BUSINESS LAW Class 13 February 27, 1996

REVIEW LECTURE - BL 308 - Spring, 1999 I. BUSINESS ORGANIZATIONS: A. SOLE PROPRIETORSHIP:
1. No separate recognition - owner personally liable

2. Owner pays taxes on its income

3. Owned by 1 person only

4. Easy to form

5. If one person business - default

6. Can do FICTITIOUS BUSINESS NAME (dba)

B. GENERAL PARTNERSHIP
1. 2 or more owners

2. Operate for profit

3. Equal management powers

4. Owners personally liable for debts

5. Owners pay taxes on Ptshp. income

6. No perpetual existence - owner dies, leaves: gets dissolved

7. JOINT VENTURE: All of the above but for special purpose

C. LIMITED PARTNERSHIP:
1. 2 or more partners: At least 1 general, 1 limited

2. General Partner: Exclusive management and personally liable

3. Limited Parnter: Cannot manage, not personally liable

4. Requires formalities: Cert. of LP

5. Owners pay taxes on income

6. However, LP’s can only offset deductions....

a. To the extent of their investment

b. Only against other passive income

7. General Partners leaves - dissolved; LP can sell/transfer ownership
D. CORPORATION
1. Perpetual existence

2. Limited Liability for shareholders

3. No pass through of income/losses

4. Management Structure separate from ownership structure

5. Formalities involved - Articles, By-Laws, etc.

6. SUBCHAPTER "S": Treats shareholders as partners for tax purposes while retaining limited liability...BUT

a. 75 or less SH

b. No aliens, corps., ptshps as SH

c. 1 class shares

d. Must file election in the 1st quarter of tax yr.

7. CLOSE CORP: Allows for more direct control of corporate management by Shareholders (less formalities)...BUT a. 35 or less SH

b. One class of stock

c. No promotion

d. Only $$ or property can buy shares

e. Stock transfer restricted

8. PROF. CORPORATIONS: Allows professionals to incorporate, but…

SH = Licensed professionals only
SH personally liable for malpractice claims
File with Secretary of State and licensing agency

E. LIMITED LIABILITY COMPANY:
1. Treated as Partnership for taxes (income/losses pass thru)

2. Limited liability for owners (called MEMBERS)

3. No limit on number of MEMBERS (unlike Sub-S)

4. Direct management by members

5. Restrictions:

a. No sale/transfer without unanimous consent of owners

b. Death/transfer of ONE forces dissolution unless remaining Members UNANIMOUSLY vote to continue.

F. LIMITED LIABILITY PARTNERSHIP
1. Primarily for Professionals

2. Taxed like a partnership

3. One Professional is NOT liable for malpractice of other partner

4. However, IS liable for nonprofessional obligations

5. Partnership assets still liable for prof. malpractice

PARTNERSHIP LAW

I. CREATION OF PARTNERSHIP:

A. DEFINITION: A partnership is an association of two or more persons to carry on as co-owners a business for profit. 1. CAPACITY: As in contracts and agency, must have capacity. Partnerships are governed primarily by contract law, as usually there is a partnership agreement.

2. CO-OWNERS: There must be an intent by the parties to co-own, that they both have...

3. Other Creation issues...

a. Three ways to create partnership... ---ORAL

---WRITTEN

---CONDUCT

b. NOTE: Statute of Frauds may require Partnership Agreement in writing where purpose of the partnership is e.g. to acquire real estate. II. ESTOPPEL: One who falsely represents himself on behalf of a partnership

A. Elements:

1. Misrepresentation by Deft. that he is in partnership or is associated with one

2. Reliance: Third Party

3. Damages

B. Result: Persons pretending to be partners will be jointly & severally liable as if they were partners.

IV. RIGHTS OF PARTNERS: There are FOUR...

--PROPERTY RIGHTS

--REPAYMENT/REIMBURSEMENT

--INSPECTION OF BOOKS

--ACCOUNTING

A. Property Rights:

1. There are three...

a. Specific Ptshp. Property

Partner cannot assign or sell
If Partner puts in SPP, can't take it out later
No creditor of individual partner can attach

b. Interest in Ptshp.

