Chapter 1.

Introduction to the Firm

Main Points:
• Some business risks cannot be avoided (non-controllable or systemic) while others can be reduced
by the parties (controllable)
• Business risks can be quantified using models that identify magnitude and probability to
calculate expected returns
• Business parties have different risk tolerances: risk-seeking vs. risk-averse
• Business risks can be allocated in business firms through different ownership structures
• Other means of allocating risks include insurance, diversification, internal controls, and
externalization
• Fiduciary duties are judge-made and fill in gaps in parties’ relationship – they go beyond the
“morals of the marketplace”
• Partners owe a duty (“punctilio of honor”) to share information about opportunities that relate to
their venture

A. Risk Allocation in the Firm

 “Business firms”: formed according to the interests of the parties.

 “Corporation”: when many investors come together and seek common management
(attributes: perpetual life, centralized management, free transferability of shares, and limited
liability).
 “partnership”: Common when parties seek to have equal financial and management rights
 Hybrid = “limited liability company” provides flexibility to create firm with both corporate
attributes (such as limited liability) and partnership attributes (such as non-transferable
shares). Parties’ agreement fixes the terms.
 A “joint venture” is a “partnership” with a limited duration or scope, unless it has been
organized in a different form.
1. Nature of Risk
 Non-controllable risks: - Cannot be completely eliminated, might affect some ventures more
than others. i.e., economy, bank interest rates, NYC commercial leasing market. Interest
rates, demand, input prices, weather
 Controllable risks: – Can be controlled. i.e., M & S could decide on kinds of tenants they
would have, quality and safety of building materials, project advertisements to potential
tenants. Rental agreements can be structured by M & S and thus controlled. Quality, safety,
hard work
 Expected Returns: Firm can determine average return by quantifying risks associated with
particular decision. Weighted average: probability x magnitude

 Risk tolerance: for those “risk-averse,” you would have to offer sizeable potential returns or
federally-insured deposit insurance. For “risk seekers,” they bet on investments even when
safer returns are available. For “risk neutrality,” they coolly calculate probabilities and
returns, and make decisions based solely on expected returns.
2. Methods to Manage Risk (Risk Management)
 Insurance: person/business pays upfront fee (premium) in exchange for right to payment if
specified event occurs; offers private parties ability to pool risks: each pool member bears pro
rata share of pool’s total loss. Easier to predict than loss to any particular member.
 “futures contract”: standardized contract, traded on a futures exchange (like the Chicago
Board of Trade, CBOT) in which parties agree to buy or sell an underlying instrument (like a
pool of corporate stocks) at a certain date in the future—at a fixed price. For example, one
could buy a futures contract on the Dow Jones Industrial Average (DJIA), which is an “index”
(or the weighted average) of the stock prices of the 30 largest publicly-traded corporations in
the United States. You also could buy a futures contract based on the price of real estate in a
particular region or city.
 Put option: contract that gives holder right to sell a # of equity shares at strike price, before
option's expiry. If investor owns shares of stock and owns put option, the option
is exercised when stock price falls below strike price.
 Diversification: Person/business can diversify by participating in numerous ventures, with
different risk for each.
o E.g. investor in stock market guard against risk of armed hostilities (or peace) by
investing in both weapons suppliers and cruise ships.
o Does not completely eliminate risk, will reduce total risk b/c performance of entire
portfolio is more likely to be balanced between gains and losses.
 Internal risk allocation: Parties in a business firm might allocate risks to the person who is
most willing or best able to bear them, (they are in better position to insure or diversify).
o more sophisticated party with superior info might allocate risks to person who is least
likely to understand risks.
 Risk externalization: To move risk to other people outside firm. (insurance is form of risk
externalization, where insiders pay outsiders to bear firm risks.)
o Modern example: limited liability, which applies to corporations and other entities.
Makes participants liable only up to amount they invest in business.
3. Business Firm as Risk Allocation

 Principal incentives: (1) wants to max expected return, (2) to use agent as much as possible
to make venture successful, (3) to receive the bulk of the profits, (4) to have agent put
principals interests above all else, (5) to know that agent is working for him, (6) to have agent
impose principal’s will.
 Principal risks: some risks better for principal. If principal is less risk averse than agent,
principal will be more willing to bear non-controllable risks of business success or failure,
while agent will want fixed salary.
o Principal accepts uncertainty, and receives compensation for risk-taking the bulk of
the returns if business succeeds.
o When giving agent fixed salary, principal accepts risk of agent shirking. Leads to
monitor and discipline. (1) principal must decide what constitutes optimal
performance by agent ex ante; (2) principal must determine whether desired level of
performance is occurring or has occurred ex post.
 Agent incentives: (1) wants to max expected return on efforts, (2) given alternative uses of
his time, (3) wants to be compensated munificently for effort, even if business is
unsuccessful, (4) wants to expend little effort to make venture success, (5) wants discretion
to accomplish goals of venture, without interference from principal or blame if venture fails.
 Agent risks: Allocate only some risk to agent by basing agent’s comp in part on success or
failure of business. Another option: principal hires agent to long-term contract, aligning with
 agent’s incentives and principal’s long-term interests. Year-to-year arrangement has
advantage that agent must prove himself each year cycle. Short-term contract puts agent at
risk by giving principal ability unilaterally to exit arrangement.
 Monitoring: Principal monitors via Direct supervision, or hiring a supervisor, but this is
time-consuming. Another option might be employment contract; which could specify agent’s
duties and decision-making discretion, and prescribe sanctions if agent failed to perform.
Cons: impossible to foresee all contingencies, and it’s costly to draft a contract.
 Discipline: sanctions, etc.

4. Role of Law in Business Firms

Firm understood as complex network of arrangements between various participants, each adding
specialized inputs. Within network, some risk allocations happen by means of contracting, but legal
rules also define relationship among parties.
 Default Rules: filler rules when not defined within a contract (Not mandatory)
o Specify allocation of risk by specifying right of the participants.
o Important factor - Info asymmetry; Transaction costs ; Impose duties when there are
opportunities for strategic behavior.
 Majoritarian default
o Most parties would bargain for it.
o Ex: employment at will
 Tailored default
o fits these particular parties
o Ex: disclose “material” information; reasonable, relevant, etc.
 Penalty default
o Encourages parties to bargain and specify their relationship
o not many parties agreed
o ex: permitting employees to leave and compete.

B. Fiduciary Duties
1. Theory of Fiduciary Duties: seek to protect those who delegate authority against negligence,
disloyalty, or worse of those who exercise authority on their behalf.

 Such duties exists only to extent parties have specified them; parties would have to negotiate
and contract for their own rules. But it’s nearly impossible; costly, difficult to foresee
agreement that covers everything.
 Law steps in that state broadly the fiduciary must exercise care, diligence, honesty, and
loyalty with respect to firm and participants.
§ 8.01 General Fiduciary Principle
An agent has a fiduciary duty to act loyally for the principal's benefit in all matters connected with
the agency relationship.
Title B. Duties of Loyalty
§ 8.02 Material Benefit Arising Out Of Position
An agent has a duty not to acquire a material benefit from a third party in connection with
transactions conducted or other actions taken on behalf of the principal or otherwise through the
agent's use of the agent's position.
§ 8.03 Acting As Or On Behalf Of An Adverse Party
An agent has a duty not to deal with the principal as or on behalf of an adverse party in a
transaction connected with the agency relationship.
§ 8.04 Competition
Throughout the duration of an agency relationship, an agent has a duty to refrain from competing
with the principal and from taking action on behalf of or otherwise assisting the principal's
competitors. During that time, an agent may take action, not otherwise wrongful, to prepare for
competition following termination of the agency relationship.
§ 8.05 Use Of Principal’s Property; Use Of Confidential Information
An agent has a duty
(1) not to use property of the principal for the agent's own purposes or those of a third party;
and
(2) not to use or communicate confidential information of the principal for the agent's own
purposes or those of a third party.
§ 8.06 Principal’s Consent
(1) Conduct by an agent that would otherwise constitute a breach of duty as stated in §§ 8.01, 8.02,
8.03, 8.04, and 8.05 does not constitute a breach of duty if the principal consents to the conduct,
provided that
(a) in obtaining the principal's consent, the agent
(i) acts in good faith,
(ii) discloses all material facts that the agent knows, has reason to know, or should
know would reasonably affect the principal's judgment unless the principal has
manifested that such facts are already known by the principal or that the principal
does not wish to know them, and
(iii) otherwise deals fairly with the principal; and
(b) the principal's consent concerns either a specific act or transaction, or acts or
transactions of a specified type that could reasonably be expected to occur in the ordinary
course of the agency relationship.
(2) An agent who acts for more than one principal in a transaction between or among them has a
duty
(a) to deal in good faith with each principal,
(b) to disclose to each principal
(i) the fact that the agent acts for the other principal or principals, and
(ii) all other facts that the agent knows, has reason to know, or should know would
reasonably affect the principal's judgment unless the principal has manifested that
such facts are already known by the principal or that the principal does not wish to
know them, and
(c) otherwise to deal fairly with each principal.
Title C. Duties Of Performance
§ 8.07 Duty Created By Contract
An agent has a duty to act in accordance with the express and implied terms of any contract
between the agent and the principal.
§ 8.08 Duties Of Care, Competence, And Diligence
Subject to any agreement with the principal, an agent has a duty to the principal to act with the
care, competence, and diligence normally exercised by agents in similar circumstances. Special
skills or knowledge possessed by an agent are circumstances to be taken into account in
determining whether the agent acted with due care and diligence. If an agent claims to possess
special skills or knowledge, the agent has a duty to the principal to act with the care, competence,
and diligence normally exercised by agents with such skills or knowledge
§ 8.09 Duty To Act Only Within Scope Of Actual Authority And To Comply With Principal’s
(1) An agent has a duty to take action only within the scope of the agent's actual authority.
(2) An agent has a duty to comply with all lawful instructions received from the principal and
persons designated by the principal concerning the agent's actions on behalf of the principal.
Lawful Instructions
§ 8.10 Duty Of Good Conduct
An agent has a duty, within the scope of the agency relationship, to act reasonably and to refrain
from conduct that is likely to damage the principal's enterprise.
§ 8.11 Duty To Provide Information
An agent has a duty to use reasonable effort to provide the principal with facts that the agent
knows, has reason to know, or should know when
(1) subject to any manifestation by the principal, the agent knows or has reason to know that
the principal would wish to have the facts or the facts are material to the agent's duties to
the principal; and
(2) the facts can be provided to the principal without violating a superior duty owed by the
agent to another person.

