in event of
unreasonable failure to pay
b. Departing partner remains liable on all firm obligations unless released by
creditors (UPA § 36 and RUPA § 703)
4. Effect on New Partners
a. If new partner joins the firm when it continues after a dissolution, the
new partner is also liable for the firm’s old debts, but such liability can
only be satisfied out of partnership property (UPA § 41(1) and RUPA §
306(B)
i. New partner cannot be held personally liable for the old debts,
unless he/she expressly agrees to be so held
RUPA § 601

Dissociated Remaining
Dissociation
partner is partners
per Article 7
Partner bought out continue
Dissociates
Dissolution Partnership is Partnership is
per Article 8 wound up liquidated

xiv. Service Partner Exception (UPA § 18(a))---if you only contribute services and not money,
you are not liable for any money losses; this exception does not apply in RUPA
xv. Buyout under RUPA---if dissociation, dissociated partner has buyout rights (RUPA §
701(a)); if partners can’t agree on buyout amount, courts can intervene
xvi. Dissolution under RUPA follows only certain “dissociations” (RUPA § 801)
1. Express will of any partner in partnership at will
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 2. Expiration of term or completion of undertaking or express will of all partners to
end such partnership
3. Expiration of 90 days after death, bankruptcy or wrongful dissociation (unless
majority of partners agree to continue)
4. Judicial dissolution in certain circumstances
5. Application of a transferee in certain circumstances
6. Partnership business is unlawful
xvii. Key difference b/w RUPA and UPA on Wrongful Dissociation is that RUPA allows the
inclusion of goodwill in the valuation of the interest of the partner who wrongfully
dissolves
e. Limited Partnerships (RULPA 201)
i. In order for a limited partnership to be formed, a Certificate of Limited Partnership must
be delivered to the Secretary of State for filing (this is unlike a partnership, more like a
corporation)—name and name must indicate it’s a limited partnership, and name of
general partner(s)
ii. Must be one general partner and one limited partner
iii. Frequently used in oil/gas industry
iv. Defined as a partnership formed by 2 or more persons having one general and one
limited partner
v. Tax benefits to setting up a limited partnership (single taxation versus double taxation)
vi. Limited partner usually wants to be a passive investor only, just wants ROI. They are
only liable up to the point of what they invested, but gain/loss pass thru the partnership
to the investors (hence the tax benefit); limited partner only becomes liable as a general
partner if he “takes part in the control of the business”

V. Corporations
a. Formation
i. Key Corporate Attributes (why you form a corporation)
1. Limited liability for investors: shareholders not personally liable for corporate
debts
2. Centralized management: management by board of directors
3. Free transferability of shares: ownership rights can be sold as a unit
4. Legal personality: corporation is treated as a separate legal person
5. Continuity of existence: corporations does not end upon withdrawal of an
owner
ii. Structure of Corporations
1. Shareholders: considered to be the “owners”; make limited decisions; exchange
money for shares of stock—get the right to dividends and right to elect BOD; not
managers of the corp and they are not agents of the corp (left to BOD and
officers); can initiate bylaw changes; can have a corp with only 1 shareholder
2. Board of Directors/Officers: elected, run the corporate structure; make key
policy decisions/investment decisions; invest shareholder money to maximize
value and revenue for shareholders; elects the CEO and other officers; BOD are

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 not agents in the classic principal/agent sense—they have independence from
shareholders; fiduciary duties to the corp and the shareholders
3. CEO/COO/CFO (C-suite): run the day to day business; accountable to the BOD;
accountable to shareholders; officers are agents of the corp (specifically of the
BOD); authority to act for and to bind the corp originates in the BOD
4. Employees: no real rule on this, have very little power in corporate law
5. Creditors, Customers, and Community (considered “outside constituents”) are
important to the corporation, but are not really governed by an law or statutes---
they aren’t really protected
iii. Separation of ownership and control
1. Boards ACT (business decisions, oversight and ownership)
2. Shareholders REACT (at most)
3. Shareholders entitled to vote on
a. Election of directors
b. Any amendments to the articles of incorporation and bylaws
c. Fundamental transactions
d. Odds and ends, such as approval of independent auditors
4. Rights of Shareholders (take a chance in letting the BOD represent their
interests/wealth, which is considered the “agency cost” in the formula of
efficiency and accountability)
a. Vote on limited range of issues
b. Receive payment on dividends when and as declared by Board
c. Inspect corporate books and records
d. Receive distribution upon termination
e. Purchase proportional share of a new issuance or corporate stock to
maintain current ownership % (this is the Preemptive Right)
f. File derivative suit to redress wrong suffered by the corporation (any
damages recovered belong to the corporation)
g. Bylaw Proposal
i. Power to initiate changes to the bylaws
ii. Delaware: must have this power, charter can give BOD
concurrent power
iii. Model Act: providing the shareholders can amend a bylaw and
expressly state the BOD cannot, then amend, repeal or reinstate
that bylaw
iv. Shareholder initiated bylaw changes cannot undermine
management power
5. Role of Corporate Officers and Executives
a. Officers (aka executives) are hired by the BOD
b. Act as agents for the corporation and thus have fiduciary duties
c. Most states same person can be both officer and BOD member
d. Top Roles include: CEO, COO, CFO, CTO, CLO
6. Shareholder Voting