Profits split equally, regardless of capital/effort
Assignable (but assignee has no voting/mgmt. rights)
Creditor of individual partner CAN attach = Charging Order

c. Management Participation - Equal & majority rules

2. Assignment of Partnership Interest: A partner can assign rights to profits (his or her partnership interest) to another (e.g. creditor). BUT creditor or assignee does NOT become new partner. No right to vote or participate, just to receive profits. Also not liable. Old partner remains liable and can vote.

V. PARTNERSHIP LAW - Duties of Partners

A. DUTIES:

1. FIDUCIARY DUTY: Same as Agency: Loyalty, service, etc. Some special areas:

a. Not to Make Secret Profits -

b. Not to Compete - Can’t compete without consent of partners.

c. Duty to Serve - Unless silent partner or managing partner appointed.

d. Duty of Care & Skill - Same as agency. Must make reasonable investigation when transacting for the partnership.

e. Duty to Stay within Scope - Same as agency.

f. Duty to Account - But also right of Indemnity remember.

g. Duty of Confidentiality

h. Duty to Disclose/Notify - But...

2. JOINT & SEVERAL LIABILITY: One for all and all for one.

VI. PARTNERSHIP OPERATION

A. CONTRACT LIABILITY: Same as Agency Law.

1. Implied Authority: Special Contract Liability Issues:

a. Conveying Real Property:

NO authority by one partner, unless in the RE business.

b. Borrowing Money (Loans):

(1) Trading Company (Inventory): Yes, OK. Needs cash flow.

(2) Non-Trading (Service): No implied authority.

c. Negotiable Instruments: YES - Partners can sign, withdraw, etc.

d. Lawsuits: NO -- no implied authority to settle, arbitrate, etc.

B. TORT LIABILITY:

1. Intentional Torts: Usually not

2. Respondeat Superior: Is alive and well in partnership law. Key is "course & scope."

3. Joint & Several Liability?: Partners are J & S’lly liable for K AND Torts.

VII. PARTNERSHIP DISSOLUTION:

A. TERMS:

1. Dissolution: see above

2. Winding Up: Liquidation and paying obLigations

3. Termination: When 1 & 2 above are completed.

B. CAUSES: NON-WRONGFUL DISSOLUTION

1. Termination of term:

2. Expiration of purpose: If it’s a joint venture

3. Change/withdrawal of partner: Coming or going.

4. All partners agree:

5. Expulsion of any partner.

6. Illegality of ptshp. purpose

7. Death of partner

8. Bankruptcy

C. DISSOLUTION BY COURT DECREE:

1. Incapacity of partner

2. Insanity

3. Misconduct: e.g. misappropriation, sale of ptshp. interest without consent, etc.

4. Losing battle: Ptshp. can only be carr'd on at loss

5. Creditor Assignee: Remember, Assignment - does NOT cause dissolution

D. WRONGFUL DISSOLUTION:

1. Where this occurs...

BAD GUY (Pt. engaged in misconduct)

a. Can’t demand wind-up - Remaining partners may continue even if

Bad Guy objects

b. Can’t participate in winding-up

c. No goodwill

d. Can’t use the name

e. Must pay damages for breach

2. But BG does still get share of capital, profits, loans MINUS above items.

E. EFFECTS OF DISSOLUTION:

1. W/drawing partner is still liable for debts incurred prior to dissolution.

** Only way out for retiring partner is a NOVATION where...

2. What about Incoming Partners if the partnership continues. They are liable for... (remember this assumes unanimous agreement for partnership to continue with new partner)

a. All debts incurred after they became a new partner.

b. As to Prior Partnership debts: only to extent of capital contrib.

VIII. WINDING UP:

A. What constitutes winding up?

1. Selling assets

2. Paying liabilities

3. Distribution to remaining partners:

B. Priorities of Distributions upon winding up:

1. Creditors:

2. Partners: Loans (non-capital)

3. Partners: Capital

4. Partners: Profits

IX. LIMITED PARTNERSHIP:

A. INTRODUCTORY ASPECTS:

1.Definition: Partnership of 2 or more persons, with at least 1 GP and 1 LP.