Meinhard v. Salmon, 164 N.E. 545 (N.Y. 1928) - Core disagreement over the scope of the venture -
(salmon as manager/co-venturer did not tell Meinhard(capital provider/co-venturer) about
executing a new 20 year lease): As sharers in a joint venture, co-adventurers owe each other a high
level of fiduciary duty. A co-adventure who manages a joint venture’s enterprise has the strongest
fiduciary duty to other members of the joint venture.
 Because Salmon’s opportunity arose as a result of his status as the managing co-adventurer,
he had a duty to tell Meinhard about it. Salmon breached his fiduciary duty by keeping his
transaction from Meinhard, which prevented Meinhard from enjoying an opportunity that
arose out of their joint venture.
 ANDREWS DISSENT: Salmon’s fiduciary duty to Meinhard was restricted to matters
pertaining to the Bristol Lease, and ended when the Bristol Lease expired.
 A fiduciary is a person who holds a legal or ethical relationship of trust with one or more
other parties. Typically, a fiduciary prudently takes care of money or other assets for another
person.
 Meaning of Meinhard v. Salmon: M v. S is a classic statement of fiduciary duties in a
partnership.
 Another way: through lens of free-market capitalist system; capitalist is entitled to
protections only within context of original agreement, which did not include right to
participate in post-venture business opportunities.

Beyond contract: fiduciary duties exist beyond contractual agreements. Even Andrews agrees result
in Meinhard v. Salmon would have been different if parties agreed to an indefinite partnership, as
opposed to a 20-year joint venture. ARE FIDUCIARY DUTIES DEFAULT TERMS UNLESS PARTIES
AGREE OTHERWISE?
 What is the remedy for breach? Putting parties back to before, or as if they had performed
a deal
 Judge-made law: Business law is a mix of statutes and case law – a dialogue between
legislature and courts.
 Gap-filling function?

Chapter 2. Agency Basics

Agency relationship exists between employer and employee, corporation and officer, client and
lawyer, and partnership and general partner.

A. Formation of the Agency Relationship (case law, some statutes, restatement)

RS3 § 1.01 Agency Defined - Agency is fiduciary relationship that arises when one person (a
"principal") manifests assent to another person (an "agent") that the agent shall act on the
principal's behalf and subject to the principal's control, and the agent manifests assent or otherwise
consents so to act.
  Express: agency that occurs when principal and agent expressly agree to enter into an agency
agreement with each other.
o E.g., exclusive agency contract, power of attorney
o Express agency contracts can be either oral or written unless the Statute of Frauds
stipulates that they must be written.
 Implied: There doesn’t have to be specific mention of “agency” or a written agreement for
agency relationship to exist.
o can be implied from conduct of parties.
o extent of agent’s authority determined from particular facts and circumstances of the
particular situation.
o Ex: Geoff has a real estate license. He asks his friend Mark to help him find a home. If
Mark continues to work with Geoff, they may enter an implied agency because he is
representing Geoff to find the desired home successfully. Since there is no written
agreement, the situation becomes implied.

(1). Manifest assent

 (Generally, no writing required) parties must assent that agent will act on behalf and subject
to control of principal
 How parties characterize relationship not dispositive - Courts look to parties outward
manifestations from viewpoint of a reasonable person.
 Agents can act or promise to act gratuitously w/o compensation or bargained-for exchange
 “Under the common-law definition, agency is a consensual relationship. The definition
requires that an agent-to-be and a principal-to-be consent to their association with each
other.”
 The “terminology [of ‘assent’] is intended to emphasize that unexpressed reservations or
limitations harbored by the principal do not restrict the principal’s expression of consent to
the agent. If an agent is otherwise on notice of the meaning the principal ascribes to a
particular expression, that meaning is operative as between principal and agent.”
(2). Control:
 Evidenced in agency by consensual relationship where principal has power and right to
direct agent as to goal of relationship.
 Whether principal is “in charge” or able to instruct agent.
 Rest. 3d § 1.01 (comment f): “Control is a concept that embraces a wide spectrum of
meanings, but within any relationship of agency the principal initially states what the agent
shall and shall not do, in specific or general terms. Additionally, a principal has the right to
give interim instructions or directions to the agent once their relationship is established.”
(3). Acting on behalf of a principal:
 The agent is acting in a representative capacity or to further interests of the principal.
 Rest. 3d § 1.01 (comment g): “The common-law definition of agency requires as an
essential element that the agent consent to act on the principal’s behalf, as well as subject to
the principal's control. From the standpoint of the principal, this is the purpose for creating
the relationship.”
 “The common law of agency encompasses employment as well as nonemployment relations.”
 “actions ‘on behalf of’ a principal do not necessarily entail that the principal will benefit as a
result”

B. Rights and Duties Between Principal and Agent

1. Principal’s Obligations to Agent

 Restatement (Third) of Agency § 8.14: principal has a duty to reimburse or indemnify the
agent for any promised payments, any payments the agent makes within the scope of actual
 authority, and when the agent “suffers a loss that fairly should be borne by the principal in
light of their relationship.”
 Restatement (Third) of Agency § 8.15: principal has an obligation to deal with the agent
fairly and in good faith.
 Principal should also generally cooperate with agent and not unreasonably interfere with
agent’s performance of his or her duties.
2. Agent’s Fiduciary Duties to Principal
 Fiduciary, not just obligations.
 Fiduciary relationship requires one party to put other party’s interests ahead of her own.
agent is fiduciary with respect to matters within scope of agency relationship.
 Restatement (Third) of Agency §§ 8.01–8.11(see above): agent owes principal the duties of
care and loyalty, and certain duties related to information and confidentiality.
 Duty of care refers to level of care, competence, and diligence that agent exercises. If agent
claims to have special skills or knowledge, then agent must act with care normally exercised
by agent with such skill or knowledge
 Duty of loyalty refers to idea that the agent must not put his or her own interest ahead of
those of the principal when the agent is acting within agency relationship.
o Act for the benefit of the principal
o E.g. agent must not compete with principal or act adversely to principal
 Duty to provide to information to principal that agent knows or has reason to know that
principal would wish to have, as well as to provide facts material to agent’s duties to
principal.
 Duty of confidentiality means agent must not disclose or misuse confidential information.
o Unlike the other duties, duty of confidentiality notably remains in force even after
agency relationship has terminated.
 Duty not to acquire a material benefit from a T for actions taken on behalf of P or through A’s
use of position
 Duty not to act as adverse party to P
 Duty to refrain from competing with P during agency relationship
 Duty not to use P’s property for A’s own purposes
 Duty to act in accordance with any contract with P

§ 8.06 Principal's Consent

(1) Conduct by an agent that would otherwise constitute a breach of duty as stated in §§ 8.01, 8.02,
8.03, 8.04, and 8.05 does not constitute a breach of duty if the principal consents to the conduct,
provided that
(a) in obtaining the principal's consent, the agent
(i) acts in good faith,
(ii) discloses all material facts that the agent knows, has reason to know, or should
know would reasonably affect the principal's judgment unless the principal has
manifested that such facts are already known by the principal or that the principal
does not wish to know them, and
(iii) otherwise deals fairly with the principal; and
(b) the principal's consent concerns either a specific act or transaction, or acts or
transactions of a specified type that could reasonably be expected to occur in the ordinary
course of the agency relationship.
(2) An agent who acts for more than one principal in a transaction between or among them has a
duty
(a) to deal in good faith with each principal,
(b) to disclose to each principal
(i) the fact that the agent acts for the other principal or principals, and
 (ii) all other facts that the agent knows, has reason to know, or should know would
reasonably affect the principal's judgment unless the principal has manifested that
such facts are already known by the principal or that the principal does not wish to
know them, and
(c) otherwise to deal fairly with each principal.

 If an agent breaches any of these duties without the consent of the fully informed principal, the
agent could be liable to the principal for any resulting damages. The agent could also be liable
to disgorge to the principal any profit made by the agent in breach of a duty.

General Automotive Mfg. v. Singer, 120 N.W.2d 659 (Wis. 1963)(manager was skimming clients
off of automotive employer): An agent has a fiduciary duty to act in good faith and to further the
interests of the principal. If an agent competes with the principal’s business, the agent has violated
his or her fiduciary duty and is liable to the principal for profits made in the competitive enterprise.
 Singer’s competitive activities, which benefited him personally and worked to the detriment of
Automotive, clearly constituted breach of contract and violation of his fiduciary duty to
Automotive.