14
 a. Each outstanding share is entitled to one vote on each matter voted on at
a shareholder meeting (MBCA § 7.21(a))---there are some classifications
of shareholders that are non-voting (spelled out in articles of
incorporation)
b. Subject matter
i. Electing/removing directors (MBCA § 8)
ii. Amending Bylaws/Charter/Articles (MBCA § 10)
iii. Approving merger (MBCA § 11.03)
iv. Approving sale of company assets (MBCA § 12.02)
v. Approving dissolution (MBCA §14.02)
vi. Ratifying COI transactions (MBCA § 8.61(b)(2))
c. Board’s role in Shareholder voting
i. BOD administers the voting mechanism
ii. BOD oversees the voting procedures (location, date, advanced
notice requirements, tabulating votes)
iii. BOD sets the voting agenda (nominating candidates, size of BOD,
proposing amendments, recommend changes, seek approval for
compensation plans)
iv. Record Dates—MBCA § 7.07 and DGCL § 213(a)---date at which all
necessary info must be received so shareholders can have info in
advance of the voting date (for example, a June 1 record date for
a July 1 vote); all shareholders on June 1 get to vote
v. Entrenchment: incumbent boards can use the BOD voting related
powers to preserve their own incumbency by manipulating voting
procedures or erecting structural barriers
iv. Articles of Incorporation (what is filed with the state to create a corporation)
1. Name (Model Act § 2.02 and § 4.01)
a. You need an “Inc.” in most cases
2. Number of Shares (Model Act § 2.02 and § 6.01)
a. Need to specify how much of each class of stock (E.G. commons stock
and preferred stock)
3. Registered Agent (Model Act § 2.02(a)(3)
4. Purpose Clause (Model act § 2.02(b)(2)(1) and DGCL § 102 (a)(3)
5. Authority to BOD (Model Act § 8.01(b)
6. Amendments to Bylaws (Model Act § 10.03; DGCL § 242(b) and Model Act
10.20(a); DGCL §109
7. Number of Directors (Model Act 2.02(b)(2)(ii)
8. Exculpatory Provision (Model Act § 2.02(c)
v. Corporate Finance
1. Equity Securities = Ownership shares
a. Common Stock: receives dividends and has “residual claim” on business
b. Preferred Stock: Receives preference over common for dividends and
surplus

15
 2. Debt Securities = Fixed Claim for Principal + Interest
a. Trade Debt: money owned on credit to suppliers
b. Bank Debt: loans
c. Bonds: secured debt
d. Debentures: unsecured debt

b. Limited Liability & Piercing the Corporate Veil

i. MBCA § 6.22(b): a shareholder of a corporation is not personally liable for the
acts/debts of the corporation expect that he may become personally liable by reason of
his own acts or conduct
ii. Questions in PCV Analysis
1. Is it a close or public corporation? Are corps publically traded or no?—Piercing
occurs more often in closely held, b/c BOD and CEO and shareholders are all
kinda the same people
a. Close Corp: small number of shareholders, shares not traded on
secondary market, looks in practice a lot like a partnership
b. Public Corp: large number of passive shareholders, stocks listed on
secondary market (NYSE), centralized management
2. Is it a corporate tort or contract?
iii. Piercing Two Part test
1. Unity of Interest and Ownership (alter ego)
a. Lack of Corporate Formalities
b. Commingling of funds and assets
c. Severe Under-capitalization
d. Treating corporate assets as one’s own
2. Refusing to allow PCV would EITHER sanction a fraud OR promote injustice (this
prong is only for contract cases, b/c you want to make the tort victims easier to
recover)
iv. To avoid piercing, you want to have separation between all functions of the business
v. Piercing protects creditors and improves efficiency and accountability

c. The Role and Purpose of Corporations

i. Special Characteristics of For Profit Organizations
1. Main Purpose: generate profits for shareholders
2. Ownership: stocks (equity)
3. Taxation: Double taxation
4. Control: votes in relation to shares owned
5. No tax exemption under federal and state income tax codes and donors or
members may not receive tax deductible contributions
6. Broad purpose clause
ii. Agency Cost in the equation is the risk that the BOD and CEO won’t maximize profits for
the benefit of the shareholders. Shareholders delegate authority to the BOD and CEO to
make business decisions