2. Principal Aspects of a Ltd. Ptshp:

a. General Partners: Manage the affairs and are personally liable

b. Limited Partners: Are not personally liable (except for their capital contributions) but may NOT participate in the management of the business.

B. CREATION OF A LIMITED PARTNERSHIP

1. Requires filing of Certificate: If I don't file a Certificate of LP with Secretary of State, or file a defective Certificate will they (LP's) be individually liable for debts of partnership.

--- YES, UNLESS THEY RENOUNCE their interest upon learning of failure to file by filing a certificate with the Secretary of State declaring such withdrawal..

C. RIGHTS & OBLIGATIONS OF LIMITED PARTNERS:

1. Liability ltd. to capital, unless the LP exercises management & control

a. What is control?

(1) TEST:

(a) LP participate in control

AND (b) Participation leads 3P to believe LP = GP

(2) WHAT KINDS OF THINGS: Check Writing, voting on decisions, making decisions, Signing Contracts, having one's NAME in the L.P.

(a) BEING EMPLOYEE, CONSULTANT, CONTRACTOR? - NO!!!!

b. What can a LP vote upon:

(1) Election/Removal of GP

(2) Sale of most assets

(3) Termination

(4). Amendment of Certificate or LPA

D. Rights of Limited Partners

1. Inspection of books

2. Assignment: (OK to have right of 1st refusal in the contract)

a. Assignment: Partners in LP may assign/sell their interest in the LP.

(1) However, new partner only have right to profits - they DO NOT

become new ltd partners absent UNANIMOUS VOTE of ptrs.

(2) Limited Partners may also WITHDRAW and receive FMV of their interest.

3. Veto new G.P.

X. FOREIGN LIMITED PARTNERSHIPS - If LP formed in CALIFORNIA, but does most of its business in ARIZONA, in which state is it a...

A. Domestic: California

B. Foreign: Arizona

CORPORATIONS

I. CORPORATIONS: FORMATION

A. BACKGROUND: 1. History: Pre 1900's, corporations only allowed by specific legislative charter.

2. Main aspects of Corporation:

a. Limited Liability

b. Perpetual existence

c. Legally Separate Entity sue, be sued, hold property, crime, taxes

d. Ownership Freely Transferable

B. FORMATION OF CORPORATION: ADVANTAGES & DISADVANTAGES
1. Advantages: a. Limited Liability:

b. Perpetual Existence: People can die, or leave, and corporation can go on. Ownership interest easily transferred without necessity of dissolution.

c. Tax Advantages:

(1) Retained Earnings: Can retain earnings & pay taxes at perhaps a lower rate than the shareholder (owner) who may be at a higher tax bracket

(2) Deductions: Certain deductions are allowed not allowed to individuals: e.g. life insurance for officers, more liberal pension plans, etc.

2. Disadvantages:
a. Taxes:
(1) Double Taxation: Corporation is taxed on earnings, and then when dividends are declared, taxed again.

(2) Losses not passed through:

b. Formalities: Meetings, minutes, two sets of books, etc.

c. Expenses: Accounting, legal & filing fees, minimum taxes (regardless of income)

3. Subchapter S: One form of corporation to minimize the disadvantage of double taxation. We already discussed requirements.

4. Closed or Exempt Corporations: Also discussed

II. CORPORATIONS: ADDITIONAL FORMATION ISSUES

A. INCORPORATION:
1. Where does a corporation do business?
a. Domestic - State where it files its corporate charter

b. Foreign - Any other state where it does business.

c. Can Calif. require qualification of a foreign corporation that does business in this state? YES

(1) But not for SOLICITATION or ISOLATED TRANSACTIONS

(2) Now what if I run over to AZ and incorporate to avoid Calif. Laws on corp. structure. Then I come back to California, sell all my shares here and do all my business here...