C. Contract Liability: Principals

5 Bases by which principal can incur contract liability: actual authority, apparent authority,
undisclosed principal liability, ratification, and estoppel.
 Possible for more than one of these bases to be present, but any one would be sufficient for
holding principal liable. First two are most common.
Implied Actual Authority versus Apparent Authority:
 Actual authority usually between principal and agent (agent’s reasonable beliefs)
 Apparent authority is usually between principal and third party (third party’s reasonable
beliefs)
1. Actual Authority: authority agent reasonably believes she has based on principal’s
manifestations, expressed through words or other conduct
 Rest. 2d § 144: a principal “is subject to liability upon contracts made by an agent acting
within his authority if made in proper form and with the understanding that the principal is
a party”
 Rest. (Third) of Agency § 2.01: agent acts with actual authority when, at the time of taking
action that has legal consequences for the principal, agent reasonably believes, in accordance
with principal’s manifestations to agent, that principal wishes agent so to act.
o Agent’s belief is reasonable if it reflects any meaning that agent knows from
principal is to be ascribed or if it accords with inferences that a reasonable person in
the agent’s position would draw in light of the context (custom or past dealings).
 May be express or implied: encompasses both explicit instructions from principal as well as
what reasonable person in agent’s position would understand to be reasonable included in
those instructions.
o Implied can be inferred from words principal used, from custom, or from relations
between parties.
o Express - A clear statement by principle to agent generated from explicit words or
conduct granting the agent power to bind the principle.
Mill St. Church of Christ v. Hogan, 785 S.W.2d 263 (Ky. Ct. App. 1990)(painter hired brother
without speaking to church to help with painting; brother was injured during painting; did he have
implied authority to hire brother?): Yes. When a principal has routinely granted an agent certain
powers, implied authority is assumed when the agent exercises those powers.
 Implied authority is actual authority circumstantially proven which principal actually
intended agent to possess and includes such powers as are practically necessary to carry out
the duties actually delegated.
2. Apparent Authority: arises, according to Restatement (Third) of Agency § 2.03, “when a third
party reasonably believes the actor has authority to act on behalf of the principal and that belief is
traceable to the principal’s manifestations.”
 Claims of apparent authority commonly arise when third party seeks to bind principal who
created impression that agent had authority for particular action when in fact he or she did
not. Protects reasonable beliefs of third parties.
 Focus of apparent authority is on what third party reasonably believes one person has
authorized another to do.
o might not be an “actual” principal arising from principal-agent relationship; instead,
there might only be an “apparent” principal, from third party’s perspective.
 Critical: determine whether principal or purported principal has made manifestation that led
third party to reasonably believe that agent or actor had authority to act on behalf of
principal or purported principal.
 § 2.03 (comment c) - [Manifestations] include explicit statements that principal makes
directly to third party, as well as statements made by others concerning actor’s authority
that reach third party and are traceable to principal.
Opthalmic Surgeons, Ltd. V. Paychex, Inc., 632 F.3d 31 (1st Cir. 2011)(third party paycheck
company believed principal surgeon practice gave designated payroll employee (agent) authority to
deposit more money into agent’s account): Paychex’s reliance was reasonable and that Connor had
apparent authority because OSL put Connor in a position where it appeared that she had the power
to authorize additional paychecks.
 “[t]he mere creation of an agency for some purpose does not automatically invest the agent
with ‘apparent authority’ to bind the principal without limitation.” Under New York law,
apparent authority can only be created through “words or conduct of the principal,
communicated to a third party” such that a third party can reasonably rely on the
“appearance and belief that the agent possesses authority to enter into a transaction.”
 By placing Connor in a position where it appeared that she had authority to order additional
checks and by acquiescing to Connor’s acts through its failure to examine the payroll
reports, OSL created apparent authority in Connor such that Paychex reasonably relied on
her authority to issue the additional paychecks.
3.Undisclosed Principal Liability: situations arise in which third party does not have notice that
person they are dealing with is an agent acting on behalf of someone else. If the agent was acting
within the scope of authority when dealing with the third party, the undisclosed principal can be
held liable on the basis of actual authority. But even if the agent was not acting within the scope of
actual authority, the undisclosed principal could still be held liable.
 Restatement § 8A: “Inherent agency power is a term used in the restatement of this subject
to indicate the power of an agent which is derived not from authority, apparent authority or
estoppel, but solely from the agency relation and exists for the protection of persons harmed
by or dealing with a servant or other agent.”
Agent acting with actual authority?
 Rest. 3d § 6.03: When an A acting with actual authority makes a contract on behalf of an
undisclosed P, both P and A are bound.
Agent acting without actual authority?
 Rest. 3d § 2.06 (either of these is sufficient for principal liability):
o An undisclosed principal is liable for its agent’s actions–acting without actual
authority – if a third party detrimentally relies on the agent and the principal has
notice and does not take reasonable steps to notify the third party of the facts.
o An undisclosed principal can’t rely on narrowing an agent’s authority to less than
what a third party would reasonably believe the agent to have under the same
circumstances if the principal had been disclosed.
Watteau v. Fenwick, 1 Q.B. 346 (Queen’s Bench 1893)(man sold company to Ds, but stayed on
as manager, license remained with him, his name still on the door. Ds told him he had no authority
to buy goods. He bought goods anyway from third party P. P did not know original man was an
agent): Court held D to P’s contract, otherwise, in every case of undisclosed principal, or at least in
every case where the fact of there being a principal was undisclosed, the secret limitation of
authority would prevail and defeat the action of the person dealing with the agent and then
discovering that he was an agent and had a principal.

4. Ratification: allows person to retroactively bind herself to contract entered into purportedly on
her behalf, even though agent or purported agent was not acting with authority at time he entered
into contract.
 Restatement (Third) of Agency § 4.01: it is “the affirmance of a prior act done by another,
whereby the act is given effect as if done by an agent acting with actual authority.”
 Effect is to validate contract as if principal or purported principal had originally authorized it.
 Agent or purported agent is relieved of liability for breach of duty to principal.
 Express: objective manifestation of acceptance of transaction, such as oral or written
statements
 Implied: person engages in conduct that justifies reasonable assumption that person
consents to transaction.
 Valid ratification requires principal is fully aware of all material facts in transaction
 It is all or nothing: there is no partial ratification or cherry picking parts of an act or contract
that principal wants to ratify.
 Operates through equitable principles
 At the time of ratification, the purported P must have knowledge of all
material facts (or not unaware of lack of knowledge), and T must not have already withdrawn
from the transaction. Ratification is not effective if there has been a material change in
circumstances that would make it inequitable to bind T, unless the T chooses to be bound.
 Ratification creates the effects of actual authority. (Both P and T are bound by the contract
and the purported A is discharged.)
  Caveats: 3rd party can rescind before ratification; 3rd party won’t be bound if there are
material chnages to circumstances; transactions is treated as though it had been authorized
at the time of contract formation.
5. Estoppel: equitable doctrine. principal or purported principal “estopped” from disclaiming
contractual liability. Estoppel does not create binding contract between parties; simply prevents
principal from avoiding obligation by arguing no authority existed at time agent entered into
contract.
 Typically raised where purported agent did not have actual or apparent authority, but
plaintiff asks court to hold defendant liable due to some fault.
 Similar to apparent authority, but different in two ways: (1) estoppel requires showing that
third party detrimentally changed position in reliance on principal or purported principal,
where AA does not require showing; (2) estoppel is one way street: allows 3rd party to hold
principal liable, but does not give principal any rights against 3 rd party (unless principal
ratifies transaction)
 Remedy: damages rather than making defendant party to contract
 § 2.05 Estoppel to Deny Existence of Agency Relationship
A person who has not made a manifestation that an actor has authority as an agent and who
is not otherwise liable as a party to a transaction purportedly done by the actor on that
person's account is subject to liability to a third party who justifiably is induced to make a
detrimental change in position because the transaction is believed to be on the person's
account, if
(1) the person intentionally or carelessly caused such belief, or
(2) having notice of such belief and that it might induce others to change their
positions, the person did not take reasonable steps to notify them of the facts.
D. Contract Liability: Agents
Disclosed principal: Fully Disclosed Agency Within Scope of Authority
Rest. 3d § 6.01: When the P is fully disclosed and A is acting within the scope of authority, P is
liable to the T. A is not liable.
 Exception: If A intends/agrees to be bound to the contract. (The rules on contract liability are
default rules that can be overridden by express or implied agreement between A and T.)
Unidentified principal/Undisclosed principal
Rest. 3d § 6.02 - Unidentified Principle: An agent acting with actual or apparent authority and
the third party has notice that the agent is acting for the principal, but does not have notice of the
principal's identity. The principal, agent and 3rd party are all parties to the contract unless agreed
otherwise.
Rest. 3d § 6.03 – Undisclosed Principle: When A is acting with actual authority and the P is
undisclosed, both the P and A are liable on the contract (unless excluded/otherwise agreed).
Agent Exceeding the Scope of Authority
Rest. 3d § 6.10: An A who enters into a contract on behalf of another impliedly warrants that he or
she has the authority to do so
 (unless A gives notice that no warranty of authority is given, or T knows that A acts without
actual authority).
 If the A acted without authority or exceeded the scope of authority, and P did not ratify, A is
liable to T for breaching the implied warranty of authority.
 A may also be liable for fraud if intentionally misrepresented his or her authority.
E. Tort Liability
Rest. 3d § 7.01: “An agent is subject to liability to a third party harmed by the agent’s tortious
conduct. Unless an applicable statute provides otherwise, an actor remains subject to liability
although the actor acts as an agent or an employee, with actual or apparent authority, or within the
scope of employment.”
Direct liability when:
 A acts with actual authority to commit tort or P ratifies A’s conduct
  P is negligent in selecting, supervising, or otherwise controlling A
 P delegates performance of a duty to use care to protect persons or property and A fails to
perform duty (aka “nondelegable duty”)
 Activity contracted for is inherently dangerous (e.g., demolition, blasting)
Vicarious liability when:
 A is an employee who commits a tort while acting within the scope of employment [§ 7.07]
 Rest. 3d § 7.08: “A principal is subject to vicarious liability for a tort committed by an agent
in dealing or communicating with a third party on or purportedly on behalf of the principal
when actions taken by the agent with apparent authority constitute the tort or enable the
agent to conceal its commission..
“Respondeat superior”: employee within scope of employment
 A is an employee who commits a tort while acting within the scope of employment [§ 7.07].
So 2 questions:
1. How do the classifications work (e.g. “employee”)?
2. What counts as “within the scope of employment”?
1. Employee Status
Restatement (Third) of Agency § 7.07(3): agent is an “employee” for purposes of vicarious liability
if the principal controls or has the right to control the manner and means by which the agent
performs his or her duties.
 Both the right to exercise control and the actual exercise of control are typically evaluated.
 where a principal gets the benefits of control of an agent, the principal should also have the
corresponding obligation of liability for the agent’s actions
 The party with control over the agent is in the best position to prevent the agent from
engaging in careless or improper conduct and has the greatest incentive to take cost-effective
precautions or get insurance: “lowest cost avoider.”
Employee vs. Non-employee
 (Rest. § 7.07(3)) “An employee is an agent whose principal controls or has the right to
control the manner and means of the agent’s performance of work”
 A gratuitous agent may be an employee
Criteria for determining employee status
 (Rest. 2d § 220)
a) Extent of control which P may exercise over details of the work
b) Is A engaged in a distinct occupation/business?
c) The kind of occupation and whether the work is usually done in that locality under P’s
direction, or by a specialist w/o supervision?
d) Skill required in the particular occupation
e) Who supplies the instrumentalities, tools, and place of work for A?
f) Length of time for which A is employed
g) Method of payment, whether by the time or by the job
h) Is the work a part of the regular business of P?
i) Do the parties believe they are creating an employment relationship?
j) Whether the P is in business
2. Scope of Employment
1. Was the conduct of the same general nature as, or incidental to, the task the agent was employed
to perform?
2. Did the conduct occur substantially within the authorized time and space limits of employment?
(“detour” vs. “frolic”?)
3. Was the conduct motivated at least in part by a purpose to serve
TWO Theories:
FIRST: § 7.07(1)(2) Employee Acting Within Scope of Employment
(1) An employer is subject to vicarious liability for a tort committed by its employee acting within the
scope of employment.
(2) An employee acts within the scope of employment when performing work assigned by the
employer or engaging in a course of conduct subject to the employer's control. An employee's act is
not within the scope of employment when it occurs within an independent course of conduct not
intended by the employee to serve any purpose of the employer.
 E.g. bounder is aggressive and commits a tort while doing his job.
 Some wiggle room around what is “within the scope.”
 “Frolic and detour.”
o A “frolic” is when an employee substantially deviates from or abandons the scope of
employment.
o By contrast, if an employee is still engaged in the scope of employment but strays
slightly from the assignment, this is a mere “detour.”
SECOND: FORESEEABILITY TEST
 Some courts have criticized the purpose test and have instead used a “foreseeability” test, asking
whether the employee’s conduct should fairly have been foreseen from the nature of the
employment or whether the risk of such conduct was typical or incidental to the employer’s
enterprise.
Clover v. Snowbird Ski Resort, 808 P.2d 1037 (Utah 1991)(skier employee collided with plaintiff at
ski resort; was skiing on the way to work): An act is within the scope of an employee's employment
if the act is so closely connected with what the employee is employed to do, and so reasonably
incidental to that work, that the act can be viewed as a method of carrying out the objectives of the
employee's employment.
 three factors: (1) whether the employee's conduct occurred while the employee was engaging
in duties assigned by the employer and going about the employer's business, rather than
engaging in personal tasks; (2) whether the employee's conduct occurred during work hours
and in the physical space of employment; and (3) whether the employee's conduct was at
least partially motivated by serving the employer's interest
F. Termination of the Agency Relationship
“Renunciation” by agent - “Revocation” by principal: renunciation or revocation is effective
when other party has notice of it. If parties have contractual relationship as well as agency it is
possible that one of the parties could be in breach, but that does not impinge upon each party’s
unilateral power to terminate the agency relationship.
The Restatement (Third) of Agency §§ 3.06–3.10:
 Death of the agent or principal (when the agent or third party has notice)
 Loss of capacity of the principal (when the agent or third party has notice)
 The expiration of a specified term, if there was one, for the agency relationship
 The occurrence of circumstances on the basis of which the agent should reasonably conclude
that the principal no longer would assent to the agent’s taking action on the principal’s
behalf (i.e., accomplishment of a specified purpose of the agency relationship, facts
constituting a supervening frustration in the agent’s ability to accomplish the principal’s
objectives).
Consequences of terminating? Under traditional common law principles, the agent’s actual
authority to bind the principal ends when the agency ends. The agent may compete with her former
principal after the agency relationship is terminated, but some duties continue such as the duty to
not disclose confidential or proprietary information learned during the agency relationship.
Agreement of parties:
 The contract between principal and agent states when it will end or upon the happening of a
specified event.
By lapse of time:
 At end of specified time, or if none, then within a reasonable time period
Any time by either party after notice:
  At common law, presumed “at will” relationship so either party may terminate (terminology is
a “revocation” by P or “renunciation” by A). Note this power exists even though the party
exercising the power may be in breach of the agency contract, if one.
 Exception where “power given as security”
By change of circumstances that should cause A to realize P would want to terminate
authority:
 E.g., destruction of subject matter of the authority, drastic change in business conditions,
change in relevant laws.
Fulfillment of the purpose of the agency relationship:
 i.e., completion of task
By operation of law:
 Termination occurs automatically; e.g., upon death or loss of capacity of either A or P, such
as dissolution of a corporation or insanity of a person.
§ 3.11 Termination of Apparent Authority
(1) The termination of actual authority does not by itself end any apparent authority held by an
agent.
(2) Apparent authority ends when it is no longer reasonable for the third party with whom an agent
deals to believe that the agent continues to act with actual authority.
- to avoid. Lingering apparent authority the principal may need to give notice of termination to third
parties.