16
 iii. Shareholder vs. Stakeholder Theory
1. Shareholder Approach: maximize profits, make decisions in accordance with
shareholder desires (b/c they are really the owners)
2. Stakeholder Approach: there is an additional social responsibility to the
community, in addition to maximizing profits
3. Shareholder approach is more common in practice; the default rules don’t
require it, but they definitely encourage this approach
iv. Business Judgement Rule (BJR) (comes from Aronson v. Lewis case---SITE ON EXAM)
1. Rebuttable presumption that a director acted in accordance with the proper
duty of care
2. Not statutory; was developed by courts
3. Operates at two levels
a. Shields individual directors from liability
b. Insulates board decisions from judicial review (“business judgement
doctrine”)
c. Plaintiff has the burden of proof to rebut the presumption
d. Gives corporations lots of discretion to make business decisions,
assuming they are furthering their duty of care to the corporation
e. BJR is overcome if director/manager actions:
i. Are not in the honest belief that action is in best interests of
corporation, or
ii. Are not based on an informed investigation, or
iii. Involve fraud, illegality, or conflict of interest
4. Shareholder Primacy: “A business corporation is organized and carried on
primarily for the profit of the stockholders. The powers of the directors are to
be employed for that end. The discretion of directors is to be exercised in the
choice of means to attain that end, and does not extend to a change in the end
itself, to the reduction of profits, or to the non-distribution of profits among
stockholders in order to devote them to other purposes.”

d. Employee Control/Worker Ownership & Cooperatives

i. Local 1330 v. US Steel
ii. Employee Stock Ownership Plans (ESOP): employees are shareholders with some
ownership rights
iii. Worker Cooperatives: the net return is back to the employees, not the shareholders;
mostly used in agricultural settings; structured more like partnership, not corp
1. Labor Primacy: membership rights (voting & financial) attach to role of worker
2. Democratic Worker Governance: one member, one vote
3. Internal Capital Accounts: Accumulated capital value retained within
cooperative and distributed to member upon departure

e. Non-Profits
i. Justifications for existence of non-profit sector

17
 1. Market Failure: consumption of goods that are hard to attribute costs
(maintaining parks, feeding the poor etc)
2. Government Failure: Government can only allocate resources that companies
do not, to the extent people vote for it. Most issues are local, so it’s easier for a
non-profit to handle it, if gov’t isn’t authorized to do it b/c they can’t get the bill
passed
3. Contract Failure: example of senior citizens…a for profit entity will want to
maximize profits, and not necessarily have another party (the senior citizens) to
appropriately evaluate the cost/benefit
ii. Special Characteristics of Non-Profit Organization
1. Main Purpose: organized for charitable, educational, civic, literary, cultural
purposes
2. Ownership: may have members rather than shareholders, but does not have to
have members
3. No Distributions: state law prohibits the org from paying dividends or
distributing income or profits to members and directors, but payment of
compensation for employees and officers is permitted
4. Democratic Control: one member, one vote
5. Taxation: exempt from federal and state taxation at the entity level; donations
are tax deductible
6. Narrow purpose clauses
iii. Obtaining Tax Exemption
1. State: must incorporate as a non-profit corporation under state law
2. Federal: Must apply to IRS for tax exemption; to qualify, must be organized and
operated exclusively for charitable and/or educational purposes
iv. Basic Default Set Up Rules
1. Name
2. Statement and description of the purposes of the organization
3. Name of agent for service of process
4. Names/addresses of original incorporators or directors
5. Statements of non-distribution and dissolution constraint statements
v. 501(c)(3) Criteria (must be in Articles of Incorporation)
1. Organized and operated exclusively for specific exempt purposes
2. No part of net earnings may inure to the benefit of private shareholders
3. No part of activities may constitute intervention or participation in any political
campaign
4. No substantial part of activities may consist of political or lobbying activities
vi. To maintain tax-exempt status, the organizations activities must substantially further its
charitable purposes. Components are:
1. commercial activity: they can operate profit making activities as long as those
activities are in furtherance of their mission/charitable purpose
2. private benefit
3. private inurement prohibition

18
 4. political activity
5. activities in violation of public policy

f. Social Enterprises
i. L3C
ii. B Corporations
1. Legally recognized in 35 states and DC
2. Legal status conferred by states that have enacted Benefit Corp Legislation
3. Must specifically state in their Articles of Inc, that they serve a double or triple
bottom line, including financial and social and environmental
4. Directors/Officers are required to consider the effect of decisions on both
shareholders and other stakeholders (defines stakeholder as all constituents, not
just shareholders)
5. Required to publish publically a report assessing overall social and environmental
performance against a third party standard
iii. B Certification
1. Not a separate business form, but a certification that a business can receive
2. A form of self-regulation
3. No private right of action for shareholders to enforce if directors are not
complying
4. Basically a C Corp that wants to show they are conscious of all constituents and
not just shareholders; it’s a way of branding your business
5. Meet verified higher levels of social & environmental performance,
transparency, and accountability