** "Runaway Corporations" laws d. REGULATION OF FOREIGN CORPORATIONS:
(1) Explain DUE PROCESS clause, and requirement of "Minimum Contacts"

(2) Also COMMERCE CLAUSE mandates no exclusion/discrimination of interstate commerce (e.g. foreign corps).

B. MISUSING THE CORPORATE STATUS:
1. Piercing the corporate veil: If third party can establish two elements:
a. Direct Domination of a corp. by its SHAREHOLDERS

b. Domination for IMPROPER PURPOSE (usually avoiding creditors)

c. What are some examples of things that will trigger this analysis:

(1). Undercapitalized

(2) Formalities ignored

(3) Commingling of corp/personal assets

(4) Looting (transfer of shares to SH for less than FMV)

d. Sometimes occurs with PARENT/SUBSIDIARY
2. Incorporators/Promoters:
a. Pre-incorporation contracts: Liability of Promoter: Promoter is liable on Pre-Incorporation contract, unless:
(1) There is specific language of release

or (2) Novation is made between corporation and the 3P

b. Corporation is NOT liable, unless...
(1) Novation -or-

(2) Adoption – implied or express

C. FAILURE TO COMPLY WITH INCORPORATION REQUIREMENTS:
1. What theories can Shareholders argue if they tried in good faith to incorporate but came up short on the formalities?
a. Corporation de Jure: Substantial compliance with state mandatory corporation's laws. ( 95% Rule)

b. Corporation de facto: Even if no substantial compliance, if promoters made every good faith attempt to incorporate and business is conducted by the corporation, their existence may not be questioned.

III. CORPORATIONS - (the Financing Process) A. FINANCING THE CORPORATION: Made by the sale of SECURITIES. Two kinds
1. Debt Financing: (1) Bonds: Secured longterm promissory obligation (usually at a prescribed maturity date), with interest

(2) Debentures: Unsecured longterm obligation

(3) Notes: Loans with fixed interest and repayment plan (usually sooner than bonds)

2. Equity Financing: More common ---the classic sale of shares or stock. We've already talked about
a. Subscription Agreement: Just like LPA --- a contract to buy if a corporation is formed. Thereafter, the Board of Directors can accept or reject.

b. Kinds of Consideration - Let’s look at

(1) money

(2) prop

(3) past services

--------------------------------

(4) future services (NOT in California; YES in MBCA &Delaware)

(5) promissry notes (NOT in California; YES in MBCA Delaware)

B. TERMINOLOGY:
1. Classes of Shares: a. Common: Most common. This is "voting stock".

b. Preferred: Usually have priorities in receiving dividends & upon dissolution. But can they vote? ---NO, NO -- unless no div. declared for a certain number of years

There are even different classes of shares among the PREFERRED...

(1) Cumulative: Last year’s arrears (paid to pref. SH)

(2) Non-Cumulative: No arrearages paid to pref. SH

c. What about if their is a surplus after dividends have been declared (do Preferred shareholders add'l dividends):
(1) Participating: Pref SH participate in Same Yr. Surplus

(2) Non-participating: NO --only common stock.

2. Two kinds of valuation:
a. Par Value: Value below which a corp’s stock may not be sold

b. No Par Value:

3. RESTRICTIONS on sale of shares a. Normally UNRESTRICTED.

b. Unless there is a Shareholders Agreement (UNANIMOUS)

IV. CORPORATE GOVERNANCE: A. EXPRESS/IMPLIED POWERS OF THE CORPORATION:
1. What is the basic purpose of a corporation?

a. To make money - PROFITS

2. Ultra Vires Doctrine: If corp. acts BEYOND its authorized powers, considered an Ultra Vires act. Intra Vires act is OK

*********THE FOLLOWING IS ONLY FOR THE SATURDAY CLASS*********** a. But, states passed corporate constituency statutes.

B. Players:

1. Shareholders:

2. Directors:

3. Officers:

C. SHAREHOLDERS: See Chapter 43 Notes

D. DIRECTORS:

1. Powers: a. General Management Power:

b. Specific powers: Amendment of By-Laws, dividends declarations, select/remove officers, fill vacancies between SH meetings.