Chapter 3. Partnership Basics

Main Points:
• A partnership is a form of business organization that exists whenever two or more persons
associate to carry on as co-owners a business for profit. No filing is required and a partnership can
be formed inadvertently.
• Partnership is a flexible form of business organization that can be customized by agreement. Few
mandatory rules.
• By default, every partner is equally able to transact business on behalf of the partnership, has
equal voting power, and an equal share in profits and losses.
• Partners owe fiduciary duties of care and loyalty.
• Partnerships have flow-through taxation.
• Partners in general partnerships are subject to joint and several liability for the obligations of the
partnership.
• Other forms of partnership exist that come with at least some measure of limited liability, filings
are required: LP, LLP, LLLP

3. PARTNERSHIPS
Sources of law - model statutes adopted by states (UPA of 1914, RUPA of 1997, HRUPA of 2013)
and case law.

Partnership: "An association of two or more persons to carry on as co-owners a business for profit."
§ 202(a)

 Most RUPA provisions are default provisions that the partners can alter. § 103/105 states
which provisions are mandatory and cannot be altered by agreement
o Non-waivable: not unreasonably restrict a partner's right of access to partnership
books, eliminate duty of care or loyalty, or restrict rights of third parties.
 Partnerships pay no income tax - profits and losses flow through to partners, JSL.
 Partnership is either:
 o Term - where partners agreed to carry on partnership for particular period of time
 Withdrawing prior to end of term  wrongful dissociation (must account for
damages)
o At -will - partners may withdraw by giving notice. Can be tenuous and more unstable.

(A) FORMATION
 Rule: two or more persons associated together to carry on as co-owners a business for profit.
o § 202(c) - sharing of profits of a business = presumption of partnership
o Court factors include - intention of parties, profit sharing, sharing of losses/risk,
management/control, ownership of property, rights of parties on termination, holding
out to third parties.
o Burden is on party alleging the partnership.
o Exception RUPA §202 (c)(3)(A) – (F) (2013) – Profitsharing does not create
presumption of a Partnerhip IF profits were received in payment for:
 Partnership by Agreement: (i) A debt; (ii) For services of an IC or compensation
to employee; iii) Rent; (iv) An annuity or other retirement/health benefit; (v)
Interest or other loan charge; (vi) Sale of the goodwill of a business or other
property.
 Martin v. Peyton - Terms of Arrangement
o Facts: Hall, a partner at KNK, was given a loan by PPF. Holding: No partnership
(question of degree). Court analysis of factors below.

 Partnership by Estoppel - separate doctrine, where parties can hold non-partners liable as
though they were partners.
o RUPA § 308 - Liability of Purported Partner.
 (a) If a person, by words or conduct, purports to be a partner, or consents to
being represented by another as a partner, in a partnership or with one or more
persons not partners, the purported partner is liable to a person to whom the
representation is made, if that person, relying on the representation, enters into
a transaction with the actual or purported partnership.
 Partnership by estoppel has two elements: (1) a representation to a third party
that there is in fact a partnership and (2) reliance by the third party on the
representation.
 Partnership JSL if all consented. Only purported partner (and any consenting
partners) JSL if partners did not consent.
(B) FIDUCIARY DUTIES AND INFORMATION RIGHTS
 Duty of Loyalty - RUPA § § 409(b). Account to the partnership and hold as trustee
property, profit, benefit derived; refrain from dealing with person having an interest adverse
to partnership, refrain from competing.
 Duty of Care - RUPA § 409(c). Refrain from engaging in grossly negligent, reckless conduct,
willfull intentional misconduct, or a knowing violation of the law.
 Good Faith - RUPA § 409(d)
 Miscellaneous
o (e) Partner does not violate a duty solely because the partner's conduct furthers own
interest.
o (f) All the partners may authorize or ratify, after full disclosure of all material facts, a
specific act or transaction by a partner that otherwise would violate the duty of loyalty.
o (g) It is a defense to a claim under subsection (b)(2) and any comparable claim in
equity or at common law that the transaction was fair to the partnership
 Information Disclosure - Under RUPA § 408(c), partners required to furnish
o (1) without demand, any information concerning the partnership's business, financial
condition, and other circumstances which the partnership knows and is material to
the proper exercise of the partner's rights and duties under the partnership agreement
or this [act]...; and
o (2) on demand, any other information concerning the partnership's business, financial
condition, and other circumstances, except to the extent the demand or the
information demanded is unreasonable or otherwise improper under the
circumstances."
 Nonwaivable Provisions - §103 and §105. Duty of loyalty, duty of care, restrict access to
books/records, eliminate contractual good faith but partnership agreement may prescribe
standards by which the performance of obligation is measured.