g. Corporate Control: Fiduciary Duties of Directors & Officers

i. Duty of Care—Procedural and Substantive Due Care (MBCA § 8.30) (allegation is
Director is lazy or dumb)
1. Each member of the BOD, when discharging the duties of a director shall act
a. In good faith, and
b. In a manner the director reasonably believes to be in the best interests of
the corporation
2. The members of the BOD when becoming informed in connection with their
decision-making function or devoting attention to their oversight function shall
discharge their duties with the care that a person in a like position would
reasonably believe appropriate under similar circumstances (reasonable
standard gives a lot of deference to judges/courts to determine the definition)
3. Three Factors in the Duty of Care (can contract out of the first 2, but not the 3rd)
a. Reasonable belief that action in the Corporation’s best interests:
i. Substantive Due Care: Question is whether the decision lacked a
“rational basis” or constituted “waste” of corporate assets
b. Reasonable Care in Becoming Informed

19
 i. Procedural Due Care: question is whether directors followed
reasonable procedures in arriving at a decision.
c. Good Faith---Question is whether director’s decisions involved fraud,
illegality, conflict of interest
4. Duty of Care and the Business Judgment Rule (BJR) (SITE Aronson v. Lewis)
a. Rebuttal presumption that a director acted in accordance with the proper
duty of care; not statutory (common law)
b. Operates at 2 levels
i. Shields directors from liability
ii. Insulates board decisions from judicial review (sometimes called
“business judgment doctrine”)
c. Can be overcome if director actions
i. Are not in the honest belief that action is in the best interests of
corporation (substantive review), or
ii. Are not based on an informed investigation (reasonable care), or
iii. Involve fraud, illegality or conflict of interest (duty of loyalty)
5. Aftermath of Smith v. Van Gorkom (DGCL § 102(b)(7)
a. Duty of care is still a default rule, but permits “exoneration” provisions---
effectively allows charter to limit/eliminate personal liability for directors’
breach of duty of care
b. Duty of Loyalty---fraud doctrine still immutable
6. Lessons from Van Gorkom etc
a. While BJR creates a presumption that the BOD’s decision was informed,
plaintiff can rebut presumption by showing that prior to making a
decision, board was grossly negligent in informing themselves about
material information reasonably available to them
b. Defendants found to have breached their Duty of Care can still defend on
other grounds: either the transaction was entirely fair to corp (Cinerama
case) or a fully informed shareholders voted to approve board action
(Van Gorkom case)
c. After § 102(b)(7), a number of corps placed “exoneration” provisions in
their charters
ii. Duty of Loyalty (allegation is Director was greedy)
1. Self-Dealing Transactions (Bayer v. Beran case)
a. BJR has a strong focus on balancing authority and accountability
(enhances efficiency, not accountability)
b. We don’t want the BJR to be an excuse for the BOD or CEO to benefit
personally and acting in their own best interests
c. So the BJR is NOT applicable in Duty of Loyalty cases……
d. DGCL § 144: a self-dealing transaction is “not void or voidable solely” b/c
of the conflict IF
i. It is authorized by a majority vote of fully informed, disinterested
directors, OR

20
 ii. It is approved in good faith by vote of fully informed shareholders,
OR
iii. The transaction is fair to the corporation
iv. Common or interested directors may be a counted in determining
the presence of a quorum at a meeting of the BOD or of a
committee which authorizes the contract or transaction
2. Usurping a Corporate Opportunity
a. What is a corporate opportunity?
b. When is a director (or officer) entitled to take a corporate opportunity?
c. Defenses to Corporate Opportunities
i. Incapacity---financial distress
ii. Source defense—even if the opportunity would quality as a
corporate opportunity under applicable tests, courts are reluctant
to hold defendant liable when opportunity came to her in a
PERSONAL capacity rather than in a FIDUCIARY capacity (in her
role as a director/officer)
d. Broz Factors (from Broz case)
i. Is it a corporate opportunity?
1. Is the opportunity in the corp’s “line of business”?
2. Does the corp have an “interest or expectancy” in the
opportunity?
ii. Are there any defenses?
1. Does the corp have the “financial capacity” to take the
opportunity?
2. Did the opportunity come to the director in her personal
or corporate capacity?
iii. Has the deal been disclosed to the BOD and formally approved
(this is the safe harbor)?
iii. Duty of Good Faith and Fair Dealing
1. Cannot be contracted out of
2. Lots of uncertainty here, but need to include it as a separate duty
3. Conscious disregard of responsibility

h. Corporate Control: Shareholders

i. Shareholders are owners of EQUITY interest in corporation
1. Economic Rights
a. Right to receive a pro rata share of corporate profits (dividends) if
authorized by the BOD
b. Right to possess the “residual” claim on the corps assets if dissolved
2. Voting Rights
a. Right to elect the directors
b. Right to approve extraordinary matters like mergers, sales of assets,
dissolutions, and amendment of the articles of incorporation

