Business Associations Outline

By Michael Cooper,2014-06-28 20:52
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Business Associations Outline ...

    Business Associations Outline

    Economic and Legal Aspects of the Firm

    I. Introduction to Business Associations

    a. Factors Involved in Choice of Organizational Form

    i. Making the investment decision

    1. If you‘ve got money in your pocket, there‘s a lot you can do

    with it

    2. It is assumed you‘d want to make the most from it

    3. Rate of return

    a. Low risk/low return and vice versa

    4. You should split up your investment diversify

    ii. Two main kinds of capital

    1. Money capital

    2. Human capital

    a. Brains, muscle, time, willingness to work

    iii. Transaction cost factors

    1. Bounded rationality

    2. Opportunism

    3. Team-specific investment

    II. Agency Law

    a. Principle of agency

    i. There are lots of relationships that fall into this category

    1. At least two people (principal and agent)

    2. Employment relationship

    ii. Deals with two kinds of relationships

    1. Relationship among people inside the business association

    2. Relationship between business association and third parties

    b. Agent‘s Fiduciary Duty

    i. Fiduciary limits on agent‘s right of action

    1. The agent is to prefer the principal‘s interests to his own

    2. The duty substitutes for an express contractual specification of

    exactly what an agent may or may not do

    ii. Fiduciary duty

    1. Imposes a general obligation to act fairly

    2. Obliges the fiduciary to act in the best interests of his client or

    beneficiary and to refrain from self-interested behavior not

    specifically allowed by the employment contract

    3. Socially optimal fiduciary rules approximate the bargain that

    investors and agents would strike if they were able to dicker at

    no cost

    iii. Duty of loyalty

    1. It‘s a one way duty


    a. The agent owes it to the principal but the principal

    doesn‘t owe it to the agent

    2. The law describes the relationship in broad terms

    a. You have a duty to be loyal to the principal

    [Community Counseling Serivce, Inc. v. Reilly: After Reilly decided to quit but before he actually stopped working for CCS, he went out and solicited current and potential CCS clients for his future similar business.

    There was no explicit contract saying he couldn‘t do this. Court held that he breached his duty of loyalty to CCS.]

    iv. Employment at Will

    1. Default rule - employer can fire at any time for any reason

    2. In the employment context, factors apart from consideration

    and express terms may be used to ascertain the existence and

    content of an employment agreement, including:

    a. The personnel policies or practices of the employer,

    b. The employee‘s longevity of service,

    c. Actions or communications by the employer reflecting

    assurances of continued employment,

    d. The practices of the industry in which the employee is


[Foley v. Interactive Data Corp.: IDC had written termination guidelines that set forth express grounds for

    discharge and a mandatory seven-step pretermination procedure. It was Foley‘s understanding that the

    guidelines applied to him as well as those he supervised. After Foley blew the whistle on his supervisor, he

    was moved from position to position before being given the option of resigning or getting fired. Foley

    brought suit for wrongful termination, alleging the guidelines altered the at-will employment relationship.

    Appellate court allowed breach of employment contract claim to proceed to trial.]

    c. Vicarious Liability: Firm‘s Relation to Outsiders via Agents

    i. The agent‘s actions will bind the principal only if the principal has

    manifested his assent to such actions

    1. Actual authority

    a. The principal manifests his consent directly to the agent

    b. The manifestation of consent may be implied by the

    conduct of the principal

    c. If actual authority exists, the principal is bound by the

    agent‘s authorized actions, even if the party with whom

    the agent deals is unaware that the agent has actual

    authority and even if it would be unusual for an agent to

    have such authority

    2. Apparent authority (also known as ostensible authority)

    a. When the principal intentionally or negligently causes

    or allows a third party to reasonably believe the agent

    possesses the authority

    b. A third party will be able to bind the principal on the

    basis of apparent authority only if the third party

    reasonably believed that the agent was authorized


    i. If the third party knows the agent has no actual

    authority no apparent authority

    ii. If the principal‘s manifestations constitute an

    insufficient foundation for forming a reasonable

    belief that the agent is authorized no apparent


    3. Inherent authority

    a. Springs from the desire to protect the reasonable

    expectations of outsiders who deal with an agent

    b. A gap-filling device used by courts to achieve fair and

    efficient allocation of the losses from an agent‘s

    unauthorized actions

    ii. Disputes between principals and third parties over the authority of

    agents two categories:

    1. Cases in which an agent exceeds her authority in an attempt to

    further the interests of the principal

    2. Cases involving totally opportunistic action, where the agent

    intentionally misleads both principal and the third party

    [Blackburn v. Witter: Long, an agent of Dean Witter, advised widow Blackburn to invest in a nonexistent

    company. B brought suit against W under a vicarious liability theory. The court entered judgment in favor

    of B on the theory of ostensible (apparent) authority.]

    General Partnership and Other Noncorporate Business Associations

    III. Overview

    a. From Sole Proprietorship to Joint Ownership

    i. Sole Proprietorship

    1. One person owns everything and runs everything

    2. External relations owner pays taxes and is liable for debt

    a. Entitled to all the profits

    3. Owner has residual claimant status

    4. This is the default if one person is the owner

    ii. General Partnership

    1. Default rules (can be changed by contract)

    a. Profits/losses/control split equally

    b. Withdrawal at will

    i. If one partner withdraws, the partnership is over

    ii. Great deal of flexibility for partners to exit

    c. Fiduciary duty owed between and among partners

    2. External relationships

    a. Agency relationship vicarious liability between


    b. Unlimited personal liability

    i. Creditors can go after personal assets of partners

    3. The default rule is that if you are co-owners of a business, you

    are partners

    a. Joint ownership is equally sharing profits/losses/control


    iii. Limited Partnership

    1. To be in an LP, you have to formally declare it and register

    with the state

    2. Internal Relationships

    a. The relationship between members is different

    b. Two kinds of partners

    i. Limited partners

    1. One step removed from partners (less

    identified with the business)

    2. Can withdraw without dissolving the


    3. Have rights to profits and losses but no

    right to control

    4. Fiduciary duties don‘t really apply to

    limited partners because they are

    forbidden from controlling the


    5. Passive partner

    ii. General partners

    1. If the general partner withdraws, the

    partnership is over

    2. Like a partner in a general partnership

    and has rights to profits/losses/control

    3. Owes fiduciary duties to the limited


    a. Has responsibility to run business

    for the benefit of the partnership

    3. External relationships

    a. Limited partners have limited personal liability

    i. Liability for the amount of money they put in

    ii. If limited partner takes part in control, they give

    up their limited liability

    iii. If you want to act like a general partner, you

    have to accept the terms

    b. General partner has unlimited personal liability

    iv. Joint Venture

    1. A partnership for a limited purpose

    2. The same things apply but the scope of the partnership is


    3. Think car companies getting together and working on fuel cell

    technology off of I-80

    a. If Ford wants to work on a solar car, Toyota is not

    liable for that only the fuel cell stuff

    b. Choice of Standard Forms

    i. For organization, states have provided standard forms of governance



    1. Corporation

    2. General partnership

    3. Limited partnership

    4. Limited liability companies

    5. Limited liability partnerships

    ii. Analogize these as form contracts

    1. These forms of organization have default aspects and

    mandatory or immutable aspects

    a. Default aspects

    i. Have to abide by them unless you change them

    b. Mandatory (immutable) aspects

    i. Have to abide by them regardless can‘t change


    ii. Usually for public policy reasons

    c. Different business entities are taxed differently and that can affect what type

    of business is chosen

IV. Fiduciary Duty of Partners

    a. Traditional Framework

    i. Fiduciaries must carry the burden of proving by clear and convincing

    evidence that they have fulfilled their fiduciary obligations

    ii. In a limited partnership, the general partner will have a heavier duty of

    loyalty because she will control the information and the business

[Meinhard v. Salmon: M and S had a de facto limited partnership in a building lease with S as the

    managing partner. As the lease neared its end, S secretly negotiated with the owner for a new lease

    excluding M. When M discovered the plan, he insisted on being part of it but was refused, so he brought

    suit. Court held that S breached his duty of loyalty and awarded M ? interest in the venture.]