(C) MANAGEMENT
 Default Rules
o § 301(1) - Each partner is an agent of the partnership. Partner's act binds the
business if it is carrying on in the "ordinary course" the business, unless there is no
actual or apparent authority.
o § 401(h) - Each partner has equal rights in the management and conduct of the
partnership's business (regardless of how much they contributed).
o § 401(k) - Difference arising as to a matter in business is to be decided by a majority.
Act outside ordinary course of business / amendment to agreement needs consent of
all partners.
 May need to alter if it is unworkable for decisions to be made by majority.
 National Biscuit v. Stroud
o Rule - Ordinary matters of a partnership should be decided by a majority vote by the
partners when no other agreement provides otherwise.
o Holding:
 Stroud had equal rights in management and conduct of partnership business,
Stroud could not restrict Freeman's authority, because it was an ordinary
matter connected with the business.
 If there is an even division of partners, no restriction can be placed upon
the power to act - unless they do it as a majority.

(D) PROPERTY, FINANCES, AND LIABILITES

 Property - §§ 203, 204
o Property acquired by a partnership is property of the partnership and not of the partners
individually
 Includes property that is either:
 (a) Acquired in name of partnership
 (b) Acquired by one or more partners with a doc transferring title that
indicates partner acting his capacity as partner.
 Property purchased with partnership funds is presumed to be partnership property
o RUPA § 401(1) - A partner may use or possess partnership property only on behalf of the
partnership
o RUPA § 501 - A partner is not a co-owner of partnership property and has no interest in
partnership property which can be transferred, either voluntarily or involuntarily
o RUPA § 502 - A transferable interest is personal property.
 Absent contrary provision in the partnership agreement or the consent of the
partners, a transferable interest is the only interest that can be transferred to a
person not already a partner.
 Transferable interest - RUPA § 102(23)
 The right, as initially owned by a person in the person's capacity as a partner,
to receive distributions from a partnership, whether or not the person remains
a partner or continues to own any part of the right. Applies to any fraction of
the interest, by whomever owned.
o Transfer of Property - RUPA § 503:
 A transfer does not by itself cause a person's dissociation / dissolution of
partnership.
 Transfer does not entitle transferee to participate in management or conduct of
partnership.
 A transferee has the right to:
 receive, in accordance with the transfer, distributions to which the transferor
would otherwise be entitled; and
 § 801(5) - seek judicial decision that it is equitable to wind up the partnership
business.
 RUPA § 504: Partner's transferable interest subject to charging order (a lien
by creditor)
 Finances
o Partnership Capital Account - RUPA § 401(a)
 Each partner has an account with a running balance, reflecting (a) contributions,
share of profits, distributions, and share of losses.
o Capital Contributions
 As a matter of default, initial capital contributions are not required from partners.
Some or all partners may contribute only services.
 Same UPA and RUPA default - each partner credited with an amount equal to the
money plus the value of any other property contributed in order to be a partner or in
the person's capacity as a partner.
 The contributed capital itself belongs to the partnership and can be any
property (real, intangible, etc.)
o Compensation for Services
 Unless otherwise agreed (and a limited exception during winding up), a partner is
not entitled to compensation for services. RUPA § 401(h).
o Distributions
 The statute is silent on when profits are distributed. Must address in agreement.
 § 401 comment - Without contrary agreement, the interim distribution of profits is
a matter arising in ordinary course of business, decided by majority of partners.
  Default - Profit sharing is done on an equal basis (50/50) and losses are allocated in
same proportion as profits. Partner not liable for losses incurred prior to becoming
partner.
 Liability
o Outside Firm - All partners are liable jointly and severally for all obligations of the
partnership unless otherwise agreed by the claimant or provided by law. § 306. (But
creditors must seek to recover from partnership's assets first.)
 Exceptions:
 (b) A person admitted into an existing partnership is not personally liable for
any partnership obligation incurred before the person's admission as a
partner.
 (c) A debt, obligation, or other liability of a partnership incurred while the
partnership is an LLP means no personal liability.
 Partnership liable for partner's actionable conduct –
 § 305(a): Liable 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 partner acting in the ordinary course of business of the
partnership or with authority of the partnership."
 If contract made in ordinary course of business or transactions typical for that
business = binds the partnership.
o Not binding IF: (1) partner did not have authority AND (2) third
party knew no authority.
 Tort liability – Partnership responsible for torts committed by partners (1) in the
OCB OR (2) with actual or apparent authority of the partnership.
o Inside Firm - Partner responsible for share of obligation, entitled to indemnification from
other partners.

(E) DISSOCIATION AND DISSOLUTION

 Dissociation - a change in the relationship of the partners, one partner who ceases to be
associated in the carrying on of the business. Does not necessarily cause a dissolution or
winding up of the partnership business under RUPA.
o UPA only provided for dissolution.
o A partner is dissociated from the partnership upon: RUPA § 601
o If any of the events listed in RUPA § 801 occur, then dissolution is triggered:
 (1) At-will p/ship, any partner who gives notice of his express will to withdraw;
 (2 & 3) If in a term p/ship, if all agree to dissolve or if the term expires; or if one
partner dissociates wrongfully, dissolution occurs if, within 90 days after the
dissociation, one-half of the remaining partners agree to wind up the partnership;
 (4) Upon an event agreed to in the partnership agreement resulting in the
dissolution and winding up of the partnership business;
 (5) Upon an event that makes it unlawful for all or substantially all of the business
of the partnership to be continued;
 (6) Upon application by a partner to a court for an order of judicial dissolution on
the grounds that economic purpose of the p/ship is likely to be unreasonably
frustrated, another partner engaged in conduct that makes it not reasonably
practicable to carry on business with that partner, or it is otherwise not reasonably
practicable to carry on partnership business in line with the p/ship agreement;
 (7) Upon the passage of 90 consecutive days during which the partnership does not
have at least two partners.
 If the event is not listed in RUPA § 801, then a buyout will occur pursuant to RUPA
§ 701 and the partnership business continues.
  Such events include death of the partner, leaving a term partnership before the end
of the term, or expelled pursuant to judicial determination, p/ship agreement, or
unanimous vote of the partners.
 § 701(b) - buyout price is the amount distributable if the assets were sold using the
greater of the going concern value or the liquidation value. Interest accrues on this
price.
o If disassociation occurs without dissolution, the disassociated partner is
entitled to the buyout price. If no agreement as to the buyout price is
reached within 120 days after the written demand for payment, the
partnership must pay the default buyout amount.
o Effects of Dissociation - RUPA § 603
 Right to management ceases; duties of care and loyalty generally also terminated,
except for matters arising before dissociation. RUPA § 603(6).
 Purchase of dissociated partner's interest. RUPA § 701.
 Indemnification of dissociated partner. RUPA § 701(d).
 Dissociated partner's power to bind partnership. RUPA §§ 702, 704.
 Dissociated partner's liability to other parties. RUPA § 703.
o Wrongful Dissociation - RUPA § 602
 A partner will be deemed to have wrongfully dissociated if:
o Dissociation is in breach of an express term of partnership agreement; or
o Partnership is for a definite term or particular undertaking and the partner
withdraws, is expelled, or becomes bankrupt before the end of the term or
completion of the undertaking (with limited exception)
 Consequences:
 A partner who wrongfully dissociates is liable to the partnership for any
damages caused by the dissociation. § 701(c)
 The partner is still entitled to a buyout, but it is minus any damages from the
wrongful dissociation and the partner does not have to be paid the buyout
amount until the end of the term, unless she goes to court and proves it
would not be an undue hardship for the partnership to pay it out earlier. §
701(h)
 Dissolution, Winding Up, Termination
o A partnership is dissolved and its business must be wound up when any of the following
occurs: See supra RUPA § 801
o A partner's power to bind the partnership after dissolution. RUPA § 804
o Dissolution causes the partnership to "wind up." § 802, absent an agreement to continue
(e.g., buyout and continuation agreements), or rescission. RUPA § 802(b) (1997 version)
cf. § 803 (2013 version).
o "Winding up" - Shutting down the business by selling off the assets, paying the
partnership liabilities, settling partner accounts. Authority of partners to act on behalf of
partnership terminated except in connection with winding up of partnership business.
o Once winding up is finished then the partnership is "terminated"; no filing or magic words
required. RUPA § 802(a) (1997 version).

Wrapping up General Partnership

 Reminder Re: Partnership Agreements
o Can: Change governance rules (i.e., voting and mgmt. rights); Define scope of fiduciary
duties, so long as “not manifestly unreasonable”; Establish financial rights between
partners (during, at dissolution, or upon termination) E.g., can address a “buy-out,”
valuation, continuation
 o Cannot: Completely eliminate fiduciary duties/right to accounting; Alter third parties’
rights; For full list, see RUPA § 103/105
(F) OTHER PARTNERSHIP FORMS (LPs, LLPs, LLLPs)
 Limited Partnerships
o A type of partnership with 2 types of partners:
 General partners: General partners manage the business and have the power to bind
the partnership. They are personally (and jointly and severally) liable for the
partnership debts
 Limited partners: Silent/passive partners without management rights.
 Not personally liable unless they participate in management or control of the
LP (old "control rule"); current uniform act has modified to not personally
liable except in extraordinary circumstances.
 Limited partner has no authority to bind by virtue of being an LP.
 The partnership must have at least one general partner and one limited
partner. The partnership name must have a signifier - ie., "LP"
o Default rule is that partners in a LP share profits and losses in
proportion to their respective capital contributions.
o Requires a formal filing (a "certificate of limited partnership") to create
a LP; each state has a LP statute.
 Most states either have some version of RULPA or ULPA (2008)
(aka Re-RULPA).
o Fiduciary duties - only owe a duty to act fairly and in good faith when dealing with the
partnership itself.
o Used in sophisticated business settings (customizable for limited investments) - makes the
ownership interest assessable; used as an estate planning device.
 LLPs
o LLP - the limited liability form of the general partnership. RUPA Article 10
o The effect is to shield partners from personal liability for the partnership debts. A partner
remains personally liable for her own wrongful acts.
o Forming an LLP requires filing a form with the secretary of state.
o The partnership name must have a signifier - ie., "LLP”
 LLLPs
o LLLP - the limited liability form of the limited partnership (the GPs get limited liability).
 Forming a LLLP requires filing a form with the secretary of state.
 The partnership name must have a signifier - i.e., "LLLP"
 Not all states allow for LLLP formation.