21
 ii. Controlling shareholders
1. Those who own more than 50% of the stock can control corp by electing the
majority of the BOD
2. If a shareholder owns less than 50%, but still a substantial block of stock, she
may still exercise control
iii. In parent-subsidiary transactions, controlling shareholders may owe a fiduciary duty to
minority shareholders, but this is pretty rare
1. Intrinsic Fairness Test (from Sinclair Oil Corp. v. Levien) applies when the
transaction involves “self dealing” b/w Parent and Subsidiary such that Parent
receives a benefit “to the exclusion of, and detriment to, the minority
shareholders of the subsidiary”
2. In Parent-Subsidiary transaction, parent has burden of proof to demonstrate that
the transaction was intrinsically fair
3. BUT, if the transaction is approved by majority vote of the minority shareholders
of the Subsidiary, then the burden shifts to plaintiff to show that the transaction
was unfair

VI. Closely Held Corporations

Close Corporation Public Corporation
Small # of shareholders Large # of shareholders
Not traded on secondary market Stock listed for trading on NYSE
Looks more like a partnership Centralized management

a. Key Features of Close Corporation

i. Size: small, tightly knit group of participants who are often family members or former
members of a small partnership
ii. Participation: active, often informal, participation by owners in managing the business
iii. Diversification: undiversified participants who often look to the corporation for means
of livelihood thru payment of dividends or salaries
iv. Market: no formal secondary market to dispose of shares

b. Freeze Out Problem---a minority shareholder who loses a vote basically loses all rights, b/c the
default rules say the majority wins. If it was a partnership, one partner leaving can dissolve the
entire partnership. That’s not the case with a closely held corp…the entity still exists if one
shareholder leaves

c. Minority Shareholder Dilemma—dissatisfied minority shareholders have limited options if they

want to leave. Finding an outside buyer is problematic, since few outsiders would be willing to
step into a situation from which the minority shareholder wants to leave. Because of this
difficulty, the use of planning agreements to structure the parties’ relationships at the inception
of the business is critical. These agreements are called control agreements.

d. Main questions for Closely Held Corporations

22
 i. Will courts enforce private agreements that deviate to some degree from the typical
corporate form?
ii. If private agreements fail, what other means exist to protect minority shareholders?

e. Control Agreements---ways to combat the minority shareholder dilemma

i. Voting Trusts (MBCA § 7.30)
1. Agreement among shareholders where all the shares owned by the parties are
transferred to a trustee, who becomes the nominal record owner of the shares
2. Trustee votes the shares in accordance with the provisions of the trust
agreement and is responsible for distributing any dividends to the beneficial
owners of the shares
3. MBCA § 7.30 permits voting trusts under which shareholders sign an agreement
that conveys shares to a trustee with the right to vote specified in the
agreement; signed copy of trust must be on file in corporation’s principal place
of business and is valid for maximum of 10 years
ii. Vote Pooling Agreements (MBCA § 7.31)
1. A contract between the shareholders under which they all agree to vote in a
particular way
2. For example, they will all agree to vote for each other when electing the BOD
3. This option still only provides minimal protection for minority shareholders. A
majority of the BOD can still vote to cease dividend payout, refuse to elect
minority shareholder as officer, or term minority shareholder employment
iii. Shareholder Agreements (MBCA § 7.32)
1. Restrict the BOD’s discretion by setting forth specific directions as to salaries,
dividends, tenure in office, etc
2. Shareholder agreements enforced if there is 1) unanimous consent by
shareholders at the time of adoption, and 2) “negligible” interference with
sphere of director decision making
3. Shareholder agreements must be conspicuously noted on the stock certificates
and any purchaser who takes w/out notice is entitled to rescission
4. Agreements are only valid for 10 years, unless agreement provides otherwise

f. Fiduciary Duties in Closely Held Corps

i. Massachusetts
1. Majority shareholders owe fiduciary duties to minority shareholders (Donahue
case)
2. Wilkes 2-part test for breach of fiduciary duty
a. Can the controlling shareholders show the action in question was taken
in accordance with a legitimate business purpose?
b. If so, can the minority shareholders show that the same legitimate
business purpose could have been achieved thru an “alternative course
of action less harmful to the minority’s interest”?

23
 3. Minority shareholders with veto power also have fiduciary duties to the majority
(Smith case)
ii. Delaware
1. No fiduciary duties imputed to shareholders in close corps (Nixon case)
2. But as officers/directors, they have fiduciary duties (duty of care and loyalty), see
Dodge v. Ford and Bayer v. Baren
iii. New York
1. Reasonable Expectations Doctrine—a shareholder who reasonably expected that
ownership in the corp would entitle him or her to a job, a share of corporate
earnings, a place in corporate mgmt. or some other form of security, would be
oppressed in a very real sense when others in the crop seek to defeat those
expectations and there exists no effective means of salvaging the investment
2. See Ingle case