    b. Standard Duties and Partnership Agreement

    i. The partnership agreement will determine the extent of disclosure

    required between partners and whether a failure of disclosure

    constitutes fraud or breach of the agreement

    1. Partners may alter the standard form fiduciary duties to suit

    their particular relationship

    ii. Some jurisdictions say you can‘t opt out of fiduciary duty but trend is

    towards allowing opt out

[Exxon Corp. v. Burglin: Limited partnership in AK oil drilling with E as general partner and B and others

    as limited partners. Partnership agreement required E to disclose only nonconfidentail information. One of

    the well results looked promising and E offered to buy limited partners out. Offer gave option of

    independent consultant to make assessment of offer. The limited partners accepted without getting the

    evaluation. The results turned out to be extremely productive and the limited partners brought suit alleging

    E breached its fiduciary duty by failing to disclose all information. Court held for E because of partnership


    iii. Fiduciary duty has two aspects


    1. Duty of loyalty

    2. Duty of care

    c. Duty of Care

    i. There is a duty of care but it only extends to gross negligence or

    intentional conduct

    ii. Negligence in the management of the affairs of a general partnership

    or joint venture does not create any right of action against that partner

    by other members of the partnership

    iii. Limited partners are owed more of a duty of care from general partners

[Ferguson v. Williams: F&W purchased two buildings with the intention of making a profit. When they thwere running low on cash, they got Williams to invest of ? interest. He helped them getting an initial loan

    and offered his employees to get the project ready. When final funding fell through and the venture was

    abandoned, Williams sued F&W to recover his losses on allegations of negligence. Court held that it

    wasn’t a limited partnership and negligence didn’t create right of action.]

V. Power of a Partner to Manage and Bind the Partnership

    a. External authority to bind the partnership

    i. Partners are jointly and severally liable for the tortious acts of other

    partners if they have authorized those acts or if the wrongful acts are

    committed in the ordinary course of the business of the partnership

    ii. The partnership is liable for the acts of the partners that are done in the

    scope of the partners‘ authority

    iii. The ability of a partner to bind the partnership is great

    iv. Apparent Authority

    1. A partner acting in the apparent scope of the partnership is

    within the authority (RUPA ? 301)

    a. Then the partnership is liable unless there is no actual

    authority and the other party knew there was no


    2. If a third person reasonably believes that the services he has

    requested of a member of the partnership is undertaken as a

    part of the partnership business, the partnership should be

    bound for a breach of trust

[Roach v. Mead: M and B formed law partnership. M handled R‘s business deals and B did R‘s tax returns.

    When R sold his business and had $20K to invest, he sought M‘s counsel. M offered to take the money at

    15% and R agreed. R considered M‘s advice to be legal advice. When M defaulted and declared bankruptcy,

    R sued partnership, so liability would fall on B. Court found for R under apparent authority doctrine.]

    b. Internal power to manage and control

    i. One partner, one vote

    1. Problem when there is an even number of partners

    2. Favors status quo

    ii. Partner doesn‘t always have to vote for something that would benefit

    the partnership


[Covalt v. High: C and H were corporate officers and shareholders in CSI. They orally agreed to form a

    partnership and bought real estate upon which they constructed an office and warehouse. CSI leased the

    building from the partnership for a 5-year term. Upon the expiration of the term, CSI remained a tenant and

    orally agreed to certain rental increases. C resigned from CSI but remained a partner with H. C demanded

    that the monthly rent for CSI be increased $1K. H did not agree and took no action to renegotiate the

    amount of the monthly rent payable. C brought suit. Appellate court held for H because conflict of interest known at formation of partnership.]

    c. Limited Partner‘s Role

    i. Limited partners are passive investors more akin to lenders than to

    general partners

    1. As long as they act like lenders and not like general partners,

    limited partners are not personally liable for the firm‘s debts

    ii. A limited partner shall not become liable as a general partner, unless,

    in addition to the exercise of his rights and powers as a limited partner,

    he takes part in the control of the business

    iii. RULPA ? 303

    1. Was there control?

    2. Did the creditor reasonably rely on the belief that the limited

    partner was actually a general partner?

    a. States that haven‘t adopted RULPA don‘t have this

    second step

[Holzman v. De Escamilla: R, A, and D formed a limited partnership for a farm business with D as general

    partner and R and A as limited partners. The three conferred as to what crops to plant. R and A overruled D

    as to certain crop choices. D had no power to withdraw money without the signature of either A or R.