Chapter 4 – Corporation Basics

Basic Corporation Vocabulary

- “For-profit” vs. “nonprofit.”

o a “for-profit” corporation is established to generate financial wealth which it can distribute
to shareholders.
o a “nonprofit” corporation may be established for a range of purposes and does not have
shareholders. Charities, and most hospitals and private universities, are examples of
nonprofit corporations.
- “Public” vs. “close.”
o Public - Corporations whose shares are publicly traded on stock exchanges are known as
“public” corporations
o Private - corporations without publicly traded stock are called “close,” “closely held,” or
“private” corporations.
- Tax status.
o Most public corporations also are known as “C Corporations,” based on the subchapter of
the Internal Revenue Code that applies to them. Many close corporations are formed as “S
Corporations,” based on a different
- Separate entity.
o Every corporation is a legal entity that is separate from the investors who provide it with
money and the people who manage its business. Investors who buy ownership interests in
a corporation are known as shareholders or stockholders.
- Perpetual existence.
o As a general rule, corporations have an unlimited existence. The individual corporate actors
inevitably will change over time. Shareholders sell their shares/ Employees/ Directors
retire, quit, are fired, or die. But the corporation remains intact and can exist forever.
- Limited liability.
o A corporation’s shareholders cannot lose more money than they invested. In other words, a
shareholder’s liability is limited to the amount of money she paid for her shares
- Centralized management.
o Shareholders elect a corporation’s directors, who have the power to manage and oversee the
corporation’s business. Shareholders agree to play only a limited governance role, in part
because the directors have fiduciary duties to act in the best interests of the corporation.
The directors typically delegate responsibility for daily decisions to corporate officers. The
separation between shareholder ownership and managerial control is one of the distinctive
features of modern public corporations.
- Transferability of ownership interests.
o Shareholders can transfer to others their ownership interests in a corporation. In publicly-
owned corporations, this is accomplished on stock exchanges and similar stock trading
markets.

Organic Documents (Articles of Incorporation and Bylaws)

- Organic documents.
o The articles of incorporation and bylaws are sometimes referred to as the “organic
documents” or “constitutive documents” of the corporation. They set out the essential
information about the corporation and its internal governance, but most of the rules that
govern the corporation are those of the applicable corporate statute and the judge-made
law that fills the statutory gaps.
- Articles of incorporation
o (the “articles) is the document filed with a state to create a corporation. All states require an
in-state registered agent (diff requirements for info for each state). The corporation’s
existence legally begins when the state files the articles. In a sense, the articles of
incorporation creates a contract between the state, the corporation, and its shareholders.
- Bylaws
o Bylaws typically are lengthier than the articles of incorporation.
o Widely vary but frequently include items such as: the powers of directors and officers,
procedures for electing directors and filling director vacancies, required notice periods and
details for calling and holding meetings of shareholders and directors, and similar internal
governance issues.
Corporate Actors

- Shareholders/ stockholders
o often described as the “owners” of the corporation. shareholders contribute capital to the
corporation in exchange for “common shares” of the corporation. These common shares
represent a divided economic stake in the equity of the corporation.
 o Do not have direct control - elect directors and must approve certain fundamental
transactions
- Directors - individuals who are elected by the shareholders to be responsible for managing or
supervising the corporation’s business. The directors act on behalf of the corporation only
collectively as the “board” or “board of directors.” Good faith business judgments.
o Directors are not considered employees or agents of the corporation, although corporate
employees can serve as directors.
 An “outside” director is a person who generally does not have any affiliation with the
corporation, other than his or her role as a director.
 An “inside” director is a person who is both a director and a corporate employee—
such as when the company’s CEO (an employee) also serves as a director on the
board.
- Officer are corporate employees - Corporate employees. Board delegates duties to these
officers. (CEO,COO,CFO)
- Stakeholders – Creditors, employees, customers – Someone who has something at stake
- In practice, there is a lot of overlap between these corporations - shareholders of close
corporation wear many hats and overlap a lot.

Corporate Securities
- Corporations raise money by issuing shares or other securities to their investors. Ownership of
securities is documented through computer records.
- Debt Securities - Debt is the least risky security and has the lowest expected return. A holder of
debt typically expects to receive only fixed payments of interest over time. Even if the corporation
does well, debt securities will receive only fixed payments—debtholders are creditors.
o If the corporation becomes insolvent, and its assets must be sold for cash (liquidated), debt
securities will have priority.
- Equity securities
o Common shares take on greater risk, and also have greater expected return. Common
shares have a claim to the residual financial rights to the corporation’s income and assets.
Once the corporation has paid everyone it owes, the common shares are entitled (at the
discretion of the board of directors) to whatever is left. Common shares can receive
payment through “dividends,” which are cash payments the corporation can make, upon
approval by the board.
 “authorized.” The corporation’s articles of incorporation specify how many shares of
common and preferred stock the corporation is “authorized” to issue. Additional
shares can be issued only if the articles are amended to increase the number of
authorized shares.
 “issued.” Of the corporation’s authorized shares, the corporation might issue all, or
just a portion, of those shares to its shareholders. Frequently, a corporation will not
issue all of its authorized shares.
 “outstanding.” The portion of the authorized stock that has been sold and remains
in the hands of stockholders is the stock “outstanding.” Because the corporation can
repurchase issued shares (which are called “treasury shares” and are held by the
corporation, and this practice is referred to as “stock buybacks”), some of the issued
shares might not be outstanding.
o Preferred Stock - have certain priorities over the common stock; e.g., right to receive
dividends before common shares. Preferred shares typically have priority in insolvency.
 VCs prefer these because you can add terms, they are more flexible.
 Can convert to common stock. You would do so if the stock price is booming.

Duty of Care and Loyalty

- The duty of care requires managers to be attentive and prudent in making decisions.
- The duty of loyalty requires managers to put the corporation’s interests ahead of their own.
The duties of care and loyalty are embodied in numerous statutes and cases, and arise in a wide
range of contexts. For now, we simply want to highlight the general nature of these twin duties.

Business Judgment Rule –

- BJR presumes that director decisions (1) are informed, (2) made in good faith, and (3) in the
honest belief that the action taken is in the best interests of the corporation.
- plaintiff must show that a decision: (1) was grossly uninformed (2) did not have a rational
business purpose (i.e., constituted waste), (3) was made by directors with a personal or financial
interest in the decision, or (4) was made by directors who were not independent (i.e., were
beholden to someone who had an interest in the decision).
- Bayer v. Beran - board approved a huge advertisement budget.
o Ad expenditure was not exorbitant because the business judgment rule protects rational
business decisions, even if they are questionable.
o Sponsorship of the show, which indirectly benefitted president, overcame presumption
against duty of loyalty, because court scrutinized the transaction and determined that the
singing and pay were at market, and the result of a fair decision-making process

Derivative vs. Class Action

- Types of recovery:

o Derivative Suit - suits brought by a shareholder on behalf of the corporation (and the
corporation is a nominal defendant) and the shareholder controls prosecution of the suit
against other defendants such as directors and officers. Recovery belongs to the corporation
for whom the action was brought.
o Class Action - recovery for shareholders brought on behalf of a class based on violation of
direct duties, like federal security fraud, etc.
o Usually bring them together to see if one works based on the same set of facts.

Liability to corporation and shareholders.

- Corporate managers who breach their fiduciary duties can be held liable for any losses they
cause the corporation.
- More often than not, the managers whose conduct is at issue control the corporate decision-
making apparatus and are not likely to sue themselves. Moreover, shareholders are not
authorized to act directly for the corporation, and thus cannot enforce a corporate claim against
the managers.
- The “derivative suit” was developed to solve this problem. The derivative suit is an action in
equity brought by a shareholder on behalf of the corporation. The action is brought against the
corporation as a nominal defendant, and the plaintiff-shareholder (and his lawyer) controls
prosecution of the suit against other defendants such as directors and officers. Any recovery
belongs to the corporation for whose benefit the suit has been brought.

Duties of shareholders. Although directors owe fiduciary duties, shareholders generally do not. Of
course, a person might be a shareholder and a director, and therefore owe duties because of her
director role. But simply being a shareholder generally will not subject a shareholder to any
fiduciary duties. There is, however, one major exception.

International Affairs Doctrine

- Internal affairs doctrine. U.S. corporate law also is distinctive in its important choice of law
rule.
o The rule is this: in general, the law of the state of incorporation governs the “internal
affairs” of the corporation. This rule means that the relationships between shareholders
and managers (directors and officers) are governed by the corporate statutes and case law
 of the state where the corporation is incorporated. (If incorporated in PA, PA rules govern
even in CO).

DGCL § 211 - Meetings of Stockholders.

(a)(1) Meetings of stockholders may be held at such place, either within or without this State
as may be designated by or in the manner provided in the certificate of incorporation or
bylaws, or if not so designated, as determined by the board of directors.
(b) Unless directors are elected by written consent in lieu of an annual meeting as permitted
by this subsection, an annual meeting of stockholders shall be held for the election of
directors on a date and at a time designated by or in the manner provided in the bylaws.
(c) . . . If there be a failure to hold the annual meeting . . . for a period of 13 months after . . .
[the corporation’s] last annual meeting . . ., the Court of Chancery may summarily order a
meeting to be held upon the application of any stockholder or director.

DGCL § 222 - Notice of Meetings and Adjourned Meetings.

(a) Whenever stockholders are required or permitted to take any action at a meeting, a
written notice of the meeting shall be given which shall state the place, if any, date and hour
of the meeting.
(b) Unless otherwise provided in this chapter, the written notice of any meeting shall be given
not less than 10 nor more than

- Proxy Contest - the act of a group of shareholders joining forces and attempting to gather
enough shareholder proxy votes to win a corporate vote. Sometimes referred to as a "proxy
battle/fight,” this action is mainly used in corporate takeovers.