VII. Limited Liability Companies

a. Started as a S Corp
i. No more than 100 shareholders
ii. One class of stock
iii. All shareholders must be individuals, estates of decedents, certain trusts or charitable
orgs
iv. No shareholder may be a non-resident alien
v. Mostly used by small businesses, but is gradually being replaced by the LLC structure
vi. Started so people could have pass thru tax (as opposed to double taxation) but still have
limited liability (unlike partnerships)

b. Limited Liability Partnership (LLP)

i. General partnership that elects limited liability partnership status by filing an application
for LLP registration
ii. Upon securing registration, all partners in the LLP, though they remain general partners,
are afforded the same liability protection enjoyed by limited partners in limited
partnerships
iii. Other than this limited liability component, LLP maintains all other characteristics of a
general partnership

c. Cross between Partnership and Corporation

i. Tax advantages of partnership
ii. Limited liability of corporations
iii. None of the restrictions (such as number and type of shareholders) applicable to S corps
iv. Began in oil/gas and real estate in 1977

d. Default Rules (ULLCA)

i. Funding
1. Members typically contribute capital

24
 2. Contribution may be cash, property, services rendered, a promissory note, or
other obligation to contribute cash, property, or to perform services (§ 401)
ii. Liability
1. Members stand to lose capital contributions, but all members have limited
liability
iii. Tax Consequence
1. Income passes thru to members
2. LLC does not pay taxes

e. Conversion of Existing Partnerships to an LLC

i. ULLCA § 902 authorizes conversion of partnerships or limited partnerships to LLCs
ii. ULLCA § 903(b)(2) converts debts of partnerships to debts of LLC---however members
remain liable as partners vis a vis pre-conversion partnership debts
iii. IRS treats conversion as a nonrecognition event (changing property from one form to
another, so this event is not taxed)

f. Formation
i. Formal filing of Articles of Organization with the state (ULLCA § 203 and RULLCA §
201)—filing fees and $800 minimum franchise tax
ii. Choose and register name (statute generally requires the name of the LLC to include the
words “limited liability company” ULLCA § 105)
iii. Designate office and agent for services of process
iv. Draft Operating Agreement---basic contract governing the affairs of an LLC and stating
various rights and duties of members
v. Add need for annual report to tickler list
vi. Articles control with respect to third parties who rely on them to their detriment
vii. You can create a single member LLC in most states, and it’s the most popular form of
small business today

g. Management
i. Agreements are typically contained in an Operating Agreement (analogous to a
Partnership Agreement)
ii. Operating Agreement controls with respect to managers, members, and members
transferees
iii. Statute prevails with respect to mandatory provisions (RULLCA § 103)
iv. Parties prevail with respect to non-mandatory provisions

h. Members Interests
i. Financial Interest
1. Profit and Loss Sharing—most allocate based on value of members contributions
(as opposed to partnership law, which uses equal shares rule ULLCA § 405(a))
2. Withdrawal—member may withdraw and demand payment of interest upon
giving notice specified in the statute or the LLC’s Operating Agreement

25
 ii. Management Rights
1. Absent contrary agreement, each member has equal rights in the mgmt of the
LLC (ULLCA § 404(a)(1)
a. Most matter decided by majority vote (ULLCA § 404(a)(2)
b. Significant matters require unanimous consent (ULLCA § 404(c))—
mergers, admission of a new member, dissolution etc
2. Manager-managed LLC option available (ULLCA § 404(b))
a. Can be structured as a BOD, CEO or both
b. Must be specified in Articles of Organization
3. Member Managed
a. All members are managers (§ 404(a))
b. Members can have ownership and control
i. Equal management rights and decide all ordinary business
matters by a majority vote. Each member has one vote
ii. Members can bind. Like a partnership except all members have
limited liability
iii. Each member is an agent of the LLC and any act carrying on in the
ordinary business binds the LLC
iv. Extraordinary transactions are binding on the LLC only if actually
authorized (ULLCA § 301(a))
4. Manager Managed
a. Has both members and managers (§ 404(b))
b. Members have limited powers and managers have exclusive
management rights and decide all ordinary business matters by majority
vote
c. Governance structure is more like a corporation
d. Members are NOT agents of LLC
e. Managers ARE agents of the LLC and have actual and apparent authority
to carry on business in the usual way (ULLCA § 301(b))
5. A member may assign his financial interest in the LLC (unless otherwise provided
in the Operating Agreement); an assignee may acquire other rights only by being
admitted as a member of the company if all remaining members consent or the
Operating Agreement so provides (ULLCA § 501-503); this is similar to
partnership rules

i. De Facto Corporation
i. Grants shareholders limited liability as though in a de jure corp if the organizers 1) in
good faith tried to incorporate, 2) had a legal right to do so, and 3) acted as a
corporation
ii. Some states don’t apply this doctrine if the person was aware the incorporation effort
was defective at the time, they purported to act on behalf of the corporation
iii. Example would be Articles of Incorporation/Organization were filed and got lost in the
mail, or something similar