    When the partnership went bankrupt, the trustee went after R and A as general partners. The court held that

    R and A were general partners because they took part in the control of the business.]

VI. Dissolution

    a. Leaving and ending a partnership

    i. A partnership agreement may specify terms of dissociation or


    1. Ex. partnership will last 5 years or partnership will last until

    such and such is completed

    2. Absent such provisions, the partnership is at will

    a. Free to dissociate

    b. Don‘t need a reason

    c. Have right to force judicial sale

    ii. Dissociation

    1. Leaving the partnership

    2. Default rule partnerships are at-will and one can disassociate

    whenever he feels

    3. Lawful dissolution gives each partner the right to have the

    business liquidated and his share of the surplus paid in cash

    4. Default rule dissociation leads to dissolution

    a. Can contract around this


    b. Can waive right to force dissolution and termination

    5. Dissociation by death does not cause a dissolution of the

    partnership and does not trigger wind up or sale of partnership


    6. If a partner is dissociated from the partnership without

    resulting in a dissolution and wind up of the partnership

    business, then the partnership must purchase the dissociated

    partner‘s interest at a statutorily defined buyout price

    iii. Dissolution

    1. When one partner dissociates, it triggers a dissolution

    2. This is a phase not an event

    3. Partnership exists during dissolution but only for wind-up


    a. Because it exists for winding-up, you‘re still partners

    and own fiduciary duties

[Hurwitz v. Padden: H and P formed a two-person law firm, but failed to enter into a written partnership

    agreement. They shared all firm proceeds on a 50-50 basis and reported all income as partnership income.

    After 5 years, P notified H that he wanted to dissolve their professional relationship. They successfully

    resolved all business issues involving their relationship, except for the division of attorney fess from

    several of the firm‘s contingency fee cases. Court held that pre-dissolution contingency fee files remain

    assets of a law firm following its dissolution in the absence of a contrary agreement.]

    4. First you have to marshal the assets and most likely to be

    liquidated and divided

    a. Throughout the process, you keep track of what each

    partner has contributed and/or owes the partnership

    (partnership account)

    i. Don‘t forget human capital

[Kovacik v. Reed: K was a licensed building contractor and R was a job superintendent and estimator. K

    told R that he had a job in San Francisco. He would put up $10K if R would do the work. Profit would be

    split 50/50. There was no discussion about loss. R agreed and contributed only his labor. K maintained all

    the financial records. After some time, K told R that the venture wasn‘t profitable and demanded that R take on a half share of the losses. R refused to pay and K brought suit. Appellate court held for R, stating that by their agreement to share equally in profits, agreed that the value of their contributions the money

    on the one hand and the labor on the other were likewise equal.]

    b. Creditors get paid first

    c. What is left over after creditors and settling partnership

    accounts, is profit and is split between partners

    i. If nothing is left over or if there are still losses

    that is split between partners

    d. Default rule is to split profits and losses equally

    e. Cash v. in-kind distribution

    i. Default = everyone has right to equal share in


    1. Partners have to agree to in-kind



    ii. In-kind distribution absent an agreement by all

    partners is limited to situations where:

    1. There are no creditors

    2. Ordering a sale would be senseless since

    no one other than the partners would be

    interested in the assets of the business

    3. It is fair to all partners

[Dreifuerst v. Dreifuerst: Three brothers formed partnership to operate two feed mills. The plaintiffs

    served the defendant with a notice of dissolution and wind-up of the partnership. The parties were unable to

    agree to a winding-up of the partnership. The defendant requested that the partnership be sold such that the

    plaintiffs could bid on the entire property and continue to run the business under a new partnership and the

    defendant‘s partnership equity could be satisfied in cash. The trial court denied the request and instead

    divided the partnership assets in-kind according to the valuation presented by the plaintiffs. The appellate

    court reversed, holding court could not order in-kind distribution without agreement among all partners.]