Schnell v. Chris-Craft Industries, Inc. – Inequitable action does not become permissible simply
because it is legally possible.
- Facts: Shareholders, dissatisfied with performance, wanted to elect a new board. The current
board amended bylaws to have an annual meeting a month earlier. Board said that it changed
the date because of challenging January weather and fewer mail problems. This did not allow
shareholders to wage successful proxy fight - not enough time.
- Rule of Law
o Corporate directors may not act with the sole purpose of obstructing shareholder action,
even if the methods are legally permissible.
- Issue - May corporate directors take action solely for the purpose of obstructing shareholder
objectives?
- Holding and Reasoning (Herrmann, J.)
o No. Directors of a corporation are bound to act in the best interest of the shareholders.
They may not take steps designed to perpetuate their own power at shareholder expense,
even if the maneuvers used are technically permitted by statute. Shareholder elections are
particularly important events and may not be manipulated by directors for their personal
gain.
 In this case, the Delaware Corporate Law permitted the directors to reschedule the
annual meeting. The result of the date change, however, would be the total
obstruction of the dissident shareholder’s efforts to unseat existing management.
Because the directors’ purpose was inequitable, the rescheduling was improper.
Therefore, the decision of the trial court is reversed, and the trial court is ordered to
reinstate January 11, 1972 as the date of the annual meeting.
- Notes
o When the bylaws of a corporation designate the date of the annual meeting of stockholders,
it is to be expected that those who intend to contest the reelection of incumbent
 management will gear their campaign to the bylaw date. It is not to be expected that
management will attempt to advance that date in order to obtain an inequitable advantage
in the contest.
o “Management has attempted to use the corporate machinery and the Delaware Law for the
purpose of perpetuating itself in office … for the purpose of obstructing the legitimate
efforts of dissident stockholders … These are inequitable purposes, contrary to established
principles of corporate democracy.”
o When the by-laws of a corporation designate the date of the annual meeting of
stockholders, it is to be expected that those who intend to contest the reelection of
incumbent management will gear their campaign to the by-law date. It is not to be expected
that management will attempt to advance that date in order to obtain an inequitable
advantage in the contest.”

Stahl v. Apple Bancorp, Inc.

- Facts: Stahl holder of 30% of stock announced a public tender offer for all remaining shares.
Proxy election for the directors of the company board. On April 10th they elected to defer.
o Tender offer – Hostile bidder publicizes offer to purchase shares at a high premium so he
can acquire the voting shares to obtain control.
o Record date - date fixed by the board of directors that identifies which shareholders will
vote at the upcoming meeting. If shares are sold before a shareholders meeting, the buyer
has to get proxy to vote the shares.
- Issue: Plaintiff filed a complaint alleging that defendants improperly decided to defer an annual
meeting on the grounds that plaintiff's contest was likely to succeed. Accordingly, plaintiff
asserted the need for a preliminary injunction to require the annual meeting.
- Held: No breach of fiduciary duty. In answering the question of whether the defendants have
exercised corporate power inequitably it is necessary to ask whether Ds have taken action for
the purpose of impairing or impeding the effective exercise of the corp franchise and, if they
have, whether the special circumstances are present warranting such an unusual step -
defendants' reaction was a response that bore a reasonable relation to a valid corporate interest.

Summary of Cases
- Schnell and Stahl, though separated by two decades, presented the Delaware courts with a
similar dispute related to setting the date of an annual meeting. In both cases, plaintiffs argued
that the board’s decision to change the meeting date, though it complied with the statute,
should be enjoined because the transaction was improperly motivated. In Schnell the

Hostile takeover - a type of acquisition where a company (the acquirer) takes control of another
company (the target company) without the approval or consent of the target company's board of
directors. In other words, the target company's management is not in favor of the takeover, hence
the term "hostile".

Chapter 8 – Organizational
Choices
 Essential Characteristics

Formation
GP LP Corp Member-Managed LLC Manager-Managed LLC
No filing A certificate Filing of articles of Filing of articles of Filing of articles of
required - must be filed incorporation organization is required organization is required
formed by naming the LP, required - must - must name LLC as - must name LLC as
consent if two designating its contain well as the designating well as the designating
or more office and information about its office and agent for its office and agent for
persons agent for the company and service of process. service of process.
“associate to service of its incorporators ULLCA §201 ULLCA §201
carry on as process, and such as: the name,
Co-owners a identifying the the number of Members must enter Operating agreement?
business for general authorized shares, into an operating
profit” partners. and the name and agreement that sets
RULPA § 201 address of each forth the members
incorporator MBCA rights and duties –
§2.02; DGCL §102 might oral or written
depending on
jurisdiction.

Liability
GP LP Corp Member- Manager-
Managed LLC Managed LLC
Face unlimited liability, jointly Pre 2001 ULPA Limited liability Limited liability- member loss
and severally. Each partner limited liability as - shareholder is limited to original
has power to bind the GP, long partner does not loss is limited investment. Allows members to
provided the partner acted in participate in to original fully participate and still
ordinary course of business. managment of LP. investment. receive LL. Default roll
RUPA § 301 “Participate” - Default rule waivable by personal
advising the GP and waivable by guarantee.
LLP - entity liable for torts voting on critical personal
and Ks obligations in OCB; transactions. RULPA guarantee *Exception - PCV
partners can be held (1985) §303
personally liable only for *Exception -
p’ship obligations as RULPA (2001) §303 - PCV
supervisor of another or for Limited liability is not
himself, not for debts of p’ship affected by
or as a whole participating in LP
management.

Management & Control

GP LP Corp Member- Manager-
Managed LLC Managed LLC
Absent contrary Old ULPA – LPs could Mgmt centralized in board Members Members are
provision, not participate in of directors. Default given not agents and
management mgmt without losing model - board manages authority to usually only
authority vested in LP protection, thus and oversees day-to-day make make major
partners. Each GPs had by delegating to appointed management decisions.
partner has equal responsibility for officers. MBCA § 8.01; decisions and
voice (RUPA §401); most mgmt decisions. DGCL § 141 act as agents Managers
decisions made by for the LLC. usually make
majority vote; but ULPA (1985) – LPs did BJR bars courts from business
major changes not lose LL for voting second guessing or decisions, given
require consent of on major decisions. overruling good faith authority to act
all partners decisions. as agent
(§401). Partners RULPA § 303 (2001) -
can bind the GP LP's have voting Directors typically elected
when carrying on rights specified in by plurality of shares
OCoB. (§301) their agreement. GP entitled to vote (MBCA
is an agent of the LP 7.28), and each share is
and can bind LP entitled to one vote (7.21).
when apparently Closed corporations
carrying on OCoB. provide otherwise through
(RULPA § 402) bylaws - guaranteeing
shareholder
representation or
governance power.

Financial Rights
GP LP Corp Member- Manager-
Managed LLC Managed LLC
Right to share Not equal by default – Allocated according to Some require sharing based on
equally in profit sharing occurs shares. Shareholders have contribution, others based on
profits and according to the capital no right to profits unless equal sharing. ULLCA 405(a)
share losses contributions of LPs and the board of directors
proportional to GPs. RULPA (2001) 503- declares a dividend based Distributions generally required
their share of 04. Only GPs in an LP on profits or other to be approved by all members.
profits RUPA share proportionally to distribution of corporate ULLCA 404(c)
401(b). No right their contribution in assets. MBCA 6.40; DGCL
to losses. 141. This assures capital Generally no right to
compensation that can be put to long- remuneration. ULLCA 403(d)
for their LLLP - GPs have LL and term use. Directors and
services unless do not bear business officers have no right to
otherwise losses compensation except by
agreed contract.

Continuity of Existence (and Withdrawl)

GP LP Corp Member- Manager-
Managed Managed LLC
LLC
Either for a term or at- Business generally Perpetual existence Default is they exist in
will. At-will GP continues upon death, but AoI may provide perpetuity, - may not result in
dissolved on bankruptcy, or for shorter term. dissolution. State laws vary
withdrawal of any withdrawal of an LP. LP greatly.
partner RUPA 601, agreement must specify Parties may agree
801. latest date upon which that corp may Partnership model - unilateral
p’ship must be dissolved. dissolve upon certain withdrawal of member by
Withdrawing partner RULPA 201(a)(4) circumstances. express will does not result in
can demand dissolution. Does not provide
liquidation and Most agreements restrict Voluntary for default buyout rights for
proceeds to be LP 's right to withdraw dissolution when members.
distributed to partners capital. board recommends
in cash. and majority voting Corporate model - member
Absent provision shares approve. cannot withdraw unless
If a partner dies, the contrary, an LP is agreement allows.
other partners can buy dissolved only when a GP
out the deceased’s withdrawals. RULPA 801.
interest.

Transferability of Interest
GP LP Corp Member- Manager-
Managed LLC Managed LLC
Default rule - all LP can transfer financial Free to transfer Generally permit transferability
partners must consent interests, but assignees stock without only of financial interest, not
to transfer of a GP rights are limited without consent. governance interest. RULLCA
interest and the consent of all remaining 502.
admission of a new partners. RULPA 702. In close
partner. RUPA 401. Does not create a risk of corporations, A member can, however,
But, a partner can personal liability LP owners often agree withdrawal and avoid any
transfer his financial agreements. to restrict continuing voting/mgmt
interest in the GP transferability to responsibilities or fiduciary
without transferee LP agreements often restrict who can duties. RULLCA 603.
gaining a voice and allow partners to transfer participate and
management. §502. financial and governance vote.
interests without
consent.