26
 j. Corporation by Estoppel
i. Estop creditors from holding shareholders personally liable—as against only contract
creditors, if the person dealing with the firm 1) thought it was corp all along, and 2)
would earn a windfall if now allowed to argue that the firm was not a corporation

k. Fiduciary Duties
i. MUST be spelled out in the Articles of Organization. If Articles are silent, the statutes
provide either that each member has one vote or votes are made based on % of
ownership
ii. Manager Managed: managers have duties of care and loyalty; members have no duty
to the LLC or the members by reason of being members
iii. Member Managed: all members have duties of care and loyalty
iv. Derivative Actions: member may bring an action on behalf of the LLC to recover a
judgment in its favor if the members with authority to bring the action refuse to do so

Direct Suit Derivative Suit

Brought by shareholder in his/her own name Brought by shareholder on corp’s behalf
Cause of action belonging to the shareholder in Cause of action belongs to corp as an entity
his/her individual capacity
Arises from injury directly to the shareholder Arises out of an injury done to the corp as an entity
v. Delaware laws provide wide latitude to contract on issues of:
1. Economic Rights
2. Voting Rights
3. Fiduciary Duties
4. Indemnification
5. Exculpation
6. Informational Rights
l. L3C’s
i. Goal is to bring in a range of investments from various sources
ii. Mainly used to accept Program Related Investments (PRI) from private charities
iii. PRI’s are investments that private charities can make in for-profit entities
iv. Unlike LLC’s, an L3C is also specifically formed for a socially beneficial purpose that is
recognized as such by the IRS
v. So private charities will not risk losing their charitable status when contributing to an
L3C

27
 General Li mite d Limited Liability Li mite d Liability
Partne rship Partne rship Company (LL C) Partnership (LLP)
No formality required. Filing a certificate of Filing articles of Registrat ion of LLP
Creation limited partnership wit h organization w ith filed w ith state
appropriate state office. secretary of state. government.
Unlimited liability of General partners: All members are liable No liability for
each partner for fir m unlimited liability for for LLC debts to the partners beyond t heir
debts. firm debts. extent of their capital contributions and
contr ibut ions and equity in firm, except
Liability Limited partners: no equity in firm. No unlimited personal
liability beyond loss of personal liability liability for their ow n
investment. beyond such. wrongful acts and
those of persons
whom they supervise.
All partners accord ing General partners By members of fir m, All partners
to their partnership according to their who may delegate according to
agreement or the UPA partnership agreement authority to managers. partnership
Management or RUPA. or the UP A or RUP A. agreement or the
UPA.
Limited partners
excluded.
As set forth in the As set forth in the As set forth in LLC As set forth in
partnership agreement partnership agreement statute or art icles of partnership
Dissolution
or the UP A or RUP A or the ULPA or RULPA organization. agreement or the
UPA or RUPA.

Advantages Of LLC Disadvantages Of LLC

Member liability is limited to amount of investment. State statutes are not

uniform.

Can be treated as a “pass through” entity for tax purposes. High Start-Up Costs

Profits can be distributed to members without the double

taxation of a corporation. Members pay personal income tax
on received dividends.

Foreign citizens can be members.

m. LLC and Piercing the Corporate Veil

i. MBCA § 6.22(b)—unless otherwise provided in the articles of incorporation, a
shareholder of a corporation is not personally liable for the acts or debts of the
corporation except that he may become personally labile by reason of his own acts or
conduct.
ii. ULLCA § 302—a limited liability company is labile for loss or injury caused to a person, or
for a penalty incurred, as a result of a wrongful act or omission, or other actionable
conduct, of a member or manager acting in the ordinary course of business of the
company or with authority of the company.
iii. ULLCA § 303—except as otherwise provided, the debts, obligations and liabilities of an
LLC are solely the debts obligations and liabilities of the company. A member or
manager is not personally responsible for a debt of the company solely by reason of
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 being or acting as a member or manager; don’t have to observe corporate formalities as
strictly as corporations
iv. Just because you can pierce the veil in the corporation by failing to have corporate
formalities, that’s not the case in LLC. That alone doesn’t let you pierce (like it does in
corporations). LLCs can have less formality and be less stringent; this is part of what
makes LLCs attractive (more flexibility, best of corporations and best of partnerships); a
greater degree of compliance should be observed when dealing with 3 rd parties (you
should keep separate bank accounts, avoid comingling funds, etc)
v. Test for Piercing
1. Unity of Interest and Ownership
a. Lack of corporate formalities
b. Commingling of funds/assets
c. Severe undercapitalization
d. Treating corporate assets as one’s own
2. Refusing to allow piercing would either
a. Sanction fraud or
b. Promote injustice
3. Whether LLC member to be held personally liable
a. Controlled the LLC and
b. Abused his/her control of the firm “in order to defeat justice or
perpetuate fraud”
4. Plaintiff must show
a. Total domination and control of the firm
b. Such control used to perpetuate a fraud
c. The control and breach of duty owed to plaintiff was a proximate cause
of the injury
vi. The doctrine of level of formality/whether you can pierce an LLC is the courts trying to
allow an LLC to be efficient, but also holding them accountable for their actions. It’s an
effort to balance the need for both efficiency and accountability