    iv. Termination

    1. End of partnership

    2. End of dissolution process and wind-up is done

    b. Wrongful Dissolution and Continuity

    i. If a partner dissociates from the partnership before completion of the

    agreed term or undertaking, such dissociation will be wrongful

    1. Under RUPA, the partnership is not dissolved

    2. Non-dissociating partners have the option of continuing the

    partnership‘s business without the consent of the wrongfully

    dissociating partner

    a. Still have to pay off the guy leaving

    3. The wrongfully dissociating partner must compensate other

    partners for damages resulting from the wrongful dissociation

    ii. RUPA defines ‗wrongful‘ as including dissociation that is in breach of

    an express provision of the partnership agreement

    iii. All partnerships are ordinarily entered into with the hope that they will

    be profitable, but that alone does not make them all partnerships for a

    term and obligate the partners to continue in the partnership until all of

    the losses over a period of many years have been recovered

[Page v. Page: The parties were partners in a linen supply business. Within the first two years, each

    contributed about $43K for business expenses. For the first 8 years, the business was not profitable, losing

    about $62K. The partnership‘s major creditor is a corporation, wholly owned by ? that supplies the linen

    and machinery necessary for the day-to-day operation of the business. This corporation holds a $47K

    demand note of the partnership. The partnership turned its first profit in 1958. Despite this improvement, ?

    wanted to terminate the partnership. Court held it to be a partnership-at-will.]

    iv. RUPA ? 602 was drafted after Page and has different take

    1. Makes it harder to find wrongfulness in a dissociation or


    2. Dissociation is wrongful only if:

    a. Breach of express provision of partnership agreement

    b. In a partnership for a term or undertaking…


    i. Leaving early

    ii. Get expelled by judicial determination (? 601[5])

    1. Partner does bad things

    a. Other partners go to judge to get

    the bad guy kicked out

    iii. Bankruptcy

    iv. If corporate partner dissolves

    3. Rejects idea that there is a general duty to do good

[Monteleone v. Monteleone: N, L, and J formed an oral partnership to own and operate an automobile

    body repair business named Monte Auto Body Shop. There was a dispute as to whom among them caused

    the dissolution. J brought suit requesting dissolution and judicial sale and alleging that N and L failed to

    conclude partnership business but rather were operating the shop under a new partnership. N and L

    counterclaimed alleging that it was J‘s wrongful conduct that had caused the dissolution of the partnership.

    They requested that they be permitted to purchase J‘s interest and to continue the partnership business.

    Appellate court remanded for trial on issue of J’s wrongful termination.]

    c. Contractual Approaches to Dissolution Issues

    i. Expulsion

    1. No clean rule on how to get rid of lousy partner

    2. You can contract regarding expulsion

    3. Partnership may expel a partner for purely business reasons.

    4. A partnership can expel a partner to protect relationships both

    within the firm and with clients.

    5. A partnership can expel a partner without breaching any duty

    in order to resolve a ‗fundamental schism.‘

    6. The fiduciary duty that partners owe one another does not

    encompass a duty to remain partners or else answer in tort


[Bohatch v. Butler & Binion: After Bohatch brought forth allegations that the managing partner was

    overbilling a major client, the firm voted to expel her. Court held that the fiduciary relationship did not create a whistleblower exception with regard to expulsion from the at-will nature of partnerships.]

    ii. Contracting to prevent opportunistic withdrawal

    1. Meehan v. Shaughnessy see class notes pg. 20

Corporate Form and the Separate Roles of Shareholders and Managers

    VII. Introduction to Corporate Form

    a. General corporation characteristics

    i. Separates ownership and management functions

    1. Directors

    a. Agent of shareholders

    b. Owe fiduciary duty to shareholders

    c. Make major policy decisions

    d. Acts as a unit via majority rule

    2. Officers


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