Mergers and Consolidations

GP LP Corp Member- Manager-
Managed LLC Managed LLC
Generally do not Mergers are Can be combined through Most states permit. A plan of
have to file articles possible if merger. Assets and liabilities merger must be adopted by
of merger to be agreed to by automatically combine. each LLC; the plan must be
considered a single all partners Consideration paid to approved by all members; and
taxable entity - the both limited shareholders is determined in merger docs must be filed with
partnerships and general merger plan. Merger plan must the state. One LLC survives the
typically combine be approved by board and merger and the other ceases to
assets by shareholders of both exist
agreement. corporations. After approval,
articles of merger must be filed
with state.

Tax
GP LP C Corp S Corp LLC
Default: Default: Generally subject to Permits corporation to elect flow- Default:
business level tax. through taxation. Corporate income,
flow-through flow- losses, and credits are attributed to through to
to partners through to Double taxation – SHs proportional to their shares. partners in
in partners in tax on corp’s income proportion to
proportion proportion and SHs pay tax on Must be a domestic corp or LLC with ownership
to ownership to dividends. ≤100 SHs. SHs must be individuals, interest.
interest. ownership estates or qualified trust, or tax-
interest. Zero Out - pay SHs exempt entities. No SH can be a
deductible salaries, nonresident alien. Corp can have only
bonuses, rental one class of stock. All SHs must
payments, or interest consent to election of subclass S
to reduce taxable treatment.
income to zero and
only have SH pay Subchapter S terminates if over a 3
taxes. year period more than 25% of the
corp's gross receipts constitute
passive investment income, if SHs
exceed 100, or any SH is not
qualified.

Chapter 9 – Incorporations

(A) PROCESS OF INCORPORATION

1) Formal Requirements

- File AoI
o MBCA §2.01 - One or more persons may act as the incorporator or incorporators of the
corporation by delivering articles of incorporation to the Secretary of State for filing.
o MBCA § 2.02( A) – AoI required to include:
 Name of the corporation
 Number of shares it is authorized to issue
 Name and address of each incorporator - one or more persons may act as
incorporator.
 Name and address for registered agent (for service of process or official notices
o MBCA § 2.02( B) - Optional to include:
 Articles may include a provision insulating directors from liability or exculpating.
 May require corporation to reimburse directors.
- Post-Incorporation Requirements
o Organizational meeting must be held (MBCA §2.05)
1. Elect/add Directors
 2. Adopt bylaws
3. Appoint officers
4. Designate bank for corporate depository
5. Approve sale of stock to initial shareholders

2) Choice of State
- Select state of incorporation.
o DE is expensive, but advantages  corporate judiciary very successful; national
incorporation and investors, DE likely better
o Many small businesses incorporate in the state where they are located.
 Avoids hassle of different state (costly, qualify to do business as a foreign corp)
 Early on, it doesn't really matter - can always incorporate again.

3) Role of Attorney

- Who does the lawyer represent?

o Entity Approach - lawyer represents only the corporation, not the individuals involved in
the business - if the firm later sues individuals in the corporation, no conflicts.
o Aggregate Approach - lawyer represents both the participants in the business and the
corporation
 More likely to apply when business involves only a few participants, and if participants
may believe the lawyer is representing them in their individual capacity
o Boils down to reasonable expectations and what the participants believe - corporate lawyer
should explain everything to participants. Who pays the attorney is not dispositive.
o One lawyer for all parties is cheaper.
o Client must give informed consent for attorney to disclose information.
- ABA MODEL RULES OF PROFESSIONAL CONDUCT - RULE 1.13: Organization as Client
o (a) A lawyer employed / retained by organization represents organization acting through its
duly authorized constituents.
o (f) Set up reasonable expectations to begin with > In dealing with organization's
constituents, a lawyer shall explain the identity of the client when the lawyer knows or
reasonably should know that organization's interests are adverse to those of constituents
with whom lawyer is dealing
o Comments
 (1) Officers, directors, employees, and shareholders are constituents; apply also to
unincorporated associations.
 (2) When constituents of an organizational client communicate with the organization's
lawyer in that person's organizational capacity, the communication is protected by
Rule 1.6 [attorney-client privileged communications]. However, does not mean
constituents of an organizational client are the clients of the lawyer.
 (3) If the organization's interest is adverse to constituents, lawyer should advise of
such potential conflict and tell the constituent they may need their own lawyer.

Post-Incorporation Formalities
- Properly filing the certificate brings the corporation into existence. (DGCL § 106) Next step is to
have an organizational meeting of the incorporators or of the subscribers for shares to elect the
directors, if not named in the certificate. (DGCL § 108) Also:
o Appoint officers
o Adopt bylaws (DGCL § 109)
o Adopt pre-incorporation promoters’ contracts
o Authorize issuance of shares, stock certificates, corporate seal, corporate account, etc. (use
a checklist to be meticulous)
- Prepare board meeting minutes, open corporate books and records, issue shares, qualify to do
business in states where business will be conducted, obtain any needed permits, taxpayer ID
numbers, etc.
- Plan for shareholder meeting as required.

(B) CORPORATE POWERS (and the ULIRA VIRES DOCTRINE)

- Historical Development:
o Under the common law doctrine ultra vires, a corporation was limited to the powers
enumerated in the purpose clause of its charter.
 The "purpose clause" is a statement describing the business the corporation is to
conduct.
 The term "corporate powers" refers to methods the corporation may use to achieve its
purpose (e.g., power to contract and power to borrow money).
o Historically, if a corporation engaged in conduct that was not authorized by its express or
implied powers, the conduct was deemed ultra vires and void.
 Whenever a transaction was beyond the corporation's limited purposes or powers,
either party to the contract could disaffirm it.
o Over time, courts began to interpret corporate powers more broadly.
 State legislatures began to allow corporations to specify in their charter that they were
formed to engage in "any lawful purpose." Corporations need not specify a single
purpose, nor do they need to list their specific powers.
 Today, most modern corporation statutes expressly grant incidental/implied powers.
Corporate managers, in the absence of express restrictions, have discretionary
authority to enter into contracts and transactions reasonably incidental to its
business purpose, which may be broadly defined. (DGCL §§ 121, 122)
- Modern Doctrine – MBCA § 3.01( A)
o “Every corporation incorporated under this Act has the purpose of engaging in any lawful
business unless a more limited purpose is set forth in the articles of incorporation.”
o In close corporations, where investors may want to limit the scope of the corporation's
business and thus limit management discretion, it is possible to place limits on the
corporation's purpose and powers in the articles
 Thus, the corporation or shareholders can disavow transactions that exceed the
corporate powers (MBCA § 3.04)
o The modern ultra vires doctrine is narrow; it applies only where the certificate of
incorporation states a limitation and there are 3 exclusive means of enforcement (DGCL §
124):
 in a proceeding by a stockholder against the corporation to enjoin a proposed ultra
vires act;
 in a corporate suit against directors and officers for taking unauthorized action (the
directors and officers can be enjoined or held personally liable for damages);
 the state attorney general can seek involuntary judicial dissolution if the corporation
has engaged in unauthorized transactions.
o An ultra vires act will be enjoined only if equitable to do so; generally means that an act
involving an innocent third party (e.g., one who didn’t know the action was ultra vires) will
not be enjoined.
o Use of the ultra vires doctrine is very rare; many legal commentators view it as a historical
relic.

(C) DEFECTIVE INCORPORATION

- MBCA § 2.03 - Incorporation
 o (a) Unless a delayed effective date is specified, the corporate existence begins when the
articles of incorporation are filed.
o (b) The secretary of state’s filing of the articles of incorporation is conclusive proof that the
incorporators satisfied all conditions precedent to incorporation except in a proceeding by
the state to cancel or revoke the incorporation or involuntarily dissolve the corporation.
- Technically, corporation comes to life only when the articles are filed - unless a delayed date is
specified. Parties may enter into a business transaction before corporation exists - used to be
common when the process was longer than a simple filing. Question whether third parties could
sue personally the "promoter" who got the money.
- Pre-Incorporation
o (1) Parties aware no incorporation
 Rule: when a promoter contracts for the benefit of a corporation that is contemplated
but not yet organized the promoters personally liable on the contract in the absence of
an agreement otherwise
 The promoter is not discharged from liability simply because the corporation is
literally organized and receives the benefits of the contract even where the corp adopts
the contract.
 To discharge the promoter from liability, there must be a novation (3 party
arrangement - new party replaces existing party into K).
 Question of parties' intentions
o Form of signature - did the promoter sign as an agent of the Corp?
o Actions of the third party - did the third party plan to look only to the
corporation for performance?
o Partial performance – did the promoters partial performance of the
contract indicate an intent to be held personally liable?
o Novation - did the later actions taken by the parties discharge the
promoter’s liability?
o (2) Parties mistakenly believe corporation exists
 Judicial Doctrines
 De facto corporation Courts infer limited liability if:
o (1) Promoter made good faith to attempt incorporation
o (2) Promoter unaware that incorporation had not happened
o (3) Promoter uses corporate form in transaction
 Corporation by estoppel - K party estopped from asserting promoter's personal
liability when the K party assumed only recourse would be against business
assets.
 Statutory Approach (MBCA § 2.04) – Liability for Pre-incorporation Transactions
 Persons purporting to act on behalf of corporation and knowing there is no
incorporation are jointly and severally liable for all liabilities created when
acting.
o Incorporation so simple and expensive, but several exceptions to above
rule:
 (1) If participant honestly and reasonably believed articles had been
filed
 (2) D mails articles, enters into transaction, but the mail is delayed
or secretary does not file the articles
 If someone knows that a person has not entered into corporation
but urges the person to take on the contract, then they may be
estopped from imposing personal liability on defendants.
- After Dissolution
o (3) Corporation formed, but Secretary of State dissolves
  Corporation dissolved for failure to pay franchise tax to report a change in registered
agent or to file annual reports.
 States usually allow the corporation to pay back taxes or make the required filings,
and then apply for reinstatement;
 Effect is retroactive recognition of the corporation, along with all corporate
attributes including limited liability

- QUORUM
o Shareholder – as long as there is a majority at the beginning, shareholders can leave
without the quorum being broken
o Directors – quorum broken and all subsequent action by other directors void if one director
walks out.