n. Fiduciary Duties
i. Default duties of Duty of Care, Loyalty, Good Faith, and Candor
ii. ULLCA § 409(b)—must account to the company for an y property, profit, or benefit
derived from a use by the member of the company’s property, including the
appropriation of a company’s opportunity, and to refrain from competing with the
company in the conduct of the company’s business before the dissolution of the
company
1. Corporate opportunity exists where:
a. Corp is financially able to take the opportunity
b. Opportunity is in company’s line of business
c. Corp has an interest or expectancy in the opportunity AND
d. Embracing the opportunity would create a conflict b/w director’s self
interest and that of the corporation

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 2. Broz Factors (see page 21)
iii. You can contract out of your fiduciary duties via the Operating Agreement
1. Delaware Code title 6, § 18-1101(c)(2): fiduciary duties and liabilities may be
expanded or restricted by provisions in a LLC agreement
2. ULLCA § 103(b)(2): operating agreements may not eliminate the duty of loyalty
but may identify specific types or categories of activities that do not violate the
duty of loyalty, if not manifestly unreasonable

o. Dissolution and Disassociation

i. Disassociation—withdrawal or expulsion of a member (ULLCA § 601)
ii. Dissolution—winding up of LLC triggered (ULLCA § 801)
iii. Unlike UPA, but similar to RUPA, every dissociation does not necessarily lead to
dissolution
iv. Disassociation without Dissolution
1. Dissociated member’s interest must be purchased by the LLC (ULLCA § 701)—
judicial appraisal proceeding available (ULLCA § 702)
2. Member’s right to participate in firm business terminates (ULLCA § 603(b)(1))—
exception for participation in a post-dissolution winding up process (ULLCA §
603(b)(2))
v. Under the ULLCA, the unilateral withdrawal of a member does not result in a
dissolution. The ULLCA is designed to confer corporate like stability on the LLC by
making it far harder for a member to force a dissolution and winding up as is the case in
a partnership
vi. Events of Dissolution
1. By operation of law
a. Upon the happening of any event specified in LLC operating agreement
b. Vote of members (as specified in operating agreement)
2. Upon Court Order
a. Economic purpose frustrated
b. Misconduct by members

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VIII. Venture Capitalist Information
a. 12-16-week process
b. 1st mtg---Due Diligence---Partner Mtg---TS---Negotiation---Close
c. Investors will seek 20-50% of the company (which is normally in the form of preferred stock in a
closely held C Corp)
d. Preferred Equity Securities with Key Terms
i. BOD seat—generally the lead venture capitalist will expect a board seat
ii. Liquidation Preference
1. Provides that upon a liquidation or dissolution of the company, the preferred
shareholders must be paid some amount of money before the common
shareholders are paid anything
2. Definition of liquidation typically broad enough to include any sale of the
business or sale of substantially all of the company’s assets
iii. Cumulative Dividend
1. Often the liquidation preference will add to the original purchase price any
accrued and unpaid dividends
2. In some deals, there will be a mandatory annual dividend that, if not paid, will
accumulate
3. Usually, the sole purpose of this cumulation is to build up the liquidation
preference over time
iv. Dividend Preference
1. Venture capitalist does not expect the dividend to be declared

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 2. This provision is included primarily to bolster the argument for tax purposes that
the preferred stock is worth more than the common stock purchases be the
founders at a lower price
v. Participating Preferred
vi. Anti-Dilution Protection/Price Protection
1. Gives the venture capitalist some protection from subsequent financing rounds
in which stock is issued at a lower share price than the investor paid
2. Types are full ratchet antidilution protection and weighted average antidilution
vii. First Right of Refusal/Pre-Emptive Rights
1. Entitles any shareholder to purchase his/her pro rata share in any subsequent
issuance to ensure that the shareholder maintains his/her % ownership
2. Usually a contractual right that terminates upon an IPO---BUT it can be made a
right attached to the preferred stock if it is included in the certificate of
incorporation
viii. Participation
ix. Protective Provisions---requires the approval of holder of each series of preferred stock,
with each series voting separately, because these investors control a larger % of a
particular series than of the preferred stock as a whole
x. Vesting Terms for Founders and Employees—the venture investors may request that the
founders subject their stock, and all other common stock to be sold to employees, to a
vesting schedule if they have not already done so
e. Best business structure for entrepreneur seeking multiple rounds of investments from VC’s is
NOT LLC, it’s C-Corp. This is due to the flexibility in the classes of stock, as well as the taxation
implications for the VC (VC will be taxed again b/c it’s not related to his business, but to an
investment)

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