2. Meetings: Must act in meetings, OR by unanimous consent decree

V. DUTIES OF CORPORATE EXECUTIVES: A. Duty of Care: Act as the reasonable director or officer would in similar circumstances.
1. Business Judgment Rule: Executive's decision will not be second guessed by the court, even if the decision was made negligently, as long as: Elements to Prove to invoke the rule...
a. Informed Decision

b. No conflicts of interest

c. Rational Basis (logical connection to the facts - no gross negligence)

******************THE FOLLOWING IS FOR BOTH 308 CLASSES*****************

VI. CORPORATE GOVERNANCE - Shareholders:

A. SHAREHOLDERS:
1. POWERS: a. Election and Removal of Directors:

b. Adoption, Repeal & Amendment of By-laws:

c. Voting Extraordinary Corporate Changes:

(1) Amending Articles

(2) Mergers (A & B merge into B) & Consolidations (A & B merge into C)

(3) Transfer of major corp. assets -OR- major business changes

(4) Dissolution

2. SHAREHOLDER MEETINGS:
a. SH powers must be exercised at a Meeting:

(1) Annual Meetings: By-laws provide

(2) Special Meetings: by holders of 10% of shares.

b. Must have Notice: Of time, place & purpose.

Waiver: OK if ALL shareholders sign

c. Quorum: Simple majority, unless specified in articles or by-laws, but never less than 1/3.

d. Voting: One share = one vote and majority rules

e. Cumulative Voting: To protect the rights of minority shareholders.

(1) See FORMULA on Page 892 f. Proxies: 1. Express, Special Agency: Governed by same rules.

2. Usually limited to 11 months (CA) or other short period, unless specified.

3. Revocable unless otherwise specified. (coupled with an interest)

g. Shareholders Voting Agreements: Also enforceable - unltd. duration
VII. DUTIES & RIGHTS OF SHAREHOLDERS A. Duties sometimes imposed on controlling SH.

B. Sale of Control: When this SH sells, he sells not only shares but control of the corporation. Owes duties to corp:

1. Duty of Care:

2. Fiduciary Duty:

C. RIGHTS: 1. Inspection Rights: SH may inspect, but only if…
Advance Written Request Proper Purpose SH for 6 months -or- 5% + SH

2. Preemptive Rights: SH has the right of 1st refusal on a pro-rata share of new stock to be issued.

3. Voting Rights: Already discussed

4. Dividends:

a. Dividends may be cash or property. SH may force declaration of dividend if corporation can afford (Dodge case). Otherwise, Directors discretion will not be disturbed by the court.

b. LIMITS on Payment of Dividends. Per MBCA must pass...

(1) Solvency Test - Dividends OK if Corp. can thereafter pay their current obligations & payments.

(2) Balance Sheet Test - Dividends OK if Corp. assets will cover liabilities + dividends to preferred SH/Bondholders

VIII. ENFORCEMENT OF RIGHTS BY SH: A. Lawsuits by Shareholders: 1. Direct Action: Damage or wrong to SH personally (e.g. Pillsbury)

2. Class Action: Where SH wants to include all SH as Plaintiffs.

3. Derivative Suit: Brought on behalf of the corporation

*** Requirements in California:

(1) Exhaust corp. remedies:

(2) Plff. must be in the minority.

(3) Must be record owner of shares at time of suit.

(4) Corporation=Defendant:

(5) Corporation receives damages

IX. CORPORATE DISSOLUTION: Three types of dissolution that might come up... A. Voluntary Dissolution: Majority of Directors & Shareholders vote to dissolve.

B. Administrative Dissolution: Brought by the State against the corporation for its failure to pay taxes or corporate fees.

C. Judicial Dissolution: Forced dissolution by court order, in suit brought usually by...

1. Creditor because corp. is insolvent

2. Shareholder because of deadlocked board.

LET'S DO OUR PRACTICE TEST!!